De Leon Insurance

THE INSURANCE CODE

OF THE PHILIPPINES (PRES. DECREE NO. 1460, AS AMENDED.)

GENERAL PROVISIONS

Section 1. This Decree shall be known as "The Insur-ance Code of 1978.*"

Historical origin of insurance. (1) Mutual insurance as old as society itself. Insurance is

based upon the principle of aiding another from a loss caused by an unfortunate event. Some writers have maintained that mutual insurance is as old as society itself. It seems that benevolent societies organized for the purpose of extending aid to their unfortunate members from a fund contributed by all, have been in existence from the earliest times. They existed among the Egyptians, the Chinese, the Hindus, and the Romans and are known to have been established among the Greeks as early as the third century before Christ. 1

*"The Insurance C o d e / ' in Presidential Decree No. 612. lThe germ of the modern mercantile insurance contract appears to have been the

transaction evidenced by the bottomry or respondentia bond, together with the practice of "general average" contribution, (see Sees. 101, 136.) The late Dr. Trenerry, author of a learned work on the early history of insurance, finds a primitive form of bottomry loans in the Babylonian Code of Hammurabi (B.C. 2250.) , and a more highly developed form in the Hindu Laws of Manu, so called. He conjectures that this important business prac-tice was taken over by the Phoenicians, who greatly improved it and carried it on to the Greeks, who may have known and used it as early as the Trojan War.

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2 THE INSURANCE CODE OF THE PHILIPPINES Sec. 1

(2) Origin of present day insurance attributed to merchants of Italian cities. The practice of insurance as we know it today, as an important agency in promoting commercial and industrial transactions, is relatively of modern invention. Its origin is to be found in the mutual agreements among merchants of the Italian cities in the early middle ages engaged in common shipping ventures for distributing among the mutual contractors, the loss falling upon any one by reason of the perils of navigation. It is thus apparent that in its early forms, the law of insurance was derived from the maritime law and, as such, was part of the general law merchant, and international in its character. 2

(3) Development of insurance in England. From Italy, the practice of insuring commercial ventures against disaster rapidly extended to other maritime States of Europe. The Italian merchants coming from the flourishing commercial centers in Northern Italy, and generally known as Lombards, founded trading houses in London in the twelfth century and brought with them the custom of insuring against hazards of trade. All questions of insurance, however, were determined in accordance with the customs of merchants, and by merchant courts, or rather,

Among the Romans, several different forms of such societies, known as Collegia, were developed, and became of sufficient importance under the Empire to attract strict regulatory legislation. They performed many of the functions of the modern mutual ben-efit society, providing primarily funeral rites for the dead, but also aid for sick and aged members. A still extant copy of the by-laws of one of these Roman societies contains such familiar provisions as that the member forfeits all rights to benefits by failure to pay dues or by committing suicide, and an earnest injunction to the members to read the by-laws and thus avoid lawsuits. F r o m the Roman Collegia probably developed the medieval guilds, which flourished throughout Europe and undoubtedly assumed to their members many obligations which we should now class as life, accident, or health insur-ance contracts. Some of them even went so far as to provide indemnity for losses by fire and shipwreck, from the death of cattle, and from theft. (Vance, op. cit., pp. 8-10.)

2 F r o m the twelfth to the sixteenth centuries, the Italian republics of Venice, Florence, and Genoa flourished greatly by reason of their extensive marit ime commerce , and it was among these Italian merchants that the contract of insurance first received that attention which the manifest benefits to be derived from its use would justify. Insurances were certainly effected as early as the beginning of the thirteenth century, and possibly in the tenth century. The earliest policy form known to be extant was written in Genoa in 1347, and a statutory form was prescribed in Florence in 1523. From Italy, the custom of making mutual contracts of insurance spread rapidly over the whole of commercial Europe, and early came to be practiced extensively by the merchants in the towns forming the Han-seatic League. The word "policy" is a monument to the Italian origin of insurance, being derived from the Italian word "poliza." (ibid., pp. 10-11.)

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the custom of submitting all contracts involving mercantile rights to courts of merchants established among themselves.

It was not until the middle of the eighteenth century that the common law courts of England began to take adequate cogni-zance of insurance cases with the passage in 1601 of the first English Insurance Act by which a special court was established for the trial of marine insurance controversies. In 1756, with the appointment of Lord Mansfield as Chief Justice of the Court of King's Bench, there came a new era in the common law with reference to questions involving the law merchant. In the skill-ful hands of this great judge who is properly called the "Father of English Commercial Law," the essential principles of the law merchant were incorporated into the common-law system of England and the common-law courts thereby rendered compe-tent to determine all questions involving insurance. 3

(4) Development of insurance in the United States. In general, the development of the several kinds of insurance has followed the same lines in the United States as in England. However, the insurance industry of the United States has grown to such an extent that with the exception of ocean marine insurance, the English practices and the English decisions have little influence on insurance in the United States, (see Vance, The Law of Insurance [3rd Ed.], pp. 7-22.)

(5) Development of insurance in the Philippines. Insurance in the Philippines is rather a young institution. Prior to the

3 Known to have triggered the early development of insurance is Lloyd's of London (referred to as the international insurance market). It began as a 17th century coffeehouse catering to merchants, vessel owners, bankers and the first underwriters. It is known that Lloyd's Coffeehouse, an inn kept by one Edward Lloyd on Tower Street in London, was, as early as 1688, a popular resort for seafaring men and merchants engaged in foreign trade.

It became the custom among those who gathered at Lloyd's to make their gather-ing an occasion for arranging their mutual contracts of insurance against the sea perils to which their ventures were exposed. The method employed in making such insurance contracts was for the person desiring the insurance to pass around among the company assembled a slip upon which was written a description of the vessel and its cargo, with the name of the master and the character of his crew, and the voyage contemplated. Those desiring to become insurers of the ventures so described would write beneath the de-scription on this slip their names or initials, and opposite thereto the amount which each was willing to shoulder. The term "underwriter" was believed to have originated from such a practice, (ibid., pp. 17-18.)

4 THE INSURANCE CODE OF THE PHILIPPINES S e c . l

19th century, insurance, in its modern sense, did not even exist. During the pre-Spanish times, when the political unit was then the family, if a member of the family died or suffered any other misfortune, it was borne by the family. When communities, such as the barangays developed, the assistance was extended accordingly. Even now, this practice of furnishing some form of assistance to bereaved members of the family of someone who dies still exists. Eventually, mutual benefit societies and fraternal associations were organized for the purpose of rendering assistance, in money or in kind, to their members. It may be that what worked much against the early development of insurance in the Philippines, aside from economic reasons (low per capita income of the people), was the fatalistic philosophy behind our oft-quoted expression 'bahala na.'

Insurance, in its present concept, was first introduced in the Philippines sometime in 1829 when Lloyd's of London appointed Stracham, Murray & Co., Inc. as its representative here. Sometime in 1939, the Union Insurance Society of Canton appointed Russel & Sturgis as its agent in Manila. The business transacted in the Philippines then was limited to non-life insurance. It was only in 1898 that life insurance was introduced in this country with the entry of Sun Life Assurance of Canada in the local insurance market.

The first domestic non-life insurance company, the Yek Tong Lin Fire and Marine Insurance Company, was organized on June 8, 1906, while the first domestic life insurance company, the Insular Life Assurance Co., Ltd., was organized in 1910. ("Supervision and Regulation of the Insurance Business in the Philippines," Journal of the IBP, First Quarter, 1976, p. 21, by Comm. G. Cruz-Arnaldo) In 1950, reinsurance was introduced with Reinsurance Company of the Orient writing treaties for both life and non-life. The first workmen's compensation Pool was organized in 1951 as the Royal Group Incorporated. In 1949, a government agency was formed to handle insurance affairs. The Insular Treasurer was appointed Commissioner ex-officio.

Social insurance was established in 1936 with the enactment of C.A. No. 186 which created the Government Service Insurance System (GSIS) which started operations in 1937. The Act covers

S e c . l G E N E R A L PROVISIONS 5

government employees. It was followed much later in 1954 by R.A. No. 1161 which provides for the organization of the Social Security System (SSS) covering employees of the private sector.

Sources of insurance law in the Philippines. (1) During the Spanish period, all of the provisions

concerning insurance in the Philippines were found in Title VII of Book Two and Section III of Title III of Book Three of the Code of Commerce, and in Chapters II and IV of Title XII of Book Four of the old Civil Code of 1889.

(2) When Act No. 2427 (enacted on December 11, 1914.), otherwise known as the Insurance Act, took effect on July 1, 1915 during the American regime, the provisions of the Code of Commerce on insurance were expressly repealed.

