Principles of Insurance

Principles of Insurance

Principles of Insurance are the key to the smooth and better functioning of the Law of Insurance. To understand it better, we must first know what insurance means.

What is Insurance?

In layman’s language, Insurance is a policy issued by the insurance company to cover the risk of the insured and compensate in case he suffers the loss from the covered risk, in return of which the insured pays a certain sum of money on regular intervals. As per the Merriam-Webster’s Dictionary^[1], Insurance means-

a: coverage by contract whereby one party undertakes to indemnify or guarantee another against loss by a specified contingency or peril

b: the business of insuring persons or property

c: the sum for which something is insured

Insurance is a contractual agreement that entails compensation from an insurer to an insured party on the happening of a specific event or set of events. These events could include things like death, personal injury, accidents, property loss or damage, or any other number of things that can be paid for in terms of money.

The way the insurance company makes money is by obtaining tiny contributions from numerous individuals who face risks. The funds obtained in the form of contributions are then utilized to resolve the claims of those who are injured as a result of such risks. The consideration that the insurance company thus collects is referred to as premium.

Principles of Insurance

After we have understood what insurance means, let us see the principles of insurance. Following are the principles of insurance-

Principle of Uberrimae Fidei

Also known as the principle of Utmost good faith, this principle requires that both parties to a legal contract are required by law to act in good faith. In Insurance contracts, Utmost Good Faith means that “each party to the proposed contract is legally obliged to disclose to the other all information which can influence the other’s decision to enter the contract”.

It is a positive duty to voluntarily disclose, accurately, and fully all facts material to the risk being proposed whether requested for or not. Every circumstance or piece of information that could alter a prudent insurer’s assessment of the risk is referred to as a material fact.

Parties to the insurance contract are required to disclose the material facts at the time when the policy is being issued. Breach of good faith can be done in two ways- Misrepresentation and Non-disclosure.

Any breach of material fact would give a right to the aggrieved party to avoid the contract. If intentional misrepresentation or nondisclosure is used to mislead the insurer into executing a contract, the agreement is void from the beginning. The burden of proof to show that the insured has misrepresented or not disclosed any material fact is on the insurer.

In India, the Legislature has enacted in Section 45 of the Insurance Act^[2] that no policy of life insurance shall be called in question by an insurer on the ground that a statement made 24 in the proposal form “leading to the issue of the policy” was inaccurate or false “unless the insurer shows that such statement was on a material matter or suppressed facts which it was material to disclose and that it was fraudulently made by the policy holder and that the policy holder knew at the time of making it that the statement was false or that it suppressed facts which it was material to disclose.”^[3]

In Mithoolal Nayak v. Life Insurance Corporation of India^[4], it was held that the three conditions for the application of the second part of Section 45 are:

(a) the statement must be on a material matter or must suppress facts which it was material to disclose;

(b) the suppression must be fraudulently made by the policy holder; and

(c) the policy holder must have known at the time of making the statement that it was false or that it suppressed facts which it was material to disclose.

In Smt. Krishna Wanti Puri v. Life Insurance Corporation of India^[5], it was held that the Corporation was entitled to avoid the policy on the grounds available to the insurers under S. 45 of the Insurance Act, 1938, as the assured not only failed to disclose what it was material for him to disclose, but he made a false statement to the effect that he had never suffered from any disease of the heart.

Principle of Insurable Interest

One of the essential ingredients of an Insurance contract is that the insured must have an insurable interest in the subject matter of the contract. Insurable Interest is a legal right to insure arising out of a financial relationship recognized under the law between the insured and the subject matter of Insurance. Insurable interest must exist both at the time of taking the policy as well as at the time of claiming the amount of loss suffered.

Although, in the case of marine insurance, insurable interest must exist only at the time of loss/claim. A person has an insurable interest in his own life; in the life of a person upon whom he depends wholly or in part for support; and in the life of any person who owes certain money to him.

In the case of a contract of fire insurance, an insured must have an insurable interest both at the commencement of the policy and at the time the risk occurs because this is treated as a personal contract and also a contract of indemnity.

Points to remember in case of determining insurable interest-

1. Not a mere emotional/sentimental interest in the property. Though, in the case of life insurance policies, right/ interest based on the life of a close family relationship may be considered.
2. There should be pecuniary interest in the insured property.
3. It should be lawful/enforceable.
4. There must be a right in the property by virtue of being the owner or right in the property arising through a contract.

For example, Alok takes a fire insurance policy for his house and after that, he sells that house before the expiration of the policy. He does not have an insurable interest in the property anymore.

