Principles of Insurance,
Core Functions
of an Insurance Company
CM20430 Principles of Insurance Team B
Agenda
• 5 Questions
• 12 MC questions
• Q&A
#1
What are the six essential
principles of insurance?
Indemnity
Insurable
Interest
Utmost
Good
Faith
Proximate
Cause
Subrogation
Contribution
4
• The essentials of insurable interest
Insurable
Interest
– must be the subject matter of the
insurance
– There must be life or limb, property,
potential liability, right or financial
interest capable of being covered
– The insured must be in a legally
recognized relationship with the
subject matter of the insurance,
whereby he benefits from its
continued safety or the absence of
liability and is prejudiced by its
damage or destruction, or the creation
of liability
5
Utmost
Good
Faith
• Each party to a proposed contract is
legally obliged to reveal to the other all
vital information which would influence
the other’s judgment, whether such
information is requested or not
• It has been said the utmost good faith
requires each party to tell the other “the
truth”
• the whole truth and nothing but the
“truth” about the proposed contract. It is
important to note that, unlike the
situation in the law courts, such an
obligation is not applicable merely to any
questions asked.
• Failure to reveal vital information, even if
not asked about it, gives the aggrieved
party the right to regard the contract is
void
6
Indemnity
• Indemnity may be defined as an
exact financial compensation.
• Indemnity restores the insured to
the same financial position after a
loss as he/she enjoyed immediately
prior to the loss.
• This is in accord with the basic
concept of finance , which is to
compensate the unfortunate for the
loss they have sustained, but which
is not intended to provide profit
from misfortune
7
Indemnity
• Indemnity cannot apply to every class of
business.
• With virtually all life and personal
accident contracts it is impossible to
provide an exact financial compensation
in respect of claims, because life, limbs
and health cannot be precisely measured
in financial terms.
• Life and personal accident contracts are
therefore termed benefit policies, in the
sense that they cannot indemnify, but
only pay a certain benefit if the insured
event happens.
8
Proximate
Cause
• The active, efficient cause that sets in
motion a train of events which bring
about a result, without the intervention
of any force started and working actively
from a new and independent source
• The dominant, effective cause must be
singled out as one which produced the
result
• The insurers is not liable for any loss
unless the proximate cause was an peril
• Cause of loss
– Must be reasonable
– Established before insurers are
considered liable
9
• Contribution is the doctrine which enables
an insurer to call upon other insurers
similarly (but not necessarily equally) liable o
the same insured to share the cost of an
indemnity payment.
• It arises where there is an “overlap” of
insurances, so that an insured is covered
more than once in respect of the same loss.
Contribution
• Subrogation is concerned with the rights of
recovery against third parties or elsewhere in
respect of payment of an indemnity
• need not involve any other insurance,
although it frequently does.
• Contribution necessarily involves more than
one insurance, each covering the interest of
the same insured.
10
Subrogation
• Subrogation means the exercise, for one’s
own benefit, of rights or remedies
possessed by another against third
parties.
• If the rights or remedies have already
been exercised, subrogation entitles one
to the proceeds there-from.
• Subrogation rights are acquired by
insurers once they have provided their
insured with an indemnity
• Common law
– any actions to recover from third
parties must be conducted in the
name of the insured.
11
#2
Distinguish between void,
voidable and unenforceable
contracts.
Void Contract
• Entirely without legal effect.
e.g. Breach of Utmost Good Faith:
Premiums
Insured
Claims
Insurer
Returnable
13
Voidable Contract
• Temporary
Situation
• may treat as void
by the aggrieved
party in certain
time.
• E.g. Non- disclosure the
related medical history
when proposing a
critical illness policy.
Usually happen…
At proposal stage,
important
information was
omitted or
wrongly given
14
Voidable Contract
Remedies:
• premium
• sum insured
• Impose
excepted peril
• Reject
the
proposal
• Void and refund
15
Unenforceable Contract
• It is not because it is void
• It require some action to become enforceable
Unenforceable
Contract
required
action
Valid
Contract
stamp duty not paid
on a lease of land
Marine
insurance
policy not issued
16
#3
When must insurable interest
exist in marine, life, fire and
accident insurance?
