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Principles Of Business Law - CHAPTER V























































Sec. 48, Introduction. Insurance is playing an increasingly
important role in our national economy. Greater security appears
to be desired in a significant degree, and, in many areas of life, in-
surance readily lends itself to the satisfaction of this desire. It
offers a method whereby possible losses may be borne by numerous
individuals, rather than by the particular person upon whom the
loss chances to fall in the first instance. The insurance company
acts as a sort of collecting agency or clearing house for the purpose
of distributing the risk, and charges a fee for its services in this con-

The subject of insurance is treated under security relations be-
cause it is often used as a security device or is closely associated
with other security which is given. Buyers who purchase on credit
are often required to keep the property insured against fire loss,
A borrower who gives a mortgage on real property as security for
an indebtedness is generally compelled to keep the property insured,
in favor of the mortgagee, against loss from windstorm and fire. A
person to whom credit has been extended often protects his creditor
by procuring a policy of life insurance equal to the indebtedness,
naming the creditor as the beneficiary. Insurance is thus used to
protect both the creditor and the debtor against loss resulting from
unusual causes or premature death.

Sec. 49. Types of insurance. Numerous types of insurance
have been originated in an attempt to meet as many of the risks
which are faced by businessmen and their employees as is possible.
Protection can be procured for almost any risk if the one subject to
the risk is able and willing to pay the required premium. Many
forms of insurance are familiar to all of us, among them life, health
and accident, fire, theft, windstorm, workman's compensation, and
public liability insurance. In addition there is available plate
glass, fidelity, marine and hospital insurance. Unemployment
compensation and old-age benefits paid by state or federal govern-
ments are closely akin to insurance.

Since insurance is treated at this point primarily as a protective
device for creditors, further mention will be made only of those legal
principles which relate to fire and life insurance. It can be said in
general, however, that the law governing health and accident insur-
ance follows closely that which controls life insurance. The other



types of insurance often spoken of as indemnity insurance are
in large measure subject to the same rules of law which govern fire

Sec. 50. Formation of the agreement. There is nothing in the
nature of a contract of insurance which requires it to be in writing,
but such contracts are written in most instances. The insurer's
application, containing many queries, is signed by the insured. It
is this application which usually constitutes an offer on the part of
the insured, although in fire insurance it often happens that the
insured merely requests the agent of the company to give him cer-
tain protection. In either of these cases, the company customarily
signifies its acceptance by delivery of the policy. Therefore, the
only terms of the agreement are embodied in the application and
the policy. The insured may reject a policy which includes terms
different from those requested in the application. An acceptance
of such a policy amounts to a substitution of the terms of the policy
for those of the application, and the terms of the former control.
The rights of the parties are usually determined by reference to the
provisions of the policy, unless a waiver of policy provisions was
effected at the time of delivery.

In fire insurance it is customary to authorize the local agent to
accept the application. Because of this fact, the insurance may
become effective before the policy is delivered, provided the agent
indicates, by action or conduct, his willingness to accept the risk for
his principal. At this point a distinction should be made between
the local agent and an insurance broker. An insurance broker is
one whose business it is to procure insurance for those desiring it.
He has no authority to represent the insurance company, but is the
agent of the insured for the purpose of obtaining the insurance,
after which the agency terminates.

One standard type of life insurance contract provides that the
contract shall be in force from the date of the physical examination,
provided the insured is an acceptable risk at that time and the pre-
mium is paid prior to the time the application is forwarded to the
company. In other words, if the insured's health, family history,
and other risk factors conform to the standards of the insurer, the
policy dates from the time of the examination. Delivery of the
policy in such a case merely indicates that the company has finally
approved the particular risk. Thus, the death of an applicant be-
fore the risk has been finally acted upon will not bar recovery by
the beneficiary, provided the insured was in good health when he
submitted to the physical examination. This is particularly true
where the company approves the risk before, or even after, death
without delivery of the policy. If the company refuses to approve


the application and has any reason for so doing, the applicant has
no insurance.

Sec. 51. Delivery of the policy. A second type of contract
used by insurance companies, primarily for industrial, fraternal, or
other insurance in which there is no physical examination or in
which the payment of the premium is deferred until some time
after the application is signed, customarily provides that it is not
to be effective until the policy is delivered to the insured in good
health and the first premium has been paid. Such an agreement
presents two questions: When has delivery been completed and
when is the applicant in good health? Under normal circum-
stances, the courts have held the policy to be delivered as soon as it
is deposited in the mail. 1 This appears to be true even though the
company mails the policy to its representative rather than directly
to the insured. The act of mailing from the home office signifies
acceptance of the risk.

