UNIT-1

INSURANCE
Insurance is a legal agreement between two parties – the insurer and the insured, also
known as insurance coverage or insurance policy. The insurer provides financial
coverage for the losses of the insured that s/he may bear under certain circumstances.
Insurance coverage can be defined as a contract in the form of a financial protection
policy. This policy covers the monetary risks of an individual due to unpredictable
contingencies. The insured is the policyholder whereas the insurer is the insurance-
providing company/the insurance carrier/the underwriter. The insurers provide
financial coverage or reimbursement in many cases to the policyholder.
The policyholder pays a certain amount called ‘premium’ to the insurance company
against which the latter provides insurance cover. The insurer assures that it shall
cover the policyholder’s losses subject to certain terms and conditions. Premium
payment decides the assured sum for insurance coverage or ‘policy limit’.
Insurance is a way to manage your risk. When you buy an insurance, you purchase
protection against financial loss.
By taking insurance policy, different policy holders pool their interest together. Loss
suffered by any of the insurance is paid out of premium amount paid by these
policyholders to insurance company.
Insurance is a way to manage your risk. When you buy an insurance, you purchase
protection against financial loss.
It is a contract between insurer and insured where insurer in consideration of sum of
money paid (premium) by the insured agrees to-:
 Make good the loss suffered by the insured against specific risk.
 To pay a fixed amount to the insured or his/her beneficiaries on happening of a
specified event.
The purpose of insurance is a method of transferring of risk to provide economic
protection to uncertain event such as death of the earning family, loss or theft, or
many other.

NATURE OF INSURANCE
1. Contract
Insurance is contract between two parties in which one party agrees to provide
protection to other party from losses in exchange for premium. The parties are insurer
and insured. Insurer guarantees compensation in occurrence of any contingency to
insured and insured pays premium to insurer for protection. Insurance companies
accept the offer made by the insurance policy holder and enter into contract. Contract
for insurance is always in written.

2. Lawful Consideration
Existence of lawful consideration is must for insurance contract like any other lawful
contract. The insurance policy holder is required to pay premium regularly to the
insurance company. This premium is paid in exchange for protection against losses
and damages guaranteed by insurance companies.

3. Payment on Contingency
Insurer is required to compensate the insured only on happening of contingency for
the damages and losses done. Insured cannot make profit from insurance policy but
can only claim compensation from insurer in case of contingency. If no contingency
occurs, insurer is not required to pay any compensation to insured. 

4. Risk Evaluation
Insurer evaluates the risk associated with subject matter of insurance contract. Proper
risk evaluation enables the insurer to calculate the right amount of premium to be paid
by insured. Insurer uses different techniques for risk evaluation. If insurance object is
subject to heavy losses, heavy premium will be charged. On the other hand, if there is
less expectation of losses then low premium will be charged.

5. Large Number of Insured Persons

There are large numbers of insured person’s takes insurance policy from insurer.
Larger the number of insurance policy holders with insurance companies, smaller will
be the degree of risk on any individual. Risk arising from any contingency is shared
among these large numbers of insured persons.

6. Co-Operative Device
Insurance is a cooperative device to pool risk among large number of persons.
Insurance is a platform where different persons come together to share risk by taking
insurance policy from insurer. All persons pay premium regularly to insurance
companies. If any of person incurs losses or damages due to occurrence of any
contingency, insurance company will compensate him out of premiums paid by
different persons. 

7. Not A Charity or Gambling

Insurance is a legal contract. It cannot be termed as a charity or gambling.
Compensation paid to insured by insurer is not in charity but is paid in exchange of
premium deposited by him. Insured pays premium to insurer for guarantee of
compensation in happening of contingency. Also, insured cannot make profit out of
insurance policy and is meant for recovering him from losses only. He is paid
compensation only when he incurs losses due to contingency. That is why it is not a
gambling.

ROLE AND IMPORTANCE OF INSURANCE

The following point shows the role and importance of insurance:

Insurance has evolved as a process of safeguarding the interest of people from loss
and uncertainty. It may be described as a social device to reduce or eliminate risk of
loss to life and property.

Insurance contributes a lot to the general economic growth of the society by provides
stability to the functioning of process. The insurance industries develop financial
institutions and reduce uncertainties by improving financial resources.

1. Provide safety and security:

Insurance provide financial support and reduce uncertainties in business and human
life. It provides safety and security against particular event. There is always a fear of
sudden loss. Insurance provides a cover against any sudden loss. For example, in case
of life insurance financial assistance is provided to the family of the insured on his
death. In case of other insurance security is provided against the loss due to fire,
marine, accidents etc.

2. Generates financial resources:

Insurance generate funds by collecting premium. These funds are invested in
government securities and stock. These funds are gainfully employed in industrial
development of a country for generating more funds and utilised for the economic
development of the country. Employment opportunities are increased by big
investments leading to capital formation.

