INTRODUCTION TO INSURANCE

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.