Fundamental principles of

insurance contract
There are six (6) principles:
 Principle of Utmost good faith
 Principle of Insurable interest
 Principle of Indemnity
 Principle of Subrogation
 Principle of Contribution
 Principle of proximate Cause
Principle of Utmost good faith

 Definition
 Utmost goods faith is a positive duty

voluntary to disclose, accurately and fully, all

material facts to the risk being proposed,
whether requested or not.
Duty of disclosure of facts

 The duty of disclosure of facts rests on both

parties
1. the insured
Since the decision to insure is taken on the
basis of subject matter, the life to be insured in
life insurance and material facts are known by
proposer, it is much responsibility of the
proposer to disclose the material facts .
2. the insurer-Telling the fact that decreases the
amount of premium payment, covered risk,
available extensions etc
 In practice there are breaches of the duties by the insured
and insurer such as;
Breaches by Insured are misrepresentation of material facts,
concealment,
Breaches by the insurer are;
i. Withholding from the proposer the fact that the sprinkler
system in his premises entitles him to substantional
discount on his fire insurance premium. Similarly non
smokers discount for life insurance premium.
ii. Accepting an insurance which the insurer knows is
unenforceable or which it is not registered to underwrite.
iii. Making untrue statement during the negotiation for the
contract
The extent of the duty

The responsibility to disclose material facts

ends at the moment when the proposal form
has been fully and correctly fulfilled provided
there is no such fact which he considers or
expects to be considered material and have
not been disclosed.
 It must be noted in this regard that the

proposer can not defend on the ground that

he had omitted to disclose it by carelessness
or by mistake or that he did not consider it
material to the contract.
Facts which must be disclosed
by proposer

The categories of facts which must be disclose are,

 Facts which show a particular risk represents a greater

exposure than would be expected from its nature or loss

 External factors which make the risk greater than would

normally expected,
 Any special terms imposed on previous proposal by other

insurer;
 Previous losses and claims under other policies

 The existence of other non indemnity policy such as life

and accident
 Full facts relating to the description of the subject

matter of insurance
Facts need not be disclosed by
proposer

 Facts which tends to diminish the risk

 Facts of public knowledge
 Facts which could be inferred from the information
disclosed.eg telling born date or manufacturing date
 Facts governed by the condition of policy
 Facts of law
 Facts which are unnecessary to disclose by the reason
of a condition or warranty
2. Principle of insurable interest

 In spite of the popular belief that everything

can be insured, not all risk are insurable.
Because They must attain certain
characteristics of insurable risk ;most
importantly there must be insurable interest
on the part of the person insuring.
Importance Of insurable interest
. It is not the house, ship, machinery, potential
liability of life that are insured but it is a
pecuniary of the insured in that house ,ship,
machinery, etc which is insured.
Thus, it is the interest of the insured in the
subject matter of insurance is insured. This is
what demonstrates the importance of
insurable interest.
Definition of insurable interest

There is no single definition of insurable

interest which is universally accepted, but it
can be similar to the following:
 The legal right to insure ;arising out of

financial relationship recognized under law

between the insured and subject matter of
insurance
The essentials features of insurable
interest

1. Presence of subject matter to be insured.

2. Existence of monetary relationship between
the subject matter and the policyholder.
3. The relationship existing between the
policyholder and the subject matter need to be
legal.
4. The policyholder must be economically
benefited by the survival or suffer economic-
loss from the damage or destruction of the
subject matter.
Implementation of insurable interest
 To elaborate the significance of insurable
interest, it is essential to see its
implementation in the following broad
classification of insurance:
1. Insurable interest in Life insurance
2. Insurable interest in non life insurance
I. Insurable Interest in life
insurance

In life insurance insurable interest may be

classified in to two categories;
A. Insurable interest in own’s life
B. Insurable interest in other life; this can be
further be sub divided in to two categories;
a. Proof required
b. Proof not required
A. Insurable interest in owns life

 Every individual who is competent to enter in to a contract has

an insurable interest in his own life.
 Its presence is not required to be proved. Buyons says, "Every
man is presumed to posses an insurable interest in his estate
for the loss of future gain or saving which might be the result of
his premature death.“
To what extent of value?
 Regarding to the extent of insurable interest in own life it may
be said that his interest is unlimited because the loss to be
insured or his dependent can not be measured in terms of
money and, therefore ,no limit can be placed to the amount of
insurance that one may take on ones own life.
 Generally, one can not purchase policy usually more than ten
(10) times of his one year's income.
B. Insurable interest in other life

