BASIC PRINCIPLES OF INSURANCE

A) Definition of some key terms

INSURANCE
 A method of sharing of financial loss of a few
from a common fund formed out of contribution
of the `many’ who are equally exposed to the
same risk or loss.
 It is a system of sharing the losses of an
individual over a group of individuals.
INSURER
 One who provides financial compensation for the
outcome of misfortune from the accumulated
common fund.
 A trustee for public fund

POLICY
 The document that promise to provide financial
compensation.
 Contract of insurance.

PERIL
 Immediate cause of losses or the event which
bring about losses.
HAZARD
 A condition which increases likelihood of operation
of peril or which worsen the process ion of the peril
already in operation.
o Physical hazard - arises from physical features.
o Moral hazard – personal character, integrity,
attitude.
Subject Matter of Insurance (SMI)
 It is the thing, property, interest or possible liability
of insured. It can be any form of property of an
event that may result in loss of right or the creation
of legal liability).
Subject matter of Contract
 It is the policyholder’s interest of financial
involvement in the subject matter of the insurance.
 It is intangible.
B) Principles of Insurance
Under this, we give answers to the following
questions:
o Who is entitled to insure?
o How should in the insurer & insured behave?
o How do insurers establish cause of loss & decide
whether payable or not?
o How much do insurers pay to insured at time of loss?
1. Insurable Interest (21)
Definition:
“Legal right to insure arising out of
financial relationship, recognized at Law,
between the insured and the subject matter of
insurance.”
o Abse of insurable interest makes the contract of
insurance illegal void or unenaprceable.
Essentials of Insurable Interest
i) There must be some property, rights interest,
life, potential liability capable of being insured.
ii) Such property, liability, etc must be the subject
matter or insurance.
iii) The insured must in a in a relationship with
SMI where s/he
- benefits from safety or well-being or
freedom
from liability.
- would be prejudiced by its damage or the
existence of liability.
iv) The relationship between the insured and
subject matter or insurance must be
recognized at law.
v) The insurable interest must be capable of
financial valuation.
Scope of Application
Insurable Interest is applied differently to main forms
of insurance: life & property (general).
 Life Insurance
o Everyone has unlimited insurable interest in his/her own
life.
o Theoretically, one is entitled to effect a policy for any
sum assured.
Who has insurable interest to effect insurance
a) husband & wife
b) creditors against debtors (loan/credit
amount)
c) partners to the extent of financial stake
 Property Insurance:- 2I arises out of
b. Absolute ownership (lawful possession)
c. P ……..joint owners – a part or joint owner
can insure for full value as n agent to another or
others.
d. Mortgagees or mortgagers – Interest of
mortgagee is limited to loan plus interest.
e. Executors & trustees – legally responsible for
property under their charge/control.
f. Bailees – a person legally holding the goods of
another either for payment or gratuitously
 g. Agents – who a principal has insurable
interest, his agent can effect insurance on his
behalf.
h. Insurers (life, property, liability)
 Liability Insurance
o Any person has 2I to the extent of any
potential legal liability he may incur by way of
damages & other costs.
E.g. Motor Liability Limits (TP & Property)
o The extent of a person’s interest in liability
insurance is without limit.
o Liability sometime limited by policy condition
or not at all.
 o Depends on court rulings in the past.
o A person can’t have insurance for criminal act;
(potential murder) but civil consequence of
some b each of criminal code (drivers).
When should Insurable Interest should exist?
Life Insurance
 Insurable Interest is only required at inception
 No requirement at time of claim
Other Insurance
o Generally speaking, in all insurances based on
indemnity.
o Insurable interest have to be preserved:
• At policy inception
• Throughout the currency of the policy and
• At the time of loss
E. g. Fire, Motor, burglary
o Exception is Marine Cargo
• Insured must be interested in SMI at the time of
loss, not at time of effecting policy.
• Customs of maritime trading: cargo may
change hands several times while in transit.
Note : Mere expectation of insurable
interest is not enough. It must
actually exist.
 2) UTMOST GOOD FAITH (UMG)
Definition:
“A positive duty to voluntarily disclose, accurately
and fully, all facts material to the risk being
proposed, whether asked for them or not”.
• Ordinary commercial or non-insurance
contracts:
 “Get the buyer beware” - good faith is
must
 Each party can examine the item or service
which is the subject matter of contract.
 Each ask questions & answers follows
 Contract concluded on basis of above
E.g. Purchase of an automobile
• Insurance contracts
 Seller (insurer) does not know about SMI
 Buyer (insured) knows everything or is
expected to know everything.
 Seller dependent on the good faith of the
proposer while granting co ….. – mere good
faith not enough.
 Thus, UTMOST GOOD FAITH
 Both insurer & insured has the duty to uphold

