CHAPTER 6

LEGAL ASPECT OF
INSURANCE
LEARNING OBJECTIVES
In Part 1
 Describe what a contract is
 Describe the formation of a contract
 Explain all essential elements of a valid contract and relate it to a valid
insurance contract
 Specify some defective contracts

In Part 2
 Define the principle of insurable interest and discuss its importance
 Define the principle of indemnity and explain how insurance companies
uphold the principle of indemnifying their insured
 Define the principle of utmost good faith and explain facts which are material
to the contract
 Define the principle of subrogation and describe how subrogation arise
 Define the principle of contribution and determine how to derive with the
amount of contribution
 Define the principle of proximate cause and explain how it works
Part 1
Law of Contract
Overview

Definition of a contract
Essentials of a contract
Defective contracts
Principle of Insurance
Insurable interest
Utmost good faith
Proximate cause
Indemnity
Subrogation
Contribution
Definition of contract

A legally enforceable agreement made between at

least two parties.
Agreements which are not legally enforceable are
not contracts.
Legally responsible mean that disputes relating to
the agreement may be referred to a court for
settlement.
 Insurance contract

A contract of insurance is an agreement

whereby one party : called the insurer

in return for an agreed consideration :

called the premium

to pay the other party, : called the

insured

a sum of money or its equivalent in kind

upon the occurrence of a specified event

resulting in loss to him.
Essentials of a contract

Offer and
Consideration Intention
acceptance

Consent Capacity Legality

 Offer and Consider
acceptance Offer- A firm ation
proposition put
forward by one
person to another The fair exchange
person of something of
value to induce the
other party to enter
Acceptance – into a legally
Unconditional binding contract
assent by one party
to the terms of the
offer
Intention Consent
Genuine assent
The parties or meeting of
must intend minds
their agreement
to have legal
consequences All parties to a
contract must
agree to exactly
the same terms
Capacity Legality

Legal ability for a

party to enter into a
binding contract
Subject matter or
transactions
contracted for must
not violate any laws
Minors, insane
or public policy
persons, intoxicated
persons and
corporations that
act outside their
authority do not
have the capacity
Defective contracts
Void Contract
• Nothing more than just an agreement that is enforceable in court.
• An agreement without those six elements of contract is void.
• An insurance contract which is affected without insurable interest is also
void.

Voidable Contract
• A contract is voidable if one party to the contract is given the option to
consider the contract void.
• A voidable contract is valid and in force until the option to treat it void is
exercised.
• A contract in which the party has breached the duty of utmost good faith is
voidable.

Unenforceable Contract
• Contract neither void nor voidable but cannot be enforceable through court
of law
• Example: Marine insurance contract which is not in writing
Part 2
Principle of
Insurance
Principles of Insurance

Insurance Utmost good Proximate

interest faith cause

Indemnity Subrogation Contribution

Insurable interest

Defined as the right to

A legally recognized
insure arising out of
financial interest is a
legally recognizes
financial interest that is
financial interest which a
recognized under the
person has in the subject
common law or statute.
matter of insurance.

Thus a person whose

financial interest in the
For example, a thief could
subject matter of insurance
not insure the goods he
is not recognized by the
stole.
law does not have
insurable interest.
 Subject matter of
Subject matter of contract
insurance is the life, limb,
is the insured’s financial
property, rights or any
interest subject matters of
potential legal liability
insurance.
insured under a policy.
When Must Insurable Interest Exists
• In general, insurable interest must exist at the time of
inception of the insurance contract and at the time of
loss for all classes of insurance except:

Life insurance Marine insurance

where insurable where
interest must exist insurable
at the time of interest must
inception. exist at the
time of loss.
Assignment

Transfer of rights
and liabilities of the Assignee, the person
insured to a new who takes over the
insured assignments will have
no better rights than
those enjoyed by the
assignor.
Prior consent

General rule; Prior consent is required

before an assignment of a policy can be
affected.

For example: The vendor of a house

cannot assign his fire policy to the
purchaser unless the insurer concerned
agrees to the substitution of the vendor
by the purchaser as the new insured .
Assignment

Exception to the rule;

Marine policies : They are freely assignable

by statutory provision.

Life policies : They are freely assignable by

statutory provision.
Utmost good faith

The duty of utmost

good faith is a positive
duty (of the insured) to
disclose fully and
accurately all material
facts that he (the
insured) knows or
ought to know,
whether asked for or
not (by the insurer)
What is a material fact

A material fact is defined

as a fact which would
influence the PRUDENT
UNDERWRITER in
accepting the risk or
fixing the premium.
Duration of Duty of Utmost Good
Faith

The duty to disclose material facts lasts until the

completion of the insurance contract.