(3) Thereafter when R.A. No. 386, otherwise known as the Civil Code of the Philippines, took effect on August 30, 1950 (Lara vs. del Rosario, 94 Phil. 778 [1954].), those provisions of the old Civil Code on insurance (Arts. 1791-1797 and 1802-1808.) were also expressly repealed.

(4) Presidential Decree No. 612, as amended, which ordained and instituted the Insurance Code of the Philippines, was promulgated and became effective on December 18 ,1974 during the period of martial law. It repealed Act No. 2427, as amended. Before Presidential Decree No. 612, amendments to the Act were made by Presidential Decrees No. 63 ,123 , and 317.

(5) Presidential Decree No. 1460 consolidated all insurance laws into a single code known as the Insurance Code of 1978 which was issued and took effect on June 11, 1978. Basically, it reenacted Presidential Decree No. 612, as amended. It has been amended by Presidential Decree No. 1814 and Batas Pambansa Big. 874.

Laws governing insurance. (1) Insurance Code of 1978. The law on insurance is

contained now in the Insurance Code of 1978 (Pres. Decree No. 1460, as amended.) and special laws (infra.) and partly, in the pertinent provisions of the Civil Code.

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The Insurance Code primarily governs the different types of insurance contracts and those engaged in insurance business in the Philippines. It took effect on June 11, 1978, the date of its promulgation "without prejudice, however, to the effectivity dates of the various laws, decrees and executive orders which have so far amended the provisions of the Insurance Code of the Philippines. (Presidential Decree No. 612.)"

(2) Civil Code. The provisions of the Civil Code dealing on insurance are found in Articles 739 and 2012 (on void donations), Article 2011 (on the applicability of the Civil Code), Articles 2021-2027 (with respect to life annuity contracts), Article 2186 (on compulsory motor vehicle liability insurance), and Article 2207 (on the insurer's right of subrogation).

The Civil Code, in the Title on Damages, provides for the insurer's right of subrogation as follows:

"Art. 2207. If the plaintiff's property has been insured and he has received indemnity from the insurance company for the injury or loss arising out of the wrong or breach of contract complained of, the insurance company shall be subrogated to the rights of the insured against the wrongdoer or the person who has violated the contract. If the amount paid by the insurance company does not fully cover the injury or loss, the aggrieved party shall be entitled to recover the deficiency from the person causing the loss or injury." In other words, insurance contracts are governed primarily

by the Insurance Code but if it does not specifically provide for a particular matter in question, the provisions of the Civil Code on contracts and other special laws shall govern.

(3) Special laws. Article 2011 of the Civil Code provides: "The contract of insurance is governed by special laws.

Matters not expressly provided for in such special laws shall be regulated by this Code."

Among such special laws on insurance are:

(a) The Insurance Code of 1978 (Pres. Decree No. 1460.); (b) The Revised Government Service Insurance Act of

1977 (Pres. Decree No. 1146, as amended.), with respect to insurance of government employees; and

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Sec .1 G E N E R A L PROVISIONS 7

(c) The Social Security Act of 1954 (R.A. No. 1161, as amended.), with respect to insurance of employees in private employment.

(4) Others. Insofar as the Civil Code is concerned, the Code of Commerce is considered a special law.

(a) In addition, there is R.A. No. 656 (as amended by Pres. Decree No. 245.), known as the "Property Insurance Law," dealing with government property.

(b) There is also R.A. No. 4898 (as amended by R.A. No. 5756.) providing life, disability and accident insurance coverage to barangay officials.

(c) Executive Order No. 250 (July 25, 1987) increases, integrates and rationalizes the insurance benefits of barangay officials under R.A. No. 4898 and members of Sangguniang Panlalawigan, Sangguniang Panlungsod, and Sangguniang Bayan under Presidential Decree No. 1147. The insurance benefits are extended by the Government Service Insurance System. 4

(d) R.A. No. 3591 (as amended.) establishes the Philippine Deposit Insurance Corporation which insures the deposits of all banks which are entitled to the benefits of insurance under the Act.

Right of subrogation of insurer to rights of insured against wrongdoer. (1) Basis of right. The doctrine of subrogation is basically a

process of legal substitution; the insurer, after paying the amount covered by the insurance policy, stepping into the shoes of the

4"Sec. 522. Insurance Coverage. The Government Service Insurance System (GSIS)

shall establish and administer an appropriate system under which the punong barangay, the members of the sangguniang barangay, the barangay secretary, the barangay treasurer, and the members of the barangay tanod shall enjoy insurance coverage as provided in this Code and other pertinent laws. For this purpose, the GSIS is hereby directed to undertake an actuarial study, issue rules and regulations, determine the premiums payable and rec-ommend to Congress the amount of appropriations needed to support the system. The amount needed for the implementation of the said insurance system shall be included in the annual "General Appropriations Act." (Local Government Code [R.A. No. 7160], effective Jan. 1 ,1992.)

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insured, as it were, and availing himself of the latter's rights that exist against the wrongdoer at the time of the loss.5 It has its roots in equity. It is designed to promote and to accomplish justice and is the mode which equity adopts to compel the ultimate payment of a debt by one who in justice and good conscience ought to pay. (Phil. American General Insurance Co., Inc. vs. Court of Appeals, 273 SCRA 262 [1997]; Delsan Transport Lines, Inc. vs. Court of Appeals, 369 SCRA 24 [2001].)

(2) Purposes of subrogation condition in policy. Its principal purpose is to make the person who caused the loss, legally responsible for it and at the same time prevent the insured from receiving a double recovery from the wrongdoer and the insurer. The insurer is entitled to recover either directly in a suit against the wrongdoer (third party) or as the real party in interest in a suit brought by the insured and thereby fully recover or at least lessen the amount of loss it may have paid the insured. The rule likewise prevents tortfeasors from being free from liabilities and is thus founded on considerations of public policy.

There exists a wealth of U.S. jurisprudence that whenever the wrongdoer settles with the insured without the consent of the insurer and with knowledge of the insurer's payment and right of subrogation, such right is not defeated by the settlement. (Danza's Corporation vs. Abrogar, 478 SCRA 80 [2006].)

(3) Right of subrogation applicable only to property insurance. The right of subrogation under Article 2207 applies only to property, and not to life insurance. The value of human life is regarded as unlimited and, therefore, no recovery from a third party can be deemed adequate to compensate the insured's beneficiary. The pecuniary value of a human life to the beneficiary of a life insurance policy can seldom be determined with accuracy (except where the insurance is taken by a creditor on the life of a debtor to secure a debt). Life insurance contracts are not ordinarily contracts of indemnity, (see Chap. II, Title 2.)

(4) Privity of contract or assignment by insured of claim not essential. Payment by the insurer to the insured operates as

5 For additional discussion, see annotations under Section 243.

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an equitable assignment to the former of all the remedies which the latter may have against the third party whose negligence or wrongful act caused the loss. The right of subrogation is not dependent upon, nor does it grow out of, any privity of contract or upon written assignment of claim. It accrues simply upon payment of the insurance claim by the insurer, (see Pan Malayan Insurance Corp. vs. Court of Appeals, 184 SCRA 54 [1990]; Phil. American General Insurance Co., Inc. vs. Court of Appeals, supra; Aboitiz Shipping Corp. vs. Insurance Company of South America, 561 SCRA 262 [2008].)

The presentation in evidence of the insurance policy is not indispensable before the insurer may recover. The subrogation receipt, by itself, is sufficient to establish not only the relationship of the insurer and the insured, but also the amount paid to settle the insurance. (Delsan Transport Lines, Inc. vs. Court of Appeals, supra; Federal Express Corporation vs. American Home Assurance Company, 437 SCRA 50 [2004].)

(5) Loss or injury for risk must be covered by the policy. Under Article 2207, the cause of the loss or injury must be a risk covered by the policy to entitle the insurer to subrogation. Thus, where the insurer pays the insured for a loss which is not a risk covered by the policy, thereby effecting 'Voluntary payment/' the insurer has no right of subrogation against the third party liable for the loss. Nevertheless, the insurer may recover from the third party responsible for the damage to the insured property under Article 1236 of the Civil Code. (Sveriges Anfartygs Assurance Forening vs. Qua Chee Gan, 21 SCRA 12 [1967]; see also St. Paul Fire & Marine Insurance Co. vs. Macondray & Co., Inc., 70 SCRA 122 [1976]; Fireman's Fund Ins. Co. & Firestone Tire & Rubber Co. vs. Jamila, Inc., 70 SCRA 23 [1976].)

