Personal Lines Insurance Basics

Basic property and 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
• 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) until repairs are complete.

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 (also called the efficient proximate cause) is the dominant or primary peril that sets in motion an unbroken chain of events leading to a loss.

• Coverage applies if the proximate cause is a covered peril, even if later events in the chain are excluded, unless the form’s own wording says otherwise. Homeowners and commercial property forms exclude loss from certain perils, such as flood and earth movement, regardless of any other cause or event contributing concurrently or in any sequence to the loss.
• As a general rule, for a loss to be covered, 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: a policy covers such 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 the 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, they must have a legitimate interest in the preservation of the life or property insured. This requirement is called insurable interest.

• An individual is presumed to have an insurable interest in their 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 in their property).

Insurable interest can also arise from a financial (pecuniary) relationship. For example, a business partner or creditor may have an insurable interest because they would suffer financial loss if the insured person or property were lost.

With life insurance, insurable interest need only exist at the time of application. This differs from property insurance, where an insurable interest must exist at the time of loss.

Subrogation

Subrogation applies broadly in property, auto, and liability insurance. When an insured enters into an insurance contract, they assign to the insurer their right of action against an at-fault party. This is also known as the transfer of rights of recovery requirement.

Subrogation occurs after the insurer indemnifies the insured and allows the insurer to recover from the responsible third party.

Other insurance

Some insureds have coverage through two or more policies. When that 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 an other insurance clause designed to prevent an insured from profiting from multiple policies and to prevent violations 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 (ACV) is another concept that supports the principle of indemnity. It is a method of loss valuation stating 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
• 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 their personal or business activities. Liability insurance covers an insured for their 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 who sustains an injury and 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 basis
• Split limit basis
• Aggregate limit basis

An individual has legal liability for damage to others if they have been negligent. Negligence involves failing to demonstrate the care required by a reasonable person (the prudent person doctrine). For negligence to exist, four elements must be present:

1. A duty of an insured is owed to the public.
2. A breach of the above duty occurs (and is not intentional).
3. Some form of injury or damage results from the breach.
4. 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 defense prevents an injured third party from recovering damages from an insured if the injured party was in any way responsible for the loss. (Note: This doctrine is obsolete in most states except Alabama, Maryland, North Carolina, Virginia, and the District of Columbia. It has been replaced by comparative negligence rules.)

Comparative Negligence

• Under this defense, the court determines the negligence of each party and awards damages proportionately.

Last Clear Chance

• This defense favors 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 liability if the injured third party voluntarily assumed the risk of injury.

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

P&C 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 or repeated exposure to the same harmful conditions.

Cancellation

When a policy is canceled midterm, unearned premiums must be refunded to the 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.

Vacancy and unoccupancy

• Vacancy means 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 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

An appraisal clause applies when the insured and the insurer disagree on the amount of the loss.

• Each party selects an appraiser.
• The two appraisers choose an umpire.
• If the appraisers can’t agree on the amount of the loss, they submit their differences to the umpire. A decision agreed to by any two of the three is binding on the loss amount only.

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 is binding on the insurer and insured.

Property policies settle a dispute over the amount of a loss by appraisal, not arbitration. In liability insurance, disputes go to court. However, some auto and uninsured/underinsured motorist (UM/UIM) policies require arbitration by contract.

Assignment

Before an insured can assign a property insurance policy to another, they must obtain the insurer’s written consent.

Because property and casualty contracts are personal contracts, the insured can’t 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.

For example, after paying a total loss on an auto, the insurer may sell all or part of the totaled auto 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 P&C insurance involve limits of liability, cancellation policies, vacancy, unoccupancy, appraisal, assignment, and salvage.

Chapter vocabulary

Definitions

Actual Cash Value (ACV)

Payment value for indemnification due to loss or damage of property; in most cases, it is replacement cost minus depreciation

Appraisal

A survey to determine a property’s insurable value or the amount of a loss.

Assignment

The transfer of a legal right of interest in an insurance contract to another person.

Cancellable Policy

A policy that may be terminated either by the insured or the insurance company by notification to the other party in accordance with the terms of the policy.

Cancellation

When an insurer cancels a policy, the unearned premium is refunded pro rata. When the insured cancels, the refund may be less than pro rata (a short-rate refund).

Contributory Negligence

When an injured person contributes to their own injuries or damage, they won’t be able to recover from the other involved, at-fault party.

Direct Loss

Damage to covered real or personal property caused by a covered peril.

Indemnity, Principle of

A general legal principle related to insurance that holds that the individual recovering under an insurance policy should be restored to the approximate financial position he or she was in prior to the loss. Legal principle limiting compensation for damages to be equivalent to the losses incurred.

Indirect Loss

Loss that is the result or consequence of a direct loss. Also called consequential Loss.

Loss Ratio

The percentage of incurred losses to earned premiums.

Market Value

Fair value or the price that could be derived from the current sale of an asset.

Negligence

Failure to exercise reasonable consideration resulting in loss or damage to oneself or others.

Noncancellable

A policy that an insurance company is not permitted to terminate or amend during its term (except for non-payment of a premium).

Occurrence

An accident, including injurious exposure to conditions, which results, during the policy period in bodily injury or property damage neither expected or intended from the standpoint of the insured. Includes continuous or repeated exposure to substantially the same general harmful conditions.

Occurrence Limit

Maximum amount payable by the insurer for any one occurrence.

Other Insurance Clause

Provision in property and casualty policies specifying how loss is shared when more than one policy covers the same risk.

Primary Insurance

Coverage that takes precedence when more than one policy covers the same loss.

Pro-rata Cancellation

When a policy is canceled midterm, unearned premiums must be refunded to the policy owner. A pro-rata refund is due if the insurer cancels.

Proximate Cause

The dominant cause in an unbroken chain of events leading to the loss.

Replacement Cost

The cost of replacing property without a reduction for depreciation due to normal wear and tear.

Salvage

A concept which 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 paid. The insurer has salvage rights once a loss payment has been made.

Standard Risk

A person who, according to a company’s underwriting standards, is considered a normal risk and insurable at standard rates. High or low-risk candidates may qualify for extra or discounted rates based on their deviation from the standard.

Subrogation

Situation where an insurer, on behalf of the insured, has a legal right to bring a liability suit against a third party who caused losses to the insured. Insurer maintains the right to seek reimbursement for losses incurred by insurer at the fault of a third party.

Subrogation Clause

Section of insurance policies giving an insurer the right to take legal action against a third party responsible for a loss to an insured for which a claim has been paid.

Substandard Risk

Risks deemed undesirable due to medical condition or hazardous occupation requiring the use of a waiver, a special policy form, or a higher premium charge.

Third Party

Person other than the insured or insurer who has incurred losses or is entitled to receive payment due to acts or omissions of the insured.

Unoccupied

Insured premises are at least partially furnished, and there may be intent for the tenant to return.

Vacant

Insured premises is empty or unfurnished and there is no intent to return to the property by the insured.