Insurance a collection of write ups

A collection of write-upsCompiled by Basem Shakhshir/ Freelance

1. What is insurance?

Insurance is a tool used to get around against the risk of a

conditional loss. Insurance is described as the equitable

transfer of risk of a loss from one entity to another in

exchange for a premium and can be thought of as a

guaranteed small loss to prevent a large possible

devastating loss. Insurance encompasses an insurer (an

entity that sells insurance), and an insured (an entity buying

the insurance that the other entity sells). The insurance rate

is a factor used to determine the amount called premium to

be charged for a certain amount of insurance coverage. In a

form insurance is a form of risk management which means

the practice to appraise and control risk.

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2. The 7 characteristics of insurance

a. A large number of homogeneous exposure units : it

allows insurers to benefit from the so-called "law of

large numbers" (as the number of exposure units

increases the actual results are increasingly likely to

become close to expected results.

b. Definite loss : the event that gives rise to the loss that is

subject to insurance should, at least in principle take

place at a known time, in a known place, and from a

known cause. Ideally, the time, place and cause of a

loss should be clear enough that a reasonable person,

with sufficient information, could objectively verify all

three elements.

c. Accidental loss : the event that is the trigger of a claim

should be fortuitous, or at least outside the control of

the beneficiary of the insurance. The loss should be

pure that is, it results from an event for which there is

only the opportunity for cost.

d. Large loss : the size of the loss must be meaningful

from the perspective of the insured. Insurance

premiums need to cover both the expected cost of

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losses, plus the cost of issuing and administering the

policy, adjusting losses, and supplying the capital

needed to reasonably assure that insurer will be able to

pay claims.

e. Affordable premium : if in the likelihood of an insured

event is so high, or the cost of the event so large, that

the resulting premium is large relative to the amount of

protection offered, it is no likely that anyone would buy

insurance. Again, the premium cannot be so large that

there is not a reasonable chance of a significant loss to

the insurer.

f. Calculable loss : there are two elements that must be at

least estimable, if not calculable: the probability of loss,

and the attendant loss. Probability of loss is generally

an empirical exercise, but cost has more to do with the

ability of a reasonable person in possession of a copy

of the insurance policy to make a reasonably definite

and objective evaluation of the amount of the loss

recoverable as a result of the claim.

g. Limited risk of catastrophically large losses : the

essential risk is often aggregation. Typically insurers

prefer to limit their exposure to a loss from single event

to small portion of their capital base. Where the loss

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can be aggregated, or an individual policy could

produce exceptionally large claims, the capital

constraint will restrict an insurer's appetite for

additional policyholders. In extreme case the

aggregation can affect the entire industry, since the

combined capital of insurers and re-insurers can be

small compared to the needs of potential policyholders

in areas exposed to aggregation risk.

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3. Indemnity

The technical definition of indemnity means to make whole again.

There are two types of insurance contracts: 1) an "indemnity"

policy and 2) a "pay on behalf" policy.

An indemnity policy will not pay claims until the insured has paid

out of pocket to some third party.

With a pay on behalf policy, in comparison, the insurance carrier

would pay the claim and the insured would not be out of pocket for

anything. Most liability insurance is written on the basis of a "pay

on behalf" language.

Generally, an insurance contract includes, at a minimum, the

following elements: the parties (insurer, insured, beneficiaries …),

the premium, the period of coverage, the particular loss event

covered, the amount of coverage, and exclusions. Insured is thus

said to be "indemnified" against the loss events covered in the

policy. When insured parties experience a loss for a specific peril,

the coverage entitles the policyholder to make a 'claim', against the

insurer for the covered amount of loss as specified by the policy

and indemnity will be in order.

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4. Insurer's business model

- Underwriting and investing

The business model can be best reduced to a simple equation:

Profit = earned premium + investment income – incurred loss –

underwriting expenses

Insurers make money in two ways:

(1) Through underwriting, the process by which insurers select

the risks to insure and decide how much in premiums to

charge for accepting those risks, and

(2) By investing the premiums they collect from insured parties.

The most complicated aspect of the insurance business is the

underwriting of policies. Using a wide assortment of data, insurers

predict the likelihood that a claim will be made against their

policies and price products accordingly. To this end insurers use

actuarial science to quantify the risks they are willing to assume

and the premium they will charge to assume them. Data is

analyzed to fairly accurately project the rate of future claims based

on a given risk. Actuarial science uses statistics and probability to

analyze the risks associated with the range of perils covered, and

these scientific principles are used to determine an insurer's

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overall exposure. From insurer's perspective some policies are

winners while some are losers.