Some uncertainty exists where the policy is mailed to the agent
of the company with instructions to check on the health of the ap-
plicant before handing the policy to the insured. Two distinct
views may be observed in the various states. The first, which is the
minority view, holds that since the local agent is entrusted with
discretion concerning delivery being obligated to ascertain the
state of health of the insured before delivery the policy is not ef-
fective until placed in the possession of the insured. In these states
the judgment of the representative appears to be final, and after
delivery the question of good health cannot be raised. On the
other hand, the majority of the states take the view that delivery is
effective at the time the policy is mailed from the home office
whether mailed directly to the insured or to an agent of the insurer,
but that it is operative only if, at that time, the insured is actually
in good health. Any serious ailment with which the applicant is
afflicted, even though he is unaware of the disease, prohibits insur-
ance protection under the policy. This is true even though the
insured has been in possession of the policy for a considerable period
of time, unless the incontestable period has been reached. A minor
illness, which later becomes serious, does not affect the validity of
the policy.

Although the insurer has a reasonable time in which to determine
whether to accept or to reject the application, unreasonable delay
followed by the death of the insured gives rise to a cause of action
against the company. Unless the company acts with reasonable
dispatch, the insured is delayed in obtaining other insurance, and
thus remains uninsured because of the negligence of the insurer.

1 New York Life Ins. Co. v. Babcock, 1898, 104 Ga. 67, 30 S,E. 273; p. 796.


It is this negligence which forms the basis for an action against the

It is customary in life insurance contracts, although not in fire
insurance, to provide that the insurance shall not be effective until
after the payment of the premium. Execution of a note for the
first premium cannot be substituted for cash unless it is accepted by
the home office. Occasionally the local agent is willing to accept
the note of the applicant and to advance the money for the first
premium from his personal funds. In such cases the insurance is
in force only if the agent pays the premium.

Sec. 52. Representations and warranties. A representation is
a statement made by the insured to the insurer at the time the con-
tract is in the process of formation. Because of the nature of the
contract of insurance the insured having full and complete infor-
mation, the insurer possessing little knowledge, relating to the risk
it becomes the duty of the insured to inform the insurer fully con-
cerning the nature of the risk. For this reason a misrepresentation
of any fact which materially affects the risk affords a basis for re-
scission by the insurer. 2

The insurer is permitted to avoid his contract whenever any
material statement found in the application is proved to be incor-
rect. This rule appears to hold even though the party responsible
for the false statement actually thought it to be true, and despite
the fact that the condition misrepresented was in no sense respon-
sible for any loss involved.

In order to avoid the necessity of determining in any particular
instance whether representations affect material matters, many
companies have adopted a provision in their policy which declares
that all representations shall be deemed warranties. A breach of
any warranty, regardless of how trivial it is, justifies rescission. To
obviate the harshness of this rule, some states, such as New York,
have by legislation converted all warranties into representations,
and some, by judicial decision, have provided that breach of war-
ranty, unless it concerns a material matter or is intentionally mis-
stated, does not afford ground for rescission. The courts are prone
to consider intentional misrepresentations as material even though
they relate to rather insignificant matters, whereas, if the misstate-
ments are unintentionally made, the materiality of the statement
must be shown by ample evidence.

Sec. 53. Fraud of the agent. Representations or warranties
stated correctly to the agent of the company, but recorded incor-
rectly by him in the application, furnish the company no ground for
relief, unless the insured knew that the agent acted fraudulently.

a Mutual Life Ins. Co. v. Denton, 1927, 93 Fla. 276, 112 So. 53; p. 797.


The mere fact that the insured signs the application does not make
him responsible for all statements contained therein, as he has a
right to assume that the agent of the company acts honestly. Any
loss resulting from the misconduct of the agent must be suffered by
the company rather than by the insured.

Lately, most insurance policies are made to include the applica-
tion as a part thereof, and the applications are made to read that
the applicant has read all answers given to questions propounded
and has found them to be correct. In the construction of contracts
of this character, many courts have held that the insured is bound
to read his policy within a reasonable time and to report any errors
promptly to the company. Failure to do so makes the applicant
responsible for all statements made. Perhaps, however, the weight
of authority holds the insurance company liable even in cases of
this character.

