ACCOUNTING AND INVESTMENT

The Accountant is another official with a vital role to play in the running of any business enterprise, and particularly that of an insurer. The functions of this department are fairly obvious, but for completeness we note:

(a) Record keeping: financial records must be accurate and reliable.

(b) Collections: ensuring that money receivable by the insurer is in fact paid clearly affects the very existence of the company. A satisfactory system for collecting, monitoring and reminding the company debtors is thus of high priority.

(c) Payments: ensuring that bills and debts are paid promptly and efficiently (and correctly) entails much routine but important work.

(d) Investment: if there is not a separate investment department, the care and placement of company assets may be the responsibility of the Accountant. It goes without saying that this is extremely important, from the perspectives of security, relative return (or yield) and liquidity (having sufficient cash-flow to meet known and anticipated monetary demands).

TRAINING AND DEVELOPMENT

Sometimes unappreciated by line managers, ever conscious of targets and deadlines, the Training and Development department within a company is very important. Some observations to note:

(a) Staff and Agents: Training is essential for both in-house personnel and field staff. The educational and training needs of both must not be overlooked.

(b) Relevance: Training is not an optional extra, nor is it independent. It is part of the overall team that constitutes the insurer, and its activities must not be selffulfilling, but relevant and effective to the continuance and enhancement of the company.

(c) Training: This may be seen as preparation for the actual job in hand, or the job in prospect. As such, it will involve courses, seminars and self-preparation arranged or encouraged by staff training personnel.

(d) Education: This may be seen as involving the quest for wider learning and professional or related qualifications. Preparations, etc. for this may beencouraged rather than provided, but having qualified staff (and insurance agents) is of great importance.

(e) In-house or external: Whether instruction is provided by its own staff, or arranged on behalf of staff with outside providers, this will be an important concern of company trainers.

(f) Resources and records: Facilities for training (library and other aids) as well as up to date records of individual training progress will clearly assist the efficient running of this section.

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POLICY ADMINISTRATION

This is another departmental description that may involve overlap with other sections or departments mentioned above or below. The general areas of concern here may be:

(a) General or Life insurance? : this is a most important question, since the policy document with each has a very different significance. With general insurance, technically there need not be a policy (although there almost invariably is) and it is seldom necessary to produce the original policy document when making a claim. With life insurance, however, the contract is non-cancellable by the insurer, and the policy documents are required to be produced at the time of a claim.

(b) Life insurance policies: as mentioned above, these must be produced when a claim is made. A mistake in a life policy is potentially much more serious than with General Business, especially since the policy may be assigned to another person and/or used as collateral with a loan and any assignees are expected to be relying on the veracity of the policy.

(c) New business procedures: especially with Life business (as noted) the process of verification and checking, both for factual accuracy and errors in document preparation, is very important. With any class of business, it is important that the policy should be prepared and issued as efficiently and as impressively as possible, for reasons that are obvious.

(d) Other procedures: this topic embraces such matters as error handling, policy correction, endorsement preparation and renewal procedures. With life insurance, once more, the great importance of the actual payment of the first premium must be considered. In other classes, the contract may commence without the receipt of a premium (often a non-marine policy requires that the insured ‘has paid or agreed to pay the premium’). With life insurance, the usual practice is that the existence of the contract depends upon the first premium being received.

CLAIMS

Once more, there are significant differences between Life and General Business claims. Specifically, the implications include:

(a) Life insurance claims: obviously, there will only be one death claim. It is quite essential for the claims handler to check each claim with the utmost care, as all sorts of considerations are involved, such as: (i) possible disputes or complications, for instance, problems may arise when the primary beneficiary cannot be traced, or more than one person lodges a claim as alleged assignees; (ii) possible outstanding policy loans; (iii) possible assignment, so that the claimant is not the original policyholder; (iv) uncertainties over actual death or the identity of the deceased; (v) dividend/bonus considerations with participating/with-profit policies. For similar reasons to those pertaining to underwriting (see 4.5 above), life insurance claims handling is frequently centralised.

(b) General insurance claims: the range of different types of claims is much wider than with life insurance. Also, it is quite possible that the amounts involved are enormous. Therefore, equal care should be taken in verification, although most claims being relatively small, the work is much more likely to be decentralised, sometimes with fairly junior staff having some degree of authority in claim settlement.

[Example: Claims may be relatively trivial, such as the loss of a camera, or exceedingly complex, such as a major explosion at a large power station.]

(c) Common features: there are two areas that must be the subject of attention in all insurance claims. These are: (i) Liability: is the insurer liable under the policy? When dealing with liability insurance, it must also be ascertained whether the insured is liable at law to the third party claimant. (ii) Quantum: how much is payable with the claim? With life insurances, it is usually pre-determined, but with other classes of business, this could involve complex and sometimes bitter discussion. (d) Significance: it has been said that an insurer stands or falls on the way it deals with its claims. There is truth in the remark and the insurance intermediary will want to know and feel confidence in the support he looks for in this area.

REINSURANCE

This is not an area where the insurance intermediary is likely to have a close association, but he should be aware that reinsurance is very important to the insurer. The aftermath of the September 11 terrorist attack is a testimony to this saying.

(a) Definition: insurance used to transfer all or part of the risk assumed by an insurer under one or more insurance contracts to another insurer, who may be referred to as a reinsurer in relation to such a transaction.

(b) Reasons: The major reason for buying reinsurance is security. It is very likely that an individual insurance claim is payable from the assets of the insurer, but it may be very inconvenient (and even costly) to produce large amounts of cash at short notice, since assets will mostly be in investments. A reinsurance contract may be so arranged as to entitle the reinsured to an immediate claim payment by the reinsurer in the event of a valid direct claim (i.e. a claim from the original insured) exceeding a pre-determined figure, even before the reinsured has actually paid the direct claim.

Another important reason for reinsurance is to increase an insurer’s ‘underwriting capacity’, which means the ability to accept proposed business with in mind all risk management considerations. Having reinsurance means that some risks may be accepted which might otherwise have to be declined in part or total.

(c) Methods: This does not concern insurance intermediaries, unless they handle reinsurance matters on behalf of insurers or reinsurers.

(d) Effects for the Insured: Reinsurance has no direct effect for the policyholder. He is not entitled to know, and probably has no need to know, that his insurance is being reinsured. That is a matter entirely between the insurer and the reinsurer(s). The insurer is always directly liable to the policyholder for the full amount payable under the contract irrespective of the financial condition of its reinsurers. Reinsurance, however, does give an added security that the insurer will be able to pay!

ACTUARIAL SUPPORT

An actuary may be thought of as a highly skilled mathematician. His particular expertise is not only in the collation and presentation of numerical information, but also in projecting and predicting future trends, based on available data and assumptions. It will immediately be understood, therefore, that such an expert has a very important role to play in insurance. Some specific observations:

(a) Life insurance: more than any other class of business, life insurance depends upon mathematical calculations (although they are very important to all classes). It is essential for the life insurer to know mathematical facts about mortality (death statistics) and projected interest earnings, for example.

Note: 1 The Insurance Companies Ordinance requires all insurers who carry on long term business to appoint a qualified actuary, acceptable to the Insurance Authority. 2 This Ordinance also requires long term insurers to carry out a valuation of all assets and liabilities at least once a year. This is perhaps the most important function of the actuary.

