A contract whereby, for specified consideration, one party undertakes to compensate the other for a loss relating to a particular subject as a result of the occurrence of designated hazards.
The normal activities of daily life carry the risk of enormous financial loss. Many persons are willing to pay a small amount for protection against certain risks because that protection provides valuable peace of mind. The term insurance describes any measure taken for protection against risks. When insurance takes the form of a contract in an insurance policy, it is subject to requirements in statutes, Administrative Agency regulations, and court decisions.
In an insurance contract, one party, theinsured, pays a specified amount of money, called a premium, to another party, the insurer. The insurer, in turn, agrees to compensate the insured for specific future losses. The losses covered are listed in the contract, and the contract is called a policy.
When an insured suffers a loss or damage that is covered in the policy, the insured can collect on the proceeds of the policy by filing a claim, or request for coverage, with the insurance company. The company then decides whether or not to pay the claim. The recipient of any proceeds from the policy is called the beneficiary. The beneficiary can be the insured person or other persons designated by the insured.
A contract is considered to be insurance if it distributes risk among a large number of persons through an enterprise that is engaged primarily in the business of insurance. Warranties or service contracts for merchandise, for example, do not constitute insurance. They are not issued by insurance companies, and the risk distribution in the transaction is incidental to the purchase of the merchandise. Warranties and service contracts are thus exempt from strict insurance laws and regulations.
The business of insurance is sustained by a complex system of risk analysis. Generally, this analysis involves anticipating the likelihood of a particular loss and charging enough in premiums to guarantee that insured losses can be paid. Insurance companies collect the premiums for a certain type of insurance policy and use them to pay the few individuals who suffer losses that are insured by that type of policy.
Most insurance is provided by private corporations, but some is provided by the government. For example, the Federal Deposit Insurance Corporation (FDIC) was established by Congress to insure bank deposits. The federal government provides life insurance to military service personnel. Congress and the states jointly fund Medicaid and Medicare, which are Health Insurance programs for persons who are disabled or elderly. Most states offer health insurance to qualified persons who are indigent.
Government-issued insurance is regulated like private insurance, but the two are very different. Most recipients of government insurance do not have to pay premiums, but they also do not receive the same level of coverage available under private insurance policies. Government-issued insurance is granted by the legislature, not bargained for with a private insurance company, and it can be taken away by an act of the legislature. However, if a legislature issues insurance, it cannot refuse it to a person who qualifies for it.
The first examples of insurance related to marine activities. In many ancient societies, merchants and traders pledged their ships or cargo as security for loans. In Babylon creditors charged higher interest rates to merchants and traders in exchange for a promise to forgive the loan if the ship was robbed by pirates or was captured and held for ransom.
In postmedieval England, local groups of working people banded together to create “friendly societies,” forerunners of the modern insurance companies. Members of the friendly societies made regular contributions to a common fund, which was used to pay for losses suffered by members. The contributions were determined without reference to a member’s age, and without precise identification of what claims would be covered. Without a system to anticipate risks and potential liability, many of the first friendly societies were unable to pay claims, and many eventually disbanded. Insurance gradually came to be seen as a matter best handled by a company in the business of providing insurance.
Insurance companies began to operate for profit in England during the seventeenth century. They devised tables to mathematically predict losses based on various data, including the characteristics of the insured and the probability of loss related to particular risks. These calculations made it possible for insurance companies to anticipate the likelihood of claims, and this made the business of insurance reliable and profitable.
When a person applies for medical, life, or disability insurance, the insurance company typically requires the disclosure of preexisting medical conditions and a family medical history. In some cases the applicant must undergo a physical examination. Based on this information, the insurance company decides whether to offer coverage and, if so, at what price.
Breakthroughs in genetics now allow persons to be tested for rare medical conditions such as cystic fibrosis and Huntington’s disease. In addition, genetic testing can reveal an increased risk of more common conditions, including breast, colon, and prostate cancer; lymphoma; and leukemia. Concerns have been raised that once these tests become affordable, insurance companies will use the results to deny coverage.
