Every individual family and
business organization needs insurance, for inherent risk exposures to which
they are exposed. Insurance seeks to redress the assured from the financial
consequences of the loss exposures in the event of the uncertain event
happening, resulting in a loss of his assets, or properties or even income
earnings. Insurance is actually a combination of three elements A transfer
system A business A contract Insurance as a Transfer System As a transfer
system, insurance enables a person, family or business to transfer the costs of
losses to an insurance company. In turn the company pays for the insured losses
and distributes the costs of losses among all insureds. Thus, the key elements
of insurance as a transfer system refers to the transferring of risks from the
insured to the insurance company which is financially sound and has the
capacity and willingness to take risks. The person transfers the consequences of
a loss to the company, thereby exchanging the possibility of a large loss for
the certainty of a much smaller periodic payment (premium). For transferring a
cost of loss it is not necessary for a loss to occur or exist. A mere
possibility of a loss constitutes a loss exposure that can be insured or
transferred. A Loss exposure can give rise to three types of losses, namely:
Property loss (including net income loss), Liability loss, and Human and
personnel loss. On the other hand, sharing of risks implies the pooling of
premiums paid by the insureds into a fund out of which the losses are paid as
and when they occur. Thus, the role of insurance is to protect insured’s assets
from the financial consequences of loss. But, not all risks are insurable.
Insurance covers only pure risks.
Insurance as a Business As
a business, insurance primarily attempts to meet its costs and expenses from
the premium that it earns and also make a reasonable margin of profit for its
own sustainability. As a business organization, it provides jobs to millions of
people in life and non-life insurance companies, agencies, brokerage firms. The
various operations of these companies include marketing, underwriting, claims
handling, ratemaking and information processing. As a business concern, it also
needs to satisfy the regulators, insureds and others of its financial
stability. Therefore, to protect the consumers, the regulator monitor the
rates, policy forms, solvency margins, and also investigate complaints and
consumers’ grievances. In addition to payment of losses, the business of
insurance offers several benefits to individuals and families and to the
society as a whole such as: Payments for the costs of covered losses Reduction
of the insured’s financial uncertain Efficient use of resources Support for
credit Satisfaction of legal requirements Satisfaction of business requirements
Source of investment funds for infrastructure development Reduction of social
burden.
However, the benefit of
insurance is not cost free. There are some direct costs as well as indirect
costs which are incurred, such as the premiums paid, operating costs of the
insurers, opportunity costs, increased losses, and increased law suits.
Insurance as a Contract As a contract, an insurance policy is a legally enforceable
contract. The contract is between the insurance company and the insured.
Through insurance policies, the insured transfers the costs of losses to
insurance company. In return for the premiums paid by the insured, the insurers
promise to pay for the losses covered under the policy. The policy contains all
the terms and conditions for its enforceability, and the benefits payable by
the insurer. The breach of these conditions by either party will result in the
invalidation of the contract. Thus, through the coverage provided by insurance
polices, the individuals, families and businesses are enabled to protect their
assets, and minimize the adverse financial affects of losses. Hence, an
insurance contract needs to be interpreted and carefully designed so that, all
fortuitous losses are covered and insured against.
The most common four basic
types of insurance (property, liability, life and health) are generally divided
into two broad categories: 1. Property/Liability insurance 2. Life/Health
insurance 1. Property insurance provides coverage for property and net income
loss exposures. It protects an insured’s assets by paying to repair, or replace
property that is damaged, lost, or destroyed or by replacing the net income
lost and extra expenses incurred as a result of property loss. Liability
insurance covers the liability loss exposures. It provides for payments on
behalf of the insured for injury to others or damage to others’ property for
which the insured is legally liable. 2. Life and health insurance cover the
financial consequence of human (personal) loss exposures. Life insurance
replaces the income-earning potential lost through death and also helps to pay
expenses related to insured’s death. Health insurance provides additional
income security by paying for medical expenses. Disability income as popular in
most of the Western countries, replaces as insured’s income if the insured is
unable to work because of injury or illness.
DEFINITION
OF ‘CONTRACT’
An agreement enforceable by
law is called a contract. It creates certain rights and obligations for parties
agreeing to it. A valid contract is one, which the court enforces.
Requirements of an
insurance contract Insurance contracts are also governed by the provisions of
the Indian Contract Act, 1872. In general, there are four requirements that are
common to all valid contracts. To be legally enforceable, an insurance contract
must meet these four requirements: 1. Offer and acceptance 2. Consideration 3.
Capacity 4. Legal purpose 1. There must be valid offer and acceptance: The
first requirement of a binding insurance contract is that there must be an
offer and an acceptance of its terms. In most cases, the applicant for
insurance makes this offer, and the company accepts or rejects the offer. An
agent merely solicits or invites the prospective insured to make an offer. A
legal offer by an applicant for insurance must be supported by a tender of the
premium and it should always be prior to commencement of the ‘coverage’. The
agent usually gives the insured a conditional receipt that provides that
acceptance takes place when the insurability of the applicant has been
determined by the Insurer. In property and liability insurance, the offer and
acceptance can be oral or written.