Sec. 54. Information vitally affecting risk. Information pos-
sessed by the insured, which vitally affects the risk, should be com-
municated to the insurer, although no questions are asked con-
cerning the matter. Failure to transmit such information, where
failure to do so would practically constitute fraud, acts as an excuse
for nonperformance on the part of the company. Thus A, knowing
of the existence of a widespread fire near certain property belonging
to him, hastens to an insurance company's agent and procures a
policy of fire insurance on the goods in question. Because he fails
voluntarily to give the information relating to the fire, he is not
allowed to recover for the loss which results from the destruction
of his property.

Sec. 55. Binder. A binder is temporary insurance, usually pro-
cured to cover a period during which the insurer is considering an
application for a regular policy. A binder does not state all the
terms of the agreement, but carries with it the ordinary and normal
provisions found in a regular policy. The premium and the dura-
tion of the binder often are not stated. In such cases a reasonable
amount must be paid, and the policy may be terminated at any time
by either party if he gives the notice required in the ordinary policy
usually five days.

Sec. 56. Insurable interest. Insurance partakes of the nature
of a gambling contract. To avoid the evil effects of ordinary wag-
ering contracts, the courts require the insured to have an insurable
interest in the life or property insured. Thus, a person who secures
a policy of fire insurance upon property cannot recover for the dam-
ages resulting from fire unless he holds some legal or equitable in-
terest in it, in which case a destruction of the property might mean
a pecuniary loss. This is the best test of an insurable interest. If


the destruction of the property or person insured might result in a
pecuniary loss to the one procuring the insurance, an insurable
interest exists. 3 Thus, an owner, lessee, mortgagee, or purchaser
has an insurable interest in property, while an employer, employee,
business associate, creditor, or a dependent relative may legally in-
sure the life of a person.

In fire insurance the insurable interest must exist at the time the
policy is issued and continue down to the time of the loss. Thus,
A, having taken out fire insurance upon an automobile while he
owned it, could not recover its value, although the property was
destroyed by fire, after the car had been sold. The new owner
would also be denied recovery unless the policy was assigned to him
with the consent of the insurer. In life insurance it is sufficient if
the insurable interest exists at the date the policy is issued. A sub-
sequent change in the relation of the party securing the insurance
and the one whose life is insured does not terminate the insurance.

In this connection, it should be pointed out that a person who
procures insurance upon his own life may make anyone he desires
his beneficiary if a company is willing to issue such a policy. Inas-
much as the insured has an interest in his own life, the beneficiary
is not required to have such an interest. It is only where one takes
out insurance upon the life of another that an insurable interest
must be present.

Risks Assumed by Insurer

Sec. 57. Life insurance. As stated before, the policy of insur-
ance contains many provisions inserted for the benefit of the various
parties. Its terms, considered in the light of the application, gov-
ern largely the rights of the parties. There are, therefore, many
types and variations of life insurance policies, but they may be di-
vided generally into three classes : term, whole life, and endowment.
Upon the death of the one whose life is insured under any of these
policies, the insurance company becomes liable for the face of the

A term policy calls for the payment of premiums for a relatively
short period with the company carrying the risk only for that period
unless the insured reaches a later agreement with the insurer to sub-
stitute another type of policy within the term or to renew the term.
The rate on term insurance is lower than on other types since the
protection is to run only for a limited period of time and results in
a lower probability of death.

The whole life insurance policy calls for payment of premiums as
long as the insured lives, unless it is modified by a paid-up provi-

3 Creed v. The Sun Fire Office, 1893, 101 Ala. 522, 14 S. 323; p. 798.


sion, which requires the payment of premiums only for a certain
specified number of years. Thus, a twenty-year paid-up policy
would require the payment of premiums for only twenty years,
although the amount of the premium would be somewhat larger
than the premium on a general life policy. The insurance, in either
case, would be paid at the death of the insured.

An endowment policy provides for the payment of the face of the
policy upon the death of the insured or at the end of a certain speci-
fied number of years. Thus, a twenty-year endowment policy calls
for payment of the policy at the end of twenty years, unless the
insured dies sooner. Such an insurance policy serves the double
purpose of insurance and investment, and requires an annual pre-
mium still larger than either of the other types of policies.

A few companies, for a slight addition to the premium, insert a
clause which provides for a monthly payment to the insured in case
he becomes permanently disabled. Another provision often in-
cluded calls for double indemnity if the insured dies as the result
of an accident. In addition to the policies enumerated, there are
various combinations and variations which take care of unusual
situations, but those mentioned constitute by far the largest portion
of the total insurance written.