- Claims

Claims and loss handling is the materialized utility of insurance; it

is the actual "product" paid for. Claims are filed by insured directly

with insurer or through brokers or agents. Insurance company

claim departments employ claim adjusters supported by staff of

records managements and data entry. Incoming claims are

classified based on severity and are assigned to adjusters whose

settlement authority varies with their knowledge and experience.

The adjuster undertakes a thorough investigation of each claim,

usually in close cooperation with the insured, determines its

reasonable monetary value, and authorizes payment.

In managing the claims handling function, insurers seek to balance

the elements of customer satisfaction, administrative handling

expenses, and claims overpayment leakages. Disputes between

insurer and insured over validity of claims or claims handling

practices occasionally escalate into litigation.

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5. History of insurance

In some sense we can say insurance appears simultaneously with

the appearance of human society. Our world is aware of two types

of economies in human societies: money economies (with money,

markets, financial instruments and so on) and non money or

natural economies (without money, markets, financial instruments

and so on). The second type is a more ancient form than the first.

In such an economy and community, we can see insurance in the

form of people helping each other. For example, if a house burns

down, the members of the community help build a new one.

Should the same thing happen to ones neighbor, the other

neighbors must help. Otherwise, neighbors will not receive help in

the future.

Insurance in the modern sense (in a modern money economy, in

which insurance is part of the financial sphere), early methods of

transferring or distributing risk were practiced by Chinese and

Babylonian traders as long ago as 3rd and 2nd millennia BC,

respectively. Chinese merchants traveling treacherous river rapids

would redistribute their wares across many vessels to limit the loss

due to any single vessel capsizing. The Babylonians developed a

system which was recorded in the famous Code of Hammurabi, c.

1750 BC, and practiced by early Mediterranean sailing merchants.

If a merchant received a loan to fund his shipment, he would pay

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the lender an additional sum in exchange for the lender's

guarantee to cancel the loan should the shipment be stolen.

Monarchs of ancient Iran (Achaemenian) were the first to insure

their people and made it official by registering the insuring process

(people would give presents and would have their names and

value of their presents registered) in governmental notary offices.

The purpose of registering was that whenever the person

registered by the court was in trouble, the monarch and the court

would help him. It is recorded that "…whenever the owner of the

present is in trouble or wants to construct a building, set up a feast,

have his children married, etc. the one in charge of this in the court

would check the registration. If the registered amount exceeded a

certain value, he or she would receive an amount of twice as

much."

A thousand years later, the inhabitants of Rhodes invented the

concept of the "general average". Merchants whose goods were

being shipped together would pay a proportionally divided

premium which would be used to reimburse any merchant whose

goods were jettisoned during storm or sinkage.

The Greeks and Romans introduced the origins of health and life

insurance c. 600 AD when they organized guilds which cared for

the families and paid funeral expenses of members upon death.

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Before insurance was established in the late 17th century, "friendly

societies" existed in England, in which people donated amounts of

money to a general sum that could be used for emergencies.

Separate insurance contracts were invented in Genoa in the 14th

century, as were insurance pools backed by pledges of landed

estates. Insurance became far more sophisticated in post-

Renaissance Europe, and specialized varieties developed.

Towards the end of the 17th century, London's growing importance

as a center for trade increased demand for marine insurance. In

late 1680s, Edward Lloyd opened a coffee house that became a

popular haunt of ship owners, merchants, and ship's captains, and

thereby a reliable source of the latest shipping news. It became the

meeting place for parties wishing to insure cargoes and ships, and

those willing to underwrite such ventures. Today, Lloyds of London

remains the leading market (note that it is not an insurance

company) for marine and other specialist types of insurance, but it

works rather differently than the more familiar kinds of insurance.

Insurance as we know it today can be traced to the Great Fire of

London, which in 1666 devoured 13,200 houses. In its aftermath

Nicholas Barbon opened an office to insure buildings. In 1680, he

established England's first fire insurance company, "The Fire

Office", to insure brick and frame houses.

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The first insurance company in the USA underwrote fire insurance

and was formed in Charles Town (Charleston), SC, in 1732.