(b) General insurance: Their expertise, especially with long-tail business (insurance where claims arise and develop over a long period of time until, say, 5 years or even more after policy expiry, e.g. liability classes), is extremely valuable. This is particularly true when having to calculate outstanding claims reserves required. The Office of the Commissioner of Insurance requires motor and employees’ compensation insurers to annually conduct actuarial review of their reserves relating to such statutory classes of business.

Note: A corresponding term, ‘short-tail business’, refers to business where claims are mostly settled within a relatively short space of time after arising, e.g. motor (own-damage) and fire insurance.

(c) Generally: the application of an actuary's skills is very obvious in such areas as premium rating, the calculation of reserves and the valuation of liabilities.

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MARKETING AND PROMOTION

Remembering the quotation above, this is a very important area for the insurer.

The particular areas of responsibility include:

(a) Public Relations: as explained, this may overlap to some extent with Customer Services, but the image of the company and its perceived standing in the eyes of the public is of great significance. This wide-ranging activity will include: (i) the co-ordination of all external communications; (ii) the co-ordination of media enquirers and interviews; (iii) press conferences, to announce or explain things, as necessary; (iv) preparing press releases and copy for trade and other journals.

(b) Promotions: organizing and coordinating their preparation and conduct.

(c) Advertising: closely interconnected with the above, this enormously important area includes: (i) selection of external agencies (if used); (ii) the extent to which TV or other media are to be involved; (iii) co-ordination of advertising campaigns; (iv) expenditure analysis and control.

Note: Advertising is an area which could involve massive expenditure. Great care must therefore be taken in its management and control. As one famous businessman said ‘Half the money I spend on advertising is wasted. Unfortunately, I do not know which half!’

(d) Sponsorship: insurers are frequently asked to sponsor industry or educational projects. Also, this is of course an important aspect of advertising, involving much time and probably a considerable budget.

(e) Market research: obviously, continuous monitoring of one's present and potential market is a vital element for a marketing department. This will seek to establish existing and perceived needs and demands in respect of insurance products.

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CORE FUNCTIONS OF AN INSURANCE COMPANY

Whilst an insurance intermediary is unlikely to have close contact with the internal organisation of insurance companies, it is good to understand something of their infrastructure and to be aware of the various departments and personnel behind the marketing process. These, in outline, are considered below. Please remember, however, that there is no single system for insurance companies to follow, and therefore the suggested structure must be seen as representative only.

PRODUCT DEVELOPMENT

Someone once said, ‘Insurance is not something that is bought, it is something that has to be sold’. We shall recall this when discussing marketing and promotion (4.3 below), but to the extent that it is true the whole exercise depends upon having something to sell. That something may be described as an insurance product. Some insurances, of course, are compulsory (e.g. third party motor and employees’ compensation), but even with these classes the precise policy wording is not decreed by the Government. Therefore there is scope for flexibility in presentation (whilst the requirements of Ordinances must be respected). With other classes of insurance business, Hong Kong is an open and very competitive business environment. Insurers must therefore be efficient and dynamic in preparing the products they ‘sell’. As an abbreviated summary, the Product Development department/section of an insurer will be much occupied with:

(a) Individual product development: this is a never-ending process. With competitors eager to learn and copy, it has been said that the unchallenged ‘lifespan’ of a totally new product is very short, perhaps a matter of only a few weeks or months. After that time, the product has been copied, adapted and frequently undersold.

(b) Product portfolio development: increasingly, producing a ‘package’ of cover, especially for larger clients, has become sensible, even vital, in order to retain a competitive edge.

(c) Product research: we may think of this in three areas: (i) our own products: nothing is perfect beyond improvement. (ii) competitors' products: we do not, and cannot, live in a vacuum. It is essential to know what is happening in our market and ‘what we are up against’. Besides, they will have no hesitation in ‘borrowing’ from us! (iii) market trend: the needs of the general public.

CUSTOMER SERVICING

Sometimes described as Client Servicing, this section has a number of functions, and with a particular insurer some of these may be carried out by other departments (such as Accounts, Claims etc.). The general scope of its responsibilities is indicated by its name. It is to provide a service to existing and potential customers/clients, and the duties probably include:

(a) Correspondence: enquiries of every imaginable kind are likely to be received, asking for guidance and information. Sometimes, the enquiries will be totally unrelated to the company's business; therefore a degree of perception and tact will be required. It is quite sure that the response a company gives to enquiries is very important.

(b) Public relations: the more formal aspects of this could be within the province of the marketing people, but the way clients are dealt with profoundly influences a company's standing in the eyes of the public.

(c) Documentation: requests for duplicate policies, amendments to existing policies, copies of motor insurance certificates, etc. will probably receive at least their initial attention in this department.

(d) Complaints: an area that must be seen to be handled fairly and promptly. This may require considerable liaison with other colleagues/departments. It must also be remembered that complaints may reach high levels of company management and receive media and even Government attention.

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SUBROGATION

Definition

Subornation is the exercise, for one’s own benefit, of rights or remedies possessed by another against third parties. As a corollary (i.e. a natural consequence of an established principle) of indemnity, subornation allows proceeds of claim against third party be passed to insurers, to the extent of their insurance payments. At common law, an insurer’s subornation action must be conducted in the name of the insured.

Suppose, for example, that a car, covered by a comprehensive motor policy, is damaged by the negligence of a building contractor. The motor insurer has to pay for the insured damage to the car. As against the negligent contractor, the insured’s right of recovery will not be affected by the insurance claim payment. However, the motor insurer may, after indemnifying the insured, take over such right from the insured and sue the contractor for the damage in the name of the insured. From this, it will easily be seen how subornation seeks to protect the parent principle of indemnity, by ensuring that the insured does not get paid twice for the same loss.

How Arising

Subornation rights arise in several manners as follows:

(a) In tort: This usually arises where a third party negligently causes a loss indefinable by a policy. For example, a fire insurer, after paying a fire loss, discovers that the fire was caused by a negligent act of a neighbor of the insured. It sues the neighbor in the name of the insured for damages recognized by the law of tort.

(b) In contract: This arises where the insured (perhaps a landlord) has a contractual right (perhaps under a tenancy agreement) against another person (perhaps a tenant) for an insured loss. After indemnifying the insured for the loss, the insurer may exercise such right against that other person in the name of the insured.

(c) Under statute: If a person is injured at work, his employer, if any, will have to pay an employee compensation benefit to him in accordance with the provisions of the Employees' Compensation (‘EC’) Ordinance. The Ordinance will then grant subrogation rights to the indemnifying employer against another person who is liable to the employee for the injury. In turn, the employer has to pass these rights to the EC insurer who has paid the employee compensation benefit for or on behalf of the employer.

(d) In salvage: This we have already considered (see 3.4.5 above). The insurer may be said to have subrogation rights in what is left of the subject matter of insurance (salvage), arising under the circumstances already discussed.

How Applicable

As with contribution, subrogation can only apply if indemnity applies. Thus, if the life insured of a life policy is killed by the negligence of a motorist, the paying life insurer will not acquire subrogation rights, as this payment is not an indemnity.

Other Considerations

There are other features to note:

(a) In the common law, subornation rights are only acquired after an indemnity has been provided. Non-marine policies usually remove such restriction by stipulating that the insurer is entitled to such rights even before indemnification.

(b) Some considerations arise in respect of proceeds of subornation:

(i) The insurer cannot recover more under subornation than he has paid as an indemnity. By way of example, suppose there is an insured loss of an antique. The insurer pays, and sometime later when the antique is found, its value is much higher. The insurer can only keep an amount equal to what he has paid and any balance belongs to the insured.

