7 Principles of Insurance : Explanation with Examples

What are the basic principles of Insurance?. The main objective of every insurance contract is to give financial security and protection to the insured from any future uncertainties. Insured must never ever try to misuse this safe financial cover. Seeking profit opportunities by reporting false occurrences violates the terms and conditions of an insurance contract. This breaks trust results in breaching of a contract and invites legal penalties. An insurer must always investigate any doubtable insurance claims. It is also a duty of the insurer to accept and approve all genuine insurance claims made, as early as possible without any further delays and annoying hindrances.

Seven Principles of Insurance

The seven principles of insurance are:-

Principle of Uberrimae Fidei (Utmost Good Faith),
Principle of Insurable Interest,
Principle of Indemnity,
Principle of Contribution,
Principle of Subrogation,
Principle of Loss Minimization, and
Principle of Causa Proxima (Nearest Cause).

1.Principle of utmost good faith:

The principle of Uberrimae Fidei (a Latin phrase), or in simple English words, the Principle of Utmost Good Faith, is a very basic and first primary principle of insurance. According to this principle, the insurance contract must be signed by both parties (i.e insurer and insured) in an absolute good faith or belief or trust.

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 in cancellation of the contract.

For example – Roshan took a health insurance policy. At the time of taking policy, he was a smoker and he didn’t disclose this fact. He got cancer. Insurance company won’t pay anything as Roshan didn’t reveal the important facts.

2. Principle of Insurable Interest:

The principle of insurable interest states that the person getting insured must have insurable interest in the object of insurance. A person has an insurable interest when the physical existence of the insured object gives him some gain but its non-existence will give him a loss. In simple words, the insured person must suffer some financial loss by the damage of the insured object.

For example :- The owner of a taxicab has insurable interest in the taxicab because he is getting income from it. But, if he sells it, he will not have an insurable interest left in that taxicab.

From above example, we can conclude that, ownership plays a very crucial role in evaluating insurable interest. Every person has an insurable interest in his own life. A merchant has insurable interest in his business of trading. Similarly, a creditor has insurable interest in his debtor.

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3. The principle of Indemnity:

Indemnity means security, protection, and compensation given against damage, loss or injury.

According to the principle of indemnity, an insurance contract is signed only for getting protection against unpredicted financial losses arising due to future uncertainties. Insurance contract is not made for making profit else its sole purpose is to give compensation in case of any damage or loss.

In an insurance contract, the amount of compensations paid is in proportion to the incurred losses. The amount of compensations is limited to the amount assured or the actual losses, whichever is less. The compensation must not be less or more than the actual damage. Compensation is not paid if the specified loss does not happen due to a particular reason during a specific time period. Thus, insurance is only for giving protection against losses and not for making profit.

However, in the case of life insurance, the principle of indemnity does not apply because the value of human life cannot be measured in terms of money.

This principle doesn’t apply to life insurance contracts.

4. Principle of Contribution:

Principle of Contribution is a corollary of the principle of indemnity. It applies to all contracts of indemnity, if the insured has taken out more than one policy on the same subject matter. According to this principle, the insured can claim the compensation only to the extent of actual loss either from all insurers or from any one insurer. If one insurer pays full compensation then that insurer can claim proportionate claim from the other insurers.

For example – If Kohli has a property worth Rs.5,00,000. He took insurance from Company A worth Rs.3,00,000 and from Company B – Rs.1,00,000.

In case of accident, he incurred a loss of Rs.3,00,000 to the property. Kohli can claim Rs. Rs.3,00,000 from A but after that he can’t make profit by making a claim from Company B. Now Company A can make a claim from Company B to for proportional loss claim value.

5. Principle of Subrogation:

Subrogation means substituting one creditor for another.

Principle of Subrogation is an extension and another corollary of the principle of indemnity. It also applies to all contracts of indemnity.

According to the principle of subrogation, when the insured is compensated for the losses due to damage to his insured property, then the ownership right of such property shifts to the insurer.

This principle is applicable only when the damaged property has any value after the event causing the damage. The insurer can benefit out of subrogation rights only to the extent of the amount he has paid to the insured as compensation.

For example :-Rohit took a insurance policy for his Car. In an accident his car totally damaged. Insurer paid the full policy value to insured. Now Rohit can’t sell the scrap remained after the scrap.

6. Principle of Loss Minimization:

In principles of insurance, a principle of mitigation of loss is the fundamental principle. Under this principle, the insured must give his 100% to save his property and not just sit and watch destruction of his property. All tough his property is insured his effort should be there to minimize the losses.

For example – Virat took insurance policy for his house. In an cylinder blast, his house burnt. He should have called nearest fire station so that the loss could be minimised.

7. Principle of Causa Proxima:

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.

The principle states that to find out whether the insurer is liable for the loss or not, the proximate (closest) and not the remote (farest) must be looked into.

For Example: A trawler vessel was insured against losses resulting from collision. Co-incidentally a trawler vessel gets to collide, which result in further delay for few days. Because of this delay, the banana on the trawler vessel got putrid and was unsuitable for consumption. Hence there are two reasons for the losses one is of collision and other is delay, the closest cause of putrid banana was delay. As the trawler vessel was insured only for collision and not for the delay, so for putrid bananas the insured will not get any compensation from the insurance company. But trawler vessel will get compensation for collision.

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