~ Principla_oflnsvrrata II -..

,
Offer and Free Cal)acilycl l..awM
eonsent Parties
A0ceplance ~
(0 _r t
-
Indemnity Adhesion Personal Ulmost Good Fail! Alaaby
Fundamental Principles of Insurance Insurable Interest
Wananty
Actual Gash Value
Repasailaiun
Sbrogation
Ca1ceal11a,t
t
~ stad):iag tlais chapta-. yoa sboa.ld be able to anderst.and:
► <lmacrmsticsofRisk ► Principlesoflndemnity
'
Proximity
1~1
Figure 17.1: Distin!1Jish Charaderistics of lnsi:rance Conlrads
;. Rules offndemu~ Insmance ► Ctmost Good Faith
► Ptuxinntc U1C2 ► Subrogation and Contribution 17.2 PRINCIPLE OF INDEMNllY
The Black's Law Dictionary defines the word indemnity as an assurance. by which one person mg:aip
17.1 DfSlllGUlSH lHAIAffillSJJCS to secure another against an anticipated los.5 or to ,pm-e:nt him from being darouified by the lepl
consequences of an act on the part of one party or of some third person. In simple words, indemnity
\\~ ~ ~ SDlf:liod the basic .famres of a contract as per the requirements of law which make an means giYing assurance to another party to contract from any m or damage. It is an act to saw someone
agtttmda d?ir-..able .i n the ey15 of.b:w. These features are equally applicable to insurance contracts.
It is an action of making good the loss. In legal sense, indemnity refers to an action to restore the position.
Jt ii to cerise that mid <6i- and acceptance. apacity ofparties. free consent, lawful consideration, and of party who suffered from losses, to position what party originally holds or enjoys. Section 124 of the
lnfm ob;«ts are the key attributes ofan ordinary as wdl as insurance contract In the present chapter, Indian Contract Act, 1872 defines indemnity contract as stated here under.
'R 1riD study' some distingwsh characteristics of insurance contracts. These characteristics may also be
A contract by which one party promises to save the other from loss caused to him by the condJut of rite
aDed u ftmdrnmtil principles ofinsnrmce contracts which distinguish it from an ordinary contract
promi.sor himself, or by the conduct ofany other person is called a contract ofindemnity.
Ad?SSifiotion ofaD characteristics has been made by Mark. S. Dorfman as in the Figure 17.1 given
bdo.: In the insurance contract, the insurer ,promises either to save the insured property or restore the
property position as insured was holding that ,property just before occurrence of loss. The principle of
Tom,. indmrni:ty, adhesion. utmost good faith, aleatory etc. are the additional characteristics of an indemnity is one of the important doctrines of the insurance. An important fundamental of indemnity
mcmzuce c.oatr..ct discussed in detail in the subsequent sections of the present chapter. is to restore the ,position of insured, but insured should not profit from an insurance transaction which
provide an inducement to cause loss with intention of making money. If insurer is legally bound to
indemnify in5ured in full amount then it could increase moral hazard.
 l'lffldamcntal Principia of lnswrance \\ 169
268 II Essnrlillls of&,,tki,tg-' ~
50lution:lheva1ue f ch thec1ateofaccldeotwouldbethcvalueofmachinerylessdepreciation
the risk of fire costing f ,. r three and h o ma lneryon ,SOOOOo
For example, Mr. X is an insuml who inswa his factory building against o 10 al( years I.e.,
the sation shouJd not be more than f 10 lacs. iess: Depreciation for first year @5% '~
?10 lacs. In any case. compen . . . . . ion for a year, a sum assured
In another mstance, Mr. x inswa his automobile agamst nsk of colhs . extent of " 3 1 Book value after 1st year dep t475000
· sh uld be "th to the maJ(JJJlUID acs or
is ?3 lacs. The loss actually occurs, the d aun ° eJ. er ~
returning the goods after getting repairs so that Mr. X could eDJOY the sam
e benefit as he could ha I,eSS: Depreciation for second year @5% (WDV) t 23150
Ve
Book value after 2nd year dep t4S1250
enjoyed ifloss would not haw occurred.
. . . b diffi ult to estimate life of a human iess: Depreciation of 3rd year @5% (WDV) t 22563
It is easy to compute the value of property or any liability, ut c . f. d .
being Even it is difficult to measure loss of any limb of body. Thus, the doctrine O ~ emruty applies Book value after 3rd year dep. t 428687
to p~perty and liability insurance only; not to life insurance or personal acciden~al msurance. It is to iess: Depreciation for half year @5%(WDV) " 10717
highlight that even non-life insurance contracts do not necessarily lead to result m full compensation
Book value on the date ofloss "417970
in each case. It depends upon the circumstances like., usage value of the property, age, salvage value,
depreciable value etc. while computing computation payable to insured However, factory has insured machinery of only f3SOOOO against boo.le value oH417970. Thus, it
For example, a chemical factory owner insured his factory building, machinery and workers during
will get compensation of i2s121s on proportionate basis instead of f3SOOOO of actual insurance, as
the performance of job on machine. The life of ractory building and machinery was twenty and ten calculated below.
years respectively; their costs were a sum oH'IO lacs and fS lacs respectively. Due to chemical reactions, "350000
factory catch fire which cause minor Joss to building of i2 lacs, a loss of Blacs to machinery occurred. f417970 x300000 = f251215
Along with that an arm of worker, who was on machine at that time, was lost. The insurance company
will assess the value of building and machinery after their depreciation and salvage value (especially
in case of machinery; if it has no further usage) after that it will release the insurance compensation.