(ii) The above saying is not true in the event of subornation arising after abandonment of the property to the insurer (see 3.4.6 above). There, all rights in the property belong to the insurer, of course including the right to ‘make a profit’!

(iii) Sharing of Subornation Proceeds Where the insurer has only provided a less-than indemnity on the basis of certain policy limitations, the insured may possibly be entitled to part of – sometimes even the whole of - the subornation proceeds, depending on what limitations have been applied in the process of claims adjustments. The following are illustrations of several manners in which the sharing of subornation proceeds between the insured and the insurer can be done:

(1) Excess: Suppose the insured is responsible for a loss (excess) of $10,000 before his liability insurer pays $40,000, and $20,000 is subsequently recovered from a negligent third party. The whole of $20,000 will belong to the insurer. However, if the subornation recovery is $45,000 instead, the insured will be entitled to $5,000 and the insurer $40,000.

(2) Limit of Liability: Suppose an insured contractor has incurred liability to a road user in the amount of $1.5 million, of which the insured has to pay $0.5 million out of his own pocket because his policy is subject to a limit of liability of $1 million. Any recovery from a joint toreador will belong to the insured, except where it amounts to more than $0.5 million in which case that part over and above the $0.5 million threshold will belong to the insurer up to the amount of insurance payment.

(3) Average: Suppose a fire insurer has paid 80% of a loss where there is a 20% under-insurance. The insured is entitled to 20% of subornation proceeds as if he was a co-insurer for 20% of the risk.

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CONTRIBUTION

Equitable Doctrine of Contribution

This is a claims-related doctrine of equity which applies as between insurers in the event of a double insurance, a situation where two or more policies have been effected by or on behalf of the insured on the same interest or any part thereof, and the aggregate of the sums insured exceeds the indemnity legally allowed.

[Example: Suppose a husband and wife each insure their home and contents, each thinking that the other will forget to do it. If a fire occurs and $200,000 damage is sustained, they will not receive $400,000 compensation. The respective insurers will share the $200,000 loss.]

Apart from any policy provisions, any one insurer is bound to pay to the insured the full amount for which he would be liable had other policies not existed. After making an indemnity in this manner, the insurer is entitled to call upon other insurers similarly (but not necessarily equally) liable to the same insured to share (or to contribute to) the cost of the payment.

Rateable Proportions

Where contribution applies, the ultimate proportion of the insured’s loss that any one particular insurer is responsible for is called the ‘rateable proportion’ of that insurer. It is not difficult to understand that the sum of all the insurers’ rateable proportions equals one, that is to say, 100% of the insured’s loss. A few methods are available for calculating rateable proportions. But as an insurance intermediary, it is not essential that you should know them well, bearing in mind that how much your clients will ultimately get paid for a loss will not depend on the basis of contribution to be employed.

How Arising

The criteria (or essentials) that need to be satisfied before contribution applies are:

(a) the respective policies must each be providing an indemnity (rather than benefit) to the loss in question (this is the reason why it is said that contribution is a corollary (i.e. a natural consequence of an established principle) of indemnity);

(b) they must each cover the interest (which term does not mean property, liability, etc.) affected (see counter-example below);

(c) they must each cover the peril (cause of loss) that has given rise to the loss;

(d) they must each cover the subject matter of insurance (property, liability, etc.) that has been affected; and

(e) each policy must be liable to the loss (i.e. not be subject to a policy exclusion or limitation preventing contribution).

[Counter-example of criterion (b): A merchant has some stock-in-trade kept in a public warehouse, and insured under a fire policy. Separately and at the same time, the warehouse operator buys fire insurance on the same property. When a fire occurs damaging the stock-in-trade, both the merchant and the warehouse operator claim under their own policies for the same damage. Immediately two basic questions come to mind. First, is the warehouse operator, not being an owner of the damaged property, entitled to claim under his own fire policy? Second, if both policyholders are entitled to claim, will there be contribution between the insurers? The answer to the first question is: the warehouse operator, being a bailee of the stock-in-trade, has insurable interest in it at the time of loss, and is thus entitled to claim under his own policy. Turning to the merchant, you probably will not conclude or argue that he cannot expect to be indemnified. Now we have to wrestle with the second question. The answer to this question hinges on that to the question of whether the two policies cover the same nterest (criterion (b)). For whose benefit has the merchant bought his fire insurance? And what about the warehouse operator? In fact, each of them has bought insurance for their own benefit. In other words, the first mentioned policy covers the merchant’s ‘interest as owner’, and the second one covers the warehouse operator’s ‘interest as bailee’. Is it apparent to you now that the two policies cover different interests, so that contribution will not apply as between them?

At this point, we have completely resolved the issue of contribution arising in the case. But there remains an issue of the cogency of indemnifying for the same loss with twice its amount. Now it is time for another principle of insurance – subrogation (see 3.6 below) – to play its part. The insurer of the merchant, upon indemnification, is entitled to claim, for his own benefit albeit in the name of the merchant, against the warehouse operator (bailee) for the indemnity provided by the other insurer.]

How Applicable

Contribution will only apply if indemnity applies. Thus, if a person dies whilst insured by two or more separate life insurance policies, each has to pay in full, because the insurances are not subject to indemnity.

How Amended by Policy Conditions

The position between insurers as governed by the equitable doctrine of contribution is of little or no concern to the insured, unless that has been modified by one of the following policy provisions:

(a) Rateable Proportion Clause (or Contribution Condition), restricting the insurer’s liability to its rateable share of the loss. The effect is that, where there is double insurance and each of the relevant policies contains such a clause, the insured could no longer claim all of his loss from one insurer alone.

[Example: Using the example in 3.5.1 again, the standard fire policy contains a clause restricting its contribution to its ‘rateable share’ in the event of double insurance. In the given circumstances, if Insurer A is approached first and his rateable share is, say, $50,000 (25%), he cannot be made to pay the full loss. He is liable only for $50,000 and the insured must himself go to Insurer B for B’s rateable share ($150,000 or 75%).]

(b) Non-contribution Clause, to the effect that it is the other policies that will have to pay the loss.

[Example: Household policies on contents may exclude items ‘more specifically insured’. If a camera is separately insured under an ‘All Risks’ policy, that policy may be regarded as more specific than the household policy, so that the latter policy, if it contains such a clause, will not be liable for a, say, theft loss of the camera from the insured premises.]

(c) Partial Contribution Condition

[Example: The so-called ‘Marine Clause’ in the standard fire policy provides that in the event of potential contribution between a marine policy and the fire policy, the fire policy will not share the loss, except for that part of the loss which is above the marine compensation. (This may happen where, for example, some cargo, while being left in a container depot awaiting the carrying vessel, catches fire. The usual marine policy will cover the damage so caused. It is also possible that there is in place a fire policy whose cover has been extended to cover a fire occurring in such circumstances.)]

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Policy Provisions Providing More Than Indemnity

Indemnity is very logical and technically easy to defend. However, in practice, most policyholders are ignorant of this and are confused and offended when insurers ‘reduce’ their claims, by deducting depreciation, wear and tear, etc. As a marketing or public relations exercise, insurers sometimes offer or agree to grant property insurances which may be said to give a commercial rather than a strict indemnity. Some examples are as follows:

(a) Reinstatement insurances (or insurances on a reinstatement basis): This is one of the several uses of the term ‘reinstatement’ (see 3.4.4(d) above) and is often found with fire and commercial ‘all-risks’ insurances. The meaning is that where reinstatement takes place after a loss, no deductions are made from claim payments in respect of wear and tear, depreciation, etc.

