Principles of Insurance

This article helps the student to understand the legal principles and provisions of
the insurance law. Starting with the fundamentals from which law is derived, this
article help the student to understand the salient aspects of any insurance
contract, the rights and obligations of parties to the contract and the legal
environment within which insurance practice is carried out. Explore the seven
most important principles of insurance.
Every insurance policy involves a contractual relation between the insurer and
the insured. This article helps the student to understand the legal principles and
provisions of the insurance contracts. Starting with the sources from which law is
derived, the article takes the students through the salient aspects of any
insurance contract, the rights and obligations of both parties to the contract and
the legal environment within which insurance practice is carried out. These
principles are the essentials or requirements of insurance irrespective of the type
of insurance concerned. There are seven fundamental principles of Insurance
What is Insurance Law?
Insurance law is the name given to practices of law surrounding insurance,
including insurance policies and claims. It can be broadly broken into three
categories ! regulation of the business of insurance" regulation of the content of
insurance policies, especially with regard to consumer policies" and regulation of
claim handling. #t common law, the de$ning concept of a contract of commercial
insurance is of a transfer of risk freely negotiated between counterparties of
similar bargaining power, equally deserving %or not& of the courts protection.
In civil law countries insurance has typically been more closely linked to the
protection of the vulnerable, rather than as a device to encourage
entrepreneurialism by the spreading of risk. 'ivil law (urisdictions ! in very
general terms ! tend to regulate the content of the insurance agreement more
closely, and more in the favour of the insured, than in common law (urisdictions,
where the insurer is rather better protected from the possibility that the risk for
which it has accepted a premium may be greater than that for which it had
bargained. #s a result, most legal systems worldwide apply common!law
principles to the ad(udication of commercial insurance disputes, whereby it is
accepted that the insurer and the insured are more!or!less equal partners in the
division of the economic burden of risk.
)egal
*. #greement+ ,ecause words often fail to convey the precise meaning
intended the law of contracts generally adheres to the ob(ective theory of
contracts. -nder this theory, a party.s words and conduct are held to
mean whatever a reasonable person in the o/eree.s position would think
they meant.
0. 1/er ! #n o/er must have reasonably de$nite terms so that a court can
determine if a breach has occurred and give an appropriate remedy.
2e$niteness is also required when a contract is modi$ed. #cceptance!
#cceptance is a voluntary act by the o/eree.s that shows assent to the
terms of the o/er. The o/eree.s act may consist of words or conduct
3. 'onsideration! 'onsideration is usually de$ned as the value given in
return for a promise. 'onsideration is broken down into two parts The
4something of legally su5cient value6 may consist of %*& a promise to do
something that one has no prior legal duty to do, %0& the performance of
an action that one is otherwise not obligated to undertake, and %3& the
refraining from an action that one has a legal right to undertake. The
second element of consideration is that it must provide the basis for the
bargain struck between the contracting parties. The consideration given
by the promisor must induce the promise to incur a legal detriment either
now or in the future. )egal su5ciency of consideration involves the
requirement that consideration be something of value in the eyes of the
law. #dequacy of consideration involves 4how much6 consideration is
given. #dequacy concerns the fairness of the bargain. 'ourts do not
question the adequacy of consideration if the consideration is legally
su5cient. -nder most circumstances, a promise to do what one already
has a legal duty to do does not constitute legally su5cient consideration
because no legal detriment is incurred. 7romises made in return for
actions or events that have already taken place are unenforceable.
8. 'apacity+ 9inors usually are not legally bound by contracts. In almost all
states, the age of ma(ority for contractual purposes is *:. The general
rule is that a minor can enter into any contract an adult can, provided that
the contract is not one prohibited by law for minors.
;undamental
Principle1: Principle of Utmost Good Faith:
7rinciple of -tmost <ood ;aith is the primary principle of insurance. The doctrine
of uberrimae $des ! utmost good faith ! is present in the insurance law of all
common law systems. #n insurance contract is a contract of utmost good faith.
The most important expression of that principle, under the doctrine as it has
been interpreted in England, is that the prospective insured must accurately
disclose to the insurer everything that he knows and that is or would be material
to the reasonable insurer.
Something is material if it would in=uence a prudent insurer in determining
whether to write a risk, and if so upon what terms. If the insurer is not told
everything material about the risk, or if a material misrepresentation is made,
the insurer may avoid %or >rescind>& the policy, i.e. the insurer may treat the
policy as having been void from inception, returning the premium paid.