17.3 IMPORTANT RULES OF INDEMNITY INSURANCE
However, the loss of arm of the worker is beyond the assessment. To evaluate the indemnity amount under insurance contract, it is necessary to understand the following
Now, it could be said that life-insurance contracts, as discussed above, are exception to contracts of important rules regarding indemnity insurance.
indemnity. Toe value of human life is different from a material or property. The rule of valuing property 1. Insurable Interest
like replacement cost less depreciation, discounted cash flows and other deductions cannot be applied 2. Actual Cash Value
to human value. Besides it replacement cost and valued insurance policy are two more exceptions to 3. Subrogation
contracts of indemnity. Replacement cost insurance is written when insurer promises to pay an amount
equal to the full cost of repairing or replacing the property without deduction for depreciation. As we
17.3.1 Insurable Interest
know the value of a car used for last five years, will have lesser replacement cost as compare to a newly
purchased car. Thus, insurance company generally assesses the replacement cost at the time of entering Insurable interest refers to financial implications in case ofloss occurred that is, obviously, financial loss
into insurance. The valued insurance are made in case where it is difficult to estimate exact value of goods of the property or goods etc. If the insured has no interest in the property then such insurance would
~der insurance, or complex to calculate exact market value on the date of loss. For example, ocean and become a gambling. An insurance contract, in fact, is legally binding only if the insured has an interest
inland marine insurance contract are made on valued basis. in the subject matter of the insurance and this interest is insurable. The subject matter of the insurance
refers to property/ assets/goods/ life etc. ~po~ whic~ ins~ce contract is formulated. The doctrine
IDustratio~ l7.l: To understand the concept of indemnity, let us reconsider the chemical factory of insurable interest is most important prmciple of mdemruty as it necessitates to establish financial
example with practical computation in respect of loss to machinery as follow: relationship between insured and_ subje~t matter which can be ~sured. _Thus, if there is no financial
• The value of machinery fS,00,000 relationship or the subject matter is not msu_ra~le then the law of mdemruty will not prevail. Therefore,
• Rateofdeprectation
· · ,or
c: • bl . t ay be defined as a financial mvolvement which is able to be insured
each year 5% written down value(WDV) method, Insura e mteres m ·
• Number of completed years at the time of occurrence of loss 3 ½ years,
·aJ f insurable interest have been presented in Figure 17.2 given on next page
The essenti s O •
• Insured value of machinery ",3,50,000, against book value,
• Actual loss occurred 300000.
 270 11 Essmtillls afB,mki,,g .-I msimm«
Subject Matter of
losU'an0B Contracl
legal RESalionshil> Subjeci Matter
be!-'lnstedand must be Insurable
Subject Matter
r,gure 17.2: Essentials Elements of Insurable Interest
Figure 172 shows the triangular relationship betv,een three elements of insurable interest. First,
there must be property/assets/goods/life/limb/potential liability or financial interest capable of being
roveml under insurance. Second, such property/assets/goods/lifenimb/potential liability or financial
interest must be the subject matter of insurance. And third, the insured must be in a legal relationship
with the subject matter of the insurance.
The above said relationship must exist at the time of talcing insurance cover till the loss actually
occuzs. However, in case of life insurance, the general rule is that insurable interest must exist at the
inception of the policy, but it is not necessary at the time of loss. It is generally considered that life
insurance is an investment instead of insurance. Thus, in case of death of insured, the legal heirs of the
deceased become eligible to get insurance claim.
17.3.2 Actual Cash Value
As discussed above that indemnity does not allow to insured to make profit out of insurance. The
maximum amount of loss that insured can cover has a value calculated on the basis of insured amount,
loss amount, replacement costs and actual cash value. There are three methods to compute actual cash
value viz., (i) replacement cost method, (ii) fair market value method, and (iii) broad evidence method.
Actual cash value generally means replacement cost of the subject matter (i.e., property/assets/goods
etc) at the time of loss less depreciation. Thus, actual cash value ensures the replacement of property/
assets/goods, in terms of money, as it has value before occurrence of loss. However, there is no perfect
fonnula to calculate actual cash value rather it varies with conditions of each case. For the purpose of
property insurance or general insurance, the actual cash value is calculated with the help of following
equation.
Actual Cash Value= Replacement Cost - Depreciation
The same equation has been used in illustration 17.1.
~ few cases, it is difficult to calculate replacement cost or depreciation value of the property/goods
: • ~ such cases fair market value is adopted, for example, sinking of ~oo~s in sea. Fair market value is
pnce ~ would normally be determined by the market forces durmg msurance contract is entered.
A bundJe of msured goods sunk in a sea during their transportation would be valued on the basis of fair
market value of goods in the free market rather than replacement cost.
Fundommtal Principles oflnsvrtlllll 11 1.71
Third method
"Jhe actual cash va~fco_mputing actual cash value it based on sdmtific techniques and financial modeling.
costs etc. in accoun~e~_calculated by taking time value of money, discounting price, or replacement
techniques and thei· · is method allows personal judgment of the aperts based on various restoring
. r expertise.
It 1s to repeat that . . . .
covers like health ins~nnciple 0 ~ indemnity has exceptions with respect to life insurance. The insurance
amount. No valuation ~ :~dental insurance etc., are paid, in case of loss, on the basis of agreed
is possible to assess th; O
vale asis ~f any quantitative method, such as replacement or fair value method,
ualitative factors and is s ube_ of life. The value of life is generally determined on the basis of certain
q
u Ject to personal · · · of · d fu liabili"· f
insured, and the value of poll . A lil . ~m1on, ~ t y . insure to earn, ture ty o
of indemnity rather it is a val cyd
in case of loss of life.
t msuran~ 15 not a policy which can be covered under the doctrine
ue po1 cy wherem the agreed upon amount in full is paid to the beneficiary
17.3.3 Subrogation
Subrogation is a Latin word which means "asking (for a payment) under another's name': In the law of
contract the term subrogation is defined as given below:
Subrogation means the restitution of the rights of an insured in favor of insurer against the third
party for any damages caused by him, in place of the insured after the insurer has indemnified him for
the loss.
In simple words, subrogation means giving right to another person to take the position of one's
person. Toe principle of subrogation is invoked when third party is responsible for loss. Therefore,
subrogation arises only in motor or vehicle insurance. Let understand the concept of subrogation with
the help of example given here under.
