PART I: Law of Insurance

Chapter One
Introduction to Insurance Law
This chapter is aimed at providing theoretical support to law of insurance. The unit does not is concerned
with the legal issues which revolve around insurance rather it is devoted with defining insurance,
identifying the nature of insurance, the significance of insurance and requirements necessary to carry out
insurance business in Ethiopia.
1.1. Definition of Insurance
Insurance may be defined in various ways. Firstly, from the point view of an individual it may be defined
as a risk transfer mechanism or an economic device whereby a person, called the insured/assured
transfers a risk of a possible financial loss resulting from unforeseeable events affecting property, life or
body to a person called the insurer for consideration. For instance, let us take a case of an owner of a
motor vehicle, who always runs the risk of suffering a financial loss resulting from the loss or destruction
of his property because of unforeseeable events such as fire, collision, overturning or even theft.
Therefore, if the person purchases a motor insurance policy covering these risks from an insurer, it means
that he transferred this possible financial loss to the insurer.

Secondly, from the point of view of the insurer, insurance may be defined as a mechanism through which
a risk is distributed among the group of persons who are exposed to the same type of risk, i.e., persons
who bear the risk of suffering a financial loss as a result of events affecting property, life or body. We can
further clarify this definition through the following example.

Let us say that X insurance Company has, through its various branches, sold 200,000 fire insurance
policies, i.e., policies that cover losses related to buildings(residential, or business...) so that the insurer
will have to pay compensation to the insured or the beneficiary of the policy in case where such property
is destroyed by fire or lightening. The money collected from the sale of these policies form the pool out
of which compensation shall be paid to those persons who have suffered financial loss because of damage
to the insured buildings houses or businesses. Let us say that in the given financial year 50,000
policyholders have sustained financial losses /or lost their properties because of various causes which are
covered by the policy. So, the insurer according to the obligation it has undertaken pays compensation to
these policy holders out of the pool mentioned above, i.e., the price collected by the insurer from the sale
of the policies (premium). This in other words means that all 200,000-policy holders who have paid the
premium have contributed to the compensation paid to those who have sustained losses. This also means

1
that, the insurer has distributed the losses sustained by the 50,000 policyholders among the remaining
150,000 policyholders whose properties were not damaged or destroyed in the given year.

Why insurance is considered as a cooperative economic device? Form the definitions provided above, we
can understand that insurance is a cooperative economic device to spread the loss caused by a particular
risk over a number of persons who are exposed to it and who agree to insure themselves against that risk.
This means that insurance provides a pool to which many persons contribute a certain amount of money
called the premium, and out of which the insurer compensates the few who suffer losses. This is always
true in the case of property and liability insurance which cover contingencies and given for a short period
of time, usually a period of one year, but does not so fully apply to insurance of persons particularly life
insurance(see Art 692) in which the policy usually becomes a claim ultimately.
We can also understand that by insurance, the risk is transferred from the individual to the insurer who
takes into account the total or probability of loss in a certain period, and then fixes the premium to be
paid by each person insured.

For example, in the case of motor vehicle insurance, if the total likely loss of Euro Trucker Trucks is 50
per year, valued Birr one million each and the total number of trucks expected to be on voyage per year is
estimated to be 25,000 trucks, the premium for each truck will be

50 x 1,000,000 = Birr 50,000,000 = Birr 2000 plus

25,000 25,000

certain amounts of money, say Birr 500, for administration expenses and profit, i.e., Birr 2500. Thus, it
can be seen that insurance is a device by which an insured person can protect himself from heavy loss
likely to be caused by an uncertain event by paying a comparatively much smaller sum of money as
premium.

Do insurance prevent loss of property, incurring civil liability, death, or injury or illness? Insurance does
not and cannot prevent loss of property, incurring civil liability, death, or injury or illness, rather it
provides financial compensation for the effects of misfortune. In other words, we can say that insurance
does not protect the insured property from loss or damage, or the insured from incurring civil liability or
the insured person from death or injury or illness, but provides a financial compensation to the insured or
the beneficiary who has suffered pecuniary losses as a result of loss or damage to property, or because he
has incurred a civil liability or illness or death of the insured.

2
1.2. Definition and Nature of Contracts of Insurance
A contract of insurance is a contract whereby one party undertakes, in return for a consideration called a
premium, to pay to the other party a sum of money on the happening of a certain event (death or
attainment of a certain age, or injury) or to indemnify the other party against a financial loss arising from
the loss or damage to property or from incurring civil liability.

Who are insurer and insured (assured)? What is insurance policy? The party which promises to pay a
certain amount of money to, or to indemnify, the other party is called the insurer (sometimes called the
assurer- in cases of insurance of persons and the under writer in cases of marine insurance and the party
to whom such protection is given is called the inured (or the assured). The document containing the terms
and conditions of the contract of insurance is called the policy, and the insured is therefore, also referred
to as a policyholder.

