BBMF2083 INSURANCE MANAGEMENT

CHAPTER 4 LEGAL PRINCIPLES IN INSURANCE (ANSWERS)

1. In order to form a valid insurance contract, several requirements or elements of a contract

must be fulfilled. Discuss how each of these requirements is fulfilled when an applicant
applies for an auto insurance policy.

ASW:

 The applicant for an auto insurance policy fills out the application for insurance.
This constitutes the offer.
 The insurer then accepts or rejects the offer.
 Consideration by the applicant 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, which can include payment of a loss from an insured peril, providing
certain services, or defending the insured.
 Each party must be legally competent and have legal capacity to enter into a
binding contract.
 The applicant for auto liability insurance must not be a minor, insane, or
intoxicated when he or she applies for insurance.
 Also, the liability insurer must have legal authorization to sell auto liability
insurance.

2.

a) Why is it important to know in an insurance transaction who makes the offer and who
accepts the offer? Discuss.

b) In a property insurance transaction, who typically accepts the offer? Discuss.

ASW:

a) It affects not only the validity of the contract but the time when it goes into effect.

b) In property & liability insurance, it is the insured who technically makes an offer to the
insurer, who accepts the offer, rejects it, or makes a counteroffer. The offer is usually
accepted by an insurance agent on behalf of the insurer.

3. In your opinion, which of the following are insurance contracts? Explain your answer.

a) A promise to replace a washing machine if it does not work properly, accidental damage
being excluded.

b) A promise to provide medical care when needed.

c) A promise to replace tires that blow out because of defects or accidental causes.

d) A promise to pay the loss sustained if a share of common stock is worth less five years
from now.

1
 ASW:

Common legal tests to determine whether a particular transaction is insurance are whether:

 There is a risk of accidental economic loss to the beneficiary / insured that is independent
of the contract;

 The risk is assumed by the insurer / promisor; and

 There is a plan to distribute the cost of the loss among the group exposed to risk.

a) No. Warranties are not generally considered insurance if they exclude losses by external
accidental causes.

b) Yes.

c) Yes. A tire manufacturer was held to be engaged in the insurance business when it
promised to repair / replace the tire if any defects were discovered / accidental losses
incurred within a stated period.

d) No. Speculative risk (not pure risk).

4. Jake borrowed RM800,000 from the Gateway Bank to purchase a fishing boat. He keeps
the boat at a dock owned by the Harbor Company. He uses the boat to earn income by
fishing. Jake also has a contract with the White Shark Fishing Company to transport tuna
from one port to another.

a) Do any of the following parties have an insurable interest in Jake or his property? If an
insurable interest exists, discuss the extent of the interest.

i) Gateway Bank

ii) Harbor Company

iii) White Shark Fishing Company

b) If Jake did not own the boat but operated it on behalf of the White Shark Fishing
Company, would he have an insurable interest in the boat? Explain.

ASW:

a)
i) The Gateway Bank has an insurable interest in the boat because it serves as collateral for
the loan. Thus the Gateway Bank has an insurable interest in the amount of RM800,000.
ii) The Harbor Company also has an insurable interest in the property. The Harbor Company
is a bailee, and there may be possible legal liability if Jake is negligent while docking the

2
 boat and using the facilities. Also, the Harbor Company would lose rental income if the
boat is damaged. The loss of rental income will support an insurable interest.
iii) The White Shark Fishing Company also has an insurable interest in the property. Jake is
acting as the company’s agent, and his negligence can be imputed to the White Shark
Fishing Company. Thus, potential legal liability for a negligent act by Jake would support
an insurable interest.

b) Yes. Jake is using the boat and has a potential legal liability as a bailee if he should
damage the boat. In addition, if the boat is damaged there may be a business income loss
and the loss of earnings, which would also support an insurable interest.

5. Jones sells a building to Smith. Does the property insurance on the building now protect
Smith? If not, what arrangement can be done to cover Smith?

ASW:

No. In order to provide coverage for Smith, an assignment of the property policy has to be
done before a loss occurs & a written consent from the insurer must be obtained first. In
this case, the control of the property & the interest therein passes out of the hands of the
original insured (Jones) to the new owner (Smith).

6. Kyle assigned his life insurance policy to Lyons with the consent of the beneficiary in
writing, but the company was never notified of the assignment. What is the status of the
parties concerned? Discuss.