Benjamin Franklin helped to popularize and make standard the

practice of insurance, particularly against fire in the form of

perpetual insurance. In 1752, he founded the "Philadelphia

Contribution-ship for the Insurance of Houses from Loss by Fire".

Franklyn's company was the first to make contributions toward fire

prevention. Not only did his company warn against fire hazards, it

refused to insure certain buildings where the risk of fire was too

great, such as wooden house.

The natural process for the insurance industry to become what it is

today was the introduction of regulations, rules and laws, which

brings us to the insurance as it is today.

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6. Types of insurance

Any risk that can be quantified can potentially be insured. Specific

types of risk that may give rise to claims are known as "perils". An

insurance policy will set out in details which perils are covered by

the policy and which are not. Below are lists of many different

types of insurance that exist. The outlined Insurance coverage is

as applied in countries that have progressed in insurance

applications.

1. Auto Insurance

Auto insurance protects insured against financial loss when

involved in an accident. It is a contract between the insured and

the insurer with insured agreeing to pay the premium and the

insurance company agrees to pay the losses as defined in the

insurance policy issued to insured. Auto insurance provides

property (damage to insured auto), liability and medical coverage:

(1) Property coverage pays for damage to or theft of insured auto.

(2) Liability coverage pays for insured's legal responsibility to

others for bodily injury or property damage. (3) Medical coverage

pays for the cost of treating injuries, rehabilitation and sometimes

lost wages and funeral expenses. Auto policy may encompass up

to six different kinds of coverage and insured is not obligated at

law to buy all of them.

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2. Home Insurance

It provides compensation for damage or destruction of a home

from disasters. In certain geographical areas the standard

insurance excludes certain types of disasters, such as flood and

earthquakes that require additional coverage. The policy may

include inventory, or this can be bought as a separate policy,

especially for those people who rent housing. In some countries,

insurers may offer a package which may include liability and legal

responsibility for injuries and property damage caused by

members of the household, including pets.

3. Health (Medical Expenses) Insurance

Almost all developed countries have governmental-supplied

insurance for health.

Health insurance policies in the UK or other publicly-funded health

programs will cover the cost of medical treatments. Dental

insurance, like medical insurance is coverage for individuals to

protect them against dental costs. In the U.S., dental insurance is

often part of an employer's benefit package, along with the health

insurance. Most countries rely on public funding to ensure that all

citizens have universal access to healthcare.

4. Disability Insurance(PA)

o Disability insurance policies provide financial

support in the event the policyholder is unable to

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work because of disabling illness or injury. It

provides monthly support to help pay beneficiary's

obligations.

o Total permanent disability insurance provides

benefits when a person is permanently disabled and

can no longer work in their profession, often taken

as an adjunct to life insurance.

o Disability overhead insurance allows business

owners to cover the overhead expenses of their

business while they are unable to work.

5. Life Insurance

Life insurance provides a monetary benefit to a decedent's family

or other designated beneficiary, and may specifically provide for

income to an insured person's family, burial, funeral and other final

expenses. Life insurance often allows the option of having the

proceeds paid to the beneficiary either in lump sums cash payment

or an annuity.

Annuities and pensions that pay benefit for life are sometimes

regarded as insurance against possibility that a retiree will outlive

his or her financial resources. They are the complement of life.

Certain life insurance contracts accumulate cash values, which

may be taken by the insured if the policy is surrendered or which

may be borrowed against.

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6. Property Insurance

Property insurance provides protection against risks to property,

such as fire, theft or weather damage. This includes specialized

forms of insurance such as fire insurance, flood insurance,

windstorm insurance, earthquake insurance, landlord and

neighbors' recourse insurance, home insurance, boiler and

machinery insurance, terrorism insurance and others, such as in

the UK and few other countries, aviation insurance, builder's risk

insurance (know as CAR), crop insurance, marine insurance and

inland marine insurance.

In the KSA, we identify each product separately and do not group

them as above. Hence, property insurance basically provides

protection against risks of fire howsoever caused. We normally

extend the fire insurance policy is to include named perils like: acts

of nature and others. When we have added all those perils there

remains the physical loss of property due to other causes that

once they are identified switch the insurance policy from fire and

perils to an all risks insurance property insurance. And all those

covers are given to any type of property including boilers,

machinery and equipment, stocks and inventories, contents of

insured property, spare parts in stock, office equipment and

furniture, fixtures and fittings and the like of articles and items that

constitute the property of the insured.