What is contingent contract? Why contract of is insurance is considered as contingent contract? A

contract of insurance is a type of contingent or conditional contract. As the name indicates, a contingent
or conditional contract is a contract to do or not to do something, if some event, collateral to such
contract, does or does not happen. In other words, it is a contract in which the performance of the
obligation arising there from by the parties or one of them is dependent upon the condition or
contingency agreed upon by them. Accordingly, as the obligation of the insurer/assurer to pay
compensation or the agreed amount to the insured or the beneficiary is dependent upon materialization of
the risk or risks specified in the policy. Thus, for instance, if X Insurance Company agrees to pay Birr
100,000 in exchange for B paying Birr 2500 as premium, if B's house is destroyed by fire; there will be
contingent contract, the performance of which depends upon the happening of an uncertain event, i.e. the
destruction of the house by fire.

Does insurance contract is a wagering or gambling agreement? Although a contract of insurance

resembles, to a certain extent, a wagering or gambling agreement whereby the insurer bets with the
insured that his house will not be burnt and giving him the odds of its value, it is a legal and enforceable
contract with important economic and social purposes.

Note: Wagering or gambling agreements are considered void in almost all legal systems. For instance,
Art 713(2) of the Commercial Code of Ethiopia provides that games and gambling shall not give
rise to valid claims for payment unless they are related to activities enumerated under Art 714,

3
 such as stock exchange speculations, sporting activities and lottery or betting authorized by the
government.

What make different insurance contract from wagering contract? A contract of insurance differs from a
contract of wagering or gambling for the following reasons:

1. The object or purpose of an insurance contract is to protect the insured against economic losses
resulting from a certain unforeseen future event, while the object of a wagering or gambling
agreement is to gamble for money and money alone.
2. In an insurance contract, the insured has an insurable interest in the life or property sought to be
insured. In a wagering or gambling agreement, neither party has any pecuniary or insurable
interest in the subject matter of the agreement except the resulting gain or loss. This is the main
distinguishing feature of a valid contingent contract as compared to a wagering agreement.
3. A contract of insurance (except life, accident and sickness insurances) is based on the principle of
indemnity. However, in a wagering agreement there is no question of indemnity, as it does not
cover any risk.
4. A contract of insurance is based on scientific calculation of risks and the amount of premium is
ascertained after taking into account the various factors affecting the risk. In a wager, there is no
question of any calculation what so ever, it being a mere gamble.
Define insurance contract according to our law? Contract of insurance is defined under the insurance law
of Ethiopia. Art 654 of the Commercial Code of Ethiopia defines insurance as follows:

Insurance (policy) is a contract whereby a person, called the insurer, undertakes, against payment of one
or more premiums, to pay to a person, called the beneficiary, a sum of money where a specified risk
materializes.

According to this definition, insurance is a contract between two or more persons in which one person
called the insurer, agrees to pay the agreed amount of money or compensation to another person, called
the insured, or the beneficiary where the insured property is lost or destroyed ( in cases of property
insurance), or where the insured person incurs civil liability (in cases of liability insurance) or where the
insured person dies or suffers bodily injury or falls ill (in case of insurance of persons). The insurer
undertakes this obligation for consideration, called premium payable by the insured person.

Sub Art(2) of the same article provides that a contract of insurance may be concluded in relation to
"damages" covering risks affecting property or arising out of the insured person's civil liability. These

4
types of insurance are generally referred to as indemnity insurances, in which the insurer's obligation is to
pay compensation, which is always equal to damage. Similarly, sub Art(3) provides that a contract of
insurance may also be made in respect of human person's life, body or health in which the insurers
obligation is to pay the amount agreed upon (the sum insured). This is a type of insurance in which the
principle of indemnity or compensation is not applicable since human life or body does not have a market
value, hence the name Non-indemnity insurance.

Thus, a contract of insurance, as a contingent contract is a perfectly valid contract, and the general
principles of the law of contract apply equally to such a contract. Hence, to be valid, it must fulfill the
following requirements: (i) there must be an agreement between the parties (ii) the agreement must be
supported by consideration, (iii) the parties must be capable of contracting (must have capacity), (iv) the
consent of the parties to the agreement must be free from defects, and (v) the object must be legal or the
object must not be illegal and immoral.

1.3. Distinguishing Characteristics of Insurance

Insurance contracts are subject to the same basic law that governs all types of contracts. However, a
special body of law has developed around legal problems associated with insurance. What make
insurance contract different from other types of contracts? Insurance contracts have the following four
distinct legal characteristics that make them different from other contracts. These include:
1. An insurance contract is aleatory rather than commutative. Aleatory contracts have a chance
element and an uneven exchange. Under an aleatory contract, the performance of at least one of the
parties is dependent on chance. An aleatory contract also involves an uneven exchange: one of the parties
promises to do much more than the other party. Depending on chance, one party may receive a value out
of proportion to the value that is given. For example, assume that Semira pays a premium of Birr 500 for
birr 100,000 of homeowners’ insurance on her home. If her home is totally destroyed by fire shortly
thereafter, she would collect an amount that greatly exceeds the premium paid. On the other hand, a
homeowner may faithfully pay premiums for many years and never suffer a loss.

In contrast, other commercial contracts are commutative. A commutative contract is one in which the
values exchanged by both parties are theoretically even. For example, the purchaser of a real estate
normally pays a price that is viewed to be equal to the value of the property.

