F-210

Risk Management and Insurance

Nusrat Jahan Benozir

Assistant Professor
Department of Finance and Banking
University of Barishal
 Principles of insurance contract
All types of insurance contracts i.e. life, fire, marine and miscellaneous insurance
contracts are based on certain fundamental principles. The only exception is the
principle of indemnity which is not applicable in case of life insurance contract
because of its being a contingent contract.
 Utmost good faith
 Insurable interest
 Indemnity
 Mitigation of loss
 Causa Proxima
 Subrogation
 Contribution
 Principles of insurance contract
Utmost good faith
Insurance contracts are based upon mutual trust and confidence between the insurer and the insured.
The doctrine of disclosing all material facts is embodied in the important principle ‘utmost good
faith’ which applies to all forms of insurance.
Both the parties to the insurance contract must disclose all the material facts which are likely to
affect the judgment of the other party. In case of insurance contract the legal maximum ‘Caveat
Emplor’ does not prevail, where it is regarded the duty of the buyer to satisfy himself of the
genuineness of the subject matter and the seller is under no obligation to supply information about it.
But, in insurance contract, the seller i.e. the insurer will also have to disclose all the material facts.
Utmost good faith thus requires each party to tell the other “the truth, the whole truth and nothing
but the truth” about the proposed contract. Bad faith or failure to reveal vital information, even if not
asked about it, gives the aggrieved party the right to regard the contract as void. As such it is said
that the insurance contract is a contract of ‘uberrimae fidai’ i.e. of absolute good faith.
 Principles of insurance contract
Utmost good faith
The duty of disclosure must be observed throughout the negotiations and continues until the
completion of the contract.
The following facts are required to be disclosed:
• Facts which would render a risk greater than normal. In absence of this information the insurer
would consider the risk as normal and naturally deceived. For example, commercial storage of
kerosene in private dwelling house as side business.
• Facts, which would suggest some special motive behind insurance, e.g., excessive over-insurance
• Facts which suggest the abnormality of the proposer himself e.g., making frequent claims.
• Facts explaining the exceptional nature of the risk.
 Principles of insurance contract
Utmost good faith
The following facts need not be disclosed unless specifically asked by the insurer:
• Facts which lessen the risk – existence of fire brigade near the premise.
• Facts of public knowledge.
• Facts pertaining to matter of law – precautions required to be taken by the factory
owner as per factory law
• Facts which should be reasonably inferred by the insurer on context of disclosed
information – for example, normal risk associated with particular business.
• Facts possible of discovery through enquiry, provided, reasonable query has been
made through some other information already given by the proposer.
 Principles of insurance contract
Insurable interest
Insurable interest implies that the assured must have an actual interest in the subject matter of insurance that he
would benefit from its continued existence and suffer loss from its destruction. The policy-holder should have a
monetary relationship with the subject-matter.
The relationship between the policy-holders and the subject-matter should be recognized by law. In other words,
there should not be any illegal relationship between the policy-holder and the subject-matter to be insured.
Insurable interest is essentially a pecuniary interest, i.e., the loss caused by bad happening of the insured risk
must be capable of financial valuation. No emotional or sentimental loss, as an expectation or anxiety, would be
the ground of the insurable interest. The event insured should be one that if it happens, the party suffers
financially and if it does not happen, the party is benefited by the existence.
In life insurance, insurable interest must exist at the time of taking of policy. It may or may not exist at the time
of death of the insured. In the case of the fire insurance, insurable interest is necessary to exist both at the time
of taking the fire insurance policy as well as at the time when the loss is incurred, and a claim is filed with the
insurance company. In case of marine insurance the insured must have insurable interest in the insured object
only at the time of loss i.e. on the happening of the event insured against.
 Essentials of insurable interest

