1.2 Core Insurance Terms: Loss, Proximate Cause, Negligence, Valuation, Salvage, Reinsurance, and Lloyd's

1.2 Core Insurance Terms: Loss, Proximate Cause, Negligence, Valuation, Salvage, Reinsurance, and Lloyd's

The first block of the Pearson VUE Texas Surplus Lines content outline lists fifteen "insurance terms and related concepts": insurance, indemnity, risk, hazard, peril, loss (direct vs. indirect), proximate cause, liability, actual cash value, replacement cost, subrogation, salvage, negligence, Lloyd's, and reinsurance. Section 1.1 covered risk, hazard, and peril. This section teaches the rest. These definitions look basic, but they drive the harder questions later in the exam: whether a loss is covered, how much the insurer owes, who can be sued, and who ultimately bears the risk in a layered surplus lines program.

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1. Insurance and the Principle of Indemnity

Insurance is a contract in which one party (the insurer) agrees, in exchange for a premium, to pay for or indemnify another (the insured) against financial loss from specified perils. Economically, it transfers pure risk from one party to a pool of similar exposures, where the law of large numbers makes the total loss more predictable.

Indemnity means restoring the insured to approximately the same financial position held immediately before the loss, no better and no worse. Property and casualty insurance enforces indemnity through several tools:

• Valuation rules (actual cash value or replacement cost) that cap payment at the value lost;
• Deductibles and retentions that keep the insured sharing in each loss;
• Insurable interest, which must exist at the time of a property loss;
• Other-insurance clauses that prevent collecting the same loss twice from two insurers; and
• Subrogation and salvage, which return value to the insurer after it pays.

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2. Loss: Direct vs. Indirect

A loss is the reduction or disappearance of value that gives rise to a claim. The outline asks you to separate two kinds:

A direct-damage form does not automatically pay indirect loss. If the insured wants the lost profits, continuing payroll, or extra expense covered, the policy must include business income or extra expense coverage (see the Chapter 3 placement discussion). Spoilage caused by an off-premises power failure is another common indirect-loss example.

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3. Proximate Cause

Proximate cause is the efficient, dominant cause that sets in motion an unbroken chain of events producing the loss, without an intervening, independent cause. When the proximate cause is a covered peril, every link in the chain it starts is treated as caused by that peril.

• Example: Lightning strikes a warehouse, starting a fire; firefighters' water then soaks inventory in an undamaged wing. The water damage is part of an unbroken chain started by lightning and fire, so it is treated as a fire loss rather than a separate, excluded water loss.
• Contrast: If a week later an unrelated pipe bursts in the repaired wing, that is a new, independent cause.

In liability cases, proximate cause is also the causation element of negligence. Texas courts describe it as cause in fact (the conduct was a substantial factor in bringing about the injury, without which the harm would not have occurred) plus foreseeability (a person of ordinary intelligence would have anticipated the danger).

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4. Legal Liability and Negligence

Legal liability is an obligation, enforceable in court, to pay damages to another person. It arises from torts (civil wrongs), from contracts (for example, liability assumed in a hold-harmless agreement), and from statutes. Liability insurance, which makes up much of the Texas surplus lines market, pays sums the insured becomes legally obligated to pay.

Negligence is the failure to use the degree of care that a reasonably prudent person would use under the same or similar circumstances. A plaintiff must prove four elements:

1. Legal duty owed to the plaintiff;
2. Breach of that duty;
3. Proximate cause linking the breach to the injury; and
4. Damages (actual bodily injury, property damage, or other loss).

Texas Proportionate Responsibility

Texas uses a modified comparative-fault system. Under Chapter 33 of the Texas Civil Practice and Remedies Code, a claimant's damages are reduced by the claimant's own percentage of responsibility, and a claimant whose responsibility is greater than 50 percent recovers nothing (§ 33.001). A claimant found 30% responsible for a $100,000 injury recovers $70,000; a claimant found 55% responsible recovers $0.

Related Liability Concepts

• Strict (absolute) liability applies without proof of fault to abnormally dangerous activities, such as blasting or storing explosives, and to many product-defect claims. These exposures are frequently written in the surplus lines market.
• Vicarious liability makes one party answer for another's negligence, most commonly an employer for an employee acting in the course of employment (respondeat superior).

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5. Valuation: Actual Cash Value and Replacement Cost

• Actual cash value (ACV) is commonly calculated as replacement cost minus depreciation. A 10-year-old rooftop HVAC unit with a 20-year useful life and a $40,000 replacement cost has 50% depreciation, so its ACV is $20,000.
• Replacement cost (RC) pays the cost to repair or replace with materials of like kind and quality, without deducting depreciation. Replacement cost forms typically pay ACV first and release the withheld depreciation only after the property is actually repaired or replaced.

Section 2.2 works through a longer ACV calculation.

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6. Subrogation and Salvage

Subrogation is the insurer's right, after paying a loss, to step into the insured's shoes and recover from the party that caused it. The insured may not destroy that right after a loss, for example by signing a release with the responsible party, without the insurer's consent. A waiver of subrogation agreed before the loss (common in construction contracts) is generally permitted when the policy allows it.

Salvage is the value remaining in damaged property. When an insurer pays for damaged property, often as a total loss, it may take title and sell what is left. That recovery reduces the insurer's net loss.

• Example: A surplus lines insurer pays $120,000 for flood-soaked electronics inventory, takes the damaged goods, and sells them to a salvage buyer for $9,000. The insurer's net loss is $111,000. Because the insured has been indemnified, the insured does not also keep the $9,000.

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7. Reinsurance

Reinsurance is insurance purchased by an insurer. The ceding insurer transfers part of its risk to a reinsurer in exchange for part of the premium.

The original policyholder normally has no contract with the reinsurer and looks only to its own insurer for payment. Texas's unauthorized-insurance restrictions do not apply to the lawful transaction of reinsurance by insurers (TIC § 101.053(b)(2)), which is why large Texas energy and coastal risks can be backed by reinsurance capital from around the world.

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8. Lloyd's: Two Different Meanings on the Exam

• Lloyd's of London is a marketplace, not an insurance company. Syndicates backed by their members' capital underwrite risks there. Lloyd's syndicates are alien, non-admitted insurers that Texas surplus lines agents use extensively (see Section 4.2).
• A Texas Lloyd's plan (TIC Chapter 941) is a Texas insurer organized as individual underwriters who write insurance through an attorney in fact. A Lloyd's plan may write any kind of insurance lawfully written in Texas except life insurance (TIC § 941.002). Many admitted Texas property carriers are Lloyd's plans. Their policies are admitted business, not surplus lines.

Exam Tip: If a question describes an "attorney in fact" managing a Texas-domiciled admitted insurer, think Texas Lloyd's plan (or a reciprocal exchange). If it describes syndicates, Names, or the Central Fund, think Lloyd's of London.