Chapter 1
Four Elements of a Legal Contract
1. Competent Parties 2. Legal Purpose 3. Agreement 4. Consideration
Insurance Contract
A legal contract purchased to indemnify the insured against a loss, damage, or liability arising from an unexpected event. The exchange of a relatively small and definite expense for the risk of loss that, if it occurs, may be large or small. A contract designed to transfer risk from the insured to the insurer.
Broker
A licensed individual who negotiates insurance contracts with insurers, on behalf of the applicant. A broker represents the applicant or insured's interests, not the insurer, and thus does not have legal authority to bind the insurer. A broker's license is not applicable in all states.
Physical Hazard
A physical condition that increases the probability of loss; use, condition, or occupancy of property. Example: Flammable material stored near a furnace.
Reciprocal Insurance Company
A reciprocal insurance company is a group-owned insurer whose main activity is risk sharing. They are unincorporated, and formed by individuals, firms, and business corporations that exchange insurance on one another. Each member is known as a subscriber. Each subscriber assumes a part of the risk of all other subscribers. If premiums collected are insufficient to pay losses, an assessment of additional premium can be made. The exchange of insurance is affected through an Attorney-In-Fact.
Insurer
A relationship between two or more parties where one party (the agent or producer) acts on behalf of the other party, known as the principal or insurer. The agent or producer binds the actions and words of the principal.
Law of Agency
A relationship between two or more parties where one party (the agent or producer) acts on behalf of the other party, known as the principal or insurer. The agent or producer binds the actions and words of the principal.
Hazard
A specific condition that increases the probability, likelihood, or severity of a loss from a peril.
Stock Insurance Company
A stock company is owned by stockholders or shareholders. Directors and officers direct the company operations and are elected by stockholders. Stockholders receive taxable corporate dividends as a return of profit when declared by the Directors. - Dividends are not guaranteed - Traditionally, stock insurers issue Non-Participating policies
Voidable Contract
A valid contract that for reasons satisfactory to a court, may be set aside by one of the parties. An example is an insurer may void or revoke coverage for misrepresentation or fraud.
Parol Evidence Rule
A written contract may not be altered without the written consent of both parties
Claims Department
Assists the policyholder in the event of a loss.
Exclusive or Captive Agency System
Deals with the insured through an exclusive or captive agent. Agent represents solely one company or group of companies having common ownership. Insurer retains ownership rights to the business written by the agent. The agent is an employee or a commissioned independent contractor. Insurer may or may not provide office and agency support services.
Motor Carrier Regulatory and Modernization Act (the Motor Carrier Act of 1980)
Deregulated the trucking industry by prohibiting any entity from interfering with a motor carrier's right to set its own rates. Motor carriers and private motor carriers that transport property are required to establish evidence of financial responsibility in the form of insurance, a bond, a guarantee, or qualification as a self-insurer.
Financial Rating Services
Independent financial rating services evaluate and rate the financial stability of insurance companies. These companies assign rating codes to show financial strength or weakness of each company rated. The ratings are available to the public and producers are responsible for placing business with insurers that are financially sound. Examples of rating services include: A.M. Best Company, Standard & Poor's, Moody's Investment Services, Weiss Insurance Rating, and Fitch Ratings.
Fraud
Intentional deception of the truth in order to induce another to part with something of value or to surrender a legal right. Contains 5 elements: False statement, made intentionally and that pertains to a material fact Disregard for the victim Victim believes the false statement Victim makes a decision and/or acts based on the belief in, or reliance upon, the false statement The victim's decision and/or action results in harm
Void Contract
Intentional deception of the truth in order to induce another to part with something of value or to surrender a legal right. Contains 5 elements: False statement, made intentionally and that pertains to a material fact Disregard for the victim Victim believes the false statement Victim makes a decision and/or acts based on the belief in, or reliance upon, the false statement The victim's decision and/or action results in harm
Insurable Risks
Large number of homogenous units or groups with the same perils.Law of Large Numbers - As the number of units in a group increases, the more likely it is to predict a particular outcome.Auto insurance losses are the easiest type of insurance loss to predict precisely because the number of units insured is so great. The chance of loss must be calculable. A statistical expectation of loss is used by insurers to calculate premiums. The loss must be measurable (definite and verifiable in terms of amount, cause, place and time). The premiums must be affordable. From the perspective of the insured, the loss must be accidental in nature. Catastrophic perils are not covered; examples include war, nuclear hazard and illegal operations.
