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Group (1) Names :

Hussein Haji Ahmed Mohamed

Hafso Osman Ahmed
Yahye Dek Mohamed
Mohamed-Amin Ahmed Haji
Hafso Abdirahman Adam
Abdi Salam Abdullahi moumin

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 Mogadishu University

Chapter Nine
Fundamental legal principal

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 In this chapter we will learn :

Principle of Indemnity

Principle of Insurable Interest

Principle of Subrogation

Principle of Utmost Good Faith

Requirements of an Insurance Contract

Distinct Legal Characteristics of Insurance Contracts

Law and the Insurance Agent

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 Principle of Indemnity

The principle of indemnity is one of the most important principles in insurance.

The principle of indemnity states that the insurer agrees to pay no more than the
actual amount of the loss , stated differently, the insured should not profit from a
loss.

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 Fundamental Purposes

The principle of indemnity has two fundamental purposes.

The first purpose is to prevent the insured from profiting from a loss

The second purpose is to reduce moral hazard

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 Actual Cash Value

• The concept of actual cash value supports the principle of indemnity.

In property insurance, the basic method for indemnifying the insured
is based on the actual cash value of the damaged property at the time
of loss.

• The courts have used a number of methods to determine actual cash

value, including the following:

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1) Replacement cost less depreciation:

• Replacement cost is the current cost of restoring the damaged property

with new materials of like kind and quality.

• Depreciation is a deduction for physical wear and tear, age, and

economic obsolescence.

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2) Fair market value:

Fair market value is the price a willing buyer would pay a willing seller
in a free market . The fair market value of a building may be below its
actual cash value based on replacement cost less depreciation.

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3) Broad Evidence Rule:
The broad evidence rule means that the determination of actual cash value
should include all relevant factors an expert would use to determine the value of
the property

Relevant factors include replacement cost less depreciation, fair market value,
present value of expected income from the property, comparison sales of similar

property, and numerous other factors.

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 Exceptions to the
Principle of Indemnity

There are several important exceptions to the principle of indemnity. They

include the following:

Valued policy

Valued policy laws

Replacement cost insurance

Life insurance

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• Valued policy: is a policy that pays the face amount of insurance if

a total loss occurs .

• Valued Policy law: is a law that exists in some states that requires
payment of the face amount of insurance to the insured if a total
loss to real property occurs from a peril specified in the law .

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• Replacement Cost Insurance: means there is no deduction for physical

depreciation in determining the amount paid for a loss .

• life insurance life insurance contract is not a contract of indemnity but is a valued
policy that pays a stated amount to the beneficiary upon the insured’s death. The
indemnity principle is difficult to apply to life insurance because the actual cash
value rule (replacement cost less depreciation) is meaningless in determining the
value of a human life.

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 PRINCIPLE OF INSURABLE INTEREST

• The principle of insurable interest states that the insured must be in a

position to lose financially if a covered loss occurs

• Purposes of an Insurable Interest:-

To prevent gambling

To reduce moral hazard

To measure the amount of the insured’s loss in property insurance

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Gambling

If an insurable interest were not required, the contract would be a gambling contract
and would be against the public interest.

reduces moral hazard

If an insurable interest were not required, a dishonest person could purchase

property insurance on someone else’s property and then deliberately cause a loss to
receive the proceeds

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To measure the amount of the insured’s loss in property insurance

in property insurance, an insurable interest measures the amount of the insured’s loss.

• Most property insurance contracts are contracts of indemnity, and one measure of recovery is the
insurable interest of the insured.

• Examples of an Insurable Interest

• Several examples of an insurable interest are discussed in this section. However, it is helpful at this
point to distinguish between an insurable interest in property and casualty insurance and in life
insurance.

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• Property and Casualty Insurance Ownership of property can support an insurable interest because owners
of property will lose financially if their property is damaged or destroyed.
• Potential legal liability can also support an insurable interest.
• Secured creditors have an insurable interest as
• well.
• Finally, a contractual right can support an
• insurable interest.
• Life insurance is a contract between an insurer and policyholder in which the insure guarantees payment of
a death benefit to named beneficiaries when the insured dies..
• When must insurable interest exist?
• Property insurance: at the time of the loss
• Life insurance: only at inception of the policy

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PRINCIPLE OF SUBROGATION

• The principle of subrogation strongly supports the principle

of indemnity. Subrogation means substitution of the insurer in
place of the insured for the purpose of claiming indemnity
from a third party for a loss covered by insurance. Stated
differently, the insurer is entitled to recover from a negligent
third party any loss payments made to the insured.
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• For example, assume that a negligent motorist fails to stop at a red light and smashes
into Megan’s car, causing damage in the amount of $5000. If she has collision
insurance on her car, her insurer will pay the physical damage loss to the car (less any
deductible) and then attempt to collect from the negligent motorist who caused the
accident. Alternatively, Megan could attempt to collect directly from the negligent
motorist for the damage to her car. Subrogation does not apply unless the insurer
makes a loss payment.

• However, to the extent that a loss payment is made, the insured gives to the insurer
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any legal rights to collect damages from the negligent third party
 Purposes of Subrogation
• Subrogation has three basic purposes. First, subrogation
prevents the insured from collecting twice for the same loss.
In the absence of subrogation, the insured could collect from
his or her insurer and from the person who caused the loss.
The principle of indemnity would be violated because the
insured would be profiting from a loss.
• Second, subrogation is used to hold the negligent person
responsible for the loss. By exercising its subrogation rights,
the insurer can collect from the negligent person who caused
the loss.
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• Finally, subrogation helps to hold down insurance rates.

