Lesson 4

Principle of insurance
principles

 These principles are the basic guides in regulating

the business of insurance.
 Six principles of insurance involved:
- Principles of utmost good faith
- Insurable insurance
- Indemnity
- Subrogation
- Contribution
- Proximate cause
Principle of utmost good faith

 According to this principle, both the parties to the

insurance contract must disclose all facts material to
the risk voluntarily to each other truly and fully.
 Any breach of this duty shall render the contract void
able at the option of the aggrieved party i.e. the party
who has suffered as a result of this breach
 In insurance contract, the rule of “caveat Emptor” (let
the buyer beware) does not prevail. Here the sellers
have to disclose all the material facts.
Material facts

 A material fact is one which affect the

judgment or decision of both parties in
entering to the contract. These facts have
bearing on the degree of risk in relation to
the subject of insurance.
 In case of life insurance, the material factors
affecting the risk will be age, occupation,
health, income etc. in property insurance, it
would be design, use, situation of property.
Full and true disclosure

 The utmost good faith depicts that all the

material facts should be disclosed in true and
full form.
 There should be no concealment ,
misrepresentation, mistake or fraud about
the material facts.
Facts which required to be
disclosed

 Facts which increase risk

 Facts which shows some special motive
behind insurance.
 Others
Facts which need not be disclosed

 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 possible of discovery
 Main contents of utmost good faith
principle

 Representations:
An Insurance contract is voidable at the
insurer’s option if the presentation is ：
(1) Material (the true facts not fitting for the
required conditions by the insurer. )
(2) False (not true facts, or misleading)
(3) Relied on by the insurer (at specified /adjusted
premium)
(4) Innocent misrepresentation （ unintentional ）
Main contents of utmost good faith
principle

warranty:
It 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. Examples:
Not drunk driving
Locking the door
Fire extinguisher

Any breach of the warranty allows the

insurer to deny payment of a claim.
Representation vs. warranty

 Representation is a statement made by the

insured to the insurer relating to a proposed
risk
 Warranty is an undertaking by the insured to
the effect that he shall or shall not do a
certain thing or that some conditions shall be
fulfilled or whereby he affirms or negatives
the existence of a particular state of affairs.
 Representation can be substantially true but
warranty must be strictly and literally true.
 Insurer has to proof that misrepresentation
relates to a material fact.
 Representation does not appear but warranty
must appear
Breaches of the duty

 Non-disclosure: omission to disclose a material fact

inadvertently
 Concealment: concealing a material fact intentionally
 Innocent misrepresentation: making an inaccurate
statement pertaining to material fact believing to be
true
 Fraudulent misrepresentation: making false
statement pertaining to material facts with the
intention to deceive the insurers.
Principle of insurable interest

 For an insurance contract to be valid, the

insured must posses an insurable interest in
the subject matter of insurance
 Insurable interest is legal right to insure.
 Insurable interest is essentially a pecuniary
interest i.e. the loss caused by the happening
of the insured risk must be capable of
financial valuation.
“an insurable interest refers to the interest which the
applicant has in the subject matter of the
insurance and is recognized by laws.
 The subject matter of the insurance refers to
either to the property of the insured and related
interests associated therewith, or to the life and
body of the insured, which is the object of the
insurance.” ---Insurance Law
 Examples of an insurance interest

When must an insurable interest

exist?
 In property insurance, the insurable interest
must exist at the time of the loss.

 In life insurance, the insurable interest

requirement must be met only at the
inception of the policy, not at the time of
death.
The essentials of insurable interest

 There must be subject matter to be insured

 The policy holder should have monetary relationship
with the subject matter
 The relationship between the policy holder and
subject matter should be recognized by law
 The financial relationship should be such that the
policy holder is benefited by the safety of the subject
matter or is prejudiced by the loss thereof.
 Case study
Example
Example

1.
1. A
A visitor
visitor came
came toto Shanghai
Shanghai forfor sightseeing.
sightseeing.
After
After he
he visited
visited the
the Tower
Tower ofof Eastern
Eastern Pearl,
Pearl, he
he
wanted
wanted toto pay
pay premium
premiumto to insure
insure the
the Tower
Tower in in
order
order to
to protect
protect the
the property.
property. Do Do you
you think
think the
the
Insurance
Insurance company
company agrees
agrees to
to accept
accept his
his offer?
offer?
 Case study

2. John and David are businessmen and friends in the same

company. In July, 2000, John wanted make his own way.
He resigned from his job and became a self-employed man.
When he began to open his business, he was in great of need
of circulating funds, so he asked David for help, promising
to pay more interest higher than that of the bank and pay his
money after one year on time. In order not to let David have
worries, John mortgaged his Honda to him.
With the consent of John, David bought one-year motor
vehicle insurance in his own name from the insurance
company.
Six months later, When John drove the car to work, an
accident occurred, the car was overturned and damaged
totally. He was seriously wounded. On hearing the bad
news, David reported the case to the insurance
company and made claims to it.
Discuss: Do you think the insurance company should
pay the claims or not? Why?
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 same position that he occupied
immediately before the happening of the event
insured
 This is possible when insurance is arranged on full
value insurance. Underinsurance may preclude the
insured from getting actual loss.
principle of Indemnity

Why this principle?

Two purposes:
First ， prevent the insured from
profiting from a loss.
Second, reduce moral hazard.

