PRINCIPLES OF INSURANCE

Fundamental Legal Principles of

Insurance
 Utmost good faith (PRINCIPLE OF UBERRIMAE FIDEI)
 Insurable Interest
 Indemnity
 Subrogation
 Contribution
 Proximate cause
 Principle of Loss of Minimization
The principle of utmost good faith
(PRINCIPLE OF UBERRIMAE FIDEI)
 Insurance contract (either life or non life) is one of utmost good
faith.
 Both the parties need to have utmost good faith in each other. The
concerned contracting parties must rely on each other’s honesty.
The duty of full disclosure of material facts rests on both parties.
‘Material fact’ refers to every fact or information, which has a
bearing on the decisions with respect to the determination of the
severity of risk involved and the amount of premium.
 Any concealment of material fact may lead to negative
repercussions in the functioning of the insurance company’s
normal business
 Both the parties i.e. the insured and the insurer should have a good
faith towards each other.
 The insurer must provide the insured complete, correct and clear
information of subject matter.
 The insurer must provide the insured complete, correct and clear
information regarding terms and
 conditions of the contract.
 This principle is applicable to all contracts of insurance i.e. life, fire
and marine insurance.
Principle of Uberrimae fidei

 Principle of Uberrimae fidei (a Latin phrase), or in simple English

words, the Principle of Utmost Good Faith,nis a very basic and first
primary principle of insurance. According to this principle, the
insurance contractnmust be signed by both parties (i.e insurer and
insured) in an absolute good faith or belief or trust.
 The person getting insured must willingly disclose and surrender to
the insurer his complete true informationnregarding the subject
matter of insurance. The insurer's liability gets void (i.e legally
revoked or cancelled) ifnany facts, about the subject matter of
insurance are either omitted, hidden, falsified or presented in a
wrong manner by the insured.
 The principle of Uberrimae fidei applies to all types of insurance
contracts.
The principle of utmost good faith
 The term “material fact” refers to every fact or information, which has a
bearing on the decisions with respect to the determination of the severity of
risk involved and the amount of premium. The disclosure of material facts
determines the terms of coverage of the policy.
 Any concealment of material facts may lead to negative repercussions on the
functioning of the insurance company’s normal business. For instance life
insurance companies normally segregate the quality of lives depending upon
the state of health of the people. Healthy people are accorded a higher
status in the table and different (lower) rates of premium are applicable to
them since their risk of ill health is lower. If a person suppresses facts about his ill
health and manages to buy a policy at rates applicable to the low risk group
then other policyholders in the same group have to share his risk. This results in
adverse selection.
 Hence, as per the principle of utmost good faith it is binding on the part of parties, the
insured and the insurer, to expressly disclose all the relevant material facts pertaining to
the contract.
 This doctrine is incorporated in insurance law and both the parties are expected to
adhere to a high degree of honesty. Based on such faith, the insurer and the insured
execute the contract of insurance. Thus each party believes that on fulfillment of the
conditions for which the insurance policy was purchased, the other party would perform
his duties as promised by him. Non-compliance by either party or any non-disclosure of
the relevant facts renders the contract null and void. All disclosures relating to an
insurance policy must be made at the time of entering into the insurance contract. The
insurance company hands over the application pro forma to the person who is buying
insurance seeking complete details. The person has to mention his profession, income,
age, family, history of family, general health, ailments suffered, medical reports, matters
relating to conduct and character, any criminal record, etc.
The duty of disclosure rests on the
insurer also
(a) withholding from the proposer the fact that the sprinkler system in
his premises entitles him to a substantial discount on his fire insurance
premium, non-smoker’s discount for life insurance premium
(b) accepting an insurance which the insurer knows is unenforceable
at law, or, which it is not registered to underwrite.
(c) Making untrue statements during the negotiations for the contract.
 Non-compliance & non-disclosure of the relevant facts by either
party renders the contract null & void.
The principle of utmost good faith

