UNIT – IVI. INTRODUCTION TO INSURANCE

Insurance is a contract between the insurance company (insurer) and the policyholder (insured). In return for a consideration (the premium), the insurance company promises to pay a specified amount to the insured on the happening of a specific event.

Insurance in terms of the relationship between the insured & the insurer – transfer device:

Insurance may be defined as the transfer of pure risk from the insured to the insurer. The insured is the person or firm or company confronted by risk and the insurer is a person or firm or company, which specializes in the assumption of risk. The primary business of the insurer is risk assumption for a fee.

According to Prof Mehr & Cammack, Insurance is a device for reducing risk by combining a sufficient number of exposure units to make their individual losses collectively predictable. The predictable loss is then shared proportionately by all units in the combination. Therefore, it implies both that uncertainty is reduced & losses are shared. Further, it is said that a device will be deemed Insurance if

(i) it implies the law of large numbers so that the requirement of future funds to cover losses are predictable with reasonable accuracy.

(ii) it provides some definite method for raising these funds by levies against the units covered by the scheme.

“Insurance is a social device which combines the risks of individuals into a group, using funds contributed by members of the group to pay for losses.”

The essence of the Insurance scheme is that it is a1) Social science 2) Accumulation of funds 3) It involves a group of risks 4) Transfer of risk to the whole group

Background of Insurance:

Insurance as security is need of all human beings. No animal, no plant nor mountains and oceans want any security, like man does. Man is afraid of uncertainty, fears and death. Although a reality, one day each one will die; early or later, timely or untimely is the question, which has no answer. He is afraid of risk & losses in future. He is ever in search of security & certainty. In early history man lived in-groups and communities to be secure.

At the earlier stage, whenever an earning member would die due to disease or death, the other members of the social group (or family or clan) would contribute to bail the survivors in the family out of financial difficulties. This contribution was in the shape of food- clothing and shelter. Even today we donate money, food, clothing and other materials of life to rehabilitate the family whose breadwinner has left for his heavenly abode, unfortunately, suddenly, sadly. (Also people, friends, relatives even today contribute towards marriage, education, healthcare expenses or mishap).

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Later, as commercial considerations grew stronger and stronger; nucleus family growth became a common practice these contributions and sharing started becoming individualistic and took the shape of ‘premium’. The ‘assurances’ which were earlier by will and practice became a commodity (though intangible). Thus the concept of Insurance grew. Any person who would not contribute, or would contribute less according to his paying capacity was denied reciprocal help or promise of help, or was given help in proportion to his contribution which he had been contributing as a faithful obedient member of the society.

In earlier days, in India, on an unexpected death of breadwinner in any family, the villagers or neighbourhood would collect funds to help the survive in the family and such practice continues even now. Today also, when after death – “Bhog” or “Kirya”s takes place, relatives give money to the survivors though this may not be adequate collection to meet expenses of remaining part of life when there is no breadwinner. Insurance is on similar pattern.

Purpose of Insurance:Every human being has fear in his mind. The fear whether he will be able to meet

the basic needs of the life i.e. Food, Clothing and Housing (Roti, Kapda and Makkan). He has fear not only for himself but also for his dependents. The source of income to meet his basic needs may be through service or business. If he is able to meet his basic needs then he acquires the assets i.e. vehicles, property or jewellery etc. Then he gets additional fear of saving the assets from destruction. (The assets may be destroyed through accident, fire or earthquake etc. and the income may be cut off due to certainty i.e. old age and death or uncertainty i.e. accident, illness or disability.)As you know, the old age and death is certain for every human being while the accident, illness, disability and destruction of assets may be by random. The number of accidents will take place but with whom is uncertain. Therefore, to overcome this problem, the Insurance plays a very important role.The principal source of income of an individual comes from the compensation for work performed by him. If this source of income gets cut off then: -Family will make social and economic adjustments like:

Wife may take employment at the cost of home making responsibilities

Children may have to go for work at the cost of education.Family members might have to accept charity from relatives, friends etc. at the cost of their independence and self-respect.

Family standard of living might have to be reduced to a level below the essentials for health and happiness.

