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Meaning

An act of insuring, or assuring, against potential future losses in exchange for a periodic payment called
premium. In other words, one of the parties undertakes to indemnify or guarantee another party against loss
by certain specified risks.

Insurance works on the basic principle of risk-sharing. A great advantage of insurance is that it spreads the
risk of a few people over a large group of people exposed to risks of similar types.

Insurance is a contract of reimbursement. For example, it reimburses for losses from specified perils, such as
fire, hurricane, and earthquake. An insurer is the company or person who promises to reimburse.
The insured (sometimes called the assured) is the one who receives the payment, except in the case of life
insurance, where payment goes to the beneficiary named in the life insurance contract. The premium is the
consideration paid by the insured—usually annually or semiannually—for the insurer’s promise to reimburse.
The contract itself is called the policy. The events insured against are known as risks or perils.

Functional Definition of Insurance


Insurance is a co-operative device to spread the loss caused by a particular risk over a number of persons, who
are exposed to it and who agree to insure themselves against the risk.
Thus, the insurance is
(a) a co-operative device to spread the risk;
(b) the system to spread the risk over a number of persons who are insured against the risk;
(c) the principle to share the loss of each member of the society on the basis of probability of loss to their risk;
and
(d) the method to provide security against losses to the insured.
Similarly another definition can be given. Insurance is a co-operative device of distributing losses, falling on an
individual or his family over a large number of persons, each bearing a nominal expenditure and feeling secure
against heavy loss.

Contractual Definition of Insurance


Insurance has been defined to be that in which a sum of money as a premium is paid in consideration of the
insurance incurring the risk of paying a large sum upon a given contingency. The insurance, thus, is a contract
whereby;

1. Certain sum, called premium, is charged in consideration,


2. Against the said consideration, a large sum is guaranteed to be paid by the insurer who received the
premium,
3. The payment will be made in a certain definite sum, i.e., the loss or the policy amount whichever may be,
and
4. The payment is made only upon a contingency.

Features of Insurance
From the above explanation we can find these following characteristics which are, generally, observed in
case of life, marine, fire and general insurances.

1. Sharing of Risk
Insurance is a device to share the financial losses which might befall on an individual or his family on the
happening of a specified event.
The event may be death of a bread-winner to the family in the case of life insurance, marine-perils in
marine insurance, fire in fire insurance and other certain events in general insurance, e.g., theft in
burglary insurance, accident in motor insurance, etc. The loss arising from these events, if insured are
shared by all the insured in the form of premium.

2. Co-operative Device
The most important feature of every insurance plan is the co-operation of large number of persons who, in
effect, agree to share the financial loss arising due to a particular risk which is insured.
Such a group of persons may be brought together voluntarily or through publicity or through solicitation
of the agents.
An insurer would be unable to compensate ail the losses from his own capital. So, by insuring or
underwriting a large number of persons, he is able to pay the amount of loss.
Like all cooperative devices, there is no compulsion here on anybody to purchase the insurance policy.

3. Value of Risk
The risk is evaluated before insuring to charge the amount of share of an insured, herein called,
consideration or premium. There are several methods of evaluation of risks.
If there is expectation of more loss, higher premium may be charged. So, the probability of loss is
calculated at the time of insurance.

4. Payment at Contingency
The payment is made at a certain contingency insured. If the contingency occurs, payment is made.
Since the life insurance contract is a contract of certainty, because the contingency, the death or the expiry
of term, will certainly occur, the payment is certain. In other insurance contracts, the contingency is the
fire or the marine perils etc., may or may not occur.
So, if the contingency occurs, payment is made, otherwise no amount is given to the policy-holder.
Similarly, in certain types of policies, payment is not certain due to uncertainty of a particular contingency
within a particular period.
For example, in term-insurance the, payment is made only when death of the assured occurs within the
specified term, may be one or two years. Similarly, in Pure Endowment payment is made only at the
survival of the insured at the expiry of the period.

5. Payment of Fortuitous Losses


Another characteristic of insurance is the payment of fortuitous losses. A fortuitous loss is one that is
unforeseen and unexpected and occurs as a result of chance. In other words, the loss must be accidental.
The law of large numbers is based on the assumption that losses are accidental and occur randomly. For
example, a person may slip on an icy sidewalk and break a leg. The loss would be fortuitous. Insurance
policies do not cover intentional issues.

6. Amount of Payment
The amount of payment depends upon the value of loss occurred due to the particular insured risk
provided insurance is there up to that amount. In life insurance, the purpose is not to make good the
financial loss suffered. The insurer promises to pay a fixed sum on the happening of an event.
If the event or the contingency takes place, the payment does fail due if the policy is valid and in force at
the time of the event, like property insurance, the dependents will not be required to prove the occurring
of loss and the amount of loss.
It is immaterial in life insurance what was the amount of loss was at the time of contingency. But in the
property and general insurances, the amount of loss, as well as the happening of loss, is required to be
proved.

