InsurancePrinciples Of Insurance

Principles Of Insurance


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What Are The Principles Of Insurance?

In life, there are neither certainties nor assurances. There is no assurance that the company won’t sustain unforeseen losses or damages. So, even though we cannot fully safeguard our interests from hazards, we can choose to get some insurance. Let’s examine principles of insurance and the roles that insurance companies play.

principles of insurance

What is Insurance?

Insurance, which takes the form of a policy, is a contract in which the person or entity receives financial protection, or payment from the insurance provider for any harm (large or small) done to their property.

The insurance policy, which offers financial security from upcoming uncertainties, is a legal agreement between the insurer and the insured.

Simply put, insurance is a contract, a binding legal arrangement between the person labeled insured and the insurance provider, also known as the insurer. The insurer agrees in this contract to assist the insured with losses resulting from the occurrence of the contingency. In contrast, the insured makes a payment in exchange for the insurer’s commitment.

Let’s go over the principles of insurance so we can understand the basis of the insurance contract between an insurer and an insured.

Principles of Insurance

Risk distribution among a group of people is how insurance works. As a result, cooperation becomes the basic principal of insurance.

The following seven principles of insurance must be upheld by both the insurer and the insured in order for an insurance contract to function properly:

  1. Utmost Good Faith
  2. Proximate Cause
  3. Insurable Interest
  4. Indemnity
  5. Subrogation
  6. Contribution
  7. Loss Minimization

Let us understand each principle of insurance with an example.

  • Principle of Utmost Good Faith

The basic principle of an insurance contract is that both parties should operate in good faith toward one another, which requires that they communicate the terms and circumstances of the contract in a clear and straightforward manner.

The Insured should disclose all relevant facts, and the Insurer must provide correct information about the contract.

For example, Ajay purchased health insurance. He failed to divulge his smoking habit when he applied for insurance. He afterwards developed cancer. Because Ajay hid crucial information in this case, the insurance company won’t be responsible for bearing the financial load.

  • Principle of Proximate Cause

This is also known as the “nearest cause” principle or “Causa Proxima.” When a loss has two or more causes, this rule is applicable. The closest reason for the property’s loss will be determined by the insurance company. The business must make restitution if the insured property’s damage was the proximate cause. No payment will be provided by the insured if the reason is not one that the property is covered against.

For Example,

A building’s wall was destroyed by fire, and the local government mandated its demolition. The neighboring structure sustained damage during the dismantling. The owner of the neighboring building filed a fire insurance claim for the damage. The court determined that fire is the most likely source of loss for the adjacent structure, and that the claim is payable because the wall’s inevitable collapse was caused by the fire.

The wall of the building that had been destroyed by fire broke down owing to a storm before it could be restored, causing damage to an adjacent building. The owner of the neighboring building filed a fire insurance claim for the damage. The storm in this instance was the direct cause, not the fire, hence the claim is not covered by the fire policy.

  • Principle of Insurable interest

According to this principle, the insured person must have an insurable interest in the subject matter. According to the definition of a “insurable interest,” the thing for which the person signs an insurance contract must both bring financial benefit to the insured and cause financial loss in the event of damage, destruction, or loss.

For Example, A vegetable cart owner has an insurable interest in the cart since he makes money off of it. He won’t have an insurable interest in the cart, though, if he sells it.

The insured must have owned the subject matter both when the contract was signed and when the accident occurred in order to be eligible to receive the insurance payout.

  • Principle of Indemnity

According to this idea, insurance is only purchased to cover losses; as a result, the insured is not permitted to benefit from the insurance arrangement. In other words, the insured should receive compensation that is both equivalent to and does not exceed the actual loss. The indemnification principle’s goal is to put the insured back in the same financial situation he was in prior to the loss happening. For property insurance, the principle of indemnification is rigidly followed; it is not relevant to life insurance contracts.

For Example, In order to cover the costs of potential losses or damages, the owner of a business building signs an insurance policy. If a fire causes structural damage to a structure, the insurance will reimburse the owner for those costs, either by paying them back in full or by reconstructing the damaged portions with the help of its own approved contractors.

  • Principle of Subrogation

A party acting in place of another is known as subrogation. According to this theory, the insurer, or corporation, acquires ownership of the property after the insured, or person, has received compensation for the loss he suffered regarding the subject matter of the insurance.

Subrogation allows the insurance company the ability to sue the party that caused the loss for the full amount.

For Example, If Mr. A sustains injuries in a car accident caused by the negligent driving of a third party, the business with which Mr. A purchased accidental insurance will make up for Mr. A’s losses and file a lawsuit against the negligent driver to recoup the money paid as claim.

  • Principle of Contribution

When an insured person purchases multiple insurance policies covering the same risk, the contribution principle is in effect. The insured cannot make money by claiming the loss of one subject matter from other policies or businesses, which is what the concept of indemnification states.

For Example, A property worth Rs. 5 Lakhs is insured for Rs. 3 Lakhs with Company A and for Rs. 1 Lakh with Company B. If the property is damaged for three lakhs, the owner can sue Company A for the full amount, but he is then barred from suing Company B for any compensation. Company A can now request from Company B the proportionate amount of value reimbursed.

  • Principle of Loss Minimisation

According to this principle, the insurer has an obligation to take the required actions as an owner to reduce the loss to the insured property. The fact that the subject matter is insured does not, according to the concept, excuse the owner from being careless or negligent.

For Example, You should take reasonable action to put out a fire if it starts in your factory. Because you know that the insurance company will cover it, you cannot just sit back and let the factory burn down.

Functions of an Insurance Company

  • Provides Reliability

The basic purpose of insurance is to take away the uncertainty associated with a sudden and unexpected financial loss. One of a business’s main concerns is this. It offers the certainty of monthly payment, or the premium to be paid, in place of this uncertainty.

  • Protection

Insurance does not lessen the possibility of loss or damage to a business. However, it offers defense against any losses that a business can face. So at least the organization does not sustain financial losses that make it difficult for them to carry out their regular operations.

  • Pooling of Risk

In insurance, each policyholder pools their individual risks. They all pay their premiums, and this fund is used to pay out if any of them has financial losses. As a result, they are all responsible for the risk.

  • Legal Requirements

In many instances, the law of the land actually requires obtaining insurance of some kind. Obtaining fire insurance could be necessary when, for instance, items are in freight or when a public place is opened. Therefore, an insurance provider will assist us in meeting these needs.

  • Capital Formation

The pooled premiums of the policyholders aid in the insurance company’s capitalization. This money can then be used for productive endeavors that bring in money for the business.

Ladies and gentlemen, it, in essence, is an insurance contract.

Abhishek Singh Negi
A keen learner and eager to learn about the finance world. Love to learn, travel and meditate.


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