Meaning, Definition And Principles of Insurance

Introduction

‘Uncertainty’ is the word which is associated with everyone’s life and business. Our future is unpredicted and unwanted events can occur at any point of time. With such unwanted events, there arises difficult times as to how to deal with such different levels of risks. The development in the financial world has made it possible to compensate such losses with financial resources. Here comes the role of an Insurance to tackle all these problems by providing security and safety to an individual. Insurance also eliminates or reduces cost of loss or effect of loss caused by various risks. Hence, insurance is evolved as a risk transfer mechanism to person or entities who have the capacity to undertake the risk.

The practice of insurance can be traced down to thousand years ago based on the concept of ‘pooling of risks’. At the village level, common funds were formed and small contributions were pooled together to compensate the loss for those who suffered. As it was not possible to assume that who will suffer the loss, calculations were made on the basis of past experiences as to how many persons suffered loss in a given period of time.

In today’s fast growing world where people are building their business, insurance upgrades business efficiency as well as reduces the uncertainty of business losses. Insurance also affords peace of mind to the people and society as they need not ponder upon their future events. Insurance encourages the people for saving and also provides with employment which is very crucial. Insurance also plays a factor in the economic growth of a country as the insurance industries set up financial institutions which in turn reduce uncertainties by improving financial resources.

Meaning and Definition of Insurance

The first ever known written insurance policy was on Babylonian obelisk monument with the code of King Hammurabi. The Hammurabi Code was one of the first forms of written laws. The Babylonian traders were protected against loss of cargo with this basic insurance. When a merchant receives a loan to fund his shipment, he would then pay the lender an additional sum in exchange for the lender’s guarantee to cancel the loan; should the shipment be stolen or lost at sea.

Many authors have cited their own definitions of insurance. Some of the prominent definitions of insurance are as follows:

According to Dictionary of Business and Finance, “Insurance is a form of contract or agreement under which one party agrees in return for a consideration to pay an agreed amount of money to another party to make good for a loss, damage, or injury to something of value in which the insured has a pecuniary interest as a result of some uncertain events.”

According to Riegel and Miller, “Thus it serve the social purpose; it is a social device whereby uncertain risks of individual may be combined in a group and thus made more certain; small periodic contribution by the individual providing a fund out of which those who suffer losses may be reimbursed.” (Riegel and Miller; Principles of Insurance and Practice; P-10)

According to Ghosh an Agarwal, “Insurance is a co-operative form of distributing a certain risk over a group of persons who are exposed to it.”

Thus, insurance refers to a contractual arrangement in which one party (insurance company or the insurer) agrees to compensate the loss or damage sustained to another party (the insured), by paying a definite amount in exchange for an adequate consideration called a premium. The losses covered are listed in the contract and the contract is called policy. The policy is a document, containing the terms and conditions, which is an evidence of the contract of insurance.

For an insurance contract to be valid it should fulfill all the requirements mentioned in Section 10 of the Indian Contract Act, 1872 which are as follows:

• Offer and Acceptance

In the context of insurance, an ‘offer’ is called ‘proposal’. A proposal can be put forth either by the insurer or the insured. Once the proposal is accepted, it turns into an agreement. A proposal form or application for insurance is filled by the insured by giving information required by the insurance company to assess the risk and arrive at a price to be charged for covering the risk. The insured goes through the application by assessing the risk and gives it decision. Before giving a decision the insured and the insurer may make some alterations in the proposal as per their needs, such alterations amount to counter – offer. If this counteroffer is accepted by the other party then it amounts to acceptance.

• Legal consideration

In an insurance contract, amount equal to the premium paid by the insured becomes the consideration of the contract. The insurer who promises to pay a fixed sum at a given contingency must be given something in consideration. Without the payment of the premium, the contract cannot be established. The consideration need not be money but it must be ‘valuable’ such as right, interest, profit or benefit according to one party or some forbearance, detriment, loss or responsibility given, suffered or undertaken by the other.

• Competent to make contract

Any person, either natural or artificial who has the legal capacity to enter into a contract can become an insurer. The person must have acquired the license for the purpose of conducting insurance practice from the government authority. The insured can enter into a contract provided he is not minor, not of unsound mind and is not disqualified from contracting by any law. In the case of a minor, the natural legal guardians enter into a valid contract on behalf of the minor, till the minor attains 18 years of age.

• Free consent

The insured and the insurer should agree upon the same thing in the same sense. The policy document clearly lays down the terms and conditions that are to be followed by both parties. Consent is as free when it is not caused by –

• Coercion
• Undue influence
• Fraud
• Misrepresentation
• Mistake

The insured should reveal all the information in the proposal form to enable the insurance company to assess the risk properly. If the insurer finds out that the insured has not truthfully disclosed the information then the insurance company can cancel the contract. When consent to an agreement is caused by the vitiating factors, the agreement which forms the contract is voidable at the option of the party whose consent was so caused.

