Insurance Contracts

Covered Topics: Principles of Insurance Contract; Elements of general Contract; Conditions for
indemnity Principles; Essentials of doctrine of subrogation; Wagering and insurance,
Reinsurance, Types of Reinsurance, Double insurance; and Return of premium.

❖ Principles of Insurance Contract

There are few basic principles that create an insurance contract between the insured and the
insurer. These principles combine to form an insurance contract. These principles are discussed
under:
➢ The Principle of Utmost Good Faith: Both parties involved in insurance contract—the
insured (policy holder) and the insurer (the company)—should act in good faith towards each
other. The insurer and the insured must provide clear and concise information regarding the
terms and conditions of the contract. If the insurance company provides you with falsified or
misrepresented information, then they are liable in situations where this misrepresentation or
falsification has caused you loss. If you have misrepresented information regarding subject
matter or your own personal history, then the insurance company’s liability becomes void.
➢ The Principle of Insurable Interest: Insurable interest just means that the subject matter
of the contract must provide some financial gain by existing for the insured (or policyholder) and
would lead to a financial loss if damaged, destroyed, stolen, or lost. The insured must have an
insurable interest in the subject matter of the insurance contract.
➢ The Principle of Indemnity: Indemnity is a guarantee to restore the insured to the
position he or she was in before the uncertain incident that caused a loss for the insured. The
insurance company promises to compensate the policyholder for the amount of the loss up to the
amount agreed upon in the contract. This is the most important matter of the contract for insured
(policy holder) to be understood about the right to be compensated or, in other words,
indemnified for his or her loss.
➢ The Principle of Contribution: Contribution establishes a consequence among all the
insurance contracts involved in an incident or with the same subject.Contribution allows for the
insured to claim indemnity to the extent of actual loss from all the insurance contracts involved
in his or her claim.
➢ The Principle of Subrogation: Subrogation is substituting one creditor (the insurance
company) for another (another insurance company representing the person responsible for the
loss).After the insured (policyholder) has been compensated for the incurred loss on a piece of
property that was insured, the rights of ownership of this property go to the insurer.
➢ The Principle of Proximate Cause:The loss of insured property can be caused by more
than one incident even in succession to each other. Property may be insured against some but not
all causes of loss. When a property is not insured against all causes, the nearest cause is to be
found out. If the proximate cause is one in which the property is insured against, then the insurer

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must pay compensation. If it is not a cause the property is insured against, then the insurer
doesn’t have to pay.
➢ The Principle of Loss Minimization:This is our final principle that creates an insurance
contract and the most simple one probably.In an uncertain event, it is the insured’s responsibility
to take all precautions to minimize the loss on the insured property.
➢ The Principles of Probability: The theory of probability is a statistical method used to
predict the likelihood of a future outcome. This method is used by insurance companies as a
basis for crafting a policy or arriving at a premium rate.

❖ Elements of general Contract:

The valid contract must have the following essentialities;
a) Agreement (offer and acceptance): The offer for entering into the contract may come
from the insured. The insurer may also propose to make the contract. Whether the offer is from
the side of an insurer or the side of the insured, the main fact is acceptance. Any act that precedes
it is the offer or a counter-offer.
b) Legal consideration: The promisor to pay a fixed sum at a given contingency is the
insurer who must have some return or his promise. It need not be money only, but it must be
valuable.
c) Competent to make a contract: Every person is competent to contract. A person is said to
be of sound mind to make a contract if, at the time when he makes it, he is capable of
understanding it and of forming a rational judgment as to its effect upon his interests.
d) 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, and mistake.
e) Legal object:In the proposal from the object of insurance is asked which should be legal
and the object should not be concealed. If the object of insurance, like the consideration, is found
to be unlawful, the policy is void.

❖ Conditions for indemnity Principles:

The following conditions should be fulfilled for the principles of indemnity:
a) 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.
b) The amount of compensation will be the amount of insurance. Indemnification cannot be
more than the amount insured.
c) If the insured gets more amount than the actual loss, the insurer has right to get the extra
amount back.

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 d) If the insured gets some amount from third party after being fully indemnified by insurer,
the insurer will have right to receive the full amount paid by the third party.
e) The principle of indemnity does not apply to personal insurance because the amount of
loss is not easily calculable there.