Sec. 58. Fire insurance. The object of fire insurance is to pro-
tect the insured against any loss to particular property which results
directly or proximately from an unfriendly fire. An unfriendly fire
is one that is not confined to its proper container. In other words,
as soon as a fire leaves the place where it is expected to burn, it
ceases to be friendly and at once assumes an unfriendly attitude. 4
To illustrate : A has his furniture insured against fire. By accident,
a valuable piece of furniture is placed so near an open fireplace as
to be materially damaged, although it never actually catches fire.
The insurer is not liable for the resulting damage. However, if the
furniture takes fire and burns, the company is liable, for at that time
the fire is said to become unfriendly; it has ceased to burn in its
customary receptacle.

The insurance company is liable for any loss caused directly or
proximately by the fire. Thus, any loss from smoke, water, theft,
removal damage, or falling walls is covered, as well as any direct loss
from the fire itself, assuming an unfriendly fire. The fact that the
unfriendly fire is confined to another building does not preclude one
whose property has been damaged by smoke, water, or falling walls
from recovering on his policy of fire insurance. It is not necessary
that the fire enter his premises in order to permit recovery.

The majority of fire insurance policies relieve the company from

1 Ellis v. Norwich Union Fire Ins. Soc., 1927, 259 Mass. 540, 156 N.E. 696; p. 798.


liability for any loss resulting from explosions. The courts, how-
ever, have construed this provision to mean that the company is
liable if the explosion results from an unfriendly fire. It is only
where the explosion is caused by a friendly fire that liability is ex-
cluded. Thus, an explosion caused by an ordinary fire in a furnace
would not be covered, but an explosion caused by an unfriendly fire
in the building where the explosion occurred would impose a lia-
bility upon the insurer to pay for both the fire and explosion loss.
In any event, and regardless of how the explosion is caused, the
insurance company is liable for the actual fire loss which follows
the explosion if an unfriendly fire ensues. In some states, a pro-
vision in the policy reads that if any portion of a building falls ex-
cept as the result of an unfriendly fire, the policy is automatically
terminated. Where such is the case, should an explosion set in
motion by a friendly fire cause a wall to fall, the policy would be ter-
minated, and the company would thus be relieved of any responsi-
bility for the fire loss which might follow.

Much the same is true of windstorm loss. The insurer is liable
for fire damage which follows, unless liability is eliminated by some
policy provision. Loss by lightning is generally covered by the
policy, although the policy often eliminates responsibility for dam-
age to electrical equipment caused by electrical disturbances. Some
policies also deny recovery in case goods are stolen when they are
removed to avoid a fire loss.

To obtain protection against many risks not covered by the or-
dinary fire insurance policy, "extended coverage" clauses are made
available. Under them the company assumes responsibility for
losses resulting from explosions, windstorms, 5 damage from air-
planes, and numerous other causes.

The fact that a fire originates through the carelessness of the in-
sured, his agent, or a member of his family does not affect the right
to recover. One of the chief purposes of insurance is to protect
against loss resulting from such causes. At the time of a fire, how-
ever, it is the duty of the insured to remove goods, where possible,
from the path of a fire in order to keep the loss of the insurance
company to a minimum.

Sec. 59. Property insured. Only property which is definitely
described in the policy is protected. Furthermore, the policy limits
its application to property owned by the insured, unless the appli-
cant clearly states his desire to have other property in his care pro-
tected by the insurance. Thus, a policy which covers the goods of

"Gerhard v. Travelers Fire Insurance Co., 1945, 246 Wis. 625, 18 N.W.(2) 336;
p. 799.


the insured located at a certain place does not cover goods held on
consignment, unless the agreement is expressly so drawn.

Insured property located at a certain place is not covered when
it is moved to a new location, unless the insurer consents to the
change, the reason being that the particular location of the property
has a material bearing on the risk.

Sec. 60. Mortgage clause. The destruction of mortgaged
property by fire gives the mortgagee no interest in the proceeds re-
covered under a fire insurance policy unless the mortgage required
the mortgagor to insure the property for the benefit of both parties.
Since the vast majority of mortgages require insurance, fire insur-
ance companies have formulated a standard mortgage clause for
insertion when insurance is issued on mortgaged property. 6 The
clause provides that any fire loss shall be paid to the mortgagee to
the extent of his interest, and, in case a balance remains, that it
shall be paid to the owner. Thus, if property mortgaged for $7,000
is fully insured, and a $9,000 loss occurs, $7,000 is payable to the
mortgagee and $2,000 to the mortgagor. The amount paid to the
mortgagee effectively reduces the amount owed by the mortgagor.
In this manner both parties are adequately protected by a single

The insurance contract, by its terms, is avoided by certain forms
of misconduct on the part of the insured, but such misconduct does
not affect the right of the mortgagee to collect in the case of a fire
loss. As to him, the policy cannot be rescinded without first giving
ten days' written notice. Because of this fact the policy may be
in force as to the mortgagee but not as to the mortgagor, in which
case subrogation is available to the insurer against the owner.