(6) Right of insured to recover from both insurer and third party. The right of subrogation given to the insurer prevents the insured from obtaining more than the amount of his loss. It is a method of implementing the principle of indemnity that is at the heart of all insurance, (see Sec. 18.) The right exists after indemnity has been paid by the insurer to the insured who can no longer go after the third party. He can only recover once. Note, however, that if the amount paid by the insurance company does not fully

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cover the injury or loss, it is the aggrieved party, i.e., the insured, not the insurer, who is entitled to recover the deficiency from the person responsible for the loss or injury, (see F.F. Cruz & Co., Inc. vs. Court of Appeals, 164 SCRA 731 [1988].) This is true in case of under-insurance.

(7) Right of insured to recover from insurer instead of the third party. The insurer cannot defeat the insured's claim for indem-nity on the ground that the insured has a right to be indemnified by a third person. Having been paid a premium to make good the insured's loss, the insurer cannot compel him to seek indem-nity elsewhere.

(8) Right of insurer against third party limited to amount reco-verable from latter by the insured. The literal language of Article 2207 makes it clear that the insurance company that has paid indemnity "shall be subrogated to the rights of the insured against the wrongdoer or the person who has violated the contract." As the insurer is subrogated merely to the rights of the insured, it can necessarily recover only the amount recoverable by the insured from the party responsible for the loss. It cannot recover in full the amount it paid to the insured if it is greater than that to which the insured could lawfully lay claim against the person causing the loss.6 (Rizal Surety & Insurance Co. vs. Manila Railroad Co., 23 SCRA 205 [1968].)

By way of illustration, if what the insured can recover under the law from the party who is guilty of breach of contract is P5,000.00, then it is only said amount that is recoverable by the insurer from said party, notwithstanding that it paid the insured more than P5,000.00. Neither can the insurer recover more than it paid the insured although the latter is able to recover the deficiency from the wrongdoer because of under-insurance. (see No. 5.)

(9) Exercise of right of subrogation by insurer discretionary. Whether or not the insurer should exercise the rights of the insured to which it had been subrogated lies solely within the

S e e , however, the case of Cebu Shipyard and Engineering Works, Inc. vs. William Lines, Inc., (306 SCRA 762 [1999]) given under Section 243.

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S e c . l G E N E R A L PROVISIONS 11

former's sound discretion. Since its identity is not of record, it has to claim its right to reimbursement of the amount paid to the insured. (F.F. Cruz & Co., Inc. vs. Court of Appeals, supra.)

(10) Loss of right of subrogation by act of insured or insurer. The right of subrogation has its limitations to wit: (a) both the insurer (of goods covered by a a bill of lading), and the consignee are bound by the contractual stipulations under the bill of lading; and (b) the insurer can be subrogated only to the rights as the insured may have against the wrongdoer. Should the insured, after receiving payment from the insurer, release by his own act the wrongdoer or third party responsible for the loss or damage from liability, the insurer loses his rights against the wrongdoer since the insurer can be subrogated to only such rights as the insured may have. For defeating the insurer's right of subrogation, the insured is under obligation to return to the insurer the amount paid thereby entitling the latter to recover the same. Under Article 2207, the insurer is the real party-in-interest with regard to the portion of the indemnity paid for he is deemed subrogated to the rights of the insured with respect thereto. (Manila Mahogany Manufacturing Corp. vs. Court of Appeals, 154 SCRA 650 [1987]; Pioneer Insurance & Surety Corp. vs. Court of Appeals, 175 SCRA 668 [1989]; Aboitiz Shipping Corp. vs. Insurance Company of South America, supra.)

Similarly, where the insurer pays the insured the value of the lost goods without notifying the carrier who has in good faith settled the claim for loss of the insured, the settlement is binding on both the insured and the insurer, and the latter cannot bring an action against the carrier on his right of subrogation, (see Pan Malayan Insurance Corp. vs. Court of Appeals, supra.)

(11) Effect of assignment by insured of its rights against third party to insurer. Where the insured (shipper/consignee of goods) has assigned its rights against defendant (carrier of goods) for damages caused to the cargo shipped to the insurer which paid the amount represented by the loss, the case is not between the insured and the insurer but one between the shipper and the carrier because the insurance company merely stepped into the shoes of the shipper. And if the shipper has a direct cause of action against the carrier on account of the damage to

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cargo, such action can be asserted or availed of by the insurer as a subrogee of the insured and the carrier cannot set up as a defense any defect in the insurance policy because it is not a privy to it. (Compania Maritima vs. Insurance Co. of North America, 12 SCRA 213 [1964].)

Applicability of the Civil Code. Article 2011 (supra.) of the Civil Code means that if the

Insurance Code does not specifically provide for a particular matter in question, the provisions of the Civil Code regarding contracts shall govern. (Musngi vs. West Coast Life Insurance Co., 61 Phil. 864 [1935].) In other words, insurance contracts are governed primarily by the Insurance Code and subsidiarily, by the Civil Code, (see Art. 18, Civil Code; see also Sec. 422. 7)

Accordingly, our Supreme Court has held that: (1) Where the insurance company's consent to the policy was

vitiated by error (see Arts. 1330 ,1331 , Civil Code.), such fact may give rise to the nullity of the contract (Lucero Vda. de Sindayen vs. Insular Life Assurance Co., 62 Phil. 9 [1935].);

(2) The contract for a life annuity was not perfected where the acceptance of the application by the home office of the insurer (see Art. 1319, par. 2, Civil Code.) never came to the knowledge of the applicant who died (Enriquez vs. Sun Life Assur. Co. of Canada, 41 Phil. 209 [1920].);

(3) An insurance contract is null and void where the consideration is false or fraudulent (see Art. 1353, Civil Code; Musngi vs. West Coast Life Insurance Co., supra.);

(4) Since the Insurance Act (now The Insurance Code) has no provision regarding the amount of recovery in case of rescission (see Sec. 74.), the rule found in the Civil Code which imposes the obligation of mutual restitution (see Art. 1385, Civil Code.) should apply (Filipinas Compania de Seguros vs. Nava, 17 SCRA 210 [1966].);

(5) A common-law wife is disqualified from becoming the beneficiary of the insured in view of the prohibition in Article 2012 in relation to Article 739 of the Civil Code and the absence

U n l e s s otherwise indicated, refers to Section in Insurance Code.


of any specific provision in the Insurance Code on the matter (The Insular Life Assur. Co. vs. Ebrado, 80 SCRA 181 [1977]; see Sees. 10, 53.); and

(6) The award of moral and exemplary damages in case of unreasonable delay in the payment of insurance claims (see Sec. 244.), shall be governed by the rules under the Civil Code. (Ze-nith Insurance Corporation vs. Court of Appeals, 185 SCRA 398 [1990].)

Construction of the Insurance Code. The construction of the Insurance Code means its interpreta-

tion and this is allowed only if its provisions are not clear.

(1) It is a settled rule of statutory construction that when a statute has been adopted from some other state or country and said statute has previously been construed by the courts of such state or country, the statute is usually deemed to have been adopted with the construction so given. (Cerezo vs. Atlantic Gulf & Pacific Co., 33 Phil. 425 [1916].) Thus, it has been held that since Act No. 2727, the former Insurance Act (with the exception of Chapter V [which deals with insurance companies and agents] thereof which was allegedly taken largely from the law of New York), was taken verbatim from the law of California, the courts should follow in fundamental points, at least, the construction placed by California courts on California law. (Ang Giok Chip vs. Springfield Fire & Marine Ins. Co., 58 Phil. 378 [1933].) The present Insurance Code is based principally upon Act No. 2427, as amended.

(2) The rules enunciated by the best considered American authorities involving similar provisions of the Philippine law on insurance should be adopted for the purpose of having our law on insurance conform as nearly as possible to the modern law of insurance as found in the United States proper. (Gercio vs. Sun Life Assur. Co., 48 Phil. 53 [1925]; Constantino vs. Asia Life Ins. Co., 87 Phil. 248 [1950].)

Sec. 2. Wherever used in this Code, the following terms shall have the respective meanings hereinafter set forth or indicated, unless the context otherwise requires:


(1) A "contract of insurance" is an agreement whereby one undertakes for a consideration to indemnify another against loss, damage or liability arising from an unknown or contingent event.

A contract of suretyship shall be deemed to be an in-surance contract, within the meaning of this Code, only if made by a surety who or which, as such, is doing an insur-ance business as hereinafter provided.

(2) The term "doing an insurance business" or "trans-acting an insurance business," within the meaning of this Code, shall include: (a) making or proposing to make, as insurer, any insurance contract; (b) making or proposing to make, as surety, any contract of suretyship as a voca-tion and not as merely incidental to any other legitimate business or activity of the surety; (c) doing any kind of business, including a reinsurance business, specifically recognized as constituting the doing of an insurance busi-ness within the meaning of this Code; (d) doing or propos-ing to do any business in substance equivalent to any of the foregoing in a manner designed to evade the provi-sions of this Code.