Research studies published in the 1990s indicate that persons already have been denied insurance coverage because of the risk of genetic disease. The prospect of widespread genetic discrimination troubles many professionals in the medical and legal communities. It is unfair, they charge, to deny a person coverage or to charge higher premiums, based on a potential risk of genetic disease that the person is powerless to modify.
The insurance industry, which currently collects medical information on genetic disease through the inspection of medical records and family histories, responds that a fundamental principle in writing insurance is charging people rates that reflect their risks. This means that each applicant pays the fairest possible price, based on her individual characteristics. The industry also notes that the concerns about genetic testing do not come into play with large-group health plans, where rates are based on methods other than individual assessments.
The British Parliament granted a Monopoly over the business of insurance in colonial America to two English corporations, London Assurance and Royal Exchange. During the 1760s, colonial legislatures gave a few American insurance companies permission to operate. Since the Revolutionary War, U.S. insurance companies have grown in number and size, with most offering to insure against a wide range of risks.
Regulation and Control
Until the middle of the twentieth century, insurance companies in the United States were relatively free from federal regulation. According to the U.S. Supreme Court in Paul v. Virginia, 75 U.S. (8 Wall.) 168, 19 L. Ed. 357 (1868), the issuing of an insurance policy did not constitute a commercial transaction. This meant that states had the power to regulate the business of insurance. In 1944 the high court held in United States v. South-Eastern Underwriters Ass’n, 322 U.S. 533, 64 S. Ct. 1162, 88 L. Ed. 1440, that insurance did, in some cases, constitute a commercial transaction. This meant that Congress had the power to regulate it. The South-Eastern holding made the business of insurance subject to federal laws on rate fixing and monopolies.
Insurance is now governed by a blend of statutes, administrative agency regulations, and court decisions. State statutes often control premium rates, prevent unfair practices by insurers, and guard against the financial insolvency of insurers to protect insureds. At the federal level, the mccarran-ferguson act (Pub. L. No. 79-15, 59 Stat. 33  [codified at 15 U.S.C.A. §§ 1011–1015 (1988)]) permits states to retain regulatory control over insurance, as long as their laws and regulations do not conflict with federal antitrust laws on rate fixing, rate discrimination, and monopolies.
In most states, an administrative agency created by the state legislature devises rules to cover procedural details that are missing from the statutory framework. To do business in a state, an insurer must obtain a license through a registration process. This process is usually managed by the state administrative agency. The same state agency may also be charged with the enforcement of insurance regulations and statutes.
Administrative agency regulations are many and varied. Insurance companies must submit to the governing agency yearly financial reports regarding their economic stability. This requirement allows the agency to anticipate potential insolvency and to protect the interests of insureds. Agency regulations may specify the types of insurance policies that are acceptable in the state, although many states make these declarations in statutes. The administrative agency is also responsible for reviewing the competence and ethics of insurance company employees.
The judicial branches of governments also shape insurance law. Courts are often asked to resolve disputes between the parties to an insurance contract, and disputes with third parties. Court decisions interpret the statutes and regulations based on the facts of the case, creating many rules that must be followed by insurers and insureds.
Insurance companies may be penalized for violating statutes or regulations. Penalties for misconduct include fines and the loss or suspension of the company’s business license. In some states, if a court finds that an insurer’s denial of coverage or refusal to defend an insured in a lawsuit was unreasonable, the insurance company may be required to pay court costs, attorneys’ fees, and a percentage beyond the insured’s recovery.
Types of Insurance
Insurance companies create insurance policies by grouping risks according to their focus. This provides a measure of uniformity in the risks that are covered by a type of policy, which in turn allows insurers to anticipate their potential losses and to set premiums accordingly. The most common forms of insurance policies include life, health, automobile, homeowners’ and renters’, Personal Property, fire and casualty, marine, and inland marine policies.
Life insurance provides financial benefits to a designated person upon the death of the insured. Many different forms of life insurance are issued. Some provide for payment only upon the death of the insured; others allow an insured to collect proceeds before death.