Although the essence of an aleatory contract is chance, or the occurrence of some fortuitous event, an
insurance contract is not a gambling contract. Gambling creates a new speculative risk that did not exist

5
before the transaction. Insurance, however, is a technique for handling an already existing pure risk.
Thus, although both gambling and insurance are aleatory in nature, an insurance contract is not a
gambling contract because no new risk is created.

2. An insurance contract is a unilateral contract. A unilateral contract is a contract in which only one
party makes a legally enforceable promise. In this case, only the insurer makes a legally enforceable
promise to pay a claim or provide other services to the insured. The term “unilateral” means that courts
will enforce the contract in one direction only: against one of the parties; in this case, the insurer after the
insured has paid the premium for coverage, the insured’s part of the agreement has been fulfilled. Under
these circumstances, the only party whose promises are still outstanding is the insurer. Although the
insured must continue to pay the premium to receive payment for a loss he or she cannot be legally
forced to do so /compare Art 666/4/ of the Commercial Code/. However, if the premiums are paid, the
insurer must accept them and must continue to provide the protection promised under the contract.

In contrast, most commercial contracts are bilateral in nature. Each party makes a legally enforceable
promise to the other party. If one party fails to perform, the other party can insist on performance or can
sue for damages because of the breach of contract.

3. An insurance contract is a conditional contract. This means the insurer’s obligation to pay a claim
depends on whether or not the beneficiary has complied with all policy conditions. If the insured does not
adhere to the conditions of the contract, payment is not made even though an insured peril causes a loss.
Conditions are provisions inserted in the policy that qualify or place limitations on the insurer’s promise
to perform.

The conditions section imposes certain duties on the insured if he or she wishes to be compensated for a
loss. The insurer is not obligated to pay a claim if the policy conditions are not met. Typical conditions
include payment of premium, providing adequate proof of loss, and giving immediate notice to the
insurer of a loss. For example, under a homeowner’s policy, the insured must give immediate notice of
loss. If the insured delays for an unreasonable period in reporting the loss, the company can refuse to pay
the claim because a policy condition has been violated.

In property insurance, insurance is a personal contract, which means the contract is between the insured
and the insurer. Strictly speaking, a property insurance contract does not insure property, but insures the
owner of property against loss. The owner of the insured property is indemnified if the property is

6
damaged or destroyed. Since the contract is personal, the applicant for insurance must be acceptable to
the insurer and must meet certain underwriting standards regarding character, morals, and credit.

Since a property insurance contract is a personal contract, it normally cannot be assigned to another party
without the insurer’s consent. If property is sold to another person, the new owner may not be acceptable
to the insurer. Thus, the insurer’s consent is normally required before a property insurance policy can be
validly assigned to another party. Since the general rule states that one cannot be forced to contract
against one’s will, the right of the insured to assign the policy is dependent on the consent of the
insurance company. Otherwise, the company could not be legally bound in a contract with an individual
to whom it would never have issued a policy originally, and one in which the nature of the risk is altered
substantially. For example, let us say that an automobile owner decided to sell his or her car to a 17-year-
old boy. If it were possible to assign the insurance policy to the boy without the consent of the insurance
company, the company would then be forced to deal with a person with whom it would not have dealt.
The assigned policy will be legally binding only with the written consent of the insurance company. /
Compare the provisions of Arts 672, 673, 660 of the Commercial Code/

In contrast, a life insurance policy can be freely assigned to anyone without the insurer’s consent because
the assignment does not usually alter the risk and increase the probability of death. Compare Arts 696-
698 of the Commercial Code.

4. Insurance contract is said to be a contract of adhesion, i.e., whose terms and conditions are not the
result of negotiations between the parties, and one party has to agree to the terms and conditions prepared
by the other. In such types of contracts, ambiguities or uncertainties in the wording of the agreement will
be construed against the drafter- the insurer. If the policy is ambiguous, the insured gets the benefit of the
doubt. This principle is due to the fact that the insurer had the advantage of writing the terms of the
contract to suit its particular purposes and the insured has no opportunity to bargain over conditions,
stipulations, and exclusions. Therefore, the courts place the insurer under a duty to make the terms of a
contract clear to all parties. In the absence of doubt as to meaning, the courts will enforce the contract as
it is.

The general rule that ambiguities in insurance contracts shall be construed against the insurer is
reinforced by the principle of reasonable expectations. The principle of reasonable expectations states
that an insured is entitled to coverage under a policy that he or she reasonably expects it to provide, and
that to be effective, exclusions or qualifications must be conspicuous, plain, and clear.

7
1.4. The Requirements to Carry on Insurance Business
What are the conditions stipulated under law for involving on insurance business? Art 656 of the
Commercial Code provides that the law shall determine the conditions under which physical persons or
business organizations may carry on insurance business. Therefore, we have to refer to other parts of the
commercial code and other laws to find out as to who may undertake insurance business and the
conditions under which it may be undertaken.

Accordingly, Art 513 of the code provides that banks and insurance companies cannot be established as
private limited companies, i.e., a private limited company cannot engage in banking, insurance or any
other business of similar nature. Similarly, Art 6(1) of the Licensing and Supervision of Insurance
Business Pro No 86/1994 provides that no person may engage in insurance business of any type unless it
applies to and acquires a license from the National Bank of Ethiopia for the particular class or classes of
insurance. Furthermore, Art 4(1) and Art 2(3) of the same proclamation provide that such person has to
be a share company as defined under Art 304 of the commercial code.