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Few coverage grouped under property are mentioned later on in

this paper.

7. Liability Insurance

Liability insurance responds to legal claims against the insured.

Many types of insurance include an aspect of liability coverage.

For example, homeowner's insurance policy that normally would

include liability coverage which protects insured in the event of a

claim brought by someone who slips or falls on the property. Auto

insurance also includes an aspect of liability insurance that

indemnifies against harm that a crashing car can cause to others'

lives, health, or property. The protection offered by the liability

policy is two folds: a legal defense in the event of a lawsuit

commenced against the policyholder and indemnification (payment

on behalf of the insured) with respect to a settlement or court

verdict. Liability policies typically cover only negligence of the

insured, and will not apply to results of willful or intentional acts of

the insured.

There are other liability policies such as: employer's liability,

environment liability insurance, professional liability insurance also

known as professional indemnity insurance, directors and officers

liability insurance, errors and omission insurance.

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8. Credit Insurance

Credit insurance repays some or all of a loan when certain things

happen to the borrower such as unemployment, disability, or

death. And offshoot to credit insurance is mortgage insurance that

insures lenders against default by the borrower.

9. Worker's (Workman's) Compensation Insurance

Workers' compensation insurance replaces all or part of a worker's

wages lost and accompanying medical expenses incurred because

of a job-related injury. In the KSA, work-related injuries are

covered by the Occupational Hazard Branch of the GOSI

(Government Organization for Social Insurance). Insurance

companies found gaps in GOSI work-related compensations and

those of the Saudi Labor Law and accordingly, they introduced a

difference in compensations coverage.

The bylaws of the Occupational Hazard Branch gives GOSI the

right to fall back on the employer to compensate any injured

employee of his when it is determined that the injury was due to

the employer's negligence.

10. Contractor's All Risks Insurance

Contractor's all risks insurance issued as CAR or EAR insurance

policies depending upon the type & Nature of contracted works.

Construction works require CAR insurance policy, while a project

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with erection work, such as steel or pre-cast works and the like,

require EAR insurance policy. The coverage in each of the two

insurance policies are for damage to property under construction

and/or erection, including contractor's equipment operating at work

sites, third party liability of the contractor (liability of contractor

resulting from execution of works), projects' material and

equipment that are moved from locations to work sites including

whilst stored at work sites. Coverage is for principal, contractor

and sub-contractors it also extends to include engineers,

designers, and consultants. All contracts require insurance cover

for maintenance operations; this comes in three coverage types

depending upon type of maintenance mentioned in contract

between contractor and principal. The three maintenance cover

types are: (1) simple maintenance, (2) extended maintenance, and

(3) guaranteed maintenance.

11. Travel Insurance

Is an insurance cover taken by those who travel abroad, which

covers certain losses such as medical expenses, loss of personal

belongings, travel delay, personal liabilities, etc.

12. Marine Insurance & Marine Cargo Insurance

Cover the loss or damage of ships at see or on inland waterways,

and of cargo that may be on them. When the owner of the cargo

and the carrier are separate corporations, marine cargo insurance

typically compensates the owner of cargo for losses sustained

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from fire, shipwreck, etc., but excludes losses the can be

recovered from the carrier or the carrier's insurance. Many marine

insurance underwriters will include "time element" coverage in

such policies, which extends the indemnity to cover loss of profit

and other business expenses attributable to the delay caused by a

covered loss.

Marine hulls insurance insures against hulls, spares, deductibles,

hull wear and liability risks.

13. Inland Transit Insurance

Is governed by an insurance contract covering on land road risks

or extended to all risks on land. The coverage allows consignee to

claim for loss or damage to cargo transported by on-land means of

transports caused by road accidents if coverage is for road risks

only, but can claim for other loss or damage to cargo if the road

risk coverage is extended to all risks.

14. Aviation Insurance

Insures against hull, spares, deductibles, hull wear and liability

risks.

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7. Insurance contract

An insurance contract determines the legal framework under which

the features of an insurance policy are enforced. Insurance

contracts are designed to meet very specific needs and thus have

many features not found in many other types of contracts. Many

features are similar across a wide variety of different types of

insurance policies.

1. Features of insurance contract

The insurance contract is a contract whereby the insurer will pay

the insured (the person whom benefits would be paid to, or on the

behalf of), if certain defined events occur. Subject to the "fortuity

principle", the event must be uncertain. The uncertainty can be

either as to when the event will happen (i.e. in a life insurance

policy, the time of the insured's death is uncertain) or as to if it will

happen at all (i.e. a fire insurance policy).

