by Helmut Heiss
1. Term, scope and classification
The term ‘indemnity insurance’ refers to insurance contracts provided by insurers to cover the risk of policyholders suffering damage. On occurrence of the insured event, the insurer settles the claim for damages actually suffered by the policyholder. Indemnity insurance policies thus have the function of compensating the policyholder for damages actually incurred.
This compensatory function distinguishes indemnity insurance policies from fixed-sum insurance policies. The latter type of insurance provides that the policyholder, in the insured event, receives the insurance sum contractually agreed upon in advance. Whether he has suffered damage is irrelevant for the payment of the sum insured. For example, if a person at risk insured under a term life assurance policy passes away, the beneficiary would receive the life assurance sum irrespective of whether the death of the person at risk constituted a financial disadvantage for him (eg a loss of maintenance payments).
Fixed-sum insurance policies are permitted for personal insurance only. With this type of policy, it is presumed that a policyholder who has taken out an insurance policy for himself will not be tempted by the financial incentive to bring about the insured event. Evidently, this presumption does not apply in the same measure to insurance policies taken out for another person. For the purpose of preventing a moral hazard in this case, continental European laws—in addition to the protection of personal integrity provided under criminal law—contain a requirement for the person at risk to consent to the insurance policy being taken out for him. By way of contrast, Anglo-American law contains a functionally equivalent provision which requires the policyholder to have an insurable interest in the life, physical integrity or the health of the person at risk. In principle, the policyholder can thus only take out a policy for another person’s life to the extent of his (financial) interest in the person at risk.
Due to the fact that only personal insurance policies can be concluded as fixed-sum insurance contracts, personal insurance policies as a distinct category were traditionally contrasted with indemnity insurance policies. It is legitimate to suggest that this categorisation is unfounded, as personal insurance may also take the form of indemnity insurance. This is perfectly illustrated by insurance policies for medical expenses, which serve to compensate the financial detriment that the policyholder suffers through his illness (medical fees). Nowadays, the differentiation between indemnity and personal insurance is therefore regarded as outdated.
Indemnity insurance can be divided into active and passive insurance. Active insurance policies are concerned with insurance cover against the loss of assets in the policyholder’s possession. Thus the policyholder is for instance protected by way of a fire insurance policy against the loss of a building owned by him. The same holds true for comprehensive motor insurance policies, for example, covering the loss of a vehicle due to theft. Passive insurance, in contrast, protects the policyholder against liabilities arising from the occurrence of a certain, ie the insured event. A classic example is third-party liability insurance. Due to the occurrence of an event insured under a third-party liability insurance policy, a duty arises on the part of the policyholder to make good the damage suffered by the injured party. The insurer, consequently, owes indemnity against the claim for damages held by the injured party against the policyholder. Similarly, when providing legal expenses insurance, an insurer shoulders the expenses incurred by the policyholder as a consequence of legal proceedings. In case the legal action in question fails, the fees of the policyholder’s lawyer as well as the opponent’s legal fees and the court fees are of particular concern. Finally, insurance for medical expenses should be mentioned. Under such an insurance policy, the insurer must pay the costs that arise for the policyholder as a consequence of consulting a doctor.
2. Rule against unjust enrichment
The rule against unjust enrichment, which represents the dominant principle of the law relating to indemnity insurance policies, can be deduced from the function of such policies, ie the compensation of damages. The rule against unjust enrichment essentially provides that the policyholder may not obtain a pecuniary advantage from the indemnity payment made by the insurer. Historically, this provision derives from the attempt to distinguish insurance policies from other aleatoric transactions (in particular gambling) by reference to the former’s function of compensating damages. Admittedly, this function is not entirely compatible with the rule against unjust enrichment. This is due to the fact that fixed-sum insurance policies, to which the rule against unjust enrichment does not apply, are also permitted in the area of personal risks. From a contemporary perspective, the prohibition serves to avoid moral hazards. The policyholder is not supposed to be tempted by the existence of the insurance contract to (intentionally) bring about the occurrence of the insured event.
The rule against unjust enrichment used to form part of the public policy provisions (public policy) of insurance contract law (insurance contracts). According to prevailing doctrine, it was considered to be a norm of absolutely mandatory character. Since then, this view has to a large extent been undermined, and in part completely abandoned, in more recent literature and case law. Thus, the German Federal Federal Supreme Court (Bundesgerichtshof) has in principle recognized contractual derogations from the rule against unjust enrichment as legitimate. In the United States, the rule against unjust enrichment has been totally abandoned in some places (eg the state of Utah). Thus, fixed-sum insurance policies can also be taken out for risks other than personal risks. However, the aim of this legislative approach is the same as that pursued by the rule against unjust enrichment. Accordingly, it is based on the premise that insurers will be most effectively deterred from offering cover for excessive insurance sums if they are held liable for the sum agreed upon with the policyholder.
Continental European codifications of insurance contract law usually contain the rule against unjust enrichment, according to which policyholders only receive compensation for the damage actually suffered by them, even if the sum insured is higher than the face value of the policy covering the insured interest at the time the insured event occurs. In Anglo-American legal systems (legal families), this function is fulfilled by the requirement that the policyholder must be able to present an insurable interest. As a consequence, the policyholder may only take out an indemnity insurance policy to the extent that he holds an insurable interest which can be gauged in monetary terms.