It avoids intentional loss

It avoids intentional act
Conditions for this principle

 Life and personal accident insurance are not

contracts of indemnities simply because life
or limb cannot be valued in terms of money.
 The insured has to prove that he will suffer
loss
 The compensation will be the amount of
insurance. Indemnification cannot be more
than the amount insured
Excess, franchise and average

 Excess : this means with regard to any loss,

a certain predetermined amount shall be
deducted & the balance if any shall be paid
 Franchise: according to this, in order to get a
claim the extent of claim must reach the
amount of franchise when the insured gets
full claim. If the loss does not reach the
franchise then insured does not get anything
 Average: by this underinsurance is defeated.
It make the insured his own part-insurer to
the extent of under insurance.
 It can be 3 types: - pro-rata condition
- special condition
- two condition
Pro-rata condition

 In this case if the actual value of the property

is more than the sum-insured, the insurers
will pay that proportion of the actual loss
Special condition

 This is known as 75% condition of average.

 If the sum insured is less than 75% value of
the property, the insurers will pay the
proportion of the loss that the sum insured
bears to the actual value
 If it is greater than 75%, no average applies
Two condition of average

 It has two parts

 First part is exactly the pro-rata condition of
average
 Second part says if it is found that there is
more specific policy covering the same loss,
that specific policy shall pay the loss first and
if there is still a balance of claim left, only this
policy shall pay this balance.
Methods of providing indemnity

 Cash payment: it is simple, easier and less

cumbersome
 Repair: the insurers will the get the loss
repaired to pre loss condition as far as
possible
 Replacement: the insurers may replace the
subject matter by another.
Principle of subrogation

 Subrogation is a right that a person has of

standing in the place of another and availing
himself of all the rights and remedies of that
another whether already enforced or not.
 Principle of subrogation refers to the right of
the insurer to stand in the place of the
insured after settlement of a claim.
 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.
 Any benefit arising out of that right shall
belong to the insurer and the insured shall
not get additional benefit from any third party.
principle of subrogation

 Purpose of subrogation:
subrogation has two basic purposes:
first, prevent the insured from collecting
twice for the same loss.
second, hold the guilty person responsible
for the loss.
Essentials of this principle

 Corollary to the principle of indemnity

 Subrogation is the substitution
 Subrogation only up to the amount of
payment
 The subrogation may be applied before
payment
Application of subrogation in claims

 When subrogation arises: under common law

the position is this that the insurers must pay
the claim first before the right of subrogation
can be exercised. In non-marine policy, the
insurer may require the insured to recover
against the liable third party first at insurer’s
cost and expenses.;
Extent of subrogation
 Under this right the insurers are only entitled to
benefit to the extent of payment made. If the insurers
recover more than the amount paid out, the are
entitled to retain from the recovery only to the extent
of the payment they made to the insured. The
balance amount must be refunded to the insured.

 If the amount received from the third party does not

represent full indemnity he is entitled to claim only
the balance from his insurers so that both the
payments together would constitute one full
indemnity only.
Example

 Insurer pays 1000 tk. Recovers tk. 1200

 Insurer pays tk 1000 rocovers tk. 800
 Actual loss Tk. 1000, insured gets tk. 1000
from third party, he has no claim on insurer.
 Actual loss tk 1000, insurer pays to insured
900, insured also recovers tk . 700 from third
party, insured has to refund … amount to the
insurer.
Principle of contribution

 Contribution is a right that an insurer has of

calling other interested insurers in the loss to
pay or contribute to the payment.
 If at the time of loss it is found that there are
more than one policy covering the same loss,
all policies should pay the loss
proportionately to the extent of their
respective liabilities so that the insured does
not get more than one whole loss from all
these sources.
 If a particular insurer pays the full loss, all
other insurers have to pay him back to the
extent of their individual liabilities.
 This principle is corollary to the principle of
indemnity
 It applies to those insurance contract which
are contracts of indemnity.
Application of this principle

 When contribution operates:

- there must be more than one policy involved & all the
policies must be in force.
- all the policies must cover the same subject matter
- all the policies must cover the same peril causing the
loss
- all the policies must cover the same interest of the
same insured.
 How contribution works:
- Usually this is the sum-insured basis under
each policy & is commonly known as
proportionate liability or respective liability of
each policy
- The formula applied is
[sum insured under each policy / total sum
insured under all policies] * loss
Principle of proximate cause

 The rule is that immediate and not the

remote cause is to be regarded.
 The real cause must be seen while payment
of the loss.
 If the real cause of loss is insured, the
insurer is liable to compensate the loss.
 Principle of Proximate Cause
Definition of the principle of proximate cause
In many cases, a loss is caused by several
reasons, not a single one. Thus, the principle
of proximate cause is used in the insurance
contract.
It means among several causes, the insurer
tries to examine whether the most effective
and decisive cause is under the coverage of
the insurance contract. If yes, the insurer pay
the sum of insurance amount; otherwise, will
not pay.
 A house caught fire due to the bombing of an
enemy air craft
 Loss is occurred due to fire
 but proximate cause is war ( which is not
included)

 Hence no claim is payable.

Rule of proximate cause

 Single cause: if the cause is an insured one,

the claim is payable , otherwise not
 Concurrent cause; if excepted peril is
involved with insured peril, the effects of
excepted peril can be separated from that of
the insured peril, the loss should be paid
otherwise not
 Unbroken sequence: if insured peril is
followed by an excepted peril, the loss
should be claimed. When several events
occur in an unbroken sequence the whole
claim is payable
 If peril is followed any other as a new and
independent cause, there is liability to pay
the loss.