Insurance Principles and Policy Basics
Domain 3 - Insurance Principles and Policy Basics
This domain tests the fundamentals you apply on every file: indemnity, insurable interest, valuation, policy architecture, and causation. Examiners use these concepts to see whether you can read a policy rather than react to a denial letter.
Core principles
- Indemnity: the insured is restored to pre-loss financial position, not improved. Betterment and depreciation follow from this.
- Insurable interest: exists when the insured would suffer financial loss; for property it must exist at the time of loss.
- Valuation: actual cash value (replacement cost less depreciation) versus replacement cost, which usually requires repair or replacement within a stated period before the holdback is released.
- Coinsurance: a property condition requiring the limit to equal a percentage of value; falling short triggers a proportional penalty.
- Deductibles apply per occurrence, per building, or per policy year depending on the form.
Policy architecture
Declarations, insuring agreement, definitions, exclusions, conditions, and endorsements. Endorsements control over the base form. Read the insuring agreement first, then exclusions, then exceptions to exclusions.
Causation: where covered and excluded perils combine, identify the dominant or efficient proximate cause; the policy's anti-concurrent causation wording can change the result.
Other basics: subrogation, salvage, abandonment, occurrence versus claims-made triggers, and the duty to defend, which is broader than the duty to indemnify.
Worked example
A building has a replacement cost of $2,000,000, an 80% coinsurance requirement ($1,600,000), and a carried limit of $1,200,000. A covered loss is $200,000 with a $5,000 deductible. Payment = ($1,200,000 ÷ $1,600,000) × $200,000 = $150,000, less the $5,000 deductible = $145,000. The insured absorbs both the penalty and the deductible.
Traps that cost marks
- Applying replacement cost when the form pays ACV first.
- Ignoring coinsurance on commercial property.
- Treating an exclusion's exception as a grant of coverage.
- Confusing the duty to defend with the duty to pay.