The basic threats which all of us may encounter to varied extent and which result in cut off of income or sudden increase in - uncalled for expenses (beyond our means or higher than our earnings) i.e. dislocates the human life, are: -ILLNESS (malnutrition, environment, chronic) – uncertain ACCIDENT – (uncertain)

Disability – Permanent or Temporary (uncertain) OLD AGE – (certain)

DEATH – ( certain)

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Need of Insurance:To provide Security and Safety The Life Insurance provides security against premature death and payment in old age to lead the comfortable life. Similarly in general Insurance, the property can be insured against any contingency i.e. fire, earthquake etc.

To provide Peace of Mind The uncertainty due to fire, accident, death, illness, disability in the human life, it is beyond the control of the human beings. By way of Insurance, he may be compensated financially but not emotionally. The financial compensation provides not only peace of mind but also motivates to work more and more.

To Eliminate Dependency On the death of the breadwinner, the consequences need not be explained. Similar to the destruction of property and goods the family would suffer a lot. It could lead to reduction in the standard of living or begging from relatives, friends or neighbours. The economic independence of the family is reduced. The Insurance is the only way to assist and provider them adequate at the time of sufferings.

To Encourage Savings Life Insurance provides protection and investment while general Insurance provides only protection to the human life and property respectively. Life Insurance provides systematic saving because once the policy is taken then the premium is to be regularly paid otherwise the amount will be forfeited.

To fulfill the needs of a person a) Family needs b) Old age needs c) Re-adjustment needs d) Special needs: Education, Marriage, health e) The clean up needs: After death, ritual ceremonies, payment of wealth tax and

income taxes are certain requirements, which decreases the amount of funds of the family members.

To Reduce the Business Losses: In business the huge amount is invested in the properties i.e. Building and Plant and Machinery. These properties may be destroyed due to any negligence, if it is not insured no body would like to invest a huge amount in the business and industry. The Insurance reduced the uncertainty of business losses due to fire or accidents etc.

To Identify the Key man: Key man is a particular man whose capital, expertise, energy and dutifulness make him the most valuable asset in the business and whose absence well reduce the income of the employer tremendously and upto that time when such employee is not substituted. The death or disability of such valuable lives will prove a more serious loss than that fire or any hazard. The potential loss to be suffered and the compensation to the dependents of such employee require an adequate provision, which is met by purchasing an adequate life policies.

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To Enhance the Limit: The business can obtain loan but pledging the policy as collateral for the loan. The insured persons are getting more loan due to certainty of payment at their death.

Welfare of Employees: The welfare of the employees is the responsibility of the employer. The employer is supposed to look after the welfare of the employees. The provisions are being made for death, disability and old age. Though these can be insured through individual life Insurance but an individual may not be insurable due to illness and age. But the group policy will cover his Insurance and the premium is very low in group Insurance. The expenditure paid on account of premium will be allowable expenditure.

II. INSURANCE AS RISK MANGEMENT TOOLWhat is Risk:

Risk is the potential of loss (an undesirable outcome, however not necessarily so) resulting from a given action, activity and/or inaction. The notion implies that a choice having an influence on the outcome sometimes exists (or existed). Potential losses themselves may also be called "risks". Any human endeavor carries some risk, but some are much riskier than others.Risk can be defined in seven different ways

1.The probability of something happening multiplied by the resulting cost or benefit if it does.

2.The probability or threat of quantifiable damage, injury, liability, loss, or any other negative occurrence that is caused by external or internal vulnerabilities, and that may be avoided through preemptive action.

PERIL AND HAZARDThe terms "peril" and "hazard" should not be confused with the concept of risk discussed earlier. Let us first consider the meaning of peril.PerilPeril is defined as the cause of loss. Thus, if a house burns because of a fire, the peril, or cause of, loss, is the fire. If a car is totally destroyed in an accident with another motorist, accident (collision) is the peril, or cause of loss. Some common perils that result in the loss or destruction of property include fire, cyclone, storm, landslide, lightning, earthquakes, theft, and burglary.HazardFactors, which may influence the outcome, are referred to as hazards. These hazards are not themselves the cause of the loss, but they can increase or decrease the effect should a peril operate. The consideration of hazard is important when an insurance company is deciding whether or not it should insure some risk and what premium to charge. So a hazard is a condition that creates or increases the chance of loss. There are three major types of hazards: Hazard can be physical or moral or Morale.Physical hazardPhysical hazard relates to the physical characteristics of the risk, such as the nature of construction of a building, security protection at a shop or factory, or the proximity of