Promises must be supported
by the exchange of Consideration: A consideration is the value given to each
contracting party. The insured’s consideration is made up of the monetary
amount paid in premiums, plus an agreement to abide by the conditions of the
insurance contract. The insurer’s consideration is its promise to indemnify
upon the occurrence of loss due to certain perils, to defend the insured in
legal actions, or to perform other activities such as inspection or collection
services, or loss prevention and safety services, or as the contract may
specify. 3. Parties must have legal capacity to contract: This requirement of a
valid insurance contract is that each party to a contract must be legally
competent. This means the parties must have legal capacity to enter into binding
contract. Parties who have no legal capacity to contract include: l Insane
persons who cannot understand the nature (obligations and liabilities) of the
agreement l Intoxicated persons l Corporations acting outside the scope of
their charters, bylaws, or articles of incorporation, or authority l Minors
Note: Minors
normally are not legally competent to enter into binding insurance contracts;
but most states have enacted laws that permit minors, such as a teenager age
15, to enter into valid life or health insurance contract. 4. Agreement must be
for legal purpose: For insurance policies, this requirement means that the
contract must neither violate the requirements of insurable interest nor
protect or encourage illegal ventures. In other words, an insurance policy that
encourages or promotes something illegal and immoral is contrary to public
interest and cannot be enforced. Example: A street pusher of heroin and other
illegal drugs cannot purchase property insurance policy that would cover
seizure of the drugs by the police.
FUNDAMENTAL
PRINCIPLES GOVERNING GENERAL INSURANCE CONTRACTS
The business of insurance
aims to protect the economic value of assets or life of a person. Through a
contract of insurance the insurer agrees to make good any loss on the insured
property or loss of life (as the case may be) that may occur in course of time
in consideration for a small premium to be paid by the insured. Apart from the
above essentials of a valid contract, insurance contracts are subject to
additional principles. These are: Principle of Utmost good faith Principle of
Insurable interest Principle of Indemnity Principle of Subrogation Principle of
Contribution Principle of Proximate cause.
These distinctive features
are based on the basic principles of law and are applicable to all types of
insurance contracts. These principles provide guidelines based upon which
insurance agreements are undertaken. A proper understanding of these principles
is therefore necessary for a clear interpretation of insurance contracts and
helps in proper termination of contracts, settlement of claims, enforcement of
rules and smooth award of verdicts in case of disputes.
The Principle of Utmost
Good Faith Definition A positive duty voluntarily to disclose, accurately and
fully, all facts material to the risk being proposed, whether requested or not.
This principle of insurance stems from the doctrine of “Uberrimae Fides” which
is essential for a valid insurance contract. It implies that in a contract of
insurance, the concerned contracting parties must rely on each other’s honesty.
Normally the doctrine of “Caveat Emptor” governs the formation of commercial
contracts which means ‘let the buyer beware’. The buyer is responsible for examining
the good or service and their features and functions. It is not binding upon
the parties to disclose the information, which is not asked for. But in case of
insurance, the products sold are intangible. Here the required facts relate to
the proposer, those that are very personal and known only to him. The law
imposes a greater duty on the parties to an insurance contract than those
involved in commercial contracts. They need to have utmost good faith in each
other, which implies full and correct disclosure of all material facts by both
the parties to the contract of insurance.
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.
Non-disclosure of any fact may be unintentional on the part of the insured.
Even so such a contract is rendered voidable at the insurer’s option and it can
refuse any compensation. Any concealment of material facts is considered
intentional. In this case also the policy is considered void. The intentional
non-disclosure amounts to fraud and un-intentional disclosure amounts to
voidable contract. For example, disclosures in life insurance pertain to age,
income, health, residence, family details, occupation and plan of insurance.
Similarly, in case of property or general insurance, the material facts pertain
to the details of the property (car) such as year of make, usage, model,
seating capacity etc. particularly in case of marine insurance, the insurance
company may not always be in a position to inspect the ship at the port
physically and it relies solely on the facts provided by the insured. Hence it
is imperative on the part of the insured to disclose all the facts voluntarily.
Utmost good faith principle
imposes duty of disclosure on both the insurance agent and the company
authorities also. Any laxity at this point may tilt judgments-in favor of the
insured in case of a dispute. However, some the following facts need not be
disclosed: Circumstances which diminish the risk (such as fire or burglary
alarms set) Facts which are known or reasonably should be known to the insurer
in his ordinary course of business Facts which are waived by the insurer Facts
of public knowledge Facts of law Facts covered by policy conditions. Breach of
duty of Utmost Good Faith Breach of duty of Utmost good faith arise under one
or both of the following: a) Misrepresentation which may be either innocent or
fraudulent with reference to false facts, material to the acceptance or
assessment of the risk. b) Non-disclosure which may be either innocent or
fraudulent gives grounds for avoidance by the second party where a fact is
within the knowledge of the first party and not known to the second party.