Mr. X took a motor insurance cover from an insurance company, say, ABC Ltd. The motor car of
Mr. X was hit from behind by another motor car belonging to Mr. Y. Now, Mr. X has two options to
cover his damages. First, he may initiate legal proceedings against Mr. Y for compensation of damages.
Second, as he has already taken insurance policy, so he can claim insurance cover from insured i.e., ABC
Ltd. If Mr. X collects his insurance cover form the insurer, then he substituted his right of initiating legal
proceedings against Mr. Y to insurance company. Now, insurance company, ABC Ltd., which acquired
the right, can initiate legal proceedings as it has indemnify the loss to Mr. X, and has restituted rights to
claim such amount from the actual defaulter who caused the loss i.e., Mr. Y.
It is important to note here that if Mr. X does not file a case against Mr. Y for compensation ofloss,
then there will be no restitution of rights to insurance company ABC Ltd. Similarly, if Mr. X n~i~er file
a case against Mr. Y nor claim compensation from ABC Ltd., or in other words, he gives up his ~ght of
compensation against loss, in these cases the doctrine of subrogation will not be invoked. ~e ngh~ of
indemnity does not allow to insured to file a case, by taking support of principle of subrogation, agat0Sl
insured in case of loss caused due to own negligence
There are following purposes of doctrine of subrogation:
1. The r!ght of subrogation is based on the principle that if it did not exist, the insured would be
permitted to collect twice for the loss, one from the insurance company and second from the
272 11 Essettfflllsof&,n/ci11g'°"l1ISllfllll«
r
negligent party. No doubt. it would be profiting from the existence of the insurance contract
which is otherWise not allowed under insurance contract. . .
_ It giveS right of restftUtion to insurance company to institute legal p~ceedings ~gamst the
2 defaulter and hold him liable for the compensation of damages. Thus, it serves twin actions,
one compensatioo to loss sufferer and second claim from guilty person.
_ It helps the insurer partially or fully to recover the amount indemnify by insurer t~ insured. It is
3 not ecessary that every loss is caused due to negligence of third party. If substantial incidences
0
of losses occur due to negligence of insured himself then it would amount to great financial
burden on insurance companies. However, the principle subrogation helps in recovering cost
of insurance ariseS due to loss caused by third person, and ultimately assists in reducing the
insurance premium.
The principle of sub~~on is ap~licable to ~nl~ general ins~~ce, i.e., property and liability
insurance. In other words, 1t is not applicable of to life-msurance policies. Let say, a person, A, covered
under life insurance killed by another person, B. In this situation, the insurer has no restitution of right to
file a case against B to recover the insurance amount paid as compensation to legal representatives of the
deceased person A. However, in this case, the legal heirs of deceased A may have two benefits, first from
insurance company, and second if court decides compensation to be paid to aggrieved family members
by murderer. Thus, subrogation is not equally applicable to general and life insurance.
To sum up, doctrine of subrogation has few limitations as given below:
1. This principle is not applicable to life-insurance policies, so the insurer has no right of action
against third party responsible for the death or personal injury inflicted on insured.
2. In case the insured gives up his rights either to file a case against defaulter or to make a claim
from insurer, the rule of subrogation cannot be invoked. For example, the car of insured is
hit by his own relative, then he will not put his relative in jeopardize of legal hassles. Thus,
surrendering of own right ceases the invocation of subrogation.
3. The right of subrogation can be raised only if insurer indemnifies the loss of insured. Insurer
has no right to claim compensation from actual defaulter unless insurer acquired that right
from insured which is possible only if it indemnifies the loss of insured.
17.4 ADHESION
Black's Law dictionary defines contract of adhesion as "any agreement offered in the take it or leave it
basis". It means one party has to accept or reject the offer. He has no option of bargaining or negotiation.
Oxford dictionary defines the term adhesion as "a contract consisting of standardized and non-negotiable
terms, especially where one party to the contract is in a weaker bargaining position than the other". It is
generally found in the contract of insurance that insured has to accept the entire contract, with all of its
terms and conditions framed by insurer. In the insurance contract, insured stands on weaker position as
compared to insurer who frame the whole policy. Thus, irlsurer has the advantage of writing the terms of
contract to suits it. On the other hand, insured has to accept entire contract without any negotiations or
conditions. The advantageous position of insurer makes imbalance between insured and insurer.
In case of any ambiguities or uncertainties in the contract will be construed against the insurer who
drafted the agreement and benefits of such contract is given to insured on the basis of benefit of doubt
-- ----
rule, To adjudicate arnb1 .
Fundammtal Prlnciplts ofInsurance II 273
it, It is important to noteg:ty or u_nc~rtainty courts take whole view of the contract instead of a part of
understandable by the ins at ambiguity or uncertainty does not mean that the terms of contract are not
that the insured did not u~ed. For the purpose of adhesion or taking benefit of doubt, there is no excuse
iJlsured reads the contn: e~tand or h:i5 not read the policy. In other words, the court assumes that the
an agrees Wlth the terms thereof.
17.5 PERSONAL ATIRIBU1B
'Ihe law of contract is recognized
. urance contract and makes insuras personal contract. This feature of law of contract is brought to
111s . . . ance contract also as personal contract. Personal feature of insurance
contracts highlight_ th~importance ofparties to contract that are insurer and insured. The personal feature
does not refer to life ~surance of an individual rather it indicates contract between two persons on a
subject matter on which they entered into contract and each has considered the other's characteristics
and conduct. ~e personal attributes of insurance contract derives its force from the concept of privily
to contract which means that a stranger to contract cannot sue, or has no entitlement to take any benefit
out of contract.