In a nutshell, a higher degree of honesty is imposed on an insurance contract
than is imposed on other contracts. ?onesty is mainly imposed on the insurance
applicants. It is supported by three legal doctrines" @epresentation, 'oncealment
A Barranty. #ccording to this principle, the insurance contract must be signed by
both parties %insurer and insured& in an absolute good faith or belief or trust.
,oth parties in the contract must disclose all material facts for the bene$t of
each other. ;alse information or non!disclosure of any important fact makes the
contract voidable.
Principle2: Principle of Insurable Interest:
The person getting an insurance policy must have an insurable interest in the
property or life insured. # person is said to have an insurable interest in the
property if he is bene$ted by its existence and be pre(udiced by its destruction.
The presence of insurable interest is a legal requirement. So an insurance
contract without the existence of insurable interest is not legally valid and
cannot be claimed in a 'ourt. The ob(ect of this principle is to prevent insurance
from becoming a gambling contract.
9ost common law (urisdictions require the insured to have an insurable interest
in the sub(ect matter of the insurance. #n insurable interest is that legal or
equitable relationship between the insured and the sub(ect matter of the
insurance, separate from the existence of the insurance relationship, by which
the insured would be pre(udiced by the occurrence of the event insured against,
or conversely would take a bene$t from its non!occurrence.
Insurable interest was long held to be morally necessary in insurance contracts
to distinguish them, as enforceable contracts, from unenforceable gambling
agreements %binding >in honor> only& and to quell the practice, in the
seventeenth and eighteenth centuries, of taking out life policies upon the lives of
strangers. In case of life insurance policies, insurable interest must exist at the
time of a policy inception, but not at the time of a loss %death&.
The intent behind this principle is that the insured must be in a position to
$nancially su/er if a loss occurs. This principle helps in preventing gambling by
way of taking insurance on a property and waiting for a loss occur. In case of life
insurance contracts it reduces moral haCard whereby a person takes life
insurance on a person and prays for hisDher death for insurance proceeds.
Principle3: Principle of Indemnit:
The essence of insurance is the principle of indemnity that the person who
su/ers a $nancial loss is placed in the same $nancial position after the loss as
before the loss occurred. ?e neither pro$ts nor is disadvantaged by the loss. In
practice, this is much more di5cult to achieve in life insurance than in property
insurance. Eo life insurance company would provide insurance in an amount
clearly exceeding the estimated economic value of the covered life. )imiting the
amount of life insurance sold to re=ect economic value gives recognition to the
rule of indemnity. #dditionally, only persons exposed to the potential loss may
legitimately own the insurance covering the insured.s life.
The principle of indemnity is applicable to all types of insurance policies except
life insurance. Indemnity means security, protection and compensation given
against damage, loss or in(ury. The insurer promise to help the insured in
restoring the $nancial position before loss has occurred. Bhenever there is a loss
of property, the loss is compensated. The compensation payable and the loss
su/ered should be measurable in term of money. The insured will be
compensated only up to the amount of loss su/ered by him. ?e will not earn
pro$t from the contractor. The maximum amount of compensation will be up to
the value of the policy which is $xed at the time of contract. The courts rely upon
the principle of indemnity to hold that an insured may not recover more than his
true loss.
Principle!: Principle of "ubro#ation:
Subrogation means substituting one creditor for another. 7rinciple of Subrogation
is an extension and another corollary of the principle of indemnity. It also applies
to all contracts of indemnity. #ccording to the principle of subrogation, when the
insured is compensated for the losses due to damage to his insured property,
then the ownership right of such property shifts to the insurer. It must be clari$ed
here that the insurerFs 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 to which the
contract of insurance relates. The principle of subrogation is applicable to all
insurances other than the life insurance. If the insured party gets a
compensation for the loss su/ered by him, he cannot claim the same amount of
loss from any other party. It prevents the insured being indemni$ed from two
sources in respect of the same loss.
?ence this principle of subrogation provided for substitution of the insurer in
place of the insured for the purpose of claiming indemnity from a third party
wrongdoer for a loss paid by the insurer. This helps in preventing collecting twice
by the insured, to hold the negligent party responsible and to bring down
insurance rates.
Principle$: Principle of %ontribution:
Sometimes a property is insured with more than one company. The insured
cannot claim more than total loss from all the insurance companies put together.
