Principles of Insurance
A contract signed between two parties, through which one party agrees or promises to cover the loss suffered by another party by receiving some money (consideration) in return is known as Insurance. The party which agrees to cover the loss for the other one is called the insurer, and the party whose loss is being covered under such a policy is known as the insured. The consideration or money paid by the insured to the insurer is known as Premium. The basic motive behind Insurance is to distribute or divide the risk of one client over a group of clients and compensate only the loss-bearing parties. Some of the insurances include Health Insurance, Life Insurance, Marine Insurance, Fire Insurance, etc.
For example, Akanksha takes a Life Insurance Policy from LIC for ₹20,00,000. She is required to pay ₹15,000 annually as Premium. In this case, LIC is the insurer, Akanksha is the insured, ₹20,00,000 is the sum assured, ₹15,000 is the premium, and the agreement between both parties in which all the terms and conditions of insurance are mentioned is called the Insurance Policy. If anything misfortunate happens to Akanksha (covered in the insurance policy), the insurance company (LIC) will pay the required sum to Akanksha or her nominee as the case may be.
Principles of Insurance
1. Principle of Utmost Good Faith
An insurance contract is a contract of ‘uberrimae fidei’. It means that it is a contract formed in utmost good faith. This Principle of Utmost Good Faith states that both the parties of an insurance contract should have good faith towards each other. Also, each party should communicate the terms and conditions in a non-ambiguous manner to the other. In other words, the insurer is obligated to provide precise details about the contract to the insured, who, in turn, should provide all the details regarding the subject matter (for which the insurance is being taken) to the former. Simply put, this principle requires both the parties to be transparent towards each other. If the insured fails to disclose the material facts during the formation of the contract, the insurance contract will be voidable at the option of the insurer. The same goes with the insurer, as they are also obligated to clear all terms and conditions of the insurance contract.
Material Fact is a fact that can influence the decision of the insurer for accepting or rejecting the risk, changing the premium rate, or fixing the conditions of insurance.
For example, Ankit, a heavy drinker and smoker, took a health insurance policy. He failed to disclose his tobacco consumption habit to the insurance company. Later in life, he was diagnosed with cancer. In this case, the insurance company will not be obligated to carry the financial burden because Ankit withheld crucial information about his habit.
2. Principle of Proximate Cause
Any loss can be caused because of two reasons: Insured Perils and Uninsured Perils. The Principle of Proximate Cause states that the insurer is only liable for the losses when they are proximately caused by the perils stated in the insurance policy. When an insured face a loss that occurred because of two or more causes, then the most dominant and effective cause is the proximate cause. The insurer is not liable for any loss caused by an uninsured peril or cause. In other words, if an insured faces a loss because of more than two causes, then the insurance company will investigate the subject’s most recent cause of loss. The company is bound to compensate the insured if the immediate cause is the one for which the subject is insured. However, if the immediate cause happens to be other than what the insurance policy states, then no compensation shall be provided to the insured. However, if the causes of loss include a combination of different insured and uninsured perils, the assessment of the claim becomes difficult for the insurance company.
For example, A building’s wall was engulfed in flames, and the local government ordered it to be dismantled. The adjacent building was destroyed during the destruction. The owner of the adjacent building had a fire insurance policy. In this case, the owner of the adjacent building will get the insurance money, as fire is the nearest cause of the destruction, and it is covered in the perils of the insurance contract.
In a similar case, a fire-damaged building’s wall collapsed because of a storm before it could be restored, causing damage to the next building. The owner of the next building had fire insurance for the building. Here the remote cause of loss is fire and the storm is ‘Causa Proxima’, hence no compensation shall be made.
3. Principle of Insurable Interest
Having some economic or pecuniary interest in the subject matter of the insurance policy or contract is known as Insurable Interest. The Principle of Insurable Interest states that the insured must have the insurable interest in the subject matter of the insurance. A person or an insured is said to have an insurable interest in the subject if any destruction of the subject adversely affects the insured. The insured of the insurance contract must either own the whole or part of the subject, or must be adversely affected by any injury to the subject. For example, an individual has an insurable interest in his/her parents instead of any stranger.