• There must be property, rights, interest, life, limb or potential liability

devolving upon the insured capable of being covered by a policy of insurance.
• Such property, rights, interest, life, limb or potential liability must be the
subject matter of insurance
• The insured must bear such relationship, recognized by law, to that subject
matter of insurance whereby he benefits by the safety of that subject matter
and is prejudiced by the loss, damage or destruction thereof.
Examples of insurable interest
• Owners: owners have got insurable interest to the extent of full value
• Part owner or joint owner: they have insurable interest to the extent of their part or
financial interest.
• Mortgagor/ Mortgagee: mortgagor, being the owner has insurable interest. Mortgagee,
though not owner, has insurable interest to the extent of the money advanced, plus
interest and an amount to cover up insurance.
• Bailees: they have got insurable interest because of a potential liability being created if
goods belonging to others get lost or damaged whilst in their custody.
• Carriers: like bailees, carriers also have got insurable interest because of a potential
liability being created if goods belonging to others get lost or damaged whilst in their
custody.
Examples of insurable interest
• Administrator, executors and trustees: they have insurable interest in view of
responsibility put on them by law.
• Life: one has insurable interest on one’s own life, life of spouse, parents, children
• Debtor and creditor: debtor has insurable interest on his own life but not on creditor’s
life. On the other hand, creditor has insurable interest on debtor’s life to the extent of
loan advanced, interest and something to cover up premium.
• Insurer: Insurer has insurable interest because of a potential liability undertaken from
the insured thus justifies the reinsurance
• Liability: the creation of potential liability justifies existence of insurable interest.
The best examples are public liability insurance and employer’s liability insurance.
 Principles of insurance contract
Indemnity
The principles of Indemnity implies that the insurer undertakes to put the insured, in the event of occurring of
insured risk resulting in loss to the insured, in the same position that he occupied immediately before the
happening of the event insured against. However, there are some exceptions such as life insurance, personal
accident and sickness insurance where the principle of indemnity does not apply. All the other insurance
contracts are the contract of indemnity where indemnity is the controlling principle of insurance law. This
implies that the assured in the case of loss against which the policy has been viewed shall be paid the actual
amount of loss not exceeding the policy value. The insured is thus not allowed to make any profit out of his loss
but will only be compensated. The assured will be fully indemnified but shall never be more than fully
indemnified.
• The amount of compensation will be the amount of insurance. Indemnification cannot be more than the
amount insured.
• If the insured gets more amount than the actual loss, the insurer has the right to get the extra amount back.
• If the insured gets some amount from the third party after being fully indemnified by the insurer, the insurer
will have the right to receive all the amount paid by the third party.
 Principles of insurance contract
Mitigation of loss
The principle of Mitigation of loss places a duty on the insured to make every effort and take all such
steps, in the event of some mishap to the insured property, to mitigate or minimize the loss, as would
has been taken by an uninsured person. The principle is included so as to check the insured to
become careless and inactive in the event of the mishap merely because the property which is getting
damaged is already insured. If the insured fails to take the reasonable steps to mitigate the loss, the
insurer can avoid the payment of loss as it occurred due to the negligence of the insured.
Causa proxima
Causa proxima means the nearest cause or the proximate cause or the most effective, dominant and
efficient cause. It is the real or actual cause of loss. If the cause of loss is insured, the insurer will
pay, otherwise the insurer will not pay. Insurer will not be liable for the losses caused by the
expected perils or by the misconduct of the assured or where the insured peril is a distant cause of
loss.
 Principles of insurance contract
Subrogation
The doctrine of subrogation refers to the right of the insurer to stand in the place of
the insured, after the settlement of a claim, in so far as the insured’s right of
recovery from an alternative source is involved.
The doctrine of subrogation, which is the outcome of the principle of indemnity and
applies only to fire and marine insurance, states that after the insurer has made good
of the loss to the insured, he is entitled to succeed to all the ways and means by
which the assured might have protected himself against the loss. Thus the insurer
for his own benefit comes to possess all the rights of the insured against third
persons as regards the subject matter once the claim is paid by the underwriter.
 Principles of insurance contract
Contribution
When the subject matter has been insured with different insurers, the principle of contribution
applies between different insurers. The main aim being to distribute losses equitably among different
insurers, who are liable under various policies of the same subject matter. This doctrine applies only
to contract of indemnity.
Warranties
There are certain conditions and promises in the insurance contract which are called warranties.
Warranty is a very important condition in the insurance contract which is to be fulfilled by the
insured. On the breach of warranty, the insurer becomes free from his liability. According to Marine
Insurance Act, “A warranty is that by which the assured undertakes that some particular thing shall
or shall not be done, or that some conditions shall be fulfilled, or whereby he affirms or negatives the
existence of a particular state of facts.” Warranties that are mentioned in the policy are called express
warranties.
 PRINCIPLES OF INSURANCE
Principle of co-operation
Insurance is based on the principle of cooperation. Co-operation was prevailing
from the very beginning up to the era of Christ. It is the duty of insurer to obtain
adequate funds from the members of society to pay them at the happening of the
insured risk. The share of loss takes the form of premium. All the insured give a
premium to join the scheme of insurance. In this way the insured are cooperating to
share the loss of an individual by payment of a premium in advance. Insurance is
pre-eminently social in nature. It represents, in the highest degree cooperation for
mutual benefit.
 PRINCIPLES OF INSURANCE

