Articles Junction: Principles of Insurance - Basic Principles of Insurance

Principles of Insurance

Insurance is based on the principle of economic co-operation. It is a pooling of risks and spreading over a number of persons. It is the basic principle of insurance. The premium is collected from a number of persons, and an insurance fund is created. From this fund, the compensation is given to the contributors who suffer contingent loss. In modern days, it is now a specialized branch of commerce. Today, insurance covers a wide range of risks. It now closely related to the day-to-day life of individuals as well as of the nation. It also plays a prominent role in the national economy.

Basic Principles of Insurance are given in the diagram below.

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Explaination, List of 7 General principles of insurance are given below.

Principle of Utmost Good Faith
Principle of Insurable Interest
Principle of Indemnity
Principle of Contribution
Principle of Subrogation
Principle of Mitigation of Loss
Principle of Causa Proxima

Fundamental Principles of Insurance are:

1. Principle of Utmost Good Faith

Principles of insurance, principle of utmost good faith is given in the diagram below.

Image credits © Manoj Patil.

In principles of insurance, principle of utmost good faith is a contract. In this insurance contract, the risk loss of is transferred from insured to the insurer. Consequently, there should be a good trust between the insurer and the insured. The insured must disclose every material fact about the subject matter of the insurance contract in the proposal form of insurance. The full, correct and reliable information must be submitted by the insured. In case of any concealment of fact or false statement, the insurer can declare the contract void, and he will not be liable for paying any compensation.

2. Principle of Insurable Interest

Principles of insurance, principle of insurable interest is given in the diagram below.

Image credits © Manoj Patil.

In principles of insurance, principle of insurable interest is a contract. The subject matter of the insurance is the correlation between the insured and insurable interest. In the subject of insurance the insured must have insurable interest. The insured must own a part or whole property. He should be in a such condition that whatever harm happened to his property; he should be held responsible for that. The contract of insurance gets void and termed as invalid in the absence of such interest.

For example: If a person owns a house and has insurable interest to the house, to protect it from any possible risk. If the person sells the same house to another person, then the house will not have insurable interest.

3. Principle of Indemnity

Principles of insurance, principle of indemnity is given in the diagram below.

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In principles of insurance, principle of indemnity (security) is not valid to life insurance contract. It is based on other forms of insurance such as marine, accidental and fire. The main objective of the general insurance is to bring the person to the same condition to the subject matter as he was before the damage.

The insurer pays compensation only against the actual loss. Assured is not allowed to make a profit out of the contract of insurance. The compensation cannot be more than the actual loss. Hence double insurance is impossible in general insurance.

In the principle of indemnity life insurance contract is not applicable, because if the person expires due to injury, then the life of that person is not measureable in terms of money. The person life is precious;; it has many insurable interest to his life.

Example: Mr. Ronaldo has three million dollar life insurance policy by his name then he would get the specific amount after his death. Not more than that because Mr. Ronaldo life value cannot be counted in terms of money.

4. Principle of Contribution

Principles of insurance, principle of contribution is given in the diagram below.

Image credits © Manoj Patil.

In principles of insurance, a principle of contribution is the fundamental principle. The principle of indemnity is conclusive to the principle of contribution. Under this principle, the insured has the liberty to claim only on the actual damages from any one insurer or all the other insurers.

Example: If Mr. Bill Gates has the property of 79 billion dollars, if he has insured himself from three companies, State Farm Group 40 billion dollars, All-State Insurance Group 30 billion dollars and from Liberty Mututal Insurance Cos 20 billion dollars. If the loss of actual property is a worth 40 billion dollar, then he can claim only 40 billion dollar from one company that is State Farm Group and not from the other companies.

5. Principle of Subrogation

Principles of insurance, principle of subrogation is given in the diagram below

Image credits © Manoj Patil.

In principles of insurance, a principle of subrogation is the fundamental principle. Principle of indemnity, is the outcome from this principle. Therefore, life insurance is not applicable in this principle. This principle applies in fire and marine insurance. This principle is established to compensate to the loss against the damages of the insure. If the claim is settled by the insurer, then the ownership of that entire property would be of the insurer company. This principle helps the insurer company from to prevent double insurance.

Example: If Pepsi company caught fire due to negligence of coco cola company, In this fire accident Pepsi, loss is of 20 billion dollars, then the insurance company has to pay 20 millions dollars to the Pepsi company. However, if the insurance company files a case against coco cola company, if the insurance company wins the case, then coco cola has to pay the entire amount, including case, lawyer expenses. If any amount is balanced with the insurance company, then it would be returned to pepsi.

6. Principle of Mitigation of Loss

Principles of insurance, principle of mitigation is given in the diagram below.

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.

7. Principle of causa proxima

Principles of insurance, principle of mitigation is given in the diagram below.

In principles of insurance, a principle of Principle of causa proxima is the fundamental principle. This principle consists of, to find one or more reasons for the cause, and the nearest cause should be taken into account to decide the liability of the insurer.

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.