• Insurance contracts are generally considered contracts of

adhesion because the insurer draws up the contract and the

insured has little or no ability to make material changes to it.

This is interpreted to mean that the insurer bears the burden

if there is any ambiguity in any terms of the contract.

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• Insurance contracts are such that the amounts exchanged by

the insured and insurer (premiums/ claims) are unequal and

depend upon uncertain future events.

• Insurance contracts are unilateral, meaning that the insurer

is required to pay the benefits under the contract if the

insured has paid the premiums and met certain other basic

provisions.

• Insurance contracts are governed by the principle of "utmost

good faith" which requires both parties of the insurance

contact to deal in good faith and in particular it imparts on the

insured a duty to disclose all material facts which relate to

the risk to be covered. This contrasts with the legal doctrine

that covers most other types of contracts – "let the buyer

beware".

2. Constituents of insurance contract

• Opening paragraph – describes what the contract is about.

• Insuring Agreement - describes the covered perils, or risks

assumed, or nature of coverage, or makes some reference

to the contractual agreement between insurer and insured. It

summarizes the major promises of the insurance company,

as well as stating what is covered.

• Definitions - define important terms used in the policy

language.

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• Exclusions - take coverage away from the Insuring

Agreement by describing property, perils, hazards or losses

arising from specific causes which are not covered by the

policy.

• Conditions - provisions, rules of conduct, duties and

obligations required for coverage. If policy conditions are not

met, the insurer can deny the claim.

• Warranties – highlight the obligations of insured to observe

throughout the policy period. If insured is in breach of

warranty insurer can decline admitting the claim.

• Policy schedules - identify who is insured, insured's address,

the insuring company, what risks or property are covered,

the policy limits (amount of insurance), any applicable

deductibles, the policy period and premium amount, the

geographical limits for the application of cover.

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8. General principles of insurance

Apart from the principles governing all contracts insurance is also

governed by its own unique principles.

Indemnity

• Is perhaps the most fundamental principle of insurance law.

Object of indemnity is to place the insured after the loss in

the same position he occupied immediately before the loss.

He is not to be placed in a better or worse position.

• Not all insurance contracts are contracts of indemnity e.g. life

insurance. Indemnity is important as it deals in part with

moral hazard.

• Indemnity does not imply that the insured will be indemnified

to the full value of his loss e.g. a person whose factory is

destroyed by fire cannot recover for loss of profits or against

any liability that may arise from the fire unless he has

appropriate policies in place specifically designed to deal

with these losses.

• Indemnity can be achieved through the following methods:

1. Cash

2. Reinstatement e.g. where a building is destroyed,

insurers may reinstate it.

3. Repair e.g. where a motor vehicle is partially damaged.

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4. Replacement-instead of paying cash a replacement

item may be tendered.

5. New for old-used for household contents. This is not a

violation of the principle of indemnity as there is no

principle of law that requires indemnity to be

determined in terms of the market value of the asset.

6. Valued policies-in terms of which the insurer and the

insured agree before hand on the value to be paid

should a particular asset be destroyed or stolen. This

method of indemnity is used for assets with a

sentimental rather than a commercial value e.g.

jewelery, works of art etc.

The principle of indemnity is supported by 2 corollaries namely-

subrogation and contribution.

Subrogation• Literally means “to stand in place of”. It is the right of one

person to stand at law in the place of another and to avail

him of all rights and remedies of that other person.

• Often when a claim occurs there may be 2 avenues of

recovery. Suppose A drives negligently and causes an

accident damaging B’s car. If B’s car is insured 2 options are

open to him to recover his loss-he can sue A for damages or

he can claim from his insurer. If B pursues both avenues he

will receive double compensation. To prevent B from profiting

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from his loss subrogation is used in terms of which once the

insurer has paid B the insurer assumes all B’s rights to sue

A. This ensures that the principle of indemnity is preserved.

• Subrogation has a number of sub-principles namely:

o The insurer cannot be subrogated to the insured’s right

of action until it has paid the insured and made good

the loss.

o The insurer can be subrogated only to actions which

the insured would have brought himself.

o The insured must not prejudice the insurer’s right of

subrogation. Thus the insured may not compromise or

renounce any right of action he has against the third

party if by doing so he could diminish his loss.