 This principle is supported by three important

legal doctrines.
1. Representation through an application
2. Concealment
3. warranty
 Representation
 1. Representation – Details given by the proposer through application. In life insurance, the
insured has to mention his
 profession
 income
 age
 family history
 general health
 ailments suffered
 medical reports
 matters relating to conduct and character
 any criminal records
 In general insurance
 all facts regarding the condition
 frequency of usage
 wear and tear
 Assessment of severity of risk and the premium to be charged depend on this.
 Concealment - It may turn out from the representations furnished by the customer that the details
are incomplete or any important information is concealed or is misleading.
 Facts which must be disclosed:
• The facts which would influence the insurer in accepting or declining a risk or in fixing the premium
or terms and conditions of the contract.
• The fact must be material on the date on which it should be communicated to the insurer.
• Facts, which show that the particular risk represents a greater exposure than would be expected
from its nature or class: e.g, taxi cabs.
• External factors which make the risk greater than would normally be expected :e.g., diseases like
B.P., diabetes, which enhance risk factor.
• Previous losses and claims under other policies.
• Any declinature or special terms imposed on previous proposals by other insurers.
• The existence of other non-indemnity policies such as life and accident.
• Full facts relating to the description of the subject matter of insurance. e.g., in life insurance, Age,
previous medical history, occupation, smoking\drinking habits. In motor insurance, the type of car,
whether it has been specially adapted, details of regular drivers.
Warranty
 In case where such minute details, statement of facts or promise made
by the insured (known as warranties) are expressly included in the
insurance policy with the active consent of both the parties, it is binding
on both the parties to adhere to it. Only upon the fulfillment of those
conditions will the insurer be bound by the contract.
 Warranties are collateral to the main purpose of the contract, i.e., they
are secondary to the main covenants of the contract and form a
condition cited by the insurer.
 Thus, if a person buying medical insurance cites regular all round medical
checkups and avails a lower premium based upon it he has to do it
regularly. In case he discontinues his checkups in some instances then it
amounts to breach of contract and the insurer can take refuge in this
and deny payment.
 Breach of utmost good faith arises under
 1. Misrepresentation– whether it is innocent or fraudulent (concealment)
 • it must be substantially false
 • it must be concerned with facts which are material to the acceptance or
assessment of the risk, or material to the benefits obtained by the proposer
 • have induced the recipient to enter into a contract of insurance, if the right to avoid
the contract is to be enforceable.
 2. Non-disclosure – arises and gives grounds for avoidance by the second party where a
fact,
 • is within the knowledge of the first party
 • is not known to the second party
 • is calculated, if disclosed, to induce the second party to either not to enter the
contract at all, or else only to enter it on terms which he considers are better
 The principle of utmost good faith is supported by three legal doctrines:
 (i) Representation is the statement made by the applicant of insurance. An insurance
contract is voidable at the insurer’s option if the representation is (i) material and
factual and (ii) relied upon by the insurer. For example, if a mediclaim policy is issued on
the proposal form showing no high blood pressure or no past records of disorder in
circulatory system, the insurer may deny payment of mediclaim if high blood pressure is
found to be pre-existing.
 (ii) Concealment is an intentional failure of the applicant to reveal a material fact to
the insurer. Concealment is silence when obligated to speak or a failure to disclose
material information. The test of materiality is a negative answer to the question:
“Would the insurer have written the same policy at the same price if it had known the
truth?”
 (iii) Warranty is a statement that something has happened or exists (affirmative
warranty), or that something will happen (promissory warranty). Another distinction
sometimes arises between written warranties (express warranties) and commonly
understood warranties (implied warranties).
Case law on Utmost Good Faith
1. Roselodgevs, Castle (1966)
 A company which had not disclosed the conviction of its sales
manager for smuggling goods in the proposal form, though there
was no specific question in this regard in the proposal, could not
succeed in recovering amount in the burglary claim for diamond
robbery.
2. Lambert v. Co-operative
Insurance Society (1975)
 The insured had not disclosed that her husband had been
convicted of a crime of dishonesty in 1971 at the time of renewal of
the insurance in 1972, though no question was asked about the
previous conviction. A claim was made for lost or stolen property in
1972. The insurers repudiated the claim on the ground that the
conviction had not been disclosed. It was held that the insured was
under a duty to disclose the original conviction and the subsequent
convicitons when renewing the policy and that was material fact
that would influence the mind of a prudent insurer.
3. Bond v. Commercial Union
Assurance Co.
 Bond completed a proposal form for Motor Insurance. Later, an
accident happened when his car was driven by his son. The claim
under this policy failed when the insurer pleaded that Bond had
failed to disclose all material facts. Although all the questions in the
proposal form has been fully answered, he should have informed
that his young son, who was likely to drive, had previous convictions
 Principle of Insurable Interest
 It is an important legal principle. Insurable interest provides the right to insure. All
insurance contracts must be supported by insurable interest.
 Insurable interest exists when the policyholder has a pecuniary or monetary
interest in the life or property, which he has insured. Any damage to the property
must result in financial loss to the policyholder.
 Only then is insurable interest said to exist.
 It states that insured must be in a position to lose financially if a loss occurs or to
incur some other kind of harm if the loss takes place. In a life insurance context,
insurable interest is deemed to exist in the case of certain relationships based on
sentiment [e.g. Husband & wife, parent & child]. It is the interest of the insured in
the subject matter of insurance, which is insured. All risks are not insurable. In
order to be insurable, the risk must be quantitatively measurable in terms of
money and there should be insurable interest in the asset that is to be insured.
Insurable interest provides the right to insure.
 Insurable interest is -
 1. An essential ingredient of every insurance contract;
 2. Considered as the legal pre-requisite for insurance.
 Definition
 The legal right to insure arising out of a financial relationship
recognized under the law, between the insured and the subject
matter of insurance.
 Insurable interest distinguishes contracts of insurance from gambling
in order to define the legitimate area of insurance business.
 Insurable interest is required for all types Insurable interest is required
for all types of insurance and its absence renders the contract void
and hence unenforceable.
 The essentials of insurable interest include:
• There must be some property, right, interest, liability or potential
liability capable of being insured.
• It is this property, right etc., which must be the subject matter of
insurance.
 Insurable interest is -
1. An essential ingredient of every insurance contract;
2. Considered as the legal pre-requisite for insurance.
PRINCIPLE OF INSURABLE INTEREST

