Insurance a collection of write ups

A collection of write-ups
Compiled by Basem Shakhshir/ Freelance
1. What is insurance?
Insurance is a tool used to get around against the risk of a
conditional loss. Insurance is described as the equitable
transfer of risk of a loss from one entity to another in
exchange for a premium and can be thought of as a
guaranteed small loss to prevent a large possible
devastating loss. Insurance encompasses an insurer (an
entity that sells insurance), and an insured (an entity buying
the insurance that the other entity sells). The insurance rate
is a factor used to determine the amount called premium to
be charged for a certain amount of insurance coverage. In a
form insurance is a form of risk management which means
the practice to appraise and control risk.
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2. The 7 characteristics of insurance
a. A large number of homogeneous exposure units: it
allows insurers to benefit from the so-called "law of
large numbers" (as the number of exposure units
increases the actual results are increasingly likely to
become close to expected results.
b. Definite loss: the event that gives rise to the loss that is
subject to insurance should, at least in principle take
place at a known time, in a known place, and from a
known cause. Ideally, the time, place and cause of a
loss should be clear enough that a reasonable person,
with sufficient information, could objectively verify all
three elements.
c. Accidental loss: the event that is the trigger of a claim
should be fortuitous, or at least outside the control of
the beneficiary of the insurance. The loss should be
pure that is, it results from an event for which there is
only the opportunity for cost.
d. Large loss: the size of the loss must be meaningful
from the perspective of the insured. Insurance
premiums need to cover both the expected cost of
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losses, plus the cost of issuing and administering the
policy, adjusting losses, and supplying the capital
needed to reasonably assure that insurer will be able to
pay claims.
e. Affordable premium: if in the likelihood of an insured
event is so high, or the cost of the event so large, that
the resulting premium is large relative to the amount of
protection offered, it is no likely that anyone would buy
insurance. Again, the premium cannot be so large that
there is not a reasonable chance of a significant loss to
the insurer.
f. Calculable loss: there are two elements that must be at
least estimable, if not calculable: the probability of loss,
and the attendant loss. Probability of loss is generally
an empirical exercise, but cost has more to do with the
ability of a reasonable person in possession of a copy
of the insurance policy to make a reasonably definite
and objective evaluation of the amount of the loss
recoverable as a result of the claim.
g. Limited risk of catastrophically large losses: the
essential risk is often aggregation. Typically insurers
prefer to limit their exposure to a loss from single event
to small portion of their capital base. Where the loss
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can be aggregated, or an individual policy could
produce exceptionally large claims, the capital
constraint will restrict an insurer's appetite for
additional policyholders. In extreme case the
aggregation can affect the entire industry, since the
combined capital of insurers and re-insurers can be
small compared to the needs of potential policyholders
in areas exposed to aggregation risk.
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3. Indemnity
The technical definition of indemnity means to make whole again.
There are two types of insurance contracts: 1) an "indemnity"
policy and 2) a "pay on behalf" policy.
An indemnity policy will not pay claims until the insured has paid
out of pocket to some third party.
With a pay on behalf policy, in comparison, the insurance carrier
would pay the claim and the insured would not be out of pocket for
anything. Most liability insurance is written on the basis of a "pay
on behalf" language.
Generally, an insurance contract includes, at a minimum, the
following elements: the parties (insurer, insured, beneficiaries …),
the premium, the period of coverage, the particular loss event
covered, the amount of coverage, and exclusions. Insured is thus
said to be "indemnified" against the loss events covered in the
policy. When insured parties experience a loss for a specific peril,
the coverage entitles the policyholder to make a 'claim', against the
insurer for the covered amount of loss as specified by the policy
and indemnity will be in order.
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4. Insurer's business model
- Underwriting and investing
The business model can be best reduced to a simple equation:
Profit = earned premium + investment income – incurred loss –
underwriting expenses
Insurers make money in two ways:
(1) Through underwriting, the process by which insurers select
the risks to insure and decide how much in premiums to
charge for accepting those risks, and
(2) By investing the premiums they collect from insured parties.
The most complicated aspect of the insurance business is the
underwriting of policies. Using a wide assortment of data, insurers
predict the likelihood that a claim will be made against their
policies and price products accordingly. To this end insurers use
actuarial science to quantify the risks they are willing to assume
and the premium they will charge to assume them. Data is
analyzed to fairly accurately project the rate of future claims based
on a given risk. Actuarial science uses statistics and probability to
analyze the risks associated with the range of perils covered, and
these scientific principles are used to determine an insurer's
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overall exposure. From insurer's perspective some policies are
winners while some are losers.