A person may purchase life insurance on his or her own life for the benefit of a third person or persons. Individuals may even purchase life insurance on the life of another person. For example, a wife may purchase life insurance that will provide benefits to her upon the death of her husband. This kind of policy is commonly obtained by spouses and by parents insuring themselves against the death of a child. However, individuals may only purchase life insurance on the life of another person and name themselves beneficiary when there are reasonable grounds to believe that they can expect some benefit from the continued life of the insured. This means that some familial or financial relationship must unite the beneficiary and the insured. For example, a person may not purchase life insurance on the life of a stranger in the hope that the stranger will suffer a fatal accident. Health insurance policies cover only specified risks. Generally, they pay for the expenses incurred from bodily injury, disability, sickness, and accidental death. Health insurance may be purchased for one’s self and for others.
All automobile insurance policies contain liability insurance, which is insurance against injury to another person or against damage to another person’s vehicle caused by the insured’s vehicle. Auto insurance may also pay for the loss of, or damage to, the insured’s motor vehicle. Most states require that all drivers carry, at a minimum, liability insurance under a no-fault scheme. In states that recognize no-fault insurance, damages resulting from an accident are paid for by the insurers, and the drivers do not have to go to court to settle the issue of damages. Drivers in these states may bring suit over an accident only in cases of egregious conduct, or where medical or repair costs exceed an amount defined by statute.
Homeowners’ insurance protects homeowners from losses relating to their dwelling, including damage to the dwelling; personal liability for injury to visitors; and loss of, or damage to, property in and around the dwelling. Renters’ insurance covers many of the same risks for persons who live in rented dwellings.
As its name would suggest, personal property insurance protects against the loss of, or damage to, certain items of personal property. It is useful when the liability limit on a homeowner’s policy does not cover the value of a particular item or items. For example, the owner of an original painting by Pablo Picasso might wish to obtain, in addition to a homeowner’s policy, a separate personal property policy to insure against loss of, or damage to, the painting.
Businesses can insure against damage and liability to others with fire and casualty insurance policies. Fire insurance policies cover damage caused by fire, explosions, earthquakes, lightning, water, wind, rain, collisions, and riots. Casualty insurance protects the insured against a variety of losses, including those related to legal liability, Burglary and theft, accidents, property damage, injury to workers, and insurance on credit extended to others. Fidelity and surety bonds are temporary, specialized forms of casualty insurance. A fidelity bond insures against losses relating to the dishonesty of employees, and a surety bond provides protection to a business if it fails to fulfill its contractual obligations.
Marine insurance policies insure transporters and owners of cargo shipped on an ocean, a sea, or a navigable waterway. Marine risks include damage to cargo, damage to the vessel, and injuries to passengers.
Inland marine insurance is used for the transportation of goods on land and on land-locked lakes.
Many other types of insurance are also issued. Group health insurance plans are usually offered by employers to their employees. A person may purchase additional insurance to cover losses in excess of a stated amount or in excess of coverage provided by a particular insurance policy. Air-travel insurance provides life insurance benefits to a named beneficiary if the insured dies as a result of the specified airplane flight. Flood insurance is not included in most homeowners’ policies, but it can be purchased separately. Mortgage insurance requires the insurer to make mortgage payments when the insured is unable to do so because of death or disability.
Contract and Policy
An insurance contract cannot cover all conceivable risks. An insurance contract that violates a statute, is contrary to public policy, or plays a part in some prohibited activity will be held unenforceable in court. A contract that protects against the loss of burglary tools, for example, is contrary to public policy and thus unenforceable.
To qualify for an insurance policy, the insured must have an insurable interest, meaning that the insured must derive some benefit from the continued preservation of the article insured, or stand to suffer some loss as a result of that article’s loss or destruction. Life insurance requires some familial and pecuniary relationship between the insured and the beneficiary. Property insurance requires that the insured must simply have a lawful interest in the safety or preservation of the property.