UGF
 Each to tell only truth
 Disclose material information whether
asked for or not
  Failure to reveal – agreed party can regard contract as
void.
 UGF applies to insurers for lesser extent

DUTY OF DISCLOSURE
 Each party to insurance contract must disclose material
facts regarding the insurance under consideration
What is Material Fact:
“Every circumstance which would influence the
judgment of a prudent insurer (underwriter) in
fixing the premium, on determining whether he
will take the risk”
o Facts essential to appreciate risk, assess it, rate it &
U/write same by acceptance.
E.g. consider a tenant to a house.
Some facts which must be disclose
1. External factors, which make the risk greater
than normal.
2. Previous losses and claims under other policies.
3. Previous insurances: declined, imposed
warranty of premium.
4. Existence of other insurance
5. Full facts relating to & description of the SMI.
6. All facts the proposer is reasonably expected to
know
Give example of Material Facts for following
classes of insurance
- FIRE
- BURGLARY
- MOTOR
- MARINE CARGO
- PERSONAL ACCIDENT/ LIFE INSURANCE
Facts which needn’t be disclosed (even if material)
a) Facts which improve the risk (fire hose)
b) Facts of law: everyone deemed to know the law
c) Facts which an insurer is deemed to know
E.g. Existence of war (Ethio-Eritrea)
d) Facts capable of discovery by insurer from
information supplied
E.g. Reference by proposer to previous
insurer
for claim history.
e) Facts which the insurer’s survey should have
noted.
 • Failure to note hazardous features unless
concealed.
f) Facts covered by policy conditions
• Burglary alarm fixed.
Note – Duty of disclosure exists until contract signed.
Thereafter only good faith, … UGF is upheld.
- In case of
- alteration in risk
- renewal of policies
REPRESENTATIONS & WARRANTIES
a) Representation
o Written or oral statements make during the
negotiations of a contract.
o They are termed so because they represent to
the insurer the proposed risk; material fact or
not.
o Those material should be true or true to the
best knowledge of proposer.
b) Warranties
- In non-insurance contracts, they are guarantees,
 - In insurance, it is undertaking by the insured
that something shall or shall not be done, or that
a certain state of fact does or does not exist,
Warranties are of two types
a) Expressed – written into policy
E.g. – proposal forms part of contract
- declare statements are true to best
knowledge
- something to be done or not to be done
b) Applied – this is generally in marine insurance.
- vessel seaworthy
- adventure lawful
BREACH OF UGF
Two types:
1) Misrepresentation
• Innocent – proposer represent fact as right & letter to
turn out to be wrong.
E.g. declaring vessel as “Andinet” where it is actually
“Abay”
• Deliberate – Proposer intending to defraud insurer
E.g. declaring age as 55 where it is actually over 65 in
GPA.
2) Non-disclosure
• Innocent – proposer an unaware of the fact or aware
but does not appreciate importance.
 E.g. undetected brain tumor.. t time of contract.
• Deliberate (------) – with the intention to defraud
E.g. insuring a damaged vehicle.
REMEDIES TO BREACH OF UGF
This depends on whether the breach is
• Innocent of deliberate
• Material or immaterial to the risk
• Breach of warranties
The aggrieved party has the following options
1. Contract becomes void from inception if
- breach of warranty
- misrepresentation with intention to defraud or
 - deliberate non-disclosure (concealment)
2. Sue for damage in case of
- misrepresentation
- concealment with purpose of defrauding
3. Waive the breach in case of
- innocent misrepresentation or non-disclosure
- facts immaterial to the risk
 3) PROXIMATE CAUSE
Definition:
“Proximate cause means the active, efficient cause
that sets in motion a train of events which brings
about a result without the intervention of any force
started and working actively from a new and
independent source”.
Proximate cause is not necessarily the first or the
last cause, rather it is the “DOMINANT CAUSE”.
In this, we need to be able to establish “cause &
effect”
o In insurance there are 3 types of perils
1. Insured perils – those named in policy
 2. Uninsured perils or other perils
o Those not stated at all in the policy, or
o Excluded but covered by extra
premiums.
3. Excepted or excluded perils
Excluded perils from scope of cover & not
insurable at all.
When loss or claim occurs, insurer finds out
cause of loss and if cause is by
1) Insured perils – payable
 2) Uninsured perils – not payable
3) Excepted/ excluded perils – not payable
This appears very simple. In actuality, it is difficult
b/c there may be:-
• More than one cause to a single loss
• Multiple cause to single loss
Three ways in which losses occur:-
1) Series or chain of events one following & resulting