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houses to a riverbank. Therefore a physical hazard is a physical condition that increases the chances of loss. Thus, if a person owns an older building with defective wiring, the defective wiring is a physical hazard that increases the chance of a fire. Another example of physical hazard is a slippery road after the rains. If a motorist loses control of his car on a slippery road and collides with another motorist, the slippery road is a physical hazard while collision is the peril, or cause of loss.Moral hazardMoral hazard concerns the human aspects which may influence the outcome. Moral hazard is dishonesty or character defects in an individual that increase the chance of loss. For example, a business firm may be overstocked with inventories because of a severe business recession. If the inventory is insured, the owner of the firm may deliberately burn the warehouse to collect money from the insurer. In effect, the unsold inventory has been sold to the insurer by the deliberate loss. A large number of fires are due to arson, which is a clear example of moral hazard.Moral hazard is present in all forms of insurance, and it is difficult to control. Dishonest insured persons often rationalise their actions on the grounds that "the insurer has plenty of money". This is incorrect since the company can pay claims only by collecting premiums from other policy owners.Morale hazardThis usually refers to the attitude of the insured person. Morale hazard is defined as carelessness or indifference to a loss because of the existence of insurance. The very presence of insurance causes some insurers to be careless about protecting their property, and the chance of loss is thereby increased. For example, many motorists know their cars are insured and, consequently, they are not too concerned about the possibility of loss through theft. Their lack of concern will often lead them to leave their cars unlocked. The chance of a loss by theft is thereby increased because of the existence of insurance.

BASIC CATEGORIES OF RISKSpeculative (dynamic) risk is a situation in which either profit OR loss is possible. Speculative risk is uninsurable.

Pure or Static RiskThe second category of risk is known as pure or static risk. Pure (static) risk is a situation in which there are only the possibilities of loss or no loss, as oppose to loss or profit with speculative risk. The only outcome of pure risks are adverse (in a loss) or neutral (with no loss), never beneficial. Examples of pure risks include premature death, occupational disability, catastrophic medical expenses, and damage to property due to fire, lightning, or flood.Besides insurability, there are other classifications of Risks. Few of them are discussed below:Fundamental Risks and Particular RisksFundamental risks affect the entire economy or large numbers of people or groups within the economy. Examples of fundamental risks are high inflation, unemployment,

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war, and natural disasters such as earthquakes, hurricanes, tornadoes, and floods.Particular risks are risks that affect only individuals and not the entire community. Examples of particular risks are burglary, theft, auto accident, dwelling fires. With particular risks, only individuals experience losses, and the rest of the community are left unaffected.Subjective RiskSubjective risk is defined as uncertainty based on a person's mental condition or state of mind. For example, assume that an individual is drinking heavily in a bar and attempts to drive home after the bar closes. The driver may be uncertain whether he or she will arrive home safely without being arrested by the police for drunken driving. This mental uncertainty is called subjective risk.

Objective RiskObjective risk is defined as the relative variation of actual loss from expected loss. For example, assume that a fire insurer has 5000 houses insured over a long period and, on an average, 1 percent, or 50 houses are destroyed by fire each year. However, it would be rare for exactly 50 houses to burn each year and in some years, as few as 45 houses may burn. Thus, there is a variation of 5 houses from the expected number of 50, or a variation of 10 percent. This relative variation of actual loss from expected loss is known as objective risk.Static RisksStatic risks are risks connected with losses caused by the irregular action of nature or by the mistakes and misdeeds of human beings. Static risks are the same as pure risks and would, by definition, be present in an unchanging economy.Dynamic RiskDynamic risks are risks associated with a changing economy. Important examples of dynamic risks include the changing tastes of consumers, technological change, new methods of production, and investments in capital goods that are used to produce new and untried products.Financial and Non-financial RisksA financial risk is one where the outcome can be measured in monetary terms.This is easy to see in the case of material damage to property, theft of property or lost business profit following a fire. In cases of personal injury, it can also be possible to measure financial loss in terms of a court award of damages, or as a result of negotiations between lawyers and insurers. In any of these cases, the outcome of the risky situation can be measured financially.There are other situations where this kind of measurement is not possible. Take the case of the choice of a new car, or the selection of an item from a restaurant menu. These could be construed as risky situations, not because the outcome will cause financial loss, but because the outcome could be uncomfortable or disliked in some other way. We could even go as far as to say that the great social decisions of life are examples of non-financial risks: the selection of a career, the choice of a marriage partner, having children. There may or may not be financial implications, but in the main the outcome is not measurable financially but by other, more human, criteria.6 | P a g e

Insurance is primarily concerned with risks that have a financially measurable outcome. But not all risks are capable of measurement in financial terms. One example of a risk that is difficult to measure financially is the effect of bad publicity on a company - consequently this risk is very difficult to insure.

