INSURANCE PRINCIPLES

1
INSURANCE PRINCIPLES

• CHAPTER-3 PART-I

2
Essentials of a valid contract of insurance
3
How different is Life Insurance Contract?

• ? A Life Insurance Policy is a contract, in terms
  of the Indian Contract Act, 1872.
• ? Insurance is a specialised type of contract.
• ? Principle of Utmost Good Faith Principle of
  Insurable Interest are applicable to both life
  and non-life contracts apart from the usual
  aforesaid essentials of a valid contract.

4
Offer Acceptance

• The Proposer offers his proposal to be accepted
  by the Insurer. If the Insurer, after considering
  the proposal and other related information, is
  willing to insure a policy, he sends a letter
  termed Letter of Acceptance. The letter of
  acceptance is counter offer.

5
Consideration

• In Insurance contract, the payment of the premium
  is consideration for the contract on the part of
  the life assured and the undertaking of the
  insurer to pay a sum of money when the claim
  arises is consideration on the part of the
  insurer.

6
Capacity to Contract

• The parties to an assurance contract must be
  capable of entering into contracts. Every person
  is competent to contract who is of the age of
  majority, who is of sound mind and is not
  disqualified from contracting by any law to which
  he is subject. Thus, minors and persons of
  unsound mind cannot enter into insurance
  contracts.

7
Consensus

• Two or more persons are said to consent when they
  agree upon the same thing in the same sense. A
  contract must be founded on a true agreement and
  the parties must be of one mind. There will be no
  consensus if either of the parties or both of
  them are under a wrong impression as to some
  circumstance affecting the contract.

8
Legality of object or purpose

• Every agreement wherein the consideration or
  object is unlawful, is void. Therefore, for a
  valid contract there should be proper
  consideration and legally valid object. The
  object or the purpose of an agreement must be
  lawful i.e. it should not be forbidden by law or
  it should not be fraudulent. For example, stolen
  goods cannot be insured.

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Insurable interest

• Insurable Interest is necessary for a valid
  contract of insurance, the insured who is to
  benefit from the proceeds must be in a
  relationship with the subject of insurance,
  whereby he benefits from its safety and
  well-being and would be prejudiced by its loss or
  damage.

10
continued

• Insurable interest is required to support the
  contract of insurance in order to make it
  enforceable at law. In absence of insurable
  interest, no contract of insurance can come into
  existence. Lack of insurable interest will render
  the contract void.

11
continued

• 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 the creation of a legal
  liability. Eg. Under a fire policy it can be a
  building, stock or machinery with a life
  insurance policy it is the life being assured in
  marine insurance it could be the ship, its cargo
  etc.

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Examples of Insurable Interest

• A person has unlimited insurable interest in his
  own life.
• A husband has insurable interest in the life of
  his wife and vice-versa.
• An employer has insurable interest in his
  employee to the extent of the value of his
  services.
• An employee has insurable interest in the life of
  his employer to the extent of his remuneration
  for the period of notice.

13
continued

• A creditor has an insurable interest in the life
  of the debtor, to the extent of the debt which he
  may lose if the debtor dies before repaying the
  loan.
• Partners have insurable interest in the lives of
  each other because they stand to lose in the
  event of death of any of them.

14
continued

• A surety has an insurable interest in the life of
  his co-surety to the extent of the debt and also
  on the life of the principal debtor.
• A company has an insurable interest in the life
  of key valuable employee.
• Parents have insurable interest in the life of a
  child till the policy vests in him on attainment
  of majority.

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Features of Insurable Interest

• In case of life insurance policies, insurable
  interest must exist at the inception of the
  policy and is not required at the time of claim
  under the policy.
• In case of Marine policies, insurable interest
  must exist at the time of claim under the policy
  and there need not be insurable interest at the
  inception of the policy.
• In other insurances, insurable interest must
  exist at the time of inception as well as at the
  time of claim.

