Insurance Principles and Concepts
Domain 1: Insurance Principles and Concepts
This domain tests the doctrines that decide whether a loss is covered and how much is payable: insurable interest, indemnity, utmost good faith, proximate cause, risk pooling, subrogation, and valuation. Expect definitional questions and short calculations.
Core principles
- Insurable interest - the insured must have a lawful economic relationship to the property or exposure. In property insurance, Connecticut requires insurable interest at the time of loss; a buyer who has not closed generally lacks it, while a mortgagee has a separate interest protected by the mortgage clause.
- Indemnity - the policy restores the insured to roughly the pre-loss financial position, not better. This is why ACV, deductibles, limits, and coinsurance exist.
- Utmost good faith - applications, proofs of loss, and claim statements must be honest and complete. A material misrepresentation that induces the insurer to issue or pay can void coverage; innocent immaterial errors generally do not.
- Proximate cause - the efficient, dominant cause that sets the loss in motion without a superseding break. If wind knocks down a wall and rain enters, wind is often the proximate cause; if rain alone enters through an open window, it is not.
- Risk pooling and adverse selection - insurers group similar exposures, use the law of large numbers to predict losses, and underwrite to avoid disproportionate selection of poor risks. Moral hazard is dishonest behavior; morale hazard is carelessness.
Valuation
Actual cash value (ACV) = replacement cost minus depreciation. Replacement cost value (RCV) pays to repair or replace with new material of like kind and quality, often with a holdback until replacement is complete. Functional obsolescence, economic obsolescence, and physical deterioration all affect value.
Worked example
A 20-year-life roof has an RCV of $24,000, is 8 years old, and the policy is ACV with a $1,000 deductible. Straight-line depreciation is 8/20 = 40%, or $9,600. ACV = $24,000 − $9,600 = $14,400. The ACV payment is $14,400 − $1,000 = $13,400. If the policy were RCV, the insurer might pay $13,400 now and release $9,600 recoverable depreciation after proof of replacement. The deduction comes before applying the limit; the limit caps the result, not the depreciation calculation.
Traps
- Treating market value as ACV; ACV is replacement cost less depreciation, not sale price.
- Assuming a policy limit is paid whenever a loss is large; limits cap, but valuation and deductible still apply.
- Missing that exclusions are interpreted narrowly and exceptions restore coverage.
- Ignoring the deductible or applying it twice.
- Confusing occurrence with claims-made triggers in liability.