ASW:

Life insurance policies are in the nature of property & may be freely assigned, subject only
to the restrictive provisions in the contract itself. A policy in which a beneficiary is named
without right of change cannot, of course, be assigned without the consent of the
beneficiary.

It is the general practice of insurance companies to include in their policies an assignment

restriction. This, however, does not mean that the consent of the insurance company is
necessary, as in the case of a property policy. Even without the knowledge of the company,
the assignment would be binding upon the assignor & assignee, but when the company has
no notice of the assignment, it is not responsible for seeing that the assignee gets the
money.

7. Indicate the correct and incorrect statements among the following:

a) Insurable interest must exist at the time of the loss.

b) For a loss to be collected, insurable interest must exist at the time the insurance is obtained.

c) Insurable interest arises only out of legal or equitable title.

3
 ASW:

a) Correct for property & liability insurance contracts only. For property & liability insurance
contracts, it is sufficient if an insurable interest exists at the time of the loss, even though
no such insurance existed at the time the policy was issued. However, unlike the situation
in property insurance, in life insurance an insurable interest need exist only when the
policy is taken out; its subsequent loss does not void the contract.

b) Correct for life insurance contracts only. For property & liability insurance contracts, it is
sufficient if an insurable interest exists at the time of the loss, even though no such
insurance existed at the time the policy was issued. However, unlike the situation in
property insurance, in life insurance an insurable interest need exist only when the policy is
taken out; its subsequent loss does not void the contract.

c) Incorrect. For property & liability insurance contracts, there are various kinds of insurable
interest, and not limited to ownership only:

 Ownership: The clearest & most common case of the existence of an insurable interest is
that of an owner of property. The owner has an insurable interest, whether he be the legal
or the equitable owner.

 Creditors: Secured creditors have an insurable interest. E.g. A commercial bank or

mortgage company that lends money to buy a house has an insurable interest in the
property. The property serves as collateral for the mortgage, so if the building is
damaged, the collateral behind the loan is impaired. However, the courts have ruled that
unsecured or general creditors normally do not have an insurable interest in the debtor’s
property.

 One who is legally liable: Potential legal liability can also support an insurable interest.
E.g. A dry-cleaning firm has an insurable interest in the property of the customers. The
firm may be legally liable for damage to the customers’ goods caused by the firm’s
negligence.

 Interest arising from contract: A contractual right can support an insurance interest. E.g.
A business firm that contracts to purchase goods from abroad on the condition that they
arrive safely in the U.S. as an insurable interest in the goods because of the loss of profits
if the merchandise does not arrive.

8. Must the beneficiary of a life insurance policy have an insurable interest in the continued
life of the person insured? Discuss.

ASW:

The beneficiary is not required to have an insurable interest in the continued life of the
person insured.

4
9. What must an insurer prove if he wants to deny a property insurance claim on the grounds
of:

a) Concealment/ hiding;

b) Misrepresentation;

c) Breach of warranty.

ASW:

a) Concealment

An insured may be accused of concealment if he does not reveal certain facts known to
him (or that should have been known to him) that the insurer could not be expected to
know on his own.

In ocean marine insurance, the insurer may refuse to pay a claim if it can show that the
insured concealed a fact that, if it had been known to the insurer, would have caused it to
refuse to issue the insurance / to make a counteroffer. Intent to conceal need not be proved
& the fact concealed need not have contributed to the loss.

The reasoning is clearest when the insurer would not have issued the contract because in
that case it would not have been involved when the loss occurred. In other lines of
insurance, intent to conceal has to be proved.

Ocean marine insureds are treated more harshly because (1) they are usually more
informed buyers, & (2) at the same time ocean marine insurance law was being developed,
communications were poor & it was usually the insurer who was in a disadvantageous
position.

b) Misrepresentation

If the insured gives an incorrect answer to a direct question by the insurer, the insurer may
accuse him of misrepresentation. If the question was 1 of fact, all the insurer need prove is
materiality as defined above. If the question asked for the insured’s opinion, both
materiality & intent to deceive must be proved.

c) Breach of warranty

If the insurer makes the insured’s response to a question a condition of the contract, he
may accuse the insured of a breach of warranty if the response is incorrect. To avoid claim,
he need not prove either intent or materiality. The fact that the insurer made the response a
condition of his promise is supposed to alert the insured to his materiality. However, the
insurer must have made it clear to the insured that his answer would be considered a
warranty. Furthermore, a distinction is made between affirmative warranties (conditions
said to exist on the date the contract was written) & promissory warranties (conditions said
to exist during some period after the issue date).