Sec. 61. Coinsurance. Coinsurance is a term applied to that
type of fire insurance which requires the insured to bear a certain
portion of the loss where he fails to carry rather full protection.
Thus, many policies on downtown city property provide that, unless
the insured carries insurance which totals 80 per cent of the value
of the property, the insurer shall be liable for only that portion of
the loss which the total insurance carried bears to 80 per cent of the
value of the property. In such cases the insured who insures for
less than the required amount assumes part of any possible loss.
This clause is not part of the regular fire insurance policy and, where
the company permits the clause, its insertion makes possible a much
lower premium than otherwise called for.

Sec. 62. Termination of policy. Fire insurance companies
have incorporated a provision in their policies which gives the in-

'See form #10.


surance company a right to terminate the risk by giving five days'
written notice, which notice states that the unearned premium is
available upon request. The notice does not become effective un-
til it has been received by the insured or his authorized agent. 7
Such a cancellation entitles the insured to the unearned portion of
the premium.

The insured likewise has a right to terminate the policy, his no-
tice taking effect as soon as it is received by the company. Termi-
nation by the insured entitles him to somewhat less than the
amount represented by the unexpired period of the policy.

Sec. 63. Lapsed policies. In other than industrial insurance,
the statutes of the states and policy provisions require the company
to extend life insurance for thirty days after the regular premium
falls due. Industrial life policies may, and often do, contain a
grace period, but the time allowed for late payment is not uniform,
the period varying from state to state. Payment made during this
grace period continues the policy in force until the next premium
falls due, but, if payment is not made during this period, the policy
is said to lapse and can be reinstated only with the consent of the
company. The mere mailing of a check in payment of the premium
is sufficient and, if the check is lost or delayed in the mail, the policy
does not lapse provided the check was supported by an adequate
bank balance. A few courts have held that a check is good pay-
ment, where the company issues its receipt, even though the check
is dishonored. This is true only when the insured immediately
offers to make good the dishonored check.

Lapsed policies of life insurance give to the insured the right to do
one of three things. He may demand the cash surrender value of
the policy all or a portion of the amount set aside as a reserve to
protect the life of the insured ; he may obtain a paid-up policy for
such an amount as the reserve will purchase, the amount being de-
pendent upon the age of the insured ; or he may obtain a term pol-
icy for the original amount, the length of the term being determined
by the amount of the reserve. When the insured fails to exercise
his choice within the time provided in the policy, it is customary for
the policy to provide that the provision for the term policy known
as extended insurance shall be effective. A lapsed policy, against
which the insured has borrowed the maximum amount, gives no
rights to the insured, but the courts are very careful, in figuring the
reserve down to the date it lapses, to be sure that the reserve has
been exhausted by loans or extended insurance.

7 Kinney v. Rochester German Ins. Co., 1908, 141 111. App. 543; p. 801.


Sec. 64. Provisions which benefit the insurer. A fire insur-
ance policy contains numerous provisions, which, if not adhered to
by the insured, may excuse the company from performing.

Since insurance companies are regarded by the courts much like
public utilities in that many features of their business can be reg-
ulated by the state it is possible for the state to prescribe a stand-
ard policy, for use in the state or merely to stipulate that any policy
used must include certain provisions and exclude others. Because
of this, the number and content of clauses contained in a policy vary
materially from state to state and careful reading of the terms of the
policy used in a particular state is imperative. Some of the more
usual provisions are discussed below.

It is customary to include a clause that the policy shall be sus-
pended if the property is vacant or unoccupied beyond a stated
time and the company has not waived the provision by a rider at-
tached to the policy. 8 The policy is automatically reinstated when
the property again becomes occupied, assuming the policy has not
expired. Another common clause provides that the insurance shall
be suspended while the risk is materially increased by any act
within the control or knowledge of the insured. This usually refers
to matters on the property of the insured over which he has control,
not including factors of risk arising out of the use made of adjoin-
ing property. Other clauses have at one time or another been in-
cluded, relating to the keeping of explosives on the premises, 9 the
title to and the liens against the property, and, in the case of mer-
chandise, the owner's keeping an iron safe in which books of ac-
count may be kept.

