Basic principles of insurance (Supplementary notes) PDF

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These notes give you basic knowledge on the insurance knowledge...applicable anywhere...

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BASIC PRINCIPLES OF INSURANCE Introduction Insurance is usually with respect to the subject matter of the insurance i.e the thing or possible liability insured and in which the insured has an insurable interest e.g.:    

Marine insurance-vessel, cargo or sailors Life insurance- life of the policy holder Fire- property insured Motor insurance- subject matter is vehicle or liability arising from its use.

Insurance contract cannot guarantee restoration or cancellation of liability it guarantees protection from a financial loss. Therefore the subject matter of the contract is the policyholder’s interest or financial involvement in the subject matter of insurance. There are five fundamental principles of insurance contracts. These are: i.

The principle of insurable interest

ii.

The principle of indemnity

iii.

The principle of utmost good faith

iv.

The principle of subrogation

v.

The principle of proximate cause

Insurable Interest This refers to the relationship between the person applying for insurance and subject matter of insurance so that there is a reasonable expectation of benefit or advantage to the applicant from continuation of the subject matter or expectation of loss or detriment from its cessation i.e. legal right to insure. Lack of insurable interest implies that one may not suffer any financial loss. The principle dictates that the insured must be in a position to financially suffer if a loss occurs. This is important because of the following: i.

To prevent gambling

ii.

To reduce moral hazard- Life insurance on a person and pray for his/her death for insurance proceeds.

iii.

In order not to indemnify more than an insured’s financial interest. This supports the principle of indemnity.

The essentials of insurable interest include: 1

  

Something capable of being insured The something must be the subject matter of insurance The insured is in a legally recognised relationship with the subject matter.

Insurable interest arises in various ways:   

Insurance of person- policy holder himself for life and personal accident. Has limited insurable interest. Other persons- husband and wife; creditors and debtors; partners Insurance of property: ownership, agents, administrators, executors and trustees, bailiffs, husband and wife

Insurable interest exists when:   

Marine- at the time of loss not necessarily when insurance is effected Life- when insurance is effected not necessarily at the time of loss All other insurances- at inception and time of loss.

Utmost good faith A higher degree of honesty is imposed on an insurance contract than is imposed on other contracts. Honesty is mainly imposed on the insurance applicants. Utmost good faith is supported by three legal doctrines: i.

Representation: this relates to statements made by the applicant. Insurance is voidable at the insurer’s option if the representation is:

ii.



Material



False



Reliance

Concealment: this is the intentional failure to disclose a material fact

iii.

Warranty: this is a statement of fact or a promise made by the insured, which is part of the insurance contract and must be true if the insurer is to be liable under the contract. For instance in exchange for a reduced premium, a store owner warrants that a burglar alarm will be always on.  



Accordingly utmost good faith relates to mutual faith, full disclosure of material facts. Each party to a proposal contract is obligated to reveal to the other all information which would influence the others decision to enter the contract whether that information is requested or not. There is need for truth, the whole truth and nothing but the truth about the proposal contract otherwise the aggrieved party is given the right to regard the contract as void. Duty rests heavily o prospective insured. Though insurer cannot withhold information in his private possession to the detriment of the prospective insured. 2

A material fact is one that could influence the mind of a prudent underwriter in assessing the risk.  Qualification of the duty of disclosure—at common law, a person cannot be penalised for not revealing facts which he does not know and which he cannot reasonably be expected to know.  Facts which need not be disclosed include: i. Which improve risk ii. Which insurer may be presumed to know iii. That are a matter of law iv. Capable of discovery from information provided v. Which insurers representative fail to report from a survey vi. Facts unnecessary to disclose because of policy conditions The breaches of utmost good faith include: i. Non disclosure ii. Concealment iii. Fraudulent misrepresentation iv. Innocent misrepresentation The effects of the breach of utmost good faith are: i. Consider the contract void- notify the offending party ii. Sue for damages- if breach was fraudulent, insured is guilty of the tort of deceit. iii. Waive the beach

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



Indemnity 

Restores insured to the same position financially after the loss as he enjoyed immediately before the loss. For life assurance and personal accidents it is not possible to provide exact compensation.



The insurer agrees to pay no more than the actual amount of the loss suffered by the insured.



Life and personal accident policies are benefit policies. There is a direct link between insurable interest and indemnity i.e. indemnity payable is the insurable interest at the time of the loss. For life and personal accident, there is unlimited insurable interest hence indemnity can never be given.



Indemnity is important because: o The purpose of the insurance contract is to restore the insured to the same economic position as before the loss. o The insured should not profit from a loss. o It reduces the moral hazard by eliminating the profit incentive. 3

To support the principal of indemnity an insurance contact uses Actual Cash Value (ACV) method



o Replacement cost (RC) less depreciation: RC – current cost of restoring the damaged property with new materials of like kind and quality. o Fair market value: The price of a wiling buyer would pay a willing seller in a free market. 

Broad evidence rule: The determination of ACV should include all relevant factors an expert would use to determine the value of the property.

To support the principal of indemnity insurance contact includes “Other Insurance Provisions”.



o Escape clause: The policy (or insurance) would not apply if the insured was covered by another policy. o Primary-Excess: It (or This insurance) is excess insurance over any other valid and collectible insurance. o Pro-rata provision: this can be proration by face amounts or Proration by amounts otherwise payable o Contribution by equal shares where each insurer contributes equal amount until it has paid its applicable limit of insurance or none of the loss remains, whichever comes first

Assessment of indemnity i.

Property insurance: indemnity = intrinsic value of the article immediately prior to loss or damage. 

It takes into account depreciation and appreciation. The insured is liable to insured.



For partial losses reapar

ii.

Liability insurance: damages plus legal costs

iii.

Pecuniary Insurance: financial loss involved with infringement of rights or prejudicial of financial interest e.g. default by cashier insured under fidelity guarantee.

iv.

Person: no indemnity or financial involvement of life insured 4

v.

Salvage

Methods of providing Indemnity i.

Cash

ii.

Replacement

iii.

Repairs

iv.

Reinstatement

NB: normally the right to choose the method of indemnity is given to the insurer who will largely try to comply to the requirements of the insured unless there are strong reasons to do otherwise. Principle of Subrogation The insurer in payment of what is due to the insured is entitled to every legal and equitable right or remedy which the insured might have against a third party. Any compensation coming from a third party must be paid to the insurer. Substitution of the insurer in place of the insured for the purpose of claiming indemnity from a third party wrongdoer for a loss paid by the insurer. The principle is important in order to: i.

Prevent collecting twice

ii.

Hold the negligent party responsible

iii.

Hold down insurance rates

The insurer is entitled only to the amount it has paid under the policy. The insured cannot impair the insurer’s subrogation rights. Subrogation does not apply to life insurance and to individual health insurance contracts. The insurer cannot subrogate against its own insured. Principle of proximate Cause 

A proximate cause is that cause that is nearest in effectiveness and not necessarily in type i.e. proximate in efficiency.



There may be a number of causes of greater or lesser importance which are combined to produce a certain result. The dominant effective cause must be singled out as the one which produced the result.

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“Causa Proxima non remota spectator” i.e the immediate or proximate and not the remote cause must be regarded.



The insurer is not liable for any loss unless the proximate cause was an insured peril.

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