• Insurable interest is a person’s
legally recognized relationship to
the subject matter of insurance
Definition
• Gives them the right to effect
insurance on it
• The relationship must be a legal one
• E.g. a thief in possession of stolen
goods does not have the right to
insure them
18
Condition
of
existence
For marine,
• Marine Insurance Act 1906
• Insurable interest is only needed at
the time of loss
• Need not exist when the
insurance is effected
19
Condition
of
existence
For life insurance,
• Life Assurance Act 1774
• only needed at policy inception
20
For fire and accident insurance,
Condition
of
existence
• Exist when the insurance contract
was effected
• Need not exist at the time of loss
21
#4
Why does utmost good faith
apply in insurance?
• It means all parties to
an insurance contract
#4.1
What is
Utmost
Good
Faith?
disclose all
material facts
must
no matter it asked by
the other party or not.
Any fact which would
influence the judgment of an
insurer in fixing the premium
or determining whether to
accept the risk is a material
fact.
23
Insurance Contracts Act 1984
Originally
the duty of
utmost good
faith was a
common law
concept which
applied directly
to contracts of
insurance.
the Act states ‘a contract of
insurance is based on the
utmost good faith and
there is implied in such a
contract a provision
requiring each party to it to
act towards the other party,
in respect of any matter
arising under or in relation
to it, with the utmost good
faith.’
24
Non-disclosure
Misrepresentation
• A fact influencing the
underwriting decision is not
disclosed in the proposal
• Withholding information or
providing incorrect
information while answering
questions in the proposal
• e.g. when an applicant who form
is suffering from kidney
failure answers in the
• When an applicant states
negative to a question on
that he is salaried but does
kidney ailment, it is non
not mention that his job is
disclosure of material fact.
highly hazardous, it is a
misrepresentation.
25
#4.2
How does “Non
disclosure” or
“Misrepresenta
tion” affect
insurance?
•
Insurance is sharing of risk by creating a pool of
funds out of the premium paid by the policyholders.
•
This means that when a claim arises, the payout
takes place from the common fund which belongs to
all the policyholders. Therefore, an Insurer has a duty
to protect the interests of the policyholders at large
and cannot pay fraudulent(dishonest) claims out of
the common fund thereby penalizing the other
policyholders.
•
Based on this principle, claim can be repudiated by
the insurer on account of non disclosure or
misrepresentation. In legal terms, if one party
commits breach of contract by not maintaining the
declaration (in the proposal form) of having replied
truly and correctly, the insurer is not liable to honor
the claim.
26
#4.3
Ensure the
insurer and
proposer’s
interest
• e.g. An individual contracting a life insurance policy
should hold as guiding principle the doctrine of
utmost good faith.
 means that the individual will not withhold
information pertaining to his/her present and past
medical conditions.
 And because this doctrine works both ways, it also
requires the insurers that when they sell the life
insurance, they need to inform the buyer of aspects
of the insurance itself and also to explain every detail
so that someone purchasing a life insurance knows
exactly what he/she is buying and what to expect.
27
28
#5
Differentiate between the
subject matter of the
insurance and the subject
matter of the contract
Subject
matter of
insurance
• It stand for some elements of special
contract relating to insurance, which
• Insurance company promise to insure
and bear the risk of the life assured
• Cover the financial loss of the life
assured
• It involves,
1.
2.
3.
4.
Person (Life / Endowment policy)
Property
Liability
Legal rights
30
Subject
matter of
the
contract
• It stand for the goals of the life assured
• Elements and requirements of the
insurance policy
• It involves,
1. Insurable interest
2. Utmost good faith
3. Indemnity
4. Subrogation
31
insurance
Object
Difference
Something or
some peoples
being insured
Examples •Life
•Physical
property
- Motor car
- House
contract
Insurable interest
from that insurance
policy
•A person was
guaranteed with an
insurable interest
•when loss-of/
damage-to
•cause financial loss
or other legal loss.
32
James purchased a insurance policy from the
Manulife in order to protect his house. He
could claim from the Manulife when any
contingencies occurs against his house, such as
fire.
Example
• Purchasing insurance policy to due with
unforeseen contingency
insurable interest
subject matter of contract
• Property (HOUSE)
subject matter of insurance
33
MC Questions
1
• Which of the following
statements is correct?
A. Spouse,
Child or Ward <18
A. insurable interest is not
possible in the life of
B. Agent, Principal’s
another;
property
B. bailees have an insurable
interest in the property C. Third Party Property
Damage, not named
of their bailors;
insured
C. liability policies can only
cover the named insured;
D. Debtor’s life
D. a creditor cannot insure
the life of his debtor.
IIQE Study Notes 1, 3.1.3, 3.1.4
35
• With which of the
following is there a valid
insurable interest?
