PRINCIPLES OF INSURANCE

In continuation to Basics of Insurance Planning regarding what is Insurance and history of insurance, let’s now know the principles applicable to Insurance.

A contract of insurance is a mercantile contract. All the principles which are applicable to mercantile contracts are applicable to contracts of insurance. In addition to this, there are special principles applicable to contracts of insurance.

Special Principles of Insurance are as follows,

1. Insurable Interest

“Ownership should be there to evaluate financial (insurable) interest”

Insurable Interest is must for validating the contract of insurance. Insurable interest must be a financial / pecuniary interest. A person is said to have insurable interest in a property when he enjoys benefit from its existence and suffers by its destruction or loss.
Irrespective of Existence of mere relationship, the financial (pecuniary) interest must be proved to have insurable interest.

Example

1. A person has insurable interest in his own life and in the life of his spouse

2. A house owner has insurable interest on his house up to the full value of his house property.

3. A creditor has insurable interest in the life of the debtors.

The time when insurable interest should exist differs according to the nature of insurance. It can be known from the below table. 

Type of Insurance	Insurable Interest
Life Insurance	At time of Contract entered
Marine Insurance	At time of Loss
Fire Insurance	Both at time of Contract entered and at time of loss

The person who purchases the insurance has an 'insurable interest' in the subject matter of the insurance if the loss or damage of it would result in a financial loss to the person.

2. Utmost good faith

“Principle of Uberrimae Fidei”

A contract of insurance is a contract of utmost good faith. The principle of disclosure of all material facts should be followed. The insured is to fully disclose to the insurer all facts (Material or otherwise) regarding the subject matter of the insurance. Misrepresentation, non-disclosure or fraudulent misrepresentation in any document leads to disowning the insurer from all liabilities under the contract. No policy can be challenged after two years on the basis of above reasons. But this provision is not applicable if the insurer proves that misrepresentation or non-disclosure of material facts has been willfully done by the insured, with a view to defraud the insurer. It is equally obligatory for the insurer to observe utmost good faith and provide all facts to the insured.

3. Indemnity

‘To indemnify’ means ‘to make good the actual loss suffered’. Not applicable in life policies.

The principle of indemnity is applicable to property insurance alone. Insurance contract are contracts of indemnity. This means that the insured who suffered loss should be placed in the identical position as how he was instantly before the loss suffered. This principle ensures that the insured does not make any profit out of the insurance. In the event of total loss, the insurer pays the actual loss or the sum insured whichever is less. It ensures that under no circumstances the insured can get more than the actual loss i.e., can’t make profit out of it.

As told earlier, the principle of indemnity does not apply to Life Insurance Contracts because it is not based on the principle of compensation and the value of human life cannot be measured in terms of money & compensated by money.

Example

If a person insures Rs.10 lakhs worth of building for Rs.6 lakhs against fire and fire occurs and he incurs a loss of Rs.2 lakhs he can get Rs. 2 lakhs only from the insurance company. If the loss due to fire exceeds Rs. 6 lakhs, he cannot get actual loss on compensation but only Rs. 6 lakhs (Subject to average clause).The principle of indemnity does not apply to life and personal accident insurance.

In Short, A contract to restore the insured to the same position immediately before the loss or damage by way of payment, repair or replacement.

4. Proximate Causes

“The 'immediate or effective cause' that leads to an event”.

Proximate means nearest. It is only the nearest reason and not the remote reason is the factor to be taken into account. The insurer is liable only if the nearest cause comes within the meaning of risk insured.

5. Contribution

“It is sharing of loss by all insurers”. Not applicable in life policies.

Insurance is based on principles of co-operation.

Where a property is over insured by double insurance, the insurer is liable only for the insurer’s rateable proportion of the loss or damage in the event other insurers are also liable for the loss or damage.

6. Subrogation

“Transfer of rights of insured to insurer”.  Applicable to all insurances other than the life insurance policies.

The principle of subrogation is referred as “stepping into the shoes of others”. Subrogation means transfer of rights and remedies of the insured to the insurer after the indemnity has been effected. According to this principle, after the insured is compensated for loss, the right of ownership of such damaged part of the property passes to the insurer. If the insured has any right of act against third party and can claim damages from that party, the benefit of recovery of compensation shall be transferred to the insurer.

Principle of Subrogation is an extension and another corollary of the principle of indemnity. It also applies to all contracts of indemnity.

By now you might have understood the basics of insurance, now you are ready to do your insurance planning.

Categories: Insurance, Insurance Planning, Tutorials