According to this article, a share company is a company whose capital is fixed in advance and divided
into shares and whose liabilities are met only by the assets of the company. The capital of the company to
be established as an insurance company must be wholly owned by Ethiopian nationals and/or business
organizations wholly owned by Ethiopian nationals, and it must be established and registered under
Ethiopian law and must have its head office in Ethiopia.

These requirements / conditions in effect prevent foreigners from engaging in insurance business and
foreign banks from opening branches and operating in Ethiopia. The most probable reason for this
position is the need to protect infant domestic insurance companies which do not have the desired
financial strength, knowhow and human resources to be able to compete with foreign banks which have
superior capacity in these areas.

The other condition that a person must fulfill to obtain a license relates to the minimum capital of the
company, i.e., it must have a minimum capital of 3 million Birr if it is applying for license to undertake
general insurance business i.e., insurances other than insurance of persons, and 4 million Birr if it is
applying for a license to undertake long term insurance business, i.e., insurance of persons and 7 million
where the application is to undertake both classes of insurance. Such capital has to be paid up in cash and
deposited in a bank in the name of the company to be established as an insurance company.

8
 Chapter Two
Basic Principles of Insurance
This chapter is more concerned with the underlining principle of insurance which are also reflected under
law of insurance. Understanding the basic principle of insurance is very important so as to analyze and
understand the key legal questions commonly arise in connection to insurance. Thus, the chapter
individually discusses some of the basic principles of insurance in connection to the commercial code of
Ethiopia.
2.1. Principle of Utmost Good Faith
Insurance contracts are contracts of utmost good faith or uberrimae fidei. Accordingly, it is the inherent
duty of both parties to a contract of insurance to make full and fair disclosure of all material facts relating
to the subject matter of the proposed insurance. It is so because insurance shifts risk from one party to
another. A material fact for this purpose is a fact, which would affect the judgment of a prudent insurer in
considering whether he would enter into a contract at all or enter into it at one premium rate or another.
For example, in life insurance suffering from a disease like asthma or diabetes is a material fact whereas
having occasionally a headache is not a material fact.

What kinds of duties are imposed under our law on the insurer and the insured as to the principle of
utmost good faith? This principle consists of the following elements under the Ethiopian law; from the
point of view of the insured, the principle of utmost good faith requires the insured;
A) To disclose to the insurer, at the time of the conclusion of the contract, all facts related to the object,
liability or person to be insured and of which he is aware and which he thinks will help the insurer to
fully understand the risks it undertakes to insure (Art 667). The insured is required to disclose facts
which may influence the decision of the insurer to enter into the contract or not or if it decides to
enter into the contract if it would affect the amount of premium it would charge (Art 668(1))

B) To notify the insurer of changes that may occur after the conclusion of the contract. The insured must
notify the insurer of changes in facts and circumstances surrounding the object or liability insured if
such changes are capable of increasing the probability of occurrence of the insured risks. The test of
materiality is also applicable here as the insured has to notify of changes if they are of such a nature
or importance that, had they existed at the time of the conclusion of the contract and had the insurer
known them, they would have influenced the decision of the insurer to enter into the contract or not
and the level of premium it would have imposed. /Art 669/1/. For instance, where the insured changes

9
 the purpose or use of his house from residence to a business purpose, let us say, distribution of
gases /fuel. The insured has to notify the insurer of such change within fifteen days from the date he
changed the purpose of the house and started the business, because the house is more exposed to risk
of fire than when it was being used for residence.

The notification of increase of risks has to be made within 15 days from the date of occurrences of
such change, which increased the risk, where such change or occurrence is the result of the act of the
insured. However, where such change resulted from the act of a third party, the insured is required to
notify the insurer of such change within 15 days from the day when he became of aware such change.

Failure to comply with these elements of the principle of utmost good faith may have one of the
following effects depending on the motive of the insured person. If the insured concealed material
facts or made false statements there in intentionally with the motive to benefit from a lower rate
/amount of premium, the contract will have no effect and the insurer shall retain the premium. Failure
to notify the increase of risks according to Art 669(1) internationally and with similar motive shall
have the same effect.

However, if the failure to comply with these obligations is not intentional or fraudulent, i.e., if it is
not a result of a motive to benefit from lower rates of premium, the policy shall remain in force.
However, the insurer may terminate the contract by giving a notice of 30 days or maintain it by
increasing the premium where insurer discovers the existence of such concealment or false statement
or failure to notify increase of the risk before the materialization of the risk. However, if such
concealment, false statement or failure to notify increase of risks is discovered after the risk has
materialized, the insurer shall not have the obligation to compensate the insured. Rather it shall pay a
reduced amount of money which shall be determined by taking into account the amount of premium
actually paid and the premium that should have been paid had the insured not concealed facts or made
false statements or failed to notify increase of risks.

