Chapter 2. The Nature of Insurance

• Pages: 28-43

CHAPTER 2

THE NATURE OF INSURANCE

2.1 INTRODUCTION

Insurance is based on risk pertaining to a future event: ‘possible, probable, contingent, fortunate

or unfortunate.’

1 The element of risk-shifting is critical to the insurance product for calculating

premiums, the quantum to be paid and potential liability under reinsurance. There is mutual-

ity as the insured fulfi ls his end of the bargain via payments described as premiums; the other

party – the insurer – promises to perform its obligation once loss is sustained. Insurance imputes,

attributes or prescribes value both to risk and intangible ‘peace of mind.’ These are viewed as

costs the insurer assumes or takes care of. Essentially, insurance attaches a cost to risk aversion.

Risk is the measure of a mathematically calculated expectation: the product of the probability

of the event multiplied by its agreed value.

2 Risk is the subject matter of insurance. Study of

insurance reveals a heady mixture of family law, crime, social and public policy as the insured

attempts to shift risk in his or her favour. Uncertainty over risk is an important indicator of the

need for insurance.

3

2.2 APPLICATION

In the United States, the formula is called the known-loss rule. In Metropolitan Life Insurance

Company v The Board of Equalization , 4 it was said of the defi nition of insurance in the Califor-

nian Insurance Code

5 that it required ‘(1) a risk of loss to which one party is subject and a

shifting of that risk among similarly situated persons.’ In Truta v Avis Rent a Car System Inc ., 6

it was held that a limit to a collision damage waiver provision in a car rental contract did

not amount to insurance because the company did not undertake to assume liability or third

party risks, but merely agreed not to insist that the person having the car make payments for

certain types of damage which otherwise would be due to the company. Channell J’s defi ni-

tion has been approved in several English courts and throughout the Commonwealth Carib-

bean. In one California case, surrounding the question of service as opposed to indemnity,

the court was asked to determine whether a subscriber to a medical contract for the poor was

insurance as a service rather than indemnity as its principal object and purpose.

7 In Re Barrett:

Ex Parte Young v NM Superannuation Pty Ltd , 8 reference was made to Justice Channell’s view in

Pr udential , Von Doussa J in the Federal Supreme Court of Australia, where this particular

situation was being considered, noted that uncertainty may give rise both to profi t and loss

to the insurer. This is a distinguishing characteristic of a contract of insurance: a contract

based upon speculation.

1 F. Ewald ( J. M. Dautrey and C. F. Stifl er trans), ‘Risk in Contemporary Society (2000) Connecticut Ins. L.J . 365.

2 Ibid.

3 R. Hodgin, ‘Problems in Defi ning Insurance Contract’ [1980] LMCLQ 14.

4 Supreme Court of California, 1982 625 P2d 426.

5 Section 22 (2000): ‘Insurance is a contract whereby one undertakes to indemnify another, against loss, dam-

age, or liability arising from a contingent on an unknown event.’

6 193 Cal App 3d 802 (California Court of A ppeal, 1987).

7 California Positions Service v Garrison , 172 P2d 4 (1946).

8 106 ALR 549 (Federal Court of Australia).

The nature of insurance 29

Regional legislation is silent on the defi nition of insurance. absent a coherent, comprehen-

sive defi nition one must resort to the common law, where the element of risk permeates the

entire set of arrangements.

9 Insurance is a mechanism by which the risk of loss is transferred

from one person to another. Lord Mansfi eld in Carter v Boehm 10 shared the view that insurance is

a contract on speculation. Indeed, one judge refrained from aspiring to lay down an exhaustive

defi nition ‘good for all pur poses and in all contexts,’ doubting whether a satisfactory defi nition

of a ‘contract of insurance’ will ever be evolved.

11 Sometimes, however, it is necessary to ascer-

tain whether a contract of insurance exists precisely because insurance regulation is predicated

on the existence of a contract. Birds suggests a contract of insurance is any contract whereby

one party assumes the risk of occurrence of an uncertain event not within his control, happen-

ing at a future time, in which event the other party has an interest, and under which contract

the fi r st party is bound to pay money or provide its equivalent if the uncertain event occurs. In

Lucena v Craufurd , 12 Lawrence J stated:

Insurance is a contract by which the one party in consideration of a price paid to him adequate

to the risk, becomes security to the other that he shall not su er loss, damage, or prejudice by the

happening of the perils specifi ed to certain things which may be exposed to them.

In Castellain v Preston , 13 it was simply stated that ‘insurance provides indemnity against loss.’

Likewise, insurance legislation defi nes insurance business as ‘the assumption of the obligations

of an insurer in any insurance business and includes reinsurance business.’ Since the assump-

tion of obligations is evidenced by the contract of insurance for which there is no adequate

defi nition, assisting principles must be sought from the common law.

2.3 THEORETICAL NOTIONS

Based on the laissez-faire doctrine, 14 contract law promotes a classical theory, a sense of indi-

vidualism with an absence of state interference.

15 Defi ciencies in the application of traditional

9 J. Lowry and P. Rawlings, Insurance Law: Cases and Materials (Hart: 2004), p. 3.

10 [1766] 3 Burr. 1905, 97 ER 1162.

11 Medical Defence Union Ltd v Department of Trade [1980] Ch 82.

12 (1802) 2 B & P (NR) 269.

13 (1883) 11 QBD 380; LJQB 368.

14 A. Smith, An Inquiry into the Nature and Causes of the Wealth of Nations (Penguin Books: 1986), p. 52:

The exclusive privileges of corporations, statutes of apprenticeship, and all those laws which

restrain, in particular employments, the competition to a smaller number than might otherwise

go into them, have the same tendency, though in a less degree. They are a sort of enlarged

monopolies, and may frequently, for ages together, and in whole classes of employments, keep

up the market price of particular commodities above the natural price, and maintain both the

wages of the labour and the profi ts of the stock employed about them somewhat above their

natural rate.

15 M. J. Trebilcock, The Limits of Freedom of Contract (Harvard University Press: 1993); M. J. Trebilcock, ‘Cri-

tiques of the Limits of Freedom of Contract: A Rejoinder.’ (1995) 33 Osgoode Hall L.J. 2; P. Benson, ‘Abstract

Right and the Possibility of a Non-distributive Conception of Contract: Hegel and Contemporary Contract

Theory’ (1989) 10 Cardozo L. Rev . 1077; P. Benson, ‘Contract’ in Dennis Patterson, ed., A Companion to Phi-

losophy of Law and Legal Theory (Blackwell: 1996); P. Benson, ‘The Idea of a Public Basis of Justifi cation for

Contract’ (1995) 33 Osgoode Hall L.J . 273; Randy Barnett, ‘A Consent Theory of Contract’ (1986) 86 Colum.

L. Rev . 269; R. Barnett, ‘The Sounds of Silence: Default Rules and Contractual Consent,’ (1992) 78 Va. L.

Rev . 891–911.