(b) ‘New for Old’ cover: Again, this means that no deductions are made in respect of wear and tear, deprecation, etc. This term is more generally used with household and marine hull policies.

(c) Agreed value policies (or valued policies): Such policies may be used for articles of high value, where depreciation is unlikely to be a factor (e.g. works of art, jewellery, etc.) or where property valuation contains a rather subjective element. The sum insured is fixed on the basis of an expert's valuation, and agreed between the insured and the insurer as representing the value at risk of the property throughout the currency of the policy. In non-marine insurance, a valued policy undertakes to pay this sum in the event of a total loss, without regard to the actual value at the time of loss, whereas in the event of a partial loss, the actual amount of loss would instead be payable without regard to the agreed value.

(d) Marine policies: Almost without exception, marine hull and marine cargo policies are written on a valued basis, and the agreed value will be taken as the actual value at the time of loss for the purposes of both partial and total loss claims.

The Practical Problems with Indemnity

Indemnity, as mentioned above, is extremely logical. What makes more sense than to say that a person should only recover what he has lost? He should not profit from a loss! However, most people feel that they should receive the amount they have insured for, with a total loss. Moreover, the fact or amount of depreciation is an area where you, or the claims handler, may definitely expect problems with the claimant. When claims are being made, a lot of claimants will say that their property has not depreciated at all, or only marginally!

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Policy Provisions Preventing Indemnity

While policies in some classes of business promise to indemnify the insured, this has to be done subject to the express terms of the policy, if any. Some of these terms mean that something less than indemnity is payable. For example:

(a) Average: Most non-marine property insurances are expressly subject to average. This means that the insurer expects the insured property to be insured for its full value. If it is not, in the event of a loss the amount payable will be reduced in proportion to the under-insurance. For example, if the actual value of the affected property at the time of a loss was $4 million and it was only insured for $1 million, we may say that the property was at the time of the loss only 25% insured. Therefore, by the application of average, only 25% of the loss is payable.

In view of this penalty for under-insurance, it is very important for insurance intermediaries to do their best to ensure that their clients will arrange full value insurance.

Note: In marine insurance, ‘average’ has a totally different meaning. Here it means partial loss, a loss other than total loss. Average in marine insurance is complex and beyond the needs of this present study.

(b) Policy excess/deductible: An excess or deductible is a policy provision whereby the insured is not covered for losses up to the specified amount, which is always deducted from each claim.

Suppose a motor policy is comprehensive, with a $4,000 excess for damage to the insured vehicle. If an accident occurs and the repair bill for the car amounts to $14,000, the insurer is only liable for $10,000. On the other hand, with a minor accident and repairs costing $3,000, the insurer would have no liability at all.

(c) Policy franchise: Seldom seen today (except for time franchise – see example below), it is similar to an excess in that it eliminates small claims. On the other hand, it is different from an excess in that if the loss exceeds or reaches the franchise – depending on the wording used - the loss is payable in full. Like an excess, a franchise can be expressed as a percentage, an amount of loss, or a time period. Suppose a ship which is insured for $5,000,000 subject to a 5% franchise sustains insured damage. If repairs cost only $100,000 (2%), nothing is payable by the insurer. But if repairs cost $1,000,000 (20%), the loss is payable in full.

Example of time franchise: A particular hospitalisation policy contains a 2- day franchise provision; in other words, there is a waiting period of two days. If the insured person stays in hospital for one day, no expenses are reimbursable. But if he has to stay for 5 days, the policy pays the medical expenses incurred during the whole of that 5-day period.

(d) Policy limits: As the sum insured is the insurer's maximum liability, any loss exceeding that limit will not be fully indemnified. Other types of limits may also exist within the policy terms; examples include: (i) Single Article Limit: It is a limit commonly found in a household contents policy. Where such a policy covers property described in broad terms like ‘contents’ for a stated amount, there is no way the insurer can tell whether the insured contents will not, at the time of loss, be found to include an article which is so valuable that its value already accounts for, say, 90% of the sum insured for the whole of the contents. This is a situation the insurer will not want to see, partly because of the theft risk it represents. In fact, the insured could have declared the value of this item of contents to the insurer, requiring that it be separately subject to a sum insured representing its value. The benefit of this approach is that the insurer will be liable for an insured loss of this item of property up to its own sum insured. On the other hand, in the event that an insured has not made such an article the subject of a separate sum insured, the insurer will have to restrict the amount payable for a loss of this item to a limit specified in the policy, called the ‘single article limit’.

(ii) Section Limit: A policy may contain two or more sections, which take effect in relation to different subject matter of insurance (as in the case of a travel insurance policy, which normally covers property damage, legal liability and others), different insured perils, etc. Each of these sections is usually made subject to its own limit of liability, which operates similarly to a sum insured.

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INDEMNITY

Definition

Indemnity means an exact financial compensation for an insured loss, no more no less.

Implications

Indemnity cannot apply to all types of insurance. Some types of insurance deal with ‘losses’ that cannot be measured precisely in financial terms. Specifically, we refer to Life Insurance and Personal Accident Insurance. Both are dealing with death of or injury to human beings, and there is no way that the loss of a finger, say for instance, can be measured precisely in money terms. Thus, indemnity cannot normally apply to these classes of business. (Note: medical expenses insurance, which is often included in personal accident and travel insurance policies, is indemnity insurance unless otherwise specified in the policies.)

Other insurances are subject to the principle of indemnity.

Note: It is sometimes said that life and personal accident insurances involve benefit policies rather than policies of indemnity. Since indemnity cannot normally apply, the policy can only provide a benefit in the amount specified in the policy for death or for the type of injury concerned.

Link with Insurable Interest

We studied insurable is above. That represents the financial ‘interest’ in the subject matter, which is exactly what should be payable in a total loss situation, if the policyholder is to be completely compensated. However, life and personal accident insurances may generally be regarded as involving an unlimited insurable interest, and therefore indemnity cannot apply to them.

How Indemnity is Provided

It is common for property insurance policies to specify that the insurer may settle a loss by any one of four methods named and described below. However, both marine and non-property policies are silent on this issue so that the insurer is obliged to settle a valid claim by payment of cash.

(a) Cash payment (to the insured): This is the most convenient method, at least to the insurer.

(b) Repair: Payment to a repairer is the norm, for example, with motor partial loss claims.

(c) Replacement: With new items, or articles that suffer little or no depreciation, giving the insured a replacement item may be a very suitable method, especially if the insurer can obtain a discount from a supplier.

(d) Reinstatement: This is a word that has a number of meanings in insurance. As a method of providing an indemnity, it means the restoration of the insured property to the condition it was in immediately before its destruction or damage.

Note: You are absolutely correct if you understand that the term ‘reinstatement’ overlaps in meaning with ‘repair’ and with ‘replacement’.

Salvage

When measuring the exact amount of loss (which indemnity is), it has to be borne in mind with certain property damage that there will sometimes be something left of the damaged subject matter of insurance (fire-damaged stock, the wreck of a vehicle, etc.). These remains are termed ‘salvage’. If the remains have any financial value, this value has to be taken into account when providing an indemnity. For example: (a) The value of the salvage is deducted from the amount otherwise payable to the insured (who then keeps the salvage); or

(b) The insurer pays in full and disposes of the salvage for its own account.

Note: The term ‘salvage’ in maritime law has a very different meaning, where it usually refers to acts or activities undertaken to save a vessel or other maritime property from perils of the sea, pirates or enemies, for which a sum of money called ‘salvage award’ (or just ‘salvage’) is payable by the property owners to the salvor provided that the operation has been successful. The term is sometimes also used to describe property which has been salved.

