Question

Explain the principles of insurance.

Define any four principles of insurance with examples.

Answer 1

The principles of insurance are as follows:

1. Principle of Utmost good faith: As per this principle, there must be good faith and honesty between the insurer and the insured. Both of them must also disclose all material facts accurately. Insured must provide complete, clear and correct information of the subject matter while insurer must provide all the relevant information regarding terms and conditions. If complete, correct and clear information is not provided by either sides of the contract, it may result in non-settlement of claim.
   E.g.: Suppose a person takes a life insurance policy of ₹ 1 crore and dies a year later due to medical problem which he had not disclosed at the time of taking policy. In this case, the insurer can refuse to give compensation to family members as the person had not disclosed all the facts.
2. Principle of Insurable interest: As per this principle, the insured must have insurable or financial interest in the subject matter of insurance. In simple words, insurable interest exists when insured derives financial or any other kind of benefit from the insured object/person. Insurable interest is applicable to all insurance contracts.
   E.g.: i)A person has insurable interest in his own life and property.
   ii) A businessman has insurable interest in the goods he deals and business property.
   iii) In life insurance, the insurable interest refers to the life insured. In case of life insurance policy, insurable interest must exist at the time of taking policy. In fire and marine insurance, it must be present at the time of both, taking policy and occurrence of loss.
3. Principle of Indemnity: To indemnify means to compensate. In insurance terms, indemnify means an assurance (promise) to put the insured in the same financial position as he was before happening of the uncertain event. So, under this principle, insurer agrees to compensate insured for the actual loss suffered.
   The applicability of principle of indemnity is as follows:
   In case of fire, marine and general insurance, amount of compensation is limited to the amount assured or actual loss incurred, whichever is less.
   E.g.: If goods worth ₹ 3 Lac are destroyed and insured value if ₹ 4 Lac, then the insurance company shall pay the insured only ₹ 3 Lac. However, if the insured value is ₹ 2 Lac, it shall pay ₹ 2 Lac only and not ₹ 3 Lac.
   ii) Principle of indemnity does not apply to life insurance as the value of human life cannot be assessed in monetary terms. In case of death of insured, the actual sum assured is paid to the nominee.
4. Principle of Subrogation: This principle is applicable to all contracts of indemnity. As per this principle, after the insurer pays compensation to the insured, legal right of the insured property gets transferred to the insurer. This principle is applicable only when the damaged property has any value after the unforeseen event causing damage.
   E.g.: Suppose Mr. Sharma owns a two-wheeler, which gets stolen. Upon receiving report from police, insurance company would compensate Mr. Sharma for the loss. Later on, if the stolen vehicle is recovered by police, insurer has right to sell or to scrap the said vehicle. This is because Mr. Sharma has already subrogated i.e. transferred the ownership rights of the vehicle to the insurer.
5. Principle of Contribution: This principle is an extension to or supplementary to the principle of indemnity. If a person has taken insurance for one property from more than one insurance company, even then the compensation paid to him cannot exceed the actual loss suffered. If one insurer pays full compensation, then that insurer can claim proportionate share from other insurers. Similarly, insured himself can claim for proportionate from all the insurer.
   E.g.: Mr. A had insured his stock in trade worth ₹ 50 lacs with three insurers; GIC for ₹ 25 lacs, Bajaj Allianz for ₹ 10 Lacs and ICICI Prudential for ₹ 15 Lacs. Suppose there was a fire in the warehouse and stock worth ₹ 20 lacs was destroyed. In this case, there are two options:
   Option 1: Mr. A can claim full loss from GIC and GIC can claim a proportionate claim from Bajaj Allianz and ICICI Prudential.
   Option 2: Mr. A can claim the loss of ₹ 20 lacs in the ratio of value of the policy i.e. ₹ 10 lacs from GIC, ₹ 4 lacs from Bajaj Allianz and ₹ 6 lacs from ICICI Prudential.
   In any case, Mr. A can get a maximum compensation of ₹ 20 lacs only.
6. Principle of Mitigation of loss: As per this principle, insured must try his best to minimise the loss to the insured property on the happening of uncertain event. He should not be negligent or inactive just because the property is insured. It is his responsibility to take all the necessary steps to control and reduce the losses.
   E.g.: If there is a fire in the office of a company, then the officials should use the fire extinguishers and call the fire brigade immediately to reduce further loss. They should not be inactive just because the property is insured.
7. Principle of Causa-Proxima: As per this principle, when loss is caused by more than one causes, then the most proximate or nearest cause must be considered to decide the liability of the insurer. This is because the property may be insured against the risk of loss from a certain causes (and not against all causes). If the proximate cause is the one against which the property is insured, the insurance company is bound to pay compensation and vice versa.
   E.g.: A cargo of rice was destroyed by sea water which flooded the ship when it collided with an iceberg. In this case, there are two possible causes for loss: Collusion of the ship with the ice berg or sea water which flooded the ship. However, the nearest cause of damage is sea water. If the cargo is insured against loss due to sea water, then the insurance company is bound to compensate for the loss. However, if the cargo was insured against loss due to collision, the insurance company is not liable to compensate for the damage.