C) To refrain from any fraudulent act aimed at making a net profit or obtaining undeserved benefit out of
a contract of insurance. For instance, the insured must refrain from intentional /fraudulent over-
insurance of the object, which occurs where on the date of conclusion of the contract, the sum
insured/amount of guarantee provided in the policy exceeds the value of the object /Art. 680/1// or
where the insured purchases several insurance policies from several insurers in respect of the same
object, covering the same types of risks and the sum insured or amount of guarantee provided by the

10
 policies exceed the actual value of the object. Over insurance where it is intentional or fraudulent
may result in the termination of the contract by the court upon the application of the insurer to this
effect and in addition, the insurer may be entitled to payment of compensation for any damage the
insurer might have suffered because of the violation of the duty to act in good faith.

However, if over insurance was not the result of intentional act of the insured to make a net profit
from the insurance or insurances, the contract shall remain in force but only to the extent of the actual
value of the object. In other words, the amount of guarantee /sum insured provided in the policy shall
be reduced to the actual value of the object. (Art 680 (2) & Art 681(2).

D) To refrain from purchasing an insurance policy in respect of goods or objects which are already lost or
damaged or destroyed or in respect of goods or objects which are no longer exposed to a risk with the
motive of receiving compensation for the loss or damage sustained before the conclusion of the
contract.

For instance, a person who purchases a motor insurance policy in respect of his motor vehicle which was
already lost or damaged or totally destroyed at the time of the contract violates the principle of utmost
good faith if he was aware of such facts and purchased the policy with the intention of receiving
compensation for the already lost or damaged or destroyed property. In such cases, the insurer is entitled
to retain all premium paid and may further claim payment of compensation for expenses it might have
incurred. /Art 682/2/

On the part of the insurer, an insurer which sells a marine insurance policy or inland marine insurance
policy (policies that cover risks which may arise during transportation) in respect of goods which are
already transported and are stored in a warehouse and of which it is aware to benefit from the premium
paid, violates this principle. In such cases, the insured is entitled to the refund of the premium he has paid
and to claim compensation for the damages he might have suffered.

2.2. Principle of Indemnity

The second fundamental principle is that all contracts of insurance are contracts of indemnity, except
those of life and personal accident insurances where no money payment can indemnify for loss of life or
bodily injury. In case of marine and fire insurances, the insurer undertakes to indemnify the insured for
loss or damage resulting from specified perils. In case of loss, the insured can recover from the insurer
the actual amount of loss, not exceeding the amount of policy. If there is no loss under the policy, the
insurer is under no obligation to indemnify the insured. The purpose of indemnity is to place the insured,

11
after a loss, in the same position he occupied immediately before the event. Under no circumstances, is
the insured allowed to benefit more than the loss suffered by him. This is because, if that were so, the
temptation would always be present to desire the insured event and thus to obtain the policy proceeds.
This would obviously be contrary to public interest.
Even contracts of fire or marine insurance cease to be contracts of indemnity when they provide for the
payment of a fixed sum of money in the event of total loss or destruction by the peril insured against,
without demanding any further proof of actual loss. This is so in the case of ‘valued policies.’ Of course,
in such policies as well, if partial loss is there then the insured is only indemnified, because nobody is
allowed to make a profit of his loss.

It must also be noted that indemnity is linked with ‘insurable interest.’ If a one-fourth co-owner gets the
full property insured, he shall be indemnified to the extent of his interest or share only in the case of total
destruction of the property insured.

This principle applies to insurance of objects (property insurances) and liability insurances. According to
this principle, property and liability insurances are contracts for indemnity or compensation, which, in
principle, is equal to the actual value of the object or the amount of economic loss or damage sustained
by the insured. Hence, in cases of insurance of objects, the liability of the insurer, if the risk materializes,
shall be to pay compensation i.e., the actual value of object on the day of occurrence, where the object is
totally destroyed or lost or the cost of repair in cases of partial damage, provided that such compensation
cannot exceed the amount of guarantee/sum insured provided in the policy. (Arts 678, 665(2))

The principle of indemnity implies that the sum insured or the amount of guarantee provided in the policy
is not necessarily payable. This is in line with purpose of insurance, i.e., reinstating a person who has
suffered a financial loss to his original financial position. It also shows that the insured cannot claim its
payment where the risk materializes unless the sum insured is equal to actual value of the object at the
time of loss or damage or unless the policy is a valued policy as discussed above.

However, there are instances, in which the principle of indemnity does not apply, i.e., the insurer does not
have the obligation to compensate the insured person. One such instance is where the object or liability is
under-insured. Under-insurance occurs where the amount of guarantee /sum insured agreed upon in the
policy is lesser than the actual value of the object or the amount of potential liability of the insured. In
such cases, the insurer’s obligation is to pay the amount of guarantee/ sum insured, rather than
compensation of the insured (Art 679).

