The 7 Principles of Insurance

Insurance, typically, is a contract between an entity or person seeking financial protection from unexpected events and insurance companies. The choice to get an insurance policy is opting for security and peace of mind to channelize focus towards other things like health, business operations, product innovation, etc. Typically, the insurance policy is a legal document where the insurer promises the insured policyholder of financial security in case of any unfortunate events incurred according to the policy. This contract is primarily based on certain fundamental principles of insurance which will be discussed here.

What Are the Principles of Insurance?

The insurance policy is a legal contract bonded to shield the insured policyholders curated with certain principles of insurance to support both the parties. The 7 principles of insurance for streamlined functioning of the policy are:

• Insurable Interest
• Utmost Good Faith
• Proximate Cause
• Indemnity
• Contribution
• Subrogation
• Loss Minimization

The 7 Fundamental Principles of Insurance

The insurance company and insured policyholder need to curate and implement the insurance policy with the 7 Principles of Insurance which acts as a rulebook with guidelines. Let’s study each of the principles of insurance as follows:

Insurable Interest:

The principle of ‘insurable interest’ iterates the prevalent financial (insurable) interest the policyholder should have in the subject matter. This signifies that in any unprecedented event, the policyholder or insured would have financial benefits based on the policy and compensate for incurred losses as a result of damage caused to the subject matter. Further, the validity of the policy lasts till the insured has complete ownership of the subject matter.

For example, a vegetable cart owner has an insurable interest in the cart as it is his primary source of income. But, if the vegetable vendor sells the cart, he will not have any insurable interest in the cart.

The principle of Insurable Interest implies that the insured should be the owner of the subject matter during the inception of the policy as well as at the time period when the unexpected event occurs.

Utmost Good Faith:

‘Utmost Good Faith’, one of the fundamental principles of insurance, iterates that the insured and insurance company should mutually have positive intentions to support each other. This signifies the insurer will help the policyholder and maintain utmost transparency with respect to terms and conditions of the legal contract of insurance policy. Likewise, the policyholder should also divulge all the required information about the subject matter or property and the associated insurance policy contract.

For example, when a business owner buys property insurance for office, he should give complete details about the property such as the location, record of maintenance and repair, risk potential of the property considering occurrence of natural calamities, price of the property, list and receipt of property contents, ownership documents and other details asked by the insurance company during inception of the policy. Likewise, the insurance company should give complete transparency about the inclusions and exclusions.

Proximate Cause:

Proximate Cause, also known as ‘Causa Proxima’ or nearest cause is one of the key principles of insurance which iterate the loss as a consequence of the two or more causes. The insurer will begin an investigation of the accident and identify all the possible causes, from which highlight the closest or nearest cause leading to the losses or damages. The insurer will provide the required coverage based on the policy limits when the proximate cause of the damage or losses is one of the enlisted reasons to insure the property in the first place.

For instance, a building wall was damaged due to a fire-accident, and broke down after a storm before repair and alongside damaged an adjoining building claiming the loss under fire insurance. The fire becomes a remote cause but the storm becomes the ‘proximate cause’, so the claim under fire insurance will get rejected unless STFI coverage is included.

Indemnity

Indemnity as a principle of insurance states that insurance policy is solely responsible for compensation of losses and not a source of making profit for the insured. In other words, ‘Indemnity’ signifies the insured would be paid the amount which is equal to the losses incurred and the coverage will not exceed the losses. The main objective of Indemnity is to restore the original condition of policyholders prior to the damages caused. The principle of indemnity is applicable on property insurance and excludes life insurance policy.

For instance, the business owner buys property insurance for commercial buildings to recover the financial losses incurred during any unexpected events. When the building suffers structural damages due to fire accident, the insurance company will indemnify the insurer for the repair costs by reimbursing the same amount spent on repair or get the property reconstructed by appointing authorized contractors.

Contribution

Contribution as a principle of insurance can be used in cases when the policyholder has more than one active insurance policy of similar type for the same subject matter. This principle is similar to indemnity, where the objective is to recover losses and not make profit. So, the individual can buy more than policies from different insurance companies. But cannot obligate both to pay the compensatory amount.

For example, Company ABC, worth Rs. 5 lakhs, has an insurance policy with Rs. 3 lakhs worth coverage from insurer X and another insurance policy with Rs. 1.5 lakhs coverage from insurer Y. So, Company ABC had 2 property insurance policies. In case of property damage with losses of Rs. 3 lakhs, Company ABC can claim the complete amount from insurer X but then he/she cannot claim coverage from insurer Y. Now, insurer X can claim the proportional amount reimbursed value from insurer Y.

Subrogation

Subrogation, as a principle of insurance, implies that one party gives complete support to the other party. According to Subrogation, after the policyholder is reimbursed for the losses for the subject matter, the property rights for ownership are switched to the insurance company. Subrogation gives the insurance company the right to recover the amount of loss from the third party responsible for the damage caused to the policyholder.

For instance, Mr. Amar was injured due to reckless driving by Mr. Param in a road accident. Mr. Amar gets the required coverage from the insurer for accidental cover. But, the insurer can claim the exact amount from Mr. Param was responsible for the accident and recover the compensation.

Loss Minimization

As one of the 7 principles of insurance, Loss Minimization elicits that the insured should take necessary steps to minimize the damage with recurrent repair and maintenance and take preventive actions when the damage occurs. This principle ensures that the insured cannot be negligent and careless after buying the insurance policy.

For example, when company AT is facing a fire-related emergency, the owner has to take preventive actions to cease the fire at the earliest. The owner of company AT cannot sit back and let the fire cause complete damage even if he/she could take preventive measures as the loss would be compensated by the insurer.

Application of Insurance Principles in General and Health Insurance

The policyholder and the insurance company need to abide by the principles of insurance which are put together with the insurance policy. For general insurance, the principles of insurance act as guidelines for claims processing. The principles on indemnity ensures the insured is compensated with a recovery amount without intent of making a profit through claims settlement. Further, subrogation ensures the insurance company has the right to compensate the settlement amount paid to the insured through third-party responsible for damage.

In the case of health insurance, utmost good faith plays an important role as one of the principles of insurance as the insured should divulge all the pre-existing health conditions and habits accurately. Likewise, insurable interest invokes the individuals to insure their own health along with dependents thereby leading to prevention of moral hazards. Further, indemnity ensures that policyholders should be reimbursed or paid the exact amount incurred in medical treatment and not profit from any claims. Also, the principle of subrogation gives insurers the scope to compensate the costs from the third-party who was responsible for the accident, keeping fairness intact.

Why These Principles Are Important for Policyholders

The insurance policy is a legal contract binding both the insured and insurance company to adhere to the principles of insurance. The policyholders need to understand the principles of insurance and its nuances as it helps streamline the claims settlement process. The insured gets complete clarity on what are the policy inclusions and exclusions and the required expectations he/she should have from the insurer. This also builds transparency regarding the cost of the policy premium as the insured gives complete disclosure about the subject matter following an accurate risk assessment process. These principles of insurance also give an established framework supporting mutual interest during conflict resolution with guidelines for streamlining claims settlement in cases of disagreements.

Conclusion

When an individual buys an insurance policy from an insurance company, the individual becomes insured and legally bonded with the insurer through the principles of insurance. The 7 fundamental principles of insurance can be enlisted as utmost good faith, proximate cause, indemnity, subrogation, loss minimization, insurable interest and contribution. The policyholders need to have complete clarity about the principles of insurance as this simplifies the claims settlement process and gives clear guidelines on navigating the intricate details about the insurance contract in all exceptional cases.