Insurance Works on Certain Fundamental Principles
Insurance Works on Certain Fundamentals Principles
Insurance Works on Certain Fundamental Principles:
- Principle of Indemnity: The principle of indemnity means insured is indemnified only to the extent of his loss; no profit or undue benefit is allowed. The insurer agrees to pay no more than the actual amount of the loss. The purpose of this principle is to prevent the insured from profiting from a loss and to reduce moral hazard. The principle of indemnity in insurance is to compensate the insured by placing him in the same financial position after the loss as before it. Under this principle, the occurrence of the insured event does not entitle the insured to compensation unless the insured suffers a monetary loss. Where a monetary loss is suffered, the insured can only claim the actual amount of his loss, which cannot be more than the sum insured. Therefore, an insured person cannot make a profit as a result of his loss. Non-indemnity or ‘valued’ policies such as life, personal accident and critical illness insurances are not contracts of indemnity. They are considered benefit policies.
Life Insurance Contract is not considered to be a contract of indemnity, because human life is incapable of being measured in terms of money. In case of life insurance, the happening of the event is certain, but the time is uncertain, whereas in non-life insurances, the event by itself is uncertain like the contingency of perils of marine and fire may or may not happen. Because of these reasons, in case of life insurance, the amount paid as a premium is paid back either after death or on maturity, whereas in non-life insurances nothing is paid if the risk that is insured does not happen.
- Principle of Insurable Interest: Insurable interest may be defined as the legal right to insure which arises out of a pecuniary relationship between the insured and the subject matter of insurance whereby destruction or damage to the latter involves the insured in financial loss. The insured must stand to lose financially if a loss occurs. The purpose of this principle is to prevent gambling, to reduce moral hazard and to measure the amount of loss. The insurable interest exists at the time of the loss in case of property insurance and only at inception of the policy in case of Life insurance.
- Principle of Subrogation: It applies to contracts of general insurance as a necessary corollary of the principle of indemnity for substitution of the insurer in place of the insured for the purpose of claiming indemnity from a third person for a loss covered by insurance. Subrogation may be defined as the transfer of rights & remedies of the insured to the insurer who has indemnified the insured in respect of the loss. The purpose of this principle is to prevent the insured from collecting twice for the same loss, to hold the negligent person responsible for the loss. The insurer is entitled only to the amount it has paid under the policy. The insured cannot make profits out of insurance. The insured cannot impair the insurer’s subrogation rights. Subrogation does not apply to life insurance and to most individual health insurance contracts. The insurer cannot subrogate against its own insureds.
- Principle of Contribution: If the same subject matter may be insured with more than one insurer. In such a case, the insurance claim to be paid to the insured must be shared or contributed by all insurers.
- Principle of Utmost Good Faith (in Latin: Uberrimae Fidei): A higher degree of honesty is imposed on both parties to an insurance contract than is imposed on parties to other contracts. This principle provides that there shall be no liability for any claim if there has been false-statement or concealment or non-disclosure or misrepresentation of any material information. In addition to the duty of disclosure, which continues during the currency of the policy, the insured is required to act as if he is uninsured, i.e., he shall take all reasonable precautions to prevent accidents.
- Principle of Proximate Cause (in Latin: Causa-proxima): It is not the latest, but the direct, dominant, operative and efficient cause that must be regarded as proximate. When an Insurance Policy is bought it is issued with respect to some peril, which may result in loss to the policyholder. No Policy covers all types of risks; there are always certain defined exclusions and conditions. The insurance company is liable to indemnify only against the insured perils subject to certain exclusions and conditions.
The term Proximate Cause literally means the nearest cause or direct cause. In insurance parlance it relates to the immediate cause of the mishap, which resulted in the loss.
In general insurance there are numerous policies on vehicle insurance, property insurance, fire insurance, burglary insurance, marine insurance etc. Each policy offers protection from the risks that are mentioned and defined in the Policy.
- Principle of Mitigation: In case of a mishap the insured must take all possible steps to reduce or mitigate the loss or damage to the subject matter of insurance. This principle ensures that the insured does not become negligent about the safety of the subject matter after taking an insurance policy. The insured is expected to act in a manner as if the subject matter has not been insured.
Requirements of an Insurance Contract:
Insurance contracts are also governed by the provisions of the Indian Contract Act, 1872. The law of insurance is multi-layered. To be legally enforceable, an insurance contract must meet four requirements:
- a) Proposal is generally made by the ‘proposer’, the person who desires the insurance cover, when he filled in the proposal form and forwarded to the insurer.
- b) Acceptance of the terms of the contract.
- c) Consideration: the values that each party exchanges.
- d) Legally competent parties, with legal capacity to enter into a binding contract. A contract of insurance, however, is not a perfect contract of indemnity. A policy of insurance is a formal document issued by the insurer expressing or embodying the contract of insurance between the parties. The law of insurance is multi-layered.
The written form of contract between the Insurer and the Proposer (Insured) is known as Insurance Policy.