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2012-11-19 13:55:02
The topic of insurance contracts is vast, but it has to be studied carefully.
After all, your family's financial security may be the price you pay for lack
of conscientiousness. One or two small terms found in a footnote can
drastically change your coverage, and you need to understand those terms. In
this article we'll explain some additional fundamentals you need to know to
understand your insurance contract fully. (To read the basic fundamentals, see
Understand Your Insurance Contract.)
The Doctrine of Utmost Good Faith
The doctrine of utmost good faith is a key principle in insurance contracts.
This doctrine emphasizes the presence of mutual faith between the insured and
the insurer. It doctrine includes:
Duty of Disclosure: You are legally obliged to reveal all information that
would influence the insurer's decision to enter into the insurance contract.
Factors that increase the risks - previous losses and claims under other
policies, insurance coverage that has been declined to you in the past, the
existence of other insurance contracts, full facts and descriptions regarding
the property or the event to be insured - must be disclosed. These facts are
called material facts.
Depending on these material facts, your insurer will decide whether to insure
you as well as what premium to charge. For instance, in critical illness
insurance, your smoking habit is an important material fact for the insurer. As
a result, your insurance company may decide to charge a significantly higher
premium as a result of your smoking habits.
Representations and Warranty: In most kinds of insurances, you have to sign a
declaration at the end of the application form, which states that the given
answers to the questions in the application form and other personal statements
and questionnaires are true and complete.
Therefore, when applying for fire insurance, for example, you should make sure
that the information that you provide regarding the type of construction of
your building or the nature of its use is technically correct.
Depending on their nature, these statements may either be representations or
warranties:
A)Representations: These are the written statements made by you on your
application form, which represent the proposed risk to the insurance company.
For instance, on a life insurance application form, information about your age,
details of family history, occupation, etc. are the representations that should
be true in every respect.
Breach of representations occurs only when you give false information (for
example, your age) in important statements. However, the contract may or may
not be void depending on the type of the misrepresentation that occurs. (For
more information on life insurance, read Buying Life Insurance: Term Versus
Permanent, Long-Term Care Insurance: Who Needs It? and Shifting Life Insurance
Ownership.)
B)Warranty: Warranties in insurance contracts are different from those of
ordinary commercial contracts. They are imposed by the insurer to ensure that
the risk remains the same throughout the policy and does not increase.
For example, in auto insurance, if you lend your car to a friend who doesn't
hold a license and that friend is involved in an accident, your insurer may
consider it a breach of warranty because it wasn't informed about this
alteration. As a result, your claim could be rejected.
Breach of Utmost Good Faith
As we've already mentioned, insurance works on the principle of mutual trust.
It is your responsibility to disclose all the relevant facts to your insurer.
Normally, a breach of the principle of utmost good faith arises when you,
whether deliberately or accidentally, fail to divulge these important facts.
There are two kinds of non-disclosure:
An innocent non-disclosure relates to failing to supply the information you
didn't know about.
Deliberate non-disclosure means providing incorrect material information
intentionally.
For example, suppose that you are unaware that your grandfather died from
cancer and, therefore, you did not disclose this material fact in the family
history questionnaire when applying for life insurance - this is innocent
non-disclosure. However, if you knew about this material fact and purposely
held it back from the insurer, you are guilty of fraudulent non-disclosure.
Action Taken by Insurer Against a Breach
When you supply inaccurate information with the intention to deceive, you
insurance contract becomes void.
If this deliberate breach was discovered at the time of the claim, your
insurance company will not pay the claim.
If the insurer considers the breach as innocent but significant to the risk, it
may choose to punish you by collecting additional premiums.
In case of an innocent breach that is irrelevant to the risk, the insurer may
decide to ignore the breach as if it had never occurred.
Principle of Waiver and Estoppel
A waiver is voluntary surrender of a known right. Estoppel prevents a person
from asserting those rights because he or she has acted in a such a way as to
deny interest in preserving those rights.
Presume that you fail to disclose some information in the insurance proposal
form. Your insurer doesn't request that information and issues the insurance
policy. This is waiver. In the future, when a claim arises, your insurer cannot
question the contract on the basis of non-disclosure. This is estoppel. For
this reason, your insurer will have to pay the claim.
Endorsements
Endorsements are normally used when the terms of insurance contracts are to be
altered. They could also be issued to add specific conditions to the policy.
Deductible
A deductible is the amount you pay in out-of-pocket expenses before your
insurer covers the remaining expense. Therefore, if the deductible is $5,000
and the total insured loss comes to $15,000, your insurance company will only
pay $10,000. The higher the deductible, the lower the premium and vice versa.
Coinsurance
Coinsurance refers to the sharing of insurance by two or more insurance
companies in agreed proportion. For the insurance of a large shopping mall, for
example, the risk is very high. Therefore, the insurance company may choose to
involve two or more insurers to share the risk.
Coinsurance can also exist between you and your insurance company. This
provision is quite popular in medical insurance, in which you and the insurance
company decide to share the covered costs in the ratio of 20:80. Therefore,
during the claim, your insurer will pay 80% of the covered loss while you shell
out the remaining 20%.
Reinsurance
Reinsurance is the insurance bought by an insurance company. Suppose you are a
famous rock star and you want your voice to be insured for $ 50 million. Your
offer is accepted by Insurance Company A. However, Insurance Company A is
unable to retain the entire risk, so it passes part of this risk - let's say $
40 million - to insurance company B. Should you lose your singing voice, you
will receive $50 million from insurer A ($10 million + $40 million) with
insurer B contributing the reinsured amount ($40 million) to insurer A. This
practice is known as reinsurance.
Generally, reinsurance is practiced to a much greater extent by general
insurers than life insurers.
Conclusion
When applying for insurance, you will find a huge range of insurance products
available in the market. If you have an insurance advisor, he or she can shop
around and make sure that you are getting adequate insurance coverage for you
money. Even so, a little understanding about insurance contracts can go a long
way in ensuring that your advisor's recommendations are on track.
Furthermore, there may be times when your claim is canceled because you didn't
pay attention to certain information requested by your insurance company. In
this case, lack of knowledge and carelessness can cost you a lot. Go through
your insurer's policy features instead of signing them without delving into the
fine print. If you understand what you're reading, you'll be able to ensure
that the insurance product that you are signing up for will cover you when you
need them most.
by Pooja Dave
Pooja Dave is a content writer/developer cum research associate at
InfoAnalytica, India. She also works as a business writer for the
Hyderabad-based Strategic Industry Services (SIS) Infotech Pvt. Ltd and Referee
Finance. In addition, she has worked as a financial writer at print/web
publications such as Investor Concepts and InvestorGuide.com. She has received
professional certification as an Associate Financial Planner (AFP) in risk
management and insurance planning from the Financial Planning Standards Board
in India and a creative writing certificate from the Writers Bureau, U.K.