Basic Principles of Insurance
BASIC PRINCIPLES OF INSURANCE
1, Principle of Utmost Good Faith
The duty to make a full and true disclosure continues until the contract is concluded, i.e., until the proposal of the insured is accepted by the insurer, whether the policy is then issued or not and it is not a continuing obligation. Thus, any material fact coming to his knowledge after the conclusion of the contract need not be disclosed. However, the duty to disclose revives with every renewal of the old policy or alterations in the existing policy.
If the principle of utmost good faith is not observed by either party, the contract becomes void able at the option of the party not at fault, irrespective of whether the non-disclosure was intentional or innocent. Of course, in case of innocent misrepresentation the premium is refundable on the avoidance of the contract.
2, Principle of Indemnity
The second fundamental principle is that all contracts of insurance are contracts of indemnity, except those of life and personal accident insurances where no money payment can indemnify for loss of life or bodily injury. In case of marine and fire insurances, the insurer undertakes to indemnify the insured for loss or damage resulting from specified perils. In case of loss, the insured can recover from the insurer the actual amount of loss, not exceeding the amount of policy. If there is no loss under the policy, the insurer is under no obligation to indemnify the insured. The purpose of indemnity is to place the insured, after a loss, in the same position he occupied immediately before the event. Under no circumstances, is the insured allowed to benefit more than the loss suffered by him. This is because, if that were so, the temptation would always be present to desire the insured event and thus to obtain the policy proceeds. This would obviously be contrary to public interest. This principle applies to insurance of objects (property insurances) and liability insurances.
3, Proximate Cause
The next principle of insurance is that the insurer is liable only for those losses which have been proximately caused by the peril insured against. In other words, in order to make the insurer liable for a loss, the nearest, immediate, or the last cause has to be looked into, and if it is the peril insured against, the insured can recover.
Thus, in deciding whether the loss has arisen through any of the risks insured against, the proximate or the last of the causes is to be looked into and others rejected. If loss is caused by the operation of more than one peril simultaneously and if one of the perils is excluded (uninsured) peril, the insurer shall be liable to the extent of the effects of insured peril if it can be separately ascertained. The insurer shall not be liable at all if the effects of the insured peril and excepted peril cannot be separated.
4, Insurable Interest
Consistent with the concept of insurance as a means of indemnifying an insured against a loss, is the corollary that insurance should not provide an insured with the means of showing a net profit from the event insured against.
Throughout the development of the insurable interest doctrine in case and statutory law, two primary purposes have captured the attention of law-makers, both rooted in public policy. The first is the elimination of insurance as a vehicle for gambling, an activity to which has been attributed idleness, vice, a socially parasitic way of life, increase in impoverishment and crime, and the discouragement of useful business and industry. The second is the removal of the temptation provided by a prospect of a net profit through insurance proceeds to deliberately bring about the event insured against, whether it is the destruction of property or human life.
‘Insurable interest’ is an essential pre-requisite in effecting a contract of insurance. The insured must possess an insurable interest in the subject matter of the insurance at the time of contract. Otherwise, the contract of insurance will be a wagering agreement which shall be void and unenforceable.
5, Doctrine of Subrogation
The doctrine of subrogation is a corollary to the principle of indemnity and as such, it applies only to property insurances. According to the principle of indemnity, the insured can recover only the actual amount of loss caused by the peril insured against and is not allowed to benefit more than the loss he suffered. In case the loss to the property insured has arisen without any fault on anybody’s part, the insured can make the claim against the insurer only. In case the loss has arisen out of tort or fault of a third party, the insured becomes entitled to proceed against both the insurer as well as the wrongdoer. However, since a contract of insurance is a contract of indemnity, the insured cannot be allowed to recover from both and thereby make a profit from his insurance claim. He can make a claim against either the insurer or the wrong doer. If the insured chooses to be indemnified by the insurer, the doctrine of subrogation comes into play and as a result, the insurer shall be subrogated to all the rights and remedies of the insured against third parties in respect of the property destroyed or damaged.
