Principles of Insurance

The principles of insurance are the set of rules which are applicable to the
agreement entered in by insurer and insured. The contract of insurance is based on
certain fundamental principles; some of them are common to life, fire, marine and
miscellaneous insurance. Fundamental principles of insurance are divided in to two
groups i.e. Primary Principles and Secondary Principles. These are discussed as
follows.
Primary Principles
Primary principles of insurance are the basic principles of insurance. These are
the backbone of insurance contract. Generally these principles are existing in all
types of insurance contract. These principles are as follows.
1. Principle of Insurable Interest –
Insurable interest means interest of the insured in the subject matter of
insurance. Prof. Hansell has defined insurable interest as “a financial involvement in
which is able to be insured”. It is the basic condition of insurance contract that
insured must possess insurable interest in the subject matter of insurance. The
insured should have monetary relationship with the subject matter. This monetary
relationship must be legally acceptable.
Insurable interest is the pecuniary interest whereby the insured is benefited by
the existence of the subject matter and is prejudiced by the death or damage of the
subject matter. In other words policy holder (insured) is economically benefited by
the survival or the existence of the subject matter and suffers economic loss vice
versa. This principle is applicable to all types of insurance contract.
When insurable interest is exist?
Generally, in life insurance contract the insurable interest should exist at the
time of taking insurance, while in marine insurance it should exist at the time of
indemnification. In case of fire and accident insurance it should exist both the time.
Who can hold Insurable Interest?
Husband and wife - Husband and wife both have unlimited insurable interest in
each other’s life. They can insure each other. For other relatives the right to insure
does not arise e.g. father, mother, independent son or daughter etc. unless some
economical interest in each other.
Partners - All partners have a mutual insurable interest in each other. The death
of any partner may cause an economical loss to other partner.
 Debtors and Creditors – A creditor has a right to insure the life of debtor to the
extent of his debt.

Trustee’s – Trustee’s, attorney, administrator have a right to insure property

entrusted to them.
Owner – Legal owner of the property has insurable interest in the said property.
Landlord and tenant – They have insurable interest to the extent of the rent.

Employers and employees – They have insurable interest in each other.