In the application of the provisions of this Code the fact that no profit is derived from the making of insurance contracts, agreements or transactions or that no separate or direct consideration is received therefor, shall not be deemed conclusive to show that the making thereof does not constitute the doing or transacting of an insurance business.

(3) As used in this Code, the term "Commissioner" means the "Insurance Commissioner." (a)*

Legal concept of insurance. (1) Insurance is a type of contract. Section 2 contains the

statutory definition of the contract of insurance and the acts any of which will constitute "doing an insurance business" or "transacting an insurance business."

The term "assurance" is also used instead of "insurance" although the former is seldom employed. Many modern writers

*Signifies that former provision in Insurance Act (Act No. 2427.) has been amended.


use "assurance" instead of "insurance" to describe the life insurance business, the former referring to an event like death, which must happen, and the latter, to a contingent event which may or may not occur. As used in the Code, the term "insurance" covers "assurance."

The definition of the law is subject to criticism. For instance, it does not include life insurance which is a contract upon condition rather than to indemnify for no recovery can fully repay a beneficiary for loss of life which is beyond pecuniary value, (see Chap. II, Title 5.)

(2) A better definition would be that, a contract of insurance is an agreement by which one party (insurer) for a consideration (premium) paid by the other party (insured), promises to pay money or its equivalent or to do some act valuable to the latter (or his nominee), upon the happening of a loss, damage, liability, or disability arising from an unknown or contingent event, (see Vance, op. cit., p. 83.)

In general, an insurance contract is a promise by one person to pay another, money or any other thing of value upon the happening of a fortuitous event beyond the effective control of either party in which the promisee has an interest apart from the contract. (Edwin W. Patterson, Essentials of Insurance Law, p. 10, 1957 Ed., published by McGraw-Hill Book Co., Inc.) In insurance, the insurer, for a stipulated consideration, undertakes to compensate the insured for a future loss, damage or liability on a specified subject caused by a specified event or peril. (Sec. 3[g].) A written insurance contract is called a policy, (see Sec. 49.)

Definition of insurance from other viewpoints. A definition of insurance may be made from several view-

points: (1) Economic. In this sense, insurance is a method which

reduces risk by a transfer and combination (or "pooling") of un-certainty in regard to financial loss;

(2) Business. As a business institution, it has been defined as a plan by which large numbers of people associate themselves


and transfer to the shoulders of all, risks that attach to individuals. Insurance may also be looked upon as an important part of the financial world, where insurance serves as a basis for credit and a mechanism for savings and investments;

(3) Mathematical. In this sense, insurance is the application of certain actuarial (insurance mathematics) principles (see David L. Bickelhaupt, General Insurance, 1974 Ed., pp. 29-31, published by Richard D. Irwin, Inc., Homewood, Illinois, 60430.) to calculate the chance of loss, (see Note 10.) Thus, in life insurance, the principles of probability are applied to statistical results of past experience represented by a mortality table. By way of illustration, suppose the mortality table shows that out of 10,000 lives, on the average, 10 die per year, the probability of death is, therefore, 1 / 1 0 0 0 or 0.001; and

(4) Social. In this sense, insurance has been defined as a social device whereby the uncertain risks of individuals may be combined in a group and thus made more certain, with small periodic contributions by the individuals providing a fund out of which those who suffer losses may be reimbursed. (Robert Riegel, Jerome S. Miller, and C. Arthur Williams, Jr., Insurance Principles and Practices, p. 15, 1976 ed., published by Prentice-Hall, Inc., Englewood Cliffs, New Jersey.) In other words, it is a plan by which the losses of the few are paid out of the contributions of all members of a group.

Determination of the existence of the contract. (1) Nature of the contract. The character of insurance is

to be determined by the exact nature of the contract actually entered into whatever the form it takes or by whatever name it may be called. Thus, it was held that an agreement entered into by a corporation, even though it was called a surety company, to indemnify for a valuable consideration another against loss by reason of uncollectible debts, was a contract of insurance and not a contract of guaranty. (Tebbets vs. Guarantee Co., 73 F. 95.)

Under the Code, a contract of suretyship shall be deemed an insurance contract "if made by a surety who or which as such, is doing an insurance business," within the meaning of the Code.

S e c 2 G E N E R A L PROVISIONS 17

But strictly speaking, a contract of suretyship is entirely different from a contract of insurance, (see Chap. 11, Title 4; also Sees. 185, 200[2, b, d].)

(2) Elements of the contract. In determining the existence of a contract of insurance, it is important to consider the following:

(a) Subject matter. This refers to the thing insured. In fire insurance and in marine insurance, the thing insured is property; in life, health or accident insurance, it is the life or health of the person that is the subject of the contract; in casualty insurance, it is the insured's risk of loss or liability; and

(b) Consideration. The consideration for an insurance contract is the premium paid by the insured, (see Sec. 77.) Its amount is principally based on the probability of loss and extent of liability for which the insurer may become liable under the contract.

(c) Object and purpose. Basically, a contract of insurance is a risk-bearing contract. The principal object and purpose of insurance is the transfer and distribution of risk of loss, damage, or liability arising from an unknown or contingent event through the payment of a consideration by the insured to the insurer under a legally binding contract to reimburse the insured for losses suffered on the happening of the stipulated event.

Nature and characteristics of an insurance contract. Broadly speaking, a contract of insurance has the following

characteristics: (1) It is consensual because it is perfected by the meeting of

the minds of the parties, (see Art. 1319, Civil Code.) So, if an application for insurance has not been either accepted or rejected, there is no contract as yet. (see Sees. 49-50.)

(2) It is voluntary in the sense that it is not compulsory and the parties may incorporate such terms and conditions as they may deem convenient (see Art. 1306, ibid.) which will be binding (see Art. 1308, ibid.) provided they do not contravene any provision


of law and are not opposed to public policy, (see Art. 1306, ibid.) It is governed by the rules which govern other contracts.

(a) Although the contract of insurance is generally a voluntary contact, the carrying of insurance, particularly liability insurance, may be required by law in certain instances such as for motor vehicles (Sees. 373-389.), or employees (Arts. 168-184, Labor Code.), or as a condition to granting a license to conduct a business or calling affecting the public safety or welfare. (43 Am. Jur. 2d. 64.)

(b) An insurance may arise by operation of law. By way of example, the War Damage Corporation Act (Sec. 5[g], Public Law 506, 77th Congress of the U.S.) may be given. It provides for the payment of compensation 8 "by the War Damage Corporation without requiring a contract of insurance or the payment of premium or other charge x x x as if a policy x x x was in fact in force at the time of the loss or damage." Section 5(g), according to the Supreme Court, "leaves no room for doubt about the intent of the Congress of the United States to establish, between the War Damage Corporation and the owner of the property, lost or damaged, a relation identical to that existing between the insurer and the insured under a contract of insurance/' (Comm. of Internal Revenue vs. Asturias Sugar Central, Inc., 2 SCRA 1140 [1961].)

Social insurance (infra.) for members of the Government Service Insurance System and for employees of the private sector covered by the Social Security System (supra.) is also established by law.

(3) It is aleatory in the sense that it depends upon some contingent event. But it is not a contract of chance (see Sec. 4.) although the event against the occurrence of which it is intended to provide may never occur. 9 "By an aleatory contract, one of the

8 In the Philippines, the payment of loss or damage to property during the war, re-sulting from enemy attack or in the furtherance of the resistance movement, was m a d e through the Philippine War Damage Commission.

9 This basic feature distinguishes an insurance contract from other contracts (called commutative) that are presumed to represent even exchanges. The buyer of groceries or clothing or a television set pays about what the goods are worth, and he gets immediate delivery of them, so that he is ordinarily able to tell right away whether he is getting his


parties or both reciprocally bind themselves to give or to do something in consideration of what the other shall give or do upon the happening of an event which is uncertain, or which is to occur at an indeterminate time/' (Art. 2010, Civil Code.)

In insurance, each party must take a risk; the insurer, that of being compelled upon the happening of the contingency, to pay the entire sum agreed upon and the insured, that of parting with the amount required as premium without receiving anything therefor in case the contingency does not happen except what is ordinarily termed "protection" which is itself is a valuable consideration. (Vance, op. ext., p. 93.)

(4) It is executed as to the insured after the payment of the premium, and executory on the part of the insurer in the sense that it is not executed until payment for a loss. In other words, it is a unilateral contract imposing legal duties only on the insurer who promises to indemnify in case of loss.