12
The other such instance is related to insurance of persons, where the parties freely fix the amount of
guarantee and is payable regardless of the actual damage sustained where the risk materialized. This is
mainly because it is generally accepted that human life or limb cannot be valued in terms of money and
are irreplaceable and the insured or beneficiary who receives it cannot be considered to have made a net
profit out of insurance. (Art 689)

2.3. Proximate Cause

The principle states that the insurer is liable only for those losses which have been proximately caused by
the peril insured against. In other words, in order to make the insurer liable for a loss, the nearest,
immediate, or the last cause has to be looked into, and if it is the peril insured against, the insured can
recover. This is the rule of proximate cause/ causa proxima. / Insurers are not liable for remote causes and
remote consequences even if they belong to the category of insured perils. The question as to which is the
causa proxima of a loss, can only arise where there has been a succession of causes. When a result has
been brought about by two causes, you must, in insurance law, look to the nearest cause, although the
result would not have happened without the remote cause. The law will not allow the assured to go back
in the succession of causes to find out what is the original cause of loss. See the following illustrations.
(A) In a marine policy, the cargo was a shipment of oranges. The peril insured against was collision with
another ship. During the course of voyage the ship collided with another ship, resulting in delay and
mishandling of shipment which made oranges unfit for human consumption. It was held that the loss was
due to mishandling and delays and not due to collision, which was a remote cause, though without it no
mishandling or delay would have resulted. As such, the insurer was not held liable. (For mishandling, the
crew and their principal could be made liable but not the insurer.)

(B) In a marine policy, the goods were insured against damage by seawater. Some rats on board bored a
hole in a zinc pipe in the bath, which caused seawater to pour out and damage the goods. The
underwriters contended that as they had not insured against the damage by rats, they were not bound to
pay. It was held that the proximate cause of damage being seawater the insured was entitled to damages,
the rats being a remote cause.

Thus, in deciding whether the loss has arisen through any of the risks insured against, the proximate or
the last of the causes is to be looked into and others rejected. If loss is caused by the operation of more
than one peril simultaneously and if one of the perils is excluded (uninsured) peril, the insurer shall be

13
liable to the extent of the effects of insured peril if it can be separately ascertained. The insurer shall not
be liable at all if the effects of the insured peril and excepted peril cannot be separated.

It may be added that although the principle of causa proxima applies mostly in the case of marine and fire
insurances, it is applicable in life insurance as well. Because in ‘personal accident policies’ the proximate
cause of the death should be accident and where the person dies as a result of natural causes the insurer is
not liable on the policy.

Define the principle of proximate cause in light of our law? The principle of proximate cause is
incorporated under the insurance law of Ethiopia, Title III of the Commercial Code of 1960. According
to Art 663, the insurer shall guarantee the insured against risks specified in the policy. In other words, the
insurer shall compensate or pay the sum insured only where the loss or damage to the property or death
or injury to the person is caused by a risk or risks specifically agreed upon in the policy. So, to be able to
determine whether an insurer is liable to pay compensation or the sum insured, we have to establish that
the loss or damage or death or injury resulted from risks or perils covered by the policy since all
insurance contracts clearly specify the risks and perils for which the insurer shall be responsible (i.e.,
risks covered by the policy) and those for which the insurer shall not be responsible.
What are covered and excluded risks under the law? According to our law there are certain risks which
are considered as covered risks and those which are excluded. Accordingly, Art 663(2) provides that
losses or damages due to unforeseen events, including acts of third parties, and those resulting from the
negligence of the insured are considered as covered risks unless the parties exclude them clearly. While
losses or damages resulting from the intentional action or inaction of the insured such as the intentional
destruction of the property by the insured himself or a third party who is acting upon the instruction of
the insured are considered as excluded risks. The law excludes intentional damages even where the
parties might have agreed that such losses or damages are covered. This is a public policy principle since
such acts shall affect the national economy and violate the purpose of insurance as a means of
transferring potential but uncertain (as to time and extent) risks. Such acts even constitute a criminal
offence punishable under the criminal law. / Art 659 of the Criminal Code of Ethiopia. /
Furthermore, Art 676 of the Commercial Code excludes from coverage, in all property insurances, risks
arising out of international or civil wars unless the insurer, in a separate agreement, undertakes to cover
them, because losses or damages caused by wars may be catastrophic and beyond the financial capacity
of insurers. Where the object insured is lost or totally destroyed or the person insured dies or is injured as

14
a result of a risk or peril not agreed upon in the policy or excluded by the policy or the law, the policy
shall terminate as of right, and the insurer shall not incur any liability. /Art 677, 711/

2.4. Insurable Interest

Consistent with the concept of insurance as a means of indemnifying an insured against a loss, is the
corollary that insurance should not provide an insured with the means of showing a net profit from the
event insured against. One rather rough-hewn method of enforcing that corollary is the doctrine of
insurable interest.

Do the principle of insurable interest fully incorporated for all types of insurance in our law? The
Ethiopian Insurance Law does not sufficiently incorporate the principle of insurable interest. Art 675 of
the commercial code, which is applicable to property insurances, is the only provision that deals with the
subject. According to this provision any person who has a direct economic interest arising from property
rights, such as ownership, usufruct or use right or indirect economic interest, arising out of contracts such
as mortgage or pledge may insure such property to protect his interests. However, the rules governing
liability insurance and insurance of persons fail to incorporate rules on the principle of insurable interest
which is considered as a mandatory requirement for the validity of contracts of insurance. Hence, we
shall try to discuss the principle based on the law and experience of other countries.
What are the Purposes of principle of insurable interest? The insurable interest doctrine has two
primary purposes both rooted in public policy. The first is the elimination of insurance as a vehicle for
gambling, an activity to which has been attributed idleness, vice, a socially parasitic way of life, increase
in impoverishment and crime, and the discouragement of useful business and industry. The second is the
removal of the temptation provided by a prospect of a net profit through insurance proceeds to
deliberately bring about the event insured against, whether it is the destruction of property or human life.