- Claims
Claims and loss handling is the materialized utility of insurance; it
is the actual "product" paid for. Claims are filed by insured directly
with insurer or through brokers or agents. Insurance company
claim departments employ claim adjusters supported by staff of
records managements and data entry. Incoming claims are
classified based on severity and are assigned to adjusters whose
settlement authority varies with their knowledge and experience.
The adjuster undertakes a thorough investigation of each claim,
usually in close cooperation with the insured, determines its
reasonable monetary value, and authorizes payment.
In managing the claims handling function, insurers seek to balance
the elements of customer satisfaction, administrative handling
expenses, and claims overpayment leakages. Disputes between
insurer and insured over validity of claims or claims handling
practices occasionally escalate into litigation.
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5. History of insurance
In some sense we can say insurance appears simultaneously with
the appearance of human society. Our world is aware of two types
of economies in human societies: money economies (with money,
markets, financial instruments and so on) and non money or
natural economies (without money, markets, financial instruments
and so on). The second type is a more ancient form than the first.
In such an economy and community, we can see insurance in the
form of people helping each other. For example, if a house burns
down, the members of the community help build a new one.
Should the same thing happen to ones neighbor, the other
neighbors must help. Otherwise, neighbors will not receive help in
the future.
Insurance in the modern sense (in a modern money economy, in
which insurance is part of the financial sphere), early methods of
transferring or distributing risk were practiced by Chinese and
Babylonian traders as long ago as 3
rd
and 2
nd
millennia BC,
respectively. Chinese merchants traveling treacherous river rapids
would redistribute their wares across many vessels to limit the loss
due to any single vessel capsizing. The Babylonians developed a
system which was recorded in the famous Code of Hammurabi, c.
1750 BC, and practiced by early Mediterranean sailing merchants.
If a merchant received a loan to fund his shipment, he would pay
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the lender an additional sum in exchange for the lender's
guarantee to cancel the loan should the shipment be stolen.
Monarchs of ancient Iran (Achaemenian) were the first to insure
their people and made it official by registering the insuring process
(people would give presents and would have their names and
value of their presents registered) in governmental notary offices.
The purpose of registering was that whenever the person
registered by the court was in trouble, the monarch and the court
would help him. It is recorded that "…whenever the owner of the
present is in trouble or wants to construct a building, set up a feast,
have his children married, etc. the one in charge of this in the court
would check the registration. If the registered amount exceeded a
certain value, he or she would receive an amount of twice as
much."
A thousand years later, the inhabitants of Rhodes invented the
concept of the "general average". Merchants whose goods were
being shipped together would pay a proportionally divided
premium which would be used to reimburse any merchant whose
goods were jettisoned during storm or sinkage.
The Greeks and Romans introduced the origins of health and life
insurance c. 600 AD when they organized guilds which cared for
the families and paid funeral expenses of members upon death.
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Before insurance was established in the late 17
th
century, "friendly
societies" existed in England, in which people donated amounts of
money to a general sum that could be used for emergencies.
Separate insurance contracts were invented in Genoa in the 14
th
century, as were insurance pools backed by pledges of landed
estates. Insurance became far more sophisticated in post-
Renaissance Europe, and specialized varieties developed.
Towards the end of the 17
th
century, London's growing importance
as a center for trade increased demand for marine insurance. In
late 1680s, Edward Lloyd opened a coffee house that became a
popular haunt of ship owners, merchants, and ship's captains, and
thereby a reliable source of the latest shipping news. It became the
meeting place for parties wishing to insure cargoes and ships, and
those willing to underwrite such ventures. Today, Lloyds of London
remains the leading market (note that it is not an insurance
company) for marine and other specialist types of insurance, but it
works rather differently than the more familiar kinds of insurance.
Insurance as we know it today can be traced to the Great Fire of
London, which in 1666 devoured 13,200 houses. In its aftermath
Nicholas Barbon opened an office to insure buildings. In 1680, he
established England's first fire insurance company, "The Fire
Office", to insure brick and frame houses.
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The first insurance company in the USA underwrote fire insurance
and was formed in Charles Town (Charleston), SC, in 1732.
