Principles of Insurance
The basic principles which govern the insurance are -
(1) Utmost good faith
(2) Insurable interest
(3) Indemnity
(4) Contribution
(5) Subrogation
(6) Causal proximal
(7) Mitigation of loss
1. Principle of utmost good faith : A contract of insurance is a contract of ‘Uberrimae Fidei’ i.e., of utmost good faith. Both insurer and insured should display the utmost good faith towards each other in relation to the contract. In other words, each party must reveal all material information to the other party whether such information is asked or not. There should not be any fraud, non disclosure or misrepresentation of material facts.
Example – in case of life insurance, the insured must revel the true age and details of the existing illness/diseases. If he does not disclose the true fact while getting his life insured, the insurance company can avoid the contract.
Similarly, incase of the insurance of a building against fire, the insured must disclose the details of the goods stored, if such goods are of hazardous nature
A material fact means important facts which would influence the judgment of the insurer in fixing the premium or deciding whether he should accept the risk, on what terms. All material facts should be disclosed in true and full form
2. Principle of Insurable Interest: This principle requires that the insured must have a insurable interest in the subject matter of insurance. Insurance interest means some pecuniary interest in the subject matter of contract of insurance. Insurance interest is that interest, when the policy holders get benefited by the existence of the subject matter and loss if there is death or damage to the subject matter.
For example – In life insurance, a man cannot insured the life of a stranger as he has no insurable interest in him but he can get insured the life of himself and of persons in whose life he has a pecuniary interest. So in the life insurance interest exists in the following cases:-
- Husband in the life of his wife and wife in the life of her husband
- Parents in the life of a child if there is pecuniary benefit derived from the life of a Child
- Creditor in the life of debtor
- Employer in the life of an employee
- Surety in the life of a principle debtor
In life insurance, insurable interest must be present at the time when the policy is taken. In fire insurance, it must be present at the time of insurance and at the time if loss if subject matter. In marine insurance, it must be present at the time of loss of the subject matter.
3. Principle of Indemnity : This principle is applicable in case of fire and marine insurance only. It is not applicable in case of life, personal accident and sickness insurance. A contract of indemnity means that the insured in case of loss against which the policy has been insured, shall be paid the actual cost of loss not exceeding the amount of the insurance policy. The purpose of contract of insurance is to place the insured in the same financial position, as he was before the loss.
Example – A house is insured against fire for Rs. 50000. It is burnt down and found that the expenditure of Rs. 30000 will restore it to its original condition. The insurer is liable to pay only Rs. 30000.
In life insurance, principle of indemnity does not apply as there is no question of actual loss. The insurer is required to pay a fixed amount upon in advance in the event of accident, death or at the expiry of the fixed term of the policy. Thus, a contract of a life insurance is a contingent contract and not a contract of indemnity.
4. Principle of Contribution: The principle of contribution is a corollary to the doctrine of indemnity. It applies to any insurance which is a contract of indemnity. So it does not apply to life insurance. A particular property may be insured with two or more insurers against the same risks. In such cases, the insurers must share the burden of payment in proportion to the amount insured by each. If one of the insurer pays the whole loss, he is entitled to contribution from other insurers
Example – B gets his house insured against fire for Rs. 10000 with insurer P and for Rs. 20000 with insurer Q. a loss of Rs. 15000 occurs, P is liable to pay for Rs. 5000 and Q is labile to pay Rs 10000. If the whole amount pf loss is paid by Q, then Q can recover Rs. 5000 from P. The liability of P &Q will be determined as under:
Sum insured with Individual insurer (i.e. P or Q ) x Actual Loss = Total sum insured
Liability of P = 10000 x 15000 = Rs.5000
30000
Liability of Q = 20000 x 15000 = Rs.10000
30000
The right of contribution arises when:
(a) There are different policies which related to the same subject matters;
(b) The policies cover the same period which caused the loss;
(c) All the policies are in force at the time of loss; and
(d) One of the insurer has paid to the insured more than his share of loss.
5. Principle of Subrogation : The doctrine of abrogation is a corollary to the principle of indemnity and applies only to fire and marine insurance. According to doctrine of subrogation, after the insured is compensated for the loss caused by the damage to the property insured by him, the right of ownership to such property passes to the insurer after settling the claims of the insured in respect of the covered loss.
Example – Furniture is insured for Rs. 1 lacs against fire, it is burnt down and the insurer pays the full value of Rs. 1 Lacs to the insured, later on the damage Furniture is sold for Rs. 10000. The insurer is entitled to receive the sum of Rs. 10000.
A loss may occur accidentally or by the action or negligence of third party. If the insured suffer a loss because of action of third party and he is in a position to recover the loss from the insurer then insured can not take action against third party, his right is subrogated (substituted) to the insurer on settlement of the claim. The insurer, therefore, can recover the claim from the third party.
If the insured recovers any compensation for the loss (due to third party), from the third party, after he has already been indemnified by the insurer, he holds the amount of such compensation as the trustee if the insurer.
The insurer is entitled to the benefits out of such rights only to the extent of the amount he has paid to the insured as compensation
6. Principle of Causa Proxima : Causa proxima, means proximate cause or cause which, in a natural and unbroken series of events, is responsible for a loss or damage. The insurer is liable for loss only when such a loss is proximately caused by the peril insured against. The cause should be the proximate cause and can not the remote cause. If the risk insured is the remote cause of the loss, then the insurer is not bound to pay compensation. The nearest cause should be considered while determining the liability of the insured. The insurer is liable to pay if the proximate cause is insured.
Example – In a marine insurance policy, the goods were insured against damage by sea water, some rats on the board made a hole in a bottom of the ship causing sea water to pour into the ship and damage the goods. Here, the proximate cause of loss is sea water which is covered by the policy and the hole made by the rats is a remote cause. Therefore, the insured can recover damage from the insurer
Example – A ship was insured against loss arising from collision. A collision took palce resulting in a few days delay. Because of the delay, a cargo of oranges becomes unsuitable for human consumption. It was held that the insurer was not liable for the the loss because the proximate cause of loss was delay and not the collision of the ship.
7. Principle of Mitigation of Loss: An insured must take all reasonable care to reduce the loss. We must act as if the property was not insured.
Example – If a house is insured against fire, and there is accidental fire, the owner must take all reasonable steps to keep the loss minimum. He is supposed to take all steps which a man of ordinary prudence will take under the circumstances to save the insured property.
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