For example, a general contract of property insurance was formed between insured, say Mr. A,
and insurer, say insurance company X Ltd. In case of loss, Mr. A is entitled to compensation and X
Ltd. is required to pay sum of amount as compensation. Let say, Mr. A sold that property to Mr. B
before occurrence of any loss and thereafter loss occurs. In this case, Mr. B is not entitled to receive any
compensation from X Ltd. as the contract of insurance was between Mr. A and X Ltd. Thus, Mr. B is
a stranger to that contract. However, if Mr. B wants to take benefit of such contract which has already
entered upon by Mr. A and X Ltd. then it could be possible through assignment.
As discussed earlier, the loss in case of life-insurance policies has different treatment as compared to
general insurance. The insurance claim in case of death of insured will be given to the legal heirs of the
deceased person. Thus, the relatives or legal representatives are not considered as stranger to contract.
Similarly, nomination is possible on the whims of insured and no intimation or permission is required
from the insurer urilike making assignment in case of general insurance.
17.6 ALEATORY CONTRACT
Aleatory contract refers to a contract, the obligation and performance of which depend upon an
uncertain event. A contract is aleatory or hazardous when the performance of that which is one of its
objects depends on an uncertain event. It is certain when the thing to be done is supposed to depend on
the will of the party, or when in the usual course of events it must happen in the manner stipulated. In
the term of insurance contract, the aleatory contracts the values exchanged by the contracting parties are
not necessarily equal. The contracts with equal exchange are called as commutative contracts.
nds
Thus aleatory contracts have two features, first, the obligation or performance of contract depe
upon chance or performance is uncertain. Second, the value of consideration is not necessarily equal to
?oth parties. These two features differentiate insurance contract from other business contracts. In the
insurance contract, the performance of contract or arise of obligation of insurer company depends upon
the c~ance o_f loss._ If loss ~ccurs only then it is obliged to perform. On the other hand, the insurance
premium paid by insured is a minor fraction of total loss. If loss does not occur he lost the amount of
 274 11 Essentials ofBanking and lnsuronC't'
premium, but if it occurs then insured get a compensation of loss against a small amount
Thus, insurance contract fulfills both ~atures and become as aleatory contract.
of premium.
--
17.1.1 Materialfact
Fundammtal Principia of lnsunmu II 175
Material Pact could be defined as a fact or situation that would influence the mind of a prudent person
ill assessing a risk. The variety of facts may ch~e the degr~ of risk. Material facts
17.7 UTMOST GOOD FAITH (UBERRIMAE ADES) have confined
measurement but vary case to case. Some facts might be obvious but may be immatma 00
l and vice-versa.
Uberrimae Fides is a Latin tenn means utmost good faith. All commerci al contracts are A few instances of material facts are listed below:
subj~ct to good faith
so that no party commits fraud. It is generally required that an agreement m~st be free from nus (i) Life Insurance: Age, living conditions, medical history, hereditary are important
representa tion to assess risk
and fraud vis-a-vis disclose all relevant and material information on subject matter 0 ~ contract of life.
to another
party. However, under commercia l agreement s, like sale of goods, parties are not reqwred to reveal all they (ii) Marine Insuranc e: Type of vessel, loading capacity, usage value,
know about the proposed agreement Such commercial contracts presuppos repair etc.
~ that let_ the b~yers beware (iii) Fire Insuranc e: Types of goods produced and stored, neighboring locations,
(caveat emptor). It means seller is responsibl e to disclose only that portion of inforn:iatio fitt extinguish
n which has been facilities, electrification quality etc.
asked for by buyer. Otherwise, it is the duty of buyer to get all the requisite informatio n m respect of price,
conditions, size, colour, life, warranty ofthe product etc. and satisfy himselfbefore buying (iv) Motor Insuranc e: Model of vehicle, previous driving record of proposed insured
any goods. Though etc.
in few cases law protects buyer but in general principle of caveat emptor prevails.
We have already made discussion that insurance contracts are special contracts based upon mutual \7.1 .2 Duty of Disclosure
trust and confidence between insurer and the insured. The insurance contracts are written by insurer Duty of Disclosur binds both party, that are insured and insurer to reveal all informatio
only and insured enters the contract without any bargainin g or adjustmen ts. Thus, n sought by
insurer is the Party other party.
who knows the term and conditions of the contract best. This feature of insurance contract The informati on so provided must have validity of in-force throughou t the negotiations
binds insurer leading up to the formation of the contract. If any information provided by one party
in legal duty to disclose all material facts to prospective insured. do not uphold till
the formation of contract or as per the terms of contract, then such informatio n may
In simple words, utmost good faith means that each party to a proposed contract is lead to recession
legally obliged of contract due to misleadin g informati on. Otherwise
to reveal to the other all informatio n which would influence the other's decision
, the aggrieved party may sue defaulting party. h
to enter the contract, is generally found that in case when
whether such information is requested or not. The insured fails to disclose required informatio n then it will lead to
required informati on must be material information.
Failure to disclose such vital information, even if not asked for, gives the aggrieved decline of contract. And, when insurer does not provide sought information then insured
party the right to may institute
regard the contract as legal proceedings against insurance company in order to recover compensa tion.
void. Each party that is insurer as well as insured is required to disclose material
information. For example, if insured did not reveal that he is suffering Similarly, insured is also required to supply material facts to insured. For example., while
from brain formation of
life-insurance cover. Later, insurer found the facts concealed by insured would amount
tumor,
to no
and enters
compensa
into
tion. I fire insurance contract, insurer asks from prospective insured about the provisions of
which must be in workable position. The insured had
fire-extinguishment
The doctrine of utmost good faith assign
all material facts relating to risk being transferred from
a positive duty voluntaril
proposed
y disclose,
insured to
accurately
insurer.
and fully,
The principle
I
I
was neither used or recheck since that time. He
installed
submits
such infrastruc
informatio n to
ture
insurer
but
in
ten years
affirmative
ago which
answer
of Uberrimae Fides relies on honesty and based on three pillars viz., representation, without disclosing the fact on its workable conditions as the instrumen t has never
warranty, and been rechecked. Thus,
concealment as shown in Figure 17.3. insurer will not be held liable to compensate if any mishap occurs, because insured
bas not obeyed his
duty of disclosure.
