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
- Proximate cause
- 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.
- 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.
- 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.
- The insured should be the owner or may possess the lawful right or interest in the subject matter to be insured.
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.
Principles of indemnity
A contract of insurance contained in a fire, marine, burglary or any other policy (except Life assurance and personal accident and sickness insurance) is a contract of indemnity. This means that the insured, in case of loss against which the policy has been issued, shall be paid the actual amount of loss not exceeding the amount of the policy, i.e. he shall be fully indemnified. The maximum amount of compensation does not exceed the amount of actual loss or the value of the policy whichever is less. The object of every contract of insurance is to place the insured in the same financial position, as nearly as possible, after the loss, as if the loss had not taken place at all. It would be against public policy to allow an insured to make a profit out of his loss damage.
The principle of indemnity does not apply to life insurance and other personal accident insurance because loss of one individual life cannot be measured in terms of money. Under the contract of life insurance, a fixed sum is agreed to be paid either on the expiry of a certain period or on the death of the insured. Fire insurance is a contract of indemnity whereby the insured cannot claim anything more than the value of goods lost or damaged by the fire or the amount of the policy whichever is less. The amount of the indemnity or compensation will be the market value of the property or goods at the place and as on the date of the loss or damage of property by fire. According to the principle of indemnity (1)The insured can be indemnified only up to the extent of actual loss and (2) the sum of indemnity can never exceed the value of the policy taken. If there is under insurance, then the loss is indemnified proportionally. That is
Amount of indemnity = Actual Loss* Value of the policy/Value of the subject matter
In the case of marine insurance, there is small deviation from the principle of indemnity. The amount of indemnity is decided at the time of taking the policy and in some cases at the time of loss. In marine insurance the insure agrees to indemnify the insured in cash and not by replacing the cargo or the ship.
Main features of the principle of indemnity
- All contracts of insurance except the life insurance and personal accident insurance are contracts of indemnity.
- The amount of indemnity should not exceed the amount of actual loss or the value of the policy whichever is lower.
- The marine insurance is not a pure indemnity contract.
- The doctrine of subrogation is applied after the settlement of the claims.
- Valued policies except marine insurance are not covered under the scope of the principle of indemnity.
The following conditions are to be fulfilled for the complete application of the principle of indemnity.
- It is the duty of the insured to prove that he will suffer loss on the insured subject matter at the time of happening of event and the loss is actual monetary loss.
- Indemnification should not be more than the amount insured.
- If the insured gets more amount than the amount insured, the insurer has the right to get back the excess amount paid.
- If the insured gets an amount from third party alter receiving the full amount of indemnity, then the insurer have the right to receive full amount paid by the third party.
- The principle of insurance is not applied in the case of personal and life insurance because the amount of loss cannot be calculated easily.
Method of indemnity
The following are the important method s of indemnification.
- Cash payment: The insurer pays the amount of the claim to the insured in cash. After receiving the claim form, the insurer conducts a proper inquiry. On the basis of the surveyor’s report, the amount of actual loss is ascertained and paid to the insured in cash or in cheque.
- Repairs: In certain cases, the subject matter may be partially damaged or destroyed. It is also capable of being repaired. In such circumstance, the insurer takes steps to repair the damaged property instead of paying cash.
- Replacement: If there is no possibility of repair, the insurer may make arrangement for replacing such subject matter. This method is generally followed in the case burglary or theft.
- Reinstatement: This method is rarely used. It is used mainly in the case of buildings or other properties damaged or destroyed by fire.
Principles of Subrogation
The doctrine of subrogation is a corollary to the principle of indemnity and applies only to fire and marine insurance. It is also known as ‘doctrine of rights substitution.’ According to it, when an insured has received full indemnity in respect of his loss, all rights and remedies which he has against third person will pass on to the insurer and will be exercised for his benefit until he (the insurer) recoups the amount he has paid under the policy. It must be clarified here that the insurer’s right of subrogation arises only when he has paid for the loss for which he is liable under the policy and this right extend only to the rights and remedies available to the insured in respect of the thing o which the contract of insurance relates.
It is the transfer of the right and remedies of the insured in ne subject matter to the insurer after indemnification. The Surer steps into the shoes of the insured after settling e claim. Further he is entitled to all rights of action against the third party to cover the loss from the responsible person regarding the subject matter of insurance after the claim of the insured have been fully settled or paid.
According to the Federation of insurance Institutes,” subrogation is the transfer of rights and remedies of the insured to the insurer who has indemnified the insured in respect of the loss”. The doctrine of subrogation does not apply in the case of personal insurance because the principle of indemnity is not applicable to such insurance. If the insured has got certain compensation from third party before being fully indemnified by the insurer, the insurer can pay only the balance of the loss. The principle of subrogation is introduced with the objective of safeguarding the interests of the insurers.
Features of subrogation
- It is an extension of the principle of indemnity.
- It is applicable to all contracts of indemnity.
- It arises only after the payment of the claim by the insurer to the insured.
- The right of subrogation may arise even before indemnification of the insured except in the case of marine insurance.
- As per the principle of subrogation the insurer has the right to sue against third party.
- If the insured gets any money from the third party as compensation after indemnification by the insurer, the insured can hold that amount of such compensation as a trustee for the insurer.
- Under the principles of subrogation insurer cannot recover anything more than the amount of indemnification paid to the insured.
