Chapter 4

Insurance Contrat

McGraw-Hill/Irwin Copyright © 2006 by The McGraw-Hill Companies, Inc. All rights reserved.
 Insurance Contract

Insurance is defined as a contract

between two parties whereby on
party (called insurer) undertake, in
exchange for a fixed sum (called
premiums), to pay the other party
(called insured) a fixed amount of
money on the happening of a certain
event.
 Insurance Contract
The Insurance Contract Involves;
• The Elements Of General Contract
• The Elements Of Special Contract Relating
To Insurance
“All agreements are contracts if
they are made by free consent of
the parties, competent to contract,
for a lawful consideration and with
a lawful object and which are not
hereby declared to be void”
 Elements of General Contract

Offer and Acceptance (agreement)

Legal consideration

Competent to make contract

Free consent

Legal object
 Offer and Acceptance
• Offer (for insurance) can come from either the
insured or the insurer.
• Whether the offer is from either side, the main
fact is acceptance.
• Prospectus, advertisement, canvassing by agents are
offer by the insurer.
• When the prospect (the potential policy-holder)
proposed to enter into contract it is an offer.
• If there is an alteration in the offer that would be a
counter-offer.
• If this alteration or change (counter-offer) is accepted
by the proposer, it would be an acceptance.
 Legal Consideration
• The insurer, for his promise, must have
something in return for promising to pay a
fixed sum for the contingency.
• Premium is considered as a valuable
consideration must be given for starting the
insurance contract.
• The amount of premium is not important to begin
the contract but the fact is that without payment
of premium, the insurance contract can not start.
 Competent to Make Contract
• Every person is competent to make contract;
• Who is of the age of majority according to the law.
• Who is of sound mind, and
• Who is not disqualified from contracting by any
law to which he is subject.
• A minor cannot sign a contract or competent
for a contract.
• A contract by a minor is void except contract for
necessities.
 Free Consent
• Parties entering into the contract should enter
into it by their free consent.
• The consent will be free when it is not caused by;
• Coercion
• Undue influence
• Fraud
• Misrepresentation or
• Mistake
• When there is no free consent except fraud the
contract would be voidable.
• In case of fraud the contract would be void.
 Legal Object
• In order to make a valid contract, the object of
the agreement should be lawful.
• An object that is;
• Not forbidden by law
• Is not immoral
• Opposed to public policy or
• Which does not defeat any provision of any law, is
lawful.
• If the object of an insurance is found to be
unlawful, the policy is void.
 Principles of Special Contract
Principle of Insurable Interest
Principle of Utmost Good Faith
Principle of Indemnity
Principle of Subrogation
Principle of Warranties
Principle of Proximate Cause
Principle of Assignment and
Principle of Return of Premium
 Principle of Insurable Interest

There must be a subject-matter to be insured.

The insured must have financial relationship

with the subject-matter.

Should be recognized by the law.

The policy holder must suffer economically in

case of the death or loss of the property.
 Insurable Interest
• For a valid insurance contract, the insured
must possess an insurable interest in the
subject matter of insurance.
• The insurable interest is the pecuniary interest
whereby the policy holder is benefited by the
existence of the subject matter.
 Insurable Interest
• The essentials of a valid insurable interest are the
following;
• There must be a subject-matter to be insured.
• The policy-holder should have monetary relationship
with the subject-matter.
• the relationship should be recognized by the law. In
other words, there should be no illegal relationship
between the policy-holder and the subject-matter.
• The financial relationship should be such that the
policy-holder is economically benefited by the survival
or existence of the subject-matter and/or will suffer
economically at the death or damage/destruction of
the subject-matter.
 Principle of Utmost Good Faith
Material facts.
Full and true disclosure.
Duty of both the parties.
Facts need not to disclose by the insured;
• Facts which will lessen the risk
• Facts of public knowledge
• Facts can be gathered from the disclosed information
• Facts waived by the insurer
• Facts governed by the conditions of the policy
 Utmost Good Faith
• The doctrine “Utmost Good Faith” of disclosing
all material facts applies to all forms of insurance.
• Both parties of the insurance contract must be of
the same mind (ad idem) at the time of contract.
• There should not be any;
• Misrepresentation
• Non-disclosure or
• Fraud concerning the material.
• An insurance contract is a contract of uberrimae
fidei, i.e., of absolute good faith both parties of
the contract must disclose all the material facts
and fully.
 Utmost Good Faith
• Material Facts;
• A material fact is one which affect the judgment or decision
of both parties in entering to the contract.
• Facts which count materiality are those knowledge which
influence a party in deciding whether or not to offer and
accept such risk.
• And if the risk is acceptable, on what terms and conditions
the risk should be accepted.
• In life insurance, the material facts or factors affecting
the risk will be the
• Age, residence, occupation, health, income etc.
• In property insurance, it would be;
• Use, design, owner, and situation/location of the property.
 Utmost Good Faith
• Full and True Disclosure;
• All material facts should be disclosed in true and full form.
• It means that the facts should be disclosed in that form in
which they really exist.
• There should be no;
• Concealment
• Misrepresentation
• Mistake or
• Fraud about the material facts
• There should be no;
• False statement or
• Half truth nor
• Any silence on the material facts.
 Utmost Good Faith
• Duty of Both the Parties;
• The duty to disclose the material facts lies on both
the insurer and the insured.
• But the assured/insured has to be more particular
about the observance of the principle because
he/she is usually in full knowledge of facts relating
to the subject-matter which, despite all effective
inspection of the insurer, would not be disclosed.
 Utmost Good Faith
• Facts Need not to be Disclosed by the Insured;
• Facts which tend to lessen the risk
• Facts of public knowledge
• Facts which could be inferred from the
information disclosed
• Facts waived by the insurer
• Facts governed by the conditions of the policy
 Principle of Indemnity
Uses