The contract contemplates the payment of the premium as condition precedent to the inception of the contract but the insured usually assumes no duty to pay subsequent premiums enforceable at the suit of the insurer unless the latter has continued the insurance after maturity of the premium, in consideration of the insured's express or implied promise to pay. But he has a right to pay the stipulated premium and the insurer is under a duty to accept the payment when tendered. Of course, the insurer may not be liable if the insured fails to pay the premiums. In such a case, the insurance usually lapses, (see ibid., pp. 94, 300.)

(5) It is conditional because it is subject to conditions the principal one of which is the happening of the event insured against. In addition to this main condition, the contract usually includes many other conditions (such as payment of premium or performance of some other act) which must be complied with as precedent to the right of the insured to claim benefit under it.

money's worth, (see E.W. Patterson, op. cit., pp. 2-3.) Insurance contracts, however, are aleatory in nature which means that they may involve the exchange of widely varying values for it is of the essence of insurance that no one knows how the risk insured against will happen. Thus, an insurer may be liable to pay the full amount insured under life policies of which only very few premiums have been paid.


(6) It is a contract of indemnity (except life and accident insurance where the result is death) because the promise of the insurer is to make good only the loss of the insured, (see Sec. 18.) Any contract that contemplates a possible gain to the insured by the happening of the event upon which the liability of the insurer becomes fixed is contrary to the proper nature of insurance. Hence, no person may secure insurance upon property in which he has no interest. (Vance, op. cit., p. 101.)

If the insured has no insurable interest, the contract is void and unenforceable (see Sees. 18-19.) as being contrary to public policy because it affords a temptation to the insured to wish or bring about the happening of the loss.

(7) It is a personal contract, each party having in view the character, credit and conduct of the other. (Vance, op. cit., p. 96.)

(a) As a rule, the insured cannot assign, before the happening of the loss, his rights under a property policy to others without the consent of the insurer, (see Sec. 83.) Consequently, the obligation of the insurer to pay does not attach to or run with the property whether it be real property or personal.

It follows that if a person whose property is insured sells it to another, the buyer cannot be his successor in the contract of insurance unless, of course, the sale is with the consent of the insurer or unless by express stipulation of the parties, the contract is made to run with the property to the transferee, (see Sees. 20, 57, 58.) Thus, where the insurance is "on account of the owner," or "for whom it may concern," or where "the loss is payable to bearer," the subsequent transferees or owners become by the terms of the contract, the real parties to the contract of insurance. Such contracts, by which the insurance is made to pass from owner to owner, are of the nature of successive novations, (see Art. 1292, Civil Code.)

(b) Regardless of how they are categorized {infra.), all insurance contracts share a common trait of "personalness."

1) The category of personal insurance, which in-cludes life, health, accident, and disability insurance, is


plainly "personal": the insurance applies only to a particu-lar individual, and it is not possible, for example, for the insured unilaterally declaring that his health insurance policy shall now be deemed to cover the health of some-one else.

2) Liability insurance is also personal in the same sense: each person purchases coverage for his own (or a group of related persons) potential liability to others. The insurer prices the coverage depending on the characteristics and traits of the particular insured.

3) Property insurance is also "personal' in this limited sense. The insurance is on the insured's interest in the property, not on the property itself. It is the damage to the personal interest not the property that is being reimbursed under a policy of property insurance (R.H. Jerry, II, Understanding Insurance Law, pp. 265-266,1987 ed., published by Mathew Bender & Co., Inc., New York.) (c) Life insurance policies, however, are generally

assignable or transferable (see Sec. 181.) as they are in the nature of property and do not represent a personal agreement between insured and insurer.

(8) Since an insurance is a contract, as such, it is property in legal contemplation. But unlike property policies, life insurance policies are generally assignable or transferable like any "chose in action." (see Sec. 181.) They are in the nature of property and do not represent a personal agreement between the insurer and the insured.

Distinguishing elements of the contract of insurance. The contract of insurance made between the parties usually

called the insured and the insurer, is distinguished by the presence of five elements, namely:

(1) The insured possesses an interest of some kind susceptible of pecuniary estimation, known as "insurable interest";

(2) The insured is subject to a risk of loss through the destruction or impairment of that interest by the happening of designated perils;


(3) The insurer assumes that risk of loss;10

(4) Such assumption of risk is part of a general scheme to distribute actual losses among a large group or substantial number of persons bearing a similar risk; and

(5) As consideration for the insurer's promise, the insured makes a ratable contribution called "premium," to a general insurance fund, (see Vance, op. cit.t pp. 1-2.)

All the elements must be present, otherwise there can be no contract of insurance, and even if the contract contains all the elements, it is not an insurance contract within the context of the Insurance Code if the primary purpose of the parties is the rendering of service and not the indemnification of a party for loss, damage, or liability incurred by the latter.

Insurance, a risk-distributing device. A contract possessing only the first three elements named

above is a risk-shifting device, but not a contract of insurance which is fundamentally a risk-distributing {risk-sharing or risk-policy) device. Thus, in a contract of guaranty, an interest possessed by the creditor (which is the payment of the debt) is exposed to impairment by the happening of contingent events such as the insolvency of the principal debtor, and the risk of the creditor is merely assumed by the guarantor.

(1) Equitably distributes losses out of a general fund contributed by all. The device of insurance serves to distribute the risk of

1 0 The insurance company, however, by using the science of probability and the law of large numbers (sometimes referred to as the law of averages or the law of probabilities can predict with considerable accuracy the number of insureds to similar risks w h o will incur losses during a specified period and the extent of such losses. As a result, the amounts of premium can be calculated such that the income therefrom should be just enough to meet expected losses incurred by that group, together with expenses, taxes and a reason-able profit but low enough to make the insurance saleable. Thus, the risk assumed by the insurance company is reduced to a minimum.

The probability that the prediction of total losses will not be thrown off by an un-expected number of losses, increases as the number of similar insurance policies issued increases. In other words, when the number of similar independent risks is increased, the relative accuracy of predictions about future losses is also increased. It is impossible to predict individual losses but the insurer can predict certain "averages" when a large number of similar policies are considered. If the number of policies sold does not reach the safe point, the insurance company can reinsure its risks with another.


economic loss among as many as possible of those who are subject to the same kind of risk. By paying a pre-determined amount (premium) into a general fund out of which payment will be made for an economic loss of a defined type, each member contributes to a small degree toward compensation for losses suffered by any member of the group.

(2) Provides protection against absorbing one's losses alone. The member has no way of knowing in advance whether he will receive compensation more than he contributes or whether he will merely be paying for the losses of others in the group; but his primary goal is to exchange the gamble of doing it alone, whereby he could either escape all losses whatsoever or, suffer a loss that might be devastating, for the opportunity to pay a fixed and certain amount into the fund, knowing that the amount is the maximum he will lose on account of the particular type of risk insured against. 1 1 This broad sharing of economic risk is the principle of risk-distribution. (J.F. Dobbyn, Insurance Law in a Nutshell, 1989 ed., published by West Publishing Co., St. Paul, Minn.)

All contracts, either expressly or implicitly, transfer risk in one way or another. If a contract possesses the five elements mentioned, principally, the allocation or pooling of risks, it is a contract of insurance, whatever be its name or form, as distinguished from contracts that transfer risk but do not constitute insurance.

EXAMPLE: If the parties agree that A will purchase B's house on a

condition that A is able to obtain financing, B bears the risk that financing will be available to A. If financing is unavailable to A, A has no duty to buy the house. In the absence of such a condition, A bears the risk that financing will not be available, because A would still be obligated to buy the house even if he does not obtain financing.

"To ensure payment for whatever losses that may occur due to the exposure to the peril insured against, the law mandates all insurance companies to maintain a legal reserve fund in favor of those claiming under their policies, (see Sees. 210-214.)


Although conditioning As duty to purchase the house upon the availability of suitable financing transfers risk from A to B, this does not mean that the contract between A and B is a contract of insurance. Insurance contracts have additional characteristics.

In the illustration under No. (3), in discussing "the value of transferring risk" (infra.) concerning the contract between X and Y, the contract not only transferred but also distributed risk. When Y assumed X's risk of loss as well as the risk of 99 other persons, Y was able to distribute the risk across a large group of persons possessing similar risks. The characteristic of risk distribution sets insurance contracts apart from other kinds of contracts.

It can be said, then, that a contract of insurance is an agreement in which one party (the insurer), in exchange for a consideration provided by the other party (the insured), assumes the other party's risk and distributes it across a group of similarly situated persons, each of whose risk has been assumed in a similar transaction. (R.H. Jerry, II, op. cit., p. 15.) By way of insurance, existing risks are distributed so that the losses resulting from them do not fall on one person or a small group of persons.