When do we say a person has insurable interest? A person is said to have an insurable interest in the
subject matter insured where he will derive pecuniary benefit from its existence or will suffer pecuniary
loss from its destruction. Insurable interest is thus a financial interest in the preservation of the subject
matter of insurance. A purely sentimental interest or a non-monetary benefit will not cause an insurable
interest. Accordingly, a creditor has an insurable interest in the life of the debtor but a son has no
insurable interest in the life of his mother who is supported by him.

15
‘Insurable interest’ is an essential pre-requisite in effecting a contract of insurance. The insured must
possess an insurable interest in the subject matter of the insurance at the time of contract. Otherwise, the
contract of insurance will be a wagering agreement which shall be void and unenforceable.

When should a person have insurable interest? In the case of marine insurance, it is not essential for the
assured to have an insurable interest at the time of effecting the insurance but the assured must have
insurable interest at the time of loss of the subject matter insured. To take the case of fire or marine
insurance, it is not only the owner who has an insurable interest but also all those other persons who run a
risk, i.e., all those persons who have something at stake or something to lose because of the loss or
damage to the property or goods insured. For example, a person who has advanced money on the security
of a house has an insurable interest in the house. Similarly, a bailee has an insurable interest in the goods
bailed. The charterer of a ship has insurable interest in the ship because he runs a risk of losing his freight
if the ship is lost or damaged.
In the case of Life Insurance, insurable interest must be present only at the time of contract (i.e., when the
insurance is effected). It need not exist at the time of death or when the claim is made because it is not a
contract of indemnity. Thus, a life insurance policy is freely assignable.

In the case of Fire Insurance, insurable interest must be present both at the time when the insurance is
concluded and at the time of loss. Being a contract of indemnity, a fire insurance policy can be assigned
only to one who has acquired some interest in the subject matter as a purchaser, mortgagee or bailee
because unless the assignee has interest at the time of loss, he cannot be indemnified.

In the case of Marine Insurance, insurable interest must be present at the time of the loss of subject matter
and it is not essential for the assured to have an insurable interest at the time of conclusion of the contract
of insurance.

2.5. Doctrine of Subrogation

The doctrine of subrogation is a corollary to the principle of indemnity and as such, it applies only to
property insurances. According to the principle of indemnity, the insured can recover only the actual
amount of loss caused by the peril insured against and is not allowed to benefit more than the loss he
suffered. In case the loss to the property insured has arisen without any fault on anybody’s part, the
insured can make the claim against the insurer only. In case the loss has arisen out of tort or fault of a
third party, the insured becomes entitled to proceed against both the insurer as well as the wrongdoer.

16
However, since a contract of insurance is a contract of indemnity, the insured cannot be allowed to
recover from both and thereby make a profit from his insurance claim. He can make a claim against
either the insurer or the wrong doer. If the insured chooses to be indemnified by the insurer, the doctrine
of subrogation comes into play and as a result, the insurer shall be subrogated to all the rights and
remedies of the insured against third parties in respect of the property destroyed or damaged.

The following three points are worth noting while applying the doctrine of subrogation. First, this
doctrine will not apply until the assured has recovered a full indemnity in respect of his loss from the
insurer. If the amount of the insurance claim is less than actual loss suffered, the assured can keep the
compensation amount received from any third party with himself to the extent of deficiency, and if after
full indemnification there remains some surplus he will hold it in trust for the insurer, to the extent the
insurer has paid under the policy. Second, the insured should provide all such facilities to the insurer that
may be required by the insurer for enforcing his rights against third parties. Any action taken by the
insurer is generally in the name of the insured, but the cost is to be borne by the insurer. Finally, the
insurer gets only such rights that are available to the insured. He gets no superior rights than the assured.
As such, the insurer can recover under this doctrine, only that which the assured himself could have
recovered.

Illustrations R owned two ships, A and B and got them insured with different insurers. The ships
collided due to the fault of the crew of ship B, because of which ship A was damaged. The insurer of the
ship A indemnified the owner and then sued him as owner of the ship B for negligence, claiming the
amount they had paid in respect of ship A. The court held that the insurer could not recover, as both
vessels were owned by one and the same person, no remedy has been transferred to the insurer, because a
person cannot file a suit against himself.

Discuss the duties of the insurer and insured under law in connection with the principle of
subrogation? Art 683 of the Commercial Code provides that the insurer that has compensated the
insured for the financial losses he has suffered because of loss of or damage to property have the right to
substitute the insured and to proceed against the third party who caused the damage. This provision
transfers to the insurer all the rights and remedies that are available to the insured against the party
responsible for the loss or the damage to the property. The extent of right of subrogation of the insurer is
limited to the amount of money it has paid to the insured. Therefore, where the insurer has not fully
compensated the insured for the losses he has suffered, as in the case of under insurance, both the insurer

17
and the insured may proceed against the third party who is responsible for the loss or damage. The
insurer for the amount it has paid and the insured for damage he has not received compensation.
The law imposes on the insured an obligation to cooperate with the insurer to enable the latter to exercise
its right of subrogation and to refrain from any act, which may damage such right or prevent the insurer
from proceeding against the third party responsible. For instance, the insured has to provide the insurer
with all the necessary information and evidences showing that the third party is responsible for the loss or
damage to the property insured. He is also required to refrain from collusive agreements intended to
release the third party from liability and assumption of responsibility with the intention of procuring a
financial benefit to himself or helping the third party.

