Legal Concepts of Insurance

LEGAL CONCEPTS OF INSURANCE

CAL-STATE EXAMS

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TABLE OF CONTENTS: LEGAL CONCEPTS OF INSURANCE

LESSON ONE — INSURABLE INTEREST 1

General - Purposes - Distinction Between Property and Life Insurance - Insurable Interest in Relation to Property Insurance Definition - Legal Interest v. Factual Expectancy - Current Case Law - When Insurable Interest Must Exist - Insurable Interest in Relation to Life Insurance - Insurance on One's Own Life - Insurance on the Life of Another - Family Relationships - Contractual Relationship - When Insurable Interest Must Exist - Assignment of a Life Insurance Policy - Consent of the Insured - Industrial Life Insurance - Standing to Raise Defense of Insurable Interest - Counter-Defenses to the Insurable Interest Doctrine.

LESSON TWO — DEFINITION OF RISKS

Unlawful Contracts - Policies in Violation of Statute - Policies in Violation of Public Policy - Policies Related to Unlawful Activity - Punitive Damages - Implied Exception for Intentional Conduct — Generally - Fortuitous Element - Express Exclusion for Intentional Conduct - Implied Exception for Normal Wear and Tear or Inherent Defect - Implied Exception for Friendly Fire - Definition of Accident - All Risk v. Specified Risk - Reasonable Expectations Rule.

LESSON THREE — PERSONS INSURED

Definition of Insured - Identification of the Insured - Endorsement - Omnibus Clause - Beneficiaries Under Life Insurance Policies - Interest of the Beneficiary - Common Disaster Clause - Beneficiary Who Predeceases the Insured - Effect of Divorce - Creditors as Beneficiaries and Assignees - Community Property - Disqualification for Murder - Facility of Payments Clause - Change of Beneficiary - Standing to Contest Change of Beneficiary - Assignments - Entire Policy - Property Insurance - Life Insurance - Reinstatement of Lapsed Policy - Incontestability Clause - Time of Reinstatement.

LESSON FOUR — WAIVER AND ESTOPPEL

Generally - Waiver - Methods of Communicating Waiver - Limitations on Waiver - Limitation in Regard to Facts - Limitation as to Coverage - Policy Limitations on Waiver - Estoppel - Limitation as to Coverage - Parol Evidence Rule - Limitation to Facts - Common Instances of Estoppel.

LESSON FIVE — MEASURE OF RECOVERY

Generally - Articles of Commerce - Unique Property - Market Value - Coinsurance - Other Insurance Clauses - Conflicts Between Other Insurance Clauses - Rights of Contribution Among Insurers - Valued Policies - Appraisal Clauses.

LESSON SIX — SUBROGATION

Application of Subrogation to Lines of Insurance - Life and Accident Insurance - Medical, Surgical, and Hospitalization Insurance - Casualty Insurance - Worker's Compensation - Remedies - Against the Insured - Division of Fund Recovered from Third Party - Defense to Subrogation - Defense of Insured - Conventional Subrogation.

LESSON ONE: INSURABLE INTEREST

GENERAL

Consistent with the concept of insurance as a means of indemnifying an insured against a loss is the corollary that insurance should not provide an insured with the means of showing a new profit from the event insured against. One method of enforcing that corollary is the doctrine of insurable interest.

PURPOSES

Throughout the development of the insurable interest doctrine in case and statutory law, two primary purposes have captured the attention of lawmakers, both rooted in public policy.

The first is the elimination of insurance as a vehicle for gambling, an activity to which has been attributed to idleness, vice, a socially parasitic way of life, increase in impoverishment and crime, and the discouragement of useful business and industry.

The second is the removal of the temptation provided by a prospect of a net profit through insurance proceeds to deliberately bring about the event insured against, whether it be the destruction of property or human life.

A third purpose, the elimination of an inducement to defraud the insurer by destroying the thing insured, has been all but totally overlooked in the genesis of the doctrine, perhaps because it is overshadowed by the first two, and perhaps because of a sense that in this regard the insurer can and should protect itself by investigation prior to issuance of the policy.

DISTINCTION BETWEEN PROPERTY AND LIFE INSURANCE

Since the time of early English statutes, the single doctrine of insurable interest has been stretched to accommodate two widely disparate forms of insurance — property and life insurance. While the purposes to be served by the doctrine in regard to the two types of insurance are basically the same, i.e., prevention of wagering and protection of the entity insured, there are major distinctions between life and property insurance that call for the application of different rules in order to achieve those purposes. For example, property insurance is purely a form of indemnity (restoration, dollar for dollar, as nearly as possible within policy limits, usually to the insured, of the value of the thing lost). Life insurance, on the other hand, is more accurately characterized as a form of investment, whereby the insured makes periodic contributions to a fund that is ultimately to be paid for the support of a beneficiary caused by the death of the insured, can seldom be measured accurately in terms of cash value, while the reverse is generally true of the loss of property. Thirdly, the degree of public interest in protecting human life from deliberate destruction far exceeds that in protecting property. In order to understand the radical differences in rules encompassed within the insurable interest doctrine as it pertains to these two forms of insurance, it seems appropriate to treat each form separately.