Employer has right to insure the key employees as well as employee can insure the
life of employer.
2. Principle of Indemnity –
It is important principle of the insurance contract. It is applicable to all types of
insurance contract excluding life insurance. Insurance is a contract of Indemnity.
Indemnity means a security against loss or compensation for loss. Such
compensation will be equal to the loss to the property. In other words the insured can
not earn any profit out of this contract. Indemnity restores the policy holder to the
same financial position after a loss as he can enjoy immediately prior to the loss.
Once the policy holder is indemnified, he has to surrender all his rights relating to
damaged property to insurance company.
Methods of Indemnification:
Usually there are three methods of indemnification. They are as follows.
Cash Payment – It is most suitable and user friendly method of payment of loss
of indemnity. Under this method actual loss is evaluated and payment in cash is done
to the insured.
Replacement / Reinstatement – Generally this method is used in fire
insurance. Both the parties prefer to settle the claim through replacement. The
insurance company replaces anew part the whole property. This concerns particularly
in fire insurance the rebuilding of premises to their former conditions.
Repairs – Under this method with the consent of the policy holder insurance
company repairs the damaged part of the property. Generally it is used for repair the
motor vehicles.
3. Principle of Utmost Good Faith –
Insurance contract is based upon the mutual trust and confidence between the
policy holder and insurance company. Utmost good faith means faith on each other;
this means each party to proposed contract is legally responsible to reveal to the
other party all material information relating to subject matter. Material information
means the information on which the decision of the other party to enter into contract
depends. In other words material fact means a fact that would influence the mind of a
prudent underwriter in assessing the risk. The policy holder should disclose and
provide all the facts to the insurance company otherwise the contract will become
invalid.
The responsibility of disclosing all the material information relating to the
subject matter lies with insured. Material fact includes the following.
The fact or information which increases the risk of the insurance company.
In case of life insurance, facts about life and health, family history, habits,
hereditary disease, risk increases due to profession etc.
In case of marine insurance, possibility of risk due to improper maintenance of
ship.
In case of burglary insurance, past history of burglary if any.
However certain facts are not included in material fact which is as follows.
The fact or information which reduces the risk of the insurance company.
The information which includes in the insurance contract.
The information easily obtained by insurance company etc.
4. Principle of Probability –
The theory of probability is the basis of insurance contract. The principle of
Probability means the chances of happenings of event and expected amount of loss.
Though the chances of incurring loss to any property are depend upon so many
factors and rates of premium are fixed in advance by considering these factors. This
theory is helpful for understanding the chances of losses and expected amount of
losses. In view point of insurance company the law of large numbers is an important
law. Probability of happening of certain event is applicable for large number. But
very few insured are suffers loss and they get compensation.
 5. Principle of Co-operation –
Professor Hansell define insurance is a social device providing financial
compensation for the effects of misfortune and the payment being made from the
accumulated contributions of all parties participating in the scheme. In other words
insurance is a co-operative measure for providing security against losses. The loss
occurs due to unfortunate event is divided into group of people. This concept of
insurance is also come into existence from ancient period. The loss is compensated
through social fund created by collecting money in the form of premium by way of co-
operative efforts. It is systematic mechanism of cooperating each other by a group of
persons who are expected to loss and actual loss suffered by anyone of them is shared
by all in the form of premium.
Secondary Principles of Insurance –
Basically insurance contract is the contract of indemnity. Secondary principles
are the outcome of the principle of indemnity. It includes the following.
1. Principles of Subrogation –
Subrogation means to exercise for own benefit, all rights and remedies which
insured possess against the third party. In other words for own benefit, the insurance
company comes to possess all the rights of the insured against the third person as
regards the subject matter can be claimed by the insurer after paying the claim.
According to Elelyn Thomas, “It is the right to which one person has to stand in
the place of another and avail himself of all the rights and remedies of that other.”
This principle is outcome of the principle of the indemnity. It is applicable only
when loss to the property is fully compensated. The payment of compensation twice
to the owner of the property is avoided. e.g. If motor car of the insured is damaged
by accident, insurance company may pay full amount of compensation to Mr. A. In
such case insurer will become entitle to all the rights of insured subject matter
against third party who is responsible to damage. Insured cannot claim amount for
damage from third party and insurance company at a time. If he gets excess amount,
it should be return to insurance company.
The right of subrogation may take place in any one of the following way.
Right arising out of tort
Right arising out of contract
Right arising out of salvage
Right arising out of contract
2. Principle of Contribution –
The principle of contribution is applicable when the policy holder takes the
insurance from two or more insurance companies on same risk or subject matter. In
such case payment towards compensation to insured by insurance company is to be
made proportionately. In other words the insurance company can call other insurance
company similarly liable to the same insured to share the cost of payment of
compensation. This principle ensures equitable distribution of losses between
different insurance companies. Under this principle insured cannot be prohibited
from taking more policies of the same property or risk with different insurance
companies but he is not allowed to make profit by way of double insurance.
For example, Mr. A has taken insurance of his house valued Rs.6 lakh with two
companies amounting to Rs. 600000 and Rs. 300000 respectively. House is fully
destroyed by fire in such case both the companies compensate the loss by
contributing proportionately as Rs. 400000 and Rs. 200000 (i.e. 2:1) respectively and
not in fully.
3. Principle of Mitigation of Loss –
The term mitigation means to minimize or take efforts to minimize. This
principle place a duty on the policy holder to make every effort and to take all such
steps to minimize the loss to the subject matter when unfortunate event take place. In
other words under this principle it is the duty of insured to take necessary steps to
minimize the loss, as if owner of uninsured property use to take. That means under
this principle he is expected to take prudent action to minimize the loss and to save
whatever is left. He must to take efforts to save the property from damages in case of
accident. If he fails to do so and it is found that he was silent or negligent at the time
of unfortunate event, the insurance company can avoid the amount of claim.
4. Principle of CausaProxima –
CausaProxima is the Latin word. It means Proximate Cause i.e. nearest cause.
Thus Proximate Cause of loss is that cause which is nearest in effectiveness and not
remote cause. At the time of payment of compensation, insurance company consider
the cause for loss which is an active cause that lead for mishap and loss occur to
subject matter. Generally this principle is used when actual cause of mishap is not
find out or cannot be fixed. If there are more than two causes operated at the same
time as a cause of loss and real cause is not found, in such case insurance company is
liable to pay loss or compensation by considering nearest cause of loss. Generally
this principle is used in marine insurance.
 Insurance Contract and Wagering Contract
Meaning of Insurance Contract:
Insurance is a contract between two parties i.e. insurer and insured. In this contract one
party (insurer) agree to compensate loss occurred due to perils to other party (Insured) by
taking consideration in the form of insurance premium.
Definition – “Insurance is a contract in which a sum of money is paid to the insured
person on happening of certain event in case of fire, marine and general insurance. And in
case of life insurance to pay certain amount either on death of insured person or on expiry of
contract period in consideration of premium”.
Nature of Insurance Contract
Insurance is a contract; hence all the provisions of section 10 of Indian Contract Act are
applicable to them. Indian Contract Act determines the nature of Insurance is a contract
which is as follows.
1. Two Parties - In insurance contracts there are two parties i.e. one is insurer (Insurance
Company) and another is insured (Policy holder).
2. Written Agreement – Any contract is legal when it is in written form. Insurance
contract is a written agreement between insurer and insured. The printed proposal
form provided by insurer to insured.
3. Consideration – Consideration means contract price. In insurance contract, insured
person to pay consideration to insurer in the form of premium and insure can accept
risk against premium.
4. Eligibility for contract – The contract is legal only when the parties involved in the
contract are eligible for contract. The insurance company is legal organization and
hence it is eligible for contract. That means the insured must be major and not mad or
insolvent.
5. Free Consent – According Indian Contract Act consent for any contract should be free.
It cannot given by forcibly, if to do so, contract may be illegal.
6. Object of Contract – The object of the contract must be legal. If object of any contract
is illegal then automatically the contract will be illegal. Recognition by Law – For
recognition of law the contract should be fulfill all the legal formalities which is given
in the law.
Difference between Insurance Contract and Wagering Contract:
The difference between insurance contract and wagering contract can be brought out
with the help of following points.
1. Meaning –
Insurance is a contract in which a sum of money is paid to the insured person on
happening of certain event in case of fire, marine and general insurance .And in case of life
insurance to pay certain amount either on death of insured person or on expiry of contract
period in consideration of premium.
A wagering contract is a contract between two parties in which one party promise to
pay money or worth of money on the happening of uncertain event in consideration of the
other parties `to pay him if the event does not happen.
2. Insurable Interest –
Insurable interest means interest of the policy holder in the subject matter of the
insurance. It is mandatory that policy holder (insured) must possess insurable interest in the
subject matter of insurance.
In case of wagering contract insurable interest is not present in the subject matter
because the happening of the event is uncertain.
3. Utmost Good Faith –
Insurance contract is depend upon good faith of insurer and insured. That means utmost
good faith is existing in insurance contract.
In wagering contract principle of Utmost Good Faith is not arise.
4. Consideration –
The insurance contract is made on the basis of consideration. Here, insured person to
pay premium to insurance company as a consideration and company accept the risk.
There is no consideration exists in the wagering contract.
5. Risk – In insurance contract risk involved and risk is distributed among so many
peoples.
In wagering contract risk is existed because they are based on uncertain events.
6. Enforcement by law –
Insurance contracts are lawful and hence they are enforceable by law. In case of any
dispute among insurer and insured, they make sure that it is obeyed.
A wagering contract is illegal and it can not enforceable by law.
7. Indemnity –
Insurance Company paid compensation after happening of certain event.
 In wagering contract there is no risk or loss hence question of indemnity is not arise.