Abandonment

This is a term mostly found in marine insurance, where it refers to the act of surrendering the subject matter insured to the insurers in return for a total loss payment in certain circumstances. This is quite standard in marine practice, but in other classes of property insurance, policies usually specifically exclude abandonment.

The important thing to be remembered with abandonment is that the subject matter insured (or what is left of it) is completely handed over to the insurer, who may therefore benefit from its residual value. (This will be important with Subrogation).

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Policy Modification of the Principle

It is very common for insurers to adopt policy wording that has the effect of modifying the application of proximate cause rules. Two examples of such practice are given below:

(a) ‘Directly or indirectly’: There are a whole number of ways that an insurer can frame his policy wording for the purposes of specifying what he wants to cover or not to cover. For instance, it may use such wording as ‘loss caused by …’, ‘loss directly caused by …’ and ‘loss proximately caused by …’. Well do they mean different things to you? Will any of them have the effect of modifying the rules of proximate cause? The answer is that they have been held to mean the same thing. That is to say, whether the term ‘directly’ or ‘proximately’ is adopted or left out, the legal rules to be applied are exactly the same and the same scope of cover is given or excluded, as the case may be. But what if the term ‘indirectly’ is used? A policy exclusion that says that loss ‘directly or indirectly’ arising from a particular peril (excepted peril) is excluded has been construed by the courts to mean that a loss will not be recoverable even where the operation of that excepted peril has only been a remotely (as opposed to ‘proximately’) contributory factor. Read the following decided court case for illustrations:

An army officer was insured under a personal accident policy, which excluded claims ‘directly or indirectly caused by war’. During wartime, the insured was on duty supervising the guarding of a railway station. Walking along the track in the darkness, he was struck by a train and killed. It was held that although the war was merely an ‘indirect’ cause of the death, the policy wording meant that the insurer was not liable.

(b) ‘Loss proximately caused by delay, even though the delay be caused by a risk insured against’ (an exclusion wording quoted from a marine cargo insurance clause most commonly used): Suppose an insured shipment of calendar for the year 2011, expected to arrive on 1 December 2010, does not arrive until 15 February 2011 because of a collision (insured peril) involving the carrying vessel during the insured voyage. By relying on the exclusion, the insurer can deny a ‘loss of market’ claim from the insured even though the loss is due to an insured peril.

Note: Remember that the principle of proximate cause is sometimes very complicated. There have been many interesting, sometimes surprising court cases which have decided its application. In particular, not too rarely are inconsistent or opposing judicial decisions seen in factually similar cases which are made on the basis of the same rule(s) of proximate cause, perhaps because the judgments of the judges vary from one case to another on how the facts of a case relate to one another. Therefore, please do not assume that knowledge of the above brief notes will make you an expert in this area.

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Types of Breach of Utmost Good Faith

A breach of utmost good faith can be in the form of either a misrepresentation (i.e. the giving of false information) or a non-disclosure (i.e. failure to give material information). Alternatively, it can be classified into a fraudulent breach and a non-fraudulent breach (i.e. a breach committed either innocently or negligently, rather than fraudulently). Both classifications combined produce a four-fold categorisation as follows:

(a) Fraudulent Misrepresentation: an act of fraudulently giving false material facts to the other party;

(b) Non-fraudulent Misrepresentation: an act of giving false material facts to the other party done either innocently or negligently;

(c) Fraudulent Non-disclosure: a fraudulent omission to give material facts to the other party; or

(d) Non-fraudulent Non-disclosure: an omission to give material facts to the other party done either innocently or negligently.

Remedies for Breach of Utmost Good Faith

If the duty of utmost good faith is breached (any one of the four types mentioned above), the aggrieved party (normally the insurer) may have available certain remedies against the guilty party:

(a) To avoid within a reasonable time the whole contract as from policy inception, with the effect that premiums (and claims) previously paid without knowledge of the breach are generally returnable, unless it was a fraudulent breach on the part of the insured or his agent;

(b) In addition to (a) above, it is in principle possible to sue in tort (see Glossary) for damages in the case of fraudulent or negligent misrepresentation;

(c) To waive the breach, alternatively, in which case the contract becomes valid retrospectively.

Note: An insurer aggrieved by a breach of utmost good faith has not the option to refuse payment of a particular claim, to treat the policy as valid for the remainder of the insurance period, and to retain part of or the whole of the premium paid. This is because rescinding only part of a contract is not an available remedy.

PROXIMATE CAUSE

Meaning and Importance of the Principle

The proximate cause of a loss is its effective or dominant cause. Why is it important to find out which of the causes involved in an accident is the proximate cause? A loss might be the combined effect of a number of causes. For the purposes of insurance claim, one dominant cause must be singled out in each case, because not every cause of loss will be covered.

Types of Peril

In search of the proximate cause of a loss, we often have to analyse how the causes involved have interacted with one another throughout the whole process leading to the loss. The conclusion of such an analysis depends very much on the identification of the perils (i.e. the causes of the loss) and of their nature. All perils are classified into the following three kinds for the purposes of such an analysis:

(a) Insured peril: It is not common that a policy will cover all possible perils. Those which are covered are known as the ‘insured perils’ of that policy, e.g. ‘fire’ under a fire policy, and ‘stranding’ under a marine policy.

(b) Excepted (or excluded) peril: This is a peril that would be covered but for its removal from cover by exclusion, e.g. fire damage caused by war is irrecoverable under a fire policy because war is an excepted peril of the policy.

(c) Uninsured peril: This is a peril that is neither insured nor excluded. A loss caused by an uninsured peril is irrecoverable unless it is an insured peril that has led to the happening of the uninsured peril. For example, raining and theft are among the uninsured perils of the standard fire policy.

Application of the Principle

The principle of proximate cause applies to all classes of insurance. Its practical applications may be very complex and sometimes controversial. For our purposes, we should note the following somewhat simplified rules:

(a) There must always be an insured peril involved; otherwise the loss is definitely irrecoverable.

(b) If a single cause is present, the rules are straightforward: if the cause is an insured peril, the loss is covered; if it is an uninsured or excepted peril, it is not.

(c) With more than one peril involved, the position is complex, and different rules of proximate cause are applicable, depending on whether the perils have happened as a chain of events or concurrently, and on some other considerations. Specific cases should perhaps be a matter of consultation with the insurer and/or lawyers, but the general rules are:

(i) uninsured perils arising directly from insured perils: the loss is covered, e.g. water damage (uninsured peril) proximately caused by an accidental fire (insured peril) in the case of a fire policy;

(ii) insured perils arising directly from uninsured perils: the loss from the insured peril is covered, e.g. fire (insured peril) damage proximately caused by a careless act of the insured himself or of a third party (uninsured peril) in the case of a fire policy.

(iii) the occurrence of an excluded peril is generally fatal to an insurance claim, subject to complicated exceptions.

(d) Other Features of the Principle (i) Neither the first nor the last cause necessarily constitutes the proximate cause. (ii) More than one proximate cause may exist. For example, the dishonesty of an employee and the neglect on the part of his supervisor of a key to a company safe may both constitute proximate causes of a theft loss from the safe. (iii) The proximate cause need not happen on the insured premises. Suppose a flat insured under a household policy is damaged by water as a result of a fire happening upstairs. The damage is recoverable under the policy, although the insured flat has never been on fire. (iv) Where the proximate cause of a loss is found not to be an insured peril, it does not necessarily mean that the loss is irrecoverable under the policy.

