Insurance Law, Summaries of Insurance law

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Insurance Law Terms you need to understand: . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3 ✓ Express authority ✓ Implied authority ✓ Apparent authority ✓ Waiver ✓ Estoppel ✓ Policy face ✓ Insuring clause ✓ Conditions ✓ Exclusions ✓ Aleatory contract ✓ Contract of adhesion ✓ Unilateral contract ✓ Executory contract ✓ Conditional contract ✓ Personal contract ✓ Warranty ✓ Representation ✓ Misrepresentation ✓ Concealment Concepts you need to master: ✓ Presumption of agency ✓ Agent errors and omissions exposure ✓ Contract formation ✓ Offer and acceptance ✓ Consideration ✓ Competent parties ✓ Legal purpose ✓ Utmost good faith ✓ Parol evidence rule 03 2602 ch03 11/4/04 9:47 AM Page 55 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .Chapter 356 Agency Law An understanding of the law of agency is important because an insurance company, like other companies, must act through agents. Agency Law Principles Agency is a relationship in which one person is authorized to represent and act for another person or for a corporation. Although a corporation is a legal “person,” it cannot act for itself, so it must act through agents. An agent is a person authorized to act on behalf of another person, who is called the prin- cipal. In the field of insurance, the principal is the insurance company and the sales representative or producer is the agent. When one is empowered to act as an agent for a principal, he or she is legally assumed to be the principal in mat- ters covered by the grant of agency. Contracts made by the agent are the con- tracts of the principal. Payment to the agent, within the scope of his or her authority, is payment to the principal. The knowledge of the agent is assumed to be the knowledge of the principal. Presumption of Agency If a company supplies an individual with forms and other materials (signs and evidences of authority) that make it appear that he or she is an agent of the company, a court will likely hold that a presumption of agency exists. The company is then bound by the acts of this individual regardless of whether he or she has been given this authority. Authority An agent has one of three types of authority: ➤ Express authority is an explicit, definite agreement. It is the authority the principal gives the agent as set forth in his or her contract. ➤ Implied authority is not expressly granted under an agency contract, but it is actual authority that the agent has to transact the principal’s business in accordance with general business practices. For example, if an agent’s contract does not give him or her the express authority of collecting and submitting the premium, but the agent does so on a regular basis, and the company accepts the premium, the agent is said to have implied authority. Lingering implied authority means that the agent carries “signs or evi- dences of authority.” By having these evidences of authority, an agent 03 2602 ch03 11/4/04 9:47 AM Page 56 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .Insurance Law 59 tions, the agent’s responsibility is to act in accordance with the agency con- tract and thus for the benefit of the insurer. In accordance with the agent’s fiduciary obligation to the insurer and his or her agency agreement, the agent has a responsibility of accounting for all property, including money that comes into his or her possession. As part of the agent’s working rela- tionship with the insurer, it is important that pertinent information be dis- closed to the insurer, particularly with regard to underwriting and risk selec- tion. If the agent knows of anything adverse concerning the risk to be insured, it is his or her responsibility to provide this information to the insur- er. To withhold important underwriting information could adversely affect the insurer’s risk selection process. In accordance with agency law, informa- tion given to the agent is the same as providing the information to the insur- er. It is the agent’s responsibility to obtain necessary information from the insur- ance applicant and to accurately complete the application for insurance. A signed and witnessed copy of the application becomes part of the legal con- tract of insurance between the insured and the insurer. Finally, the agent has a responsibility to deliver the insurance policy to the insured and collect any premium that might be due at the time of delivery. The agent must be prepared to provide the insured with an explanation of some of the policy’s principal benefits and provisions. If the policy is issued with any changes or amendments, the agent will also be required to explain these changes and obtain the insured’s signature acknowledging receipt of these amendments. Company’s Responsibility to Agent The company is required to permit the agent to act in accordance with the terms of the agent’s employment contract, and the company must recognize all the provisions of that contract. In addition, the company must