?e cannot claim the same loss from di/erent insurance companies. If one insurer
pays full compensation then that insurer can claim proportionate claim from the
other insurers. # person cannot be restored to a better position than before the
loss occurred. The total loss su/ered by the insured will be contributed by
di/erent companies in proportion to the value of policies issued by them.
7rinciple of 'ontribution is a corollary of the principle of indemnity. It applies to
all contracts of indemnity, if the insured has taken out more than one policy on
the same sub(ect matter. #ccording to this principle, the insured can claim the
compensation only to the extent of actual loss either from all insurers or from
any one insurer. If one insurer pays full compensation then that insurer can claim
proportionate claim from the other insurers.
Principle&: Principle of Pro'imate %ause:
7rinciple of 7roximate 'ause means when a loss is caused by more than one
causes, the proximate or the nearest or the closest cause should be taken into
consideration to decide the liability of the insurer. This principle is found very
useful when the loss occurred due to series of events. The principle states that to
$nd out whether the insurer is liable for the loss or not, the proximate %closest&
and not the remote %farthest& must be looked into.
?owever, in case of life insurance, the principle of 7roximate 'ause does not
apply. Bhatever may be the reason of death the insurer is liable to pay the
amount of insurance.
-nder this rule, in order to determine whether a loss resulted from a cause
covered under an insurance policy, a court looks for the predominant cause
which sets into motion the chain of events producing the loss, which may not
necessarily be the last event that immediately preceded the loss.
Principle(: Principle of Loss )inimi*ation:
#ccording to the 7rinciple of )oss 9inimiCation, insured must always try his level
best to minimiCe the loss of his insured property, in case of sudden events like
$re etc. The insured must take all necessary steps to control and reduce the
losses and to save what is left. This principle makes the insured more careful in
respect of this insured property, (ust as any prudent person would do in those
circumstances. If he does not do so, the insurer can avoid the payment of loss
attributable to his negligence. ,ut it must be remembered that though the
insured is bound to do his best for his insurer, he is, not bound to do so at the
risk of his life.
The insured must not neglect and behave irresponsibly during such events (ust
because the property is insured. ?ence it is a responsibility of the insured to
protect his insured property and avoid further losses.
9iscellaneous
*. 7rinciple of assignment!Transfer by the holder of a life insurance
policy %the assignor& of the bene$ts or proceeds of the policy to
a lender %the assignee&, as a collateral for a loan. In the event of
the death of the assignor, the assignee is paid $rst and the balance %if
any& is paid to the policyFs bene$ciary. 1ther types of insurance
policies may not be used for this purpose.
0. 'onditional contract! #n insurance policy is also a contract. This insurance
contract between the insurer and the insured has many basic contract
principles. It is often considered a personal contract where the loss that is
paid is based on the loss to the person that holds the policy. The policy is
also conditional contract where the insured has certain conditions that
they must meet before the insurer is required to pay any bene$t. #lso,
since the insured typically cannot negotiate terms of terms of the contract,
any uncertainties in the contract will usually conclude to the advantage of
the insured party. ;inally, insurance contracts are usually considered
contracts of indemnity.
#s always, you should understand and read your insurance policy
understanding that it is a contract. -nderstand what it covers and, maybe
more importantly, what it doesnFt cover. #sk the insurance agent
questions and make sure get a good straight answer that can be veri$ed
with written contract.
3. 'ontracts of adhesion! Insurance contracts are generally
considered contracts of adhesion because the insurer draws up the
contract and the insured has little or no ability to make material changes
to it. This is interpreted to mean that the insurer bears the burden if there
is any ambiguity in any terms of the contract. Insurance policies are sold
without the policyholder even seeing a copy of the contract.
8. Insurance contracts are unilateral, meaning that only the insurer makes legally enforceable
promises in the contract. The insured is not required to pay the premiums, but the insurer is
required to pay the benefits under the contract if the insured has paid the premiums and met
certain other basic provisions.
G. @eturn of 7remium
Insurance policies are often o/ered with the option of guaranteeing
that you, or your bene$ciary, will receive at least the amount of money
you paid into the plan for the coverage.
Term life insurance policies have started to o/er this option as a way
to assure the buyer that they will not be throwing their money away.
@egular term life policies will only pay a bene$t if you die while the
policy is in force. If you are still alive at the end of the term you get
nothing.
The return of premium option also gives the buyer an incentive to
continue paying the premium for the entire term of the policy or risk
losing their money altogether.
If you have any real doubt about being able to pay the premium for the
entire period, you should probably not take this option.
Some )ong Term 'are Insurance policies also o/er this option.