Parties to Contract In most of cases, the insurers appoint agents to sell their policies. Agents are the representatives
of the insurance companies. They work on the behalf of the company. In such case., the ag~nts ~e dut_Y
bound to disclose all material information to proposed insured. But they cannot be held liable m therr
-Insurer Material Facts Duty of Disclosure Insured
personal capacity in case of any shortcomings arises from insurance company in
requirements.
respect of disclosure
Utmost Good Faith
17.7 .3 Representations
Representations refer to a statement made by proposed insured to insurance company
or its agent before
entering into contract generally not in writing. But on later stage such information is sought in writing
Representation in a form accompanied with main application. For example, seeking
Warranty I Concealment
information on
medical status of health, surgery etc., are the representations given by the insured.
age, weight, height,
Information on all
Figure 17.3: Utmost Good Faith
276 II EssenfUllsof&mkilll-'1~
these factors is material one as it helps in assessment of risk. Similarly, heredity medical problems, age
of parents are also material in{onnation. But information on age of a deceased grandfather who died
in accident has no material fact. If any information which is material and relied by the insurer whUe
assessing risk found false on later stage would amount to contract void.
For example, while covering ~ medical insurance, a ~uestion is asked regardin~ ~y major surgery
in last three years from proposed msurcd has not been disclosed to insurer, And within a short span of
time. a Jump is found at the place of surgery which caused cancer. This was material information false!
rep0rted by insured which would amount to contract void and no compensation will be given to insurel.
~
Representations need not necessarily incorporate material facts, but they must be substantially tru
This means that they must be true to the best knowledge and believed of the prospective insured.
innocent misrepresentation is one that is unintentional. If a person has no symptom of lung infection
the time ofinquiry and he reported himself medically fit, but after a month he suspects problem in Jun at
In this case, the insurance contract would render voidable at the option of insurer as the informatigs.
~
was not concealed by proposed insurer intentionally and he submitted information on the facts kno on
~~~~
17.7.4 Warranty
Warranty has been defined in Section 12(3) of the Sales of Goods Act, 1930 as 'a stipulation collateral
to the main purpose of the contract, the breach of which gives rise to a claim for damages but not to
a right to reject the goods and treat the contract as repudiated'. In simple words, warranty refers to
collateral conditions to contract which may require be present at the time of either formation of contract,
during happening of loss, or after the occurrence of loss. In case of commercial contracts, warranty is a
statement guaranteed by maker of the contract Insurance contracts are special form of contract, thus
the terms of warranty is stipulated by insurer only who write the contract as we have already studied in
the principle of adhesion.
For example, A.BC Ltd. sold a car to Mr. X on the warranty of working of engine of the car. On the
very next day, Mr. X brought car back complaining the working of engine. ABC Ltd. repaired it and
return back to Mr. X without any cost In this case, the main contract is of sale of car, and collateral
agreement is orderly working of engine. Thus, in case of engine problem the contract of sale of car will
not be repudiated.
In the insurance contract, insured may warranty to insurer in respect of any action which could help
in reducing associated risk. For example, in a property contract, a bank agreed to engage security guard
at night to prevent expected Joss of cash. If a loss occurs and it is found that on that particular night there
was no arrangement of security guard at bank, then it obviously amount to no recovery of loss.
Warranty is the strict application of principle of utmost good faith. A warranty creates condition(s)
to contract, and any breach of warranty, even if immaterial, will void the contract. This is the main
distinction between misrepresentation and warranty. A misrepresentation does not void the insurance
co~tract unless it is material to the risk. But in case of warranty, an immaterial fact may hold contract
void. The second difference between representation and warranty is that the contract is not repudiated
~ ~e ~ors must link with material facts. But in case of warranty, there is no need of establishing any
assoctation with material facts or cause ofloss. Third difference lies on contract itself. The representation
Pundammtal Prlndpl,s ofInsrmmce II 277_
Is not a requi ty . •L-
it But, warran IS LUC'
..li"' duty of the partt"es.
re111 of the contract but ls a fiduciary l.-.1
attached condltlo:rit
s to contract, thus are expressed duty of the parties to fulfiil
17.7.5 Concealment
Concealment is the anuth . . Act, 1972 reads 'the
active concealment of f esis of disclosure. Section 17(2) of the Indian ~
concealment refers to: :~by one having knowledge or belied of the fact' results~ fraud In
eak Concealment r~ i°" of proposed insured to hide material facts or mere silence when°
oth
b:~ rds,
t
0
sp ·d · ft • b u ts into deliberate withholding of material facts from the insured. The proposed
1nsuretli is o fen m a etter position to know the material facts about the risk that insurer does not The
I gale ect o concealment is · ii ,_._L,_ th ·
e. . . sun ar to misrepresentation and results into contract VOIUiWlC at e option
of msured. ~owever, mtentional Withholding of material facts with intent to deceive constitutes fraud for
which applicant may be prosecuted.
For exai:nple, :"11'· X takes marine insurance of goods (edible oil) transported from one place to
another. He mtentionally conceals the facts from insurer that the few containers of goods are filled with
highly inflammable ~il. During transportation all goods damaged because of fire set. In this case, the
contract would be v01dable at the option of insurer. Therefore, any intentional concealment of facts will
disrupt the objective of utmost good faith.
Explanation appended to Section 17 of the Indian Contract Act, 1972. further explain that 'a mere
silence as to facts likely to affect the willingness of a person to enter into a contract is not fraud, unless
the circumstances of the case are such that, regard being had to them, it is the duty of the person keeping
silence to speak, or unless silence, is, in itself, equivalent to speech: Therefore, the circumstances of each
will decide whether silence amounts to concealment of facts or not.
