By Rabih Hamawi, CPCU®, CIC, CRM, LIC, MSF
The Journal of Insurance and Indemnity Law Volume 16 Number 1, January 2023.
Author’s note. This article is the first of what is intended to be a continuing series on topics related to insurance and indemnity law.
For those who see themselves as being at the start of the learning curve, we introduce a series on basic insurance and indemnity principles. The learning curve doesn’t actually have an end, but it does have a beginning, and the basic principles are worth reiterating. The plan, therefore, is to present a series of articles that discuss some of the principles that underlie and govern both insurance coverage and indemnity issues. We’ll also discuss the intersection of indemnity and insurance. Because the goal of the series is to provide general information and explanations rather than advocacy, it will follow the philosophy of the Section, and remain neutral as between insureds and insurers.
“The purpose of insurance is to insure against a [fortuitous] loss.” That’s why insurance contracts are “aleatory” contracts, which means that the duty to perform depends on the “happening of some event that is not certain to occur and that is not within the control of either party.” An aleatory contract involves a “hazard, chance, or risk.” More than a century ago, the Michigan Supreme Court stated it perfectly: one can’t insure a sinking ship.
A good place to start this Insurance and Indemnity 101 series is with “fortuity” and the “loss-in-progress” and “known-risk” doctrines. These are complementary doctrines that address the fundamental question whether a particular peril can be insured. These are not “policy defenses,” because they do not depend on the language of any policy, but are based on the fundamental nature of insurance and what kinds of losses are insurable. These doctrines are “based on the rationale that insurance policies cover fortuitous events or risks of loss, not losses that are certain to occur. Once a loss has happened, or once it is in progress, the event is no longer fortuitous, and the risk has already been realized.”
“Fortuity” is a common term in insurance law. In the real world, “fortuity” means “lucky or fortunate.” But in insurance, “fortuity” means that the insured event or peril is either uncertain to occur, or it is certain to occur but at an uncertain time. The common expression of the loss-in-progress and known risk doctrines is that no one can insure a sinking ship, and the first case in Michigan to apply the rule did involve a ship. In Gauntlett v Sea Ins Co, a ship sank near Mackinac Island. Notice of the loss was telegraphed at 6:30 a.m. to the insured. The insured had already been in the process of negotiating for insurance before the ship sank, but had not yet obtained it. At 8:00 a.m., the insured sent a telegram requesting insurance. The Michigan Supreme Court held that because the ship had sunk, the policyholder could not recover. The court acknowledged that “[v]essels and cargoes upon the seas may be insured when both parties are in ignorance of the condition of the property,” but concluded that the insured knew of the loss before any policies were issued.
The next case to apply the rule is Harper v Tornado v Michigan Mutual Tornado Ins Co, in which the plaintiff sought to collect insurance on a building that had burned down. The building had been insured by the previous owner with a mutual company, but the underwriting rules of the company required that the company approve any new insured when the property was transferred. The building burned down before the successor owner was approved as an insured, and the court held that there was no insurance.
More recently, the Michigan Supreme Court applied the rule in American Bumper v Hartford Fire Ins Co. The court acknowledged that Michigan “recognizes that a completed loss is not covered under an after-acquired insurance policy.” This reference to a “completed loss” must be read in the context of the Supreme Court’s more general statement of the rule:
Under the loss-in progress doctrine, an insurer is not liable if the loss was already in progress before the policy’s coverage took effect. The doctrine is based on the rationale that insurance policies cover fortuitous events or risk of loss, not losses that are certain to occur. Once a loss has happened, or once it is in progress, the event is no longer fortuitous and the risk has already been realized.
These principles are not based on or limited by the terms of the policy. Fortuity, and the loss-in-progress and known-risk doctrines are related to two other insurance concepts – “adverse selection” and “moral hazard.” Adverse selection is the tendency of a person who knows he or she is more likely to suffer a loss to buy insurance. Moral hazard is the state of mind that one who has insurance will engage in riskier behavior – or intentional conduct – because he or she knows the insurance will cover the loss. Moral hazard should not be confused with morale hazard, which usually implies a certain indifference to loss simply because of the existence of insurance (for example, failure to maintain or repair an insured property).
Adverse selection and moral hazard by applicants or policyholders provide perhaps the greatest threat to fortuitous underwriting by insurers. Adverse selection is the tendency of persons who are more likely to suffer a loss to purchase insurance on such risks. At its worst, adverse selection can mean an insurance applicant’s seeking a policy that will cover a loss he knows is certain to occur.
Michigan has applied the moral-hazard rule in several cases. Addressing the issue in the context of the insured’s failure to disclose a material fact, the Michigan Supreme Court held: It cannot be presumed that a breach of a condition which increases the moral hazard does the insurer no injury. Quite the contrary. Courts have uniformly avoided the policy upon breach of such conditions, upon the ground that an essential and material change of the contract was thus effected and the insurer prejudiced.
Insurers may address the moral-hazard problem in several ways. They may exclude certain loss to address that problem (exclusions are the subject of future articles). The most obvious, in a liability insurance policy, is the “expected or intended injury” exclusion (a/k/a the intentional act exclusion). A property insurance policy will usually contain a provision that requires the insured to take steps to prevent certain types of loss. Also, a policy may contain a provision that precludes coverage when the insured fails to disclose a material fact in the application.
About the Author
Rabih Hamawi is a principal at Law Office of Rabih Hamawi, P.C. and focuses his practice on representing policyholders in fire, property damage, and insurance-coverage disputes with insurers and in errors-and-omissions cases against insurance agents.
He has extensive expertise in insurance coverage and is a licensed property and casualty, life, accident, and health insurance producer and counselor (LIC). He earned the Chartered Property and Casualty Underwriter (CPCU), Certified Insurance Counselor (CIC), and Certified Risk Manager (CRM) designations. Rabih Hamawi is the current chairperson of the Insurance and Indemnity Law Section. He is a frequent author on insurance and indemnity topics.