Insurance Principles and Concepts
What the exam expects
Insurance transfers pure risk (chance of loss only) rather than speculative risk (chance of gain or loss). Know the vocabulary chain: exposure unit (what is insured), peril (the cause of loss, e.g., fire, wind, theft), hazard (a condition that increases the chance or severity of loss), loss, and proximate cause. Insurable risks are ideally accidental, definite and measurable, predictable in the aggregate, and spread over many similar units; catastrophic and speculative risks are generally uninsurable or handled by government programs.
Core doctrines: insurable interest (must exist at time of loss for property/casualty), indemnity, subrogation, and utmost good faith (representations, concealment, warranties). Know the contract characteristics - contract of adhesion, aleatory, unilateral, conditional, and personal.
Traps
- Mixing moral and morale hazard: moral hazard is dishonesty (arson for profit); morale hazard is carelessness (leaving keys in the car).
- Subrogation is the insurer's right after paying a loss; an insured who signs away that right can jeopardize coverage.
- A binder gives temporary coverage before the policy is issued; apparent authority can bind an insurer even when the agent lacked actual authority.
- Waiver is the voluntary giving up of a known right; estoppel prevents the insurer from asserting a right after the insured reasonably relied on its conduct.
Worked example
The indemnity principle: ACV = replacement cost minus depreciation. A roof with a 20-year life costs $20,000 to replace and is 10 years old, so depreciation is $10,000 and ACV is $10,000. With a $1,000 deductible the ACV payment is $9,000; a replacement cost settlement would withhold depreciation and pay it after repairs.