Benjamin Franklin helped to popularize and make standard the
practice of insurance, particularly against fire in the form of
perpetual insurance. In 1752, he founded the "Philadelphia
Contribution-ship for the Insurance of Houses from Loss by Fire".
Franklyn's company was the first to make contributions toward fire
prevention. Not only did his company warn against fire hazards, it
refused to insure certain buildings where the risk of fire was too
great, such as wooden house.
The natural process for the insurance industry to become what it is
today was the introduction of regulations, rules and laws, which
brings us to the insurance as it is today.
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6. Types of insurance
Any risk that can be quantified can potentially be insured. Specific
types of risk that may give rise to claims are known as "perils". An
insurance policy will set out in details which perils are covered by
the policy and which are not. Below are lists of many different
types of insurance that exist. The outlined Insurance coverage is
as applied in countries that have progressed in insurance
applications.
1. Auto Insurance
Auto insurance protects insured against financial loss when
involved in an accident. It is a contract between the insured and
the insurer with insured agreeing to pay the premium and the
insurance company agrees to pay the losses as defined in the
insurance policy issued to insured. Auto insurance provides
property (damage to insured auto), liability and medical coverage:
(1) Property coverage pays for damage to or theft of insured auto.
(2) Liability coverage pays for insured's legal responsibility to
others for bodily injury or property damage. (3) Medical coverage
pays for the cost of treating injuries, rehabilitation and sometimes
lost wages and funeral expenses. Auto policy may encompass up
to six different kinds of coverage and insured is not obligated at
law to buy all of them.
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2. Home Insurance
It provides compensation for damage or destruction of a home
from disasters. In certain geographical areas the standard
insurance excludes certain types of disasters, such as flood and
earthquakes that require additional coverage. The policy may
include inventory, or this can be bought as a separate policy,
especially for those people who rent housing. In some countries,
insurers may offer a package which may include liability and legal
responsibility for injuries and property damage caused by
members of the household, including pets.
3. Health (Medical Expenses) Insurance
Almost all developed countries have governmental-supplied
insurance for health.
Health insurance policies in the UK or other publicly-funded health
programs will cover the cost of medical treatments. Dental
insurance, like medical insurance is coverage for individuals to
protect them against dental costs. In the U.S., dental insurance is
often part of an employer's benefit package, along with the health
insurance. Most countries rely on public funding to ensure that all
citizens have universal access to healthcare.
4. Disability Insurance(PA)
o Disability insurance policies provide financial
support in the event the policyholder is unable to
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work because of disabling illness or injury. It
provides monthly support to help pay beneficiary's
obligations.
o Total permanent disability insurance provides
benefits when a person is permanently disabled and
can no longer work in their profession, often taken
as an adjunct to life insurance.
o Disability overhead insurance allows business
owners to cover the overhead expenses of their
business while they are unable to work.
5. Life Insurance
Life insurance provides a monetary benefit to a decedent's family
or other designated beneficiary, and may specifically provide for
income to an insured person's family, burial, funeral and other final
expenses. Life insurance often allows the option of having the
proceeds paid to the beneficiary either in lump sums cash payment
or an annuity.
Annuities and pensions that pay benefit for life are sometimes
regarded as insurance against possibility that a retiree will outlive
his or her financial resources. They are the complement of life.
Certain life insurance contracts accumulate cash values, which
may be taken by the insured if the policy is surrendered or which
may be borrowed against.
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6. Property Insurance
Property insurance provides protection against risks to property,
such as fire, theft or weather damage. This includes specialized
forms of insurance such as fire insurance, flood insurance,
windstorm insurance, earthquake insurance, landlord and
neighbors' recourse insurance, home insurance, boiler and
machinery insurance, terrorism insurance and others, such as in
the UK and few other countries, aviation insurance, builder's risk
insurance (know as CAR), crop insurance, marine insurance and
inland marine insurance.
In the KSA, we identify each product separately and do not group
them as above. Hence, property insurance basically provides
protection against risks of fire howsoever caused. We normally
extend the fire insurance policy is to include named perils like: acts
of nature and others. When we have added all those perils there
remains the physical loss of property due to other causes that
once they are identified switch the insurance policy from fire and
perils to an all risks insurance property insurance. And all those
covers are given to any type of property including boilers,
machinery and equipment, stocks and inventories, contents of
insured property, spare parts in stock, office equipment and
furniture, fixtures and fittings and the like of articles and items that
constitute the property of the insured.
