7 Principles of Insurance Explained

Insurance principles are the foundational rules governing every insurance contract, designed to protect both the insurer and the insured. The seven core principles are: Utmost Good Faith, Insurable Interest, Indemnity, Contribution, Subrogation, Loss Minimization, and Proximate Cause.

These principles apply across life insurance, motor insurance, and property insurance, forming the basis of all policies. In India, they are supported by the legal framework of the Insurance Act, 1938, which regulates insurance practices and safeguards policyholder rights.

Together, these principles ensure that contracts are legally valid, claims are settled fairly, and neither party takes undue advantage of the other.

The fundamental principle of an insurance contract is that both parties must act in uberrima fides (Latin phrase meaning "utmost good faith") towards one another. This means that they must give each other clear and succinct information on the terms and conditions of the agreement. The insurer must disclose precise information about the contract, and the insured must supply all relevant information.

For instance, Rohan has purchased a health insurance plan. He did not declare that he was a smoker while buying the insurance policy. He later developed lung disease. Due to Rohan's non-disclosure of crucial information, the insurance company will not be responsible for any financial losses in this scenario.

Moreover, a life insurance policy cannot be challenged after 2 years from policy issuance as per Section 45 of the Insurance Act, 1938 unless any fraudulent act happens.

Insurable interest refers to the subject matter for which an insured enters an insurance contract. The principle dictates that the policyholder must have a lawful, financial stake in the person or property being insured.

For instance, you can purchase property insurance to safeguard your home, but not the neighbour’s property. The insured can only claim the insurance amount when he owns the subject matter while entering the contract, as well as during the loss or damage.

Similarly, in life insurance, the insurable interest is the spouse, children, business partners, or creditor-debtor. Additionally, in general insurance, the insurable interest is the property owner, lessee, or mortgagee.

As per the Indian Contract Act, 1872, an insurance contract without any insurable interest is void and can lead to a wagering agreement. Additionally, Section 7 of the Indian Contract Act, 1872, states that for a proposal to be converted to a promise, the acceptance must be absolute and unqualified, along with being expressed in a usual and reasonable manner.

Insurable interest should exist at a particular time, as per the type of insurance you purchase. For instance, in life insurance, insurable interest should exist during inception. Again, for property insurance, it should exist when the property gets damaged.

As per the principle of indemnity in insurance, the insured will not be able to get any profit from the insurance contract, as it is purchased only to cover the loss. So, the insured will only receive compensation for the loss incurred and nothing more than that.

The indemnity principle sets the insured back to their existing financial condition as before the loss took place. It prevents profiting from insurance. This principle is not applicable to life insurance but plays a crucial role in general insurance contracts (motor, property, and health).

For instance, a car owner enters an insurance contract with the aim of recovering the expenses for any damage or loss caused to the vehicle in future. If the insured car, which is worth 5 lakh, suffers structural damage due to fire, the insurer will reimburse the owner for the exact amount spent on repairs.

The insurance company will provide indemnity in the form of cash, repair, replacement, or reinstatement.

The principle of subrogation refers to the act of one person acting on behalf of another. According to this theory, ownership of the subject matter passes to the insurer once the insured, or the individual, has received compensation for the loss he suffered on the insured subject. Subrogation grants the insurance company the ability to demand payment from the third party that caused the loss.

For example, Rahul met with a car accident due to the careless driving of a third person. The firm that provided Rahul with accidental insurance will reimburse him for his losses and file a lawsuit against the third party to recover the money paid as a claim.

The principle of subrogation is applicable for general insurance only when the condition is indemnity-based, i.e., the insurer can only recover the exact amount they have paid, not more than that.

When an individual (insured) purchases multiple insurance policies for one subject matter, the principle of contribution in insurance is applicable. This principle is similar to the principle of indemnity, which states that an insured cannot get coverage for the loss of the same subject matter from different insurance companies or policies.

