What Does Utmost Good Faith In Insurance Means?

When you purchase an insurance policy, whether it is property insurance or group employee insurance for your team, you enter into a legal relationship with the insurance provider. Trust is the main factor as both parties assume that they will act with honesty and conviction. The utmost good faith principle is based on this obligation only. This principle states that there should be transparency and honesty among both the insurer and the insurance provider. Let’s explore the meaning of utmost faith when you purchase an insurance policy, and understand how you can comply with this.

What is the Meaning of Utmost Good Faith?

The principle states that the parties involved in an insurance contract will act with complete honesty, and will be transparent to each other.

This principle of utmost good faith is also known as uberrimae fidei in Latin, which translates to having “complete good faith”. According to this principle, the insurer and the insured should be honest with each other when they initiate an insurance policy. For example, the insured will supply actual and correct material facts to their insurance provider, while the provider should ensure that the policy satisfies the interest of the insured. These material facts can be any information that may influence the risk assessment by the insurance provider.

How Do You Define a Good Faith?

Good faith essentially means a legal obligation to act with transparency and communicate with honesty. For example, if you purchase group health insurance for your business, you will have to provide factually correct information such as any pre-existing disease of your team members. Or, if you are purchasing property insurance, you will have to describe the current condition of the property. This helps the insurer to a great extent, to assess the actual value of the property and hence estimate the risk.

Read also how to check CIBIL score free step-by-step.

How Doctrine of Utmost Good Faith Works

Whenever a policy is proposed, the principle is immediately set in action. Here are the steps in which utmost good faith in insurance works:

Stage 1: Disclosure Stage

The insured must supply all the relevant information to the insurer. This will enable the insurer to determine the right policy type and also examine the degree of risks.

Stage 2: Assessment Stage

The insurer notes down the information available and uses it to assess the risks and underwrite the policy. This also helps both the insured and insurer to establish honest communication with each other.

Stage 3: Policy Issuance Stage

After the principle of utmost good faith is firmly established, the policy is issued. Mutual trust begins as soon as the policyholder purchases the policy and the insurer decides to sell it. All the details of the policy and insured however remain confidential.

Stage 4: Claims Stage

This stage comes only when the insured files a claim. The insurer examines if the claim raised is covered by the insurance benefits. Here the insurer tries to find if any misrepresentation or concealing of any fact has taken place. After successful verification, the insurer finally acknowledges the claim and credits the claim amount to the account of the insured.

Example of Utmost Good Faith

Let’s say you are running a travel agency with a micro team of 5 members. You choose to buy employee insurance for your team but do not disclose to the insurer that one of your employees suffers from a pre-existing diabetic condition. If the policy does not cover this pre-existing disease, your insurer can reject your claim when that employee is hospitalized. There are three reasons for this:

• One, you did not disclose the information prior
• The claim does not cover pre-existing diseases
• Your non-disclosure of truth has breached the principle of utmost faith

Read also about commercial crime insurance, its coverage, and benefits.

Legal Treatment of Utmost Good Faith in India

In India, there is no specific law that mentions the legal treatment of utmost faith, although the Insurance and Regulatory Authority of India (IRDAI) issued the “Protection of Policyholder's Interest Act” in 2017, which is based on this principle of good faith.

Protection of Policyholder’s Interest Act, 2017

In summary, this Act by IRDAI states that:

• The policyholder or the insured person’s interest should be protected
• The insurer needs to fulfill its responsibilities towards the insured
• The policyholder’s grievance shall be addressed by the insurer

The major foundation of this Act is the good faith principle, as both the policyholder as well as the insurer are required to reconcile policy information with each other. If any of the parties hide or misrepresent any fact, the policy will be void and canceled.

Main Elements of Utmost Good Faith

We will now understand the main elements of absolute good faith from the perspective of the insured, as well as from the perspective of the insurer. The reason for this is to understand the difference in how the utmost faith principle applies to both the policyholder and the insurer.

For the Insured

The insured has several responsibilities towards the insurer, which are:

Material Facts Disclosure By Insured

Providing incorrect material facts can affect the underwriting process, as the insurer will record misstated data. For example, if the insured does not provide the right material facts about their health condition, the claim can be void because of not disclosing actual information.

Material facts could include:

• Age and gender
• Occupation and income
• Existing diseases or medical history
• Lifestyle habits like smoking or drinking
• Previous insurance claims

No Misrepresentation From Insured Side

The utmost principle states that the information provided should be accurate and not exaggerated or falsified. Any misinterpretation or any modified information for the sake of claiming the insurance benefits is harmful once it is flagged by the insurer. The worst consequence can be policy determination and rejection of the claim benefits.

For the Insurer

While the insured has few responsibilities to inform correct facts, the insurer also has certain obligations according to the law of utmost good faith in insurance. Here are they:

Explaining Insurance Policy in Clear Terms

It turns out to be an obligation for the insurer to explain all the policy wordings unambiguously and simply to the insured. For policies that have riders, such as mediclaim policies, the insurer bears the obligation to explain rider benefits as well as coverage details in a clear way.