Coping with risk. 2

The inherent uncertainty of events can be described in terms of chance or probability. In insurance, the uncertainty is normally described in terms of risk. People make judgments about risk everyday. A person usually makes some sort of calculation, perhaps instinctively, before deciding to engage or not to engage in an activity.

People cope with risk in various ways.

(1) Limiting the probability of loss. One way to attempt to manage risk is to limit the probability of loss. For example, many industries utilize complex, dangerous machinery, which place the employees who use them at some risk. However, the probability that an employee will lose a finger or hand in a cutting machine is reduced if guards or other safety devices are used around the cutting device. Similarly, concrete buildings are less likely to

1 2 F o r additional discussion, see annotation under Section 51.


catch fire than wood buildings. Thus, a builder might choose to use masonry rather than wood in a given structure or install loss prevention devices (e.g., firewalls, sprinkler systems) so as to limit the probability of loss.

(2) Limiting effects of loss. Another way to cope with risk is to limit the effects of loss. For example, passengers in automobiles are at risk of injury through accidents. If an accident occurs and the passenger is wearing a seat belt, the passenger is less likely to suffer injury; if an injury is suffered, it is likely to be less severe. Thus, to limit the effects of an accident should it occur, many people choose to "buckle up," thereby limiting the effects of loss. Similarly, buildings are subject to a risk of fire, regardless of the construction materials used. To limit the effects of a fire should it occur, many building owners install sprinkler systems. A sprinkler system will not prevent a fire, but it will limit the effect of a fire should one occur.

Diversification is a particularly important way of limiting the effects of loss. For example, individuals who invest in the stock market expect to make money, but they are also at risk of losing money. To minimize the risk that a sharp decline in the value of one stock will decimate the investor's assets, most investors own a wide variety of the stocks. Through this strategy, losses in one stock are much more likely to be offset by profits in other stocks; if fortunate, the investor will show a net profit from the total portfolio. Of course, diversification also limits the chance, or / / r i sk / , that the investor will benefit from a sharp increase in the value of one stock. 1 3

(3) Self-insurance. Sometimes people cope with risk through self-insurance. For example, a restaurant owner, cognizant of the possibility that a patron may contract food poisoning, is likely to take substantial preventive measures to limit the risk of such an occurrence. After taking such steps, a remote risk nonetheless exists that a customer might be poisoned. The owner may calculate that such an event will rarely occur and may conclude

1 3 The two above methods of minimizing risks through preventive measures to protect the personal and financial interests of individuals and business or at least to reduce loss involve the practice of "risk management."Transferring certain risks from the insured to the insurance company is the most common method of risk management.


that if it does occur, the damages associated with the event could easily be paid from the owner's assets. Alternatively, the owner may choose to set aside a portion of each year's profits into a special or reserve fund designated to pay the loss should it occur.

In either case, the owner chooses to bear or assumes the risk himself thru special funds set aside to cover the loss. This is, in effect, self-insurance or self-financing.

(4) Ignoring risk. Sometimes, after weighing potential ben-efits and costs of a particular activity, and after taking appropri-ate steps, if any, to minimize the probability or extent of loss, the individual may choose to engage in the activity without do-ing anything further with regard to the risk. Thus, some people choose to ignore risk.

For example, the tightrope walker may purchase special shoes to reduce the risk of falling and may install a safety net to minimize the amount of loss should a fall occur, but if the performer proceeds with the walk, the performer has decided both to assume the risk that remains and to bear the costs of loss should the injury materialize. The performer is not self-insuring, because the performer has no assets to compensate for his loss of life, which is one of the risks. Rather, the performer is choosing to ignore the risk.

(5) Transferring risk to another. In situations where risk cannot be managed sufficiently through preventive measures or through steps that reduce the effects of loss, and where assumption of the risk is not feasible, people usually cope with risk by transferring it to someone else (see H. Jenny, III, op. cit., pp. 10-11.) by a contractual arrangement. An example of such an arrangement is a seller's warranty of goods sold. Also, a person may, by entering into a contract of insurance, relieve himself, at least in part, from the risk of loss which under the law must be borne by him, i.e., by buying insurance. This approach to coping with risk is discussed in the next topic.

The value of transferring risk. An individual's attitude toward risk is influenced by several

factors, including the probability of loss, the potential magnitude of the loss, and the person's ability to absorb the loss.


With respect to loss, people are either risk preferring, risk neutral, or risk averse. Imagine forcing several individuals to choose between a 50% chance of losing P1,000 (which computes to an "expected loss" of P500) 1 4 or a certainty of losing P500.

(1) Some people are risk preferring. These people would choose to forego the certain loss in the hope of incurring no loss, despite the equal probability of suffering a large loss.

(2) In the same situation, many people are risk neutral, that is, indifferent to the alternatives.

(3) A substantial group of people are risk averse. This group would choose to lose P500 with certainty instead of confronting the 50% chance of losing twice as much.

(a) As the potential magnitude of loss increases, most people become more risk averse. 1 5 This is true even though the probability of loss declines.

EXAMPLE: When confronted with a one in 10,000 chance of losing

P10,000 (an expected loss of PI) and the prospect of losing PI with certainty, many people previously indifferent would prefer to lose PI with certainty to avoid the possibility, albeit a remote one, of suffering a substantial loss.

The more wealth a person has, the less likely it is that the person will be averse to risk: a multimillionaire is more likely to be indifferent toward the choice of losing PI with certainty and confronting the one-in-10,000 chance of losing P10,000.16

1 4 A n "expected loss" is the magnitude of the loss, should it materialize, times the probability that it will occur. Thus, if someone has a one in two chances of losing P500, the expected loss is P250. If the chance of losing P500 is one in ten, the expected loss is P50. (ibid., p. 11.)

1 5 This discussion assumes rational behavior. Sometimes people behave irrationally and ignore risk, e.g., Ray vs. Federated Guaranty Life Ins. Co., 381 So. 2d 847 (La. App. 1980), where the insured, insane and under delusion that he possessed supernatural powers, held his head under water in bathtub and drowned, (ibid., p. 11.)

1 6 With respect to moderate beneficial risks, many people are risk preferring. For ex-ample, lotteries operated by state governments have been successful because large num-bers of people prefer moderate amounts of risk: when faced with the choice of retaining one dollar in the pocket and exchanging that dollar for a one-in-a-million chance of win-ning several thousand dollars, many people are willing to trade the dollar for the small chance of winning the large prize. However, when faced with the prospect of receiving


(b) When people are averse to the risk of a loss, they are usually willing to pay someone else to assume the risk.

EXAMPLE: Assume that X has a one-in-100 chance of suffering a loss

of P1,000 (an expected loss of P10). Since X is risk averse, X is willing to pay P15 to someone else, Y, in exchange for Y's promise to reimburse X for X's loss, should X incur it.

In other words, the value to X of having the risk assumed by someone else is P15. If 99 people similarly situated to X reach the same agreement with Y, Y will receive Pl,500 (100 times P15), and Y will have to pay one person the sum of P1,000 (since if 100 people each have a one-in-100 chance of suffering the loss, the probabilities indicate that one person probably will suffer the loss).

Y earns a profit of P500, which increases Y's satisfaction. Also, the satisfaction of X and each of the 99 similarly situated people is enhanced, because each of them transfers to someone else, the risk to which they were averse.

In this illustration, X and the others entered into agreements with Y to transfer risk for a price. X and the others are the insured and Y is the insurer; each of the 100 insured entered into an insurance contract with Y. A market existed in which X and Y could meet, and in which X could transfer and Y could assume risk for a price. X placed a value on having the risk transferred, and X received this value when Y assumed the risk.

Also, Y benefited by assuming the risk of many people similarly situated to X and by pooling these risks together, so that each individual's risk could be distributed across the pool. The P15 which Y charged X is the insurance premium. Based on the loss experience of the pool and statistical probabilities, Y knew that collecting P15 from each insured very likely would be adequate to cover the losses of all the insureds, plus provide Y a reasonable return for putting itself at risk.

An insurance contract has a variety of economic impli-cations, a few of which are discussed subsequently, (ibid., pp. 11-12.)

P500 with certainty and a 50% chance of receiving P1,000, many people would be indiffer-ent, and many others would be risk averse, in that they would prefer P 5 0 0 with certainty rather than face a 50% chance of getting nothing, (ibid., p. 12.)


Economic effects of the transfer and distribution of risk.