Does the insurer exercise the principle of subrogation on all persons who have caused the damage? The
insurer may not exercise its right of subrogation against certain group of people. Art 683/3/ provides that
the insurer cannot proceed against ascendants, descendants, and employees, agents of the insured and
against persons living with him. This restriction on the right of insurer is not totally acceptable and is not
based on legally justifiable grounds.
As the insured does not have remedy against his minor children, his employees and agents who caused
damage to the property while performing their duties and while acting within the scope of their power/
Art. 2130, Art 2222/, the restriction on the right of the insurer is based on acceptable legal ground and
appropriate. However, preventing the insurer from proceeding against the ascendants and descendants of
the insurer who are not his dependants and who may have their own businesses, for instance, does not
seem to be legally explainable.

What are the purposes of principle of subrogation? The primary purpose of subrogation is to make sure
that insurance is a means of compensation or reinstatement of the insured who has suffered a financial
loss and not a mechanism to make a net profit out of loss or damage covered by insurance. It denies the
insured the opportunity to claim payment twice, from the insurer on the basis of the contract of insurance
and the third party who is responsible for the loss or damage to the insured object on the basis of tort law,
for instance, and thereby making a net profit.
Secondly, it is also intended to make sure that the third party /the tort feasor/ does not escape liability
because the owner of the property happens to have insurance and bears the consequence of his negligence
or intentional act.

18
2.6. Risk Must Attach
What is risk? What does the subject matter of insurance mean? For a valid contract of insurance the risk
must attach. If the subject-matter of insurance ceases to exist (e.g. the goods are burnt) or the insured ship
has already arrived safely, at the time the policy is effected, the risk does not attach, and as a
consequence, the premium paid can be recovered from the insurers because the consideration for the
premium has totally failed. Thus, where the risk is never run, the consideration fails and therefore the
premium is returnable. It is a general principle of law of insurance that ‘if the insurers have never been
on the risk, they cannot be said to have earned the premium.’
The risk also does not attach and therefore the premium is returnable where a policy is declared to be
void ab-initio on account of some defect, e.g., assured being minor or parties not being ad-idem. But
where a policy is void because there is no ‘insurable interest’ premium paid cannot be recovered because
in that case it amounts to ‘wager’, except in the case of marine insurance where the assured is not
required to have insurable interest at the time of entering into the contract. In addition, the premium
cannot be recovered where the insurer on grounds of fraud avoids the policy by the insured.

Discuss the effect of absence of risk under law? Art 682/1/ of the commercial code provides that
contracts of insurance concluded in respect of goods, which are already lost, damaged, or destroyed, or in
respect of goods, which are no longer exposed to a risk, shall be of no effect. The premium paid in
respect of such contracts shall be refunded to the insured, as the insurer was not bearing the risks as it
would have under normal circumstances, i.e., in cases of valid contracts, provided that the insured, at the
time he purchased the policy, was not aware of the loss, or damage or destruction of the object, nor of
their safe arrival at the warehouse.
2.7. Doctrine of Contribution
The doctrine of contribution states that ‘in case of double insurance all insurers must share the burden of
payment in proportion to the amount assured by each. If an insurer pays more than his ratable proportion
of the loss, he has a right to recover the excess from his co-insurers, who have paid less than their retable
proportion.’ Like the doctrine of subrogation, the doctrine of contribution also applies only to contracts of
indemnity, i.e., to property insurances. Double insurance occurs where the same subject matter is insured
against the same risk with more than one insurer. If two different policies are taken from the same
insurer, it is not a case of double insurance. It will be termed as ‘full insurance.’ Under double insurance,
the same risk and the same subject matter must be insured with two or more different insurers. In the
event of loss under double insurance, the assured may claim payment from the insurers in such order as

19
he thinks fit, but he cannot recover more than the amount of actual loss, as the contract of property
insurance is a contract of indemnity. What are the essential conditions for the application of doctrine of
contribution? The following are the essential conditions required for the application of the doctrine of
contribution.
First, there must be double insurance, i.e., there must be more than one policy from different insurers
covering the same interest, the same subject matter and the same peril which has caused the loss.
Second, there must be either over-insurance or only partial loss. If the amount of different policies is just
equal to the value of the subject matter destroyed, the different insurers are liable to contribute towards
the loss up to the full amount of their respective policies and as such, the question of contribution as
between themselves does not arise. See the following illustrations.
A building is insured against fire for BIRR 20,000 with insurer X and for BIRR 10,000 with insurer Y.
There occurs a fire and the damage is estimated at BIRR 15,000. X and Y should share the loss in
proportion to the amount assured by each of them, i.e., in the proportion of 2:1. X should pay BIRR
10,000 and Y should pay BIRR 5,000. The policyholder can sue both the insurers together or insurer X
only. Suppose that he sues X only and recovers from him the full amount of loss, i.e., BIRR 15,000, X is
entitled to claim contribution from Y to the extent of BIRR 5,000.

20