Life insurance can be issued on the lives of third parties

provided the proposer has insurable interest in third party.
It depends on the requirment;
A. Proof not required
B. Proof required
a. Proof not required
 In the following two cases, the presence of insurable

interest is legally presumed and therefore need not be

proved;
i. Wife has insurable interest in life of husband
The wife will suffer financially if the husband is dead
and will continue to gain if the husband is surviving
ii. Husband has insurable interest in life of his wife
b. Proof required
In the following cases, the presence of
insurable interest has to be proved:
1. Business relationship
2. Family relationship
1. Business relationship
 The insurable interest may be present in the life of

assured due to business or contractual relationship

between them.
 Here, the amount of insurable interest corresponds

with the amount of risk involved. Some of such

examples are described hereunder:
◦ A creditor has insurable interest in life of debtor
◦ Trustee
◦ Surety and principal,
◦ Partners interest in life of other partners
◦ An employers interest in life of key man
◦ An insurer has insurable interest in the life Assured
 ◦ A creditor has insurable interest in life of debtor
 If the debtor dies before the loan is repaid, the
creditor may loose money. Continuing of debtor's life is
financially meaningful to the creditors because the latter will
get all his money repaid at formers survival
◦ Trustee
 A trustee has insurable interest in respect of the interest of
which he is trustee because at the survival of the other person
the trustee is benefited and at his death he will suffer.
◦ Surety and principal,
 A surety has insurable interest in the life of his principal. If the
principal is dead, the surety is responsible for payment of
outstanding loan or obligated amount. At the survival of
principal, he will not suffer this loss. The insurable interest is
limited up to the amount
 ◦ Partners interest in life of other partners
 As per provision of partnership act at the death of partner, the
partnership will be dissolved and surviving partner loss financially.
Even if the firm continues at the death of partners the firm has to
pay to deceased partners share to his dependent. This will involve
huge financial loss to partnership. Therefore, the firm collectively
can purchase insurance policies in life of each partner's life
◦ An employers interest in life of key man
 The person, whose presence or potential cause profit to the business
may be termed as a key-man. If the key-man dead the business may
reduce profit up to a certain extent. The business suffers reduced
profit, expense involved in appointing and training new persons and
the amount to be given to the dependent of key-man at his death
◦ An insurer has insurable interest in the life Assured
 The insurer suffers at the death of life assured and therefore, he can
get reinsurance of the assured person by him
2. Family relationship
 The insurable interest may arise due to family

relationship if pecuniary interest exist between the

policy holder and life assured.
 because mere relation ship or ties of blood and love

does not constitute insurable interest.

 The interest must be based on value and not on mere

sentiments.
 Similarly mere moral obligation is not sufficient to

warrant existence of insurable interest unless there is a

legal obligation to get support will form insurable
interest of the person who is supported in life of the
person who is supporting.
II. Insurable interest in property insurance

 Insurable interest in property insurance arises

in the following ways
 Ownership
 Apart or joint ownership

Any person who has partial interest in

some property is entitled to ensure to the
extent of full value of the property
 Husband and wife
 Executer and trustee
 Agents
- Mortgagees and mortgagor
Mortgagees are common in the house and vehicle
purchase.
They involve a lender (normally a bank) known as
mortgagee and the purchaser known as mortgagor.
Both parties have an insurable interest. The purchaser
interest arises from ownership of the house or vehicle
and the financial institution's as a creditor that is
limited to the extent of loan.
- Bailees
A bailee is a person legally holding the property of
another which may be for payment. Motor garages,
laundries and watch repairs are examples of bailees.
3. Principle of Indemnity
According to this principle, the insurer undertakes to put the
insured in the event of loss in the same position that he
occupied immediately before the happening of the event
insured against.
In true sense of the indemnity, the insured is not entitled to
make a profit of his loss.
This principle does not apply in life insurance because of the
fact that the human life is not measured by financial means
Merits of Indemnity
 It reduces moral hazard
 This principle helps in avoidance of anti-social act
 The principle of indemnity helps to maintain premium at

low level
 Methods of Providing Indemnity
There are four basic methods of providing an indemnity:
 Cash: - Many claims are settled by means of cash payment to the insured.
All that insurers require is reasonable proof of the cause and extent of the
loss, and the cash payment is the measure of indemnity, or extent of the
insurer's liability for any given loss.
 Repair: - An adequate repair constitutes an indemnity. This form of
settlement is particularly common in motor insurance, where the insurer
settles the repair bill direct with the garage concerned.
 Replacement: - It is sometimes advantageous for the insurer to replace an
article rather than to pay cash. With a very new item or with such things as
jewelry and furs, depreciation is likely to be negligible and the insured
may well be content with a new replacement, which might possibly be
acquired at a discount from the appropriate dealer.
 Reinstatement: - This is a term usually found in fire insurance and
concerns the restoration or rebuilding of premises (not necessarily on the
same site) to their former condition.
4. Principle of Subrogation