from the other culminating in loss,

2) Series of events broken by a new independent
event from a d/t source resulting in loss,
3) Concurrent events: Combination of two or more
events occurring simultaneously & resulting in
loss
In each case, the insurer has to establish the cause of
the loss.
In the above cause,
• For # 1, payable if 1st peril is insured against
• For # 2, payable if new independent event is
insured peril
• For # 3, conditional, i.e.,
o If concurrently occurring perils are insured
-Payable
4) Indemnity
Most interesting and important of a I the principles.
Definition:-
“A mechanism by which insurers provide
financial compensation in an attempt to place the
insured in the same financial position after the
loss as s/he enjoyed immediately before it”.
It is protection or security against damage of loss of
security against legal responsibility.
The important can be seen in the following:
• The payment needs to be adequate to restore
insured’s financial position
• Indemnity is the insured’s interest in the SMI
(linked to insurable interest)
• Insured neither gets worse off nor better off
• Prevents insured from making gain out of loss
• Discourage insured from causing loss to SMI
• Avoids or minimize destruction to national
economy
• Uphold idea of sharing risks; otherwise fast
depletion of common fund
• Without indemnity principle prevailing, insurers
could not be able to meet future obligations
In fact, indemnity is limited financial value expressed
in monetary terms and thus, does not make good to
the insured in all respects:
• Sentimental values
• Loss of life
Not that the exact amount of compensation
(indemnity) is not known before the loss occurs
although SI only tells us the maximum limit.
There are classes of insurance where the principle is
not strictly applied:
• Marine – agreed value
o Encourage international trade
o Fluctuations in values of goods & hull
 • Life/PA –unlimited interes
o Capacity to pay premium is limiting
factor
o Earning capacity of assured (indemnity
not totally overlooked)
o Enquiry by insurers if sum assured
excessive
Factors limiting indemnity
a) Policy limits
o Sum insured
o Liability limits
 o Item-Wise limits (work of art)
b) Inadequate SI (under insurance)
o Value insured less than actual value at
risk
o Average to apply (to each item)
o Inadequate compensation
o Less premium, risk underestimated
o Insured considered self-insured for d/C
c) Depreciation, wear & tear & market value
o Depreciation – reduction in value
o Tear & wear – deterioration due to
constant use
 o Market value – what the insured item
fetches in the market at time & place of loss
d) Excess, Franchise & deductible
• Excess – first part of each & every loss
borne by insured
• Franchise – part of loss taken by insured
up to given limit, if exceeded full loss paid
by insurer
• Deductible – very large excess
Rationales
o Make the insured to share loss
o Prevention of loss
o Avoid high administrative loss
o More excess, more premium discount
Modes of indemnification:-
o One ‘C’ & three ‘R’s
 Cash – most popular; applied in all classes
 Repair – common in motor insurance
 Replacement – common in motor & all risk
 Reinstatement – in fire mostly for buildings
o Mode of indemnification is optional for
insurers
Types of losses:
o Total loss (constructive, arranged, actual)
o Partial loss
o Loss requiring repair
o Loss requiring replacement
o Loss involving meeting a liability
o Loss of life, disablement, etc
Basis of indemnity
1) Property insurance
o Indemnity not determined by cost
o Value at the date & place of loss
o Not element of profit to involve
No Property Type of loss Basis of indemnity
A Machinery Total loss MKT value (cost of
& building new bldg or machine
less depreciation,
wear & tear