3. Life insurance encourages savings:

Insurance does not only protect against risks and uncertainties, but also provides an
investment channel too. Life insurance enables systematic savings due to payment of
regular premium. Life insurance provides a mode of investment. It develops a habit of
saving money by paying premium. The insured get the lump sum amount at the
maturity of the contract. Thus life insurance encourages savings.
 4. Promotes economic growth:
Insurance generates significant impact on the economy by mobilizing domestic
savings. Insurance turn accumulated capital into productive investments. Insurance
enables to mitigate loss, financial stability and promotes trade and commerce activities
those results into economic growth and development. Thus, insurance plays a crucial
role in sustainable growth of an economy.

5. Medical support:
A medical insurance considered essential in managing risk in health. Anyone can be a
victim of critical illness unexpectedly. And rising medical expense is of great concern.
Medical Insurance is one of the insurance policies that cater for different type of
health risks. The insured gets a medical support in case of medical insurance policy.

6. Spreading of risk:
Insurance facilitates spreading of risk from the insured to the insurer. The basic
principle of insurance is to spread risk among a large number of people. A large
number of persons get insurance policies and pay premium to the insurer. Whenever a
loss occurs, it is compensated out of funds of the insurer.

7. Source of collecting funds:

Large funds are collected by the way of premium. These funds are utilised in the
industrial development of a country, which accelerates the economic growth.
Employment opportunities are increased by such big investments. Thus, insurance has
become an important source of capital formation.

INSURANCE CONTRACT
Insurance may be defined as a contract between two parties whereby one party called
insurer undertakes in exchange for a fixed sum called premium to pay the other party
called insured a fixed amount of money after happening of a certain event.

Insurance policy is a legal contract & its formation is subject to the fulfilment of the
requisites of a contract defined under Indian Contract Act 1872.
According to the Act “A Contract may be defined as an agreement between two or
more parties to do or to abstain from doing an act, with an intention to create a
legally binding relationship.”

Since Insurance is a contract, certain sections of Indian Contract Act are applicable.

Essentials of an Insurance Contract-:

 Offer and Acceptance

When a prospective insured goes to buy an insurance policy, they must fill out an
application provided by the insurance company. If they are shopping online, they will
complete a digital application. If they are working with an agent or broker, then he or
she may fill this out for the customer.

The application is legally known as an offer, where the insured offers to

make premium payments of a certain dollar amount in return for insurance coverage
up to specific limits. Acceptance occurs when the insurance company formally issues
the policy, or when the agent or broker issues a certificate of temporary coverage.

 Consideration

There is no validity of a contract if there is no consideration, which is the act or

promise offered by one party and accepted by the other as the price of his promise. In
Insurance contracts the consideration is the premium that the Insured pays to the
Insurer as the price of the promise that the Insurer has made that he shall indemnify
the insured. Hence premium payment is the consideration on part of the insured and
the promise to Indemnify is the consideration on part of the Insurer.

 Legal Capacity to Contract or Competency

For an agreement to be binding on all parties, the parties involved must have the legal
capacity to enter into a contract. With respect to the insurer, if the company is formed
as per laws of the country & empowered to solicit insurance then the insurer is
capable of entering into an agreement.

With respect to the insured, the person should be of legal age i.e. 18 years and of
sound mind.

If a contract is made with an underage the application may be held unenforceable if

the minor decides to repudiate it at a later date. In Insurance contract the insurer is
bound by the contract as long as the underage wishes to continue it.

If the minor repudiates his contract, the law will allow him a refund of all premium
paid. Insanity or mental incompetence precludes the making of a valid Insurance
contract.
  Consensus “ad idem” (Same mind)

The understanding between the insurer & insured person should be of same thinking
or mind. The reasons for taking the Insurance policy should be understandable to both
the parties. Both parties to the contract should be of the same mind and there must be
consent arising out of common intention.

Both parties should be clear about what the other is saying. The Insurer should know
what the insured wants and the insured should know what the insurer is offering and
both should be agreed on this. For example, if an Insured seeking a fire policy is
issued a burglary policy there is no consent arising out of common intention.

 Free Consent

Both parties in any insurance contract must enter into the contract with free consent,
which means it is on their own volition. There cannot be any fraud, misrepresentation,
intimidation or coercion involved when the contract is signed. The contract also
cannot be signed as a result of an error.

 Legality of Object

To be a valid, a contract must be for a legal purpose & not contrary to public policy.
Insurance is legal business therefore it cannot be illegal on the part of the insurer. An
individual can take the life Insurance of his own life or his/her family members. If an
individual takes a policy on the life of an unknown person it will not be a valid
contract as it will amount to gambling.