Similarly, in the principle of contribution, you can claim the coverage amount from multiple insurance companies, but it should not exceed your actual loss amount.

For instance, a property is insured with a coverage amount of 50 lakh with two companies. Now, if the property incurs a loss of 40 lakh, the insured can either claim the full amount from any insurer or claim 20 lakh from each insurer for the same subject matter, same insured, same peril, etc.

The principle of proximate cause in insurance (causa proxima) or the nearest cause, is applicable when loss occurs due to two or more reasons. As per this principle, the insurance company will look for the nearest cause for which the property is damaged or faces loss.

The company is liable to compensate for the loss if the proximate cause is one of which the property is insured against, and if it is not the cause of the loss, then the insurer will not compensate.

For instance, a building's window was destroyed by a storm, and rain damaged the goods in it. Thus, the storm is the proximate cause of damage in this case, and since it is included in the coverage clause, the insurer will compensate.

Again, if fire breaks out due to an earthquake and a building is damaged by fire, the proximate cause is fire in this case. Since fire is included in the coverage clause, the damage will be covered by the insurance company.

The insurance company goes through the chain of events to find the proximate (closest) cause of damage and provides coverage for a single cause only.

As per the principle of loss minimisation, the insured should take the required steps to minimise the damage or loss caused to the insured property. This principle is anticipated on the idea that it is the insured's duty to take reasonable and necessary actions to prevent or lessen the loss or damage to the insured property after an accident.

All insurance plans, including life insurance plans, liability, and property insurance, are subject to the loss minimisation concept. When purchasing property insurance, the policyholder is required to take safety measures to prevent loss or damage to the insured property.

For instance, if your house catches fire, you should call the fire brigade to protect it from further damage. Additionally, in case of a flood affecting your warehouse, you need to relocate the undamaged stock to a dry area to avoid damage.

All the 7 principles of insurance play crucial roles in managing and forming different types of insurance plans. Now that you are aware of each of the principles, here’s a brief overview of each of them for better understanding:

There types of insurance for which all seven principles are applicable, but there are exceptions. So, it is necessary to identify which principles apply to each insurance type to avoid confusion.

Here is a representation of the applicability of different principles of insurance in life insurance, general insurance, and health insurance:

The principles of insurance play crucial roles in claim rejection or approval. If the principles are not followed by an insured, the insurance company may reject their claim. Therefore, it is necessary to understand how your insurance claim is affected by these principles.

Here are 3 real-life scenarios to represent the insurance claim principles effectively:

Policyholders as well as insurance companies should follow the principles of insurance to maintain transparency and legality. If an insured does not follow these principles accurately, they may face claim rejections. On the other hand, following these principles can be beneficial for the insured in many ways.

In this regard, here are some insurance tips that every insured individual must follow:

• It is essential to disclose all your insurance risk-related information to the insurer to maintain the principle of utmost good faith. Not disclosing crucial information like pre-existing health conditions or lifestyle-related details (alcohol consumption or smoking) can lead to claim rejection.
• An insured individual should document their insurable interest to ensure that they are insuring the right subject matter.
• Don’t claim a higher amount than the actual loss, as this can lead to claim rejection. So, the insured should understand their indemnity limits and act accordingly.
• Try to protect your insured subject matter to minimise the impact of damage or loss. Always take photos of the damage after an incident takes place as proof.
• Do not sign away the subrogation rights without knowing all the aspects clearly. This can affect your claim settlement procedure.
• In case a subject matter is covered by two insurance policies, always claim contributions from both to maintain the principle of contribution.

The 7 principles of insurance are something more than just theoretical concepts. These principles directly influence the claim settlement, policy validity, and financial protection of your insurance policy. They help maintain a balance between the insured and insurer through prevention of overcompensation, ensuring transparency, and more.

You can make informed insurance decisions by understanding these seven principles effectively, along with avoiding claim rejections. These principles are applicable to all types of insurance. So, whether you buy health insurance, life insurance, or general insurance, always follow these principles to stay compliant.