7 Most Important Principles of Insurance
The important principle of insurance are as follows:
The main motive of insurance is cooperation. Insurance is defined as the equitable transfer of risk of loss from one entity to another, in exchange for a premium.
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1. Nature of contract:
Nature of contract is a fundamental principle of insurance contract. An insurance contract comes into existence when one party makes an offer or proposal of a contract and the other party accepts the proposal.
A contract should be simple to be a valid contract. The person entering into a contract should enter with his free consent.
2. Principal of utmost good faith:
Under this insurance contract both the parties should have faith over each other. As a client it is the duty of the insured to disclose all the facts to the insurance company. Any fraud or misrepresentation of facts can result into cancellation of the contract.
3. Principle of Insurable interest:
Under this principle of insurance, the insured must have interest in the subject matter of the insurance. Absence of insurance makes the contract null and void. If there is no insurable interest, an insurance company will not issue a policy.
An insurable interest must exist at the time of the purchase of the insurance. For example, a creditor has an insurable interest in the life of a debtor, A person is considered to have an unlimited interest in the life of their spouse etc.
4. Principle of indemnity:
Indemnity means security or compensation against loss or damage. The principle of indemnity is such principle of insurance stating that an insured may not be compensated by the insurance company in an amount exceeding the insured’s economic loss.
In type of insurance the insured would be compensation with the amount equivalent to the actual loss and not the amount exceeding the loss.
This is a regulatory principal. This principle is observed more strictly in property insurance than in life insurance.
The purpose of this principle is to set back the insured to the same financial position that existed before the loss or damage occurred.
5. Principal of subrogation:
The principle of subrogation enables the insured to claim the amount from the third party responsible for the loss. It allows the insurer to pursue legal methods to recover the amount of loss, For example, if you get injured in a road accident, due to reckless driving of a third party, the insurance company will compensate your loss and will also sue the third party to recover the money paid as claim.
6. Double insurance:
Double insurance denotes insurance of same subject matter with two different companies or with the same company under two different policies. Insurance is possible in case of indemnity contract like fire, marine and property insurance.
Double insurance policy is adopted where the financial position of the insurer is doubtful. The insured cannot recover more than the actual loss and cannot claim the whole amount from both the insurers.
7. Principle of proximate cause:
Proximate cause literally means the ‘nearest cause’ or ‘direct cause’. This principle is applicable when the loss is the result of two or more causes. The proximate cause means; the most dominant and most effective cause of loss is considered. This principle is applicable when there are series of causes of damage or loss.
Subrogation Principle in Insurance: How it Works?
In simple words, the Subrogation Principle in Insurance means;
When insurer (insurance company) pays full compensation for any insured loss (of insured property), the insurer (insurance company) holds the legal right (claim) of the insured property.
This also means the insurer (insurance company) has legal right to claim any future gains from the said property for any recovery and/or settlement.
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.
In insurance, after payment of a claim, the insurers shall be entitled to take over the legal right of the insured against the liable third party for the purpose of recovery.
Everybody is entitled to live peacefully and if this peace is disturbed by the wrongdoer of another then the person who has been subjected to this wrong has a legal right of action against the wrongdoer.
Here comes up the proposition then that if the damage sustained by the wronged is also covered by a policy of insurance then after getting the claim from insurers he gives up his right of recovery against the wrongdoer in favor of his insurers.
Insurers then proceed against the liable third party direct and recover the loss or damage for their own benefit.
An example will make this position clear. Let us assume that A’ had been to New Market driving his car. After parking the car somewhere in front of the market he went inside, made some shopping, came back and found that ‘B’ was damaging the car.
In law ‘A’ has a legal right of action against ‘B’ for damages. Incidentally A’ may also have a comprehensive motor insurance which protects him against such losses.
Here ‘A’ has open to him two avenues of recovery and the principle of subrogation asserts that if the insurers pay the full loss then they (insurers) shall take over the right of ‘A’ (insured) for proceeding against B (third party) for their own (insurers) benefit. In reality, various other propositions may be thought about.
