Insurance Principles and Concepts
Domain 2 tests the doctrines underneath every coverage decision: indemnity, insurable interest, good faith, the character of an insurance contract, causation and valuation. Expect questions that give you a loss and ask which principle controls the payment, not definitions in isolation.
The indemnity principle
- Insurance restores the insured to roughly the pre-loss position; it does not create profit. Actual cash value (replacement cost less depreciation) and replacement cost are two ways of serving that goal, and the policy's own definitions control - some forms use fair market value rather than depreciated cost.
- Valued items, scheduled property and agreed-value endorsements replace the indemnity calculation with a stated amount.
- Deductibles, coinsurance and policy limits further cap recovery. Coinsurance is a penalty for underinsurance, not a second deductible.
Insurable interest and good faith
- In property insurance the insured must have insurable interest at the time of loss; in life insurance the interest must exist when the policy is issued. A policy held by someone with no interest is a wager and is unenforceable.
- Insurance is a contract of utmost good faith: applicants must disclose material facts, and material misrepresentation or concealment lets the insurer rescind.
- The contract is one of adhesion (the insurer drafts the wording), aleatory (unequal exchange), conditional (the insured must perform duties after loss) and unilateral (only the insurer makes an enforceable promise to pay).
Causation and recovery rights
- Trace the loss to a covered peril. Where covered and excluded perils combine, the policy's causation wording - including anti-concurrent causation language - decides the outcome; document your chain of causation.
- Subrogation lets the insurer stand in the insured's shoes against a negligent third party after payment; salvage is the insurer's right to the damaged property. Neither increases total recovery beyond the loss.
Worked example
A fire causes $50,000 in repair cost and $8,000 of depreciation; the dwelling limit is adequate and the deductible is $1,000. Pay ACV first: $50,000 minus $8,000 minus $1,000 equals $41,000. The $8,000 of depreciation is recoverable only when repairs are completed and documented, which is a second payment, not an extra benefit.
Traps that cost marks
- Applying the deductible to each coverage part instead of once per loss.
- Paying replacement cost up front.
- Testing property insurable interest at policy inception.
- Treating subrogation as contribution, or as a windfall.
- Ignoring the form's definition of actual cash value and substituting a rule of thumb.