pay the agent the compensation agreed upon in the contract, must reimburse the agent for proper expenditures made on behalf of the principal, and must indemnify the agent for any losses or dam- ages suffered without fault on the part of the agent but occurring on account of the agency relationship. Potential Liabilities of Agent/Errors and Omissions (E&O) Exposure Errors and omissions (E&O) insurance is needed by professionals who give advice to their clients. It covers negligence, error, or omission by the insur- er or producer who is the insurer’s representative. E&O policies protect pro- 03 2602 ch03 11/4/04 9:47 AM Page 59 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .Chapter 360 ducers from financial losses they may suffer if insureds sue to recover for their financial loss due to a producer giving them incorrect advice (error) or not informing them of an important issue (omission). Because a producer’s office is very busy, he or she must take special care to follow strict procedures in regard to taking applications, explaining coverages, collecting premiums, submitting changes to policies upon an insured’s request, and preparing claim forms. Formation of a Life and Health Insurance Contract The formation of a life or health insurance contract differs from the forma- tion of other insurance contracts because the life or health producer usually does not have the authority to bind the insurer. Contract Elements Insurance policies are legal contracts and are subject to the general law of contracts. This is a distinct body of law that is separate from criminal law (crimes against society) and tort law (legal liability issues usually involving damages for negligence). A contract is a legal agreement between two or more parties promising a certain performance in exchange for a valuable consideration. Under the law, the following elements are necessary for the formation of a valid contract: ➤ Agreement (offer and acceptance) ➤ Consideration ➤ Competent parties ➤ Legal purpose Agreement (Offer and Acceptance) There can be no contract without the agreement or mutual assent of the par- ties. A common intention on all terms of the contract is essential to an agree- ment and no essential terms of the contract may be left unsettled. Further, the intention of the parties to a contract must be communicated to one another. The parties to an insurance contract are the insurance company and the applicant, who may become the insured or may name another person to be 03 2602 ch03 11/4/04 9:47 AM Page 60 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .Insurance Law 61 insured. Unless otherwise indicated, it is assumed that the applicant is the prospective insured. Offer An offer is a proposal that creates a contract if accepted by another party according to its terms. If an applicant gives the insurer a completed applica- tion and pays the first premium, the application is an offer. If the policy is issued as applied for, the insurer accepts the offer. There is no offer if the applicant sends the application to the insurance com- pany without payment of the premium. Such an application is merely an invi- tation to the company to make an offer. The insurance company makes an offer by issuing the policy. The applicant accepts it by paying the first pre- mium. Acceptance An acceptance must be unconditional and unqualified. If an insurance com- pany, after receiving an application and premium payment, issues a policy with more restrictive coverage than that applied for, the company has made a counter offer. For example, a counter offer occurs if an applicant applies for a standard health insurance policy, pays the premium, and receives a policy containing an exclusionary endorsement for specified physical conditions. The applicant must decide whether to accept the policy as modified. If he or she accepts the policy, there is a contract. If he or she rejects the modified policy, there is no contract, and the applicant is entitled to a return of his or her premium. Consideration Each party to the contract must give valuable consideration. In the insurance contract, the value given by the insurer consists of the promises contained in the policy contract. The consideration given by the insured consists of the statements made in the application and the payment of the initial premium. The consideration may consist of any of the following: ➤ A monetary payment ➤ An act ➤ A forbearance from action ➤ The creation, modification, or destruction of a legal right ➤ A return promise 03 2602 ch03 11/4/04 9:47 AM Page 61 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .Chapter 364 The Entire Contract The courts look at the entire contract to determine the intent of the parties. It does not consider material added to the basic contract, nor does it take only parts of the contract to make a determination. Interpretation in Favor of Valid Contract Because the courts assume that when people make a contract they intend for it to be valid, the courts will, if possible, render an