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PRINCIPLE OF UTMOST GOOD FAITH UBERRIMAE FIDES

• Commercial contracts are normally subject to the
  principle of Caveat emptor i.e. let the buyer
  beware. Each party can verify the correctness of
  the statements of the other party and proof can
  be asked for.

17
continued

• The seller under a commercial contract has no
  duty to disclose any information about the
  subject-matter of the contract to the buyer. The
  seller cannot deliberately mislead the buyer but
  it is the duty of the buyer to inspect the goods
  to see if there are any defects. ExampleFor a
  purchase of a car, the buyer has to take all
  precautions by inspecting the car for any
  defects. The seller has no duty to disclose the
  defects.

18
continued

• However, Life Insurance contract is a contract of
  Uberrimae Fides i.e. contracts in which the
  Utmost Good Faith is required. The proposer has a
  legal duty to disclose everything that is
  relevant to the subject-matter of insurance,
  because the insurer knows nothing about it.

19
continued

• The duty of full disclosure rests on both
  parties.
• The duty exists on the part of the proposer to
  disclose and furnish all material information for
  proper assessment of the risk by the insurer. The
  insurer cannot possibly be aware of all the
  details of the health, family history, habits and
  other matters relevant to the assessment of the
  risk and has frequently no means of verifying
  them.

20
continued

• It is true that the underwriter can have a survey
  for fire insurance or medical examination of life
  for health insurance, carried out, but even then
  there are certain aspects of the risk which are
  not apparent at the time of survey or medical
  examination, for example, the previous loss or
  medical history and so on.

21
continued

• Duty on the part of the Insurer
• The proposer also because of his lack of
  technical knowledge has to depend on the good
  faith of the Company to ensure that the terms of
  the contract are fair and equitable. The insurer
  or his agent has to make true statements at the
  time of sale of insurance, advise the proposer
  properly about the terms and conditions of the
  policy without withholding any information.

22
continued

• An insurer must disclose the precise terms of the
  contract and make no untrue statements in
  negotiations with the proposer. It is customary
  for insurer to issue prospectus or leaflets
  setting out briefly the terms and conditions of
  the contract. Lack of good faith on the part of
  the insurer would arise if the terms and
  conditions of the policy issued differ from those
  advertised.

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Disclosure of Material Facts

• In the event of failure to disclose material
  facts, the contract can be held to be void ab
  initio i.e. from the beginning itself.
• Material Fact Every circumstance that would have
  a bearing on the judgment of a prudent insurer in
  fixing the premium or determining the
  acceptability of the proposal for insurance is a
  material fact.

24
continued

• The proposer cannot defend non-disclosure by
  contending that he did not think that the fact
  was material to be disclosed (correction on page
  27, point 7, last line- the fact was material)
• Facts of common knowledge, facts of law, facts
  revealed by a survey or facts which could be
  reasonably discovered by reference to previous
  policies and records available with the insurer
  need not be disclosed.

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Duty of Disclosure

• The duty of disclosure in life insurance,
  operates till the risk commences.
• However, if the policy is issued with a condition
  that any change in occupation must be notified to
  the insurer or if the terms of the policy are to
  be altered or if a lapsed policy is to be revived
  or a surrendered policy is to be reinstated,
  there would be a duty to disclose all material
  facts at that time since what follows is a
  contract novell or a new contract.

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Breach of Principle of Utmost Good Faith

• The breach of the principle of utmost good faith
  arises due to misrepresentation or non-disclosure
  of material facts.
• Any statement made in the Proposal for insurance
  or any report of a Medical Examiner or refree or
  friend of the insured or any other document
  leading to the policy, was on a material matter
  fraudulently suppressed by the policy holder who
  knew at the time of making it that the statement
  was false, amounts to misrepresentation or
  non-disclosure.

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Declaration

• In a proposal for life insurance, the proposer
  makes a declaration to the effect that all the
  statements in the proposal form are true and that
  he agrees that these statements as also any
  further statement made or to be made by him
  before the medical examiner shall be the basis of
  the contract between him and the insurer and if
  any untrue statement be contained therein, the
  insurer would be entitled to treat the contract
  as null and void and forfeit all the moneys paid
  therefor.