7. Large Number of Insured Persons


To spread the loss immediately, smoothly and cheaply, large number of persons should be insured. The co-
operation of a small number of persons may also be insurance but it will be limited to smaller area.
The cost of insurance to each member may be higher. So, it may be unmarketable. Therefore, to make the
insurance cheaper, it is essential to insure large number of persons or property because the lessor would
be cost of insurance and so, the lower would be premium.
In past years, tariff associations or mutual fire insurance associations were found to share the loss at
cheaper rate. In order to function successfully, the insurance should be joined by a large number of
persons.
Insurance is a form of risk management primarily used to hedge against the risk of potential financial loss.
Again insurance is defined as the equitable transfers of the risk of a potential loss, from one entity to
another, in exchange for a premium and duty of care.

The seven principles of insurance are :-


1. Principle of Uberrimae fidei (Utmost Good Faith),
2. Principle of Insurable Interest,
3. Principle of Indemnity,
4. Principle of Contribution,
5. Principle of Subrogation,
6. Principle of Loss Minimization, and
7. Principle of Causa Proxima (Nearest Cause).

1. Insurable Interest
In a contract of insurance, it is necessary that the insured must have an insurable interest in the
subject matter of the insurance. The insurable interest is the pecuniary interest (monetary interest)
whereby the policyholder is benefited by the existence of the subject matter and shall be put to a
loss by the death or damage of the subject matter.
Insurable interest is essentially a monetary or pecuniary interest i.e. the loss caused by the
happening of the insured risk must be capable of financial valuation. A mere hope or expectation,
which may be frustrated by the happening of a particular interest, is not an insurable interest.

The essential conditions to be satisfied for a valid insurable interest are the following:

1. There must be a physical object or subject matter to be insured. The subject matter should be
subjected to risk. The risk can operate on such object and cause damage of destruction.

2. The policyholder must have monetary relationship with the subject matter.

3. The relationship between the policyholder and the subject matter should be recognized by law.
In other words, the relationship should be legal and not illegal.

4. The insured must stand in such relation to the subject matter insured that he will be benefited,
by its safety and will suffer by its destruction.

For example, the insured must be put to a loss if the goods are lost in transit or destroyed by fire
etc. Similarly, in case of life insurance the individual has unlimited financial interest in his own
life. Husband and wife have insurable interest in each other’s life. A partner has an insurable
interest on the life of the other fellow partners.

2. Utmost Good Faith


Insurance is a contract based on utmost good faith. It is a contract of Uberrima fidle i.e. of
absolute good faith where both parties to the contract must disclose all the material facts truly and
fully.
In all contracts, as a general rule, the principle of Caveat Emptor i.e. “ Let the Buyer Beware” shall
apply. It means that the buyer before contracting to purchase anything must satisfy himself as to
the nature and quality of the goods he is purchasing. This general rule does not apply to the
contract of insurance. Both the parties must disclose all material facts relating to the subject
matter of insurance. The disclosure should also be true and full in form.
A material fact is one, which affects the judgement or decision of both parties in entering into the
contract. Both the insurer and the insured, of course, stand on the same footing in relation to the
disclosure of material facts. The burden, however, falls more on the insured than the insurer
because he is in possession of the subject matter to be insured.

For instance, in case of life insurance, the material facts or factors affecting the risk will be age,
residence, occupation, health, income etc. The insured alone is in possession of the facts and it is
his duty to make a frank and full disclosure of such facts. What is a material fact, however, will
depend upon the circumstances of each case and has to be decided as such.
The following facts, however, need not be disclosed, though they materially affect the insurance
contract.

1. Facts which tend to lessen the risk,


2. Facts of public knowledge,
3. Fact, which could be inferred from the information disclosed,
4. Facts waived by the insurer,
5. Facts, which are embodied in the policy itself or facts governed by the conditions of the policy.
3. Principle of Indemnity
Indemnity means security against loss, or damage. In a contract of insurance (other than life
assurance) the insurer undertakes to indemnify or compensate the insured for losses occurring
due to the risk covered.

The compensation payable and the loss suffered are to be measured in terms of money. The
occurrence of the loss or risk is also contingent. If the risk does not occur the insurer need not pay
anything to the insured.

The principle of indemnity shall apply only to general insurance i.e. fire, marine and theft
insurance and not to life insurance. Therefore, the insured shall be indemnified only for the actual
loss suffered by him.
For example if the worth of the assets damaged by fire amounts to Rs.40,000 the insurer will pay
Rs.40,000 only even though the whole of the assets are insured for Rs.1,00,000. Actual worth
here means the actual book value of the property damaged. Therefore, it can be inferred that the
insurer does not undertake to make good the profit, which the insured might have earned if his
property remain safe.

In the above example, we have stated that if the book value of the damaged property is Rs.40,000
the insured will be compensated for that exact amount only. If the property remains undamaged,
he could have sold it at a profit i.e. say Rs.50,000 or more. But the Insurance Company will not
pay for the loss over and above its book value. From this it is clear that no profit can be made out
of the insurance contract.

