The principles of insurance serve as the foundation for the functioning of the insurance industry. These principles ensure fairness, transparency, and efficiency in insurance transactions. They form the legal and ethical basis for contracts between insurers and policyholders.
1. Principle of Indemnity
The principle of indemnity ensures that the insured is compensated only to the extent of their actual financial loss, preventing profit from an insurance claim.
- Key Features:
- Applicable primarily to general insurance (e.g., motor, property, health insurance).
- The amount paid cannot exceed the actual loss.
- Example:
If a fire damages a property valued at ₹5 lakh, and the insurance policy is worth ₹6 lakh, the insurer will compensate only ₹5 lakh.
2. Principle of Utmost Good Faith (Uberrima Fides)
This principle obligates both the insurer and the insured to disclose all material facts truthfully and completely during the policy agreement.
- Material Facts: Information that affects the insurer’s decision to accept or reject the risk (e.g., pre-existing health conditions, hazardous job profiles).
- Consequences of Breach:
- Non-disclosure or misrepresentation can lead to the policy being voided.
- Example:
A person applying for health insurance must disclose chronic illnesses like diabetes.
3. Principle of Proximate Cause
Proximate cause refers to the closest or most direct cause of a loss. It helps determine whether the loss is covered under the insurance policy.
- Application:
- The insured event must directly lead to the loss.
- Losses due to an uncovered risk are not compensated.
- Example:
- If a fire (covered peril) leads to water damage during firefighting, the insurer will compensate for both fire and water damage.
- If an earthquake (excluded peril) causes a fire, the loss is not compensated.
4. Principle of Insurable Interest
The insured must have a financial or legal relationship with the subject matter of insurance, which would result in a financial loss if the subject matter is damaged or lost.
- When Insurable Interest Applies:
- Life Insurance: At the time of policy inception.
- General Insurance: At the time of loss.
- Example:
- A person can insure their own house but not their neighbor’s.
- A company can insure its inventory against fire.
5. Principle of Contribution
If the insured has taken multiple policies for the same risk, they can claim compensation from all policies. However, the total compensation cannot exceed the actual loss.
- Purpose: Prevent over-compensation.
- Example:
If a property worth ₹10 lakh is insured with two companies (₹6 lakh and ₹4 lakh), the insured can claim from both, but the total payout will be ₹10 lakh.
6. Principle of Subrogation
This principle allows the insurer to step into the shoes of the insured after the claim is settled, to recover the loss from a third party responsible for the damage.
- Purpose: Prevents the insured from recovering more than the actual loss.
- Example:
- If a car is damaged due to a third-party’s fault and the insurer pays for the repair, the insurer can recover the amount from the third-party responsible for the accident.
7. Principle of Loss Minimization
The insured is expected to take all reasonable steps to minimize the loss or damage to the insured property.
- Responsibility of the Insured: Act as if uninsured in the event of a loss.
- Example:
- If a fire breaks out, the insured must call the fire brigade to control the damage instead of letting it spread.
8. Principle of Mitigation
This principle overlaps with loss minimization and emphasizes that the insured should not act negligently after an insured event.
- Example:
- In the event of flooding, the insured should move valuable items to a safer place.
Importance of Principles of Insurance
- Builds Trust: Ensures transparency and fairness between insurers and policyholders.
- Legal Framework: Provides a clear basis for the validity and enforceability of insurance contracts.
- Risk Management: Promotes responsible behavior by the insured to prevent or mitigate losses.