 This principle refers to the right of the insurer to

stand in the place of the insured after settlement
of claim; as far as the insured's right of recovery
from an alternative source is involved.
 The legal right of insurer to collect the paid
amount at the time of loss from negligent third
party.
 The right of subrogation may exercised by insurer
before payment of loss but not in marine cargo
insurance.
 This principle does not apply in life insurance
contracts
 Essentials of subrogation
 Corollary/supportive to the principle of indemnity
 Subrogation is substitution
 Subrogation is up to the amount of payment
 Subrogation may be applied before payment
 subrogation does not apply in life insurance, only
his or her dependence
 The insured has the right to recover the amount
of the loss from the third party along with the
policy amount.
Modification of subrogation

 There are situations in which insurers would be

claiming back from each other very frequently
because of this most insurers to become
parties to the knock to knock agreement.
 This agreement operates between companies
and simply means that insurers will not
exercise subrogation right each other for
damage to their own insured vehicle.
 Subrogation may also be waived where an
employee suffers injury at the workplace as the
result of negligence of another employee.
5. Principle of contribution

 Contribution is the right of insurer who has paid

claim under a policy to call upon other insurers
liable for the same losses to contribute to the
payment.
 This principle does not apply in life insurance.
 Doctrine of contribution operates in the following
circumstance:
i. The concerned policy must always cover the same
peril which causes the loss.
ii. They must cover the same subject matter.
iii. They must protect the same interest.
iv. They must be enforced at the time of loss
 CONTRIBUTION:
 An insured may have taken many policies on the same
subject matter. The principal of contribution would lead to a
situation in which the insured would be able to recover his
loss from any one insurer, who then will have to effect
proportionate recoveries from other insurers concerned.
Normally the insurers seek to control additional insurances at
the proposal stage itself.
 Remember at no cost an infringement to the principle of
indemnity is accepted.
 The principal of contribution does not apply to personal
accident policies.
6. Principles of proximate cause

 According to this principle an insurance policy is

designed to provide compensation only for such
losses caused by the peril which are stated in the
policy.
 It is necessary to ascertain the cause of the loss to
decide whether it is payable under the policy or not
 The doctrine of this principle is based on cause and
effect. To be proximate a cause must be immediate.
The word immediate does not mean that it should
be the cause nearest to the loss in point of time,
but it should be understood in terms of
effectiveness and efficiency.
 Perils relevant to an insurance claim can be
classified under three categories
A. Insured peril ; those named in the policy as
insured
B. Excluded peril ; Those stated in the policy as
excluded
C. Uninsured peril; those peril are not
mentioned in the policy at all.
 The rules of this doctrine are as follows:
1) If the insured peril and uninsured peril operates together, the
insured peril is the proximate cause.
2) Where the insured peril operates finally after uninsured peril, the
insured peril is the proximate cause.
3) Where the operation of insured peril followed by the operation of
uninsured peril, the insured peril is the proximate cause if there
is a direct chain of causation from it to the loss.
4) Where the insured peril and excluded peril operates together, the
excluded peril is a proximate cause.
5) Where the insured peril follows and is followed by excluded peril
the last peril to operate is the proximate cause, unless the last
peril can be regarded as merely incidental to a chain of causation
set up by the first peril, in which event the first cause is the
proximate cause.
 Example:
 An insured sustained an accident while hunting.
Due to shock and weakness, he was unable to walk
and whilst lying on wet ground, he contracted cold
which developed into pneumonia causing death
ultimately.


 The proximate cause was considered to be the

accident and not the pneumonia, the disease,
which was only a remote cause. The claim was
payable under personal accident policy
Group discussion
 Simon receives br 1500 from his motor
insurance company in respect of total loss
value of his car following accident with
another motorist, Trevor, due entirely to
Trevor's fault. As Simon believes his car was
worth much more at the time of accident, he
sues Trevor. The judge awards Simon br
2000 which Simon has now received. Discuss
whether Simon is entitled to retain all or any
of the br 2000 awarded to him.
 Mr. x has suffered fire loss involving
destruction of fixture and fitting in his
warehouse. The original cost of items was br
6000.replecement cost is br 8000. It is
considered that 50% depreciation has
occurred in the four years since acquisition.
What sum would represent an indemnity?