Insurance

Course Code: 208

Book Recommended
Insurance Principles and Practice
M.N. Mishra & Dr. S.B. Mishra
 Insurance
1. From a functional point of view-
 Insurance is defined as a cooperative device to spread the risk.
 The system spreads the risk over a number of persons who are
insured against the risk.
 The principle is to share the loss of each member of society
on the basis of the probability of their risk.
 The method to provide security against losses to the insured.
2. From a contractual point of view-
Insurance is defined as when a sum of money as a premium is
paid in consideration of the insurer’s incurring the risk of paying
a large sum upon a given contingency.
A certain sum, called a premium, is charged in consideration,
A large sum is guaranteed to be paid by the insurer who received
the premium against the mentioned consideration,
A certain definite sum will be made for the payment,
The payment is made only upon a contingency.
 Nature of Insurance
 Sharing of Risk;
 Co-operative Device;
 Value of Risk;
 Payment at Contingency;
 Amount of Payment;
 A Large Number of Insured Persons;
 Insurance is not a gambling/ wagering;
 Insurance is not a charity.
 The Role and Importance of Insurance
 Provides safety and security;
 Generates financial resources;
 Life insurance encourages savings;
 Promotes economic growth;
 Medical support;
 Spreading of risk;
 Source of collecting funds.
Risk: Risk is the uncertainty of a financial loss. –Mishra
Risk is defined as uncertainty concerning a possible loss. In other
words, risk is the variation in possible outcomes of an event based
on chance. -Dorfman
 3 Types of Risk in Insurance
A. Financial and Non-Financial Risks
• Financial risks are the risks where the outcome of an event (i.e.
event giving birth to a loss) can be measured in monetary terms.

• The losses can be assessed and a proper monetary value can be

given to those losses.

• Example-Theft of a property which may be a motorcycle, motor

car, machinery, items of household use, or even cash.
The losses can be replaced, reinstated, or repaired or
even a corresponding reasonable financial support (in
case of death) can be thought about.

We would call financial risks insurable risks and these are

indeed the main subjects of insurance.
Non-Financial risks are the risks the outcome of which cannot be
measured in monetary terms.

Examples can be:

 Choice of a car, its brand, color, etc.
 Selection of a restaurant menu,
 Career selection, whether to be a doctor or engineer etc.

Since the outcome cannot be valued in terms of money, we shall call

these non-financial risks uninsurable .
B. Pure Risk and Speculative Risks
Pure risk is the potential for losses where there is no viable opportunity
for any gain. Insuring an automobile is an example of pure risk. If the
insured auto is involved in an auto accident, there is most definitely
going to be some sort of damage (loss). Pure risks are those risks where
the outcome shall result in loss only or at best a break-even situation. We
cannot think about a gain-gain situation. The result is always
unfavorable, or maybe the same situation (as existed before the event)
has remained without giving birth to a profit (or loss).
Speculative risks are those risks where there is the possibility
of gain or profit. At least the intent is to make a profit and no
loss (although loss might ensue). Investing in shares may be a
good example. Pricing, marketing, forecasting, credit sale, etc.
are yet examples falling within the domain of speculation.
C. Fundamental and Particular Risks

Fundamental risks are the risks mostly emanating from nature. These are the
risks that arise from causes that are beyond the control of an individual or
group of individuals.

The common examples are:

 Flood & Cyclone, Subsidence & landslip,
 Earthquake & volcanic eruption, Tsunami,
Normally fundamental risks were not supposed to be insurable because of the
magnitude and these were considered to be the responsibility of the State. Now
because of demand and insurers’ strength, these risks are easily insurable.
Particular risks are which usually arise from the actions
of individuals or even groups of individuals. These are
mostly men created because of their negligence, error in
judgment, carelessness, and disregard for law or respect.
We may call these risks of personal nature. The common
examples are:
 Fire, Explosion,
 Burglary, housebreaking, larceny, and theft,
 Stranding, Sinking, Capsizing, Collision in case of a ship,
including cargo loss,
 Insurance Contract
Insurance is a contract between two parties one party insurer undertakes
in exchange for a fixed sum called a premium to pay another party called
the insured a fixed amount of money on the happening of a certain event.
A certain sum, called a premium, is charged in consideration,
A large sum is guaranteed to be paid by the insurer who received the
premium against the mentioned consideration,
A certain definite sum will be made for the payment,
The payment is made only upon a contingency.
 Elements of Insurance Contract
A. General Elements of Insurance Contract
 Agreement (offer and acceptance)
 Legal consideration (Premium)
 Competent to make contracts (not minor, a man of sound mind, not
disqualified by any law)
 Free consent ( free from coercion, undue influence, fraud,
misrepresentation, or mistake)
 Legal object (not forbidden by law, not immoral, not opposed to
public policy, doesn’t defeat the provision of any law)
 Special Elements /Principles of Insurance
 Principles of Insurable Interest
 Utmost Good Faith
 Indemnity
 Subrogation
 of Causa Proxima
 1. Insurable Interest
The insurable interest is pecuniary interest whereby the policy-holder is
benefited from the existence of the subject matter and is prejudiced by death or
damage of the subject matter The principle of insurable interest states that the
person getting insured must have an insurable interest in the object of insurance.
Essentials:
 There must be a subject matter to be insured.
 Monetary relationship between the policyholder and the subject matter.
 Relationship between the policyholder and the subject matter should be
recognized by law.
 Policy-holder is economically benefited by the survival or existence and or
suffers loss at the death or damage of the subject matter.
 2. Utmost Good Faith

