Concept 1 · free preview
Principles of insurance: utmost good faith, insurable interest, indemnity and more
Understand
Insurance works by pooling. Suppose 1,000 shopkeepers each face a small chance that fire destroys their ₹5 lakh stock. No single shopkeeper can predict whether his shop will burn, but across 1,000 shops the expected number of fires is fairly predictable. If each pays a modest premium into a common pool, the pool can pay the few who suffer a loss. The insurer manages this pool: it collects premiums, invests them, and pays claims. The person who buys cover is the insured (or policyholder), the promise is written in a policy, and the event covered is the 'risk' or 'peril'. Because the insurer pays only for genuine, accidental losses, insurance contracts follow special principles. They stop people from hiding facts, insuring things they have no stake in, or making a profit out of a loss. Utmost good faith (uberrimae fidei): both sides must disclose all material facts. A buyer who hides a known heart condition breaches it, and the insurer may repudiate the claim. Insurable interest: you can insure only something whose loss would hurt you financially — your own house, your own life, your spouse's life — not a stranger's car. Indemnity: the insured is put back in the same financial position as before the loss, not a better one; this applies to general insurance, not to life insurance, because a human life cannot be valued. Subrogation: after paying, the insurer steps into the insured's shoes to recover from whoever caused the loss. Contribution: if the same property is insured with two insurers, they share the loss and the insured cannot collect twice. Proximate cause (causa proxima): the claim depends on the nearest, dominant cause of the loss — if it is an insured peril, the loss is covered. Many texts add loss minimisation: the insured must act like an uninsured prudent person to limit the damage.
Rule
Utmost good faith applies to both parties; non-disclosure of a material fact lets the aggrieved party avoid the contract.
Insurable interest must exist at the start of a life policy, and at the time of loss for marine insurance; for most other general insurance it must exist both at the start and at the time of loss.
Indemnity, subrogation and contribution are corollaries that apply to general (non-life) insurance; life insurance is a contract to pay a fixed sum.
Proximate cause looks for the effective, dominant cause, not the cause nearest in time.
Premium is the price of cover; sum assured (life) or sum insured (general) is the maximum the insurer will pay.
Reinsurance is insurance bought by insurers to share large risks; GIC Re is India's national reinsurer.
Example
Meena insures her ₹8 lakh car with one insurer. A truck hits it and repair costs ₹1.2 lakh. Under indemnity, she gets ₹1.2 lakh (minus any deductible), not ₹8 lakh. Under subrogation, the insurer can then recover ₹1.2 lakh from the truck owner — Meena cannot also claim it from him. If she had wrongly insured the same car with two insurers, contribution would make them share the ₹1.2 lakh.
| Principle | Meaning in one line | Applies to life insurance? |
|---|---|---|
| Utmost good faith | Disclose all material facts | Yes |
| Insurable interest | Must suffer financially from the loss | Yes (at inception) |
| Indemnity | Restore, do not enrich | No |
| Subrogation | Insurer takes over recovery rights after paying | No |
| Contribution | Co-insurers share the loss | No |
| Proximate cause | Dominant cause decides the claim | Yes |
Common mistake
Indemnity does not apply to life insurance — a life policy pays the sum assured, not the 'value' of a life.
Subrogation operates only after the insurer has paid the claim.
Proximate cause is the dominant cause, not simply the last event in time.
Utmost good faith binds the insurer too: it must explain terms and exclusions honestly.