Lloyds of London
Lloyds of London is not an insurance company, but consists of groups of underwriters called Syndicates, each of which specializes in insuring a particular type of risk. Lloyds provides a meeting place and clerical services for syndicate members who actually transact the business of insurance. Members are individually liable for each risk they assume. Coverage provided is underwritten by a syndicate manager, such as an attorney-in-fact or individual proprietor.
Executives
Oversee the operation of the business.
Loss
Reduction, decrease, or disappearance of value. The basis of a claim for damages under the terms of an insurance policy.
Facultative Agreements
Reinsurance agreement that allows ceding and reinsurance companies the opportunity to negotiate coverage for individual risks.
Treaty Agreements
Reinsurance agreement that covers all risks contained in the subject line(s) of business automatically.
Underwriting Deparment
Responsible for the selection of risks (persons and property to insure) and rating that determines actual policy premium.
Risk Retention Groups (RRGs)
Risk Retention Groups are group-owned insurers that primarily assume and spread the liability related risks of their members. RRGs are owned by their policyholders and licensed in at least one state. However, they may insure members of the group in other states. The Group must be made up of a large number of homogeneous or similar units and membership is limited to risks with exposure to similar liability needs, such as theme parks, go cart tracks, or waterslides. The Group also must have sufficient liquid assets to meet loss obligations and each member assumes a portion of the risks insured.
Loss Exposure
The condition of being at risk for a loss. Purely by existing, property and people are at risk for loss.
Applicant
The party submitting an application for insurance
Underwriting
The process of selecting, classifying, and rating a risk for the purpose of issuing insurance coverage.
Underwriter
Underwriting protects the insurer against adverse selection and risks that are more likely than average to suffer losses. The underwriter's primary responsibility is the selection of risks to be insured. The underwriter also determines the classification, and premium rate if a risk is accepted by the insurer. The goal of an underwriter is to select risks that fall into the normal range of expected losses. The producer is the field underwriter; the line and staff underwriters are employed by the insurer.
Fraternal Benefits Society
Usually organized on a non-profit basis, fraternal benefit societies are primarily social organizations that engage in charitable and benevolent activities that provide life and health insurance to their members. Membership typically consists of members of a given faith, lodge, order, or society.
Fair Credit Reporting Act
protects consumer privacy, while ensuring data collected is confidential, accurate, relevant and used for a proper and specific purpose. It also protects the public from overly intrusive information collection practices.
Contract Law
Pertains to the formation and enforcement of contracts.
Estoppel
Prevents the denial of a fact, if the fact was admitted to be true previously.
Premium Assumptions
An adequate premium must be charged for the risk based on the same factors used in evaluating the risk. Premium rates are considered inadequate when they do not cover projected losses and expenses; rates must not be excessive or unfairly discriminatory.
Indemnity Contract
An agreement to pay on behalf of another party under specified circumstances, such as when a loss occurs.
Direct Writing System
Producer or Agent is an employee of the insurer. Insurer owns the accounts. The agent may be paid a salary, salary plus bonus, or commission.
Unilateral Contract
Only one party is legally bound to the contractual obligations after the premium is paid to the insurer. Only the insurer makes a promise of future performance, and only the insurer can be charged with breach of contract.
Moral Hazard
Dishonest tendencies that increase the probability of a loss; certain characteristics and behaviors of people. Example: An insured burns down his/her own house to collect the insurance payout.
Personal Producing General Agent
Does not recruit career agents. Sells insurance for carriers it is contracted with and maintains its own office and staff.
