Insurance Law Outline – Avaraham – Summer 2011
Class 1 & 2
Preface to the Course: Theoretical perspectives.
· Kenneth Abraham, Distributing Risk (Chapter 2) (BB Introduction)
· The History and Function of Insurance (KA 1-5)
Intro Class One
– A mechanism for protecting a party from future loss by shifting risk of loss to another party, usually, an insurance company
– Classification by
o The risk covered by the insurance
o According to the loss that is actually insured
§ 1st party ins. – loss suffered by the insured
§ 3rd party ins – loss suffered by another party
o by the organization
§ Stock company – owners are shareholders who don’t have to be policyholders
· Most life ins companies are stock companies
§ Mutual company – owners are policy holders
· Dividends may be refunded to policyholders
– History
o Religious or social groups took care of the underprivileged
o Modern insurance developed in middle ages
§ Beginning of modern economic practices,
§ And maritime trade/travel was very risky
o Underwriter – those who signed under the contract for maritime travel
– US History
o Fire Insurance
§ First company – Charleston SC – ins for homes against fire
§ Philadelphia Contributorship – ins for homes against fire
o Civil War/RR expansion – accident insurance expanded
o Health/disability Ins – 20th century development
2
Economic Efficiency
– Allocation of resources to methods that maximize their value
– Two Keys
o Moral Hazard
o Adverse Selection
– Expected Loss = Probability of loss x magnitude of loss
o Premium will be more than expected loss
– Optimal insurance contract maximizes coverage and loss prevention
– Entry of new insurers is restricted
o Only risk adverse will buy insurance
Things that hinder Economic Efficiency
– Externalities
o Cost or benefit of transaction that parties external to transaction bear
o Cause divergence in private and social value of a transaction, like when a company pollutes a towns water
o If the careful pay as much as the careless, then the careful bear more cost and have disincentive to perform in accord with standards
– Cognitive Biases
o Availability Ristic – ???
o Optimism Bias – where you think nothing bad will happen to you
o Probability distortion – people are more concerned with small probability losss than large probability losses
o Others
§ Framing effects – asian disease problem
§ Status Quo Bias – people prefer status quo even when another program is better
– Symmetry of information – where insurers and insureds have info that is unavailable to the other side
o Insurers know the statistics and their policies
o Insureds know their own risks and actions
– 2 main problems
o Moral Hazard
§ Ex ante – hazard prior to loss, insureds take less care prior to loss
§ Ex post – hazard after the loss has incurred, insureds take actions to increase magnitude of the loss after the loss is sustained
§ There is less incentive to invest in care to minimize loss after insurance is obtained
§ Ins companies try to combat this with deductibles and coinsurance
· By charging deductibles, insureds take optimum care and companies can charge less for coverage
o Adverse Selection
§ Those who have higher risk will seek more coverage than lesser risky parties
§ In a risk pool, higher risk parties will have an incentive to buy insurance where the premium is based on a pooled risk lessened by the lower risk parties. This raises the pooled risk, causing raised premiums, and causing lower risk parties to drop out and bear the risk of their own expected loss, thus causing the pooled risk to increase further
o How companies combat MH and AS?
§ MH
· Require insured to have insurable interest in the resource insured
· Excluding unusual risks
· Deny coverage to MH behavior
· Include deductibles, coinsurance, policy caps
· Experience rate the premium for coverage renewal
§ AS
· Screen applicants to determine individual risk, classify applicants according to the degree of risk posed, and charge them a premium based on the degree of risk
· Policy caps on new coverage – limits impact on risk pool
– Function of Insurance
o 3 functions
§ Risk Transfer (shifting)
· Ins transfers risk from risk averse parties to risk neutral parties
· Risk Averse
o Most insureds
· Risk Seeking
· Risk Neutral
o Ins companies
§ Risk Pooling (Spreading)
· Combining of large group of similar insureds
· ???
· Lowers the transaction cost of transferring risk
· Risks must be independent
o Law of large numbers does not work when risks are correlated
o So companies reject correlated risks (like war)
§ Risk Management
· Set premiums according to probability of loss
· RM incentivizes the means taken to prevent loss by lowering premiums
Class 3
Chapter 1- Introduction-
a) Breach of Warranty (KA 8- 15)
· Vlastos v. Sumitomo Marine & Fire Insurance Co.
3
Formation of ins contracts
– Warranties and Representations
o Vlastos v. Sumitomo
§ Endorsement warranted 3rd floor was janitors residence, but portion was used by 2nd floor business occupant
§ TC jury found Vlastos breached the endorsement
§ Issues –
· 1 – was endorsement a warranty or representation?
o This is important because classification is outcome determinative
§ Breach of warranty does not require materiality
§ Representation, if broken, must be material in order to prevent payment on the insurance policy
o CT held the endorsement was a warranty
o General Rule –
§ If it is unclear, Should be representation rather than warranty
· 2 – Was it promissory or affirmative warranty
o Affirmative – stmt concerning a f
rovisions
§ Warranties may be easier to prove breach, so if you know the risk is material or contributory cause, may as well go ahead as a warranty
– Misrepresentations vs. Concealments
o Marine Insurance Rule – withholding any information voids the policy
o Scienter requirement – insured must know that they are withholding the information
o Concealment – failure to disclose material fact
§ No scienter requirement
o Misrepresentation – an affirmative lie
§ Requires scienter
o People may choose to pay higher cost for having to answer less questions
o Neill v Nationwide Mutual
§ Innocent misrepresentation, agent relayed incorrect info
§ TC granted SJ because material and reliance
§ APPCT remanded because there was a question of fact as to whether the agent asked the question or recorded wrong answer
§ ***where the facts have been truthfully stated by an insured to the soliciting agent, but by fraud, negligence, or mistake, the facts are misstated in the application to the insurer, the insurer cannot rely on the misstatements in avoidance of liability, if the agent was acting within his real or apparent authority, and there is no fraud or collusion on the part of the insured.
§ ***However, a person is bound under the law to know the contents of the papers he signs and he cannot excuse himself by saying that he did not know what the papers contained.
o Incentives in an agency relationship
§ Insurers
· Costs of proving misrepresentations or concealments
· Return premiums in avoidance
§ Insureds
· Want to procure coverage at the lowest cost possible
§ Agents
· Want to sell as many policies as possible
· In Neill, agents distorted incentives
o Legislation attacked this by making agents liable for misstatements
§ If the agent were judgment proof, Leg can require malpractice insurance for their operation
§ Insurer could have 3rd party confirm accuracy of applications with no sales incentives
– Duty to read
o CTs excuse for failure to read for contracts of adhesion
§ Insured face two options
· 1 – accept terms
· 2 – not take the insurance
– Duty to report Changes
o Changes to facts during period of application and enactment of the policy
o Should material facts, discovered by insured after application but before issuance of the policy be a basis for denial of coverage?