(1) Benefit to society as a whole. The illustration above demonstrates several aspects of the economic impact of a contract of insurance. Most obviously, X completely eliminated his risk by transferring it to Y for a price. This transfer has value for X, since X desired to be free of the risk and this objective was achieved. Moreover, the transaction had value to Y, since Y, by dealing in risk on a large scale, could earn a profit.

If the costs and benefits of the transaction are viewed in this way, it can be said that since the satisfaction of both parties was improved, the transaction was a desirable one; indeed, society as a whole would be better off if a large number of similar, mutually beneficial transactions would occur.

(2) Undesirable side effects. However, total elimination of risk can have undesirable side effects. If X's risk is completely eliminated through transfer to Y, X might have less incentive to take measures that prevent the loss from occurring or minimize the effect of loss once it occurs. Thus, if Y agrees to reimburse X for damage to or loss of X's personal property, X is likely to have a reduced incentive to take steps to protect his property.

Consequently, the existence of insurance could have the per-verse effect of increasing the probability of loss. For example, if a mechanic knows that in the event his tools are stolen the insurer will reimburse his loss in full, the mechanic may be less likely to suffer the inconvenience of putting his tools in a locked storage area at the end of each working day. This phenomenon is called moral hazard.

(3) Problem regarding measurement of amount of risk transferred. The theoretically ideal response to the problem of moral hazard would be for the insurer to monitor the insured's behavior and adjust the premium based on the extent to which the insured takes adequate steps to safeguard his property. If such measurements were possible, the insurance would be priced in exact conformity with the amount of risk being transferred to the insurer.

For obvious reasons, however, monitoring the behavior of each insured is not feasible. Even if the prospect of having a third


party constantly inquiring into one's behavior were acceptable, the administrative costs of such a system would be prohibitive.

(4) Sharing by insured of some responsibility for the risk. To deal with the moral hazard phenomenon in most insurance transactions, the insured retains some responsibility for the risk through either a deductible or coinsurance. With a deductible, the insured bears any loss up to some stated amount with the insurer bearing the rest. With coinsurance, the insured bears some stated percentage of the loss regardless of its amount, with the insurer bearing the rest. Thus, in the foregoing example, the insured has an incentive to preserve his property, since the insured will bear some portion of any loss to himself.

Requiring the insured to bear a portion of the loss is not a totally satisfactory solution for the risk averse person. On balance, however, that solution is the best one. To compensate for the moral hazard phenomenon, premiums would have to be much higher if all of the insured's risks were transferred; the insured benefits in the long run by paying lower premiums while simultaneously taking some measures that prevent loss or limit its effects.

(5) Problem regarding computation of premium to be charged. Another economic effect of an insurance contract devolves from practical limitations inherent in the process by which the fee charged the insured is computed. The amount of the fee, or premium, should equal the insured's expected loss (e.g., a one-in-five probability of losing P100 computes to an expected loss of P20) plus a pro rata share of the insurer's administrative costs. 1 7

However, because life is uncertain, calculating each person's expected loss with absolute precision is impossible. Indeed, the expenses involved in calculating each person's expected loss would be enormous; to cover these administrative costs, premiums would be exorbitant. Moreover, if such predictions were possible on an individual basis, insurance would not be necessary, since each person would know when loss would occur

1 7 In the case of stock company (ibid., pp. 12-14.), the insurer's administrative costs should include an allowance for a reasonable profit.


and then would take all necessary preventive measures, thereby eliminating the value of transferring risk.

(6) Classification of risks. Because of the complete impracti-cality of individual rating, insurers group similar risks together and charge each member of the group the same premium. Insur-ers will subdivide the insureds into distinct groups as long as the cost of measuring the differentiating factor is less than the premium reduction the insurer can offer members of a differenti-ated, better-risk group.

EXAMPLE: Assume that smokers on the average have a shorter life

span than non-smokers. This distinction could be the basis for an insurer offering non-smokers lower cost life insurance than smokers.

However, making the distinction will involve some admi-nistrative and investigative costs. Some of these costs will result from attempting to control factors that will tend to make the smoker/non-smoker distinction inaccurate, such as problems with the trustworthiness of the data (applicants who know they can secure a lower premium will have a tendency to understate their smoking habits), the uncertainty over whether a person who has quit smoking has a different life expectancy than either a non-smoker or a presently-active smoker, and the possible differential impact of different amounts of daily smoking.

If the cost of accurately distinguishing smokers from nonsmokers exceeds the premium reduction that could be offered to non-smokers, insurers will not make the distinction, since the insurer is likely to lose more smoking customers to insurers who do not make the distinction than the insurer who will gain in new non-smoking customers.

(7) Sub-classification of risks. At a certain point in any risk classification scheme, further subdivision of the group becomes too expensive relative to the benefits gained. Thus, it is inevitable that within the same group, some insureds will be better risks than others, even though all members of the group pay the same premium. In fact, any group will have a higher proportion of less desirable risks, since more applications for the insurance


will tend to come from those who get a better bargain. This phenomenon is called adverse selection.

Insurers and regulators must take into account the existence of adverse selection when deciding upon the scope of coverage and the premiums to be charged for the coverage, (ibid., pp. 12-14.)

The fields of insurance. (1) In general. The basic classification emphasizes the

difference between social (government) and voluntary (private) insurance. Voluntary insurance includes the major category of commercial insurance, which is divided into personal (life and health) and property types of protection, and traditionally in property insurance, the major groupings of fire-marine and casualty-surety insurance are important.

With recent trends toward broader insurance operations and contracts, the terms "multiple line insurance" and "all lines insurance" have become important. The first term has been accepted to denote not just several kinds of insurance but the combination of at least two kinds of insurance, specifically the traditional fire and casualty lines. The second is not used in a technical sense, for few insurers or contracts do include every possible kind of insurance. The term is used rather to describe the broadening nature of insurance operations which combine at least most of the basic types of insurance including the traditional fire, casualty, life, and health lines, (see note 14.)

(2) Social (government) insurance. It is compulsory and is designed to provide a minimum of economic security for large groups of persons, particularly those in the lower income groups. It concerns itself primarily with the unfavorable losses (income and costs) resulting from the perils of accidental injury, sickness, old age, unemployment, and the premature death of the family earner. The concept here is limited to that insurance which are required by the government and have for their object the provision of a minimum standard of living.

The compulsion element is predicated upon the experience that some persons cannot or will not voluntarily purchase


insurance, and the obligation of the government to protect the general welfare of its citizens.

(3) Voluntary (private) insurance." It is not based upon government compulsion and is sought by the insured to meet a recognized need for protection. It divides itself into three (3) groups:

(a) Commercial insurance. This is what persons usually have in mind when they refer to the insurance business. In contrast to cooperative plans, it receives its motivating force from the profit idea. Two major classifications are parts of commercial insurance:

1) Personal insurance.19 This division is based on the nature of the perils; that is, whether they are more directly concerned with losses due to loss of earning power of a person. Life insurance, including annuities, and health and accident insurance are important parts of the personal category of commercial insurance; and

2) Property insurance. In this category is included every form that has for its purpose the protection against loss arising from the ownership or use of property. There are two general classifications of property insurance. The first indemnifies the insured in the event of loss growing out of damages to, or destruction of his own property. The second form pays damages for which the insured is legally liable, the consequence of negligent acts that result in injuries to other persons or damage to their property. Included in the first classification are fire and marine insurance, and in the second are casualty and surety insurance.

(b) Cooperative insurance. The term "cooperative" is applied to associations usually operating under hospital, medical, fraternal, employee, or trade-union auspices. The associations are organized without regard to the profit

1 8 F o r differences between social insurance and private insurance, see annotation un-der Section 228.

1 9 Another classification of all kinds of insurance might contrast "individual or fam-ily" versus "business" insurance depending on the nature of the purchases (family as opposed to business firm purchases). (D.L. Bickelhaupt, op. ext., p. 69.)


motive and represent, in fact, an effort to accomplish the ends of social insurance by private enterprise. Here, the non-profit cooperative objective of the insurance is emphasized; and

(c) Voluntary government insurance. This category is principally distinguished from social insurance in that there is no element of compulsion. The various plans offered are designed to benefit the entire community but are used only by those persons who wish to use the available benefits. In the category are to be found such plans as the insurance of mortgage loans and insurance of growing crops, (see D.L. Bickelhaupt, op. cit.f pp. 66-74.)