Principle of Causa Proxima
The term causa proxima means nearest or proximate or immediate cause. In other words the rule of causa proxima means that the cause of the loss must be proximate or immediate and not remote. If the proximate cause of the loss is a peril insured against, the Insured can recover. If the real cause of the loss is insured, the insurer is liable to pay compensation. Otherwise the insurer is not liable to pay compensation. Proximate cause means the active efficient cause that sets in a motion of events which brings about a result. When a loss has been brought about by two or more causes, the question arises as to which is the causa proxima, although the result could not have happened without the remote cause. But if the loss is brought about by any cause attributable to the misconduct of the insured, the insurer is not liable.
It is mainly applicable in the case marine insurance. According to section 55 of the Marine insurance Act 1963, the insurance company is liable to indemnify only those losses which has been caused by proximate or nearest cause covered under the policy and not for other remote causes. Proximate cause has been defined in a well known case of Pawsey Vs Scottish Union and National Insurance Company. According to this case, proximate cause is the effective efficient cause that sets in motion a train of events which brings about a result, without the intervention of any force started and working actively from a new independent source”.
AS per this definition the causa proxima means the direct, the most dominant and most effective or efficient cause which results in to a definite loss. For example an insured suffered injuries in an accident. He was admitted to the hospital. He contracted an infectious decease while undergoing the treatment. He dies due to this infectious decease. The court held that the proximate cause of his death was infectious decease and not the injury. The original accident was not the remote cause. So the claim cannot be payable under personal accident insurance.
Determination of proximate cause
If there is single cause then there is no problem of determining the cause. If there are concurrent causes (causes occurring simultaneously), then the causes are to be segregated into insured perils and exempted perils. When there is a chain of events causing the loss to the subject matter insured, the insurer’s liability would arise if the original cause event is the insured peril. In case the chain of events is broken by the intervention of a new and independent cause, the insurer’s liability depends upon whether the new peril, cause or event is an insured peril or an exempted peril. It is the duty of the insured to prove that the loss is proximately caused by the insured peril.
Principle of Mitigation of Loss
In the event of some mishap to the insured property, the insured must take all necessary steps to mitigate or minimize the loss, just as any prudent person would do in those circumstances. If he does not do so, the insurer can avoid the payment of loss attributable to his negligence. But it must be remembered that though the insured is bound to do his best for his insurer, he is, not bound to do so at the risk of his life. Mitigation of loss means to minimize or reduce the severity of loss.
Principle of contribution
Principle of contribution is another outcome of the principle of indemnity. Where there are two or more insurance on one risk, the principle of contribution comes into play. The aim of contribution is to distribute the actual amount of loss among the different insurers who are liable for the same risk under different policies in respect of the same subject matter. Any one insurer may pay to the insured the full amount of the loss covered by the policy and then become entitled to contribution from his co-insurers in proportion to the amount which each has undertaken to pay in case of loss of the same subject-matter. Contribution is the right of the insurer, who has paid under a policy, to call upon other insurers or otherwise liable for the same loss to contribute the payment. The doctrine ensures equitable distribution of losses between different insurers.
In other words, the right of contribution arises when..
- there are different policies which relate to the same subject-matter
- the policies cover the same peril which caused the loss, and
- all the policies are in force at the time of the loss, and
- one of the insurers has paid to the insured more than his share of the loss.
According to marine insurance act a warranty is that by which the assured undertakes that some particular thing shall or shall not be done, or that some conditions shall be fulfilled, or whereby he alarms or negatives the existence of a particular state of tact’s. A warranty in a contract of marine insurance is substantially the same as a condition in a contract of sale of goods. These are the conditions and promises in the insurance contract. It gives the aggrieved party the right to avoid the contract. Warranty 1s an important condition in the insurance contract which is to be fulfilled by the insured.
There are two types of warranties. Expressed warranties and implied warranties. Ii the conditions are mentioned in the policy, it is called express warranties. There are certain warranties which are not mentioned in the policy. Such warranties are called implied warranties. It is an important condition in the insurance contract which is to be fulfilled by the insured. If there is breach of warranty, the insurer is not liable to pay compensation.
An express warranty 1s one, which is expressly stated in the policy of insurance it must be included in or written upon the policy. There is no limit to the number of express warranties, but those generally included in a marine policy are that the ship is seaworthy on a particular day, that the ship will sail on a specified day, that the ship will proceed to its destination without any deviation and that the ship is neutral and will remain so during the voyage.
Implied warranties are conditions not incorporated in a policy but assumed to have been included in the policy by law, custom or general agreement. These warranties are:
- Seaworthiness: A ship is deemed to be seaworthy when she is reasonably it in all respects to encounter the ordinary perils of the sea or the adventure insured. This warranty attaches only up to the time of the sailing of the ship. In a time policy there is no implied warranty that the ship shall be seaworthy at any stage of the adventure. In a voyage policy where the voyage is to be performed in stage, the ship must be seaworthy at the commencement of each stage, it must be fit to encounter the ordinary perils of the part and if the voyage policy is on goods, it must be fit to carry the goods to the destinations contemplated by the policy
- Legality of the Voyage: There is an implied warranty that the adventure insured is a lawful one and that the adventure shall be carried out in a lawful manner.
- Non-deviation: The warranty that the ship shall not deviate from its prescribed. Usual or the customary route is also an implied warranty. The risk does not attach ill the places of departure or destination of the ship are hanged, or if the ship takes the ports of call by an order different from the one mentioned in the policy. The insurer is discharged From his liability as from the time of devein, and also 1l there is unreasonable delay is excuse under certain circumstances.