 The insured must have insurable interest n the subject matter of

insurance.
 In life insurance it refers to the life insured.
 In marine insurance it is enough if the insurable interest exists only at
the time of occurrence of the loss.
 In fire and general insurance it must be present at the time of taking
policy and also at the time of the occurrence of loss.
 The owner of the party is said to have insurable interest as long as he
is the owner of it.
 It is applicable to all contracts of insurance.
Principle of Insurable Interest

 There are certain legal requirements to be met in the actual working

of insurance contracts. The principle of insurable interest ensures
some of these requirements are met resulting in the creation of a
valid legally enforceable contract.
 Insurable interest means the policyholder must have a pecuniary or
monetary interest in the property, which he has insured. Any
damage to the property must result in financial loss to the
policyholder. Only then insurable interest is said to exist.
Creation of insurable interest

 By common law (ownership of a car – he is entitled to insure)

 By statute – act of parliament
 By contract – agreement. If there is an agreement between land
and tenant that tenant has to maintain the house he is entitled to
insure.
Importance of the principle of
insurable interest
 The principle adds legal validity without which such contracts would
be wagering or gambling in nature according to Indian Contract
Act here. The concerned parties don’t suffer any loss in case Sachin
misses the tournament.
 To measure the amount of insured’s loss (indemnity – in case of
property insurance) a non-owner of the property cannot take up an
insurance policy on it even if he has a partial interest in the property.
For example, ataxi driver, an employee in a factory.
 Presence of insurable interest prevents fraudulent practices.
Essentials of insurable interest

 There must be some property, right, interest, life

 It is this property or right or interest, which must be the subject matter
of insurance
 The insured must stand in a relationship with the subject matter of
insurance whereby he benefits from its safety than loss
 The relationship between insured & subject matter must be
recognized at law
The Principle of Indemnity

 It is one of the important legal principles in Insurance. The principle

of Indemnity states that the insurer agrees to pay not more than the
actual amount of the loss, which means that the insured should not
gain anything from a loss. And this principle has two fundamental
purposes:
 To prevent the insured from gaining from a loss; and
 To reduce moral hazard.
 Indemnity means guarantee or assurance to put the insured in the
same position in which he was immediately prior to the happening
of the uncertain event. The insurer undertakes to make good the
loss.
 • It is applicable to fire, marine and other general insurance.
 • Under this the insurer agreed to compensate the insured for the
actual loss suffered
 The dictionary meaning of ‘indemnity’ is ‘the protection or security
against damage or loss or security against legal responsibility’. A
contract of general insurance is a contract of indemnity. All
contracts of insurance except life, personal accident, and health
insurance are contracts of indemnity.
 The principle of indemnity means making good the losses suffered
by an unfortunate person. But in any life insurance or Personal
Accident Insurance Contract, it is impossible to assess the value of
human life of an individual and so the principle of indemnity cannot
be applied in both these cases.
 Indemnity may be referred to as a mechanism by which insurers
provide financial compensation in an attempt to place the insured
in the same pecuniary position after the loss as enjoyed just before
it. The literal meaning of the term “Indemnity” is making good the
loss. On the happening of the insured event for which the insurance
policy is taken the insured should be replenished the amount of loss
by the concerned insurer.
 This principle sets the rule according to which insurance companies
undertake to compensate the insured upon fulfillment of all the
stipulations that are agreed upon in the insurance contract. The
insurer charges a small amount as premium for undertaking the
liability to cover the risk and in return promises to pay the value of
the insurance policy or the amount of loss whichever is lower..
Principle of Subrogation

