P&C Insurance Basics | Achievable Property & Casualty

Basic Property and Casualty Insurance Terms and Related Concepts

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
Subrogation
Other insurance
Depreciation
Actual cash value

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:

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 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.

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
Intervening Clause

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: Short rate cancellation is utilized when an insured decides to cancel an insurance contract, and pro-rata is used when an insurer cancels the contract.
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.
Occurrence Limit: Maximum amount payable by the insurer for any one occurrence.
Other Insurance Clause: A provision found in many life and health insurance policies stating the disposition of claims when any other insurance contract covers the same events as the policy in which the provision is contained.
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: Event covered under insured’s policy agreement.
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.