Summary
An individual and his business is exposed to several risks in their life. e.g. premature
death, accident, sickness, fire, flood, earthquake, theft etc. His income capacity may come to
end or reduce for a certain period of time. His business assets and other property may be
adversely affected and their working life and income generation capacity is reduced. No
amount of precaution can avoid these risks. However, some arrangement can be made to
recover the loss arising from their occurrence. Insurance is one of such arrangements and the
insurance business has flourished over the years. Insurance business plays a vital role in the
economic development of a country. The business significance of insurance also can not be
ignored. It also educates the businessmen about loss prevention. Thus, insurance is
indispensable for the business.
Insurance is a contract between the insurer and insured by which the insurer in
consideration of premium received from the insured, agrees to indemnify the insured against
the financial loss caused to the subject matter insured by specific risks during the period of
the insurance contract. The provisions of Indian Contract Act are applicable to the insurance
contracts. Besides these provisions, some special principles, such as utmost good faith,
indemnity and insurable interest apply to insurance contracts. For getting insurance
protection, the risk must be uncertain in nature. If the risk is certain it can not be insured.
Insured should not be allowed to make profit from insurance. Insurance is a contract of
indemnity and not a contract of wager / gambling. Insurance business is based upon the dual
theories i.e. theory of probability and the theory of large numbers which facilitate insurer to
estimate the probable loss as accurately as possible. It is a business and not a charitable or
philanthropic activity.

Key Words
Insurer – Insurance Company

Insured – Policy holder

Insurable interest - Interest of the insured in the subject matter of insurance.

Subject Matter – Insured Property

Indemnity – Security from loss

Utmost good faith - Faith on each other

Causa Proxima - Proximate Cause, nearest cause