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Few coverage grouped under property are mentioned later on in
this paper.
7. Liability Insurance
Liability insurance responds to legal claims against the insured.
Many types of insurance include an aspect of liability coverage.
For example, homeowner's insurance policy that normally would
include liability coverage which protects insured in the event of a
claim brought by someone who slips or falls on the property. Auto
insurance also includes an aspect of liability insurance that
indemnifies against harm that a crashing car can cause to others'
lives, health, or property. The protection offered by the liability
policy is two folds: a legal defense in the event of a lawsuit
commenced against the policyholder and indemnification (payment
on behalf of the insured) with respect to a settlement or court
verdict. Liability policies typically cover only negligence of the
insured, and will not apply to results of willful or intentional acts of
the insured.
There are other liability policies such as: employer's liability,
environment liability insurance, professional liability insurance also
known as professional indemnity insurance, directors and officers
liability insurance, errors and omission insurance.
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8. Credit Insurance
Credit insurance repays some or all of a loan when certain things
happen to the borrower such as unemployment, disability, or
death. And offshoot to credit insurance is mortgage insurance that
insures lenders against default by the borrower.
9. Worker's (Workman's) Compensation Insurance
Workers' compensation insurance replaces all or part of a worker's
wages lost and accompanying medical expenses incurred because
of a job-related injury. In the KSA, work-related injuries are
covered by the Occupational Hazard Branch of the GOSI
(Government Organization for Social Insurance). Insurance
companies found gaps in GOSI work-related compensations and
those of the Saudi Labor Law and accordingly, they introduced a
difference in compensations coverage.
The bylaws of the Occupational Hazard Branch gives GOSI the
right to fall back on the employer to compensate any injured
employee of his when it is determined that the injury was due to
the employer's negligence.
10. Contractor's All Risks Insurance
Contractor's all risks insurance issued as CAR or EAR insurance
policies depending upon the type & Nature of contracted works.
Construction works require CAR insurance policy, while a project
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with erection work, such as steel or pre-cast works and the like,
require EAR insurance policy. The coverage in each of the two
insurance policies are for damage to property under construction
and/or erection, including contractor's equipment operating at work
sites, third party liability of the contractor (liability of contractor
resulting from execution of works), projects' material and
equipment that are moved from locations to work sites including
whilst stored at work sites. Coverage is for principal, contractor
and sub-contractors it also extends to include engineers,
designers, and consultants. All contracts require insurance cover
for maintenance operations; this comes in three coverage types
depending upon type of maintenance mentioned in contract
between contractor and principal. The three maintenance cover
types are: (1) simple maintenance, (2) extended maintenance, and
(3) guaranteed maintenance.
11. Travel Insurance
Is an insurance cover taken by those who travel abroad, which
covers certain losses such as medical expenses, loss of personal
belongings, travel delay, personal liabilities, etc.
12. Marine Insurance & Marine Cargo Insurance
Cover the loss or damage of ships at see or on inland waterways,
and of cargo that may be on them. When the owner of the cargo
and the carrier are separate corporations, marine cargo insurance
typically compensates the owner of cargo for losses sustained
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from fire, shipwreck, etc., but excludes losses the can be
recovered from the carrier or the carrier's insurance. Many marine
insurance underwriters will include "time element" coverage in
such policies, which extends the indemnity to cover loss of profit
and other business expenses attributable to the delay caused by a
covered loss.
Marine hulls insurance insures against hulls, spares, deductibles,
hull wear and liability risks.
13. Inland Transit Insurance
Is governed by an insurance contract covering on land road risks
or extended to all risks on land. The coverage allows consignee to
claim for loss or damage to cargo transported by on-land means of
transports caused by road accidents if coverage is for road risks
only, but can claim for other loss or damage to cargo if the road
risk coverage is extended to all risks.
14. Aviation Insurance
Insures against hull, spares, deductibles, hull wear and liability
risks.
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7. Insurance contract
An insurance contract determines the legal framework under which
the features of an insurance policy are enforced. Insurance
contracts are designed to meet very specific needs and thus have
many features not found in many other types of contracts. Many
features are similar across a wide variety of different types of
insurance policies.
