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Insurance Law
Wayne State University Law School
Pijls, Johannes Hans

Insurance_Law,_Pijls,_Fall_2010.docx
INSURANCE LAW OUTLINE

INTRODUCTION

THE HISTORY AND FUNCTIONS OF INSURANCE
· Insurance is one method of addressing/managing risks people are exposed to, such as:
Natural disasters, industrial accidents, property damage, medical mistakes, illness, etc.

Insurance: A risk distribution arrangement for the compensation of damages or loss that is entered into by one party as its business, rather than as an incident of another business

Principal sellers of insurance: Stock and mutual companies; reciprocals and fraternal benefit societies (less common)

Owners of stock companies are shareholders; owners of mutual companies are policyholders or “insureds” – the individuals or institutions that have purchased insurance from the company.

Some companies sell exclusively through their own agents, others through independent agents who represent more than one company.

Distinct categories of insurance:
Insurance against loss of property and against legal liability vs. insurance against loss of life, ill health, and disability

How Insurance Works – Functions to protect the policyholder in the event of future loss.
Three separate functions:
(1) Risk transfer from comparatively risk-averse to less risk-averse or risk-neutral parties
· A risk-neutral party is indifferent as between a small risk of suffering a large loss and greater risk of suffering a small loss, when ea. risk has the same expected value – the probability of a loss multiplied by its magnitude if it occurs.
· A risk-averse party would prefer the large risk of suffering a small loss to a smaller risk of suffering the large loss
(2) Risk-pooling/diversification – By insuring a large number of insured posing homogenous and independent risks, an insurer can reduce the amt of variance in its expected losses to a very small range.
· An insurance co. is a vehicle by which risk-averse parties combine to share and thereby reduce their collective risk.
· Profits constitute payment for providing this service to policyholders and for bearing the residual risk that losses will vary beyond the range predicted
(3) Risk-allocation – Insurers accept the transfer of risk and then pool them. In charging for coverage, insurers attempt to set a price that is proportional to the degree of risk posed by ea. insured.
· Allocate risk to groups of insureds posing similar or identical degrees of risk.

Social Functions of Insurance
· Unlawful to drive car w/out liability insurance; drs denied medical malpractice insurance may be denied certain privileges; takes money from the lucky and gives it to the unlucky

THE PROBLEM OF IMPERFECT INFORMATION
Most of the costs incurred by the seller of insurance in providing the insurance product are not known at the time an ins. policy is sold.
· Disparity in the info available to the insurers and the insureds about factors that influence the degree or risk posed by a prospective insured;
· Informational deficiencies result in two potentially disruptive effects: adverse selection and moral hazard

Adverse Selection – A party facing a high risk of loss is more likely to seek insurance than a party facing a lower risk; If potential policyholders know better than insurers whether they pose comparatively high or low risk, then adverse selection may occur:
· When insurers charge ea. party the same price for coverage, then high-risk parties elect to be insured in greater proportion than low-risk parties, and insurers are forced to raise the price of coverage
· Some of the comparatively low risk parties that had previously been insured decline to purchase coverage or purchase less of it, the average degree of risk posed by the insurer’s policyholders rises, and the insurer is forced to raise prices again, thus restarting the cycle of adverse selection

Moral Hazard – Originally described the risk that an insured or insurance beneficiary would deliberately destroy the subject matter that was insured in order to obtain payment of an ins. benefit.
· Now refers more generally to the tendency of any insured party to exercise less care to avoid an insured loss than would be exercised if the loss were not insured

Combating these threats:
· Underwriting – the process of screening and evaluating applications to determine the degree or risk posed by prospective insureds; classify insureds based on the degree or risk posed and set premium levels accordingly
· Include deductible, coinsurance, and dollar limits of coverage in policies so that all losses are not fully insured
· Do not let people buy insurance on the lives of strangers or on property in which the prospective policyholder has no interest
· Fashion terms of coverage so that unusual risks are not insured by standard policies and so that results of inordinately dangerous behavior are not insured

BREACH OF WARRANTY

Vlastos v. Sumitomo Marine & Fire Ins. Co. (p. 8)
Facts: Woman owned commercial building; business on 1st floor, 2nd/3rd floors – massage parlor; 3rd floor partly occupied by janitor who lived here; 4th floor – empty with office space/storage (but others sleeping there and died during fire). Type of claim: Fire damage/First party property insurance claim.
Homeowners ins. policy – 2 types of coverage – property and liability.
Policy language: endorsement stated “warranted that the 3rd floor is occupied as Janitor’s residence.” Endorsement typically added to particular policies, not all. This particular language does not appear to be standard language – seems highly unique to this situation.
Issues: Whether the provision in endorsement no. 4 of the insurance contract was a warranty or a representation. If it were a representation than the insurers would be under an obligation to show that the provision was material to the risk insured against in order for the insurers to avoid their obligations under the contract.
Insurance law is generally contract law – contract language matters.
Distinguish b/w warranty and representation:
Nature of a warranty – statement that something is true and if it turns out that warranty is violated, insurance co. has right to deny coverage, regardless of whether the “breach” was material or relevant to coverage/risk, etc.
· A warranty in a policy of insurance is a condition or a contingency, and unless that be performed, there is no contract.
Representation, unlike a warranty, is not part of the insurance contract, but is collateral to it. If a representation is not material to the risk, its falsity does not avoid the contract. OTOH, the materiality of a warranty to the risk insured against is irrelevant; if the fact is not as warranted, the insurer may deny recovery. If warranty – both material and non-material breaches would void policy.
RULE: ***In a case of doubt, courts normally construe a statement in an insurance contract as a representation rather than a warranty.
Whether a written contract is ambiguous is one for the court to decide as a matter of law. The language of the policy may not be tortured to create ambiguities where none exist. If any ambiguity exists, however, it is well-settled that the ambiguity “must be construed against the insurer, and in a manner which is more favorable to coverage.”
Court concluded that it was in the nature of a warranty. So materiality did not come into play. Sole issue was whether or not the warranty was violated – if stmt is a warranty the only question is “was the stmt wrong?” if in the nature of misrepresentation – 2nd question comes into play… “was the stmt wrong?” and “was the stmt material?” — Materiality = so what?
Parties stipulated that it was an affirmative warranty.
Result: Because provision is ambiguous it must be construed in a manner favorable to insurance coverage.
Hold: The insured warranted only that the janitor resided on the third floor, not that there was no other occupancy of the floor. Only question to be determined is if the janitor lived on the third floor at the time the contract was made.

