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Principles of Insurance
As you known insurance is a form of contract between the insurance company i.e the insurer and the policyholder. For this contract to hold valid there are certain principles that must be ensured. The principles of insurance are mentioned below and explained one by one.
- Law of large numbers
- Principle of Insurable interest
- Principle of Utmost good faith
- Principle of Indemnity
- Principle of Subrogation
- Principle of Contribution
- Principle of Proximate cause
Law of large numbers
It states that the more the number of members who are insured, the more likely it is that the actual result (that actually occur- like the number of death that takes places which would result in payment by the insurer) would be closer to the expected (as calculated by the insurance company).
Principle of Insurable interest
Insurable interest is the term used to describe the relationship between the insured and the subject matter of insurance. A person is said to have an insurable interest in something (say A) that he would have benefit from its existence (of A) and loss from its destruction (of A).
Suppose a person named Vijay wants to buy an health insurance policy for
Case A: his family members
Case B: his neighbor
In Case A, its an Insurable interest he benefits from the good health and suffers a financial loss by way of hospital expenses if one of the members of his family falls ill. Hence he can buy the policy for his family members.
In case B, It is not an Insurable Interest since Vijay does not suffer any financial loss due to his neighbour falling ill. So Vijay cannot buy an insurance policy for his neighbour.
Principle of Utmost good faith
Disclosure of all material information from both the parties.
The Principle of Utmost good Faith denotes a positive duty of the person seeking insurance to voluntarily disclose accurately and fully, all facts material to the risk being proposed whether requested or not.
Example: The insurance company sells the insurance policy to cover the risks of the proposer (who will buy the policy). When the insurer enters the contract of insurance he is only able to guess the chance of the loss and the amount of the loss that may happen (which would be huge compared to the premium collected) based on his knowledge of the ‘risk’ that he is accepting and based on the data that the policy buyer is disclosing.
If the policy buyer does not discloses the correct data, the insurer may guess wrong chances of loss and amount.
The insurer can assess the probability of loss (depending on which he decides to accept the risk and charge the premium) only based on what the insured tells him about the risk.
Similarly, the insured would not understand what the benefits are in relation to the cost paid (premium paid) unless the same are made known to him to enable him to make an informed choice.
Disclosure of all material information has to be made by both the parties to the contract. Hence the contracts of insurance are referred to as contracts of utmost good faith.
- In respect of insuring a factory, one must disclose the type of construction of the building and the nature of goods stored;
- In the case of goods in transit (Marine Cargo insurance), the method of packing and the mode of transportation has to be disclosed.
iii. In the case of life insurance, the state of the health of those proposed for insurance, details of past ailments and the treatments done have to be disclosed.
Principle of Indemnity
In one line it means – You get compensated for what you lose – no more, no less.
The insurance company will pay up to the amount of the incurred loss or the insured amount agreed on in the contract, whichever is less.
Example: You buy an insurance policy for your shop for risk upto Rs.5,00,000.
Case A: Your shop catches fire and goods worth Rs 1,00,000 gets burn. In this case you will only Rs 1,00,000 from the insurance company as you have suffered this much loss. You will not get the full Rs 5,00,000 as in such case the remaining Rs 4,00,000 would become your profit. Insurance is a product to cover your risk and not for making profit.
Case B: Your shop catches fire and goods worth Rs 6,00,000 gets burn. Here you would get only Rs 5,00,000 as that is the maximum amount for which your shop is insured.
Principle of Subrogation
The taking over of the insured’s right to claim the insurance by the insurer so that he/she may not claim the insurance multiple times is called ‘subrogation’. So the insured will not be able to make a profit from the damaged property or sell it. So, the insured’s right to claim from anywhere else is taken over by the insurer when he pays a claim
Understand this by an example:
Mr. Ajay gets transferred from Dehradun to Kolkata. Ajay sends his household goods worth Rs.2,00,000 through M/s. Vijay Transports. During the transit, part of the goods got damaged due to the truck driver’s negligence.
The insurer assessed the loss and found that the value of the damage was Rs. 50,000 and paid this amount to Ajay as indemnity.
However Ajay took up the matter against M/s Vijay Transports with the Court of Law and the Court ordered M/s. Vijay Transports to pay Rs.50,000 to Ajay. Having already received Rs.50,000 from the insurer, Ajay would be making a profit out of the loss if he gets Rs.50,000/- from the transporter also.
In such situations, the insured’s right to claim from anywhere else is taken over by the insurer when he pays a claim. Since the insurer has paid the amount of loss to the insured, the insurer would be the one who has borne the loss. Hence, the name of the insurer should be substituted for the insured and the right to recover the amount of loss from the person causing loss has to be transferred to the insurer who paid for the loss and compensated the insured.
Principle of Contribution
This principle comes into play when a subject is insured by more than one insurer. The principle of contribution means that one insurer can ask the other insurers to contribute their share of the compensation. If the insured claims full insurance from one insurer he losses his right to claim any amount from the other insurers.
Example: Sanjay had a car worth Rs.5,00,000 and he took full insurance for this car from two insurance companies. The car got damaged in an accident and total loss was Rs.5,00,000. Sanjay filed a claim with the 1st company and got paid Rs.5,00,000. He goes to the 2nd insurance company and makes a claim for Rs.5,00,000. The second company informed Sanjay that he was not eligible for getting any more sum because he was already indemnified by the 1st Company. If the 2nd company had also paid him, he would have made a profit out of his loss, to the disadvantage of all the other members who had contributed premiums. So suppose Sanjay claims Rs 2,50,000 from 1st insurer he can claim the remaining Rs 2,50,000 from the other insurer.
Principle of Proximate cause
This principle comes into play when the loss is the result of two or more causes. The word ‘proximate’ means ‘nearness’ or ‘closeness’. The concept is that the cause that is ‘closest’ (in its effect) to the loss, is considered to decide whether a claim is payable or not.
Example: Ramesh had taken an accident insurance policy which covered death by accident. While walking on the road one day, he was hit by a car. He was rushed to the hospital. Being a person with a weak heart, he could not stand the shock of the event and died after a few hours from heart failure. The insurance company disputed the claim saying it was the heart attack rather than the accident which had caused his death. The court ruled that even though the immediate cause of death may have been collapse of the heart, the proximate cause of death was the accident and ordered the company to pay the claim.