Chapter 1

Basic Principles of Insurance

Basic principles of insurance

(The elements of special contract relating to insurance)

A contract of insurance, in addition to fulfilling the basic or essential features of a valid contract must also fulfil certain essential principles.

The essential principles of insurance are,

  • Insurable interest
  • Utmost good faith
  • Indemnity
  • Subrogation
  • Proximate cause
  • Contribution
  • Mitigation of loss

1. Principle of Insurable Interest

Contract of insurance is valid if the insured possess insurable interest. It means that the insured must have an actual pecuniary interest and not a mere anxiety or sentimental interest in the subject matter of the insurance. The insured has an insurable interest in the object or in the life of the insured person. A person is said to have an insurable interest in the property, if he is financially benefitted by its existence and is biased by its loss, destruction or non existence. Likewise, if a person is taking a life insurance policy, then he must have insurable interest in the life of the insured person. No person can enter into a valid contract unless he has insurable interest in the subject matter of insurance. For example, the owner of a ship run a risk of losing his ship, the charterer of the ship runs a risk of losing his freight and the owner of the cargo incurs the risk of losing his goods and profit. So, all these persons have something at stake and all of them have insurable interest. A creditor has insurable interest in the life of his debtor. It is the existence of insurable interest in a contract of insurance, which distinguishes it from a mere watering agreement.

In order to insure something or someone, the insured must provide proof that the loss will have a genuine economic impact in the event the loss occurs. Without an insurable  interest, insurers will not cover the loss. It is worth noting that for property insurance policies, an insurable interest must exist during the underwriting process and at the time of loss. However, unlike with property insurance, with life insurance, an insurable interest must exist at the time or purchase only. Insurance provides financial protection against a loss arising out of happening of an uncertain event. A person can avail this protection by paying premium to an Insurance company. The rule of insurable interest differs in the case of life, marine and fire insurance. In the case of life insurance, the individual who is taking an insurable policy should have a pecuniary insurable interest in the life of the insured person at the time of taking insurance policy. It may or may not present at the time of death of the person whose life is assured or at the time of making claim on maturity. In the fire insurance, the insurable interest must be present at the time of taking out the policy and at the time of incurring loss. In the case of marine insurance insurable interest must be present at the time of occurrence of loss. As per Section 7(2) of the Marine Insurance Act 1963, there are three essentials of insurable interest. These three essential legal conditions are not present; there should be no insurable interest in the subject matter and so it cannot be insured.

  1. Subject matter of the insurance must be definite. Various properties, interest, rights, interest or life or possible liability must exist at the time of taking insurance, these things must be capable of being insured called subject matter.
  2. The insured should have a legal relationship to the subject matter or he must be the owner. He should be benefited by the safety or continuous of the property, rights, interest, life or liability and will lose by any loss, damage, injury death or creation of liability to the subject matter.
  3. The insured should be the owner or may possess the lawful right or interest in the subject matter to be insured.
  4. Principle of utmost good faith

The contracts of insurance are contracts of Uberrima fides,

Since insurance shifts risk from one party to another, it is essential that there must be almost good faith and mutual confidence between the insured and the insurer. In a contract of insurance the insured knows more about the subject matter of the contract than the insurer. Consequently, he is duty bound to disclose accurately all material facts and nothing should be withheld or concealed. Any fact is material, which goes to the root of the contract of insurance and has a bearing on the risk involved. It is only when the insurer knows the whole truth that he is in a position to judge (a) whether he should accept the risk and (b) what premium he should charge. If that were so, the insured might be tempted to bring about the event insured against in order to get money

Under the contract of insurance, greater degree of good faith is expected from the proposer. He should disclose all material facts relevant to the subject matter. Insurance contracts are different from ordinary business contracts. Ordinary business contracts are based on the principle of caveat emptor (let the buyer beware). The seller has no duty to disclose any information about the subject matter of the contract to the buyer. It is the responsibility of the buyer to take reasonable care to satisfy himself as to the genuineness of the material facts disclosed and he has to bear all the risks of loss. But in the case of insurance, both parties are required to disclose material facts relevant to the contract. Material information is that information which helps the insurance company to decide whether to accept or not accept any risk; if it is to be accepted what should be the rate of premium to be collected and on what terms and conditions. If at any time, it is found that the insured cancelled certain material facts related with the subject matter of insurance, then the contract of insurance become voidable at the option of the insurer. The utmost good faith mentions that all the material facts disclosed must be true and in full form. There should be no concealment, misrepresentation, mistake or fraud about the material facts. However the following facts are not required to be disclosed by the insured.

  • Facts that may tend to reduce the risk.
  • Facts which the insurer knows already.
  • Facts of public knowledge.
  • Facts waived by the insurer.
  • Facts governed by the conditions of the policy.
  • Facts which could have been secondary from the information supplied by the insured.
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