• Legal object

While filling out the proposal form the parties should ensure that the object of insurance is legal and should not be concealed. If the object of an insurance agreement is found to be unlawful then the policy is void.

Types of Insurance

Unlike the old days the concept of insurance is not encompassing only around life. An individual can face risks of families, health, properties, assets, etc. the oldest form of insurance is marine insurance followed by life insurance and fire insurance. Thus the various types of insurance are:

1. Life Insurance
2. General Insurance
3. Marine Insurance
4. Fire Insurance
5. Motor Vehicle Insurance
6. Miscellaneous Insurance
7. Reinsurance

Principles of Insurance

In legal aspect insurance is a contract whereby one person agrees to indemnify another against a loss which may happen or to pay a sum of money to him on the occurring of a particular event. Along with the essential requirement of the insurance contract, one must also take into consideration the principles of insurance. If any of the principles is missing then the insurance contract becomes void.

The six underlying principles of insurance are as follows:

1. Principle of Utmost Good Faith

The principle of ‘Uberrimae fidei ‘or ‘Utmost good faith’ is the first and foremost principles observed while entering into insurance contract. This principle relates to the duty of disclosure upon the parties involved in the insurance contract.

Section 20(1) of the Marine Insurance Act, 1963 provides that “Subject to the provision of this section, the assured must disclose to the insurer, before the contract is concluded, every material circumstance which, is known to the assured, and assured in deemed to know every circumstance which, in the ordinary course of business, ought to be known to him. If the assured fails to make such disclosure, the insurer may avoid the contract.”

Characteristics of Utmost Good Faith

1. The parties to the insurance contract should willingly and truly disclose all the material facts.
2. The duty of fully disclosing and surrendering true facts applies to all insurance contracts
3. The duty of disclosing continues up to the conclusion of the contract.
4. It also covers any alterations or changes that are made during the proposal and acceptance.
5. Concealment of material fact on misrepresentation may affect the validity of the contract.
6. When the policy is being renewed, the duty of utmost good faith revives.

Breach of Utmost Good Faith

When it is observed that the utmost faith is broken, the aggrieved person may take a course of action. Breach can occur in the following ways:

1. Concealment
2. Non – disclosure
3. Fraudulent Misrepresentation
4. Innocent Misrepresentation

Remedies for breach of Utmost Good Faith

1. Avoid the contract
2. Refuse payment of a particular claim;
3. Sue for damages if fraud is involved;
4. Waiving off the breach where the contract/claim is valid.

2. Principle of Insurable Interest

Insurable interest is the legally recognized relationship to the subject matter that gives a person the right to effect insurance on it. The relationship must be a legal one.

In the words of Riegel and Miller, “An insurable interest is an interest of such a nature that the possessor would be financially insured by the occurrence of the event insured against.”

The principle of insurable interest means that the insured person must have some insurable interest in the object of insurance. If the insured gains profits with the physical existence of the object of insurance, then he is said to have insurable interest but the non – existence of the object will lead him to loss.

For example – A merchant has an insurable interest in the ship because he is getting income from it. But, if he sells it, he will not have an insurable interest left in that ship.

Characteristics of Insurable Interest

1. Subject – matter to insure must be present, like – family, property, vehicle, etc.
2. Legally recognized relationship between the insured and the subject – matter of insurance.
3. The insured gains profit with the safety of the subject – matter and loss if the subject – matter is damaged.
4. The subject – matter should have value of money and should be definite.

• Exception – Life insurance is different as it is long-term The policy cannot be cancelled by the insurer. In life insurance the policy is of the insured, although access to the policy money awaits some time or event in the future. Insurable interest is only needed at policy inception.

3. Principle of Indemnity

The word indemnity means a contractual obligation of one party to compensate, protect or provide security to the loss occurred to the other party. It means make good the loss. The principle of indemnity is one of the important factor of insurance. The principle of indemnity does not aim at profit-making as the insured gets only indemnified. Profit-making is against the principle of indemnity.

For example – An insured pays Rs 5 Lakhs to the insurer as a premium for his house. One day the house of the insured catches fire and incurs a loss/damage of Rs 1 Lakh. Then the insurer will only pay Rs 1 Lakh to the insured because of the principle of indemnity and not Rs 5 Lakhs. Similarly, if the loss incurred is more than Rs. 5 Lakh, the insured cannot recover more than the amount for which the house was insured because this principle sets a limit to the compensation.

• Exception – the principle of indemnity is applied to all insurances except life insurance and personal accident insurance because the value of human life cannot be measured in monetary terms and thus the insurer decides o pay a fixed or guaranteed sum irrespective of the loss suffered.