[Illustration: There are four containers of cargo being carried on board a vessel and insured respectively under four marine cargo policies. The first policy solely covers the peril of collision, the second fire only, the third explosion only, and the fourth entry of water only. During the insured voyage, because of the master’s negligence, this vessel collides with another. The collision causes a fire, which then triggers an explosion. As a result, the vessel springs several leaks and all the cargo is damaged by seawater entering through the leaks. These facts show that the cargo damage was proximately caused by negligence. Bearing in mind that negligence is merely an uninsured rather than insured peril of each of the four cargo policies, an immediate, important question that has to be grappled with is: ‘Is the cargo damage irrecoverable under those policies?’ In search of an answer to this question, we must look at the links between the individual events of the incident. Negligence, the identified proximate cause, naturally causes a collision, which then naturally causes a fire. The fire naturally leads to an explosion, which then naturally causes an entry of water. At last, the water damages the cargo. Before us is a chain of events, happening one after another without being interrupted by other events. With respect to each policy, the water damage is regarded as a result of its sole insured peril, notwithstanding that this peril can be traced backward to an uninsured peril. Therefore, the only conclusion that we can reach is that each of the policies is liable for the water damage to the cargo it has insured. (Of course, if the proximate cause is found to be an excepted peril, the opposite conclusion will have to be made.)]

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UTMOST GOOD FAITH

Ordinary Good Faith

At common law, most types of contracts are subject to the principle of good faith, meaning that the parties have to behave with honesty and such information as they supply must be substantially true. However, it is not their responsibility to ensure that the other party obtains all vital information which may affect his decision to enter into the contract, or may affect the terms on which he would enter into the contract. For example, if only after you have boarded a double-decker and paid the fare do you find that no seats on it are vacant, you will have no grounds for complaint. In technical terms, you are not entitled, in such circumstances, to avoid your contract with the bus company for its failure to voluntarily disclose to you the fact that all the seats have been taken on the bus.

Utmost Good Faith

Insurance is subject to a more stringent common law principle of good faith, often called the principle of utmost good faith. It means that each party is under a duty to reveal all vital information (called material facts) to the other party, whether or not that other party asks for it. For example, a proposer of fire insurance is obliged to reveal the relevant loss record to the insurer, even where here is not a question on this on the application form.

Note: 1 Insurers sometimes extend the common law duty of utmost good faith by requiring the proposer to declare (or warrant) that all information supplied, whether relating to ‘material’ matters or not, is totally (not simply substantially) true. For example, where a proposer for medical insurance enters ‘30’ as his current age on the proposal form when he is aged 31, this is a technical breach of the above kind of warranty, if any, although this inaccuracy is unlikely to be material in the eyes of the common law principle of utmost good faith as applied to medical insurance. 2 On the other hand, a policy provision may state that an innocent or negligent (as opposed to ‘fraudulent’) breach of the duty will be waived (excused).

Material Fact

(a) Statutory Definition: ‘Every circumstance which would influence the judgment of a prudent insurer in fixing the premium, or determining whether he will accept the risk’. From this definition, it can be seen that there are three categories of material facts, by reference to the kinds of decisions likely to be affected by their disclosure. The first one only concerns the decision to accept or to reject a proposed risk (e.g. the fact that a proposed life insured has an inoperable malignant brain tumour.) The second only concerns the setting of premium (e.g. the fact that the insured person of a proposed personal accident insurance is a salesperson). And the third concerns both (e.g. where a proposed life insured is a diabetic). You should also note that the law looks at an alleged ‘material fact’ in the eyes of a prudent insurer - not a particular insurer, a particular insured or a reasonable insured.

(b) Facts that need not be disclosed: In the absence of enquiry, certain facts need not be disclosed; they include: (i) matters of common knowledge (e.g. the explosive character of hydrogen); (ii) facts already known, or deemed to be known, to the insurer (e.g. the problem of piracy in Somalia); (iii) facts which diminish the risk.

[Example: A proposer for commercial fire insurance did not mention the fact that his premises were protected by an automatic sprinkler system, which fact, if disclosed, would have influenced the determination of the premium. This omission does not breach utmost good faith, as the fact (although very relevant) actually indicates a lower risk.]

When to Disclose Material Facts

It may be said that utmost good faith involves a duty of disclosure by the proposer/insured. Technically, the insurer is under the same duty, but here we will concentrate on the proposer's duty. This duty has some features that we should note:

(a) Duration (at common law): Those material facts which do not come to the proposer’s (or his agent’s) knowledge until the insurance contract has been concluded do not have to be disclosed. Suppose a proposal for a one-year medical insurance commencing on 15 January 2011 was accepted on 2 January, and the insured had a routine medical examination on 10 January, which revealed to him on 16 January the contraction of malaria. An important question to ask is: ‘Is the insured legally obliged to disclose such finding to his insurer?’ Applying the legal rule just said, the insured is not obliged to do so, assuming that the terms of insurance are silent on this point. Of course, the policy will normally contain an exclusion for preexisting diseases, in which case the insurer may rely on this exclusion rather than a breach of utmost good faith in trying to deny a claim in respect of malaria.

(b) Duration (under policy terms): Some non-life policies require the disclosure of material changes in risk happening during the currency of the contract, such as a change in occupation in the case of a personal accident insurance. At common law, such a change, which could at most represent an increase in risk, need not be notified until renewal.

(c) Renewal: when the policy is being renewed, the duty of utmost good faith revives. (Note: the duty of utmost good faith does not revive when a life policy is approaching its anniversary date.)

(d) Contract alterations: If these are requested during the currency of the policy, the duty of utmost good faith applies in respect of these changes. Where, for example, the insured of a fire policy is requesting an extension to cover theft, he is immediately obliged to disclose all material facts relating to the theft risk, e.g. the physical protections of the insured premises and his record of theft losses, if any.

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PRINCIPLES OF INSURANCE

INSURABLE INTEREST

The word ‘interest’ can have a number of meanings. In the present context, it means a financial relationship to something or someone. There are a number of features to be considered with ‘insurable interest’, as below.

Definition

Insurable interest is a person’s legally recognised relationship to the subject matter of insurance that gives them the right to effect insurance on it. Since the relationship must be a legal one, a thief in possession of stolen goods does not have the right to insure them.

Importance of Insurable Interest

An insurance agreement is void without insurable interest. The rules relating to return of premiums under such an agreement vary as between the different classes of insurance. These rules are the general rules on illegality of contract and the relevant provisions of the Insurance Companies Ordinance (‘ICO’) and of the Marine Insurance Ordinance.

Its Essential Criteria

For insurable interest to exist, the following criteria must be satisfied:

(a) there must be some person (i.e. life, limbs, etc.), property, liability or legal right (e.g. the right to repayment by a debtor) capable of being insured;

(b) that person, etc. must be the subject matter of the insurance (that is to say, claim payment is made contingent on a mishap to such person, etc.);

(c) the proposer must have the legally recognised relationship to the subject matter of insurance, mentioned in 3.1.1 above, so that financial loss may result to him if the insured event happens. (However, insurable interest is sometimes legally presumed without the need to show financial relationship. For example, any person is regarded as having an insurable interest in the life of their spouse.)

Note: A financial relationship alone is not sufficient to give rise to insurable interest. For instance, a creditor is legally recognised to have insurable interest in the life of his debtor, but is not allowed to insure the debtor’s property despite his financial relationship to it, unless the property has been mortgaged to him.