Subrogation recoveries are reflected in the ratemaking process,
which tends to hold rates below where they would be in the
absence of subrogation. Although insurers pay for covered
losses, subrogation recoveries reduce the loss payments.

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• Importance of Subrogation

• The insurer is entitled only to the amount it has paid under the policy

• The insured cannot impair the insurer’s subrogation rights

• Subrogation does not apply to life insurance and to most individual health
insurance contracts

• The insurer cannot subrogate against its own insures

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 PRINCIPLE OF UTMOST GOOD FAITH

An insurance contract is based on the principle of utmost good faith— that is a

higher degree of honesty is imposed on both parties to an insurance contract than is
imposed on parties to other contracts.
• Supported by three legal doctrines:
Representations are statements made by the applicant for insuranceA
contract is voidable if the representation is material, false, and relied on
by the insurer
An innocent misrepresentation of a material fact, if relied on by the
insurer, makes the contract voidable

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 Date:

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 A concealment is intentional failure of the applicant for insurance to reveal a

material fact to the insurer

 A warranty is a statement that becomes part of the insurance contract and is

guaranteed by the maker to be true in all respects

Statements made by applicants are considered representations, not warranties

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 REQUIREMENTS OF AN INSURANCE CONTRACT

FOUR BASIC REQUIREMENTS

Offer and Acceptance.1

The first requirement of a binding insurance contract is that there must be an offer and
acceptance In most cases, the applicant for insurance makes the offer, and the company
.accepts or rejects the offer. The offer and acceptance can be oral or written

The applicant for insurance fills out the application and pays the first premium agents
.typically have the power to bind their companies through use of a binder

. A binder
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is a temporary contract for insurance and can be either written or oral
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2. Consideration

the value that each party gives to the other. The insured’s consideration is
payment of the premium (or a promise to pay the premium) plus an
agreement to abide by the conditions specified in the policy.

The insurer’s consideration is the promise to do certain things as specified in

the contract.
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3. Competent Parties

each party must be legally competent . This means the parties must have legal capacity to enter
into a binding contract. Most adults are legally competent to enter into insurance contracts, but
there are some exceptions. Insane persons, intoxicated persons, and corporations that act outside
the scope of their authority cannot enter into enforceable insurance contracts.
The insurer must also be legally competent. Insurers generally must be licensed to sell
insurance in the state, and the insurance sold must be within the scope of its charter or
certificate of incorporation.
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4. Legal Purpose

• the contract must be for a legal purpose . An insurance contract that

encourages or promotes something illegal or immoral is contrary to the
public interest and cannot be enforced.

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 DISTINCT LEGAL CHARACTERISTICS
OF INSURANCE CONTRACTS

Insurance contracts have distinct legal characteristics that make them

different from other legal contracts. Other distinct legal characteristics
are as follows:-
Aleatory contract
Unilateral contract
Conditional contract
Personal contract
Contract of adhesion
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 Aleatory Contract

An insurance contract is aleatory rather than commutative. An aleatory contract

is a contract where the values exchanged may not be equal but depend on an
uncertain event . Depending on chance, one party may receive a value out of
proportion to the value that is given. In contrast, other commercial contracts are
commutative. A commutative contract is one in which the values exchanged by
both parties are theoretically equal . For example, the purchaser of real estate
normally pays a price that is viewed to be equal to the value of the property.
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 Unilateral Contract

An insurance contract is a unilateral contract. A unilateral contract means that only

one party makes a legally enforceable promise . In this case, only the insurer makes

a legally enforceable promise to pay a claim or provide other services to the insured.

After the first premium is paid, and the insurance is in force, the insured cannot be

legally forced to pay the premiums or to comply with the policy provisions

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 Conditional contract

An insurance contract is a conditional contract . That is, the insurer’s

obligation to pay a claim depends on whether the insured or the beneficiary has
complied with all policy conditions. Conditions are provisions inserted in the
policy that qualify or place limitations on the insurer’s promise to perform . The
conditions section imposes certain duties on the insured if he or she wishes to
collect for a loss.

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 personal contract

In property insurance, insurance is a personal contract , which means the

contract is between the insured and the insurer . Strictly speaking, a property
insurance contract does not insure property, but insures the owner of property
against loss. The owner of the insured property is indemnified if the property is
damaged or destroyed. Because the contract is personal

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 Contract of adhesion

A contract of adhesion means the insured must accept the entire contract, with

all of its terms and conditions . The insurer drafts and prints the policy, and the

insured generally must accept the entire document and cannot insist that certain

provisions be added or deleted or the contract rewritten to suit the insured.

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 LAW AND THE INSURANCE AGENT

An insurance contract normally is sold by an agent who represents the

principal (the insurer). An agent is someone who has the authority to
act on behalf of someone else. The principal (insurer) is the party for
whom action is to be taken.

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 Low of Agency

Important rules of law govern the actions of agents and their relationship to insureds.
They include the following:-

There is no presumption of an agency relationship.

An agent must have authority to represent the Principal

A principal is responsible for the acts of agents acting within the scope of their
authority.

Limitations can be placed on the powers of agents

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 End of the chapter

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