Principle of Insurable
Interest 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. The existence of insurable interest is an essential
ingredient of any insurance contract. It is an important and fundamental principle
of insurance. Insurable interest simply means “right to insure”. The
policyholder must have a pecuniary or monetary interest in the property, which
he has insured. The subject matter of insurance can be any type of property or
any event that may result in a loss of a legal right or creation of a legal
liability. Therefore 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. The insured must stand in a relationship with the subject matter
of insurance whereby he benefits from its safety, well being or freedom from
liability and would be prejudiced by its loss, damage or existence of
liability.
The relationship between
the insured and the subject matter of insurance must be recognized at law. For
example, the subject matter of insurance under a fire policy can be a building,
stocks, machinery, under a liability policy it can be a person’s legal
liability for injury or damage, a ship in a marine policy etc. Any damage to
the property must result in financial loss to the policyholder. Only then
insurable interest is said to exist. There are a number of ways in which
insurable interest will arise or be limited: a) By Common Law: under common law
insurable interest is automatically created by ‘ownership’ rights. Similarly,
the common law of ‘duty of care’ that one owes to the other may give rise to a
liability which is also insurable. For E.g. the owner of a tractor who depends
on it for his agricultural operation stands to lose financially if the tractor
meets with an accident, as his business will come to a standstill. Thus the
owner has an insurable interest in the asset, i.e., his tractor. Hence the
tractor forms the subject matter when insurance is purchased on it. b) By
Contract: sometimes insurable interest is also created by contractual
obligations. For example, a lease agreement between a landlord and a tenant may
make a tenant responsible for the maintenance or repair of the building. This
contract places the tenant in a legally recognized relationship to the building
which gives him insurable interest. c) By statute: sometimes an act of
parliament may create insurable interest either by granting a benefit or by
imposing a duty.
Application of insurable
interest There are three main categories of application of Insurable interest
as mentioned below: Life Every individual has unlimited insurable interest in
his or her own life. In life insurance context, insurable interest is deemed to
exist in the case of certain relationships based on sentiment. (E.g. Husband
& wife, parent & child) Insurable interest is also deemed to exist when
the members of a family are in business together. Under such circumstances, it
is not the family ties which create insurable interest but it is the extent of
financial involvement that creates insurable interest. The business partners
can insure each other’s lives because they stand to loose in the event of the
death of any of them.
Property Insurable interest
normally arises out of ownership where the insured is the owner of the subject
matter of insurance, such as a car or a house. Sometimes, there are some other
financial relationships that give rise to insurable interest although they do
not involve full ownership. They include: - Part of joint ventures – wherein
the joint owner is treated as trustee for the other owner[s]. - Mortgagees and
Mortgagors – the insurable interest under a mortgage sale arises for the
purchaser (mortgagor) from the ownership of an asset and for the financial
institution (mortgagee) as a creditor, it is limited to the extent of the loan.
- Executors and Trustees – insurable interest arises out of the legal
responsibility vested in them for the property kept in their charge. - Bailees
– who are responsible to take reasonable care of the goods which are in their
custody, have insurable interest. - Agents – where a principal has insurable
interest, his agent can effect insurance on his behalf.
Liability The concept of
liability insurance is very different from property and life assurance. In this
insurance, it is not possible to predetermine the extent of the insurable
interest because there is no way of knowing how often one may incur liability
and in such a case, what would be the monetary value of such liability. Thus,
in other words it is implied that insurable interest in liability insurance is
without monetary limit, but in practice it is possible to make a realistic judgment
as to the maximum liability that may be incurred. Hence it can be said that a
person has insurable interest to the extent of any potential liability which
may be incurred by way of damages and other costs (limited by sum insured which
is the max. expected liability quantum). Another important aspect in the
application of the principle of insurable interest is the time of its
application. While in life insurance, insurable interest needs to be present at
the inception of the contract or policy, there is no requirement at the time of
a claim under the policy. On the contrary, insurable interest in the subject
matter of insurance must be present at the time of loss in a marine insurance
contract, and it means in other words, that there need be no insurable interest
when the insurance is effected. In all other insurance policies, insurable
interest must be present both at the time of inception of the contract and as
well as at the time of loss.
INSURER’S
INSURABLE INTEREST
Like the insured, the insurance companies also
derive an insurable interest having assumed liability under the policies which
they issue. In other words, they may insure with another insurer a part or all
of the risk they have assumed. This is usually done under a contract of
Reinsurance.
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