How It Arises

Insurable interest arises in a variety of circumstances, which may be considered under the following headings:

(a) Insurance of the Person: everyone has an insurable interest in his own life, limbs, etc. One also has an insurable interest in the life of one's spouse. Further, one may insure the life of one's child or ward (in guardianship) who is under 18 years of age, and a policy so effected will not become invalid upon the life insured turning 18.

(b) Insurance of Property (physical things): the most obvious example arises in absolute ownership. Executors, administrators, trustees and mortgagees, who have less than absolute ownership, may respectively insure the estate, the trust property and the mortgaged property. Bailees (i.e. persons taking possession of goods with the consent of the owners or their agents, but without their intention to transfer ownership) may insure the goods bailed.

(c) Insurance of Liability: everyone facing potential legal liability for their own acts or omissions may effect insurance to cover this risk (sometimes insurance is compulsory), such liability being termed ‘direct liability’ or ‘primary liability’. Insurance against vicarious liability (see 2.2(c) above) is also possible, where, for example, employers insure against their liability to members of the public arising from negligence, etc. of their employees.

(d) Insurance of Legal Rights: anyone legally in a position of potential loss due to infringement of rights or loss of future income has the right to insure against such a risk. Examples include landlords insuring against loss of rent following a fire.

Note: Anyone (agent) who has authority from another (principal) to effect insurance on the principal’s behalf will have the same insurable interest to the same extent as the principal. For instance, a property management company may have obtained authority from the individual owners of a building under its management to purchase fire insurance on the building. There is no question of a fire insurance effected under such authority being void for lack of insurable interest, even if it is the property management company (rather than the property owners) which is designated in the policy as the insured.

When Is It Needed?

(a) With life insurance, insurable interest is only needed at policy inception. Suppose a woman had effected a whole life policy on the life of her husband, who died some years later. When the woman presented a claim to the insurer, the latter discovered that at the time of the man’s death, they were no longer in the relationship of husband and wife. That means the woman had no insurable interest in the life of the deceased at the time of the death. Nevertheless, this lack of insurable interest will not disqualify her for the death benefit.

(b) However, with marine insurance, insurable interest is only needed at the time of loss.

(c) The above marine insurance rule is probably applicable to other types of indemnity contracts as well.

Assignment

‘Assignment’ is a legal term that generally means a transfer of property. In insurance, there are broadly two types of assignment: assignment of the insurance contract (or insurance policy) and assignment of the right to insurance money (or insurance proceeds). They are different from each other in the following manner:

(a) Effect of an assignment of the insurance contract: With an effective assignment of a policy (or contract) from the assignor (original policyholder) to the assignee (new policyholder), the interest of the assignor in the contract passes wholly to the assignee to the effect that when an insured event occurs afterwards, the insurer is obliged to pay the assignee for his loss, not that suffered by the assignor, if any. In the case of life insurance, assignment will never substitute a new life insured.

(b) Effect of an assignment of the right to insurance money (sometimes simply referred to as an assignment of policy proceeds): Assignment of policy proceeds will have an effect on both losses that have arisen and those that may arise. An assigned policy remains to cover losses suffered by the assignor, not those by the assignee, although it is now the assignee (instead of the assignor) who has the right to sue the insurer to recover under the policy.

(c) Necessity for insurable interest: With assignment of the insurance contract, both the assignor and the assignee need to have insurable interest in the subject matter of insurance at the time of assignment; otherwise the purported assignment will not be valid. (Taking assignment of motor policy as an illustration, the requirement of insurable interest will be satisfied by having the motor policy assigned to the purchaser contemporaneously with the transfer of property in the insured car.) However, with assignment of the right to insurance money, no insurable interest is needed on the part of the assignee, so that it may actually take effect as a gift to the assignee.

(d) Necessity for insurer’s consent: An assignment of the right to insurance money requires no consent from the insurer, irrespective of the nature of the insurance contract concerned. But the position is not that simple with assignment of the insurance contract. Different types of insurance are subject to different legal rules as to whether a purported assignment of the insurance contract will have to be agreed to, by the insurer. The matter is further complicated by the fact that very often non-marine policies include rovisions that override these legal rules. Fortunately, it is sufficient for you simply to know that, in practice, unlike all other types of policies, life policies and marine cargo policies are assignable without the insurers’ consent.

(e) Assignment of benefits as opposed to obligations: Assignment does not have the effect of transferring the assignor’s obligations under the insurance contract to the assignee. Such a transfer requires the insurer’s consent.

Note: 1. It is sometimes misunderstood that any policy provision that claim payments have to be made to a designated person other than the insured is an assignment of the right to insurance money. In fact, the courts may construe such a provision as a mere instruction to pay, which will at most give the designated payee an expectation to be paid, rather than the right to sue the insurer, which right remains in the hands of the insured. 2 Statutory assignment, the best known form of assignment, is subject to the requirements of Section 9 of the Law Amendment and Reform (Consolidation) Ordinance.

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Duties Owed by Agent to Principal

These may be summarised as follows:

(a) Obedience: The agent has to follow all lawful instructions of his principal, strictly or as best as is reasonably possible.

(b) Personal performance: The agent is not allowed to delegate his authority and responsibilities to others (subagents) unless he has authority to do so.

(c) Due care and skill: The law does not demand perfection, and an agent is normally only required to display all reasonably expected skills and diligence in performing his duties. Whilst his principal may be bound by his lack of care, the principal may in turn reclaim from the agent in respect of a loss caused by the lack of care.

(d) Loyalty and good faith: The agent’s obligations of loyalty and good faith are governed by several strict rules of law, the no conflict rule being one of them.

(e) Accountability: The agent has to account for all moneys or other things he receives on behalf of his principal. He also has to keep adequate records relating to the agency activities.

Duties Owed by Principal to Agent

These may be summarised as follows:

(a) Remuneration: The agent is entitled to receive commission or other remuneration (such as bonus) as agreed. This the principal has to pay within a reasonable time or any specified time limit, as the case may be.

(b) Expenses, etc.: The principal, subject to any express terms in the agency agreement, has to reimburse the agent for costs and expenses properly and reasonably incurred by the agent on behalf of the principal; e.g. legal defence expenses paid by a claims settling agent.

(c) Breach of duty: The agent may take action against the principal for the latter’s breach of obligations to him.

Termination of Agency

There are a number of ways in which an agency agreement can be brought to an end. These include:

(a) Mutual Agreement: Generally speaking, all agreements may be terminated by mutual agreement, on terms agreed between the parties.

(b) Revocation: Subject to any contract terms as to notice and/or compensation, either the principal or the agent may revoke (i.e. cancel) the agreement during its currency.

(c) Breach: If either the principal or the agent commits a fundamental breach of contract, the other party may treat the contract as ended (with a possible right of compensation). For example, an exclusive agent, upon discovering that the principal, in breach of a contract condition, has appointed a second agent before the expiry of the agency agreement, may terminate performance immediately and sue the principal for any loss of the profit expected from performing the agreement during the remainder period.

(d) Death: Because an agency relationship is a personal one, the death of either the principal or the agent will end the agreement. Should either party be a corporate body (company), its liquidation will have the same effect.

(e) Insanity: If either the principal or the agent becomes insane so that he no longer can perform the agreement, the agreement will automatically come to an end.