Maintain Transparency Throughout

The insurer should also bear complete transparency and communicate the exact policy details to the insured. The insurer is always under the responsibility to protect and satisfy the interest of the insured under the Protection of Policyholder's Interest Act, 2017 by IRDAI.

Read also key man insurance, its meaning and benefits.

Duties Under Good Faith

Duty of the Insurer

The insurer has to:

• Explain policy terms and conditions in simple language
• Offer correct and full disclosure about the inclusions and exclusions of the policy
• Assess the risk most correctly according to the material facts provided by the insured
• Provide a customer information sheet also in the local language according to the wish of the insured

As per the IRDAI circular, insurers must provide a "customer information sheet" that explains the policy terms and conditions in a simplified manner, including coverage details. This sheet was made effective by IRDAI from January 1, 2024.

Duty of the Insured

The insured must:

• Provide the insurer with all correct personal and financial details such as the correct date of birth, correct name, and so on
• Supply all authentic documents such as identity proof, residential proof, correct medical certificate, and diagnosis report
• Inform about any changes such as canceling the policy or upgrading any rider benefits within the free look period

You should note that all the smaller details count, such as a change in your current phone number or a change in your residential address. Failure to update can cause unnecessary delays in claim processing, as the insurer has to verify the condition and reassess the risk.

Consequences of Violating Good Faith

Violating this principle can be disastrous for both the insured and the insurer. Let’s list all the possible consequences for breaching this principle of insurance:

Claim Rejection

This is the most immediate consequence of reaching the principle. The principle of absolute good faith directly refers to trust and honesty between the policyholder and the insurer. If that is violated, the claim can face rejection.

Policy Cancellation

The other consequence is policy cancellation as breaching good faith means breaching the trust. For example, if the insured fails to describe his pre-existing disease condition to the insurer, the insurer has the right to cancel the policy as per IRDAI law.

Loss of Premium Paid

The insured will also lose all benefits of paying a high premium in case the policy is canceled. For example, if you pay a fixed premium at the end of every month and still lose all benefits attached to your policy, that is naturally a great financial loss for you.

No Possibilities of Refund

You may not even get a refund if the breach is serious. In some cases, the insurer may not refund any premium because the insured had hidden crucial details that would have helped the insurer to underwrite the policy.

Legal Repercussions

The insurer can also file a legal claim against the insured for fraud, misrepresentation or manipulation by not disclosing the details. Legal claims can cause loss of reputation, and can also financially damage the insured.

Read also commercial general liability, its meaning, and coverage details.

Importance of Utmost Good Faith in Reinsurance Contracts

It is natural to ask the question - what is the basis of utmost good faith? The answer is that the good faith principle relies on honesty. As we have clarified before, the principle states that there should be complete transparency and both parties should act honestly.

The principle is important for three reasons:

• It helps the insured to have complete transparency and understand the policy coverage within the free look period
• The insurer can assess the risk accurately and create a policy that aligns with the policyholder’s interest Reinsurers who provide insurance to other insurance companies also benefit from the principle. These reinsurers can provide policies aligned with the actual interest of the third-party insurers because of honest communication

For example, if a health insurer does not share the actual claim data for critical illness with its reinsurer, the reinsurer may void the claims later. That denial negatively impacts the insurer’s ability to pay its end customers.

How to Comply with the Principle of Utmost Good Faith?

The utmost good faith in insurance urges both the insured and the insurer to act in a justified and honest manner. Follow these steps to comply with the insurance principles and avoid claims getting rejected.

For Insured:

If you are the policyholder, then always follow these steps below to claim your insurance benefit successfully:

• Always remember that the insurers can easily cross-check your information, so stay true to the information. Acting in good faith is necessary here.
• Always read the policy documents carefully, and raise a concern as soon as you find the coverage details not aligning with your interest.
• Update any changes in your current contact number or your health conditions immediately to your insurer. Remember that the principle of good faith is based on being honest and truthful, so always act accordingly

For Insurers:

• Always provide clear and direct statements, with no fine print. As per IRDAI guidelines, the insurance provider should always explain and act in the interest of the insured
• Explain policy wordings in simple and easy language. If possible, explain the policy wordings in their local language as that helps the insured to understand coverage details better
• Cross-verify and make use of digital tools such as e-KYC and digital underwriting. This will establish fair and honest communication between you and the insured
• Following up with the insured is an obligation for you as an insurance provider. Always contact policyholders for any missing details or inconsistency

Conclusion

The utmost good faith principle is not limited to the insurance providers, or to the policyholders. If you look closely, good faith is the foundation of doing a successful business and improving customer satisfaction. Even in your business, transparency is the major factor that drives the business.

In India, a large number of claims get rejected because they breach the principle of good faith. Either the policyholder does not provide the correct information, or the insurer does not assess the risk accordingly. If this principle of absolute good faith is followed, a massively good number of insurance claims will be acknowledged in India, with policyholders getting back their claims most of the time.

Preventing financial liabilities arising from employee theft and commercial crime has become easier with Covrzy's commercial crime insurance policy. Get covered for wrongful abstraction, cheque forgery, unauthorized access of company funds, and more such cases in a single policy. Get in touch with Covrzy or reach out at [email protected] to secure your best quote.