Textbook
2. Personal Lines Insurance Basics
Loss is defined as the reduction in value of property. In property and liability insurance, the concept of loss involves damage to property or monetary loss arising from legal action.
There are two basic classifications of loss: direct loss, which involves an actual physical loss to any type of property, and indirect loss, which is an additional loss that is a result of a direct loss. Indirect loss is also called a resultant loss.
Direct loss
A direct loss is one that involves a direct physical loss to property caused by a covered peril. Damage to property caused by a fire, falling object, collision, civil commotion, smoke, vandalism or flood are examples of direct losses. Property insurance policies provide coverage for direct loss to an insured’s property unless the property or the peril is excluded.
Indirect loss
An indirect loss is an additional form of 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 following the direct loss, the insured may incur additional living expenses if he/she must live in a motel until repairs are complete.
Other types of indirect loss that will be discussed later in this text include loss of income, loss of rent, rental value, or loss of use.
Proximate Cause
Proximate cause is also called the efficient cause of loss. It is not necessarily the principal cause, but it is responsible for the loss or damage through a “domino effect.” For a loss to be covered by an insurance policy, the covered peril must be the proximate or original cause, or it must exist within the chain of events that connects the proximate cause to the loss in question.
Contract of Indemnity
Property and liability insurance policies are contracts of indemnity. This means that an insured is only entitled to recover payment to the extent of the economic loss incurred. The principle of indemnity states that no one should profit from an insurance claim.
This principle prevents an insured from profiting from an insurance policy. The purpose of buying insurance is not to make a profit but 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
A basic rule governing insurance states 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 of doing so) 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 holds that an insurable interest must exist at the time of loss.
Subrogation
This concept is especially applicable in auto insurance. When an insured enters into an insurance contract with the insurer, he/she assigns to the insurer their 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. If so, the claim examiners must know this and must communicate with each other to make sure that the combined amount of money paid on the claim does not exceed 100% of the actual loss.
Most insurance policies include a clause or provision relating to coverage by other insurance that is designed to prevent an insured from profiting due to the ownership of a policy or to prevent a violation of the principle of indemnity. Common types of clauses include:
• Pro Rata
Each policy shares a proportional share of the loss. Assume that XYZ Mutual provides $70,000 of coverage on an insured property and ABC Casualty provides another $30,000 of coverage on the same property. Since XYZ Mutual provides 70% of the total coverage provided, it will pay only 70% of the loss; ABC Casualty will pay 30%
• Non-concurrent/Excess
This policy clause generally reads: “This insurance is excess over any of the other insurance provided whether primary, excess, contingent or on any other basis that is effective prior to the beginning of the policy period.” Non-concurrent policies can be of the same type but do not cover exactly the same property. For example, Jude owns two fire policies. One provides coverage for a building and its contents. The other covers contents only. One policy is designated the primary insurance, and will pay its full policy obligations. Any other insurance will then pay whatever amount is necessary to bring the total claim to 100% of total costs.
Actual Cash Value
This is another concept that supports the principle of indemnity. Actual cash value is a method of loss valuation that states that no matter how much insurance is purchased, the recovery amount is limited to the amount of the actual loss incurred. 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, or liability imposed by law. Any person or entity owning property or a business is legally responsible for any 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. While property insurance contracts have two parties (the insured and the insurer), liability insurance also involves a third party. The third party is 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 will provide coverage up to stated limits. Coverage may be provided on a single limit, split, dual limit, or aggregate limit basis.
An individual has a legal liability for damage to others if he/she has been negligent. This concept involves the failure of an individual to demonstrate the care required by a reasonable person (prudent person doctrine). For negligence to exist, four elements must be present:
Certain defenses may be used which will 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.
• Intervening Clause
Under this defense, an insured may be released from liability if another factor caused or increased the damages.
Accident and Occurrence Limits
P&C policies sometimes provide coverage based on a maximum limit of liability “per accident” or “per occurrence.” An accident is a single event, whereas 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. A short-rate refund is due if the policy owner cancels. Whenever a policy is canceled by an insurer, proper written notice, including the reasons for cancellation, must be sent to the first named insured at his/her last known address.
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 P&C insurance, when it is understood between the insured and insurer that coverage exists but they do not agree on the amount of the loss. The policy provides that each party shall select an appraiser who will represent them and attempt to arrive at an agreement. The appraisal procedure is not utilized when an insurer and insured disagree over whether a loss is actually covered under the policy. In this case, a process known as arbitration is used.
With arbitration, the insured and insurer each select a disinterested party (arbitrators), these two arbitrators then select a disinterested or uninterested third party. When an agreement is reached by any two of these arbitrators, it will be binding on the insurer and insured. This process is common to property insurance. In liability insurance, disputes go to court.
Assignment
Before an insured can assign a property insurance policy to another, he/she must provide written notice to the insurer. Whereas Property and casualty contracts are personal contracts, the insured cannot transfer a policy unless the insurer provides written permission to do so.
Salvage
This concept allows the insurer to take title to the damaged property and recoup some of the money paid resulting from a covered peril if a total loss is paid. In other words, this principle allows the insurer to sell all or part of the totaled auto for salvage to recoup part of the amount paid to the insured.
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:
Other related concepts include:
Defenses for reducing or eliminating liability in negligence cases include:
Additional concepts in P&C insurance involve limits of liability, cancellation policies, vacancy, unoccupancy, appraisal, assignment, and salvage.
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