RISK MANAGEMENT‘Risk, in insurance terms, is the possibility of a loss or other adverse event that has the potential to interfere with an organization’s ability to fulfill its mandate, and for which an insurance claim may be submitted’.What is risk management?Risk management ensures that an organization identifies and understands the risks to which it is exposed. Risk management also guarantees that the organization creates and implements an effective plan to prevent losses or reduce the impact if a loss occurs.A risk management plan includes strategies and techniques for recognizing and confronting these threats. Good risk management doesn’t have to be expensive or time consuming; it may be as uncomplicated as answering these three questions:

1.What can go wrong?

2.What will we do, both to prevent the harm from occurring and in response to the harm or loss?

3.If something happens, how will we pay for it? An effective risk management practice does not eliminate risks. However, having an effective and operational risk management practice shows an insurer that your organization is committed to loss reduction or prevention. It makes your organization a better risk to insure.Role of insurance in Risk Management:

Insurance is an important risk management tool in India. Public and classified organisations are the basic organisations for improving risks. Regulatory controls reduce individual risks. For instance, in India, the IRDA combines insurance mechanisms with regulatory controls to control risk failures. In open markets, risk is improved through insurance markets by diversifying the expenditures.

Risk management is major part of finance. But now insurance companies are selling the financial risk management products and the substitutes are directly put in capital markets. Insurance policies protect a large number of insurable risks and cover financial risks.

Risk Financing

Risk financing refers to the manner in which the risk control measures that have been implemented shall be financed. It is necessary to transfer or reduce risks when risk exposure of a company goes beyond the maximum limit. But both these methods involve costs. Risk financing is defined as the funding of losses either by using the internal reserves or by purchasing insurance. The main objective of risk financing is to spread the losses over time in order to reduce the financial strain. Three ways through which risk is financed are:

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Losses are charged according to the present operating costs.

Ex-ante provision is made for losses by procuring insurance or by constructing an unforeseen event for which losses are charged.

Losses are financed with loans that are paid after few months.Risk financing provides the techniques for funding of losses after their occurrence.

In general, risk management deals with risks by designing the procedures and implementing the methods that lessens the loss occurrence or the financial impacts.

Insurance is a prime risk management tool which defines risk as „a preloss exercise reflecting an organisation‟s post loss goals‟. The main purpose of risk management is to minimise losses and protect people. Insurance is an easily affordable loss prevention technique.

Insurance acts as contractual transfer for risks. Insurance is an appropriate management tool when the amount of loss is low and amount of potential loss is high. For smaller and medium sized organisations, insurance acts as risk management tool. In certain cases, larger-sized organisations may also need the services of insurance companies for loss settlements. Even after insuring a loss procedure, risk manager faces some problems. Hence risk managers need to choose an appropriate insurance company, policy and agent. Increasingly, insurance is a prime management tool which resolves the liability limitations. For example, if a production process requires chemical components, then special toxic risk insurance is needed.

Risk avoidance

Risk avoidance is where a certain loss exposure is never acquired or the existing one is totally removed. This is one of the strongest methods to deal with risks. The major advantage of this method is that it reduces the chanceof loss to zero. The two ways by which risk can be avoided are proactive avoidance and abandonment avoidance. In the first case, the person does not assume any risk and therefore any project which brings in risk is not taken up. For example a company which has chances of nuclear radiation will not set up the company, due to the perils which it can bring up.In the case of abandonment avoidance, the existing loss exposure is abandoned. All activities with a certain degree of risk are abandoned. The case of abandonment avoidance is very few. If a firm abandons risky activities, then it faces difficulties in remaining in the market. The firm in the process of abandoning might take up new activities which exposes to another type of risk.

Risk reduction

This strategy aims to decrease the number of losses by reducing the occurrence of loss, which can be done in two ways namely loss prevention and loss control.Loss prevention is a desirable way of dealing with risks. It eliminates the possibility of loss and hence risk is also removed. The examples of this are safety programs like medical care, security guards, and burglar alarms.Loss control refers to measures that reduce the severity of a loss after it occurs. For

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example segregation of exposure units by having warehouses with inventories at different locations. Insurance companies provide guidance and incentives to the company which has taken the policy to avoid the occurrence of loss.