Principle of probability
The whole building of insurance science is based on the theory of probability, if we toss a coin we
are certain that it will come head upwards or head downwards. Our common sense tell us that the
probability of its coming up is half and of the tail coming upward is half the number of tosses. This
probability increases with the number of tosses. The chances of loss are estimated in advance to affix
the amount of premium. The loss in the shape of premium can be distributed only on the basis of the
theory of probability with the help of this principle the uncertainty of loss is minimized. The insurer
charges only so much of amount which is adequate to meet the losses. Pooling of a large number of
risks is very necessary for the successful operation of the theory of probability. The law of large
numbers is a sub principle of the principle of probability. According to the law of large numbers the
greater the number of exposures, the more nearly will the actual results obtained approach the
probable result expected with an infinite number of exposures.
 Insurance and wagering distinguished
1. Insurance contracts are legally valid contracts, whereas, gaming and wagering
contracts are void.
2. Utmost good faith is required to be exercised in insurance contract but it is not
applicable to gaming and wagering.
3. In insurance, insured event may take place or may not take place, or may take
place more than one( except life insurance); but in gaming and wagering, the event
will definitely take place and it will take place only once.
4. Indemnity applies to insurance, but in case of gaming and wagering, the person
winning gets back his stake along with a windfall gain.
5. In insurance, it is known a to which party is prone to risk or loss but, in gaming
and wagering it can not be known which party is going to win or lose.
 Void, voidable and unenforceable contract
Void: Void contracts are those which are contracts at all. They are destitute of any legal effect.
They can not be brought in a court of law for any action. Ex. Gaming and wagering as it is
illegal. In insurance contract, a policy taken by concealment or fraudulent misrepresentation or
an insurance contract not supported by insurable interest will be void.
Voidable: voidable contracts are those where minor breaches exist, e.g., breach of duty of
utmost good faith. In such situation, it is the option of the aggrieved party to decide whether
the contract is to be treated as valid. If the party decides so, the contract becomes good valid
enforceable contract. If the decision is otherwise, the contract becomes void. Therefore, it can
be said that a voidable contract shall remain valid until it is declared void by the party who has
suffered from the breach of contract.
Unenforceable: An unenforceable contract is a contract which cannot be enforced in a court of
law. These are very much valid contracts but simply can not be enforced in a court of law
because of the absence of some essential legal requirements or evidential features. Stamp Act
requires that insurance policies are to be appropriately stamped. If therefore, a policy is not
stamped, then even though the contract will be valid but such a policy can not be presented in a
court of law as evidence to contract.