To avoid an anti-social act

To maintain the premium at low-level

Conditions for indemnity principle;

• Proof of financial loss
• Amount insured
• Excess amount must be returned
• Third party payment
• Not for personal insurance
 Principle of Indemnity
• As a rule all insurance contracts except
personal insurance are contracts of indemnity.
• According to this principle, the insurer
undertakes to put the insured, in the event of
loss, in the same position that he/she
occupied immediately before the happening of
the event insured against.
• In true sense of indemnity, the insured is not
entitled to make any profit.
 Principle of Indemnity
• Uses of this Principle;
• In absence of this principle, the insured would
tend to over-insurance and then intentionally
cause a loss so that financial gain can be achieved.
• So to avoid this intentional loss, only the actual
loss becomes payable, not the assured sum.
• If the property is under-insured, i.e., the insured
amount is less than the actual amount of the
property insured, the insured is generally regarded
his own insure for the amount of under insurance
and in case of loss one shall share the loss himself.
 Principle of Indemnity
• To Avoid Anti-social Act;
• If the assured is allowed to gain more than the
actual loss, (which is against the principle of
indemnity), he/she will be tempted to gain by
destruction of hi/her own property after getting
insured against a risk.
• He/she will be under temptation to destroy the
property.
• Thus the whole society will be doing only ant-
social act, i.e., everyone would be interested in
gaining after destruction of the property.
 Principle of Indemnity
• To Maintain the Premium at Low Level;
• In absence of the principle, larger amount will be
paid for small amount of loss which would
increase the cost of insurance and the premium
will have to be raised.
• Increasing premiums will cause;
• Less interest in insurance
• Unscrupulous persons would get insurance to destroy
the property to gain from such act.
 Principle of Indemnity
• Conditions for Indemnity Principle;
• The insured has to prove that he will suffer loss on the
insured matter at the time of happening the event and
the loss is actual monetary loss.
• The amount of compensation will be the amount of
insurance and cannot be more than the insurance.
• If the assured gets more than the actual loss, the
insurer has the right to get the extra amount back.
• If the insured gets some amount from third party after
being fully indemnified by insurer, the insurer have the
right to receive all the amount paid by the third party.
• This principle does not apply to personal insurance –
because the amount of loss not easily calculable there.
 Doctrine of Subrogation

Essentials of doctrine of subrogation;

•Corollary to the principle indemnity
•Subrogation is the substitution
•Only up to the amount
•May be applied before payment
•Personal insurance
 Doctrine of Subrogation
• The doctrine of subrogation refers to the right of
the insurer to stand in the place of the insured,
after settlement of a claim, in so far as the
insured’s right of recovery from an alternative
source is involved.
• If the insured is in a position to recover the loss in
full or in part from a third party due to whose
negligence the loss may have been precipitated,
his right of recovery is subrogated to the insurer
on settlement of the claim.
• The insurer, thereafter recover the claim from the
third party.
Essentials of Doctrine of Subrogation

• Corollary to the principle indemnity;

• The doctrine of subrogation is the supplementary
principle of indemnity.
• Prevent the insured from collecting twice for the
same loss.
Essentials of Doctrine of Subrogation

• Subrogation is the substitution;

