The business of insurance aims to protect the economic value of assets or life of a person. Through a contract of insurance, the insurer agrees to make good any loss on the insured property or loss of life (as the case may be) that may occur in course of time in consideration for a small premium to be paid by the insured.
Apart from the above essentials of a valid contract, insurance contracts are subject to additional principles. These are:
- Principle of Utmost good faith
- Principle of Insurable interest
- Principle of Indemnity
- Principle of Subrogation
- Principle of Contribution
- Principle of Proximate cause
- Principle of Loss of Minimization
These distinctive features are based on the basic principles of law and are applicable to all types of insurance contracts. These principles provide guidelines based upon which insurance agreements are undertaken.
A proper understanding of these principles is therefore necessary for a clear interpretation of insurance contracts and helps in proper termination of contracts, settlement of claims, enforcement of rules and smooth award of verdicts in case of disputes.
Now we will be discussing various principles of Insurance in detail
- PRINCIPLE OF UBERRIMAE FIDEI (UTMOST GOOD FAITH)
- Both the parties i.e. the insured and the insurer should have a good faith towards each other.
- The insurer must provide the insured complete, correct and clear information of subject matter.
- The insurer must provide the insured complete, correct and clear information regarding terms and conditions of the contract.
- This principle is applicable to all contracts of insurance i.e. life, fire and marine insurance.
The principle of uberrimae fidei (a Latin phrase), or in simple English words, the Principle of Utmost Good Faith, is a very basic and first primary principle of insurance. According to this principle, the insurance contract must be signed by both parties (i.e insurer and insured) in an absolute good faith or belief or trust.
The person getting insured must willingly disclose and surrender to the insurer his complete true information regarding the subject matter of insurance. The insurer’s liability gets void (i.e legally revoked or canceled) if any facts, about the subject matter of insurance, are either omitted, hidden, falsified or presented in a wrong manner by the insured.
The principle of Uberrimae fidei applies to all types of insurance contracts.
- PRINCIPLE OF INSURABLE INTEREST
- The insured must have insurable interest n the subject matter of insurance.
- In life insurance it refers to the life insured.
- In marine insurance it is enough if the insurable interest exists only at the time of occurrence of the loss.
- In fire and general insurance it must be present at the time of taking policy and also at the time of the occurrence of loss.
- The owner of the party is said to have insurable interest as long as he is the owner of it.
- It is applicable to all contracts of insurance.
The principle of insurable interest states that the person getting insured must have insurable interest in the object of insurance. A person has an insurable interest when the physical existence of the insured object gives him some gain but its non-existence will give him a loss. In simple words, the insured person must suffer some financial loss by the damage of the insured object.
For example: The owner of a taxicab has insurable interest in the taxicab because he is getting income from it. But, if he sells it, he will not have an insurable interest left in that taxicab.
From above example, we can conclude that, ownership plays a very crucial role in evaluating insurable interest. Every person has an insurable interest in his own life. A merchant has insurable interest in his business of trading. Similarly, a creditor has insurable interest in his debtor.
- PRINCIPLE OF INDEMNITY
- Indemnity means guarantee or assurance to put the insured in the same position in which he was immediately prior to the happening of the uncertain event. The insurer undertakes to make good the loss.
- It is applicable to fire, marine and other general insurance.
- Under this the insurer agreed to compensate the insured for the actual loss suffered.
Indemnity means security, protection and compensation given against damage, loss or injury. According to the principle of indemnity, an insurance contract is signed only for getting protection against unpredicted financial losses arising due to future uncertainties. Insurance contract is not made for making profit else its sole purpose is to give compensation in case of any damage or loss.
In an insurance contract, the amount of compensations paid is in proportion to the incurred losses. The amount of compensations is limited to the amount assured or the actual losses, whichever is less. The compensation must not be less or more than the actual damage. Compensation is not paid if the specified loss does not happen due to a particular reason during a specific time period. Thus, insurance is only for giving protection against losses and not for making profit.
