Insurance is basically a contract, between the insurer and insured. The consideration for the contract is the premium paid by the insured. Therefore, the insurance contract must contain all the essential elements of a contract under the law of contract. They are Offer and Acceptance, Legal Consideration, Capacity to Contract, Free Consent, and Legal Object.
Besides, the contract of insurance has certain special principles. They are as follows:
- Insurable Interest,
- Utmost Good Faith,
- Causa Proxima,
- Assignment and Nomination, end
- Return of Premium.
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.
- Facts which tend to lessen the risk,
- Facts of public knowledge,
- Fact, which could be inferred from the information disclosed,
- Facts waived by the insurer,
- 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.
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.
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:
- The premium on such policy must have been paid regularly.
- The policy must be in force.
- If the policy is surrendered, only a lesser amount known as surrender value shall be paid to the policyholder.