Risk retention

Retention simply means that the firm retains part or all the losses incurred from a given loss. Risks may be knowingly or unknowingly retained by the organisation. They are hence classified as active and passive based on this. Active risk retention is when the firm knows of the loss exposure and plans to retain it without making any attempt to transfer it or reduce it. Passive retention is the failure to identify the loss exposure and retaining it unknowingly.Retention can be used only under the following circumstances:

When insurers are unwilling to write coverage or if the coverage is too expensive.If the exposure cannot be insured or transferred.

If the worst possible loss is not serious. When losses are highly predictable.

Based on past experience if most losses fall within the probable range of frequency, they can be budgeted out of the company’s income.

Risk combination

In this strategy, risks are retained in a proportion that reduces the overall risk combination to a minimum level. In order to minimise the overall risk, one risk is added to another existing risk instead of transferring a risk. This strategy is mostly used in management of financial risk. The risk is distributed over a number of issuers instead of putting it on a single issuer. This reduces the chances of default. For example it is better to have multiple suppliers instead of relying on a single supplier.

Risk transfer

If the risk is being borne by another party other than the one who is primarily exposed to risk then it is termed as risk transfer. In this case, transfer of asset does not take place but only the risk involved is transferred. The two parties involved in this strategy are the transferor (party transferring the risk) and the transferee (party to whom the risk is transferred). The contracts made in this strategy are grouped as exculpatory contracts.In this contract the transferor is not liable if the event of risk takes place. But if the transferor is supposed to pay for the risk incurred then it cannot be termed as risk transfer.

Risk sharing

This is an arrangement made by which the loss incurred is shared. For example in a corporation, a large number of people makes investments and hence each bears only a portion of risk that the enterprise faces. Insurance involves the mechanism of risk sharing.

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Risk hedging

Hedging is buying and selling future contracts to balance the risk of changing prices in the cash market. A hedger is someone who uses derivatives to reduce risk caused by price movements. Derivatives are instruments derived from the base securities like equity and bonds. Forward contracts, futures, swaps and options are examples of derivatives.

III. PRINCIPLES OF INSURANCEThe business of insurance aims to protect the economic value of assets or life of a person. Through a contract of insurance the insurer agrees to make good any loss on the insured property or loss of life (as the case may be) that may occur in course of time in consideration for a small premium to be paid by the insured.

1.Principle of Utmost good faith 2.Principle of Insurable interest 3.Principle of Indemnity 4.Principle of Subrogation 5.Principle of Contribution 6.Principle of Proximate cause 7.Principle of Loss of Minimization

1. PRINCIPLE OF UBERRIMAE FIDEI (UTMOST GOOD FAITH) • Both the parties i.e. the insured and the insurer should have a good faith towards

each other. • The insurer must provide the insured complete, correct and clear information of

subject matter. • The insurer must provide the insured complete, correct and clear information

regarding terms and conditions of the contract. • This principle is applicable to all contracts of insurance i.e. life, fire and marine

insurance. Principle of Uberrimae fidei (a Latin phrase), or in simple English words, the Principle of Utmost Good Faith, is a very basic and first primary principle of insurance. According to this principle, the insurance contract must be signed by both parties (i.e insurer and insured) in an absolute good faith or belief or trust.The person getting insured must willingly disclose and surrender to the insurer his complete true information regarding the subject matter of insurance. The insurer's liability gets void (i.e legally revoked or cancelled) if any facts, about the subject matter of insurance are either omitted, hidden, falsified or presented in a wrong manner by the insured.The principle of Uberrimae fidei applies to all types of insurance contracts.

2. PRINCIPLE OF INSURABLE INTEREST

• The insured must have insurable interest n the subject matter of insurance. • In life insurance it refers to the life insured. • In marine insurance it is enough if the insurable interest exists only at the time of

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occurrence of the loss. • In fire and general insurance it must be present at the time of taking policy and

also at the time of the occurrence of loss. • The owner of the party is said to have insurable interest as long as he is the owner

of it. • It is applicable to all contracts of insurance.