In Hughes v. Liverpool Victoria Legal Friendly Society^[6], it was held that where a life policy is taken out by a person who has no insurable interest in the life assured, and so the policy is illegal, an action will lie for recovery of premiums paid if the person taking out the policy was induced to do by fraudulent misrepresentation on the part of the insurance company’s agent, but not otherwise.

In Vijay Kumar v. New Zealand Insurance Co.^[7], owner of property has insurable interest in property. A bailee has lien over the goods and is entitled to insure the goods for full value as he will be liable for loss or damage to the goods to the owner.

Principle of Causa Proxima

This is also known as the “proximate cause” principle.  When a loss has two or more causes, this principle is applicable. The nearest reason for the property’s loss will be determined by the insurance company. The insurance company must pay compensation if damage was caused to the insured property due to the proximate cause.

In Pink v. Fleming^[8], it was held that proximate cause or causa proxima means “in law the immediate and not the remote cause is to be considered in measuring the damages.” Where there is a succession of causes which must have existed in order to produce a particular result, the direct and proximate cause i.e. the last cause must be looked into and the others rejected although the result would not have been produced without their concurrence.

In Ley land Shipping Co. Ltd. v. Norwich Union Fire Insurance Society Ltd.^[9], it was held that the proximate cause of an event is the real and efficient cause to which the event may be attributed and the application of the doctrine varies according to the question whether the loss was caused by the peril insured against.

In New India Insurance Company Ltd. v. M/s Zuari Industries^[10], a fire policy and a consequential loss due to fire policy were the two insurance policies the complainant had taken. One day, the main switch board in the sub-station receiving power from the “State Electricity Board” experienced a short circuit, causing a flashover and over currents to flow. There was too much heat produced by the flashover and over currents.

This extreme heat caused the paint on the panel board to burn, producing an excessive amount of smoke and soot, and the adjacent feeder’s partition developed a hole. Ionized air, smoke/soot, and a short circuit all made their way to the generator compartment, where the generator power also tripped.

As a result, the entire plant’s power supply was cut off due to which the waste heat boiler’s supply of water and steam, which was being fed into it at a high temperature from the flue gases, continued to operate, causing damage due to fire. It was held that the fire was the efficient and active cause of the damage. The damage would not have happened if the fire had not broken out.

There was no independent, intervening agency causing harm. Furthermore, it was decided that the length of the fire is not relevant. Even if the fire only lasted for a short period, the claim can still be upheld as long as it was caused by fire.

Principle of Subrogation

According to this principle, the insurer acquires ownership of the property after the insured, or person, has received compensation for the loss he suffered regarding the subject matter of the insurance. Subrogation gives the insurance company, the right to recover the amount paid as compensation from any third party due to which the loss was caused.

Only the amount of compensation the insurer has already paid to the insured qualifies for subrogation rights on his behalf. This applies to all policies of insurance which are contracts of indemnity.

For example, If Ashok gets injured in an accident, due to the fault of C, a third party, the insurance company which issued the insurance policy to Ashok will compensate the loss that occurred to Ashok and will also sue the third party to recover the money paid as claim. This right arose due to the principle of subrogation.

Principle of Contribution

When an insured person takes multiple insurance, policies covering the same risk, the contribution principle is in effect. The insured cannot earn profits by claiming the loss of one subject matter from other policies. It is applicable to all indemnity contracts if the insured has obtained more than one policy on the same subject matter.

Conditions necessary for the right of contribution:

• Common subject matter of insurance to all the policies (may include other properties).
• The peril which causes the loss must be common to all the policies (may include other perils).
• The same assured must take all insurance policies on his or her own behalf.
• At the time of the loss, all insurance policies must be active.
• The policy cannot contain any clauses that forbid the right to contribute.

For example, a certain risk has been independently covered by insurers ABC Co. and XYZ Co. If the insured is fully indemnified by ABC Co., he may claim a proportional contribution from XYZ Co.

End Notes

^[1] Insurance Definition & Meaning – Merriam-Webster

^[2] The Insurance Act, 1938

^[3] Mithoolal Nayak v. Life Insurance Corporation of India

^[4] AIR 1962 SC 814

^[5] AIR 1975 Delhi 19

^[6] (1918) 2 KB, 482

^[7] 1954 Bom. 34

^[8] (1890) 25 QBD 396

^[9] (1918) A.C. 350

^[10] (2009) 8 SCC 70

This article has been contributed by Kumud Kukreja.