Different types of policies require different premiums based on the degree of risk that the situation presents. For example, a policy insuring a homeowner for all risks associated with a home valued at $200,000 requires a higher premium than one insuring a boat valued at $20,000. Although liability for injuries to others might be similar under both policies, the cost of replacing or repairing the boat would be less than the cost of repairing or replacing the home, and this difference is reflected in the premium paid by the insured.
Premium rates also depend on characteristics of the insured. For example, a person with a poor driving record generally has to pay more for auto insurance than does a person with a good driving record. Furthermore, insurers are free to deny policies to persons who present an unacceptable risk. For example, most insurance companies do not offer life or health insurance to persons who have been diagnosed with a terminal illness.
The most common issue in insurance disputes is whether the insurer is obligated to pay a claim. The determination of the insurer’s obligation depends on many factors, such as the circumstances surrounding the loss and the precise coverage of the insurance policy. If a dispute arises over the language of the policy, the general rule is that a court should choose the interpretation that is most favorable to the insured. Many insurance contracts contain an Incontestability Clause to protect the insured. This clause provides that the insurer loses the right to contest the validity of the contract after a specified period of time.
An insurance company may deny or cancel coverage if the insured party concealed or misrepresented a material fact in the policy application. If an applicant presents an unacceptably high risk of loss for an insurance company, the company may deny the application or charge prohibitively high premiums. A company may cancel a policy if the insured fails to make payments. It also may refuse to pay a claim if the insured intentionally caused the loss or damage. However, if the insurer knows that it has the right to rescind a policy or to deny a claim, but conveys to the insured that it has voluntarily surrendered such right, the insured may claim that the insurer waived its right to contest a claim.
An insurer may have a duty to defend an insured in a lawsuit filed against the insured by a third party. This duty usually arises if the claims in the suit against the insured fall within the coverage of a liability policy.
If a third party caused a loss covered by a policy, the insurance company may have the right to sue the third party in place of the insured. This right is called Subrogation, and it is designed to make the party that is responsible for a loss bear the burden of the loss. It also prevents an insured from recovering twice: once from the insurance company, and once from the responsible party.
An insurance company can subrogate claims only on certain types of policies. Property and liability insurance policies allow subrogation because the basis for the payment of claims is indemnification, or reimbursement, of the insured for losses. Conversely, life insurance policies do not allow subrogation. Life insurance does not indemnify an insured for a loss that can be measured in dollars. Rather, it is a form of investment for the insured and the insured’s beneficiaries. A life insurance policy pays only a fixed sum of money to the beneficiary and does not cover any liability to a third party. Under such a policy, the insured stands no chance of double recovery, and the insurance company has no need to sue a third party if it must pay a claim.
Following the attacks on the World Trade Center and the Pentagon, insurance premiums skyrocketed, especially for tenants of highly visible landmarks like sports arenas and skyscrapers. The Terrorism Risk Insurance Act of 2002 (TRIA), Pub. L. No. 107–297, 116 Stat. 2322, established a temporary federal program providing for a shared public and private compensation for insured losses resulting from acts of terrorism. The act, which is valid only for three years, provides that insurers must make terrorism coverage available and must provide policy-holders with a clear and conspicuous disclosure of the premium charged for losses covered by the program. TRIA caps the exposure of insurance carriers to future acts of foreign terrorism, leaving the federal government to reimburse the insurance company for excess losses up to a maximum of $100 billion per year. Under TRIA, the Treasury Department covers 90 percent of terrorism claims when an insurer’s exposure exceeds 7 percent of its commercial premiums in 2003, 10 percent of premiums in 2004, and 15 percent in 2005.
TRIA defines an act of terrorism as any act that is certified by the U.S. secretary of the treasury, in concurrence with the U.S. Secretary of State and U.S. attorney general. The act of terror must result in damage within the United States, or outside the United States in the case of an airplane or a U.S. mission. A terrorist act must be committed by an individual or individuals acting on behalf of any foreign person or foreign interest. An event must be a violent act or an act that is dangerous to human life, property, or infrastructure. Nuclear, biological, and chemical attacks are not covered, and an event cannot be certified as an act of terrorism unless the total damages exceed $5 million.
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