Importance of These Principles in Insurance Policies
Before moving ahead, it's crucial to have a basic understanding of what insurance is first. Insurance is a financial arrangement that protects policyholders against unexpected losses by sharing risk among a large group of people. To maintain fairness and efficiency in insurance policies, insurers and policyholders must adhere to the principles of insurance. The principles of insurance establish trust, prevent fraud, and ensure smooth claim settlements. Here’s why each principle is important:
Principle of Utmost Good Faith:
The principle of utmost good faith is the foundation of an insurance contract as it ensures complete honesty between the insurer and the insured. It requires both the insurer and the insured to be honest and transparent about all relevant information. The insured must disclose all material facts, while the insurer must clearly explain the terms and conditions of the policy. It's important because:
- Prevents fraud and misrepresentation.
- Ensures that risks are accurately assessed.
- Protects both parties from future disputes.
Example:
Vani applies for health insurance but does not disclose her history of heart disease. Later, when she files a claim for heart surgery, the insurer denies it, as she withheld critical information. If she had disclosed her condition, she might have received coverage with adjusted premiums.
Principle of Insurable Interest:
This principle states that a person can only take insurance on something that directly affects their financial well-being. If the insured item or person suffers a loss, the policyholder must experience a financial setback. This is important because:
- Prevents people from taking advantage of insurance policies for personal gain.
- Ensures that insurance is purchased for genuine financial protection.
- Establishes legal ownership and accountability.
Example:
Aman cannot buy life insurance for his neighbour since he has no financial dependency on them. However, he can insure his spouse or business partner because their absence would impact him financially.
Principle of Proximate Cause:
The principle of proximate cause ensures that claims are only paid if the primary cause of loss is covered under the policy. If multiple causes contribute to a loss, the closest and most direct cause is considered to determine valid claims. This principle is crucial because:
- Prevents false claims unrelated to the insured risk.
- Helps insurers accurately assess liabilities.
- Ensures fair and just compensation.
Example:
A storm damages a warehouse, making it structurally weak. Before repairs could begin, an earthquake collapsed the building. If the warehouse was insured against storms but not earthquakes, the claim may not be honoured as the proximate cause was the earthquake.
Principle of Subrogation:
This principle prevents duplicate claims by transferring the insured’s rights to the insurer after compensation is provided. It allows insurance companies to recover losses from responsible third parties, reducing unnecessary financial burdens on insurers. Here’s why it’s important:
- Prevents policyholders from making financial gains from claims.
- Ensures responsible parties are held accountable.
- Helps insurance companies recover costs and keep premiums affordable.
Example:
Vamika’s car is damaged in an accident caused by another driver. Her insurer covers the repair costs and later sues the driver at fault to recover the amount paid.
Principle of Indemnity:
This principle ensures that an insured person is compensated only for the actual loss suffered, preventing them from making a profit from an insurance claim. This maintains the primary function of insurance as financial protection rather than a source of gain. This principle is vital because:
- Prevents policyholders from exploiting insurance for financial gain.
- Ensures fairness and integrity in insurance claims.
- Maintains affordability and sustainability of insurance policies.
Example:
If a shop owner insures their stock for ₹2,000,000 and a fire destroys goods worth ₹1,500,000, the insurer will only compensate them for ₹1,500,000, not the full insured amount.
Principle of Contribution:
If multiple policies cover the same asset, this principle ensures fair claim distribution among insurers. This prevents overcompensation and maintains the financial balance in the insurance sector. It plays a significant role as:
- Prevents excessive claims from multiple insurers.
- Ensures fair distribution of liability.
- Maintains balance in the insurance industry.
Example:
Sarah insures her house worth ₹60,00,000 with two insurers. Company A for ₹35,00,000 and Company B for ₹25,00,000. If a fire causes ₹24,00,000 in damage, both insurers will contribute proportionally based on their respective coverage amounts.
Principle of Loss Minimisation:
Policyholders are expected to take reasonable steps to prevent further damage after an insured event. This principle ensures that insurance is not misused as an excuse for negligence and encourages responsible behaviour. Why it’s important:
- Encourages responsibility and preventive measures.
- Reduces the frequency and severity of claims.
- Helps insurers maintain lower premium rates.
Example:
If a homeowner notices a gas leak, they must take immediate action to fix it rather than waiting for an explosion to occur and claiming insurance. This aligns with the principle of loss minimisation.