17.7.6 Reasons and Effect of Breaches of Utmost Good faith
From the above points, the important reasons of breach of utmost good faith are listed below.
(a) Non-disclosure is the failure to disclose a material fact, either by accident or the fact was not
considered to be important. Such breaches of utmost good faith results into contract voidable
at the option of the insurer.
(b) Concealment is the willful failure to disclose material facts or hide substantial facts or not to
speak about material facts. Concealment amounts to an insurance contract void. The insured
does not entitled to claim any compensation form insurance company.
(c) Fraudulent misrepresentation refers to deliberate supply of false or misleading information on a
material fact. This would amount to insurance contract void and may held insured responsible
for guilty of tort.
(d) Innocent misrepresentation is the act of giving false information but unintentionally. The eff~ct
of such breach of utmost good faith would amount to insurance contract voidable at the option
of insurer.
(e) Failure t_o fulfillment of warranty is neither a production of false information nor hiding
substantial facts. It is a mere non-fulfillment of collateral conditions of contract. ln case of
 278 II Essentials ofIJanking QJ1a Jnsumnce
breach of such conditions, insurance contract would stand void and insured
· · I
get any compensauon against oss.
is not .
q~d
e to

--
rather the
Unlawful mob pracuce 5
(.Marsden vs. City & Country Assuran

--- ce C~.)- .

Fundame ntal Principles of Insurance

. I direct cause of burglary. Thus, insurer was held for compensation

II '1:19
The gen
era1rule In proper insurance 1s that ·for the lmsured
ty to collect, the proximate cause must be
a coved peril. In other words, all bo
J7B PROXIMrTY CAUSE insuranc e comparu e~ are eg_ Y und to give compens ation to insured
· . f . ·ty is nearness in terms space, time, or
. .
relations
for only those losses that are covered under the policy. ~e msuranc e compani es also describe the types
hip. The proximate
The dictionary meaning O proxmn Th result of a direct action and cause of
cause is also known as
direct cause. e loss to property that set
. . s
of perils which may cause Joss, e.g.,
the insurers never pay any compens_allon agamst a
l~ss due :o
fire, ac~tde~t , collapse etc. It is important to note that
th . p~ril
.
in motion a
chain of events at is un broken and causes damage, injury andaldestruct .
ion with no othe were excluded from ~e terms of policy. For example, if a house was insured
which was either not covered under policy or
. h· r
. ..r. The proxunate cause floss is a vital concept especially in gener insurance, w 1ch distinct
o ' fir caused by other perils cannot be compens
against loss of fire, then loss
111tenerence. fro . . ated, let say by
. ce contracts m commerc.' al contracts. The proximate cause of a loss the st perils m a chain of flood. Similarly , if a person is covered under
msuran . . . . aCcidental insurance then cannot be compensated in case of suicide
events resultlllg ID a 1oss. The term proximate cause was explained in a leading case on msurance, Pawsey already excluded from
. or natural death. Further, if peril IS •
vs. Scottish Union & National (1907) as stated below. the msuranc e contract then compens ation cannot be sought for such excluded
. . . . peril; for example, a store of finished goods is covered
. eans the active, elhcient cause that sets m motion a tram of events which brings under fire insuranc e caused due to electrical
"Proxima te cause m -JI' . . reasons only. But if fire blazed out due to gas cylinder then insurer would
about a result, without the intervention ofanyforce started and working . not compensate for such loss.
activelyfrom a new and independent Where a loss occurs due to one and single peril the proximit y clause does not evolve any problem in
source." giving compensation to insured subject to that it was
For example, a house was covered not excluded from the policy and peril was covered
under fire-insu r~ce. A_ construc tion. was g?ing on in the under the insurance policy. But if loss happens due to chain of events
neighbouring house and a water logging _found there then one has to make assessment
which ~xc1ted the electnca l fittings of ins~ed either the chain consists unbroke n sequence
house and cause fire amounting to loss to rnsured house. In this case, or not. Along with that it has to look into that either insured
the fire was not set due to direct peril excited other perils or other perils excited
cause of fire but a reason which has agitated insured peril. In simple words in case of sequence of
fire. Thus, insuranc e compan y has to compensate for such peril, it is to determine which peril falls first either insured or
Joss. According to the doctrine of proxima te cause, uninsure d. Further, if a group of perils
a policy covering a particul ar peril covers not only occur at same point of time and loss is caused due to their multiple impacts
losses caused directly by that peril but also losses resulting from other then it will be attempted to
mishaps that were triggered by the separate their effect if possible.
insured peril, as long as there is an uninterrupted chain of events from the initial
peril to the loss itself. The classification of perils proximity and their effect has clearly presente
However, the proximity is generally decided by court as it varies in each case. d by D.S. Hansell in his
work "Elements of Insurance" as given in Figure 17.4.
Before deciding the fact of loss caused by peril must be direct or consequ ential but should not be Thus, it becomes important that all details related to proximate cause
remote or indirect. The proximit y of cause must be understo od on reasonab le have to be clearly mentioned
basis that a rational person at the time of entering
can establish by following logical analogy instead of into insuranc e contract. Sometim es the causes not covered by the policy have to
any scientific formula. The direct relationship,
reasonability and proximity among perils and loss can be understo od with be expressly mentioned if it has high proximit y with insured cause. Though
the help of following it is impossible to mention
illustrations. the whole range of perils but the proximity of cause may be decided accordin g to case to case. A brief
outline can be drawn from the above discussion in which insurer either
illustration 17.2: A fire at neighboring house left a wall in a dangerous will be held for compensation
state. The local authority ordered or not as follow:
the wall to be demolished. Before the wall was demolished it collapsed and
fell down on the property of (i) Insurer is liable if there is a single peril and it is insured, e.g., compensation on
adjoining neighbor covered under fire insurance. It was held that loss is caused account of
due to proximity of fire accidental insurance and a mishap takes place during driving of vehicle.
(Johnston vs. West of Scotland Insurance Co.).