Subrogation against the insurer: Just as insured cannot profit

from his loss the insurer may not make a profit from the

subrogation rights. The insurer is only entitled to recover the

exact amount they paid as indemnity nothing more. If they

recover more the balance should be given to the insured.

Subrogation gives the insurer the right of salvage.

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Contribution

• Is another principle that aids indemnity. Often a person has

more than one policy on the same asset. Following a loss the

position of the 2 policies is governed by the principle of

contribution. Since indemnity forbids the insured from

recovering more than the loss then he cannot recover the full

value of the loss from each of the 2 policies.

• The law does not forbid people from engaging in double

insurance it only forbids profiting from a loss.

• Under the common law a person who has double insurance

can look to any of the insurers involved for compensation.

The insurer who would have paid can then claim contribution

from the other insurer involved.

• For contribution to apply the following conditions must be

met:

(1) The 2 policies must cover the same

insured.

(2) They must cover the same subject matter.

(3) They must cover the same interest.

(4) The peril causing the loss must be

covered by both policies albeit for

different amounts.

(5) Both policies must be current.

• Policies contribute pro-rata to the loss.

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Average• Average is a concept used by insurers to deal with under-

insurance. Under-insurance occurs when an item is insured

for less than its market value.

• The general rule is that a person who under-insures his

property is entitled to the full amount of his loss whether total

or partial subject to the limits of the policy in the absence of

any provision in the policy to the contrary, e.g. if a house

worth SR500 000 is insured for SR300 000 and a loss of

SR100 000 occurs the insured in the absence of an average

clause in the policy would be entitled to SR100 000. By

implication therefore average is an alien concept to the

common law.

• Reduced to its logical conclusion average entails that if there

is under-insurance the insured shall be his own insurer to the

extent of the under-insurance. This means the insured will

bear part of the loss as a penalty for underinsurance.

• Insurer would have to include the average condition in the

policy for average to apply.

In marine insurance the term average has a meaning to that

ascribed to it in property. In marine insurance the word

'average' means "loss", hence came the terms general average,

general average sacrifice and general average expenditure.

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• The formula for average is: Sum insured/Market

value x loss sustained.

• Average only applies to contracts of indemnity

hence since life insurance contracts are not

contracts of indemnity all concepts derived from

indemnity like subrogation, contribution and average

do not apply to life policies.

The rationale behind average is that the insured should

pay a premium that is commensurate with the risk he

introduces to the pool to avoid prejudicing other

contributors.

Insurable Interest

• Insurable interest distinguishes contracts of insurance from

gambling in order to define the legitimate area of insurance

business.

• Insurable interest is required for all types of insurance and its

absence renders the contract void and hence unenforceable.

The leading Roman-Dutch law case on insurable interest is

Littlejohn v Norwich Union Fire Insurance Society 1905 TH 374

where it was held that if the insured can show that he stands to

lose something of an appreciable commercial value by the

destruction of the thing insured then his interest will be an

insurable one. The Court went further to state that as a general

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rule insurable interest should exist at the time of taking the

policy and at the time the loss is incurred.

If a person has insurable interest in an asset at the time of

taking the policy but loses the interest thereafter e.g. if he sells

the car, the policy ceases to have any validity.

• Insurable interest can be acquired in various ways notably:

(1) Ownership

(2) Legal possession

(3) Custody of property belonging to others e.g. bailees.

(4) Marriage-spouses have an insurable interest in each

other’s life.

(5) A lien-holder has insurable interest in the property

subject to the lien.

(6) A debt creates insurable interest between debtor and

creditor.

(7) An employer has an insurable interest in the life of an

employee.

• In life insurance the general rule is that insurable interest

need only exist at the time of taking the policy. Thus if A who

is married to B takes a life policy on his life and they later

divorce the policy will pay on B’s death even if technically

insurable interest no longer exists because the parties

divorced.

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Utmost Good Faith (UBERRIMA FIDES) & the Duty of

Disclosure• Insurance contracts are characterized by information

asymmetries between the parties. Generally the insured

knows more about the risk to be insured than the insurer. To

rectify this imbalance the law compels disclosure of

information between the parties.

• To act in good faith entails involved parties deal openly and

honestly with each other without suppressing material facts

that may influence the judgment of the other party.

