Principles of Life Insurance
Some Basic Terms
Peril – an event or incident that may cause a
loss, e.g. fire, theft, flood, earthquake
Risk – possibility of adverse results flowing
from any occurrence
if perils can cause damage to an asset , we
can say the asset is exposed to that risk
Hazard – a condition that may create or
increase the chance of a loss
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Risk
• Risk means that there is a possibility of
loss or damage
• When an event is possible, it has a
probability between zero and one
• If the loss of value is intended or if it is
certain, it is not a loss
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Degree of risk
• The greater the uncertainty, the greater is
the risk
• Higher the probability of loss, greater is
the risk
• The mathematical value of a risk at any
point of time , is the probability of the loss
multiplied by the amount of potential loss
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• Insurance covers only those risks where
the possibility of occurrence is uncertain.
• If it is certain then that risk will not be
covered
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Hazard
Hazards - different categories
Physical hazard – physical conditions that
increase the chance of loss from any peril
Moral Hazard –increase in the probability of loss
that results from dishonesty in the character of
the insured person
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Pure & Speculative risks
• Pure risk – situations that involve the
chance of loss or no loss
• Speculative risk – a situation where
there is possibility of gain also
• Only pure risks are insurable
• Speculative risks are not insurable.
Speculative risk is voluntarily accepted
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Personal risks
Some basic pure risks an individual has
to face –
 premature death
 dependent old age
 sickness & disability
 unemployment
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Property risks
• Loss of the property
• Loss of use of the property
• Additional expenses occasioned by the
loss of the property
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Methods of handling Risks
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Risk may be avoided
Risk may be transferred
Risk may be shared
Risk may be reduced
Risk may be retained
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Insurance is defined as the
equitable transfer of the risk of
a loss, from one entity to
another, in exchange for
payment
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Insurance
Insurance has 2 fundamental characteristics
 Transfer of risk from one individual to a
group
 Sharing losses, on some equitable basis,
by all members of the group
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Probability theory & Law of large
numbers
• Probability theory is that body of
knowledge concerned with measuring the
likelihood that something will happen and
making estimates on the basis of this
likelihood
• Law of large numbers- the frequency with
which an event happens reflects the actual
probability of the event occurring more
closely if the cases involved are larger
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Dual application of
the law of Large numbers
The requirement of a large number has dual
application:
a) To estimate the underlying probability
accurately, the insurance company must
have a sufficiently large volume of data
b) Sufficiently large number of contracts
must be entered into avoid possible
losses as a result of small volumes
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Basic Principles
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• Insurance policy is a contract as per
Indian Contract Act 1872
• A contract may be defined as an
agreement between two or more parties
to do, or no to do , so as to create a
legally binding relationship
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Essentials of a valid contract
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Offer and acceptance
Consideration
Capacity to contract
Consensus ad idem( genuine meeting
of minds)
• Legality of object or purpose
• Intention to create legal relations
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• Insurance is a contract between
a) the insurance company and
b) the policy holder
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• According to the insurance contract:
the insurance company agrees to pay the
policyholder a certain sum of money( sum
assured)
If the event specified in the insurance
contract happens
provided the policyholder has been paying
the premium as specified in the insurance
contract
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• Insurance is a specialized type of
contract
• Insurance contracts are subject to two
additional principles apart from the
usual essentials of a valid contract
Principle of Utmost Good Faith
and
Principle of Insurable Interest
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Principle of Insurable Interest
• A person is said to have an “ insurable
interest” when they stand to gain or benefit
from the continued existence and well
being of the person or property insured
and would suffer a financial loss if there is
a damage to the person or property.
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Principle of Insurable Interest
• It forms the legal basis for deciding
whether insurance can be taken or not
• The relationship of the insured with the
subject matter should be recognized by
law
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• Risk of losing in bets, horse race etc,cannot
be insured
• Such contracts are called wagering contracts
• Section 30 of Indian Contract Act declares
wagering contracts as void
• What distinguishes a wagering contract from
insurance contract is that the insured must
have insurable interest in the subject matter
of insurance
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Subject matter of insurance
• Building, stock or machinery in fire
insurance, life being insured in life
insurance, ship or cargo in marine
insurance
• It is not the house, stock, ship, cargo or
life that is insured but it is the
pecuniary interest of the insured in that
house, stock, ship, cargo etc which is
insured
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Essentials of insurable
interest
• There must be some property, right, life,
liability etc. capable of being insured
• It is this property, right, life etc. which
must be the subject matter of the
insurance
• The insured must stand in a relationship
with the subject matter of insurance
• The relationship between the insured and
the subject matter of insurance must be
recognized by law
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• Insurance Act 1938 does not define
insurable interest
• Court judgments have established the
circumstances in which insurable
interest is deemed to exist
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Application of Insurable
interest in Life insurance
• Every person has an unlimited insurable interest in
his or her own life
• Unlimited insurable interest on the life of his/her
spouse
• Partners in business has insurable interest on the
life of copartner to the extend of partnership amount
• Creditor has insurable interest on the life of debtor
the extent of the debt
• Employer has insurable interest in his employee to
the extend of the value of his services
• Employee has insurable interest in the life of his
employee
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Features of Insurable
interest
• Life: Insurable interest need be present at
inception of the insurance, need not be
present at the time of claim.