• The insurer, according to this principle, becomes
entitled to all the rights of insured subject matter
after payment because he has paid the actual loss
of the property.
• He is substituted in place of other persons who act
on the right and claim of the property insured.
Essentials of Doctrine of Subrogation

• Subrogation only up to the Amount of

Payment;
• The insurer is subrogated all the rights, claims,
remedies and securities of the damaged property
after indemnification, but he is entitled to get
these benefits only to the extent of his payments.
• The insurer, thus, subrogated to the alternative
rights and remedies of the insured, only up to the
amount of his payment to the insured.
Essentials of Doctrine of Subrogation

• The Subrogation may be Applied Before

Payment;
• If the assured got certain compensation from third
party before being fully indemnified by the insurer,
the insurer can pay only the balance of the loss.
Essentials of Doctrine of Subrogation
• Personal Insurance;
• The doctrine of subrogation does not apply to
personal insurance because the doctrine of indemnity
is not applicable to such insurance.
• The insurers have no right of action against the third
party in respect of the damage.
• For example, if an insured dies due to the negligence
of a third party, his dependents have the right to
recover the amount of the loss from the third party
along with the policy amount.
• No amount of the policy would be subrogated by the
insurer.
 Warranties
• There are certain conditions and promises in
the insurance contract which are called
warranties.
• According to Marine Insurance Act, “A
warranty is that by which the assured
undertakes that some particular thing shall or
shall not be done, or that some conditions
shall be fulfilled, or whereby he affirms or
negatives the existence of a particular state of
facts”.
 Warranties
• Warranties which are mentioned in the policy
are called express warranties.
• There are certain warranties which are not
mentioned in the policy are called implied
warranties.
• Warranties which are answers to the
questions are called affirmative warranties.
• The warranties fulfilling certain conditions or
promises are called promissory warranties.
 Warranties
• Importance of Warranties;
• Warranty is a very important condition in the
insurance contract which is to be fulfilled by the
insured.
• On breach of warranty, the insurer becomes free from
his liability.
• Therefore, insured must have to fulfill the conditions
and promises during the insurance contract whether it
is important or not in connection with the risk.
• The contract can continue only when warranties are
fulfilled.
 Proximate Cause

The peril is the proximate cause in case of one

Separable, inseparable peril

Chain peril
• Unbroken chain
• Broken
 Proximate Cause
• The rule of proximate cause is that immediate
not the remote cause is to be regarded.
• The maxim is sed causa proxima non-remota
spectature, i.e. see the proximate cause and not
the distance cause.
• The real cause (peril) must be seen while paying
for the loss.
• If the real cause (peril) of loss is insured, the
insurer is liable to compensate the loss; otherwise
the insurer may not be responsible for loss.
•
 Proximate Cause
• Determination of Proximate Cause;
• If there is a single cause of a loss, the cause will be
the proximate cause and if the peril was insured,
then insurer will have to indemnify the loss.
• If there are concurrent causes, the insured perils
and the uninsured perils have to be separated.
• If the causes occurred in form of chain, they have
to be observed seriously.
• If there is unbroken chain the expected and insured
peril have to be separated.
Assignment or Transfer of Interest

The subject matter of insurance

The policy

The policy money when payable

Assignment or Transfer of Interest
• The legal transfer of contractual rights and
duties from one party to another.
• Marine and life policies can be freely assigned
without prior consent of the insurer.
• Fire and accident policies cannot be transferred
without prior consent of the insurer.
• The life insurance can be assigned whether the
assignee has an insurable interest or not.
 Return of Premium
By agreement

For reasons of equity;

• Non attachment of risk

• Undeclared of balance of on open policy
• Payment of premium is apportion able

Over-insurance by double insurance

 Return of Premium
• Ordinarily the premium once paid cannot be
refunded. However in the following cases the
refund is allowed;
• By agreement in the Policy; special packaging may
reduce the risk.
• For Reasons of Equity;
• Non attachment of risk
• Undeclared balance of an Open Policy
• Payment of Premium is Apportioanble
• No Insurable Interest of the insured
• Over-insurance
• Over-Insurance by Double Insurance;
Difference Between Different Types of
Insurance
Occurring of Subject-
Forms
Event Matter

Variance in Classification Period of

Premiums of Risks Insurance

Protection and Premium Insurable

Investment Payment Interest
 Difference Between Fire and Life
Insurance
Type of Contract

Occurring of Event

Classification of Risk

Period of Insurance

Protection and Investment

Insurable Interest

Moral Hazard
Difference Between Fire and Marine
Insurance

Moral Hazard

Insurable Interest

Profit

Valued Policy
 Insurance and Gambling
• Nature of Risk
• Insurable Interest