THE TRANSFORMATION OF WARRANTY LAW: MODERN LAW OF MISREPRESENTATION & CONCEALMENT

To mitigate harshness of warranty law courts took 4 approaches:
(1) Interpret what may be a warranty as a “mere” misrepresentation, thus requiring materiality.
(2) A warranty should be strictly construed against the insurer, and then find that it has been complied with.
(3) Interpret warranties that seem to relate to future facts (“promissory warranties”) as relating only to present facts (“affirmative warranties”). – Warranty need only be complied with at the time it is made.
(4) Interpret warranty as satisfied if there has been “substantial compliance” with its terms.

Distinguishing warranties and misrepresentations from coverage provisions
Coverage provisions are conditions and exclusions that specify the terms of coverage.

Standard rules governing voiding a contract b/c of misrepresentation by one of the parties — in insurance and other fields — require that the representation be false, material, and induce justifiable reliance by the party who suffers damages as a result of the misrepresentation.

Concealment distinguished from affirmative misrepresentation
The insurer must prove a failure to dis

INSURANCE CONTRACT FORMATION & MEANING

THE ROLE OF STANDARDIZED FORMS

THE POLICY STANDARDIZATION PROCESS
Virtually all insurance policies are standard-form contracts – causes much debate/litigation
Insurance policies are contracts of adhesion – the same standard-form policies are often used by many insurance companies
Standardization in insurance not only involves a take-it-or-leave-it offer of the same policy by one company to all its customers, but (in the extreme case) a take-it-or-leave-it offer of the same policy, to all customers, by all companies

CONSTRUING AMBIGUITIES AGAINST THE INSURER

All contract interpretation:
Interpretation is typically matter for the court. Purpose of interpretation is to determine the intent of the parties.
Extrinsic evidence is not admissible to prove the meaning of an unambiguous contract provision.
An insurance policy is to be read as a whole, with reference to the relation among its provision; wherever possible, the same terms in different parts of the policy are to be interpreted consistently.
All provisions of the policy are to be given effect.

Distinct to Insurance Contracts:
The insuring agreement, or affirmative grant of coverage in a policy, is broadly construed, whereas exclusions from or limitations on coverage are narrowly construed.
Policy provisions ordinarily are not given a hyper-technical meaning, but are instead interpreted as they would be understood by the typical policyholder of that kind of policy.
Contra proferentem – “against the drafter” “against the offeror” – Rule that an ambiguous provision in an ins. policy – one that is subject to two reasonable interpretations – is interpreted against the drafter. – Interpreted in favor of coverage

Vargas v. Ins. Company of North America (1981) (p. 38)
Policy (1977) provided in part that it would apply “only to occurrences, accidents or losses which happen within the USA, its territories or possessions, Canada or Mexico… an endorsement added extended territorial limits to Bahamas. Continental USA boundaries only extend 3 miles off of the coast in any direction.
Facts: Khurey, wife and kid killed when plane crashed into sea ~ 25 miles west of Puerto Rico. Family had been traveling from NY to PR and stopped in Miami and Haiti to rest and refuel. Crash occurred on last leg of trip, while en route from Haiti to PR. PR is a “territory” of the U.S. ISA denied coverage on ground that loss did not occur “within” the U.S., its territories or possessions. Claims policy losses cover only in the enumerated areas or in territorial waters w/in 3 miles adjacent to coasts of such areas.
Appellants/Ps read language more broadly, to include coverage for losses that occur b/w two points that are expressly covered.
NY Law Governs: An ambiguous provision in an ins. policy is to be construed “most favorably to the insured and most strictly against the insurer.” The insurer bears a heavy burden of proof for it must ‘establish that the words and expressions used not only are susceptible of the construction sought by the insurer but that it is the only construction which may be fairly placed on them. The insurer is obliged to show (1) that it would be unreasonable for the average man reading the policy to construe it as the insured does and (2) that its own construction was the only one that fairly could be placed on the policy.
Any reason that ins. co. cannot limit risk by specifying in insurance coverage what can and cannot be covered? If you want to convince someone that you’re right, it helps to explain why the policy says what it says. What arguments did insured bring forth in this case to suggest interpretation was unreasonable?