As for example, a carrier is primarily liable for safe delivery of the goods as per contract of affreightment. A bailee is primarily liable as per contract of bailment. Such goods may also be covered by insurance policies where the insurer’s liability is secondary.
Here, even though the insurers would make payments in respect of a loss, nevertheless, they would be entitled to, or subrogated to the right of the insured against the negligent or liable carrier or bailee. “If an insured has a means of diminishing the loss, the result of the use of these means belongs to the insurers.”(CASTELLAIN V. PRESTON, 1883)
A very prominent question that crops up into our mind is why the insured shall not be entitled to recover from both the sources? Why shall he have to give up his right in favor of and for the benefit of the insurers?
In fact, it has to be borne in mind that the principle of indemnity prevents the insured from getting more than the actual amount of loss.
As a result of a loss, a person certainly cannot benefit or make a profit. Moreover, under the principle of indemnity, it has been well asserted and established that after a loss the insured should get the actual amount of loss, neither more nor less.
If this principle is to be maintained and preserved from any possible threat or defect, then it has to be ensured that all possible flaws are properly guarded and loopholes are properly blocked.
The principle of subrogation is a method whereby the possibility of getting more than the actual amount of loss from various sources, thereby infringing the principle of indemnity, is defeated.
Therefore, it is also very correctly said that the principle of subrogation is indeed a corollary to the principle of indemnity, it has its birth from the principle of indemnity and it has its existence to preserve the principle of indemnity.
It should be clearly borne in mind and appreciated that as the principle of subrogation is a corollary to the principle of indemnity, therefore, it applies only to those insurance contracts which are contracts of indemnity.
As such it has to be understood that subrogation does not apply to life insurance and personal accident insurance contracts as these are not contracts of indemnity.
How This Right of Subrogation Arises
As already indicated, the right of subrogation arises in the following ways:
- Under tort: This is a wrongdoing to another. In other words, it is a breach of duty owed to^a third party. A person cannot do wrong to another thereby causing damage to another’s property or inflicting injury on the person of that another. If it is so done then a right of action accrues in favor of the wronged and to the detriment of the wrong-doer.
- Under contract: A contract may put some obligation on the person making a breach of the contract to compensate the person who has been aggrieved as a result of the breach. As for example, an obligation under the contract of affreightment and contract of bailment etc.
- Under Statute: Statutes may also create liability, for making compensation, arising out of a breach thereof Examples are Factories Act. Occupiers Liability Act. The Riot Act Carriage of Goods by Sea Act etc.
Application of Subrogation in Claims
It has already been explained how subrogation arises and how this goes to the benefit of insurers. In so far as the application of subrogation in claims is concerned, certain considerations must be properly grasped and these are as follows;
When Subrogation Arises
The position is different, with regard to common law and with regard to contractual terms and conditions.
Under common law, the position is this that the insurers must pay the claim first before the right of subrogation can be exercised.
In other words, the insurers cannot go against the third party for the purpose of recovery unless they (insurers) have made payments to the insured. This position may, however, be varied by means of policy terms and conditions.
In non-marine policies, there is usually a policy condition, known as subrogation condition, whereby the insurers may require the insured to recover (or take all steps of recovery) against the liable third party first at insurer’s cost and expenses.
This, in fact, modifies the common law position.
In marine insurance, however, the right of subrogation arises only after making payment by insurers as it is not customary ( and most unusual ) to incorporate any policy condition as such so as to modify the Common law position
Extent of Subrogation
Under the right of subrogation, the insurers are only entitled to benefit to the extent of payment made.
Therefore, if the insurers recover more than the amount paid out, then they 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, however, the recovery is less than the amount of claim paid out to the insured, there is no question of realizing balance money from the insured.
If the insured already recovers from the third party and if that is a full indemnity, he has no claim against his insurer.
If he has also received payment from the insurer, he must refund the payment received from his insurers.