Characteristics of Indemnity

1. The amount of compensation is proportionate to the amount of loss and the insured is not allowed to make any profit.
2. If there are multiple insurers to the property then the insured can avail money only from one of the insurer and not all of them.
3. The insurers take all the rights that the insured had, after the payment of compensation.
4. Except life insurance and personal accident insurance, principles of indemnity applies to all other insurance.

4. Principle of Proximate Cause

The principle of ‘Causa Proxima‘ or ‘Proximate Cause’ means when a loss is caused by more than one causes, the proximate or the nearest or the closest cause should be considered as to decide the liability of the insurer. It literally means ‘the immediate and not the remote cause’

Types of perils

Peril is known as a cause of loss. There are three kinds of peril. They are as follows:

1. Insured Perils – those which are covered in the policy. Example – fire, sea water, lightening, etc
2. Excluded Perils – those which are stated in the policy but are specifically removed by a policy exclusion. Example – riots, war, etc.
3. Uninsured Perils – those which are not covered by the policy at all as insured or excluded perils. Example – water damage covered in a fire policy

Practically it can be seen that there must be insured perils in the insurance policy. If uninsured perils are arising out of the insured perils then the loss is covered. Excluded perils are generally fatal to the claim.

For Example – if a ship is damaged by rats and the water enters into the ship then the most proximate cause for damage i.e. the damage caused by the water is taken into consideration first rather than the damage cause by the rats which is a remote cause.

• Exception – the principle of causa proxima does not apply to life insurance because whatever may be the reason of the death, the insurer is liable to pay the amount of insurance.

5. Principle of Subrogation

This principle of subrogation is also a corollary to the principle of indemnity. It literally means substituting one creditor for another. It applies to all contracts of indemnity. With this principle, the insurer who provides an indemnity is entitled to take over and use for his own benefit any recovery rights the insured may possess against third parties. This principle applies to both marine and fire insurance.

According to W.A. Dinsdale, “Subrogation is the insured’s right to receive the benefit of all the rights of the assured against third parties which, is satisfied, will extinguish or diminish the ultimate loss sustained.”

For example – a car owner has been insured with vehicle insurance by an insurance company. One day if the owner of the car meets with an accident by clashing to another car (third party) then the insured has two options with – either to compensate from the third party or to claim damages from the insurance company. If the car owner decided to claim compensation from the insurance company then his rights against third party are subrogated to the insurance so that the company will collect damages from the third party later on.

This principle is only applicable when the damaged property has some value after the event causing the damage. The insurer is entitled to benefit the amount only to the extent that he has insured as compensation. If the insured gets partly compensated by the third party before getting fully indemnified by the insurer then the insurer can pay only the balance of loss.

6. Principle of Contribution

This principle is also a corollary to the principle of indemnity. The principle of contribution applies when an insured gets the subject-matter insured with one or more insurers then all of the insurers should be called upon to contribute towards the claim in proportion to the sum assured with each. Hence if one insurer pays the full compensation then that insurer can demand a proportionate claim from the other insurers. The insured once claimed full compensation from one insurer; he cannot further claim same compensation from other insurers to make profit.

For example – ‘A’, an insured insures his house against fire from three companies – X, Y, Z with Rs 30,000, Rs 40,000, Rs 30,000 respectively. The house of the insured catches fire one day and incurs a loss of total Rs 60,000. The contribution from X, Y, Z would be Rs 18,000, Rs 24,000, Rs 18,000 respectively. If Company X has made the payment of claim for Rs. 60,000/- to A, X has right to claim Rs. 24,000/- and Rs. 18,000/- from Y and Z respectively.

Essential conditions of contribution

1. All the insurance must relate to the same subject-matter.
2. The policies concerned must all cover the same interest of the same insured.
3. The policies concerned must all cover the same peril which caused the loss.
4. The policies must have been in force and all of them should be enforceable at the time of loss.

Conclusion

In India the practice of insurance developed through the joint family concept of social security. The insurance sector developed immensely and rapidly in our country and has many legislations on insurance as of now. The whole concept of insurance can be explained with the help of the other general contracts. With the principles of insurance, one can understand how the practices of insurance work even though it is a contract between the policyholders and the parties. Many courts have taken these principles as the basis to resolve disputes regarding insurance.

References

• Vardhaman Mahaveer Open University,Kota – Insurance Laws in India, CBIL – 02
• Insurance Laws of India – CA Rajkumar s. Adukia, taxguru.in
• Insurance Intermediaries Quality Assurance Scheme – Principles and Practices of Insurance
• Mannings six principles Of general insurance – Dr. Allan Manning
• Insurance – Law and Practice – The Institute of Company Secretaries of India
• https://legal-dictionary.thefreedictionary.com/insurance
• https://businessjargons.com/insurance.html

This Article is Authored by Rutuja Dhotre, 4th Year BA LLB Student at ILS Law College, Pune.

Also Read – Explain The Various Types Of Insurance Policies In India