The policy always provides that the insured shall give immediate
notice of loss to the insurer. Furthermore, unless the loss is settled
in the interim, within sixty days he must make a sworn statement
of loss to the company, detailing the extent of the fire loss.

Provisions placed in policies for the protection of the company
may be waived by any general agent of the insurer; therefore, when-
ever it becomes necessary or desirable to violate such provisions, a
rider signed by the agent and temporarily waiving the clause in
question should be attached to the policy.

Sec. 65. Subrogation. The purpose of fire insurance is to in-
demnify the insured in the event of a loss which results from fire.
If the insured suffers no loss as a result of fire, the insurance com-
pany should suffer none. For this reason, any right of action pos-

1 Aldridge v. Piedmont Fire Ins. Co., 1945, 183 Va. 830, 33 S.E.(2) 634; p. 802.
'Rabinowitz v. National Fire Ins., Co., 1927, 258 Mass. 508, 155 N.E. 435; p. 803.


sessed by the insured against some third party, which would com-
pensate the former for the loss, automatically passes to the insurer
upon settlement in full for the loss suffered. This right of substi-
tution of the insurer to the position of the insured is known as sub-
rogation. Thus, a mortgagee who takes out insurance to protect
only his interest, if allowed to recover insurance in case the mort-
gaged property is destroyed, must assign his mortgage debt to the
insurer. The latter then has a cause of action against the mort-
gagor, just as the mortgagee would have had. Insurance taken to
protect only the mortgagee affords the mortgagor no protection.
In case of a fire loss the liability of the mortgagor for the debt
merely runs to the insurance company to the extent it has paid the
mortgagee for the fire loss.

The right of subrogation does not apply to life or accident insur-
ance, inasmuch as it is not directly the purpose of such insurance to
compensate for the actual loss sustained.

Sec. 66. Division of loss. At one time fire insurance policies
provided that, in case other insurance was obtained on the same
property without the consent of the insurer, the policy would be
void. Today most policies expressly provide that additional in-
surance may be carried. Since the purpose of fire insurance is to
indemnify the owner against loss, it should be emphasized that,
regardless of how much insurance one carries or how many policies
he holds, he is entitled to recover no more than his actual loss. If
the insured carries policies in several companies, the loss is appor-
tioned among them according to the amount of insurance each com-
pany has issued. To illustrate: Jones carries on certain property
a $10,000 fire insurance policy in the Beech Fire Insurance Com-
pany and a $5,000 policy in the Fidelity Insurance Company. His
property, which is worth only $6,000, is totally destroyed. He can
recover only $4,000 of the Beech Company and $2,000 of the Fidel-
ity Company.

Rights of Beneficiary in Life Insurance

Sec. 67. Rights vest at the time policy is issued. Such rights
as are given the beneficiary named in a life insurance policy vest at
the time the policy is issued. The insured possesses no power to
alter or amend effectively the terms of the contract, without the
consent of the beneficiary. Unless the right has been specifically
reserved in the policy, the insured may not designate a new bene-
ficiary. However, the policy is customarily drawn so as to permit
the insured to borrow of the insurer on the strength of the policy
or to surrender it and obtain the cash surrender value.


The insured in many cases expressly reserves in the policy the
right to change beneficiaries. Practically all policies provide that,
in case the beneficiary dies before the insured, and no substitute
beneficiary is named, the proceeds are payable to the estate of the
insured. Where the right to change the beneficiary is expressly re-
served in the policy, it may be changed without the consent of the
existing beneficiary. The change dates from the time it is indorsed
on the policy, but in cases where the insured has done all possible
on his part to effect the change, and dies before the indorsement is
made, the new beneficiary is protected. Delay on the part of the
mail, or in the conduct of the company employees after receiving
the request for a change, will not injuriously affect the rights of
the newly named beneficiary.

Sec. 68. Rights of creditors. The creditors of the insured have
practically no rights in the proceeds of his life insurance. Upon
the death of the insured, the money is paid directly to the desig-
nated beneficiary, who is in no sense responsible for the debts of the
insured. Should the insurance be payable to the estate of the in-
sured, then, like any asset, the amount may be used to satisfy the
debts of the deceased.