(f) Illegality: If it happens that the agency relationship or the performance of the agreement is no longer permitted by law, this will automatically end the agreement. Suppose a British company (buying agent) has a contract with a company (principal) incorporated and domiciled in another country whereby the buying agent will purchase in the United Kingdom stuffs like wheat, steel, sulphur and other chemicals on behalf of the principal. On the outbreak of a war between the two countries, this agreement will, in the English law, automatically end for illegality.

(g) Time: If the agreement is for a determined period, it will terminate at the end of such period.

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Legal PRINCIPLES

This and the next Chapter will concern principles of law, but the Notes will not provide a comprehensive survey of some very complex issues. The purpose of the Notes, as with the overall study, is to give an insight into the important aspects of an insurance intermediary's professional activities.

THE LAW OF CONTRACT

This is an area of law which affects every one of us, whether in our personal or business lives. As we shall see, contract is an essential element in civilised societies, therefore it is important to have some appreciation of this important subject.

Definition

The simplest definition for ‘contract’ is probably: a legally enforceable agreement. There are a large variety of agreements, but not all are intended to have legal consequences. A social arrangement between two persons, such as a lunch appointment for example, is an agreement, but where either of them unilaterally cancels the appointment, there is no suggestion that the disappointed party should be able to take legal action against the other party, because the agreement is not legally recognised as valid.

Contracts comprise promises or undertakings, usually given in exchange for a promise or undertaking from the other side. In legal terminology, contracts are something intangible. Therefore, an insurance policy in itself is not a contract; instead it is the most commonly used evidence of an insurance contract. An insured who has been affected by a fire will not expect the insurer to deny his insurance claim on the grounds that the insurance contract no longer exists after the insurance policy has been destroyed in the fire. Contracts may concern relatively trivial (such as buying a newspaper or taking a tram ride) or very important matters (such as a major building project or employment). In any event, the contracting parties expect promises to be honoured, and can demand compensation or enforced performance if they are not honoured.

Types of Contracts

For our purposes, we may consider that there are two major types of contract, as follows:

(a) Simple contracts: Although these are described as ‘simple’, this does not mean that they only deal with uncomplicated matters and are easy to understand. Rather, it means that they are simple or easy to form. A simple contract is one created verbally, or by writing not under seal. It can also be inferred from conduct. In short, the validity of simple contracts does not depend on special formalities.

[An example of a contract inferred from conduct is where someone picks up a newspaper from a street vendor and where their body language clearly indicates a purchase. Technically, a contract is formed between the seller and buyer, with the acts of handing over and accepting the money for the newspaper: no words or writing are needed.]

In fact, the great majority of insurance contracts are ‘simple’ contracts. Technically, insurance contracts, to be valid, do not have to be evidenced in writing; but in practice, they almost always are. Nevertheless, as we shall see later, insurance contracts of a certain type are legally required to be evidenced by insurance policies.

(b) Contracts by deeds: A deed is a written instrument signed, sealed and delivered. (Delivery is no longer required to be physical delivery; an intention to be unconditionally bound by the deed suffices.) It must be used with certain transactions such as a transfer of land. Besides, suretyship is always issued in the form of a deed; otherwise, when a claim arises, the obligee may possibly face a defence put up by the surety that he has not the right to sue because he has provided no consideration (see 2.1.3 (c) below for the doctrine of consideration).

Elements or Essentials of a Contract

For the purposes of this section, we shall be talking only of simple contracts (see 2.1.2(a) above), since these constitute the great majority of contracts that are met in insurance transactions. To be a valid contract, an agreement must meet certain criteria called ‘elements of contract’ in the course of its formation. Should any of these elements be absent, the proposed contract either does not exist or is defective in another sense. There are three types of defective contracts, as follows:

1 Void (or invalid) contracts: This means that the proposed contract does not exist in law; it is entirely without legal effect. In the context of insurance, the implication is that generally all premiums which have already been paid under a void contract (or invalid agreement) are returnable; so are claims paid.

Voidable contracts: A voidable contract is one that is apparently of legal effect and that remains to be legally effective unless and until an aggrieved party to the contract treats it as void as from contract conclusion within a reasonable time after acquiring knowledge of the availability of such a right of election. In insurance, it could arise, for instance, with a breach of some types of policy provision, or the discovery that important information was omitted or wrongly given at the proposal stage (see 3.2 below);

3 Unenforceable contracts: This means what it says, an unenforceable contract cannot be enforced (or sued on) in a court of law. However, this is not because it is void, but because some required action has not been taken (e.g. stamp duty not paid on a lease of land, marine insurance policy not issued, etc.). This defect can be remedied by carrying out the required action, so that the contract becomes enforceable (e.g. by issuing a marine policy even after a loss has realised).

Turning to the elements of contract themselves, legal textbooks are not always agreed just exactly how many elements should be found with any one valid contract, but we shall consider six criteria here, as follows (remembering that we eed not go into great detail):

(a) Offer: if no offer is made, obviously there can be no agreement between the two or more parties. In insurance, the offeror may be the intending insured (perhaps by completing and submitting to the insurer a proposal form (or application form)), or the insurer (perhaps as a counter-offer or in connection with a policy renewal); all depends on intention as evidenced by facts. Therefore, although it is widely accepted that an act of completing an insurance proposal form is normally an act of offer, it is technically incorrect to say that it is a settled law that completing an insurance proposal form is an act of offer to the insurer.

(b) Acceptance: the proposed contract cannot come into being unless the offer is accepted by the other party (the offeree). All terms of the offer must be accepted before a contract is concluded. If that other party intends to vary the terms of the proposed contract (requiring increased premium or policy restrictions, for example), this, upon its communication, constitutes a counter-offer, which will have the effect of nullifying the original offer. A counter-offer is subject to acceptance by the original offeror (who becomes the offeree with the counter offer).

(c) Consideration: this is the price (monetary or otherwise) a contracting party pays for the promise the other party (‘promisor’) makes to him. In the case of a simple contract, consideration must be given by both parties; otherwise it is void. On the other hand, a promise contained in a deed, even if it has been given not for consideration, is enforceable at common law by the promisee. In other words, a unilateral promise not made by a deed is invalid. In insurance, the consideration is: the promise by the insured to pay premium; and (ii) the promise by the insurer to pay or compensate as per policy terms.

Note: 1 Where an insured event occurs before the premium promised is paid, the insured will still be entitled to insurance payment in accordance with the terms of the contract and the insurer will have a separate claim against him for the unpaid premium. However, some policies require actual payment of premium as consideration, which requirement will have the effect of overriding the said legal rule.

2 The insurer's consideration is the promise to pay, etc., rather than the actual payment. In many cases, no claim arises under the policy, but when the insured period ends the insurer is treated as having provided consideration, and therefore there will not be a question of the contract being void for lack of consideration leading to an entitlement to return premiums.

(d) Capacity to contract: it means the legal ability to enter into a contract. With individuals, if they are mentally disordered, or are minors, the contracts they make are generally voidable at their option. With companies, they must not act in a way that exceeds their legal powers.

(e) Legality: the subject of the agreement must be legal. A contract to kill or to commit any other crimes, for example, is not valid. Likewise, insurance on smuggled goods would also not be legally recognised. However, exceptions do exist. For instance, the courts may enforce an insurance claim in favour of an insured under an insurance contract that is illegal because the insurer was not authorised to transact the kind of insurance business in question.

(f) Intention to create legal relation: to make a valid contract, each party to it must clearly have the intention that it is to have legal consequences. This seldom gives rise to any problem with insurance contracts because, unlike social or domestic agreements, commercial agreements are presumed to have been made with an intention to create legal relation.

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