Insurable Interest plays a different role in different types of insurance:
Under Life Insurance, the presence of insurable interest at the time of contract is necessary. For example, a woman took a Life Insurance Policy for her husband. After a few months, the couple got divorced, and husband died because of a Heart Attack. In this case, the wife will get compensation from the insurance company because, at the time of insurance, the husband (insurable interest) was present.
In the case of insurance of property, the insurable interest of the insured must be present at the time of signing the insurance contract. However, it does not mean that the insured must own the property at the time of entering into the insurance contract.
In the case of fire insurance also, the insurable interest must be present at the time of entering into the insurance as well as at the time of loss of that subject. For example, Sahil took a Fire Insurance Policy for his Art Studio. If his Art Studio faces loss because of fire, he can claim compensation for the same. However, if he sells his Art Studio before the break-out of fire, then he cannot claim compensation for the loss by fire.
Same is the case with Marine Insurance. The insurable interest of the subject must be present at the time of loss.
4. Principle of Indemnity
Indemnity means ‘Security against Loss’. The Principle of Indemnity aims at putting the insured (in the event of loss) in the exact same position he has immediately before the occurrence of that event. In other words, the insured of the insurance contract can recover the loss suffered by him/her up to the limit of the amount covered by the insurance policy. The compensation payable to the insured for the loss suffered by him/her is measured in terms of money. Also, the insured is not allowed to make any profit out of the misfortune or unwanted event. All life and marine insurance contracts are the contracts of indemnity; however, the life insurance contract is not a contract of indemnity because one cannot measure the loss arised on the death of the insured in terms of money.
For example, if Kashish has insured his house against fire for ₹8,00,000 and he suffers a loss of ₹5,00,000, then the insurance company will pay him only ₹5,00,000 and not the amount of policy, i.e., ₹8,00,000.
5. Principle of Subrogation
According to the Principle of Subrogation, after providing the compensation to the insured for the subject-matter, the insurer gets every right against the third party. This principle is applied to all the insurance contracts that are the ‘Contracts of Indemnity’.
For example, Sukant took insurance for his sports car for ₹10,00,000, which got stolen after a while. Now the insurer will compensate the loss suffered by him according to the policy. However, if Sukant recovers his sports car later, then the insurance company (insurer) will have full rights to that car. It is because the insured already got the compensation for the loss and is not allowed to make any profit by any means.
6. Principle of Contribution
According to the Principle of Contribution, an insurer who has already paid the amount of claim to the insured has a complete right to recover the proportionate contribution from the other insurer. In other words, the principle states that an insured can take more than one policy for a subject or property. However, if an insured faces a loss for the subject or property, then he/she has no right to recover more than the full compensation amount of the actual loss. In other words, if the insured gets the full amount of the actual loss from one insurer, he/she cannot obtain further money from the other insurer. However, the insurer who has paid the full amount to the insured will recover the proportionate amount of contribution from the other insurer. The principle aims at distributing the losses between the insurers equally.
For example, Mayank buys an insurance policy of ₹40,000 for a property of ₹80,000 from Insurer X and ₹20,000 from Insurer Y. He suffered a loss of ₹ 30,000, which he can claim from both the insurers. The proportionate liability of Insurer X and Insurer Y will be
7. Principle of Mitigation
According to the Principle of Mitigation, the insured is obligated to take reasonable steps to minimize the damage or loss to the insured subject or property. The main aim behind this principle is to ensure that the insured does not become careless towards the insured property or subject after taking the policy for covering the risks. If the insured does not take reasonable care of the insured property, then he/she might lose the claim amount from the insurer.
For example, In case of a fire breaking out in a factory, which was covered under the Fire Insurance Policy, the owner should try to put it out and minimize the damage as much as possible. He is not entitled to stand by just because he has bought an insurance policy for the factory.
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