If the insured has not reserved the right to change the beneficiary,
the rights of the beneficiary are not affected by the insolvency or
bankruptcy of the insured. Since the rights under such a policy
are vested in the beneficiary at the time the policy is issued, the
cash surrender value of the policy cannot be touched by the credi-
tors or by the trustee in bankruptcy. Where the right to change
beneficiaries has been reserved, the bankruptcy of the insured per-
mits the trustee in bankruptcy to claim the cash surrender value for
the benefit of creditors. In order to protect the families of those
carrying insurance, several states have enacted legislation exempt-
ing the cash surrender value from claims of creditors or exempting
a portion of insurance payable to the estate of the insured. Refer-
ence must be made to the statutes of a particular state to determine
the extent of this protection.

An insured person who borrows money and pledges to his creditor,
as collateral, a policy of life insurance gives security of doubtful
value where some person other than the creditor has been designated
as the beneficiary in the policy. If no right to change the benefi-
ciary has been reserved, the creditor secures no interest in the policy
unless the beneficiary joins in the assignment. Where the insured
has reserved the right to change the beneficiary, the majority of the
courts protect the creditor to whom the policy is pledged. 10 Many

10 Antley v. St. Mathcws National Bank, 1927, 139 S.C. 23, 137 S.E. 199; p. 804.


of the courts take the contrary view, however. The creditor's posi-
tion is always strengthened if both the beneficiary and the insured
join in the assignment.

A policy of insurance, taken out upon the life of a debtor by his
creditor, is enforceable for the face amount despite the fact that the
debt is reduced below the face of the policy. In such cases the
courts compel the creditor to turn the excess above the indebted-
ness over to the estate of the debtor. Similarly, where the debtor
carries the insurance and has named the creditor as beneficiary, the
claim of the creditor extends only to the amount of the indebted-

Sec. 69. Incontestable clause. Many states, by statute, and
most companies, by provision in the policy, provide that a life in-
surance policy may not be contested after a certain period of time,
except for nonpayment of premiums or violation of the military or
airplane clauses found in the policy. Thus, fraud on the part of the
insured at the inception of the policy may not be raised by the com-
pany after the policy has been outstanding for two years ; two years
represent the usual period provided in which the company is given
a right to rescind. 11 To illustrate: An applicant for life insurance
materially misrepresents to the insurer the condition of his health
at the time his application is filed. Three years later he dies from
tuberculosis, with which he was afflicted at the time he made the
application. His beneficiary is entitled to recover on the policy,
because the incontestable clause bars the insured's fraud as a de-
fense. Misstatement of the applicant's age gives no right of rescis-
sion to the company, but the face of the policy is correspondingly
reduced. 12

The clauses of a life insurance policy calling for double indem-
nity in case of accidental death or for payments in case of disability
may be contested after the contestable period has expired. The
courts have felt that these clauses are not essentially a part of life
insurance, and, consequently, are not subject to the provision or
statute concerning incontestability. Of course, the contract can
be so drawn as to make the policy incontestable on these points, if
the company desires.

Sec. 70. Assignment. A life insurance policy in which the in-
sured is also the beneficiary may be sold and assigned to a third
party, although the assignee is a stranger and has no insurable in-
terest in the life of the insured. The assignment binds the com-
pany as soon as it receives notice thereof. If the assignee continues
to pay the premium, he is entitled to the face of the policy upon the

11 Powell v. Mutual Ins. Co, 1924, 313 111. 161, 144 N.E. 825; p. 804.

* New York Life Ins. Co., v. Veit et al., 1945, 294 N.Y. 222, 62 N.E.(2) 45; p. 805.


death of the insured, 13 unless he receives the assignment merely
as security for an indebtedness. Certain fraternal insurance pro-
vides that the policy of life insurance may be made payable only to
certain members of the family. In such cases the policy may not
be assigned, being payable only to the estate of the insured or to the
members of his family indicated in the policy.

A fire insurance policy may not be assigned without the consent
of the insurer. Such a policy gives a personal right, and, as the
risk varies in many cases with the person protected, the right may
not be assigned. If the insured no longer needs protection, he may
assign the policy, provided the company consents; or, if the com-
pany refuses, the insured may cancel the policy and demand a re-
turn of a portion of the premium previously paid.

After a fire loss has occurred, the right to the proceeds may be
assigned and the assignment becomes effective as soon as the insur-
ance company receives notice of it. Only where an attempt is made
to assign the policy protection is the assignment ineffective unless
it is assented to by the insurer.

Review Questions and Problems

1. Where are the terms of a contract of insurance embodied? When
does the contract of fire insurance become effective? Of life insurance?