1. Features of insurance contract
The insurance contract is a contract whereby the insurer will pay
the insured (the person whom benefits would be paid to, or on the
behalf of), if certain defined events occur. Subject to the "fortuity
principle", the event must be uncertain. The uncertainty can be
either as to when the event will happen (i.e. in a life insurance
policy, the time of the insured's death is uncertain) or as to if it will
happen at all (i.e. a fire insurance policy).
• Insurance contracts are generally considered contracts of
adhesion because the insurer draws up the contract and the
insured has little or no ability to make material changes to it.
This is interpreted to mean that the insurer bears the burden
if there is any ambiguity in any terms of the contract.
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• Insurance contracts are such that the amounts exchanged by
the insured and insurer (premiums/ claims) are unequal and
depend upon uncertain future events.
• Insurance contracts are unilateral, meaning that the insurer
is required to pay the benefits under the contract if the
insured has paid the premiums and met certain other basic
provisions.
• Insurance contracts are governed by the principle of "utmost
good faith" which requires both parties of the insurance
contact to deal in good faith and in particular it imparts on the
insured a duty to disclose all material facts which relate to
the risk to be covered. This contrasts with the legal doctrine
that covers most other types of contracts – "let the buyer
beware".
2. Constituents of insurance contract
• Opening paragraph – describes what the contract is about.
• Insuring Agreement - describes the covered perils, or risks
assumed, or nature of coverage, or makes some reference
to the contractual agreement between insurer and insured. It
summarizes the major promises of the insurance company,
as well as stating what is covered.
• Definitions - define important terms used in the policy
language.
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• Exclusions - take coverage away from the Insuring
Agreement by describing property, perils, hazards or losses
arising from specific causes which are not covered by the
policy.
• Conditions - provisions, rules of conduct, duties and
obligations required for coverage. If policy conditions are not
met, the insurer can deny the claim.
• Warranties – highlight the obligations of insured to observe
throughout the policy period. If insured is in breach of
warranty insurer can decline admitting the claim.
• Policy schedules - identify who is insured, insured's address,
the insuring company, what risks or property are covered,
the policy limits (amount of insurance), any applicable
deductibles, the policy period and premium amount, the
geographical limits for the application of cover.
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8. General principles of insurance
Apart from the principles governing all contracts insurance is also
governed by its own unique principles.
Indemnity
• Is perhaps the most fundamental principle of insurance law.
Object of indemnity is to place the insured after the loss in
the same position he occupied immediately before the loss.
He is not to be placed in a better or worse position.
• Not all insurance contracts are contracts of indemnity e.g. life
insurance. Indemnity is important as it deals in part with
moral hazard.
• Indemnity does not imply that the insured will be indemnified
to the full value of his loss e.g. a person whose factory is
destroyed by fire cannot recover for loss of profits or against
any liability that may arise from the fire unless he has
appropriate policies in place specifically designed to deal
with these losses.
• Indemnity can be achieved through the following methods:
1. Cash
2. Reinstatement e.g. where a building is destroyed,
insurers may reinstate it.
3. Repair e.g. where a motor vehicle is partially damaged.
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4. Replacement-instead of paying cash a replacement
item may be tendered.
5. New for old-used for household contents. This is not a
violation of the principle of indemnity as there is no
principle of law that requires indemnity to be
determined in terms of the market value of the asset.
6. Valued policies-in terms of which the insurer and the
insured agree before hand on the value to be paid
should a particular asset be destroyed or stolen. This
method of indemnity is used for assets with a
sentimental rather than a commercial value e.g.
jewelery, works of art etc.
The principle of indemnity is supported by 2 corollaries namely-
subrogation and contribution.
Subrogation
• Literally means “to stand in place of”. It is the right of one
person to stand at law in the place of another and to avail
him of all rights and remedies of that other person.
• Often when a claim occurs there may be 2 avenues of
recovery. Suppose A drives negligently and causes an
accident damaging B’s car. If B’s car is insured 2 options are
open to him to recover his loss-he can sue A for damages or
he can claim from his insurer. If B pursues both avenues he
will receive double compensation. To prevent B from profiting
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from his loss subrogation is used in terms of which once the
insurer has paid B the insurer assumes all B’s rights to sue
A. This ensures that the principle of indemnity is preserved.
• Subrogation has a number of sub-principles namely:
o The insurer cannot be subrogated to the insured’s right
of action until it has paid the insured and made good
the loss.
o The insurer can be subrogated only to actions which
the insured would have brought himself.
o The insured must not prejudice the insurer’s right of
subrogation. Thus the insured may not compromise or
renounce any right of action he has against the third
party if by doing so he could diminish his loss.
