Principles of Insurance

Principles of insurance are crucial in understanding the general awareness section of various competitive exams. Topics related to types and principles of insurance are frequently tested in insurance exams such as LIC, IRDA, NIACL, NICL, and others. This study material delves into the different types and principles of insurance in the industry.

What is Insurance?

Insurance is a contract where an individual or firm obtains financial protection from an insurance company. It is represented as a policy, allowing the insured to claim reimbursements for any damage caused to their property.

In insurance, there are two parties involved: the insurer and the insured. Both parties enter into a legal contract, known as the insurance policy, for availing and providing insurance. This policy ensures financial security against unforeseen uncertainties.

In simpler terms, insurance is a legal agreement between the insured and the insurance company. The insurer promises to provide financial assistance to the insured in case of any contingency, while the insured pays a premium in return for this assurance.

Types of Insurance

There are various types of insurance available, each catering to specific needs and risks. Some common types of insurance include:

• Life Insurance: Provides financial support to the beneficiaries of the insured in the event of their death.

• Health Insurance: Covers medical expenses incurred due to illness, injury, or hospitalization.

• Motor Insurance: Protects against financial losses resulting from damage or theft of vehicles.

• Home Insurance: Covers damages to the insured’s property, such as their home, due to events like fire, theft, or natural disasters.

• Travel Insurance: Provides coverage for unexpected events during travel, such as medical emergencies, trip cancellations, or lost luggage.

Principles of Insurance

The principles of insurance form the foundation of how insurance operates and functions. These principles include:

• Utmost Good Faith (Uberrimae Fidei): Both the insurer and the insured must act with utmost good faith and honesty when entering into an insurance contract. Any misrepresentation or concealment of material facts can invalidate the policy.

• Insurable Interest: The insured must have a legitimate interest in the subject matter of the insurance. This means they must stand to suffer a financial loss if the insured event occurs.

• Proximate Cause: The loss or damage must be a direct result of the insured event specified in the policy. Indirect or remote causes are generally not covered.

• Indemnity: The primary objective of insurance is to place the insured in the same financial position they were in before the insured event occurred. Insurance policies aim to provide compensation for losses, not profit.

• Subrogation: Upon paying a claim, the insurance company is entitled to the insured’s rights against any third party responsible for the loss. This allows the insurer to recover the amount paid out.

• Contribution: If multiple insurance policies cover the same risk, the insurers may share the liability for the claim in proportion to their respective policy limits.

Understanding these principles is essential for comprehending the intricacies of insurance and how it operates. By familiarizing yourself with the different types and principles of insurance, you can enhance your knowledge and preparation for insurance-related exams and general awareness sections in various competitive examinations.

Principle of Utmost Good Faith

This fundamental principle of insurance requires both parties to act in good faith towards each other. The insurer and the insured must provide clear and concise information regarding the terms and conditions of the insurance policy.

Example of Utmost Good Faith Principle:

Mr. X took a health insurance policy. However, he was a chainsmoker at the time but did not inform the insurance company. Later, he was diagnosed with cancer. In this case, the insurance company is not liable to bear the financial burden because Mr. X hid his smoking habit.

Proximate Cause Principle

• Also known as ‘Causa Proxima’ or the nearest cause.
• When a loss results from multiple causes, the insurer investigates the nearest cause of the property loss.
• If the proximate cause is covered by the insurance, the insurer is liable for compensation.
• If the proximate cause is not covered, the insurer is not liable for compensation.

Example:

• A building’s wall is damaged by fire, leading to its demolition.
• During demolition, the adjoining wall is also damaged.
• The adjoining wall owner claims the loss under the fire policy.
• The court considers fire as the nearest cause of loss to the adjoining wall, making the claim payable.

Principle of Insurable Interest

• The insured must have an insurable interest in the property.
• Insurable interest means the property provides financial benefit to the insured and would result in financial loss if damaged or destroyed.

Example:

• A stationery shop owner has an insurable interest in the shop as it generates income.
• If the shop is sold or leased, the owner no longer has an insurable interest.
• To claim insurance, the insured must own the property when the contract is made and when the loss occurs.

Principle of Indemnity

• Insurance covers losses only, and the insured should not profit from the insurance contract.
• The insured is compensated for the actual loss incurred, not exceeding the loss amount.
• The principle aims to restore the insured’s financial position to before the loss.
• Indemnity applies to property insurance, not life insurance.