If the amount received from the third party does not represent full indemnity then he is entitled to claim only the balance from his insurers so that both the payments together would constitute one full indemnity only.
The idea is this that as a result of a loss the insured cannot get more than actual indemnity even though he may have numbers of avenues open to him for recovery.
If the insured realizes from both insurer and a third party, then the (insured) retains only to the extent of full indemnity and returns balance to the insurer subject to the limit of insurer’s payment
Although not legally liable, insurers do sometimes make payments under their policies as a matter of grace or favor.
Maybe, there have been minor breaches of policy terms for which the insurers could easily repudiate the claim.
But considering the commercial aspect and minor nature of the breach, maybe the insurers will not be that much strict and will be willing to make some payment (whether in full or not) without admitting liability under the policy.
Such payments are in fact known as exgratia payments and never create a precedence so as to give a right of claim to the insured in similar other cases.
It should be remembered that when exgratia payments are made insurers are not subrogated to the right of the insured. This is because payments are not made by admitting liability.
When, however, one insurer makes a normal payment and the insured gets an exgratia payment from another insurer also, then the former insurer shall stand subrogated to the exgratia money received from the latter insurer even though this money has not been received as a matter of legal right under that policy.
In connection with the study of subrogation, it is necessary for the students to understand the implication of “Salvage” and “Abandonment” as these do have a bearing on subrogation right.
This usually refers to remains of the property after a loss. Normally, as a result of a loss, the whole property is not lost, damaged or destroyed. Mostly, there remains some value in the damaged property or maybe it is a case of partial loss when the question of salvage becomes more prominent. The rule is this that when it is a case of partial loss, the insured can only claim to the extent of the loss or damage sustained.
He cannot normally abandon the property and claim the full. The situation may be different only if the insured surrenders the remains of the property and the insurer also agrees to accept the salvage.
In such a situation the claim shall be paid in full and the insurer shall become the owner of the salvage, hi cases of clear-cut total losses, the insurers will pay in full and, therefore, shall be entitled to the benefit of the salvage.
Confusion may arise as to the ownership of salvage in circumstances when under-insurance exists and there is a total loss.
As the insured will not be fully indemnified he shall be entitled to salvage, but only to such an extent that the loss payment and the value of salvage together do not exceed the full loss or actual indemnity.
It should also be remembered side by side that when full insurance exists (i. e., no under-insurance) and the loss is paid in full, the insurers become the absolute owners of the salvage, if any, and the total sale proceeds belong to them even though the proceeding may turn up to be more than the amount of the claim paid out.
Abandonment usually means surrendering by the insured the remains of the damaged property to the insurer and claiming the total loss.
It is not basically peculiar to marine, as in marine insurance practice the assured has the right to abandon the property (subject to the acceptance by the insurer) thereby claiming a constructive total loss.
When, therefore, the insurer pays a total loss he takes over the salvage as owner thereof. He becomes the absolute owner irrespective of what value is received from the subsequent sale.
The comments made in the English Court judgment of Kaltenbach V. Mackenzie (1878) is important in this regard, which goes on to say, “that abandonment is not peculiar to policies of marine insurance; abandonment is part of every contract of indemnity.
Whenever, therefore, there is a contract of indemnity and a claim under it for an absolute indemnity, there must be abandonment on the part of the person claiming indemnity of all his right in respect of that for which he receives indemnity”.
The situation is different in respect to most of the non-marine policies. Usually, there is a policy condition in such policies prohibiting abandonment by the insured and claiming the total loss.
However, the insurers may waive this condition in appropriate circumstances on merit basis.
The doctrine of Subrogation in Marine Insurance
The aim of the doctrine of subrogation is that the insured should not get more than the actual loss or damage.
After payment of the loss, the insurer gets the light to receive compensation or any sum from the third party from whom the assured is legally liable to get the amount of compensation.
The main characteristics of subrogation are as follows:
- The insurer subrogates all the remedies fights and liabilities of the insured alter payment of the compensation.