Domicile
Domicile refers to the jurisdiction (i.e., state or country) where an insurer is formed or incorporated. There are three types of Insurer domiciles:
Actuarial Department
Gather and interpret statistical information used in rate making. An actuary determines the probability of loss and sets premium rates.
Principle of Indemnity
Insured is restored to the same financial or economic condition that existed prior to the loss. Insured should not profit from an insurance transaction.
Risk Sharing
Investments of a large number of people may be pooled by use of a corporation or partnership
Marketing/Sales Department
Responsible for advertising and selling.
Insurability
The ability of an applicant to meet an insurer's underwriting requirements.
Risk
A condition where the chance, likelihood, probability or potential for a loss exists; Uncertainty concerning a loss.
Valued Contract
A contract that pays a stated amount in the event of a loss (most insurance policies are NOT valued contracts unless they are endorsed).
Hold Harmless Agreement
A contractual agreement that transfers the liability of one party to another party; it is used by landlords, contractors, and others as a way to avoid or reduce risk.
Application
A document submitted by an applicant to an insurer that provides information needed for the insurer to underwrite a risk; becomes part of the insurance contract. Most applications require statements on the application to be true to the best knowledge and belief of the applicant.
Misrepresentations
A false statement contained in the application; usually does not void coverage or the policy. If material to the issuance of coverage, meaning the insurer would not have issued coverage had the misrepresentation not been made, coverage does not apply. In some cases, a material misrepresentation may void the policy.
Mutual Insurance Company
A mutual company is owned by policyholders (who may be referred to as members). A Board of Trustees or Directors directs the company operations and is elected by policyholders. Policyholders receive non-taxable dividends as a return of unused premium when declared by the directors. - Dividends are not guarunteed - Mutual Insurers typically issue participating policies
Producer
A person or agency appointed by an insurance company to represent it and to present policies on its behalf. A producer possesses three types of authority: Express - Authority that is written into the producer's agency contract. An example would be the producer's binding authority if written in the contract. Implied - Authority the public assumes the producer has. An example would be the business activities of providing quotes, completing applications and accepting premiums on behalf of the insurer. Apparent - Authority created when the producer exceeds the authority expressed in the agency contract. This occurs when the insurer does nothing to counter the public impression that such authority exists. An example would be the producer's acceptance of premiums on a lapsed policy.
Residual Markets
A private coverage source of last resort for businesses and individuals who have been rejected by voluntary market insurers. A Joint Underwriting Association or Joint Reinsurance Pool requires insurers writing specific coverage lines in a given state to assume the profits/losses accruing their share of the total voluntary market premiums written in that state. Risk Sharing Plan - Insurers agree to apportion among themselves those risks that are unable to obtain insurance through normal channels. Coverage is typically written as workers' compensation, personal auto liability or property insurance on real property.
Experience Rating
A rate based on the policyholder's actual loss history when compared to the loss history of similar risks.
Class Rating
A rate charged to a group of policyholders who have similar exposures and experience.
Individual Rating
A rate used for a policyholder because a large enough pool of similar risks is not available to any other type of rate. It is primarily used for commercial and specialty risks because of the number of unique variables involved.
Loss Cost Rating
A rating organization provides insurers with the portion of a rate that does not include provisions for expenses or profit.
Career Agency System
Agents are recruited, trained and supervised by either a managing employee or General Agent who is contracted with the insurance company.
Independent Agency
An agent or agency that enters into agency agreements with more than one insurer. It may represent an unlimited number of insurers. Agency retains ownership of the business written. An independent contractor that is paid a commission and covers the cost of agency operations.
Adverse Selection
An imbalance created when risks that are more prone to losses than the average (standard) risk are the only risks seeking insurance within a specific marketplace. For example, only those living in earthquake-prone areas seek to buy earthquake insurance. High-risk exposures tend to seek or continue insurance at a higher participation rate than the average risk exposures do.