6, Risk Must Attach
The next principle of insurance is that for a valid contract of insurance the risk must attach. If the subject-matter of insurance ceases to exist (e.g. the goods are burnt) or the insured ship has already arrived safely, at the time the policy is effected, the risk does not attach, and as a consequence, the premium paid can be recovered from the insurers because the consideration for the premium has totally failed. Thus, where the risk is never run, the consideration fails and therefore the premium is returnable. It is a general principle of law of insurance that ‘if the insurers have never been on the risk, they cannot be said to have earned the premium.’
7, Mitigation of Loss
When the event insured against occurs, for example, in the case of a fire insurance policy when the fire occurs, it is the duty of the policyholder to take steps to mitigate or minimize the loss as if he were uninsured and must do his best for safeguarding the remaining property. Otherwise, the insurer can avoid the payment for loss attributable to the negligence of the policyholder. Of course, the insured is entitled to claim compensation for the loss suffered by him in taking such steps from the insurer.
8, Doctrine of Contribution
Like the doctrine of subrogation, the doctrine of contribution also applies only to contracts of indemnity, i.e., to property insurances. Double insurance occurs where the same subject matter is insured against the same risk with more than one insurer. If two different policies are taken from the same insurer, it is not a case of double insurance. It will be termed as ‘full insurance.’ Under double insurance, the same risk and the same subject matter must be insured with two or more different insurers. In the event of loss under double insurance, the assured may claim payment from the insurers in such order as he thinks fit, but he cannot recover more than the amount of actual loss, as the contract of property insurance is a contract of indemnity.
Thus, the essential conditions required for the application of the doctrine of contribution are:
1. There must be double insurance
2. There must be either over-insurance or only partial loss
An insurer assuming larger risk from the direct insurance business may arrange with another insurer to off load the excess of the undertaken risk over his retention capacity. Such arrangement between two insurers is termed as ‘reinsurance.’ Thus, by the device of reinsurance the original insurer transfers part of the risk to the reinsurer. Payment made by the ceding insurer (called original insurer or reinsured) to accepting insurer (called reinsurer) for the assumption of the risk by the latter is termed ‘reinsurance premium.’
10, Third Party Interests in Liability Insurance
Liability insurance originated solely as a protection for the interests of the insured against loss suffered through liability to third parties. It began in the area of employers’ insurance against loss through liability to employees for work related injuries. Since indemnification of the employer/insured was the sole function of the insurance, the injured third party could not bring a direct action against the insurer even after obtaining a judgment against the insured. Even the insured could not bring action on the policy until he had sustained an actual loss by payment of the judgment debt to the third-party. If the insured happened to be insolvent and judgment proof, no claim could arise under the policy.
In subsequent years, legislation has radically transformed the function of liability insurance in many areas to make the injured third-party with a cause of action against the insured a quasi third-party beneficiary of the liability policy.
One of the first areas under legislative attack was the inequity of allowing an insured to pay premiums to an insurer to keep liability insurance current and then to allow the insurer to hide behind the shield of the insolvency of the tortuous insured to prevent payment of the judgment debt owed to the third-party victim.
A second form of “no action” clause provides that “No action shall lie against the company until the amount of the insured’s obligation to pay shall have been finally determined either by judgment against the insured after actual trial or by written agreement of the insured, the claimant and the company.”
A third aspect in which legislation has created rights for the third-party victim in the insured’s liability policy involves defenses against recovery on the policy. In the area of automobile liability insurance particularly, legislatures have generally provided in financial responsibility statutes for the protection of tort victims that defenses that would bar collection of the proceeds by the insured, such as fraud in the application, non-cooperation in defense of a tort action, or failure to notify the insurer of an accident, will be of no effect in a direct action by the third party tort victim against the insurer.
In the past, the issue of tort immunity has occupied a more important place in the determination of insurance issues. With the trend in the law toward limiting tort immunity for charitable institutions and other parties, the issue of tort immunity in insurance law has become less of a factor. However, where the tort feasor is immune from suit, the issue as it relates to liability insurance is generally addressed in one of three ways.
First, a policy may be silent on the issue of tort immunity.
Second, the policy might reserve to the insured the right to determine whether tort immunity will be exercised.
Third, the policy may totally forbid the insurance company from exercising a right to tort immunity