Classifications of contracts of insurance. The principal and older forms of insurance are marine (see

Sec. 99.), fire (see Sec. 167.), life (see Sec. 179.) and accident, (see Sec. 180.) Their rapid growth and successful conduct have in recent years stimulated the attempts to apply the principles of insurance to contracts of indemnity for numerous other kinds of loss. These attempts have resulted in a wide extension of insurance to almost all the innumerable varying risks to which the interests of the members of a society are subject under m o d e m economic and industrial conditions. 2 0

The different kinds of insurance contracts written at the present time vary infinitely in name and form but for convenience they may be grouped under three great heads as follows:

(1) Insurance against loss or impairment of property interests, which may be either in existence or merely expected; that is, present rights or profits yet to accrue. The loss or impairment may be due to marine perils (called marine insurance), fire (called

^Historically, insurers undertook to issue insurance only in one of the distinct cate-gories of risk. This was not entirely a voluntary choice, as statutes in most states confined insurers to writing insurance in only one line. Over time, however, those restrictions were removed, and many insurers commenced what was called multiple line underwriting, meaning the writing of insurance in all lines except life. Eventually, these insurers were allowed to add the insurance to their lines, resulting in what was known as all line un-derwriting. Today, with the practice of the multiple-line and all-line underwriting, the prospective insured can often deal with one company and one agent to meet all his insur-ance needs. (R.H. Jerry, II, op. cit., p. 33.)


fire insurance), earthquake, explosion, etc. or due to the non-performance of contracts of which the insured is a party (known as guaranty insurance); or the insolvency of debtors (called credit insurance); or defalcations of employees and agents (termed fidelity insurance); or theft and burglary (so there are written theft insurance policies); or defective titles or interest in property (called title insurance);

(2) Insurance against loss of earning power due to death {life insurance), accidental injury, ill-health, sickness, old age or other disability, or even unemployment; and

(3) Insurance against contingent liability to make payment to another, that is to say, the insured is protected against his loss with regard to claims for damages. Thus, we have reinsurance (see Sec. 95.), workmen's compensation insurance and motor vehicle liability insurance, all of which are designed to reimburse the insured for any liability he might incur to a third party, (see Sec. 174; also Sec. 99[2]; see Vance, op. cit., pp. 51-55.)

A modernized classification scheme recognizes four (4) categories of insurance, namely: marine, property, personal, and liability. Property insurance is designed to indemnify the insured for loss to his property interests while personal insurance is intended to protect his personal interests. Insurance contracts are also divided into two large classes: property insurance (Nos. 1 and 3) and personal insurance (No. 2).

Classification by interests protected. Another way to classify insurance is to categorize the

subject matter according to the interests being protected by the arrangement. At least two such methods of categorization exist: the third-party/first-party distinction, and the all-risk/specified-risk distinction.

(1) First-party versus third-party insurance. In first-party insurance, the contract between the insurer and the insured is designed to indemnify the insured (or other insureds such as family members) for a loss suffered directly by the insured.

(a) Property insurance, is first-party insurance; the dam-age to the property is an immediate, direct diminution of the


insured's assets. The proceeds are paid to the insured to re-dress the insured's loss.

(b) Liability insurance, on the other hand, is sometimes described as third-party insurance because the interests pro-tected by the contract are ultimately those of third parties injured by the insured's conduct. Thus, if the insured negli-gently causes injury to a third party, the third party will pos-sess a claim against the insured. If this claim is reduced to a judgment, the insured will suffer a loss.

The insured's loss, however, is "indirect" in the sense that the third party suffers the "direct" loss. The liability insurer will reimburse the insured for any liability the insured may have to the third party, but in the event of payment, the insured merely serves as a conduit for transmission of the proceeds from the insurer to the third party. Thus, it is sometimes said that liability insurance is actually designed to protect unknown third parties.

(c) All insurance except liability can be fairly thought of as first-party insurance.

(d) In life insurance, the insured ordinarily designates a beneficiary to receive the proceeds of the policy, but this does not mean that the insurance is third-party. The loss is suffered by the insured; it is the insured who loses his life. Unless the owner of the policy chooses to create third-party rights in a beneficiary, it is the insured's estate that receives the proceeds.

(e) Health insurance is also uneasily categorized under this framework. Frequently, the health insurer pays the provider of health care services {e.g., the hospital or doctor) directly, rather than paying the proceeds to the insured. But the loss the illness and its expenses is suffered directly by the insured. The health care provider suffers a "loss" in a sense when it provides medical care, but the insurance is designed, first and foremost, not to help health care providers but to help individuals who incur medical bills.

The health care provider is similarly situated to the auto repair shop that fixes the insured's automobile damaged by a


falling tree: the insurer may pay the auto repair shop directly, but this does not mean the insurance is for the benefit of the auto repair shop.

(f) The first-party versus third-party insurance distinction assists in understanding the concept of "no-fault" insurance. No-fault insurance is essentially the substitution of first-party insurance for tort liability. The victim of a tort, instead of looking to the tortfeasor and his insurer for reimbursement, looks to his own insurer for first-party protection. First-party insurance is compulsory under the typical no-fault scheme.

The term "no-fault" connotes that the victim recovers for his loss from his own insurer, without regard to the fault of the third party or his own contributory fault. (R.H. Jerry, II, op. cit., pp. 43-44.) (2) All-risk versus specified-risk. Another way to categorize

insurance according to the interests protected is the all-risk/ specified-risk distinction. All-risk insurance reimburses the insured for damage to the subject matter of the policy from all causes except those specifically excepted in the policy. In other words, all those not excluded are automatically included. Specified-risk insurance covers damage to the subject matter of the policy only if it results from specifically identified causes listed in the policy.

(a) Language of the policy. It is helpful but not necessarily determinative on whether a policy is all-risk or specified-risk. Language such as "this vessel is insured for physical loss or damage from any external cause" except for certain explicit exclusions is all-risk coverage. In contrast, the typical homeowner's policy which lists several insured events is ordinarily treated as a specified-risk policy.

The historical development of the policy can be important in determining whether the policy covers all risks. Marine insurance, for example, has traditionally been treated as all-risk insurance. The so-called "jeweler's block insurance" was developed to provide jewelers with coverage regardless of the cause, and thus traditionally has been treated as all-risk insurance. On the other hand, homeowner's insurance,


normally treated as specified-risk insurance, evolved by joining several distinct coverages fire, liability, theft, etc. in one policy.

(b) Coverage of the policy. The distinction can make a considerable difference in whether a particular loss is covered by a policy. For example, in Northwest Airlines, Inc. vs. Globe Indemnity Co. (303 Minn. 16, 225 N.W. 2d 831 [1975].), a hijacker extorted a large sum of money from the airline and then parachuted from the jet over the northwest. The airline's policy had five categories of coverage, two of which were 'Toss inside the premises" and 'Toss outside the premises." The insurer argued that the loss did not fall within the technical limits of any of these coverages, but the court reasoned that the policy read as a whole would be interpreted as all-risk coverage, meaning that the loss was covered unless the insurer could show that the specific risk was excluded. Since no explicit exclusion pertained to the hijacking risk, the insured's loss was covered.

(c) Burden of proof An important reason that the distinction between all-risk and specified-risk insurance can alter outcomes involves the effect of the distinction on the burden of proof. Under a specified-risk policy, the burden is ordinarily placed on the insured to initially prove that the loss falls within the policy's provisions on coverage. However, under an ill-risk policy, once the insured establishes that a loss occurred through some event other than an inherent defect or normal depreciation, the burden is ordinarily placed on the insurer to prove that the loss falls within an explicit exception to coverage.

In property insurance, the insured has merely to show the condition of the property insured when the policy attaches and the fact of loss or damage during the period of the policy. If the causation leading to the loss is difficult to identify and prove, an all-risk policy can be highly beneficial to the insured, (ibid., pp. 44-45; see Vda. de Gabriel vs. Court of Appeals, 264 SCRA 137 [1996].)

(d) Illustration. The potential advantage to the insured of all-risk coverage is illustrated by the case of Pan American


World Airways, Inc. vs. Aetna Casualty & Surety Co. (505 F. 2d 989 [2d Cir. 1974].) A Pan American Boeing 747 was hijacked and ultimately destroyed by members of the Popular Front for the Liberation of Palestine. The insurers argued that three specific exclusions barred Pan Asia's recovery for the loss of the aircraft: capture or seizure of property by governmental authority or agent; war, invasion, or civil war; and strikes, riots, or civil commotion.

Treating the policy as all-risk coverage, the U.S. Court of Appeals held that the insurers had failed to prove that the cause of the loss was within the scope of the policy's exclu-sions which were ambiguous as applied to a "political hijack-ing" or an "act for political or terrorist purposes." Consistent with well established rules of interpretation, the exclusions were construed in a manner most beneficial to the insured.

If the policy in Pan American World Airways had been a specified-risk policy, the insurers might have prevailed. The insurers' difficulty in showing that the cause of the loss fell within an exclusion would have instead been the insured's problem of showing that a covered peril caused the los

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