7 Principles of Insurance

We all have heard about insurance a lot more in recent times than ever before. Are you aware of what exactly is insurance and the idea behind it? What mainly governs any insurance policies? Let us take you through the 7 principles of insurance.

Introduction

Insurance in current times has become an important aspect of a person’s life. Everybody is taking some form of protection like health or life insurance to cover themselves from uncertainty. Considering the unprecedented times we live in, human life off late has been under constant threat from all sorts of unforeseen events. Insurance, in some ways, helps mitigate the risk and loss that one can suffer. Setting aside a certain amount for insurance is a move that will give you confidence in the case of a mishap. Let’s dig deep into the topic and understand what actually governs insurance or the ‘7 principles of insurance’.

Here is a kickass guide to buy a health insurance in case you still haven’t got one and would like to make an informed decision.

For latest insurance update on Covid-19 visit: COVID-19: Insurance Regulatory Updates – Coronavirus (COVID-19) – India

7 Principles of Insurance

Insurance basically means a contract to compensate for any loss, damage, illness, or death by payment of a certain amount. It tries to restore the financial position before the disrupting event took place. In insurance, people at equal risk of a loss helps in sharing the loss a single person can face. Here is a diagram to understand it in short:

Before we move forward, let us first understand the two most widely used terms, namely. ‘Insurer’ and ‘Insured’.

An insurer is someone that takes up the responsibility to pay compensation in event of loss. The insurance company basically.

Insured is the party that has received safeguards against any unseen future event. For the purpose, a periodical payment of premium is made to the insurer.

Insurance is based on 7 pillars commonly known as ‘7 principles of insurance’. These are basic principles that govern any insurance policy we buy.

Let’s discuss all these principles in a lucid manner to have clear knowledge about them.

Principle 1: Principle of Utmost Good Faith

This principle is the base of any insurance policy an individual takes. Imagine you are unaware of some material facts from someone you trust the most, in this case, the insurer or the insured. It means there should be mutual trust. No important fact should be kept between the parties to have such faith. For instance, an individual who wants to get health insurance should disclose about any health issues he is aware of to the insurance company. The fact should have the power to affect the decision one can possibly make.

Principle 2: Principle of Insurable Interest

This principle says that person or thing that is getting insured should have some value or benefit to its owner. Let’s understand it with the help of an example. Rita bought a new car. She is concerned about any damage that can happen to the car. Imagine the setback she will endure might the car gets stolen or damaged in an accident. Under such a situation, Rita will suffer material and financial loss and wants to get her car insured. The car is of value to her, hence it can be said that Rita has an insurable interest in the car.

Other Examples can be:

Source: Google images

Principle 3: Principle of Indemnity

To indemnify someone simply means to restore the financial position of an individual as it was before the event took place. This principle applies to all kinds of insurance except for life insurance. In the case of life insurance, the loss of something one cannot replace, but a compensation is paid to help. When a loss is indemnified, the maximum amount paid is lower of:

• Sum insured
• Loss incurred

Let’s say, Ram’s factory caught fire. The insurance policy is of Rs 1,00,000. The actual loss is Rs. 95,000. In this case, the insurance company will at most pay him for the loss suffered i.e. Rs 95,000. If the loss is of Rs. 1,35,000, the maximum amount will be limited to Rs. 1,00,000.

Here is a website to further help you to grasp this concept if you want to read further into it: No limit to number of life insurance policies

Principle 4: Principle of Contribution

This principle is mainly present in case the amount insured is very high. It basically means that if a property is under cover of multiple insurance, the actual compensation in the event of a loss will be divided amongst the various insurance companies. No single company is liable to pay the full amount of loss. The total payment received from all companies put together will not exceed the actual loss sustained. It would be clearer if we take an example.

Consider a situation where Jaggu gets her house insured against losses with 3 insurance companies namely Company A, Company B, and Company C.

The total sum insured = Rs 5,00,000.

The house catches fire and the estimated loss is of Rs. 4,00,000. This loss will be divided between the insurance companies in the following proportions:

Principle 5: Principle of Subrogation

This principle is based on the concept of substitution. Like the ownership of the asset is passed on. Here the insurer swaps his position with the insured. This principle applies when the property that is under damage still has value remaining to it. Once the insurer pays the value to the insured, the ownership of property is transferred to the insurer. 

We will consider an example to understand better:

Remember Rita who bought a new car. Let’s say that her car is hit by another car when it was in front of a shop. The car was damaged and Rita couldn’t be any less heartbroken. Gladly she had already taken up car insurance. Now, the insurance company will pay Rita for the loss she suffered and, then the ownership of the car will belong to them. The insurance company can now sell off the car as a whole or in parts to recover as much as possible. It will have full right over the car now. If after selling the car off, the company received Rs 1,00,000. But had paid Rita Rs 85,000. Rita will be the rightful owner of the excess Rs 15,000. This is how the Principle of Subrogation works.

Principle 6: Principle of Loss Minimisation

Nobody in this world would like to suffer losses. I am sure we all would agree to it. Loss is something that makes us uncomfortable. We want to reduce any loss to its minimum. This is exactly what this principle says. According to this principle, an insured party must try it’s best to reduce the losses that can happen. Thus, all possible steps should be taken to reduce the loss to as low as it can be. It is the responsibility of the insured to protect the insured property. 

So if Ram’s factory catches fire, he should take all steps like calling the fire station, using a fire extinguisher to stop the fire from spreading. He shouldn’t be like this.

The last and final of the 7 principles of insurance is as below.

Principle 7: Principle of ‘Causa Proxima’ or ‘Nearest Cause’

The term “Causa Proxima” is a Latin term which means “Nearest or Immediate cause”. It means that if any loss is there because of more than one reason or cause, the closet cause will be taken into consideration. Does it seem confusing? No worries, let’s use a situation to grasp it.

Mr. Khan has taken marine insurance to reduce the risk of damage to his cargo on a ship. The ship has a collision from some solid matter under the sea during transport. This collision causes a hole in the ship through which seawater enters the ship and damage happens to the cargo. In this case the two main cause:

• The collision of the ship with solid matter
• The seawater entering the ship

The insurance company here cannot say that the main cause of damage is the collision and this is not covered in the policy. The crux is that damage has happened due to seawater which is a sufficient cause. 

Source: Google Images           

Mr. Khan took the insurance of his cargo and since it was damage happened due to seawater, the insurance company is required to pay the claim. 

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