interpretation of the con- tract that makes it valid rather than invalid. Unclear Contract of Adhesion Interpreted Against the Insurer If a contract contains wording that is unclear the courts will interpret the language used against the writer of the contract, unless the wording used is required by law to be stated in a specific manner. Insurance contracts are con- tracts of adhesion, which means the insured had no part in determining the wording of the contract; therefore, the courts will interpret the contract in favor of the policyholder, insured, or beneficiary. Written Contracts If a contract contains unclear or inconsistent material between printed, typed, or handwritten text in the contract, the typed or handwritten materi- al will determine intent. Contract Characteristics The insurance contract has certain characteristics not typically found in other types of contracts. Utmost Good Faith The insurance contract requires utmost good faith between the parties. This means that each party is entitled to rely on the representations of the other and each party should have a reasonable expectation that the other is acting in good faith without attempts to conceal or deceive. In a contact of utmost good faith, the parties have an affirmative duty to each other to disclose all material facts relating to the contract. That is not just a duty not to lie, but also a duty to speak up. Failure to do so usually gives the other party ground to void the contract. Aleatory An insurance contract is said to be aleatory, or dependent upon chance or uncertain outcome, because one party may receive much more in value than 03 2602 ch03 11/4/04 9:47 AM Page 64 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .Insurance Law 65 he or she gives in value under the contract. For example, an insured who has a loss may receive a greater payment from an insurer for the loss than he or she has paid in premiums. On the other hand, an insured might pay his or her premiums and have no loss, so the insurer pays nothing. Adhesion In insurance, the insurer writes the contract and the insured adheres to it. When a contract of adhesion is ambiguous in its terms, the courts will inter- pret the contract against the party who prepared it. Unilateral Insurance contracts are unilateral. This means that after the insured has completed the act of paying the premium, only the insurer promises to do anything further. The insurer has promised performance and is legally responsible. The insured has made no legally enforceable promises and can- not be held for breach of contract. For example, the insured may stop pay- ing premium because he is not legally responsible to continue paying premi- um. Executory An insurance contract is an executory contract in that the promises described in the insurance contract are to be executed in the future, and only after certain events (losses) occur. Conditional Insurance contracts are also conditional contracts because when the loss occurs certain conditions must be met to make the contract legally enforce- able. For example, a policyholder might have to satisfy the test of having an insurable interest and satisfy the condition of submitting proof of loss. Personal Contract Generally, insurance policies are personal contracts between the insured and insurer. Generally, insurance is not transferable to another person without the consent of the insurer. Fire insurance, for example, does not follow the property. Warranties and Representations A warranty is something that becomes part of the contract itself and is a state- ment that is considered to be guaranteed to be true. Any breach of warranty provides grounds for voiding the contract. 03 2602 ch03 11/4/04 9:47 AM Page 65 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .Chapter 366 A representation is a statement believed to be true to the best of one’s knowl- edge. An insurer seeking to void coverage on the basis of a misrepresentation usually has to prove that the misrepresentation is material to the risk. Under most state laws, an applicant’s statements or responses to questions on an application for insurance (in the absence of fraud) are considered to be representa- tions and not warranties. An example would be a question on the application asking for your sex or date of birth. You represent yourself to the insurance company as being male or female and a certain age. The accuracy of these items is very important to the insurance company issuing the policy. If they are incorrect, they may be considered misrepresentations, and the policy may be voided as a result. There is a difference between representation of a fact and an expression of opinion. A good example is a question on many applications: “Are you now to the best of your knowledge and belief in good health?” If the applicant answers “yes” while knowing in fact that he or she is not, there is a misrep- resentation of actual fact. If, on the other hand, he or she has had no med- ical opinion and suffers from no symptoms recognizable to a layman, his or her