• Marine: The insured must be interested in the
subject matter at the time of loss. Need no
insurable interest when the insurance is
effected
• Other insurances: There must be insurable
interest at inception and at time of loss
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Insurer's insurable interest
• Having assumed liability under policies
which they issue, insurers derive
insurable interest from that liability
• Insurer may insure with another insurer
part or all of the risk they have
assumed- through Reinsurance
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Principle of Utmost Good Faith
• Let the buyer Beware (principle of
caveat emptor) – Commercial
contracts are subject to this doctrine
• Each party is able to examine the
item or service which is the subject
matter of the contract
• There is no need to disclose
information, which is not asked for
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Principle of Utmost Good
Faith
• also called- Principle of Uberima
fides
• In insurance , the product is
intangible one
• Circumstances surrounding the
subject matter are known by one of
the parties, namely proposer
• Only proposer knows all the relevant
facts about the risk being proposed
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Principle of Utmost Good
Faith
• The law imposes greater duty on the
proposer to reveal all material facts to
the insurer, without being asked, to
correctly evaluate the risk
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Principle of Utmost Good Faith
• A definition- A positive duty voluntarily to
disclose ,accurately and fully, all facts
material to the risk being proposed, whether
requested or not.
• Material facts – Every circumstance is
material which would influence the judgment
of a prudent insurer in fixing the premium or
determining whether he will take the risk.
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Facts which must be
disclosed
• Any circumstances which would
influence the insurer accepting or
declining a risk or in fixing the premium
or terms and conditions of the contract
• A fact which was immaterial when the
contract was made , but becomes
material later on need not be disclosed
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Facts which must be
disclosed
• Facts which increases the risk exposure
• External factors which make the risk greater
than normal
• Any declinature or special terms on previous
proposals
• The existence of other policies
• Full facts relating to the description of the
subject matter of insurance- e.g. . Age, previous
medical history, occupation, smoking / drinking
habits.
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Facts which need not be
disclosed
• Facts of law
• Facts of common knowledge
• Facts which could reasonably be
discovered, by reference to records
available with the insurer
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Common law
• The duty to disclose ends when the
contract is formed
• No need to disclose changes while the
contract is running
• No duty of disclosure operating at
renewal
• At the time of alterations in the terms of
contract, there is a duty to disclose all
material facts relating to the alteration
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Breach of duty of Utmost Good
Faith
Arise under one or both of the following
a) misrepresentation, which may be
either innocent or fraudulent
b) non-disclosure, which may be
innocent or fraudulent
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• Declaration by the proposer at the end
of the proposal form, turns the
representations in the proposal in to
warranties, which must be complied in
toto.
• If any mis representation or non
disclosure is there in the proposal form
the contract becomes null and void
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Section 45 of Insurance Act 1938
• The insurer's right to cancel the
contract is limited by the provisions of
section 45 of Insurance Act
• This section stipulates that a policy
cannot be called in question after 2
years , on the grounds of inaccurate or
false statement, unless it is proved to
be material and fraudulent.
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Principle of Indemnity
• The principle of indemnity is an insurance principle
stating that an insured may not be compensated by
the insurance company in an amount exceeding the
insured's economic loss
• Insurance is meant to compensate loses
• Insurance cannot be used to make a profit
• Financial compensation sufficient to place the
insured in the same financial position after a loss as
he enjoyed immediately before it occurred.
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• Principle of indemnity also makes sure
that the insured person does not make a
profit from insurance by making the same
claim with two insurance companies
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Principle of Indemnity & L.I
• There is a link between indemnity and
insurable interest
• It is the interest of the insured in the subject
matter of insurance that is insured
• The amount of claim cannot exceed the
extend of insurance
• Since in L. I., the insurable interest is
unlimited on one’s on life, the principle of
indemnity does not apply
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Principle of Indemnity & General
Insurance
• The principle of indemnity is applicable
in General Insurance
• Because of this there could be
difficulties in settling claims in GI
• Assessment of loses made by qualified
surveyors are often disputed
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Principle of Subrogation &
Contribution
• These 2 principles are corollary to the
principle of indemnity
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Principle of subrogation
• Ensures 2 things
1. Having paid the claim, the insurance co.
gets the right to make good the damages
from the party who caused the loss
2. Having been indemnified by the insurer,
the insured does not retain the right to be
compensated by the party who caused
the lss
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Principle of Contribution
• Ensures 2 things
1. Insured does not profit by making
separate claims from multiple companies
for the same event
2. Each insurer pays only their proportionate
share of loss
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JP
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