"A" Rating or Judgment Rating
An individual rate that doesn't use loss history as a component and that is derived largely from the underwriter's evaluation and best judgment the risk poses to the insurer.
Reinsurance Companies
An insurance company that assumes all or a portion of a risk for a primary or ceding insurance company; reinsurance transfers risk among insurance companies. The insurer originating the application is the primary or ceding company. The insurer sharing in the risk is the reinsurance company. Consumer inquiries must originate with the ceding company, which then obtains reinsurance.
Foreign Insurer
An insurer not organized under the laws of this state, but in one of the other states or jurisdictions within the United States, whether or not it is admitted to do business in the state or jurisdiction.
Alien Insurer
An insurer organized under the laws of any jurisdiction outside of the United States, whether or not it is admitted to do business in this state.
Domestic Insurer
An insurer organized under the laws of this state, whether or not it is admitted to do business in this state.
Insurable Events
Any event, past or present, that may cause loss, or damage, or create legal liability on the part of an insured.
Risk Retention
Assume the responsibility for loss Self insure the entire loss or a portion of the loss. Choosing deductibles is a method of risk retention. It might be economically practical for an insured to not insure each exposure to loss, and instead insure only those risks that threaten financial stability security
Morale Hazard
Attitude that increases the probability of a loss. Example: Indifference or carelessness of leaving one's house or vehicle unlocked.
Merchant Marine Act of 1920 (The Jones Act)
Because workers' compensation laws do not apply to seamen, the Jones Act allows insured seamen to make claims for injuries suffered during the course of employment. It also regulates maritime commerce in U.S. waters, transportation of cargo, and the rights of seamen.
Contract of Utmost Good Faith
Both parties bargain in good faith when forming and entering into the contract. The two parties rely upon the statements and promises of the other and assume no attempt to conceal or deceive has been made.
Conditional Contract
Both parties must perform certain duties and follow rules of conduct to make the contract enforceable. The insurer must pay claims if the insured has complied with all the policy's terms and conditions.
Risk Avoidance
Elimination of the risk Avoid the activity that gives rise to the chance of loss After potential areas of hazards have been identified, it may be found that some exposure to risk can be eliminated, but it is impossible to avoid all risk
Fraud and False Statements (Fraudulent Insurance Act)
Fraud always involves a false statement and deceit; it can be either a criminal or civil crime. Federal laws prohibit the commission of fraud. In 2001, the NAIC adopted model legislation for the prevention and enforcement of insurance fraud. Subsequently, each of the states enacted its own Fraudulent Insurance Act.
Mass Marketing
Mass marketing is used to target a specific type of insurance to a large group of individuals, such as the American Association of Retired People (AARP). Insurer reduces marketing and underwriting expenses.
Risk Reduction
Minimizing the chance of loss, but not preventing the risk. For example, sprinkler systems, burglar alarms, pollution controls and safety guards on machinery. Pooling or spreading the risk among a large number of persons or entities
Underwriting Factors
Nature of the risk Hazards that are present Claims history Other factors that depend upon the type of risk being insured
Contract of Adhesion
One party writes the contract, without input from the other party; one party (insurer) prepares the contract and presents it to the other party (applicant) on a "take-it-or-leave-it" basis, without negotiation. Any doubt or ambiguity found in the document is construed in favor of the party that did not write it (insured).
Direct Mail or Direct Response Company
Sells insurance policies directly to the public with licensed employees or contractors. A marketing system utilizing direct mail, newspapers, magazines, radio, television, internet, web sites, call centers and vending machines.
Pure Risk
Situations where there is no chance for gain, only loss. Only pure risks can be insured (For instance, the possibility of damage to property caused by a fire or other natural disaster; or the possibility of financial loss as a result of premature death).
Warranties
Statements in the application or stipulations in the policy that are guaranteed true in all respects. If warranties are later discovered untrue or breached (past, present or future), coverage (and sometimes the contract) is voided.
