Insurance Principles and Concepts
Insurance Principles and Concepts tests the contract and risk concepts that drive coverage analysis: indemnity, insurable interest, policy structure, coinsurance, subrogation, and other insurance. Expect calculation questions and questions asking which principle resolves a coverage gap.
Contract characteristics
- Insurance is a contract of adhesion: the insurer drafts the policy, so ambiguous language is generally construed against the insurer.
- It is aleatory because performance depends on chance, and unilateral because the insured pays premium while the insurer makes the core promise to pay covered claims.
- It is conditional: the insured must satisfy duties after loss, such as notice, proof of loss, and cooperation.
- Utmost good faith requires honest representations; concealment or misrepresentation of a material fact can affect coverage.
Indemnity and valuation
- Indemnity restores the insured to the pre-loss financial position, without profit.
- Actual cash value is generally replacement cost minus depreciation.
- Replacement cost pays repair or replacement first, often withholding depreciation until work is completed.
- Commercial property coinsurance requires a limit of at least a stated percentage of value; the penalty is (limit divided by required limit) times the loss, capped by the policy limit, then reduced by the deductible.
Worked example
A building is valued at $1,000,000 with an 80% coinsurance clause. The limit is $600,000, the loss is $200,000, and the deductible is $5,000. Required limit is $800,000. The coinsurance factor is $600,000 / $800,000 = 0.75. Payment is $200,000 x 0.75 = $150,000, minus $5,000 = $145,000. Had the limit been $800,000, payment would be $200,000 minus $5,000 = $195,000.
Traps
- Ignoring the deductible after the coinsurance calculation.
- Treating replacement cost as actual cash value without depreciation.
- Applying coinsurance without first determining the required limit.
Key points
- Ambiguities are construed against the drafter.
- Indemnity prevents profit from a loss.
- Coinsurance penalizes underinsurance on commercial property.
- Subrogation lets the insurer pursue the responsible party after payment.
- Other insurance clauses determine how insurers share a loss.