 Subrogation means the restitution or transfer of the rights of an

assured in favour of the insurer against the third party for any
damages caused by him, in place of the assured after the insurer
has indemnified him for the loss.
 The principle of subrogation is invoked when a third party is
responsible for the loss.
 The principle of subrogation is applicable to fire and marine
insurance policies. It is to be noted that on the happening of the
event for which the asset has been insured and after the damage
has been caused the insured can sue the party who has caused the
damage to claim compensation for the loss. Alternatively the
insured can seek compensation from the insurance company.
 In case the insured opts for the latter course he loses the right to sue
the party, who has caused the damage and seek further
compensation from him. In accordance with the principle of
subrogation the insurance company acquires the right of the
insured to sue the third party to compensate for his negligence and
loss inflicted upon when it indemnifies the insured the losses suffered
by him. Therefore, if the assured recovers the full extent of the loss
from the insurance company, then the insurance company gets the
rights and remedies of the assured, and can proceed against the
third party for the recovery of compensation. In case, the insured
also receives the compensation from the third party in respect of
the same loss, then he must pay that amount to the insurance
company.
Importance of the principle of
subrogation
 The principle of subrogation serves to achieve the following
objectives:
 1. It prevents the insured from profiting from the damage, i.e.,
obtaining compensation twice for the same loss.
 2. It enforces the rule of law that the guilty is brought to book and
made to pay for the loss.
 3. It helps the insurer to partially or fully recover the amount paid for
the loss.
 4. It helps to lower the insurance rates. With reimbursement from the
concerned third party, the insurance company’s losses are
substantially scaled down, the benefit of which in turn is passed on
to the final policyholder by way of reduction in premium.
 Applicability of the doctrine of subrogation
 Necessarily the principle of subrogation applies to general insurance
(other than insurance on human) only. It has no relevance with
respect to life insurance or health insurance since the principle of
indemnity on which it rests upon applies exclusively to general
insurance.
 Limitations of the doctrine of subrogation
 1. This doctrine is not applicable to life insurance policies and therefore the insurer
has no right of action against third parties responsible for the death.
 2. The doctrine becomes operative only after the insured has been indemnified.
There is no relation between the indemnity provided for and the exercise of
subrogation. The insurer may not be able to recover exactly the same amount by
exercising the right of subrogation against the third party.
 3. Subrogation cannot be exercised where the assured is not in a position to take
action against the damaging party.
 Example
 Mr. Bhagat had insured his personal computer. It was damaged by his teenage
son Jagat who smashed it with a cricket ball in a fit of rage. In this case Mr.
Bhagat does not want to subject his son to any action. Hence the insurer is not
obliged to make payment for the loss.
Principle of Contribution

 the principle of contribution mean as the right of an insurer who has

paid for a loss under a policy to recover a proportionate amount
from the other insures who are liable for the loss. Thus, Contribution is
the right of an insurer to call upon others similarly, but not necessarily
equally liable to the same insured to share the cost of an indemnity
payment. This principle of contribution enables the total claim to be
shared in a fair way.
 The doctrine of contribution operates as a corollary of the doctrine
of Indemnity and hence is applicable to general insurance.
 The principle of contribution should be property worded in the
contract.
 If at the time of any loss, damage or liability arising under this policy
there shall be any other insurance, whether effected by the insured
or any other person covering the same property or liability or any
part thereof, the company shall not be liable for more than its
rateable portion of such loss or damage
 Thus, as per the doctrine of contribution, the indemnity provided for
the loss occurring on the asset, which is insured with several insurers
has to be proportionately shared among them according to the
rateable proportion of the loss. The amount of total compensation
or indemnity provided to the insured by all the insurers should not
exceed the amount of loss
Requisites to invoke the doctrine of
contribution
 1. The insured asset/Person (subject matter of insurance) (in case of
hospitalization insurance) must be common to all the policies.
 2. The risk insured(event) against must be common to all the policies
 3. The insured owner of the asset must be the same person
 4. All the policies must be in force during the occurrence of loss
 The following conditions must be satisfied for the applicability of the
principle of contribution:
 1. The same subject matter is insured with more than one insurer
 2. The policies must cover the same peril.
 3. The assured must be the same person in all the polices.
 4. All the policies must be in force at the time of loss.
 5. Each insurer has to pay to the insured his share of loss only.
Principle of Proximate Cause