Representations
Statements made by the applicant on the application that are believed to be true to the best of the knowledge and belief of the applicant; may be withdrawn prior to policy issuance.
Surplus (Excess) Lines Insurance
Surplus Lines insurance finds coverage when the kind or amount of insurance cannot be obtained from admitted insurers. It may not be utilized solely to receive lower cost coverage than would be available from an admitted carrier. Each State regulates the procurement on Surplus Lines insurance in their State. Non-admitted business must be transacted through a Surplus Lines Broker.
Terrorism Risk Insurance Act
The Terrorism Risk Insurance Act of 2002 (TRIA) was enacted in direct response to the terrorist attacks on New York City and Washington, D.C. on September 11, 2001. Congress provided temporary financial compensation to insured parties during its crisis of recovery from the terrorist attacks. TRIA was intended to respond to the chaos the 9/11 terrorist attacks caused in the insurance industry as well as to assure that commercial property and liability insurance would continue to be able to provide coverage for the peril of terrorism. It also was a temporary program that allowed the federal government to share in terrorism losses with private insurers in the event a certified act of terrorism took place.
Peril
The cause of loss
Management
The determination of what types of protection are required to meet an insured's needs
Speculative Risk
The determination of what types of protection are required to meet an insured's needs using:
Rate
The dollar amount charged for a particular unit of insurance, such as $5 per $1,000 of insurance
Aleatory
The exchange of value is unequal. Insured's premium payment is less than the potential benefit to be received in the event of a loss. The insurer's payment in the event of a loss may be much greater, or much less (e.g., $0 in the event a loss doesn't occur), than the insured's premium payment.
Violent Crime Control and Law Enforcement Act of 1994
The largest crime bill in U.S. history expands funding to federal agencies such as the FBI, DEA, and INS and includes provisions that address (among other topics) domestic abuse and firearms, gang crimes, immigration, registration of sexually violent offenders, victims of crime, and fraud.
Premium
The total cost for the amount of insurance purchased For instance, $50,000 of coverage = $5 rate x 50 (per $1,000 of insurance) for a $250 premium
Concealment
The willful holding back or secretion of material facts pertinent to the issuance of insurance (or a claim), even if the applicant or insured was not about the subject. Concealment results in denial of coverage and may void the policy.
Gramm-Leach-Bliley Act (GLBA, a.k.a. the Financial Services Modernization Act of 1999)
This act repealed parts of the Glass-Steagall Act of 1933 to allow the merger of banks, securities companies, and insurance companies. It also established the Financial Privacy Rule and Safeguards Rule for the protection of consumers' privacy. The Financial Privacy rule requires "financial institutions," which include insurers, to provide each consumer with a privacy notice at the time the consumer relationship is established and annually thereafter. The privacy notice must explain: The information collected about the consumer Where that information is shared How that information is used How that information is protected
Self-Insurer
To self-insure means to assume the financial risk one's self. This is generally an option only for large companies who may even reinsure for risks above certain maximum limits.
Tort Law
Torts are civil wrongs; they're not crimes or breaches of contract. They result in injuries or harm that constitute the basis of a claim by a third party.
Risk Transfer
Transferring the risk from one party to another, such as from a consumer to an insurance company Transfer the uncertainty of loss via a contract
Waiver
Voluntary surrender of a known right, claim or privilege.
Reasonable Expectations Doctrine
What a reasonable and prudent policy owner would expect; the reasonable expectations of policyowners are honored by the Courts although the strict terms of the policy may not support these expectations.
Admitted (authorized) Insurer
authorized by this State's Commissioner of Insurance to do business in this State. It has received a Certificate of Authority to do business in this State.
Non-admitted (Unauthorized) Insurer
has either applied for authorization to do business in this state and was declined or they have not applied. They are not authorized to transact insurance in this state
Financial Anti-Terrorism Act
imposes record keeping and government reporting requirements on banks, financial institutions and non-financial businesses for specific financial transactions and customer financial records (a part of the Bank Secrecy Act).
