"Safeguarding Tomorrow: Unveiling the 7 Essential Principles of Insurance"

Principles of Insurance

Insurance is a contractual agreement between two parties, where one party commits to indemnify or compensate the other party for losses in exchange for a monetary consideration. The party providing the coverage is referred to as the insurer, while the party receiving the coverage is known as the insured. The payment made by the insured to the insurer is termed as the premium. Insurance aims to mitigate individual risk by spreading it across a larger group and providing compensation exclusively to those experiencing losses. Various types of insurance exist, such as Health Insurance, Life Insurance, Marine Insurance, Fire Insurance, and more. 

 

For example, As an illustration, Sam has acquired a Car Insurance Policy from Pioneer with a coverage amount of $200,000. He is obligated to make an annual payment of $1,500 as the premium. In this scenario, Pioneer assumes the role of the insurer, Sam is the insured party, the insured amount is $200,000, the annual payment is $1,500, and the comprehensive document outlining all the terms and conditions of the insurance arrangement is termed the Insurance Policy. Should any unfortunate events, as specified in the insurance policy, befall Sam, the insurance company (Pioneer) will disburse the agreed-upon sum to Sam or the designated nominee, as applicable.

 

1. Principle of Utmost Good Faith

An insurance agreement is characterized by the principle of 'uberrimae fidei,' signifying that it is a contract established in the utmost good faith. This principle emphasizes that both parties involved in the insurance contract must exhibit good faith towards each other. Furthermore, it mandates clear communication of terms and conditions in an unambiguous manner by both parties. Specifically, the insurer is duty-bound to provide precise details about the contract to the insured, who reciprocates by disclosing all pertinent details related to the subject matter for which the insurance is sought. In essence, this principle underscores the necessity for transparency between the contracting parties.

Failure on the part of the insured to disclose material facts during the contract formation renders the insurance contract voidable at the discretion of the insurer. Similarly, the insurer is under an obligation to transparently communicate all terms and conditions associated with the insurance contract.

 

A material fact is a factual information that has the potential to impact the insurer's decision regarding the acceptance or rejection of risk, the adjustment of premium rates, or the establishment of insurance conditions.

 

For example, Sam, a frequent drinker and smoker, obtained a health insurance policy. However, he neglected to disclose his tobacco consumption to the insurance company. Subsequently, he was diagnosed with cancer. In this instance, the insurance company is not obliged to bear the financial responsibility as Sam withheld vital information about his habit.

 

2. Principle of Proximate Cause

Losses can arise from two main factors: Insured Perils and Uninsured Perils. The Principle of Proximate Cause stipulates that the insurer is only responsible for losses directly caused by the perils specified in the insurance policy. In cases where an insured experiences a loss due to two or more causes, the proximate cause, being the most dominant and effective, is the one for which the insurer is liable. The insurer bears no responsibility for losses caused by uninsured perils.

To elaborate, if an insured undergoes a loss resulting from multiple causes, the insurance company investigates the most immediate cause. Compensation is provided if the proximate cause aligns with the peril covered by the insurance policy. Conversely, if the immediate cause deviates from the policy's stipulations, no compensation is granted to the insured. However, when the causes of loss involve a combination of different insured and uninsured perils, the evaluation of the claim becomes complex for the insurance company.

 

For example, In the first scenario, when a building's wall was consumed by flames, leading the local government to order its dismantling, the adjacent building suffered destruction. The owner of the adjacent building, having a fire insurance policy, is eligible to receive insurance funds. The reason is that fire, being the closest cause of the destruction, falls within the perils covered by the insurance contract.

In a parallel situation, a building damaged by fire experienced the collapse of its wall due to a subsequent storm, preventing restoration and causing harm to the adjacent building. The owner of the latter building had fire insurance. In this case, the remote cause of the loss is fire, and the storm is considered the 'Causa Proxima' or the proximate cause. Consequently, no compensation shall be provided in this situation.

 

 

 

3. Principle of Insurable Interest

 

Insurable Interest refers to having an economic or pecuniary stake in the subject matter covered by an insurance policy or contract. The Principle of Insurable Interest asserts that the insured must possess insurable interest in the subject matter of the insurance. An individual or insured is deemed to have an insurable interest if any harm to the subject adversely impacts the insured. The insured must either own the entire or a portion of the subject, or be adversely affected by any harm to the subject. For instance, an individual has insurable interest in their parents as opposed to a stranger.