10. Nicole is applying for a health insurance policy. She has a chronic liver ailment and other
health problems. She honestly disclosed the true facts concerning her medical history to the
insurance agent. However, the agent did not include all the facts in the application. Instead,
the agent stated that he was going to cover the material facts in a separate letter to the

5
 insurance company’s underwriting department. However, the agent did not furnish the
material facts to the insurer, and the contract was issued as standard. A claim occurred
shortly thereafter. After investigating the claim, the insurer denied payment. Nicole
contends that the company should pay the claim because she answered honestly all
questions that the agent asked.

a) On what basis can the insurance company deny payment on the claim? Discuss.

b) What legal doctrine can Nicole use to support her argument that the claim should be paid?
Discuss.

ASW:

a) The insurer could attempt to deny payment of the claim on the basis of a material
concealment.
b) The principal is responsible for all acts of the agents when they are acting within the scope
of their authority. Also, knowledge of the agent is presumed to be knowledge of the
principal with respect to matters within the scope of the agency. In this case, the agent
knew that Nicole had a health problem and deliberately omitted this information from the
application. This knowledge is imputed to the insurer. Thus, if the insurer issues the policy,
it cannot later attack the validity of the policy on the grounds that Nicole concealed a
material fact. Based on the doctrine of estoppel, the company could not deny liability for
the claim. The agent told Nicole the health information would be given to the underwriters.
Nicole relied on the agent’s statement and believed she had coverage. Since the insurer is
responsible for the acts of agents, including acts of omission and fraud, the company
cannot deny liability for the claim.

11. Matthew was involved in an auto accident. He was judged to be 40% at fault in the
accident and the other party was judged to be 60% at fault. Matthew’s actual damages were
RM50,000. Under a contributory negligence law, how much, if any, will Matthew receive
for his injury?

ASW:

Under a contributory negligence law, you can collect damages for your injury even if you
are negligent, but your damage award is reduced proportionately. Mathew has actual
damages of RM50,000. Because he is 40 percent at fault, his damage award is reduced 40
percent. Mathew will collect RM30,000 for his injury.

12. Michael went deer hunting with Ed. After seeing bushes move, Michael quickly fired his
rifle at what he thought was a deer. However, Ed caused the movement in the bushes and
was seriously injured by the bullet. Ed survived and later sued Michael on the grounds that
“Michael’s negligence was the proximate cause of the injury”.

6
a) Based on the above facts, is Michael guilty of negligence? Your answer must include a
definition of negligence and the essential elements of negligence.

b) Michael’s attorney believes that if contributory negligence could be established, it would

greatly influence the outcome of the case. Do you agree with Michael’s attorney? Your
answer must include a definition of contributory negligence.

c) Assume that Michael and Ed are hunting on farmland without obtaining permission from
the owner. If Michael fell into a marshy pond covered by weeds and injured his back,
would the property owner be liable for damages? Discuss.

ASW:

a) There are four elements of negligence:

1. Existence of a legal duty to use reasonable care. Michael has a legal duty to protect others
from harm. This also includes a legal duty toward Ed. Michael should have been aware of
Ed’s presence and should not have fired into the bush without first determining Ed’s
location. The first requirement is met.
2. Failure to perform that duty. Michael quickly fired the rifle into the bush without first
determining if Ed or a deer caused the movement. It appears that Michael did not take the
necessary precautions to protect Ed from harm. The second requirement is met.
3. Damages or injury to the claimant. Since Ed was injured, this requirement is met.
4. Proximate cause relationship. There must be an unbroken chain of events between the
negligent act and infliction of damages. In this case, Michael’s actions were the proximate
cause of loss.
The four requirements of a negligent act are satisfied, and Michael is guilty of negligence.
b) Yes. The damage award would be reduced. Under the contributory negligence doctrine, if
an injured person contributed to the injury, he or she can still collect damages but the
damage award will be reduced.
c) Michael would be considered a trespasser since he did not obtain permission to hunt on the
farmer’s land. In general, a trespasser takes the property as he or she finds it. The farmer
has no legal obligation to warn Michael of the marshy pond and is not liable for damages.