The duty to act in good faith applies to all types of insurance

contracts. In contracts of sale the maxim caveat vendito applies

meaning let the buyer beware. This maxim places an obligation

on the buyer to take all reasonable steps to verify that the item

he intends to buy meets his expectations. In insurance this

maxim does not apply.

• In England the doctrine of utmost good faith is incorporated

in the Marine Insurance Act 1906.

• The requirement of utmost good faith is complimented by the

duty of disclosure which places an obligation on both parties

to the insurance contract to disclose material facts relevant

to the contract to each other.

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• In England the Marine Insurance Act 1906 defines a material

fact as every circumstance that would influence the judgment

of a prudent insurer in fixing the premium or determine

whether he will take the risk. Hence in England a material

fact is defined from the perspective of a prudent insurer. This

can result in a heavy burden on the insured.

• Failure to disclose material facts renders the contract void-

able at the instance of the insurer. Of course the insured is

only expected to disclose facts that he knows or ought to

know.

• In life insurance facts commonly regarded as material

include: medical history; financial status; family medical

history; state of health; life style etc.

• In short term insurance common material facts would

include: previous convictions; financial status; whether

another insurer has cancelled insured’s policy in the past.

• The duty of disclosure lasts for the duration of the

negotiations and terminates when the contract is concluded.

Material facts that come to light after the contract has been

concluded are deemed to be part of the risk that the insurer

would have assumed.

• Naturally in short-term contracts the duty to disclose material

facts is revived at renewal of the policy. Life insurance

contracts are continuing contracts hence the duty to disclose

is not revived unless there is a specific duty in the policy

obliging the insured to do so.

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• To avoid liability on grounds of non-disclosure the onus is on

the insurer to prove that:

(1) The undisclosed facts were material.

(2) That the facts were within the actual or presumed

knowledge of the insured.

(3) That the facts were not communicated to the insurer.

• Upon discovering the non-disclosure the insurer must

exercise the right to repudiate the contract within a

reasonable time. Thus if upon discovering the non-disclosure

the insurer continues to accept the premium for example, the

insurer would be deemed to have waived the right to

repudiate and the contract will be binding as if there was no

non-disclosure.

• In summary therefore the duty of disclosure is justified on the

following grounds:

(1) The insured knows more about the risk than the

insurer hence the law must compel disclosure.

(2) Without the duty of disclosure the insurance market

cannot operate efficiently such that the supply side of

insurance can be disrupted.

(3) Disclosure enables the insurer to quantify and price the

risk appropriately.

(4) Disclosure also enables the insurer to determine

appropriate policy terms and conditions to be

incorporated in the policy. It enables the insurer to

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determine the extent to which the risk being presented

deviates from the norm.

(5) Disclosure also helps insurers manage the problem of

adverse selection.

On the other hand critics of the duty of disclosure point to the

following in support of their argument:

(1) The duty is unduly burdensome on the insured

depending on the test used to determine what

constitutes material facts.

(2) Insurers rarely warn the insured about the

consequences of non-disclosure.

(3) Given the current technological advances it is no

longer true to say insurers know less about the risk

than the insured. The reverse may well be true.

(4) The duty of disclosure may be abused by insurers

seeking to avoid their obligations.

(5) There is an element of self-serving hypocrisy by

insurers by insisting that facts that lessen the risk need

not be disclosed yet these may benefit the insured by

way of reduction of premium. Why are insurers only

interested in the bad and not the good?

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9. Cause of Loss – the doctrine of Proximate

Cause

• The general rule is that for a loss to be paid under a policy of

insurance, it must have been caused by an insured peril. Unless

the loss is proximately caused by an insured peril the policy

does not respond.

• The proximate cause of loss is the most dominant and efficient

cause in terms of bringing about a particular result.

• The onus of proving that the loss was proximately caused by an

insured peril rests with the insured.

• In Etherington v Lancashire and Yorkshire Accidental Insurance

Co (1909) a man fell from a horse and sustained injuries that

prevented him from moving. As a result he contracted

pneumonia due to lying in the wet and died. The proximate

cause of his death was held to be the fall not pneumonia.

• Similarly if furniture is thrown out of a burning house to arrest

the spread of the fire and is damaged in the process the

proximate cause of the damage would be the fire.

• If the insured makes a prima-facie case that the loss was

proximately caused by an insured peril the insurer is obliged to

indemnify unless they can prove that an exception applies.

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Insurance a collection of write ups

Education

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