Certain types of insurance policies contain derogations from the rule against unjust enrichment. However, these policies appear to be permissible as they are deemed not to bear any subjective moral hazards. In this context, contractual agreements concerning the value of the insured interest, especially in the case of movable property, are of particular concern. It is thus common to refer to the market value of the insured object at the time and place that the insured event occurs. This could refer to either the sale value or the replacement value of the object in question. For things of personal use, reference is commonly made to the value of the object in use (present value). The value of an object in use is frequently higher than the market value of used goods (eg clothes, jewellery). However, an agreement for compensation based on the value in use (present value) can be justified in view of the rule against unjust enrichment. This is due to the fact that the subjective benefit that the policyholder draws from something which he has acquired and since used is actually higher than the market value. Generally, there is no need to fear false incentives in this context. At the same time, it should also be permissible to insure goods at their reinstatement value. It can, of course, not be denied that a policyholder who receives a new thing instead of the old, burnt-down house or the old, stolen bicycle is enriched (‘new for old’). For this reason, there have been attempts to make insurance payments at reinstatement value compatible with the rule against unjust enrichment. This was to be achieved by assuming that, in addition to covering the risk of losing the object in question, the insurer had also agreed to underwrite the risk of covering the external financing required for the recovery of the object or the acquisition of a new one. This justification is, if at all, only convincing for high value goods, in particular buildings. By contrast, the justification fails from the outset for things like bicycle theft insurance policies. Furthermore, the financial expenditure would in any case be lower than the difference between the value of the object when new and its present value. It must therefore be conceded that reinstatement value clauses in insurance contracts derogate from the rule against unjust enrichment in favour of the policyholder. This derogation is permissible, however, as the policyholder has a legitimate interest in being compensated according to the reinstatement value of the insured object; therefore, the transaction is supported by sound economic considerations. Reinstatement value insurance policies do not, therefore, bear a risk of degenerating into gambling per se. The potential false incentives also remain within bounds in this case. This holds particularly true for buildings, the loss of which not only represents a loss of property for the owner, but is also generally associated with a great deal of administrative expense and similar costs. Moreover, the same can be said for other goods for which the difference between the value in use (present value) and the value when new is not particularly large (insurance for bicycle theft).
In the commercial insurance branches and especially in the field of transport insurance, agreements concerning the insurance value, calculated on the basis of valuations, are of special importance. By agreeing on an estimate, the value of the insured goods (eg transport goods) is stipulated in the contract by the parties as binding for the time when the insured event occurs, ie ex ante. Provided that the valuation estimate does not exceed, or only marginally exceeds, the actual value, such agreements are unobjectionable when viewed from the perspective of the rule against unjust enrichment. They eliminate the need for tedious damage surveys and possibly also long-winded proceedings. Therefore, an estimated insurance value serves the efficient processing of claims for insured events. However, in cases where the valuation estimate exceeds the actual value, concerns with regard to the rule against unjust enrichment arise. For this reason, many legal systems provide that an insurer may reduce the valuation estimate where this sum significantly exceeds the actual insurance value at the time of occurrence of the insured event. Nevertheless, policies in excess thereof are customary and also permissible in marine insurance, where the insurer is not entitled to object to an overly excessive valuation (‘policy proof of interest’).
3. Indemnity insurance in the acquis communautaire
In the European acquis of insurance law, a lack of contract law provisions concerning matters of indemnity insurance is to be noted. Admittedly, there are directives in the areas of legal expenses insurance and, especially, third party motor insurance, which essentially deal with questions of contract law. Yet, these directives are not concerned with general principles of indemnity insurance, but rather with other specific problems. At the same time, these directives, without a doubt, implicitly presuppose the compensatory function of both third party motor insurance and legal expenses insurance.
Nevertheless, an indirect reference to indemnity insurance using the term ‘non-life’ is made in the directives. For regulatory purposes, the directives are divided into the Consolidated Life Assurance Directive (Dir 2002/83) and three directives concerning non-life insurance (Dir 73/239, Dir 88/357, Dir 92/49). The German version of the Third Non-Life Insurance Directive (Dir 92/49) even uses the term Schadenversicherung (indemnity insurance). Technically speaking, this is imprecise as the directives concerning non-life insurance policies also cover fixed-sum insurance policies (eg accident insurance). In any event, the directives currently in force will be replaced by Dir 2009/138 as of 1 November 2012.
4. Indemnity insurance in the PEICL
The Principles of European Insurance Contract Law (PEICL) also contain a Part II, which provides for rules on all types of indemnity insurance. Of these, Art 8:101(1) of the PEICL should be highlighted. According to this provision, the insurer is not obliged to compensate more than the loss actually suffered by the policyholder. Pursuant to Art 1:103(2)2, this provision is only mandatory in favour of the policyholder in the area of mass risk insurance, but may also be derogated from for insurance policies covering large risks. Thus, in either case the principle can be departed from for the benefit of the policyholder. This leads to compensation payments based on an object’s reinstatement value as well as valuations (these are expressly permitted by Art 8:101(2) of the PEICL) being effective. Thus, Art 8:101 of the PEICL assumes the function of being a guideline for assessing the permissibility of agreements concerning the insurance value, an assessment which is based on the limits posed by the general civil law and especially the need for contracts to conform with morality.
Rudolf Gärtner, Das Bereicherungsverbot—Eine Grundfrage des Versicherungsrechts (1970); Jürgen Basedow and Till Fock (eds), Europäisches Versicherungsvertragsrecht, vols 1 and 2 (2002) and vol 3 (2003); Yvonne Lambert-Faivre, Droit des assurances (12th edn, 2005); Malcolm Clarke, The Law of Insurance Contracts (5th edn, 2006); Herman Cousy (ed), ‘Insurance Law’ in Jan M Smits (ed), International Encyclopaedia of Laws (2006); Manfred Wandt, Versicherungsrecht (4th edn, 2009).