Principles of Insurance

Contract and Insurance Interest
Chapter - 02
A legally enforceable agreement. Contracts comprise promises or
undertakings, usually given in exchange for a promise or
undertaking from the other side: Therefore, an insurance policy in
itself is not a contract; instead it is the most commonly used
evidence of an insurance contract
Elements or Essentials of a Contract
1 Void (or invalid) contracts: This means that the proposed contract
does not exist in law; it is entirely without legal effect. In the
context of insurance, the implication is that generally all premiums
which have already been paid under a void contract (or invalid
agreement) are returnable; so are claims paid.
2. Voidable contracts: A voidable contract is one that is apparently
of legal effect and that remains to be legally effective unless and
until an aggrieved party to the contract treats it as void as from
contract conclusion within a reasonable time after acquiring
knowledge of the availability of such a right of election.
3. Unenforceable contracts: This means what it says, an unenforceable
contract cannot be enforced (or sued on) in a court of law.
However, this is not because it is void, but because some required
action has not been taken (e.g. stamp duty not paid on a lease of
land, marine insurance policy not issued, etc.
Agency is the relationship which exists between a Principal and his
Agent. An agent in this context is a person who represents a
principal. Insurance Agents (usually representing the insurer) or as
Insurance Brokers (usually representing the insured/proposer)
Duties Owed by Agent to Principal:
(a) Obedience: The agent has to follow all lawful instructions of his
principal, strictly or as best as is reasonably possible.
(b) Personal performance: The agent is not allowed to delegate his
authority and responsibilities to others (subagents) unless he has
authority to do so.
(c)Due care and skill: The law does not demand perfection, and an
agent is normally only required to display all reasonably expected
skills and diligence in performing his duties.
(d)Loyalty and good faith: The agent’s obligations of loyalty and
good faith are governed by several strict rules of law.
(e)Accountability: The agent has to account for all moneys or other
things he receives on behalf of his principal. He also has to keep
adequate records relating to the agency activities
Duties Owed by Principal to Agent
(a) Remuneration: The agent is entitled to receive commission or
other remuneration (such as bonus) as agreed. This the principal
has to pay within a reasonable time or any specified time limit, as
the case may be.
(b) Expenses: The principal, subject to any express terms in the
agency agreement, has to reimburse the agent for costs and
expenses properly and reasonably incurred by the agent on behalf
of the principal; e.g. legal defence expenses paid by a claims settling
(c) Breach of duty: The agent may take action against the principal
for the latter’s breach of obligations to him.
• Insurable interest is a person’s legally recognised relationship to the
subject matter of insurance that gives them the right to effect
insurance on it. Since the relationship must be a legal one, a thief in
possession of stolen goods does not have the right to insure them.
Importance of Insurable Interest
• An insurance agreement is void without insurable interest. The
rules relating to return of premiums under such an agreement vary
as between the different classes of insurance
• Its Essential Criteria
For insurable interest to exist, the following criteria must be
(a) there must be some person (i.e. life, limbs, etc.), property,
liability or legal right (e.g. the right to repayment by a debtor)
capable of being insured;
(b) that person, etc. must be the subject matter of the insurance
(that is to say, claim payment is made contingent on a mishap to
such person, etc.);
(c)the proposer must have the legally recognised relationship
to the subject matter of insurance, mentioned in 3.1.1 above,
so that financial loss may result to him if the insured event
How It Arises
• Insurance of Interest :Everyone has an insurable interest in his
own life, limbs, etc. One also has an insurable interest in the life of
one's spouse. Further, one may insure the life of one's child or ward
• Insurance of Property:
The most obvious example arises in absolute ownership. Executors,
administrators, trustees and mortgagees, who have less than
absolute ownership, may respectively insure the estate, the trust
property and the mortgaged property.
• Insurance of Liability:
Everyone facing potential legal liability for their own acts or
omissions may effect insurance to cover this risk (sometimes
insurance is compulsory), such liability being termed ‘direct
liability’ or ‘primary liability’ Insurance of Legal Rights
Ordinary Good Faith:
Meaning that the parties have to behave with honesty and such
information as they supply must be substantially true. However, it is
not their responsibility to ensure that the other party obtains all
vital information which may affect his decision to enter into the
contract, or may affect the terms on which he would enter into the
Utmost Good Faith:
Insurance is subject to a more stringent common law principle of
good faith, often called the principle of utmost good faith. It means
that each party is under a duty to reveal all vital information (called
material facts) to the other party, whether or not that other party
asks for it
Material Fact
Every circumstance which would influence the judgment of a
prudent insurer in fixing the premium, or determining whether he
will accept the risk’.
Facts that need not be disclosed:
(i) Matters of common knowledge (e.g. the explosive character of
(ii) Facts already known, or deemed to be known, to the insurer (e.g.
the problem of piracy in Somalia);
(iii) Facts which diminish the risk.
[Example: A proposer for commercial fire insurance did not
mention the fact that his premises were protected by an automatic
sprinkler system
Types of Breach of Utmost Good Faith
(a) Fraudulent Misrepresentation: an act of fraudulently giving false
material facts to the other party;
(b) Non-fraudulent Misrepresentation: an act of giving false
material facts to the other party done either innocently or
(c) Fraudulent Non-disclosure: a fraudulent omission to give
material facts to the other party; or
(d) Non-fraudulent Non-disclosure: an omission to give material
facts to the other party done either innocently or negligently
Indemnity means an exact financial compensation for an
insured loss, no more no less.
• Indemnity cannot apply to all types of insurance. Some types
of insurance deal with ‘losses’ that cannot be measured
precisely in financial terms. It is sometimes said that life and
personal accident insurances involve benefit policies rather
than policies of indemnity.
How Indemnity is Provided
(a) Cash payment (to the insured): This is the most convenient method,
at least to the insurer.
(b) Repair: Payment to a repairer is the norm, for example, with motor
partial loss claims.
(c) Replacement: With new items, or articles that suffer little or non
depreciation, giving the insured a replacement item may be a very
suitable method, especially if the insurer can obtain a discount from
a supplier.
(d) Reinstatement: This is a word that has a number of meanings in
insurance. As a method of providing an indemnity, it means the
restoration of the insured property to the condition it was in
immediately before its