2. An applicant for fire insurance is asked if the property is encum-
bered. He replies that it is not, although there is a mortgage of $4,000
against the property. May the company avoid the policy? Would the
same result obtain if the applicant were unaware of the mortgage?

3. A, a stockholder in X Steamship Company, procured insurance
upon the company's steamer X. The steamer was destroyed, but the com-
pany refused to pay, contending that A possessed no insurable interest.
Was the company correct in its contention?

4. A, an applicant for life insurance, was asked whether he used in-
toxicating liquor. He informed the agent that he did, but the agent,
without the applicant's knowledge, inserted in the application the word
"no." May the company avoid the policy?

5. Several buildings were insured against fire, the policy providing
that no gasoline was to be kept on the premises. Gasoline had been kept
on the premises, but none was there at the time the fire occurred. May
the insured recover?

6. What is meant by an unfriendly fire? May a friendly fire become
unfriendly? Is the insured in a fire insurance contract protected against
loss from an explosion, assuming that the explosion was caused by fire?

7. A fire caused the wall of a building owned by A to fall and damage
a building owned by B. May B recover on a policy of fire insurance
covering his building? Suppose that B J s furnishings had been damaged

13 Prudential Ins. Co. v. Deyerberg et al, 1927, 101 N.J. Eq. 90, 137 Atl. 785; p. 807.


by the smoke from the fire in the adjoining building, what would be the

8. What is meant by the term "coinsurance"? What is its purpose?

9. M owned certain buildings which were insured by the X Company.
As a result of the negligence of the Y Railway Company, a fire takes
place, damaging the buildings. The X Company paid M the amount of
the damage. May the X Company recover from the Railway Company?

10. May a fire insurance contract be assigned without the consent of
the company? May a life insurance policy be assigned?

11. A took out insurance in the name of his wife, without reserving
the right to change beneficiaries. He later asked the company to change
the beneficiary and to substitute his son's name for that of his wife. Has
the company a right to change the beneficiary?

12. What is the purpose of an incontestable clause? When is a policy
of life insurance contested, within the meaning of the clause?

13. Assume that a policy contains a two-year incontestable clause.
A in his application states that he does not use intoxicating liquors.
Three years after the policy is issued, he dies from excessive use of such
liquors. The evidence clearly shows that lie was a user of intoxicants
at the time he filed his application. May his beneficiary recover?

14. What is a standard mortgage clause? To whom is a fire loss paid
when a policy includes a standard mortgage clause? If the insured vio-
lates the terms of the policy, does this fact relieve the insurer of its duty
to the mortgagee?

15. A carried a $10,000 life insurance policy in which J5, his wife, was
named the beneficiary. If A dies while he is insolvent, must B use the
proceeds of the insurance to pay A y s obligations?

16. The insured desired to change the beneficiary in a policy of life
insurance from his wife to his mother. The policy provided that he
might do so by making the request, surrendering the policy, and having
the change indorsed thereon. He made the request for change but failed
to return the policy for indorsement. At the time of his death, was his
wife or mother entitled to the insurance? Suppose his wife had posses-
sion of the policy and refused to surrender it?

17. A obtained a policy of life insurance for $500 in which W, his wife,
was named as beneficiary. The policy provided that it was to be effec-
tive when the policy was delivered to the insured in good health. At
the time the policy was delivered to the insured he was afflicted with pneu-
monia, as a result of which he died a few days later. Was W entitled to
recover from the insurer?

18. A carried a policy of life insurance for $5,000, which was payable
to his estate. Shortly before his death, he mailed the policy to his fiancee,
telling her that he wanted her to have it in case anything happened to
him. At his death, will the money be paid to his estate or to his fiancee?

19. A carried a policy of insurance for $10,000 on his life, the premium
falling due on August 1, 1939. He mailed a check on August 29 in pay-
ment and immediately received an official receipt of payment. The check
was dishonored because of insufficient funds and the company refused to
accept a money order on September 5 in settlement. The insurance com-
pany refused to reinstate the policy because of the poor health of the in-
sured. Had the policy lapsed, if the insured had tendered the money
order as soon as he learned the check had been dishonored? If the in-
sured had carried no bank account, but had paid a neighbor the amount
of the premium for the latter's check which was indorsed and mailed
to the company and this check had been dishonored, would your answer
be the same?

20. A borrowed $15,000 of B and as security procured a policy of life
insurance for that amount and named B as the beneficiary. A died at a
time when the debt had been reduced to $7,000. Determine the rights
of A, and B. Would the result be the same if B had taken out the in-
surance on A's life?

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