The Insurance Industry has undergone a major transformation in the last two decades. Major changes are seen in the product range, distribution channels and customer preferences. With the fast pace of changes, there is a danger of us ‘letting go’ of the fundamental principles while practising insurance. It is important that we rewind and reinforce the fundamental principles often so that the practitioners do not swerve away from these principles. Hence, a brief note on these principles is given below.
There are three basic principles of insurance that form the core of insurance practises:
The principles of subrogation and contribution are also considered basic principles. However, they are treated more as enablers for implementing the Principle of Indemnity rather than separate principles. Principles of proximate cause and principles of loss minimisation are also considered as other basic principles. The same is not considered in the note currently. Including these principles as separate principles, there are 7 basic principles of insurance to be understood and followed by insurance practitioners.
Insurable Interest:
This principle defines who can take insurance. Without Insurable Interest, there cannot be any insurance contract. Insurable Interest gives the insured the legal right to insure. While the subject matter of Insurance could be property, life or liability under different lines of business, the core coverage is against financial loss, which might happen on the occurrence of an Insured Event. Insurable Interest is established if the proposer suffers financial loss if the insured event occurs.
The existence of Insurable Interest as a basic requirement for taking insurance makes the Insurance contract different from gambling transactions. In the absence of such a requirement, anyone would be able to take insurance on any property (property not owned by him also) and any person can take insurance on the lives of the public, which is against the public policy.
Different ways by which Insurable Interest arises include ownership in the property being insured, arising from Law as in the case of the bailee, arising from the contract as in the case of the lessee, arising from legal liabilities including employment liabilities etc. In respect of life and personal accident policies, the interest exists on own life or on the life of a spouse or dependent children or dependent parents. Similarly, an employer has an interest in all the persons providing services to him, as an employee’s sickness or accident can result in impairment of the employer’s business. In all these cases, the basic criterion of Insured standing to benefit by the safety of subject matter of insurance and losing in the event of loss or damage or injury to the subject matter of Insurance is fulfilled.
A creditor has an Insurable Interest in the property mortgaged as joint owner of the property. However, the interest is limited to the extent of the loan. A creditor also has interest on the life of debtors to the extent of the loan, as loss of such life can lead to non-re-payment of the loan. Many of the credit-linked Insurance products in the market are based on this type of Insurable Interest. In all these cases, the claim amount that is paid to the creditor should not exceed the loan amount at the time of claim. In the circ*mstances where the claim settled exceeds the loan amount, the excess amount is received by the creditor as agent for the Insured or Insured’s legal heir only.
And finally, there are many Insurance schemes run by State or Central Governments where the Insurable Interest arises as part of the social obligation by the welfare state. In many such schemes, Governments act as enablers of Insurance or support the insureds by providing for part of the Insurance premium. Under these schemes, the claim proceeds or the benefit of Insurance is passed on fully to the Insured member only.
Principle of Utmost Good Faith:
While it is essential to observe Good Faith in all commercial contracts, Insurance Contracts are expected to observe Utmost Good Faith. The two contracting parties under the Insurance contract suffer from Information asymmetry regarding the subject matter being insured, making the observance of a higher degree of good faith critical i.e Utmost Good Faith is important in these contracts.
Utmost Good Faith expects the proposer to disclose all material facts related to the subject matter for insurance to the Insurer. Discloser is required on all the information known to the Proposer and the information which is ought to be known by the Proposer. Breach of Utmost Good Faith happens either due to non-disclosure or misrepresentation. Intentional or fraudulent misrepresentations lead to the insurance contract becoming void. Other breaches make the contract voidable.
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In respect of personal Insurances like Health Insurance, the means available with the Insurer/underwriter to evaluate the risk is very restricted as the past and current health information of the proposer is known only to the proposer and it is better than the information any medical test can reveal. This is unlike in property Insurance where physical examination of the risk can give a better understanding of the risk to the Insurer. Hence, the duty of disclosure by proposer assumes even greater importance in personal Insurances and the non-disclosure in such cases definitely leads to avoidance of the contract.
Principle of Indemnity:
The term Indemnity means protection against loss or damage. The Principle of Indemnity means that the insured claim should be so settled as to ensure that the Insured is not better-off than or worse-off than the financial condition in which he was before the loss occurred. This principle results in the Insured not making any profit from an Insurance claim and reduces the moral hazard. If this principle is not followed in letter and spirit, there is the danger of the insured causing deliberate losses or the insured not making genuine attempts for loss containment.
The different clauses in the Insurance contract which help in enforcing the Principle of Indemnity are the depreciation clause, salvage recovery clause, subrogation clause and contribution clause.
While the Principle of Indemnity is applicable for all lines of business, its application is easy in the policies where the losses can be quantified in terms of money. In products covering persons like Personal accident policies, critical illness policies etc. it is difficult to quantify the loss in terms of money and hence, it is difficult to apply this principle. However, the element of over-insurance is avoided and a certain level of indemnity is followed in such policies by linking the sum insured to parameters like earning capacity or financial status which can be considered as a proxy for the loss to the insured’s family.
The Principle of Indemnity is subjected to certain deviations in some of the products, where instead of considering the actual loss (i.e value of the depreciated asset as on the date of loss), the cost of replacing the damaged asset with a new asset of similar make and capacity (without application of depreciation) is considered to quantify the claim. Examples are Reinstatement value fire policies, NIL depreciation Motor policies etc… This is done to ensure that the Insured can reinstate the property lost in an insurance event in full, so that insured’s economic activity dependent on the asset is not impaired due to the Principle of Indemnity.
Similar modification is also seen under benefit products like Hospital Daily cash or parametric products, which are becoming increasingly popular both with Insurers and insureds. These products are based on the principle of fixed benefit payment on the occurrence of Insured events. It is presumed and important that the benefit amounts in such products are fixed keeping in mind the likely loss the Insured event may cause to the Insured and avoid over-insurance and profiteering through insurance.
Another category of products where the Principle of Indemnity does not seem to be applied is agreed value or valued policies. These policies generally cover Marine cargo, marine hull, a special type of property like sculptures, paintings etc. It is difficult to establish the value of Insured property at the time of loss as the values fluctuate widely (as they move from one geography to another) or difficult to find suitable replacement value. Hence, the value of subject matter is agreed upon before commencement of cover and the settlement is based on the same. The agreed value should be reasonable so that the spirit of the Principle of Indemnity holds good.
It is important that the above principles are kept in mind while developing new products and also while processing claims under the Insurance policies.
The above article has been penned by Mr. K U Bhasker, Associate Vice President & SBU Head – Govt., Rural & Misc., Cholamandalam MS General Insurance Limited