- The insurer has right to pay the amount of loss after reducing the sum received by the insured from the third party. But in marine insurance, the right of subrogation arises only after payment has been made, and it is not customary as in fire and accident insurance, to alter this by means of a condition to provide for the exercise of subrogation rights before payment of a claim. At the same time, the right of subrogation must be distinguished from abandonment. If the property is abandoned to a marine insurer, he is entitled to whatever remains to the property irrespective of the value of subrogation.
- After indemnification, the insurer gets all the rights of the insured on the third parties, but insurer cannot file suit in his own name. Therefore, the insured must assist the insurer in receiving money from the third party. If the insured is revoking from filing suit against the third party, the insurer can receive the amount of compensation from the insured. It is a corollary of principle indemnity.
What Are the Six Principles of Insurance?
The six principles of insurance address legal and moral issues.
Each of the six principles of insurance defines a fundamental rule of action or conduct that addresses the legal side of the insurance industry. Each applies to both the insured and insurer throughout the life of an insurance contract, from the date of application to the date of cancellation. In total, the six principles of insurance make up legal, binding guidelines for entering into an insurance contract and for preparing, lodging and managing lawful insurance claims.
Utmost Good Faith
Utmost good faith, a principle dating back to Carter v. Boehm in 1766, is a principle based on precedent rather than on a set of defining codes or statutes. Utmost good faith requires honesty and full disclosure at all times, starting with the application phase. It prevents both the insured and insurer from concealing or misrepresenting facts during the application phase, prevents the insurer from ever altering the policy without full disclosure during the time the policy is in force and, in the event of a loss, requires the insured to provide a full, honest representation of the facts surrounding the event and loss. Violating this principle can be the basis of a case for fraud.
Principle of Indemnity
The principle of indemnity refers to the payment of money for claims. It says an insured should get no more and no less money than the insurance policy permits and the extent of the loss allows. Provisions in the policy dictate whether claims are valued at cash or replacement value – taking or not taking an allowance for depreciation – or the face value a policy defines for policies that insure valuables such as artwork or antiques. Indemnity does not apply, however, to life insurance policies.
Subrogation is a principle of substitution and recovery. It puts an insurance company in a middleman position when a third party causes a loss and in this way helps to control insurance costs. For example, in the case of an auto accident, subrogation stops an insured from collecting payment from two insurance companies for the same loss, places responsibility for the accident on the third party and gives an insurance company the legal right to demand recovery for any payments made to the insured as a result of the accident.
Contribution applies in a case where an insured holds more than one policy for the same thing. It allows insurance companies to share the cost of claims and prevents an insured from collecting in full on more than one policy. The principle of contribution states that an insured can make a claim equal to the extent of a loss from one or all insurers. If one insurer pays the claim in full, the insurer can then recover a percentage of the payment from the other insurers.
The principle of insurable interest states that in order for a loss to “count” an insured must have an interest in or own the item being insured. Interest can be subjective, as in life insurance, or it can be a physical thing, such as a car or home. Either way, insurable interest prevents a person from taking out a policy or an insured from making a claim or collecting payments for a person he doesn’t have a direct relationship with or an item he doesn’t own.
Proximate cause – which does not apply to life insurance – addresses what perils an insured chooses to cover and identifies insurer liability when two or more perils come together to cause a loss. It states that the proximate, closest or most dominant cause determines liability. For example, if an insured has fire but no flood insurance, and a fire causes water pipes to burst and flood the home, the insured is liable for damage the fire causes. However, because bursting water pipes are the dominant cause of the flood damage, the insurance company is not legally liable to pay any claims resulting from repairs.
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About the Author
Based in Green Bay, Wisc., Jackie Lohrey has been writing professionally since 2009. In addition to writing web content and training manuals for small business clients and nonprofit organizations, including ERA Realtors and the Bay Area Humane Society, Lohrey also works as a finance data analyst for a global business outsourcing company.