Casualty Insurance Basics
Basic Casualty Insurance Terms and Related Concepts
Loss is a reduction in the value of property. In property and liability insurance, a loss can involve:
- Damage to property, or
- A monetary loss that results from legal action
There are two basic classifications of loss:
- Direct loss: an actual physical loss to property
- Indirect loss: an additional loss that results from a direct loss
Indirect loss is also called a resultant loss.
Direct loss
A direct loss involves direct physical damage to property caused by a covered peril. Examples include damage caused by:
- Fire
- Falling objects
- Collision
- Civil commotion
- Smoke
- Vandalism
- Flood
Property insurance policies generally cover direct loss to an insured’s property unless the property or the peril is excluded.
Indirect loss
An indirect loss is an additional loss that results from a direct physical loss to property.
For example, if an insured’s home is damaged by fire and is unlivable for 6 weeks, the insured may incur additional living expenses (such as staying in a motel) while repairs are completed.
Other types of indirect loss discussed later in this text include:
- Loss of income
- Loss of rent
- Rental value
- Loss of use
Proximate Cause
Proximate cause is also called the efficient cause of loss. It isn’t necessarily the first or most obvious cause. Instead, it’s the cause that sets a chain of events in motion (a “domino effect”) that leads to the loss.
As a general rule, for a loss to be covered by an insurance policy, the covered peril must be the proximate (original) cause. A covered peril that appears later in a chain of events an excluded peril set in motion does not by itself make the loss covered. Property forms exclude certain perils “regardless of any other cause or event contributing concurrently or in any sequence to the loss,” and they cover a later loss, such as a fire that follows an earthquake, only where an exception in the form says so.
Contract of Indemnity
Property and liability insurance policies are contracts of indemnity. This means an insured is entitled to recover payment only to the extent of the economic loss incurred.
The principle of indemnity states that no one should profit from an insurance claim. Insurance is designed to restore the insured to the same financial condition that existed prior to the loss.
The principle of indemnity is controlled by and related to other concepts, including:
- Insurable interest
- Subrogation
- Other insurance
- Depreciation
- Actual cash value
Insurable interest
A basic rule of insurance is that before an individual can benefit from insurance, he/she must have a legitimate interest in the preservation of the life or property insured. This requirement is called insurable interest.
An individual is always presumed to have an insurable interest in his/her own life and/or property. Therefore, anyone who is legally capable may apply for an insurance policy on themselves.
An individual is also considered to have an insurable interest in the life of a close blood relative or spouse (but not necessarily their property).
Insurable interest can also be based on a financial relationship. For example, a bank that holds the mortgage on a debtor house would have an insurable interest in the house until the mortgage is paid off.
With life insurance, insurable interest need only exist at time of application. This differs from property insurance, which requires that an insurable interest exist at the time of loss.
Subrogation
Subrogation is especially applicable in auto insurance. When an insured enters into an insurance contract with the insurer, he/she assigns to the insurer the right of action against an at-fault party. This is also known as the transfer of rights of recovery requirement.
Other Insurance
Some insureds may have coverage through two or more policies. When this happens, claim examiners must communicate with each other to make sure the combined amount paid does not exceed 100% of the actual loss.
Most insurance policies include a clause or provision relating to coverage by other insurance. The purpose is to prevent an insured from profiting due to the ownership of multiple policies and to prevent a violation of the principle of indemnity. Common types of clauses include:
Pro Rata
- Each policy pays a proportional share of the loss. Assume XYZ Mutual provides $70,000 of coverage on an insured property and ABC Casualty provides $30,000 of coverage on the same property. Since XYZ Mutual provides 70% of the total coverage, it will pay 70% of the loss; ABC Casualty will pay 30%.
Primary and Excess
- A primary policy pays first, up to its limits, as though no other insurance existed. An excess policy pays only after the primary insurance is exhausted, so the two together pay no more than the actual loss. For example, when an insured borrows someone else’s car, the owner’s auto policy is primary and the borrower’s own policy applies as excess.
Nonconcurrency
- Policies are nonconcurrent when they cover the same risk but on different terms, such as different property, perils or locations. For example, Jude owns two fire policies. One covers a building and its contents; the other covers the contents only. Nonconcurrent policies make it harder to share a loss, because each insurer’s share turns on what its own policy covers.
Actual Cash Value
Actual cash value supports the principle of indemnity by limiting recovery to the amount of the actual loss incurred, regardless of how much insurance is purchased.
ACV is defined more specifically as replacement cost minus depreciation. Depreciation is the reduction in the value of property over time due to use, wear and tear, and obsolescence.
Most property insurance policies protect the insured’s property only. Such contracts are referred to as mono-line policies. If casualty or liability protection is also provided under the same contract, a multiple-line policy has been created.
Liability or casualty insurance protects an insured against injury or damage claims made by another party. An insured may have legal liability as a result of:
- Negligence
- Contractual obligations
- Liability imposed by law
Any person or entity owning property or a business is legally responsible for bodily injury or property damage to others arising out of his/her personal or business activities. Liability insurance covers an insured for his/her legal responsibility for bodily injury or property damage to others.