The principle of insurable interest states that the person getting insured must have insurable interest in the object of insurance. A person has an insurable interest when the physical existence of the insured object gives him some gain but its non-existence will give him a loss. In simple words, the insured person must suffer some financial loss by the damage of the insured object.For example: The owner of a taxicab has insurable interest in the taxicab because he is getting income from it. But, if he sells it, he will not have an insurable interest left in that taxicab.From above example, we can conclude that, ownership plays a very crucial role in evaluating insurable interest. Every person has an insurable interest in his own life. A merchant has insurable interest in his business of trading. Similarly, a creditor has insurable interest in his debtor.

3. PRINCIPLE OF INDEMNITY • Indemnity means guarantee or assurance to put the insured in the same position

in which he was immediately prior to the happening of the uncertain event. The insurer undertakes to make good the loss.

• It is applicable to fire, marine and other general insurance.

• Under this the insurer agreed to compensate the insured for the actual loss suffered.

Indemnity means security, protection and compensation given against damage, loss or injury. According to the principle of indemnity, an insurance contract is signed only for getting protection against unpredicted financial losses arising due to future uncertainties. Insurance contract is not made for making profit else its sole purpose is to give compensation in case of any damage or loss.In an insurance contract, the amount of compensations paid is in proportion to the incurred losses. The amount of compensations is limited to the amount assured or the actual losses, whichever is less. The compensation must not be less or more than the actual damage. Compensation is not paid if the specified loss does not happen due to a particular reason during a specific time period. Thus, insurance is only for giving protection against losses and not for making profit.However, in case of life insurance, the principle of indemnity does not apply because the value of human life cannot be measured in terms of money.

4. PRINCIPLE OF SUBROGATION • As per this principle after the insured is compensated for the loss due to damage

to property insured, then the right of ownership of such property passes to the insurer.

• This principle is corollary of the principle of indemnity and is applicable to all

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contracts of indemnity. Subrogation means substituting one creditor for another. Principle of Subrogation is an extension and another corollary of the principle of indemnity. It also applies to all contracts of indemnity.According to the principle of subrogation, when the insured is compensated for the losses due to damage to his insured property, then the ownership right of such property shifts to the insurer.This principle is applicable only when the damaged property has any value after the event causing the damage. The insurer can benefit out of subrogation rights only to the extent of the amount he has paid to the insured as compensation.For example: Mr. Arvind insures his house for ` 1 million. The house is totally destroyed by the negligence of his neighbour Mr. Mohan. The insurance company shall settle the claim of Mr. Arvind for ` 1 million. At the same time, it can file a law suit against Mr. Mohan for ` 1.2 million, the market value of the house. If insurance company wins the case and collects ` 1.2 million from Mr. Mohan, then the insurance company will retain ` 1 million (which it has already paid to Mr. Arvind) plus other expenses such as court fees. The balance amount, if any will be given to Mr. Arvind, the insured.

5. PRINCIPLE OF CONTRIBUTION • The principle is corollary of the principle of indemnity. • It is applicable to all contracts of indemnity. • Under this principle the insured can claim the compensation only to the extent of

actual loss either from any one insurer or all the insurers. Principle of Contribution is a corollary of the principle of indemnity. It applies to all contracts of indemnity, if the insured has taken out more than one policy on the same subject matter. According to this principle, the insured can claim the compensation only to the extent of actual loss either from all insurers or from any one insurer. If one insurer pays full compensation then that insurer can claim proportionate claim from the other insurers.For example: Mr. Arvind insures his property worth Rs. 100,000 with two insurers "AIG Ltd." for `90,000 and "MetLife Ltd." for `60,000. Arvind's actual property destroyed is worth ` 60,000, then Mr. Arvind can claim the full loss of `60,000 either from AIG Ltd. or MetLife Ltd., or he can claim `36,000 from AIG Ltd. and `24,000 from Metlife Ltd.So, if the insured claims full amount of compensation from one insurer then he cannot claim the same compensation from other insurer and make a profit. Secondly, if one insurance company pays the full compensation then it can recover the proportionate contribution from the other insurance company.

6. PRINCIPLE OF CAUSA PROXIMA (NEAREST CAUSE) • The loss of insured property can be caused by more than one cause in succession

to another. • The property may be insured against some causes and not against all causes. • In such an instance, the proximate cause or nearest cause of loss is to be found

out. • If the proximate cause is the one which is insured against, the insurance company

is bound to pay the compensation and vice versa.