However, in case of life insurance, the principle of indemnity does not apply because the value of human life cannot be measured in terms of money.
- PRINCIPLE OF SUBROGATION
- As per this principle after the insured is compensated for the loss due to damage to property insured, then the right of ownership of such property passes to the insurer.
- This principle is corollary of the principle of indemnity and is applicable to all contracts of indemnity.
Subrogation means substituting one creditor for another. Principle of Subrogation is an extension and another corollary of the principle of indemnity. It also applies to all contracts of indemnity.
According to the principle of subrogation, when the insured is compensated for the losses due to damage to his insured property, then the ownership right of such property shifts to the insurer.
This principle is applicable only when the damaged property has any value after the event causing the damage. The insurer can benefit out of subrogation rights only to the extent of the amount he has paid to the insured as compensation.
For example: Mr. Arvind insures his house for ` 1 million. The house is totally destroyed by the negligence of his neighbour Mr. Mohan. The insurance company shall settle the claim of Mr. Arvind for ` 1 million. At the same time, it can file a law suit against Mr. Mohan for ` 1.2 million, the market value of the house. If insurance company wins the case and collects ` 1.2 million from Mr. Mohan, then the insurance company will retain ` 1 million (which it has already paid to Mr. Arvind) plus other expenses such as court fees. The balance amount, if any will be given to Mr. Arvind, the insured.
- PRINCIPLE OF CONTRIBUTION
- The principle is corollary of the principle of indemnity.
- It is applicable to all contracts of indemnity.
- Under this principle the insured can claim the compensation only to the extent of actual loss either from any one insurer or all the insurers.
Principle of Contribution is a corollary of the principle of indemnity. It applies to all contracts of indemnity, if the insured has taken out more than one policy on the same subject matter. According to this principle, the insured can claim the compensation only to the extent of actual loss either from all insurers or from any one insurer. If one insurer pays full compensation then that insurer can claim proportionate claim from the other insurers.
For example: Mr. Arvind insures his property worth Rs. 100,000 with two insurers “AIG Ltd.” for `90,000 and “MetLife Ltd.” for `60,000. Arvind’s actual property destroyed is worth ` 60,000, then Mr. Arvind can claim the full loss of `60,000 either from AIG Ltd. or MetLife Ltd., or he can claim `36,000 from AIG Ltd. and `24,000 from Metlife Ltd.
So, if the insured claims full amount of compensation from one insurer then he cannot claim the same compensation from other insurer and make a profit. Secondly, if one insurance company pays the full compensation then it can recover the proportionate contribution from the other insurance company.
- PRINCIPLE OF CAUSA PROXIMA (NEAREST CAUSE)
- The loss of insured property can be caused by more than one cause in succession to another.
- The property may be insured against some causes and not against all causes.
- In such an instance, the proximate cause or nearest cause of loss is to be found out.
- If the proximate cause is the one which is insured against, the insurance company is bound to pay the compensation and vice versa. Principle of Causa Proxima (a Latin phrase), or in simple English words, the Principle of Proximate (i.e Nearest) Cause, means when a loss is caused by more than one causes, the proximate or the nearest or the closest cause should be taken into consideration to decide the liability of the insurer. Lesson 2 General Principles and Concepts of Insurance 19 The principle states that to find out whether the insurer is liable for the loss or not, the proximate (closest) and not the remote (farest) must be looked into. For example: A cargo ship’s base was punctured due to rats and so sea water entered and cargo was damaged. Here there are two causes for the damage of the cargo ship – (i) The cargo ship getting punctured beacuse of rats, and (ii) The sea water entering ship through puncture. The risk of sea water is insured but the first cause is not. The nearest cause of damage is sea water which is insured and therefore the insurer must pay the compensation. However, in case of life insurance, the principle of Causa Proxima does not apply. Whatever may be the reason of death (whether a natural death or an unnatural death) the insurer is liable to pay the amount of insurance.