 Proximate cause is a key principle of insurance and is concerned with

how the loss or damage actually occurred and whether it is indeed as
a result of an insured peril and is payable under the affected policy
issued by the concerned insurer.
 Cause Proxima is necessary for a valid contract of insurance. It has
been defined as the active efficient cause that sets in motion a train of
events which brings about a result, without the intervention of any
force, started and working actively from a new and independent
source.
 It is not the latest, but the direct, dominant, operative and efficient
cause that must be regarded as proximate.
 When an insurance policy is bought it is issued with respect to some
peril, which may result in loss to the policyholder. No policy covers all
types of risks. The insurance company is liable to indemnify only against
the insured perils.
 The term “Proximate cause “literally means the nearest cause or
direct cause. In insurance parlance it relates to the immediate
cause of the mishap, which resulted in the loss.
 In general insurance there are numerous policies relating to vehicle
insurance, property insurance, fire insurance, burglary insurance,
etc. Each policy offers protection from the risks that are mentioned
in the policy.
 If a person has bought fire insurance for his house, the protection will
be from the loss caused by fire, which may have resulted from the
sources mentioned in the policy. In case the fire occurs from any
source other than that mentioned in the policy the insurer is not
liable to compensate the insured.
Determination of proximate cause

 Where the mishap occurs as a single event the determination of

Proximate Cause is simple and that particular event can be
attributed for the loss. Where the loss occurs as a chain of events in
succession with one event triggering the other, it may be difficult to
determine the exact cause of the damage. In such an eventuality
the parties have to carefully examine and find out the correct
reason for the loss, the extent to which the loss has been caused by
the proximate cause and the amount of compensation to be paid
based upon it. It may happen that the actual peril, which has
caused the loss in turn, is caused by another peril.
 It has to be noted that while determining ‘proximate cause’ the
sequence of events according to their time of occurrence is
irrelevant. The deciding factor is the correct cause of loss.
 Many court judgments act as precedents in arriving at decisions while making
settlements. They have been enumerated in the following paragraphs.
 I. The insurer is liable:
 • When the peril is a single event and it is insured.
 • Where the insured peril (the event for which the policy has been taken for
protection) occurs first and it is followed by an excluded peril (the event which
has not been covered by the policy, i.e., which is not insured). Here the insurer
has to pay for the loss, which had occurred up to the happening of the
excluded peril only if the two perils can be distinguished from each other.
 • Where the excluded peril causes the insured peril and the events occur in a
broken sequence the insurer has to pay for the loss caused by the insured peril.
 • Where both the perils are occurring concurrently and both the events are
independent of each other.
 II. The insurer is not liable:
 • Where the excluded peril is the cause of the insured peril and they
act consecutively.
 • Where the insured peril is followed by the excepted peril and both
cannot be distinguished from each other.
 • Where both the perils are occurring concurrently.
PRINCIPLE OF CAUSA PROXIMA
(NEAREST CAUSE)
 • The loss of insured property can be caused by more than one
cause in succession to another.
 • The property may be insured against some causes and not against
all causes.
 • In such an instance, the proximate cause or nearest cause of loss
is to be found out.
 • If the proximate cause is the one which is insured against, the
insurance company is bound to pay
 the compensation and vice versa.
PRINCIPLE OF LOSS MINIMIZATION

 Under this principle it is the duty of the insured to take all possible steps
to minimize the loss to the
 insured property on the happening of uncertain event.
 According to the Principle of Loss Minimization, insured must always try
his level best to minimize the loss of
 his insured property, in case of uncertain events like a fire outbreak or
blast, etc. The insured must take all
 possible measures and necessary steps to control and reduce the losses
in such a scenario. The insured
 must not neglect and behave irresponsibly during such events just
because the property is insured. Hence it
 is a responsibility of the insured to protect his insured property and avoid
further losses