It means that both the policyholder and the insurer need to disclose all material and
relevant information to each other before the commencement of the contract. It
means that both the Proposer (who wishes to buy the insurance plan) and
the Insurer will be honest and not withhold critical information which is required to
issue the insurance policy.

Responsibility of the insurance company

The insurer or its agent should disclose all critical terms and conditions of the plan,
including exclusions so that the person taking the policy knows exactly what she or
he is buying.

Responsibility of the proposer

The person who wishes to take the policy should disclose all material facts which
can impact the decision to issue the policy or impact the pricing decision of the
insurance company.
 Facts need not be disclosed by the insured
 Facts that tend to lessen the risk.
 Facts of public knowledge.
 Facts that could be inferred from the information disclosed.
 Facts waived by the insurer.
 Facts governed by the conditions of the policy.
 3. Principles of Indemnity
The principle of indemnity states that an insurance policy shall not
provide compensation to the policyholder that exceeds their economic
loss. This limits the benefit to an amount that is sufficient to restore the
policyholder to the same financial state they were in prior to the loss.

In other words, the principle of indemnity ensures that the insured gets
made whole from their loss but will not benefit, gain, or profit from an
accident or claim. Nor will you get less than what is necessary to restore
yourself to the same financial position.
Uses of Principles of Indemnity
 To avoid Intentional loss
 To avoid an Anti-social Act
 To maintain the premium at Low-level
Application of Principles of Indemnity
 Marine Insurance
 Fire Insurance

Exception of Principles of Indemnity- In life insurance this Principle is

not applicable because the claim is predetermined and loss of death is
not measurable in terms of money.
 Conditions for Indemnity Principle
 The insured has to prove that he will suffer a loss on his insured
matter at the time of happening the event and the loss is an actual
monetary loss.
 The amount of compensation will be the amount of insurance.
Indemnification can not be more than the amount insured.
 If the insured gets more amount than the actual loss, the insurer has
the right to get the extra amount back.
 If the insured gets some amount from a third party after being fully
indemnified by the insurer will have the right to receive all the
amount paid by the third party.
 This does not apply to personal insurance.
 4. Doctrine of Subrogation
Subrogation refers to the practice of substituting one party for another in
a legal setting. Essentially, subrogation provides a legal right to a third
party to collect a debt or damages on behalf of another party.

Subrogation in the insurance sector generally involves three parties:

 The insurer (insurance company);
 The policymaker (insured party); and
 The party responsible for the damages.
The process usually starts when the insurer pays out the losses of the
insurance claim filed by the policymaker.

When the policyholder receives the amount of money for the claim, the
insurer may start the process of collecting the amount of the claim from
the party that caused the damages.

Note that if the party responsible for the damages is covered by another
insurance carrier, the carrier will represent the interests of the client.
 Essentials of Doctrine of Subrogation

 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
 Personal Insurance
 5. Proximate Cause
Proximate cause refers to a direct cause of loss, without which the loss
would not occur.

Proximate cause means the active, efficient cause that sets in motion a
train of events that brings about a result, without the intervention of any
force started and working actively from a new and independent source -
Pawsey v. Scottish Union and National (1908).

Proximate cause is a key principle of insurance and is concerned with

how the loss or damage actually occurred and whether it is indeed a
result of an insured peril. The important point to note is that the
proximate cause is the nearest cause and not a remote cause
 Functions of Insurance
A. Primary Functions:
 Insurance provides certainty
 Insurance provides protection
 Risk-Sharing
B. Secondary Functions:
 Prevention of loss
 It provides capital
 It improves efficiency
 It helps economic progress
 Reinsurance
Reinsurance is an insurance contract between two insurance companies
where the ceding company (First insurer) transfers full or a part of
insurance liability to another insurance company called the second
insurer. With reinsurance, the company passes on some part of its own
insurance liabilities to the other insurance company. The risk remains the
same.
 Double insurance
In double insurance, the same risk is insured with different insurance
companies or more than one insurance company. If in case the insured
faces a huge loss then he can claim the insurance amount from different
insurance companies. All the insurers will be liable to compensate the
insured for the loss. But the compensation amount provided by all the
insurance companies can be never more than the loss that occurred. All
the insurers will contribute to the actual loss proportionately and there
will be no burden only on one company.

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