Subrogation against the insurer: Just as insured cannot profit
from his loss the insurer may not make a profit from the
subrogation rights. The insurer is only entitled to recover the
exact amount they paid as indemnity nothing more. If they
recover more the balance should be given to the insured.
Subrogation gives the insurer the right of salvage.
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Contribution
• Is another principle that aids indemnity. Often a person has
more than one policy on the same asset. Following a loss the
position of the 2 policies is governed by the principle of
contribution. Since indemnity forbids the insured from
recovering more than the loss then he cannot recover the full
value of the loss from each of the 2 policies.
• The law does not forbid people from engaging in double
insurance it only forbids profiting from a loss.
• Under the common law a person who has double insurance
can look to any of the insurers involved for compensation.
The insurer who would have paid can then claim contribution
from the other insurer involved.
• For contribution to apply the following conditions must be
met:
(1) The 2 policies must cover the same
insured.
(2) They must cover the same subject matter.
(3) They must cover the same interest.
(4) The peril causing the loss must be
covered by both policies albeit for
different amounts.
(5) Both policies must be current.
• Policies contribute pro-rata to the loss.
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Average
• Average is a concept used by insurers to deal with under-
insurance. Under-insurance occurs when an item is insured
for less than its market value.
• The general rule is that a person who under-insures his
property is entitled to the full amount of his loss whether total
or partial subject to the limits of the policy in the absence of
any provision in the policy to the contrary, e.g. if a house
worth SR500 000 is insured for SR300 000 and a loss of
SR100 000 occurs the insured in the absence of an average
clause in the policy would be entitled to SR100 000. By
implication therefore average is an alien concept to the
common law.
• Reduced to its logical conclusion average entails that if there
is under-insurance the insured shall be his own insurer to the
extent of the under-insurance. This means the insured will
bear part of the loss as a penalty for underinsurance.
• Insurer would have to include the average condition in the
policy for average to apply.
In marine insurance the term average has a meaning to that
ascribed to it in property. In marine insurance the word
'average' means "loss", hence came the terms general average,
general average sacrifice and general average expenditure.
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• The formula for average is: Sum insured/Market
value x loss sustained.
• Average only applies to contracts of indemnity
hence since life insurance contracts are not
contracts of indemnity all concepts derived from
indemnity like subrogation, contribution and average
do not apply to life policies.
The rationale behind average is that the insured should
pay a premium that is commensurate with the risk he
introduces to the pool to avoid prejudicing other
contributors.
Insurable Interest
• Insurable interest distinguishes contracts of insurance from
gambling in order to define the legitimate area of insurance
business.
• Insurable interest is required for all types of insurance and its
absence renders the contract void and hence unenforceable.
The leading Roman-Dutch law case on insurable interest is
Littlejohn v Norwich Union Fire Insurance Society 1905 TH 374
where it was held that if the insured can show that he stands to
lose something of an appreciable commercial value by the
destruction of the thing insured then his interest will be an
insurable one. The Court went further to state that as a general
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rule insurable interest should exist at the time of taking the
policy and at the time the loss is incurred.
If a person has insurable interest in an asset at the time of
taking the policy but loses the interest thereafter e.g. if he sells
the car, the policy ceases to have any validity.
• Insurable interest can be acquired in various ways notably:
(1) Ownership
(2) Legal possession
(3) Custody of property belonging to others e.g. bailees.
(4) Marriage-spouses have an insurable interest in each
other’s life.
(5) A lien-holder has insurable interest in the property
subject to the lien.
(6) A debt creates insurable interest between debtor and
creditor.
(7) An employer has an insurable interest in the life of an
employee.
• In life insurance the general rule is that insurable interest
need only exist at the time of taking the policy. Thus if A who
is married to B takes a life policy on his life and they later
divorce the policy will pay on B’s death even if technically
insurable interest no longer exists because the parties
divorced.
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Utmost Good Faith (UBERRIMA FIDES) & the Duty of
Disclosure
• Insurance contracts are characterized by information
asymmetries between the parties. Generally the insured
knows more about the risk to be insured than the insurer. To
rectify this imbalance the law compels disclosure of
information between the parties.
• To act in good faith entails involved parties deal openly and
honestly with each other without suppressing material facts
that may influence the judgment of the other party.
