Principles of Risk and Insurance - The Legal Aspects of Insurance

Principle of Indemnity

The indemnity principle applies to most insurance contracts whereby the insurer seeks to reimburse the insured for approximately the amount lost, no more and no less. The purpose of an indemnity contract is to return the insured back to his or her original financial position.

Subrogation- In the event that a claim is paid, the insurer acquires the insured's right to action against any negligent third party that may have caused or contributed to the loss.

Value Contract- A value contract differs from indemnity in that it pays a stated sum, regardless of the actual amount of the loss. An example of a value contract is a life insurance policy that pays a $50,000 death benefit.

Insurable Interest
An important element of a valid insurance contract is insurable interest. This is a relationship between the applicant and individual being insured whereas the person seeking the contract (applicant) must be subject to loss upon the destruction, damage, illness, disability, or death of the insured.

Practice Question:
Which of the following pertaining to life insurance contracts is/are correct?

I. There must be an insurable interest at the time of the contract
II. After issuance, the beneficiary can be changed to anyone
III. After issuance, the ownership can be transferred to anyone I
V. All policies are subject to a four-year suicide clause to protect the insurer

A. I only
B. I and II only
C. I, II, and III
D. I, II, III, and IV

Answer: C
With life insurance contracts, an insurable interest must exist at the time of the contract for it to be valid. Once issued, there is no insurable interest requirement. At any time after issue, a change of ownership or beneficiary can be submitted to the insurance company by the policy owner. Most life insurance contracts have a two-year suicide clause to protect the insurer from intentional claims.

As a general rule, if the applicant (owner) is not the insured, then the consent of the insured is required before a policy is issued- even if the applicant has an insurable interest. A parent insuring small children is an exception. The insurance companies themselves have the legal responsibility to verify the insurable interest and obtain the consent of the insured before they issue a contract.

Important: Insurable interest must exist at the inception of contracts; however, with life & health contracts it does not have to exist at the time of claim. Property and casualty insurance policies require that the insurable interest must exist at the time of the claim.

Contract Requirements
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