INSURABLE INTEREST IN RELATION TO PROPERTY INSURANCE DEFINITION

As a functional definition, it might be said that insurable interest is that interest that the law requires a beneficiary of an insurance policy to have in the thing or person insured in order that the contract of insurance will not be held to be void as a wager or an inducement to bring about the event insured against. Focusing more directly on the nature of that interest, section 281 of the California Insurance Code defines it as Every interest in property, or any relation thereto, or liability in respect thereof, of such a nature that a contemplated peril might directly damnify the insured, That will suffice for the moment until the following discussion can highlight areas of contention that require further particularity for a working definition.

LEGAL INTEREST V. FACTUAL EXPECTANCY

Origin. One of the most ancient yet continuing controversies in defining the law of insurable interest involves the question of whether the insured is required to hold some legally recognized interest in the property or whether a simple factual expectancy of loss in the event of its destruction is sufficient. Modern cases determining current policy continue to draw for their roots upon one or the other of two early English cases interpreting the Statute of George II. These opting for the factual expectancy text harken back to the case of Le Cras v. Hughes (1782). During the war with Spain, British naval forces captured the Spanish ship, Santo Domingo, in the harbor of St. Fernando de Omoa, together with its cargo. By virtue of custom, the British captain and crew had every expectation of being granted rights of Prize in the captured ship and cargo since wherever a capture had been made, since the Revolution, by sea or land, the Crown has made a grant: there is no instance to the contrary. The captain and crew insured the vessel and cargo for the voyage back to England, during which it was lost due to the perils of the sea. In an action on the policy, Lord Mansfield held as one alternative ground that although Master Holford's insurance was not a legal interest, the mere factual expectancy of a profit to be made by way of Prize if the ship had survived the voyage was sufficient. An interest is necessary [under the Statute of George II], but no particular kind of interest is required.

The second case, Lucena v. Craufurd (1805), provided the cornerstone for the legal interest school. The subject was again a captured vessel, insured by the Royal Commissioners during a voyage from the point of capture to a British port. The issue of insurable interest in the Commissioners was tried and resulted in a verdict for the Commissioners. On appeal, the House of Lords remanded the case for a new trial because of erroneous directions to the jury. The opinion of Lord Eldon in that case continues to be cited by adherents to the legal interest doctrine. He imposed upon the definition of insurable interest the requirement that it be a right in the property, or a right derivable out of some contract about the property, which in either case may be lost upon some contingency affecting the possession or enjoyment of the party. If any doubt of the additional requirement remained, he further stated that "if the Lee Cras v. Hughes case was decided upon the expectation of a grant from the Crown, I never can give my assent to such a doctrine. That expectation, though founded upon the highest probability, was not interest, and it was equally not interest, whatever might have been the chances in favor of the expectation. He reasoned that hundreds, perhaps thousands anticipated some advantage from the safe passage of the ship, from the dock company down to the porter, and concluded, without stating a further rationale, that without a legal interest in the ship these latter should not be permitted to insure their expectancy. It is conjecturable that the true basis for the legal interest distinction lay in the traditional English predilection for defined property rights. In the same opinion, Lord Eldon quoted the words, Courts of justice sit here to decide upon rights and interests in property; rights in property, or interest derived out of contracts about property. They do not sit here to decide upon things in speculation. Speculative profits are nothing."

Once Lord Eldon made the technicality of a legally recognized right the touchstone of insurable interest, he went on to carry it to extremes by allowing it to suffice even if the factual expectation was that the right would be economically worthless. His famous example ran as follows:

Suppose A to be possessed of a ship limited to B in case A dies without issue; that A has 20 children, the eldest of whom is 20 years of age; and B, 90 years of age; it is a moral certainty that B will never come into possession, yet this is a clear interest.

Early Case Law. If the end to be served is the prevention of gambling or inducement to destruction, it seems clear that the factual expectancy theory is the more appropriate. It is the lack of prospective gain from the practical point of view of the insured that produces the desired effect, rather than some technical legal right, regardless of value. Nevertheless, until recent years, the majority of American jurisdictions had opted for Lord Eldon's legal interest theory.

This choice produced results at odds with the indemnification theory in a number of instances. For example, in Hartford Fire Ins. Co. v. Cagle (1957), the insured contracted to purchase a farm for $3500. He was to live on the farm, paying $35 per month until title could be perfected in the seller, at which time he would be obligated to pay the full remaining purchase price. The contract gave the insured the option of calling off the agreement if the seller could not acquire title, whereupon the $35 installments would be considered rent. It became obvious before the destruction of the property by fire that the seller would be unable to perfect title. After the property was destroyed, the insurer challenged the insured's insurable interest because of the total worthlessness of the legal right. Following Lord Eldon's view, the court affirmed an award for the insured. In the same vein, in Insurance Co. v. Stinson (1880), a mechanic's lien that was factually worthless because of a prior security interest that exceeded the value of the property was considered adequate to support an insurable interest to the full extent of the debt. In both cases, the technicality was served, but the insured stood to profit substantially from the fire.

The rationale for this counterproductive approach to insurable interest has occasionally been stated to be that it would be an excessive burden on the insured to require him to prove the dollar value, as well as the existence of his legal interest, especially in instances in which the value is not subject to accurate proof. Where cases are to be won or lost, not on the facts, but on the insured's inability to prove the facts one way or the other, it is not extraordinary for the courts to favor