❖ Essentials of doctrine of subrogation

The doctrine of subrogation refers to the right of the insurer to stand in the place of the insured,
after the settlement of a claim, in so far as the insured’s right of recovery from an alternative
source is involved. Followings are the essentialities for doctrine of subrogation:
a) Corollary to the Principle of Indemnity: The doctrine of subrogation is the supplementary
principle of indemnity. The latter doctrine says that only the actual value of the loss of
the property is compensated, so the former follows that if the damaged property has any
value left, or any right against a third party the insurer can subrogate the left property or
right of the property because if the insured is allowed to retain, he shall have realized
more than the actual loss, which is contrary to principle of indemnity.
b) 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.
c) Subrogation only up to the amount of payment: The insurer is subrogated all the rights,
claims, remedies and securities of the damaged insured property after indemnification,
but he is entitled to get these benefits only to the extent of his payment. The insurer is,
thus, subrogated to the alternative rights and remedies of the insured, only up to the
amount of his payment to the insured.
d) The Subrogation may be applied before Payment: If the assured got certain
compensation, from the third party before being fully indemnified by the insurer, the
insurer could pay only the balance of the loss.
e) Personal Insurance: The doctrine of subrogation does not apply to personal insurance
because the doctrine of indemnity does not apply to such insurance. The insurers have no
right of action against the third party in respect of the damage.

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 ❖ Wagering and insurance
Insurance Contract is not a wagering agreement but it is like wagering agreement. Both,
Insurance Contract and wagering agreement depend upon a future uncertain event.
No Insurance Contract Wagering Agreement
1) Insurance Contract is an agreement Wagering Contract is one by which two persons,
between the parties in which one party; the professing to hold opposite views touching the
Insurer accepts significant insurance risk issue of a future uncertain event mutually agreed
from another party, the policyholder to dependent upon the determination of the event
compensate the policyholder if uncertain that one shall win from the other a sum of money,
future event impacts the policyholder. neither of the contracting parties having any other
interest.
2) Insurance Contract is legally enforceable Wager agreements are void.
and Valid Contract.
3) In case of an insurance contract, there is In case of a wagering contract, no consideration
consideration due to the presence of by way of premium is given by the insured to the
insurable interest. insurer.
4) Parties will have Insurable interest. In case of Wagering, Agreement parties do not
have insurable interest.
5) In Insurance Contract risk of loss is not In wagering agreement risk of loss or gain is
created but natural. created by the parties.
6) Insurance of Contract Protects the Wagering agreement affects the interest of the
Economic Interest of the Parties. parties.

❖ Reinsurance
Reinsurance is insurance for insurance companies. Reinsurance is the mechanism that insurance
companies use to lower their risk or reduce their exposure to a specific catastrophic event.
According to M. N. Mishra, “Re-insurance is an arrangement whereby an original insurer who
has insured a risk, insures a part of that risk again with another insurer.
Reinsurance is the practice whereby insurers transfer portions of their risk portfolios to other
parties by some form of agreement to reduce the likelihood of paying a large obligation resulting
from an insurance claim. The party that diversifies its insurance portfolio is known as the ceding
party. The party that accepts a portion of the potential obligation in exchange for a share of the
insurance premium is known as the reinsurer.
For example, when Hurricane Andrew caused $15.5 billion in damage in Florida in 1992, seven
U.S. insurance companies became insolvent because they were unable to pay the claims resulting
from the disaster.

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Example, a small auto insurance company collected a total of $10,000 in premiums from
customers this year. However, if a customer gets into a serious accident, it could easily create a
claim for which insurer has to pay that amount. So, insurance company use a portion of the
premiums that receive to purchase a reinsurance contract that will pay out in the event of an
exceptionally large loss.

