Ch2. Insurance Contract Law — Characteristics and Legal Principles

Legal Characteristics of an Insurance Contract

Bilateral Contract:
Policyholder: obligated to pay premiums
Insurer: obligated to pay covered claims

Contract of Adhesion:
The insurer drafts the standard policy form.
The applicant can only accept or reject — no negotiation.
Ambiguities are interpreted against the insurer (contra proferentem).

Aleatory Contract:
The insurer's obligation to pay is triggered by a
contingent, uncertain event.
Not all policyholders receive claim payments.

Contract of Utmost Good Faith:
Both parties must act in complete honesty and transparency.
The insured must disclose all material facts; the insurer
must clearly explain policy terms and exclusions.

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Duty of Disclosure (Material Misrepresentation)

Duty of Disclosure:
The applicant must disclose all material facts
before the contract is issued.

Material Fact:
Any information that would affect the insurer's
decision to issue coverage or set the premium —
e.g., medical history, occupation, prior claims.

Breach of the Duty of Disclosure:
Insurer may rescind (void) the policy if:
  - the misrepresentation was intentional or fraudulent,
  - the fact was material, and
  - the insurer was unaware of the true information.
Insurer may also deny the claim.

Limits on Rescission:
If the insurer knew or should have known the fact: cannot rescind.
If the misrepresented fact is unrelated to the loss: claim must be paid
(the no-causation exception).

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Indemnity, Coinsurance, and Subrogation

Principle of Indemnity:
The insured cannot collect more than the actual loss.
Prevents unjust enrichment (double recovery).

Over-insurance:
Insured value > actual value → pays out only up to actual value.

Under-insurance:
Insured value < actual value → pro-rata (coinsurance) penalty applies.

Double Insurance (Concurrent Policies):
The same property insured by multiple insurers
for the same risk and same interest.
Each insurer contributes proportionally;
total recovery cannot exceed actual loss.

Salvage and Subrogation:
After paying a claim, the insurer "steps into the shoes" of
the insured and may pursue recovery from the responsible party.

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Key Concept Cards

Duty of Disclosure = Disclose All Material Facts Before Binding ★★★★★ : The applicant must reveal everything material before the policy is issued. Memory hook: Disclose before binding

Indemnity = Recovery Capped at Actual Loss ★★★★★ : No double recovery; insurance restores the insured to pre-loss position. Memory hook: Indemnity = make whole, not profit

Double Insurance = Pro-Rata Contribution ★★★★☆ : Multiple policies on the same risk share the loss proportionally. Memory hook: Double = share, not stack

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Practice Quiz

Q. Under what conditions can an insurer deny a claim for misrepresentation?

The misrepresentation must have been intentional or fraudulent (or at minimum, grossly negligent). The concealed fact must be material — meaning it would have affected the insurer’s underwriting decision or premium. The insurer must have been unaware of the true fact. The no-causation exception: even if there was misrepresentation, if the concealed fact had no causal connection to the loss, the claim must be paid. For example: failing to disclose hypertension, then making a claim for a car accident injury — the hypertension is unrelated, so the claim must be honored.

Q. Why does the principle of indemnity not apply to life insurance?

Life insurance pays a fixed, pre-agreed death benefit — it is not designed to measure or compensate an economic “loss.” The value of a human life cannot be objectively quantified. The indemnity principle applies to property and casualty insurance, where actual dollar losses can be measured. Because life insurance is a fixed-benefit product, multiple life policies can each pay their full face amount — there is no pro-rata contribution. In contrast, duplicate property policies share losses up to the actual property value.