answer is an opinion and thus not a misrepresentation. Impersonation Impersonation means assuming the name and identity of another person for the purpose of committing a fraud. The offense is also known as false pre- tenses. In the case of life insurance, an uninsurable individual applying for insurance may ask another person to substitute for him to take the physical examination. Misrepresentation and Concealment A misrepresentation is a written or oral statement that is false. Generally, in order for a misrepresentation to be grounds for voiding an insurance policy, it has to be material to the risk. Concealment is the failure to disclose known facts. Generally, an insurer may be able to void the insurance if it can prove that the insured intentionally con- cealed a material fact. Material information or a material fact is crucial to acceptance of the risk. For example, if the correct information about something would have caused the insurance company to deny a risk or issue a policy on a different basis, the information is material. 03 2602 ch03 11/4/04 9:47 AM Page 66 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .Insurance Law 69 5. When representing an insurer, a producer acting as an agent has a responsibility to act with the degree of care that ❍ A. A licensed insurance producer would apply under similar circumstances ❍ B. A reasonable person would apply under similar circumstances ❍ C. A lawyer would apply under similar circumstances ❍ D. Any person would apply under similar circumstances 6. Which element is not necessary for the formation of a valid contract? ❍ A. Consideration ❍ B. Competent parties ❍ C. Written document ❍ D. Legal purpose 7. The initial premium payment sent with an application constitutes which part of the formation of an insurance contract? ❍ A. Consideration ❍ B. Acceptance ❍ C. Offer ❍ D. Legal purpose 8. Life insurance contracts contain all the following except ❍ A. Policy folder ❍ B. Insuring clause ❍ C. Conditions ❍ D. Exclusions 9. Ken has paid only four premiums on his health insurance policy when he is hit by a car. The insurance company pays out nearly half a million dollars to cover his treatment and a lengthy stay in intensive care. This is an example of ❍ A. Contract of adhesion ❍ B. Aleatory contract ❍ C. Unilateral contract ❍ D. Utmost good faith 10. Carol applies for a life insurance policy and pays the initial premium. Carol has ❍ A. Accepted an offer from the insurer ❍ B. Made an offer to the insurer ❍ C. Accepted a counter offer from the insurer ❍ D. Made a counter offer to the insurer 03 2602 ch03 11/4/04 9:47 AM Page 69 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .Chapter 370 11. The insurer looks at Carol’s application and decides to offer Carol a modified policy, including an exclusion Carol did not request. The insurer has ❍ A. Accepted an offer from Carol ❍ B. Made an offer to Carol ❍ C. Accepted a counter offer from Carol ❍ D. Made a counter offer to Carol 12. The failure to disclose known facts is ❍ A. Misrepresentation ❍ B. Concealment ❍ C. Fraud ❍ D. Impersonation 03 2602 ch03 11/4/04 9:47 AM Page 70 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .Insurance Law 71 Exam Prep Answers 1. A is correct. Express authority is spelled out in an agent’s written con- tract. 2. D is correct. Apparent authority is the authority an agent appears to have because of past actions that have not been challenged by the insurance company. 3. B is correct. Implied authority is not expressly stated in an agent’s contract but it is actual authority related to common business practices, such as accepting premiums for the insurer. 4. A is correct. Under the principal of estoppel, a pattern of past behav- ior may prevent the insurer from exercising a right it might have had if it had exercised it earlier. 5. B is correct. A producer has a duty to act with a reasonable degree of care when representing an insurer. 6. C is correct. Valid contracts do not need to be in writing. Oral con- tracts are legally binding. 7. A is correct. The premium is the consideration given by the insured in exchange for the insurer’s promise to pay if a loss occurs. 8. A is correct. All life insurance policies include an insuring clause, con- ditions, and exclusions. There is no requirement for a policy folder. 9. B is correct. An aleatory contract is one that depends on chance or an uncertain outcome. Ken may have received far more in benefits than he paid as premiums, but others who pay premiums may never have a loss and never receive even a dollar in benefits. 10. B is correct. The act of submitting an application with a premium payment is an offer that is still subject to acceptance by the insurer. 11. D is correct. By not accepting the initial offer and offering alternative terms, the insurer has made a counter offer. 12. B is correct. The failure to disclose known facts is concealment. Intentionally giving false answers or misstating facts would be misrep- resentation, and possibly fraud. 03 2602 ch03 11/4/04 9:47 AM Page 71