The proposer is required to notify the changes to

the insurer otherwise the contract would be
voidable.

The duty of disclosure will terminate upon the

inception of the contract.

The duty of disclose may be extended and may

continue throughout the currency of the contract
by a policy condition.
Breaches of Utmost Good Faith

Utmost good faith is

breached if the duty
of disclosure is not
observed.

Misrepresent a
material fact i.e.
Fails to provide
providing the
the insurer with
insurer with
information
incorrect
relating to the
information
material fact, or
relating to the
material fact.
Proximate Cause

“Proximate cause means the

active, efficient cause that sets in
motion a train/chain of events
which brings about a result,
without the intervention of any
force started and working from
a new and independent source”.
Proximate Cause Vs Remote Causes

The dominant cause

Frequently a loss i.e. the cause that
is preceded by overshadowed the
two or more other causes are
causes. deemed to be ‘remote
causes’.
Indemnity

Insured shall be restored to the same

financial position after the loss as he
has enjoyed immediately before it.

The object of the principle is to ensure

that the insured after being indemnified
shall be either before the loss.

The effect of the principle is to prevent

the insured from making a of loss.
Method of Indemnity
 Method 1
Total loss
Measure of
Method 2
indemnity
Partial loss
 Method of Indemnity
The four methods of indemnity used by insurers are cash, repair,
replacement and reinstatement.
 Measure of Indemnity
Total Loss
There are two main methods of measuring indemnity used by
properly insurers:-
Method 1 :Reinstatement/replacement cost
Less: allowance for new & better features
Method 2 :Market value of a property similar to the one destroyed.

Partial Loss
The measures of indemnity used are the cost of repair.
Subrogation

The rights belonging to the

Subrogation in the context of
insured may include: those
insurance can be defined
rights against third parties who
taking the rights belonging to
are also liable for the loss
an insured by the insurer after
which is the subject of the
the latter has indemnified the
claim and the right of the
insured.
insured in the salvage.

Subrogation is evolved to
support the principle of
indemnity.
Why Is Subrogation Necessary?
Contribution

Contribution can be defined as the amount

which each insurer has to contribute to the
cost of a loss when the loss is covered by
two or more insurers.

According to the principle of contribution,

an insurer who has indemnified the insures,
may call upon the other insurers who are
similarly liable for the loss to contribute
towards the payment of indemnity.
• For example Mr. A insure his RM600,000 house with
insurer X for RM200,000, Insurer Y for RM200,000 and
Insurer Z for RM200,000. In the event of claim, let say
the amount of loss is RM90,000, insurer X, Y and Z will
apply the principle of contribution. Therefore, each
insurer will contribute RM30,000.
• Calculation for Contribution
Value Insured = Sum X + Sum Y + Sum Z
= 200 000 + 200 000 + 200 000
= RM 600 000
% of Contribution for each Insurer
= Sum X x 100
Value Insured
= 200 000 x 100
600 000
= 33.33%
Contribution X, Y, and Z
= % of each Insurer x Total Loss
= 33.33% x RM 90 000
= RM 30 000
Why is contribution necessary

It follows naturally from the

principle of indemnity that if
the insured is allowed to
recover from more than one
insurer for the same loss the
Like subrogation, the principle of
insured would be recovering
contribution is evolved to support the
more than his loss.
principle of indemnity
 Conditions for the application of
contribution
Contribution applies only when the following
conditions are fulfilled:

Cover a common
Two or more policies Cover a common
peril which gives rise
of indemnity exist interest
to the loss

Cover a common Each policy must be

subject matter liable for the loss.
Part 3
Insurance
Documents
BASIC DOCUMENTS USED BY INSURERS

Proposal forms Renewal notice Claims forms

Completion of
Policy forms Endorsements satisfaction note
and discharge

Certificate of
Cover Note
insurance
Proposal forms

A document which is drafted by the

insurer containing questions designed to
elicit material information about the
particular risk proposed for insurance.

To be completed by the proposer and

answers to questions will enable insurers
to assess the proposed risk.

i.e. answer to the questions will shed light

on the physical and moral hazards
involved.
Functions of Proposal Forms

• The standards type of form is likely to

Convenience produce the required information more
speedily.

• Most proposal forms contain details of the

Advertising cover available under the company’s
standard policy for that class of insurance.

• The completed proposal form constitutes an

Offer offer by the proposer to the insurer.