The duty to act in good faith applies to all types of insurance
contracts. In contracts of sale the maxim caveat vendito applies
meaning let the buyer beware. This maxim places an obligation
on the buyer to take all reasonable steps to verify that the item
he intends to buy meets his expectations. In insurance this
maxim does not apply.
• In England the doctrine of utmost good faith is incorporated
in the Marine Insurance Act 1906.
• The requirement of utmost good faith is complimented by the
duty of disclosure which places an obligation on both parties
to the insurance contract to disclose material facts relevant
to the contract to each other.
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• In England the Marine Insurance Act 1906 defines a material
fact as every circumstance that would influence the judgment
of a prudent insurer in fixing the premium or determine
whether he will take the risk. Hence in England a material
fact is defined from the perspective of a prudent insurer. This
can result in a heavy burden on the insured.
• Failure to disclose material facts renders the contract void-
able at the instance of the insurer. Of course the insured is
only expected to disclose facts that he knows or ought to
know.
• In life insurance facts commonly regarded as material
include: medical history; financial status; family medical
history; state of health; life style etc.
• In short term insurance common material facts would
include: previous convictions; financial status; whether
another insurer has cancelled insured’s policy in the past.
• The duty of disclosure lasts for the duration of the
negotiations and terminates when the contract is concluded.
Material facts that come to light after the contract has been
concluded are deemed to be part of the risk that the insurer
would have assumed.
• Naturally in short-term contracts the duty to disclose material
facts is revived at renewal of the policy. Life insurance
contracts are continuing contracts hence the duty to disclose
is not revived unless there is a specific duty in the policy
obliging the insured to do so.
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• To avoid liability on grounds of non-disclosure the onus is on
the insurer to prove that:
(1) The undisclosed facts were material.
(2) That the facts were within the actual or presumed
knowledge of the insured.
(3) That the facts were not communicated to the insurer.
• Upon discovering the non-disclosure the insurer must
exercise the right to repudiate the contract within a
reasonable time. Thus if upon discovering the non-disclosure
the insurer continues to accept the premium for example, the
insurer would be deemed to have waived the right to
repudiate and the contract will be binding as if there was no
non-disclosure.
• In summary therefore the duty of disclosure is justified on the
following grounds:
(1) The insured knows more about the risk than the
insurer hence the law must compel disclosure.
(2) Without the duty of disclosure the insurance market
cannot operate efficiently such that the supply side of
insurance can be disrupted.
(3) Disclosure enables the insurer to quantify and price the
risk appropriately.
(4) Disclosure also enables the insurer to determine
appropriate policy terms and conditions to be
incorporated in the policy. It enables the insurer to
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determine the extent to which the risk being presented
deviates from the norm.
(5) Disclosure also helps insurers manage the problem of
adverse selection.
On the other hand critics of the duty of disclosure point to the
following in support of their argument:
(1) The duty is unduly burdensome on the insured
depending on the test used to determine what
constitutes material facts.
(2) Insurers rarely warn the insured about the
consequences of non-disclosure.
(3) Given the current technological advances it is no
longer true to say insurers know less about the risk
than the insured. The reverse may well be true.
(4) The duty of disclosure may be abused by insurers
seeking to avoid their obligations.
(5) There is an element of self-serving hypocrisy by
insurers by insisting that facts that lessen the risk need
not be disclosed yet these may benefit the insured by
way of reduction of premium. Why are insurers only
interested in the bad and not the good?
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9. Cause of Loss – the doctrine of Proximate
Cause
• The general rule is that for a loss to be paid under a policy of
insurance, it must have been caused by an insured peril. Unless
the loss is proximately caused by an insured peril the policy
does not respond.
• The proximate cause of loss is the most dominant and efficient
cause in terms of bringing about a particular result.
• The onus of proving that the loss was proximately caused by an
insured peril rests with the insured.
• In Etherington v Lancashire and Yorkshire Accidental Insurance
Co (1909) a man fell from a horse and sustained injuries that
prevented him from moving. As a result he contracted
pneumonia due to lying in the wet and died. The proximate
cause of his death was held to be the fall not pneumonia.
• Similarly if furniture is thrown out of a burning house to arrest
the spread of the fire and is damaged in the process the
proximate cause of the damage would be the fire.
• If the insured makes a prima-facie case that the loss was
proximately caused by an insured peril the insurer is obliged to
indemnify unless they can prove that an exception applies.
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