Repair Reasonable cost of
repair
Replacement Cost of new parts
parts plus cost of fitting
less betterment
B Stocks
No Property Type of Basis of indemnity
loss
i) Retailers - Wholesaler’s price
plus transport &
handling
ii) Wholesalers - Mfg price + Transport
& handling cost
iii) Mfg - Cost of prodn up to
finished stock date of loss (M+L+OH
costs)
iv) Mfg in- M+L+OH up to loss
process date
 o Watch out market values of stock at these of
loss
3) Marine - To the manner & extent agreed
4) Life - not policy of indemnity
5) Liability - Court award up to limit + legal costs
5) Subrogation
Definition:-
“Subrogation is the right of one person,
having indemnified another under a legal
obligation to do so, to stand in the place of the
other and avail himself of all the rights and
remedies of that other,
 whether already enforced or not.”
o Fundamental point – insured is entitled to
indemnity but not more than that.
o Enable insurers to recoup any profit that may
accrue to the insured
o Applies where contract is one of indemnity
o Allows insurer to get remedies t……. insured
may have
Extent of Subrogation Rights
o Due to link b/n indemnity & subrogation,
insurers are not entitled to recover more than he
has paid
 o Insurers are not to make profit in exercising the right
o Insurers are not to make profit in exercising the
right
o Insured will not get any money in excess of his
indemnity
 Excess, deductible recovered along with claim
 Where under insurance (average) applied, insured can
recoup the d/c
o Ex gratia (payment of claim made in marketing
consideration)
 No indemnity no subrogation
Subrogation Rights arise in four ways
1) Rights arising out of tort
o Tort – is a civil wrong; negligence, ..
Famation, & like
o In ..red indemnified & right exercise against
wrongdoers
Ex. Drivers’ fault in motor cover
2) Right Arising form contract
o A contract right to ……….. Regardless of
fault
Ex. Tenancy contracts
o Custom of trade to which contract applies that
 certain bailees are responsible
Garages
Hotel Proprietors
3) Rights arising out of statute
o Possibly ‘not’ applicable in Ethiopia
o Public Order Act
 Recovery against Police for loss in putting of riot
4) Rights arising from SMI
o When insurers sell savage, …… are
exercising sub gation
o S ………. Cut of principle of indemnity
When does subrogation right arise?
o After admission & payment of claim, not before
o Given by policy conditions
o Insured harried fro thwarting the right of the
insurer
Modification of the operation of the Right
The right is waive in case of:
o Employer’s liability/ Workmen’s’ compensation
 harmful to industrial relations
o Knock-for-knock in motor (market agreement)
Limitation of the Doctrine
 1) Insurers must first pay
o Problem – tortfeasor may disappear
- Change in ownership of
property
- Death
2) Assured himself must have b……….. To b……
o Problem two cars owner by the person &
c..ered colliding.
6) Contribution
Definition:-
“Contribution is the right of an insurer to call
upon others similarly, but not necessarily equally,
 liable to the same insured to share the costs of an
indemnity payment.”
o It arises where there is more than one insurance
covers for a given insurable interest.
o Under-insurance is compared to contribution
o Co-insurance contrasted
How many contribution arise
The following conditions must be met for
contribution to arise
1) Two or more policies of indemnity exist;
2) The policies cover a …………
 o Same subject matter of contract
Ex. Motor comprehensives VS
Example cited in books
o Deposit of grain by “B” in ……. Story where
“B” insured the grain as …. & “B” as matter of
liab.
o Head that interest not same
3) The policies cover a common peril which caused
loss
4) The policies cover the same SMI
o Fire policies one covering bldg & the other content