(ii) There will be no liability of insurer if there is single peril but uninsure
illustration 17.3: A similar situation took place, as discussed in illustration d, e.g., no compensation
17.2 above. The fire left a on account of fire insurance ifloss occurs due to flood.
dangerous wall. After few days, a windsto rm came and caused the wall to (iii) If a loss occurs
fall and damage neighbor due to a chain of events those are unbroke n with no expected
property c~ve:ed under fire insurance. It was held peril involved,
that fire has no proximi ty with cause of loss as the compensation of every loss after happenin g of
consequentiality of chain of events is broken due to insure~ per~. For example , a person covered
interfere nce of an indepen dent cause. The occurrence under accidental insurance met an accident due to this peril
ofnew peril Le., windstorm, splits the direct impact of fire (Gaskarth vs. Law he went under shock and never
Union). recovered back, suffered from various diseases due to his _neurological probl~m
s arose because
~ on 17·4=A shop was insured against loss due to burglary except fire. A fire
of shock, ultimately dies. Tue insurer will be held responsible though the
peril of death was not
was set at neighboring
_an~ a cracked piece of steel material smashed to glass plate of insured. A mob got success in expected.
ffltaing m shop due to cracked glass plate and carried on . . . .
looting. Insuran ce company refused to make . ) I rer will not be liable for compens ation 1f expected pen! occurs
(iv nsu first to msured peril. Let
CG!llpeD&atian as the break of glass plate happene d due to fire. It was held .d d . .
that fire has a remote chance say, l·f in above said example• insured met an acc1 ent ue to neurologtcal problems which was
280 II Essentials ofBanking and Insurance ---- Fundamental Principles of Insurance II 281
~
~0 ~ 0~ expected earlier to happening of accident, then insured would not be entitled for any insurance
claim.
~~-~~
rn C -0 (v) In case of broken sequence of events n<>nHtl will be granted up to loss caused by
~
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msured event e1t er it occurs prior or later to expected perils. For example, a wall damage Y
a. =., "' 8_.2 ~...Jg-~
o I- earthquake was fallen down after three months caused electrical short-circuit and blazed fire. A
f
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house covered under fire insurance suffered a loss of damage can claim of compensation ofloss
ii g~ occurred due to fire not due to earthquake.
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e E o. 8 (vii) In case where perils carmot be separated then the compensation is awarded on the basis
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compensation is granted to insured.
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17.9 CONTRIBUTION
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~ a. §~~£~ In few cases property o~er failed to cover risk of loss under a single insurance policy. In case of
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gic~!?~=i -~ occurrence of loss'. the msurer make contribution towards total loss on proportionate basis as the
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agreed to assume nsk or percentage of premium they have collected from the insured. Toe doctrine of
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liable to the same insured to share the cost of an indemnity payment. It arises where there is an overlap
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subrogation. As per indemnity principle, no insured is allowed to make profit out of insurance which
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may turn insurance in gambling. If an insured purchases two or more insurance policy to cover a loss and
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claim compensation when loss actually arises, in such case he may get more amount of compensation
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from two or more than two insurers. The statutory laws on insurance and general principles do not allow
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a. such practice to have more compensation in comparison of actual amount ofloss. Thus, the principle of
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contribution permits an insurer to call upon other insurers to indemnify loss in equal or proportionate
basis.
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CT ~ a. E ~:, Second law related with contribution is subrogation. We have already study the doctrine of
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subrogation in detail in the preceding section of this chapter. Subrogation is the legal stand in which
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EW= ~ insured confers his statutory rights to insurer to recover the amount of damages from the real defaulter.
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~ However, in contribution that right is vested with the insurer against other insurer t~ the extent of
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c- :!::: 0 $ b accepted . .
as fundamental legal pnnc1ple of most .msurance. As sai'd ahove' contribution. follows
rl ~ ~j
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een
"' 0. g =c ~g ::::, practices as in case of indemnity and subrogation. For that reason it is applicable to general _msurance
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and do not normally apply to life and personal accidental or health insurance. :t is to m~erate
contribution has two important features first it allows insurer to call upon other msurer to
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1~ loss, and second, it_ ~estricts insured to ~alee ,profit out of insurance contract in excess of loss actu
CJX- ~~~SOC :i: occurred. The reqwsites of principle of contribution are presented in Figure l 7.5 below:
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(.) 0.
in
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a. •e
:,
0
1. There are two or more polic1es.
to indemnify the loss.
0
(.) 1/)
 282 11 Essentiills ofBanking""" JIUfl1Glf(,e
2. The msured person must be common to all policies. . .
3. All bought policies must cover same peril, and peril must be common to all policies.
4. All undertaken policies must be relating to same subject matter and legal one.
5. The policies might have bought intentionally or accidentally.
6. All the policies must be in force at material time i.e., during the occurrence of loss.
To understand the concept of contribution, Jet's take the help of illustration 17.5 and 17.6.
Figure 17.5: Requisites of Doctrine of Contribution
IDustration 17.5: An industrialist having big manufacturing unit enters into contract with three insurer,
let say A, B, and C, to cover the loss of fire for a sum of f600000 annual premium i.e., nooooo to every
company. Each insurance company undertook the risk of fS000000 each. A mishap occurs and causes a
loss oHl.2crore.
In no case insured can get tso lakh from each insurer and in whole sum n.s crore where the actual
loss is f l.2crore only. However, the insurers will follow the principle of contribution, and will indemnify
the loss of industrialist up to maximum extent of fl.2crore. By following the principle of subrogation,
every insurer has right to make call to other insurer to contribute to indemnify the loss. This is the case of
general insurance, in which insured is not allowed to make profit out of insurance contract, even if he has
entered into fire insurance contact separately without stating the fact of earlier contract to new insurer.
WUStration 17.6: Aperson take two insurance policies one accidental insurance and second life-insurance
ofasum of'200000 and fHlOOOOO. He met an accident and admitted to hospital and unfortunately dies.