Another example is that the contract will not be legal if it has anything to do with
stolen property or if it is in respect of any unlawful activity. Hence Insurance of stolen
goods or the Insurance of smuggling operation shall not stand scrutiny in the court of
law and such contracts will be void.

Role of Insurance towards society

The role of insurance as a social protection mechanism is perhaps what first comes to
mind when asked to think about its benefits. Indeed, by mitigating the effects of
exogenous events over which we have no control—illness, accident, death, natural
disasters—insurance allows individuals to recover from sudden misfortune by
relieving or at least limiting the financial burden. In the case of health insurance, it
could even mean the difference between life and death.

Insurance, however, has a far wider and more profound impact than this initial
perception, though its value to society derives from this primary function. Because it
manages, diversifies and absorbs the risks of individuals and companies, insurance is
often a precondition for the development of other productive activities, such as buying
a home and starting or expanding a business. In turn, these activities fuel demand,
facilitate supply and support trade—but are only generally engaged in once the
associated external risks are managed through insurance.

This facilitating effect operates also on an individual level, spreading out as a natural
consequence of its social protection value. An insured person who does not suffer
undue financial loss after a sudden misfortune will more easily maintain his
purchasing power. The aggregate impact of insurance, therefore, is to level
consumption patterns and contribute more widely to financial and social stability. This
stabilising factor is reinforced by the role of insurance as a long term investor in
projects and businesses.

Insurance has a real effect on the global economy, of course, through the sheer
number of people that the sector employs. But it also acts in a complementary fashion
with the banking sector, offering easier access to credit, channelling savings into long-
term investments and providing greater transparency and liquidity to the markets, thus
providing further support and growth to the economy.

It contributes to public safety and new product development by raising awareness

about security, leading to improved safety requirements that save lives and fuel
innovation in the manufacturing sector (e.g. car insurance and seat belts, home
insurance and fire prevention).

Finally, as a risk management service provider, the insurance industry is ideally

placed to help design innovative products and contribute to solving urgent global
societal challenges such as population ageing and emerging threats such as climate
change and cyber risks.

The ways in which insurance contributes to society and economic growth can be
summed up as follows:

• it allows different risks to be managed more efficiently;

• it encourages loss mitigation;
• it enhances peace of mind and promotes financial stability;
• it helps relieve the burden on governments for providing all services of social
protection to citizens via social security systems;
• it facilitates trade and commerce, supporting businesses and economic growth; • it
mobilises domestic savings; and,
• it fosters a more efficient allocation of capital, advancing the development of
financial services.

PRINCIPLES OF INSURANCE
 1. Nature of contract:
Nature of contract is a fundamental principle of insurance contract. An insurance
contract comes into existence when one party makes an offer or proposal of a contract
and the other party accepts the proposal.

A contract should be simple to be a valid contract. The person entering into a contract
should enter with his free consent.

2. Principal of utmost good faith:

Under this insurance contract both the parties should have faith over each other. As a
client it is the duty of the insured to disclose all the facts to the insurance company.
Any fraud or misrepresentation of facts can result into cancellation of the contract.

3. Principle of Insurable interest:

Under this principle of insurance, the insured must have interest in the subject matter
of the insurance. Absence of insurance makes the contract null and void. If there is no
insurable interest, an insurance company will not issue a policy.

An insurable interest must exist at the time of the purchase of the insurance. For
example, a creditor has an insurable interest in the life of a debtor, A person is
considered to have an unlimited interest in the life of their spouse etc.

4. Principle of indemnity:
Indemnity means security or compensation against loss or damage. The principle of
indemnity is such principle of insurance stating that an insured may not be
compensated by the insurance company in an amount exceeding the insured’s
economic loss.

In type of insurance the insured would be compensation with the amount equivalent to
the actual loss and not the amount exceeding the loss.
This is a regulatory principal. This principle is observed more strictly in property
insurance than in life insurance.

The purpose of this principle is to set back the insured to the same financial position
that existed before the loss or damage occurred.

5. Principal of subrogation:
The principle of subrogation enables the insured to claim the amount from the third
party responsible for the loss. It allows the insurer to pursue legal methods to recover
the amount of loss, For example, if you get injured in a road accident, due to reckless
driving of a third party, the insurance company will compensate your loss and will
also sue the third party to recover the money paid as claim.

6. Double insurance:
Double insurance denotes insurance of same subject matter with two different
companies or with the same company under two different policies. Insurance is
possible in case of indemnity contract like fire, marine and property insurance.

Double insurance policy is adopted where the financial position of the insurer is
doubtful. The insured cannot recover more than the actual loss and cannot claim the
whole amount from both the insurers.

7. Principle of proximate cause:

Proximate cause literally means the ‘nearest cause’ or ‘direct cause’. This principle is
applicable when the loss is the result of two or more causes. The proximate cause
means; the most dominant and most effective cause of loss is considered. This
principle is applicable when there are series of causes of damage or loss.