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Section 45 of the Indian Insurance Act,1938

• The effect of the declaration at the foot of the
  proposal form by the proposer is to turn the
  representations in the proposal into warranties
  which must be complied in toto.
• Any incorrect or inaccurate answers to a question
  on the proposal form will render the contract
  voidable at the option of the insurer,
  irrespective of the fact whether it is material
  to the risk or not. The answers are required to
  be literally true and absolutely correct.

29
continued

• However, section 45 of the Indian Insurance Act,
  1938 stipulates that a policy cannot be called in
  question after 2 years, on the grounds of
  inaccurate or false statement, unless it is
  proved to be material and fraudulent. After
  expiry of a period of 2 years from the date of
  acceptance of risk the burden of proof rests with
  the insurer.

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Principle of Indemnity

• Insurance is meant to compensate losses and
  cannot be used to make profit.
• The amount paid out as a claim cannot exceed the
  amount of loss incurred.
• Insurer should place the insured in the same
  financial position after a loss as he enjoyed
  before it, but not better.

31
continued

• Indemnity is defined as compensation for loss or
  injury sustained. Insurance contracts promise
  to make good the loss or damage. However,
  payments for loss or damage are limited to the
  actual amount of the loss or damage subject to
  the sum insured.

32
continued

• For example, if an insured takes a policy of Rs.1
  lac on a house worth Rs.75,000/- and later sells
  it during the policy period, no payment is made
  under the policy if the house is destroyed by
  fire because the insured has suffered no loss. If
  the house is destroyed before it is sold, the
  insured will be paid only Rs.75,000/- because
  that is his actual loss.

33
continued

• From the above example it is clear that an
  insured can recover a loss under a policy only if
  he has insurable interest and he can recover a
  loss only to the extent of his insurable
  interest.
• The object of the principle of indemnity is to
  place the insured after a loss in the same
  financial position as far as possible, as he
  occupied immediately before the loss to prevent
  the insured from making a profit out of his loss
  or gaining any benefit or advantage.

34
continued

• If it were possible to make profit out of the
  happenings of loss or damage, the insured would
  be tempted to deliberately cause the loss or
  damage. It would also tend to make the insured
  careless in maintaining the property in good
  condition and in preventing the loss.

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Whether the Principle of Indemnity applicable to
Life Insurance?

• There is a link between indemnity and insurable
  interest in the sense that the amount of claim
  cannot exceed the extent of interest.
• In case of life insurance however, because the
  insurable interest is assumed to be unlimited,
  the principle of indemnity does not apply.

36
continued

• The Principle of Indemnity is applied in
  insurance where the loss suffered by the insured
  is measurable in terms of money. Thus the
  principle is applied to insurances of physical
  property (i.e. fire, burglary etc.) and in
  insurances of liabilities (employers liability)

37
continued

• The Principle of Indemnity does not apply to life
  insurance where human life is the subject matter
  of these insurances, because of difficulty in
  putting monitory value on human life. It is not
  possible to measure the financial loss caused by
  the death of the insured or bodily injury
  sustained by him due to accident.

38
continued

• However, in practice the spirit of the Principle
  of Indemnity is preserved in life insurance
  policies by restricting the sum insured to an
  amount which is commensurate to the financial
  status of the insured and by insuring that the
  monthly benefit for disablement is in line with
  the insureds normal earning capacity.

39
continued

• For example, a person whose monthly salary is
  Rs.1000/- will not be granted a personal accident
  policy of Rs.1,00,000/- which would provide a
  monthly benefit of Rs.4000/-. This amount is far
  in excess of his monthly income and, in the event
  of disablement due to accident, the insured would
  be tempted to prolong his recovery to derive
  undue financial advantage under his policy.

40
continued

• Insurers also try to control over-insurance. A
  question is asked in the proposal form whether
  the proposer has already covered himself by
  previous policies on his life and the sun insured
  thereunder. The sum insured is fixed under the
  proposed insurance taking into account the amount
  already insured under the existing policy.

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