❖ Types of Reinsurance
Generally, reinsurance policy reduces the losses sustained by insurance companies by allowing
them to recover all, or part, of the amounts they pay to claimants. Reinsurers help insurance
providers avoid financial ruin in case a huge number of policyholders turn out to make their
claims during catastrophic events. Below are some of the major types of reinsurance policies.
a) Facultative Coverage: This type of policy protects an insurance provider only for an
individual, or a specified risk, or contract. If there are several risks or contracts that
needed to be reinsured, each one must be negotiated separately. The reinsurer has all the
right to accept or deny a facultative reinsurance proposal.
b) Reinsurance Treaty: Treaty reinsurance represents a contract between the ceding
insurance company and the reinsurer who agrees to accept the risks of a predetermined
class of policies over a period of time. Here, reinsurer agrees to cover all or a portion of
the risks that may be incurred by the insurance company being covered. Treaty
reinsurance is insurance purchased by an insurance company from another insurer. The
issuing company is called the cedent, treaty reinsurance gives the ceding insurer more
security for its equity and more stability when unusual or major events occur.
c) Proportional Reinsurance: Proportional reinsurance coverage is reinsurance of part of
original insurance premiums and losses being shared between a reinsurer and insurer.
With proportional reinsurance coverage, the ceding company and the reinsurer share risks
and premiums on a proportional basis. The insurer and the reinsurer both share the
premiums and the claims on a given risk in a specified proportion.
d) Non-proportional Reinsurance: Non-proportional reinsurance, or excess of loss basis, is
based on loss retention. The ceding insurer agrees to accept all losses up a predetermined

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 level. The reinsurer agrees to reimburse the ceding insurer for losses above the
predetermined level and up to the reimbursement limit provided for in contact.
e) Excess-of-Loss Reinsurance: This is actually a form of non-proportional coverage. The
reinsurer will only cover the losses that exceed the insurance company’s retained limit.
However, what makes this type of contract unique is that it is typically applied to
catastrophic events. It can cover the insurance company either on a per occurrence basis
or for all the cumulative losses within a specified period.
f) Risk-Attaching Reinsurance: A basis under which reinsurance is provided for claims
arising from policies commencing during the period to which the reinsurance relates. The
insurer knows there is coverage during the whole policy period even if claims are only
discovered or made later on.
g) Loss-occurring Coverage: This is a type of treaty coverage where the insurance company
can claim all losses that occur during the reinsurance contract period. The important
factor to consider is when the losses have occurred and not when the claims have been
made.
h) Reinsurance Premiums: There are generally two types of premium that can be paid for
reinsurance. These two variants of the premium payment have been listed below:
• Direct premium or original premium: This will depend on the percentage of risk that is
transferred by the ceding company to the reinsurance company. If an insurance company
wishes to transfer 40% of its risk to a reinsurance company, the accepting company, in
that case receive 40% of the premiums received by the ceding company.
• Revised risk premiums: This type of premium does not depend on the amount of
premium received by the ceding company. The reinsurance company in this case will
quote a premium on their own depending on the extent of risk covered by the company.

❖ Double Insurance
Double insurance is a type of insurance where the same subject matter is insured more than
once. In such cases the same subject is insured, but with different insurers. The method of double
insurance is considered a legal act. In case of loss the insured can claim from both the insurers
and the insurers are liable to pay under their respective policies.
The features of double insurance are:
i. subject matter is insured with two or more insurance companies;
ii. the insured can claim the amount from the policies; and
iii. the insured cannot claim more than the actual loss.
Double insurance also follows the basic principles of insurance.

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 ❖ Return of Premium:
Ordinarily the premium once paid cannot be refunded. However, in the following cases the
refund is allowed:
a) By Agreement in the Policy: the assured may pay full premium while effecting the
insurance but it may be agreed to return it wholly or partly in the happening of certain
events. For example, special packing may reduce the risk.
b) For Reasons of Equity:
i. Non-attachment of risk. Where the subject-matter insured or part thereof, has never been
imperiled for example, term insurance with returnable premium where premium is
returned to the policy-holder if death does not occur during period of insurance.
ii. The undeclared balance of on open policy: The policy may be canceled and premium
may be returned for short interest allowed provided there was no further interest in the
policy.
iii. The payment of Premium is apportionable. The apportioned part of the consideration is
refundable when a part of policy interest is not involved. For example, insurance may be
taken for a voyage in stages, each stage being rated separately. In such a case if some
stages are not completed the premium relating to the incomplete stage is returnable.
iv. Where the assured has no insurable interest throughout the currency of the risk, the
premium is returnable provided the policy was not attached by way of wagering.
v. Unreasonable delay in commencing the voyage may also entitle the insurer to cancel the
insurance by returning the premium.
vi. Where the assured has over-insured under an unvalued policy a proportionate part of the
premium is returnable.
c) Over-insurance by Double Insurance
If there is over-insurance by double insurance, a proportionate part of the several premiums is
returnable provided that if the policies are taken at different times and any earlier policy has at
any time born the entire risk or if a claim has been paid.

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