Basic Property 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 happens because of 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 have 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 most obvious or immediate cause. Instead, it’s the cause that sets the loss in motion through a chain of events (often described as a “domino effect”).

For a loss to be covered by an insurance policy:

• The covered peril must be the proximate (original) cause, or
• The covered peril must appear within the chain of events connecting the proximate cause to the loss

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 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

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 that happens, claim examiners must:

• Identify all applicable policies
• Communicate with each other
• 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. These provisions are designed to prevent an insured from profiting from multiple policies and 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

Actual cash value (ACV) supports the principle of indemnity by limiting recovery to the amount of the actual loss incurred, regardless of how much insurance was 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
• 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 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. Property insurance contracts have 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 basis
• Split limit basis
• Dual limit basis
• Aggregate limit basis

An individual has legal liability for damage to others if he/she has 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.

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 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

Property 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 the 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 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

In property insurance, appraisal is used when the insured and insurer agree that coverage exists but do not agree on the amount of the loss. The policy provides that each party will select an appraiser who will represent them and attempt to arrive at an agreement.

The appraisal procedure is not used when the insurer and insured disagree over whether a loss is covered under the policy. In that situation, a process known as arbitration is used.

With arbitration:

• The insured and insurer each select a disinterested party (arbitrators).
• Those 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.

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. Because property and casualty contracts are personal contracts, the insured cannot transfer a policy unless the insurer provides written permission to do so.

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
• Intervening Clause

Additional concepts in Property 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.