 

Insurable Interest plays distinct roles in various types of insurance:

 

1. Life Insurance: The presence of insurable interest at the time of contract is imperative. For example, if a woman took a Life Insurance Policy for her husband and they later divorced, but the husband passed away due to a heart attack, the wife would still receive compensation because, at the time of insurance, the husband (insurable interest) was present.

 

2. Property Insurance: The insurable interest of the insured must exist at the time of entering into the insurance contract. It doesn't necessarily mean that the insured must own the property at the time of contract formation.

 

3. Fire Insurance: In fire insurance, insurable interest must be present both at the time of entering into the insurance and at the time of the loss. For example, if Sahil took a Fire Insurance Policy for his Art Studio and the studio suffers a loss due to fire, he can claim compensation. However, if he sells the Art Studio before the fire occurs, he cannot claim compensation for the fire loss.

 

4. Marine Insurance: The insurable interest of the subject must be present at the time of loss in the case of marine insurance.

4. Principle of Indemnity 

Indemnity refers to 'Security against Loss.' The Principle of Indemnity is designed to restore the insured, in the event of a loss, to the precise position they held immediately before the occurrence of the event. In simpler terms, the insured party in an insurance contract can recover the loss suffered up to the limit specified by the insurance policy. The compensation provided to the insured for their loss is quantified in monetary terms. Additionally, the insured is prohibited from gaining any profit from the unfortunate or unforeseen event.

While all life and marine insurance contracts operate on the principle of indemnity, it's noteworthy that a life insurance contract does not strictly adhere to this principle. This is because the loss incurred upon the death of the insured cannot be precisely measured in monetary terms.

 

For example, Jack has insured his house for $800,000 against fire, and he experiences a loss amounting to $500,000. In this scenario, the insurance company will compensate him solely for the actual loss incurred, which is $500,000, rather than the total policy amount of $800,000.

 

5. Principle of Subrogation

In adherence to the Principle of Subrogation, once the insurer has compensated the insured for the subject matter, the insurer acquires all rights against any third party involved. This principle is applicable to all insurance contracts categorized as 'Contracts of Indemnity.'

 

For example, Tom secured insurance coverage for his sports car, valuing it at $1,000,000. Unfortunately, the car was stolen, and the insurer will provide compensation for the incurred loss as per the policy terms. However, should Tom recover his sports car subsequently, the insurance company (insurer) will possess full rights to the vehicle. This is because the insured has already received compensation for the loss and is prohibited from deriving any profit from the situation.

 

6. Principle of Contribution

 

In accordance with the Principle of Contribution, an insurer who has already disbursed the claim amount to the insured retains the right to seek proportionate contribution from other insurers involved. This principle allows an insured to obtain multiple policies for a given subject or property. However, in the event of a loss to the subject or property, the insured cannot claim more than the total compensation amount corresponding to the actual loss. In other words, if the insured receives the entire sum of the actual loss from one insurer, they are not entitled to seek additional funds from another insurer. Nevertheless, the insurer that has fully compensated the insured has the right to recover a proportionate contribution from the other insurer. The principle aims to equitably distribute losses among the insurers involved.

 

For example, Mark buys an insurance policy of $40,000 for a property of $80,000 from Insurer X and $20,000 from Insurer Y. He suffered a loss of $ 30,000, which he can claim from both the insurers. The proportionate liability of Insurer X and Insurer Y will be

      = $20,000

     = $10,000

 

 

7. Principle of Mitigation 

The Principle of Mitigation dictates that the insured has a responsibility to undertake reasonable measures to mitigate the damage or loss to the insured subject or property. This principle is designed to prevent the insured from neglecting the safeguarding of the insured property or subject after obtaining the policy to cover associated risks. Failure on the part of the insured to exercise reasonable care for the insured property may result in a potential loss of the claim amount from the insurer.

 

For example, If a fire erupts in a factory covered by a Fire Insurance Policy, the owner is expected to take active measures to extinguish the fire and minimize the damage. Merely possessing an insurance policy for the factory does not entitle the owner to refrain from taking immediate action in such situations.