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Principle of Causa Proxima (a Latin phrase), or in simple English words, the Principle of Proximate (i.e Nearest) Cause, means when a loss is caused by more than one causes, the proximate or the nearest or the closest cause should be taken into consideration to decide the liability of the insurer.The principle states that to find out whether the insurer is liable for the loss or not, the proximate (closest) and not the remote (farest) must be looked into.For example: A cargo ship's base was punctured due to rats and so sea water entered and cargo was damaged. Here there are two causes for the damage of the cargo ship - (i) The cargo ship getting punctured beacuse of rats, and (ii) The sea water entering ship through puncture. The risk of sea water is insured but the first cause is not. The nearest cause of damage is sea water which is insured and therefore the insurer must pay the compensation.However, in case of life insurance, the principle of Causa Proxima does not apply. Whatever may be the reason of death (whether a natural death or an unnatural death) the insurer is liable to pay the amount of insurance.

7. PRINPLE OF LOSS MINIMIZATION• Under this principle it is the duty of the insured to take all possible steps to

minimize the loss to the insured property on the happening of uncertain event. According to the Principle of Loss Minimization, insured must always try his level best to minimize the loss of his insured property, in case of uncertain events like a fire outbreak or blast, etc. The insured must take all possible measures and necessary steps to control and reduce the losses in such a scenario. The insured must not neglect and behave irresponsibly during such events just because the property is insured. Hence it is a responsibility of the insured to protect his insured property and avoid further losses.For example: Assume, Mr. Arvind's house is set on fire due to an electric short-circuit. In this tragic scenario, Mr. Arvind must try his level best to stop fire by all possible means, like first calling nearest fire department office, asking neighbours for emergency fire extinguishers, etc. He must not remain inactive and watch his house burning hoping, "Why should I worry? I've insured my house."

IV. CHARACTERISTICS OF INSURANCE CONTRACT A contract of insurance is an agreement whereby one party, called the insurer, undertakes, in return for an agreed consideration, called the premium, to pay the other party, namely the insured, a sum of money or its equivalent in kind, upon the occurrence of a specified event resulting in a loss to him. The policy is a document which is an evidence of the contract of insurance.As per Anson, a contract is an agreement enforceable at law made between two or more persons by which rights are acquired by one more persons to certain acts or forbearance on the part of other or others.The Indian Contract Act, 1872, sets forth the basic requirements of a Contract. As per Section 10 of the Act:“All agreements are contracts if they are made by the free consent of parties competent to contract, for a lawful consideration and with a lawful object, and are not hereby expressly declared to be void…..”.

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An Insurance policy is also a contract entered into between two parties, viz., the Insurance Company and the Policyholder and fulfills the requirements enshrined in the Indian Contract Act.ESSENTIALS FOR A VALID CONTRACT1.Proposal: When one person signifies to another his willingness to do or to abstain

from doing anything, with a view to obtaining the assent of that other to such act or abstinence, he is said to make a proposal (“Promisor”).

In Insurance paralance, a Proposal form (also called application for insurance) is filled in by the person who wants to avail insurance cover giving the information required by the insurance company to assess the risk and arrive at a price to be charged for covering the risk (called “premium). When a proposal form is submitted, the Customer does not make a proposal, but it is only “invitation to offer”. The insurance company, based on the information furnished in the proposal form, assesses the risk (also called underwriting), and conveys the decision – if accepted, at what premium and on what terms and conditions. This is also called “counter offer” in insurance terminology by the insurance company to the Customer. A medical examination is also conducted, where necessary, before making the counter offer.2.Acceptance: When a person to whom the proposal is made, signifies his assent

thereto, the proposal is said to be accepted (“Promisee”). A proposal, when a accepted, becomes a promise;

When the Customer accepts the terms of the offer and signifies his assent by paying the First Premium (the amount payable as the consideration), the proposal is accepted by the Customer. A proposal of the insurance company (terms of offer), when accepted by the Customer, becomes a promise.

3. Consideration: When, at the desire of the promisor, the promisee or any other person has done or abstained from doing, or does or abstains from doing, or promises to do or to abstain from doing, something, such act or abstinence or promise is called a consideration for the promise; every promise and every set of promises, forming the consideration for each other, is an agreement;

4.Competency to contract: Every person is competent to contract who is of the age of majority according to the law to which he is subject, and who is sound mind and is not disqualified from contracting by any law to which he is subject.