Liability protection is sometimes referred to as third-party coverage. Property insurance contracts involve two parties (the insured and the insurer). Liability insurance also involves a third party: the person sustaining an injury who may take legal action against the insured. While a liability insurance contract is a two-party contract, it may make claim payments to a third party.
Liability policies provide coverage up to stated limits. Coverage may be provided on a:
- Single limit
- Split limit
- Aggregate limit basis
An individual has legal liability for damage to others if he/she has been negligent. Negligence involves the failure to demonstrate the care required by a reasonable person (prudent person doctrine). For negligence to exist, four elements must be present:
- A duty of an insured is owed to the public.
- A breach of the above duty occurs (and is not intentional).
- Some form of injury or damage results from the breach.
- The act (or failure to act) is the reason for the injury or damage.
Certain defenses may be used to reduce or eliminate the insured’s legal liability for negligence. Such defenses include, but are not limited to:
Contributory Negligence
- This is a common defense which will prevent an injured third party from recovering damages from an insured if the injured party was in any way responsible for the loss.
Comparative Negligence
- Under this defense, the court determines the negligence of each party and awards damages proportionately.
Last Clear Chance
- This defense will favor the insured if it can be determined that the injured party had a “distinct chance” to avoid the loss or injury.
Assumption of Risk
- Under this defense, an insured is absolved of any liability if the injured third party assumed the risk of injury voluntarily.
Superseding (or Intervening) Cause
- Under this defense, an insured may be released from liability if an independent event breaks the chain of causation and becomes the dominant cause of the injury.
Accident and Occurrence Limits
Casualty policies sometimes provide coverage based on a maximum limit of liability “per accident” or “per occurrence.”
- An accident is a single event.
- An occurrence involves continued exposure.
Cancellation
When a policy is canceled midterm, unearned premiums must be refunded to a policy owner.
- A pro-rata refund is due if the insurer cancels.
- If the policy owner cancels, the refund may be less than pro rata (a short-rate refund).
Whenever a policy is canceled by an insurer, written notice stating the date the cancellation takes effect must be mailed or delivered to the first named insured, in advance, at the last mailing address known to the insurer.
Vacancy and Unoccupancy
Vacancy means that a building, residence, or insured premises is empty or unfurnished, and there is no intent to return to the property by the insured, as interpreted by the insurer.
Unoccupied means that no one is present, but the building is furnished in some capacity; there may be an intent to return on the part of the insured.
Appraisal
With Casualty insurance, appraisal applies when the insured and insurer do not agree on the amount of the loss. The policy provides that each party selects a competent and impartial appraiser, and the two appraisers select an umpire. If the appraisers do not agree on the amount of the loss, they submit their differences to the umpire, and a decision agreed to by any two of the three is binding.
The appraisal procedure is not used when the insurer and insured disagree over whether a loss is covered under the policy. Arbitration is a separate process. In the personal auto policy, uninsured motorist coverage allows it, if both parties agree, when the insured and the insurer disagree on whether the insured is legally entitled to recover damages or on the amount of those damages. A dispute over coverage may not be arbitrated under that provision.
With arbitration, the insured and insurer each select a disinterested party (arbitrators). These two arbitrators then select a disinterested or uninterested third party. A decision agreed to by at least two of the arbitrators is binding on whether the insured is legally entitled to recover damages. It binds on the amount of damages only up to the minimum bodily injury limit of the financial responsibility law of the state where the covered auto is principally garaged; if the amount exceeds that limit, either party may demand a trial within 60 days of the decision.
Property policies and auto physical damage coverage settle a dispute over the amount of a loss by appraisal, not arbitration. In liability insurance, disputes go to court.
Assignment
Before an insured can assign a property insurance policy to another, he/she must obtain the insurer’s written consent. Because property and casualty contracts are personal contracts, the insured cannot transfer a policy unless the insurer provides written permission.
Salvage
Salvage allows the insurer to take title to damaged property and recoup some of the money paid when a total loss is paid.
In other words, if an auto is totaled, the insurer may sell all or part of the vehicle for salvage to recover part of the amount paid to the insured.
Lesson Summary
Loss in property and casualty insurance refers to a reduction in the value of property due to damage or monetary loss from legal action. There are two classifications:
- Direct Loss: Involves actual physical loss to property caused by covered perils like fire or vandalism.
- Indirect Loss: Additional loss resulting from a direct loss, such as additional living expenses due to property damage.
Other related concepts include:
- Proximate Cause: The primary cause of loss leading to damage.
- Contract of Indemnity: Insurance policies aim to indemnify the insured up to the extent of economic loss, preventing profiting from claims.
- Insurable Interest: Before benefiting from insurance, one must have a legitimate interest in the life or property insured.
- Subrogation: The insured assigns their right of action against an at-fault party to the insurer.
- Actual Cash Value: Method of loss valuation detailing the replacement cost minus depreciation.
- Liability Insurance: Protects against injury or damage claims involving legal liability for negligent actions.
Defenses for reducing or eliminating liability in negligence cases include:
- Contributory Negligence
- Comparative Negligence
- Last Clear Chance
- Assumption of Risk
- Superseding (intervening) cause
Additional concepts in Casualty insurance involve limits of liability, cancellation policies, vacancy, unoccupancy, appraisal, assignment, and salvage.