640 Class 3 - Class 3 Insurance and Risk Management George...

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Class 3 Insurance and Risk Management George D. Krempley Bus. Fin. 640 Autumn Quarter 2007
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Mid-term Exam Correct Date: Wednesday, 10/24/07 Mid-Term Material: Chapters 1-3, 9-12, 13 (p. 275-277, 284-289), 14, 16 & 18
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Agenda Principle of Indemnity Principle of Insurable Interest Principle of Subrogation Principle of Utmost Good Faith Requirements of an Insurance Contract Distinct Legal Characteristics of Insurance Contracts Law and the Insurance Agent
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Principle of Indemnity The insurer agrees to pay no more than the actual amount of the loss Purpose: To prevent the insured from profiting from a loss To reduce moral hazard
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Principle of Indemnity In property insurance, indemnification is based on the actual cash value of the property at the time of loss There are three main methods to determine actual cash value: Replacement cost less depreciation Fair market value is the price a willing buyer would pay a willing seller in a free market Broad evidence rule means that the determination of ACV should include all relevant factors an expert would use to determine the value of the property
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Principle of Indemnity There are some exceptions to the principle of indemnity: A valued policy pays the face amount of insurance if a total loss occurs Some states have a valued policy law that requires payment of the face amount of insurance to the insured if a total loss to real property occurs from a peril specified in the law Replacement cost insurance means there is no deduction for depreciation in determining the amount paid for a loss A life insurance contract is a valued policy that pays a stated sum to the beneficiary upon the insured’s death
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Actual Cash Value Underlies the principle of indemnity The standard method for indemnifying in a property loss ACV = Replacement cost minus depreciation Example of Sarah’s couch (p. 176 of text)
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Exceptions to the Principle of Indemnity Valued policy Antiques Fine arts Rare paintings Family heirlooms
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Exceptions to the Principle of Indemnity Valued policy laws Original purpose to protect insured from over- insurance Less important now
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Exceptions to the Principle of Indemnity (cont.) Life Insurance Not a contract of indemnity Valued policy that pays a stated sum at the Insured’s death
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Exceptions to the Principle of Indemnity (cont.) Replacement Cost Insurance No deduction taken for depreciation in determining the amount paid for a loss Recognizes that few people budget for depreciation. Under ACV, Insured could be required to come up with a substantial cash to restore the property to its original condition.
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Indemnity versus Valued Contracts Indemnity contract - insurer pays based on the amount of loss that occurred Example: auto physical damage Valued contract - insurer pays a pre- determined amount Example: life insurance
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Type of contract explained by two factors The costs of assessing value Moral hazard
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640 Class 3 - Class 3 Insurance and Risk Management George...

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