Basis of a • If the contract is completed, the proposal

becomes the basis on which the contract is
contract formed.
 Structure of Most Proposal Forms
General Questions
Proposer’s Name Questions mainly for identification and communication
purposes.
Proposer’s Address Question mainly for communication and under writing
& Situation of Risk purposes.
Proposer’s Question important for underwriting. Proposer’s occupation may
Occupation indicate physical and/or moral hazard.
Insurance History Question important for underwriting. If previous insurer(s)
declined or refused to renew, details of their experience would be
important for making underwriting decision.
Loss story Question important for underwriting. Information may indicate
poor physical and/or moral hazard.
Sum insured Question important for assessment of premium and need for
reinsurance
Note: Liability insurance, the limit of indemnity is indicated.
 Structure of Most Proposal Forms
Particular Questions
Insurance of Questions relating to the personal history of the insured and
person activities engaged by the insured. Questions asked may related to
date of birth, marital status,health,habits and family history

Insurance of Questions designed to provide further information on subject

property matter of insurance.

Insurance of liability Questions designed to give underwriter a better understanding of

the risk to be insured
Structure of Most Proposal Forms

Declaration

Signature
Policy forms

A document produced by the

insurer, setting out the terms of
contract.

The policy is not the contract but

merely the written evidence of it.
A policy has to be stamped

In accordance with the provisions of

the Stamp Act; otherwise it cannot
be used as evidence in the court.
 Structure Of Scheduled Policy
The Heading This provides the full name and the registered addition of the insurance company at
the top of the front page.
The Preamble This clause is basically the introduction to the contract. It recites the circumstances in
(or Recital Clause) which the policy will operate.

The Operative This clause details the insured perils for which the insured or his legal representatives
Clause are indemnified or which the policy benefits are payable.
Exception Whereas the Operative Clause outlines the cover provided by the policy, the
exception will indicate any restrictions in the scope of the insurance.
Schedule This section contains all the type-written information applicable to the particular
contract. The schedule gives the policy number, the insured’s name, premium, sum
insured etc.
Attestation or This makes provision for the insurer to affirm the conditions of the contract as set out.
Signature Clause The policy is signed by authorized official of the insurer.

Conditions All policies are subject to conditions. Policy conditions can be classified in two main
ways;
 Express and implied conditions
 Conditions precedent and conditions subsequent (*Note below)
Classification of Policy Conditions

Express
conditio
ns Conditions which
actually appear in
the policy
document.

Example: claim
condition and
cancellation which can
be found in the policy.
 Implied
conditions The law reads into
any contract of
insurance but which
does not appear in
the contract.

For example:
that the insured has
insurable interest
that the subject matter
insured is actually in
existence
 Conditions Precedent and Conditions
Subsequent

Conditions precedent to the policy

These conditions which must be
fulfilled before the contract can be E.g. implied condition of U.G.F
valid

Conditions precedent to liability

These are conditions which must
be fulfilled before the insurer is E.g. claim condition
liable for a claim.
 Conditions subsequent
to the policy
E.g. an express condition
Conditions which must
often found in personal
be fulfilled if the contract
accident policy requiring
is to continue once it has
the insured to notify any
become binding
change in occupation.
Cover note

A document issued in It may also be issued

advance of the policy during the course of Cover notes are used quite
because it may take some negotiations to provide extensively in several
time before the policy is cover on a provisional classes of insurance.
issued. basis.

Cover notes may be in

Cover notes are usually printed form, with
issued for a limited period provision for particular
say,14 days or one month. details of the risk and
future policy to be issued.
 A certificate of
insurance is normally
issued when
insurance is
compulsory.

Certificate
of
insurance
The certificate
certifies that the
insurance is issued
by an authorized
insurer in accordance
with the
requirements of the
law.
Means of recording on policy
document alterations to its
terms and conditions during
its currency or to vary or
extend the printed wording
at the time of issue.

Endorsement

In the former instance,

an endorsement avoids
the need to terminate the
original policy and issue
a new one in
replacement.
Renewal Notice

Renewal notices
The renewal of a In this respect a
frequently contain a
policy for a further renewal notice
warning on the duty
period is not a advises the insured
to disclose changes
continuance of the to notify the insurer
affecting the policy
insurance but is in of its renewal
inception or last
effect new contract. insertions.
renewal date.
Claim Forms
The purpose of a claim form is
to identify the insured, the
insured’s interest in the
damaged or lost property, the
cause, the time, and date of loss
and also to quantify the
amount of loss.
Claim forms for some classes of
insurance seek information
regarding any action taken by
the insured to recover from
other parties responsible, as
well as the reporting of the loss
to the police.
 Completion/Satisfaction Note &
Discharge

Completion/
Satisfaction Discharge
Note
An
Used by insurers acknowledgement
to indicate that by the person
the repair had legally entitled to
been completed receive the payment
and that the from the policy that
insurers could the sum payable is
pay the garage’s in full satisfaction of
account. all claims at law
which he may have
under the policy.
END