The principle of indemnity shall not apply to life insurance. The insurance company should pay
the actual amount of the policy in the event of death of the policyholder or expiry of the policy.

Conditions for Applying the Principle of Indemnity


The following conditions must be fulfilled while applying the principle of indemnity:

1. The insurer should prove that he will suffer loss on the insured matter at the time of happening
of the event and the loss is an actual monetary loss.

2 The amount of compensation will be the actual loss or the amount insured whichever is less.
Indemnification cannot be more than the amount insured. (Here readers should note that when
the property is unfetter insured, the insurance company would pay only the insured amount even
though the loss is more than it).

3. If the insured gets more amounts than the actual loss, the insurance company has right to get
back the extra amount paid.

4. If the insurer gets some amount from a third party after being fully indemnified by the insurer,
the insurer shall have the right to receive the entire amount paid by the third party. It would be
against public policy to allow an insured to make a profit out of the happening of the loss or
damage insured against. Hence, over insurance is avoided.
4. Subrogation
The doctrine of subrogation is corollary to the principle of indemnity. It applies to all insurance
contracts, which are contracts of indemnity.

According to this doctrine, after the insured is compensated for the loss caused by the damage to
the property insured by him, the right of ownership over such damaged property shall pass on to
the insurer.

It follows that any value the damaged property has or if the assured can recover from the lost
property, the right to such value of property must also pass on to the insurer. But this right is
limited to the extent of the payment made by the insurer. Thus, the doctrine of subrogation
means effect in the substitution of the insurer in the place of the insured, as the rightful claimant
of the rights, possession etc.

Essentials of the Doctrine of Subrogation


The students should note the following points in regard to subrogation.

1. The insurance company is subrogated to the rights of the insured only after it has settled the
claim. However, the right may be exercised by the Insurance Company even before the payment
of loss.

2. The Insurance Company has to exercise such rights only in the name of the insured.

3. The company is entitled to the benefit out of such right only to the extent of the amount it has
paid to the insured as compensation.

4. If the insured received any money or compensation for the loss from any other third party after
he has been indemnified by the Insurance Company, the insured should hand over the amount so
received from such third party to the Insurance Company.

5. The principle of subrogation shall not apply to personal insurance such as life, accidents,
sickness etc.

5. Warranties
There are certain conditions and promises in the insurance contract. They are called as
warranties. Warranty is a very important condition in the insurance contract, which is to be
fulfilled by the insured.

On breach of warranty the insurer becomes free from his liability. Therefore, the insured should
fulfill the conditions and promises during the insurance contract, whether, it is important or not
in connection with the risk insured.

The contract shall continue and remain in force only when the warranties are fulfilled. The
insured, however, can refuse to fulfill the warranty only when it is declared illegal and there shall
no reverse effect on the contract.

Warranties are generally mentioned in the policy itself. Such warranties are called express
warranties. There are certain warranties, which are not mentioned in the policy. These warranties
are called implied warranties.

6. Causa Proxima
Causa Proxima is a Latin phrase, which means proximate cause. The rule is that immediate and
not the remote cause is to be regarded. The maxim is “Sed causa proxima non-remota spectature”
i.e. see the proximate cause and not the distant cause. The real cause of the loss must be
considered while payment of the loss. If the real cause of loss is not insured, the insurance
company is not liable to indemnify the loss sustained by the insured.
The determination of the real cause depends upon the working and practice of insurance and
circumstances to losses. The question of determining the real cause shall become difficult, when
there is a series of causes.

A loss may not be occasioned merely by one event. If there are concurrent causes or chain of
causes, it is necessary to look into the nearest cause and not to the remote cause. The term
nearest cause here means the cause actually responsible for the loss.

7. Assignment and Nomination


Marine and life insurance policies can be assigned to someone without the prior consent of the
insurance company. However, fire and accident policies can be assigned to someone only with the
prior consent of the insurer.

Assignment means the transfer of the right to claim the money from the insurance company.
When a policy is assigned in favour of someone, the assignee becomes entitled to receive the
amount of the policy and the policyholder shall be debarred from claiming the right.

Nomination, on the other hand, refers to the conferring of the right to receive payment of the
policy in the event of death of the policyholder. The question of nomination has particular
importance only in case of life policies. In the event of death of the policyholder, the nominee
shall become entitled to receive payment from the insurance company.

8. Return of Premium
Premium once paid shall not be refunded. In other words, the question of returning the premium
shall not arise in all types of insurance including life insurance. In case of general insurance, a
single premium is paid and it will not be returned, even if the contingency does not occur during
policy is in force. However, in case of life insurance, the policy amount will be paid to the
policyholder in the event of expiry of the term assured.

Payment of the policy amount is also subject to various conditions. They are:

1. The premium on such policy must have been paid regularly.


2. The policy must be in force.
3. If the policy is surrendered, only a lesser amount known as surrender value shall be paid to the
policyholder.