In this case, the legal representatives ofthe insured are entitled to get full benefit of both policies. 1he
c.ooc.ept of contribution is not applicable to personal insurance, thus they are entitled to claim f 1200000
(f200ooo + flOOOOOO).
--- ______ll_283_
- - -- - - - -- -~~:=:::::::::=-:....:Prlndples.:=:!:.~o/_buunrn«
In case of general Insurance, the principle of contribution hu timilar Implication In both cues
eith~r the contract of Insur~~ ~ been entered deliben&ely a,r ac:ddentaly. In pncnl ~
buymg lllultiple policies are md1cation of defrauding but such practice ii controlled by the principle of
contribution. The doctrine of contribution is applicabJe even if polka arc purcbae,l ac:ddentally- For
example, the th~ft ~surance cover is purchased by both spou,a for a - set of jewellery. ii allowed u
it does not deceive msurers but the combined sum assured will be curtail down to actual Joa. However,
the position of multiple policies in case of personal or life insurance is differait u understood in above
illustration.
<tJo The doctrine of indemnity provides that the function of insurance is to reimburse Insured for his
actual losses, but is not to pay in excess of actual lOSSes.
~ Insurable interest is the key feature of doctrine of indemnity. In absence of insurable Interest, the
contract of insurance will be a mere gambling.
<tJo Insurable interest refers to financial implications or financial Joss to insured who covered the
property as a subject matter of insurance contract against future ha7.aJds.. A triangular rdationship
between legal ownership of property, insurable capability of property, and property as a subject
matter set the doctrine of indemnity under insurance contracts.
~ The principle of insurable interest is necessary for an insurance contract to be valid. 1hc principles
of indemnity and subrogation reinforce the principle of insurable interest.
'9- The inderrmity principle is supported by laws of contract, especially provisions pertaining to
(a) insurable interest, (b) actual cash value, and (c) subrogation.
~ Actual cash value is the value ofloss that is compensated by insurer to insured to regain the position
what he had before occurrence of loss. The actual cash value is calculated by with the help of
replacement method, fair market value method, or broad evidence method.
'9- Subrogation is the principle of substituting rights of one's to another where later indemnifies the
loss of former caused by a third person. It is a situation of putting one's feet in another's shoes.
'9- It is essential to acquire right of restitution (subrogation) that insurer must indemnifies the loss
of insured. If insurer does not indemnify the loss or insured waived off his right, the question of
subrogation cannot be raised.
',l)o Because insurance is a contract of Uberrimae Fidei, breach of warranty or a material mis-
representation on the part of the insured can void the coverage.
',l)o Insurance policies are contracts of utmost good faith, i.e., the parties to them are held to especially
high standards of fairness and honesty.
',l)o The rule of representation, warranty and concealment support the principle of utmoSt good faith.
',l)o Aleatory contract has two features, first, performance of contract is based on chance, and secood ,
unequal gain and loss.
,g. Proximate cause is the chain of events started from either insured peril or expected peril and
ultimately causes loss t 0 b'
su 1ect matter of the insurance contract.
 284 11 Essentials ofBtarking anJ IJISllllllt« Fundammta1 Prilldpks of1nsurrata 11 215
.,.,. The direct and consequential impact o{ insured peril is the pre-requisite to daim compensation. bject to doctrine of utmost good faith?
If a peril other than insured peril has indirect, trivial or independent e1fect on cause of loss then Jo. Why are Insurance contraeU:good faith
J l. Explain the concept of utm
being a distinguishing feature of insurance contract AJao
insured peril cannot be invoked to claim compensation.
.,.,. The presence of expected perils. their continuity, concurrent happeningS and onler of occurrence explain aItsmaterial
l2. Define /1.ct
main pillars. an d give examples. What are the reasons and CODSequenceg of bRach of
has significant role in determination of compensation. th
.,.,. The insured peril may have its independent existence, or consequential occurrence either before or utmost good fai · d from the proximate cause? Give its applications.
after other expected perils with or without any break of series of happenings, or concurrent falls at 13. What do the
14. Explain unde~o f contribution. How
you doctrine does it follow the principles of indemnity and
a same point of time. ti ?
.,,. The concept of contribution is applicable to general insurance. It has no implication on persona} or What are on.
subroga . ·tes of principle of contribution? Give rdevant examples.
the reqws1
life insurance.
.,_ Contribution is the doctrine which adhere the principles of indemnity and subrogation. As
15. □□a
indemnity it compensates the loss of insured and does not allow him to make profit out of insurance
contract. As subrogation, it permits right to insurer to restitute his loss by way of sharing of loss in
a determined percentage.
.,.,. The insured has the choice to recover from any insurer on a priority basis. After recovering the
share of loss from the first insurer the insured can approach other insurers as per the doctrine of
contribution.
.,_ Covering same peril by purchasing multiple policies, protecting the interest of insured, relating to
same subject matter, and enforceability of all policies at material time are essentials of contribution.
NS_ _
RmEW QUESTIO,._
I. What is indemnity? What are the ways in which the doctrine of indemnity is enforced in property
insurance contract?
2. What are the different methods to determine actual cash value? Elucidate replacement and fair
value method.
3. Explain the distinguishing features of insurance contracts.
4. Why insurable interest is required in principle of indemnity. Explain the relationship of insurable
interest, title ofproperty, and subject matter of insurance contract to constitute concept of indemnity.
5. Subrogation means 'asking for payment under another's name'. Explain the statement in the light of
doctrine of subrogation.
6. Describe important purposes and limitations of principle of subrogation.
7. Elucidate the principle of subrogation and explain its functions.
8. Write short notes on the following:
(a) Contract of Adhesion
(b) Personal feature of insurance contract
(c) Aleatory Contract
(d) Differentiate representation and warranty
9. What are the various features of insurance contract those distinct it from ordinary comme rcial
contracts?