Example:

• A residential building owner takes insurance to cover future property loss or damage.
• If the building suffers structural damage due to fire, the insurance company compensates the owner for the repair costs.
• The compensation matches the exact amount spent on authorized repairs or reconstruction.

Principle of Subrogation

• The insurer, after paying the insured for a loss, is entitled to the insured’s rights against a third party responsible for the loss.
• The insurer can pursue legal action against the third party to recover the compensation paid to the insured.

Example:

• A car owner’s insured car is damaged in an accident caused by another driver.
• The insurance company pays for the car repairs.
• The insurance company can then pursue legal action against the at-fault driver to recover the repair costs.

Subrogation Principle

Subrogation occurs when one party (the insurer) stands in the place of another (the insured) to exercise the insured’s rights against a third party who caused a loss. Once the insurer compensates the insured for a covered loss, the insurer is subrogated to the insured’s rights against the third party.

Example:

Mr. X is injured in a car accident caused by a third party’s negligence. Mr. X’s insurer compensates him for his injuries. The insurer is then subrogated to Mr. X’s rights against the third party and can sue the third party to recover the amount paid to Mr. X.

Contribution Principle

The contribution principle applies when an insured has multiple insurance policies covering the same property. Under this principle, each insurer is liable to contribute to the payment of a covered loss in proportion to the amount of insurance coverage provided.

Example:

The owner of a property worth ₹5 lakhs insures it for ₹1 lakh with Insurer A and ₹3 lakhs with Insurer B. If the property is damaged, the owner can claim the full ₹3 lakhs from Insurer B, but not from Insurer A. Insurer B can then seek contribution from Insurer A for the amount paid to the owner.

Loss Minimization Principle

The loss minimization principle requires the insured to take reasonable steps to minimize the loss to the insured property. The insured cannot be negligent or irresponsible with their insured property and expect the insurer to pay for the loss.

Example:

If a fire breaks out in a commercial building, the insured owner must take steps to put out the fire and minimize the damage. The owner cannot simply let the fire burn and expect the insurer to pay for the damage.

General Insurance

General insurance is a type of insurance that provides financial compensation for losses or damages other than those related to life. It covers a wide range of assets and liabilities against potential risks.

In general insurance, the insurance company agrees to pay the insured a sum of money as compensation for losses incurred due to various events, such as:

• Vehicle accidents, theft, or fire
• Fire damage to property or goods
• Financial emergencies during travel
• Medical treatments and healthcare expenses

General insurance can be further classified into different types based on the coverage provided:

1. Health Insurance: Covers the costs associated with healthcare and medical treatments.

2. Fire Insurance: Provides coverage for damages caused to property or goods due to fire.

3. Travel Insurance: Covers financial liabilities arising from medical or non-medical emergencies during travel within or outside the country.

4. Motor Insurance: Protects motor vehicles against damages and losses resulting from accidents, theft, fire, and other covered events.

5. Home Insurance: Covers damages to the home caused by natural calamities, man-made disasters, and other specified events.

General insurance offers a wide range of coverage options, making it an essential tool for individuals and businesses to protect their assets and mitigate financial risks.

Benefits of Taking Insurance

Insurance provides various benefits to individuals and organizations, including:

1. Reimbursement for Losses: Insurance companies reimburse the insured for losses incurred.

2. Cash Flow Management: Insurance helps manage cash flow uncertainty when an individual’s paying capacity is significantly reduced during a loss.

3. Legal Compliance: Insurance fulfills contractual and statutory obligations and provides evidence of financial resources.

Frequently Asked Questions (FAQs) on Insurance Principles:

What is insurance?

Insurance is a contract between an individual or firm and an insurance company, where the insurance company provides financial protection against specified risks or events in exchange for regular premium payments.

What are the main types of insurance?

The two main types of insurance are life insurance and general insurance.

What are the different types of life insurance?

Life insurance policies include term life, whole life, endowment life, money back insurance, savings & investment insurance, ULIPs, retirement insurance, and child insurance plans.

What are the different types of general insurance?

General insurance policies include health, fire, travel, motor, and home insurance.

What is the most important principle of insurance?

The principle of utmost good faith is considered the most important principle of insurance, emphasizing honesty and transparency between the insured and the insurer.

By understanding these principles, individuals and organizations can make informed decisions when purchasing insurance policies, ensuring adequate financial protection against various risks and uncertainties.