A. a man wishes to insure
his wife;
B. a man wishes to insure
his brother;
C. a company wishes to
insure counterfeit
computer software;
D. smugglers wish to insure
goods against seizure by
customs.
IIQE Study Notes 1, 3.1.3, 3.1.4
2
subject matter of
insurance is…
A. legally recognized
B. Not legally recognized
C. Illegal
D. Illegal
36
3
• The duty of utmost
good faith applies:
A. to both the proposer
and the insurer;
B. only to the proposer;
C. only to the insurer;
D. only in the first year of
the insurance policy.
IIQE Study Notes 1, 3.2.2
• It is duty to each party
to reveal vital
information to the other
party when
– Policy application
– Policy is in effect
– Contract alterations /
Risk changes
– Contract renewal
– Until termination
37
• A material fact is one:
A. that the reasonable
policyholder would think
to be important;
B. which would influence
the mind of a prudent
underwriter;
C. only has to be disclosed
if a specific question is
asked;
D. which will only affect
property insurance.
IIQE Study Notes 1, 3.2.3
4
Every circumstance which would
influence the judgment of a
prudent insurer in fixing the
premium, or determining whether
he will accept the risk
A. It is also think to be
important to insurer
B. 
C. It should be disclosure
even it is not asked
D. All kinds of insurance
38
5
• Which of the following
facts must be disclosed?
A. matters of common
A.
knowledge;
B.
B. facts which increase
C.
the risk beyond normal;
D.
C. facts which decrease
the risk below normal;
D. matters covered by a
policy warranty.
IIQE Study Notes 1, 3.2.3
Non-material facts
Material facts
Non-material facts
Non-material facts,
deemed to be known
to insurer
39
• Indemnity is a principle
that:
A. is unrelated to
insurable interest;
B. promises to pay the
sum insured with all
total losses;
C. settles partial losses on
a proportional basis;
D. seeks to give an exact
financial compensation
IIQE Study Notes 1, 3.4
6
A. It is linked with
insurable interest
B. X, average underinsurance
C. X, life insurance
D. Financial
compensation must be
exact
40
7
• A policy franchise:
A. will pay larger claims in
full;
B. will deduct the stated
amount from every
claim;
C. is exactly the same as a
policy excess;
D. is another name for a
policy deductible.
IIQE Study Notes 1, 3.4.7
41
8
• The principle of
subrogation:
A. is a corollary of the
principle of indemnity;
B. is unconnected with the
principle of indemnity;
C. allows the insured to
recover more than he
has lost;
D. can apply to all
insurance claims.
IIQE Study Notes 1, 3.6
A. 
B. X
C. X, subrogation arising
after abandonment
allow insurer to make
profit (after sufficient
compensation to
insured.)
D. X, subrogation can
only apply if indemnity
applies
42
• The principle of
contribution:
A. is a corollary of the
principle of indemnity;
B. has no relationship with
the principle of
indemnity;
C. is where the insured and
a third party policy each
cover a loss;
D. relates to situations
involving underinsurance.
IIQE Study Notes 1, 3.5.1,3e
9
A.  ,it apply only when
indemnity applies
B. X
C. each must be providing
an indemnity, cover the
same interest, peril,
subject matter of
insurance and loss
D. Related to Double
insurance
43
• The doctrine of proximate
cause:
A. determines whether a
particular risk is
insurable;
B. determines whether or
not the insured has
committed fraud;
C. is trying to find out the
primary cause of a loss;
D. is trying to discover the
final cause of a loss.
IIQE Study Notes 1, 3.3
10
A. It is decided by insurer
B. utmost good faith
determines that
C. The proximate cause of
a loss is its effective or
dominant cause.
D. X
44
• The proximate cause for a
given loss:
A. is not necessarily the
cause immediately
before the loss arises;
B. is always the cause
nearest the loss in time;
C. may only have an
indirect bearing upon
the loss;
D. must not arise from an
excepted peril.
11
A. 
B. X, not related to the
loss in time
C. X, there can be direct
bearing
D. X, It can or can arise
from excepted peril
but may not insured.
45
12
• In a car accident case, the
third person’s
carelessness caused the
incident. In this situation,
which type of insurance is
subrogation used?
A. life insurance;
B. personal accident
insurance;
C. car insurance;
D. all of the above.
A. Subrogation can not
apply in life insurance
and personal accident
insurance
B. X,
C. , there is an
indemnity
D. X
46
References
• http://goo.gl/mtAc
• http://goo.gl/qC8W
• http://goo.gl/LFri
• IIQE study notes 1 principle of
insurance, 2004.
47
Q&A
48