Insurance Principles and Policy Basics
This domain tests the doctrinal foundation examiners use to interpret coverage: indemnity, insurable interest, contract interpretation, and the anatomy of a property policy.
Core doctrines
- Indemnity restores the insured to pre-loss financial position; it does not create profit. Insurable interest must exist at the time of loss.
- Insurance is a contract of utmost good faith. Material misrepresentation or concealment on an application can void coverage.
- It is an adhesion contract: ambiguity is construed against the drafter, but clear exclusions are enforced. It is also aleatory, unilateral, and conditional.
Policy anatomy
- Declarations identify insureds, locations, limits, and deductibles. The insuring agreement grants coverage; conditions impose duties after loss; exclusions remove coverage; endorsements amend the form.
- Key limits: per occurrence, per location, aggregate, sublimits. Valuation is actual cash value (replacement cost less depreciation) or replacement cost.
- Commercial property coinsurance requires the insured to carry a percentage of value, often 80%; underinsurance triggers a penalty.
Worked example
A commercial building has a $500,000 replacement value, an 80% coinsurance clause, and a $2,000 deductible. The insured carries only $300,000. A $100,000 covered loss occurs. Required limit is $400,000. Penalty ratio = 300,000 ÷ 400,000 = 0.75. Payment = 0.75 × $100,000 = $75,000, less the $2,000 deductible = $73,000. Reasoning: coinsurance applies before the deductible, and the ratio uses the limit carried over the limit required.
Traps
- Deducting depreciation and then applying coinsurance to ACV; apply coinsurance to the loss valuation the policy specifies.
- Treating an endorsement as subordinate to the printed form; endorsements control.
- Confusing coinsurance with a deductible or with the insurer's reinsurance.