In the case of Insurance the person with whom the Contract is entered into is called “Policyholder” or “Policy Owner” who could be different from the subject matter which is insured. In Life insurance contracts, for example, the person whose life is insured could be different. For example, the Policyholder could be the Father and the Life assured could be the son. In the case of Fire insurance, the Policy owner could be the Owner of a building and the subject matter of insurance would be the building itself.The Policyholder must have attained the age of majority at the time of signing the proposal and should be of sound mind and not disqualified under any law. However, the life assured could suffer from the above infirmities.

5.Consensus ad idem: Two or more person are said to consent when they agree upon the same thing in the same sense.

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Both the insurance company and the Policyholder must agree on the same thing in the same sense. The Policy document issued to the Policyholder (“Customer”) clearly defines the obligations of the insurer and the terms and conditions upon which the Insurance contract is issued.6.Lawful object: The consideration or object of an agreement must be lawful, The

consideration or object of an agreement is unlawful under the following circumstances:

(a) Where a contract is forbidden by law or (b) Where the contract is of such nature that, if permitted, it would defeat the

provisions of any law or is fraudulent; (c) Where the contract involves or implies, injury to the person or property of

another; or (d) Where the Court regards it as immoral, or opposed to public policy. (e) The object of an insurance contract, i.e. to cover the risk by taking out an

insurance policy, is a lawful object.7.Agreement must not be in restraint of trade or legal proceedings: Every

agreement by which anyone is restrained from exercising a lawful profession, trade or business of any kind, is to that extent void. Every agreement, by which any party thereto is restricted absolutely from enforcing his rights under or in respect of any contract, by the usual legal proceedings in the ordinary tribunals, or which limits the time within which he may thus enforce his rights, is void to the extent

8.Agreement must be certain and not be a wagering contract: Agreements, the meaning of which is not certain, or capable of being made certain, are void. Agreements by way of wager are void; and no suit shall be brought for recovering anything alleged to be won on any wager, or entrusted to any person to abide the result of any game or other uncertain event on which may wager is made.

FEATURES OF INSURANCE CONTRACTThough all contracts share fundamental concepts and basic elements, insurance

contracts typically possess a number of characteristics not widely found in other types of contractual agreements. The most common of these features are listed here:(a) AleatoryIf one party to a contract might receive considerably more in value than he or she gives up under the terms of the agreement, the contract is said to be aleatory. Insurance contracts are of this type because, depending upon chance or any number of uncertain outcomes, the insured (or his or her beneficiaries) may receive substantially more in claim proceeds than was paid to the insurance company in premium dollars. On the other hand, the insurer could ultimately receive significantly more money than the insured party if a claim is never filed.(b) AdhesionIn a contract of adhesion, one party draws up the contract in its entirety and presents it to the other party on a 'take it or leave it' basis; the receiving party does not have the option of negotiating, revising, or deleting any part or provision of the document.

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Insurance contracts are of this type, because the insurer writes the contract and the insured either 'adheres' to it or is denied coverage. In a court of law, when legal determinations must be made because of ambiguity in a contract of adhesion, the court will render its interpretation against the party that wrote the contract. Typically, the court will grant any reasonable expectation on the part of the insured (or his or her beneficiaries) arising from an insurer-prepared contract.(c) Utmost Good FaithAlthough all contracts ideally should be executed in good faith, insurance contracts are held to an even higher standard, requiring the utmost of this quality between the parties. Due to the nature of an insurance agreement, each party needs - and is legally entitled - to rely upon the representations and declarations of the other. Each party must have a reasonable expectation that the other party is not attempting to defraud, mislead, or conceal information and is indeed conducting themselves in good faith. In a contract of utmost good faith, each party has a duty to reveal all material information (that is, information that would likely influence a party's decision to either enter into or decline the contract), and if any such data is not disclosed, the other party will usually have the right to void the agreement.(d) ExecutoryAn executory contract is one in which the covenants of one or more parties to the contract remain partially or completely unfulfilled. Insurance contracts necessarily fall under this strict definition; of course, it's stated in the insurance and agreement that the insurer will only perform its obligation after certain events take place (in other words, losses occur).(e) UnilateralA contract may either be bilateral or unilateral. In a bilateral contract, each party exchanges a promise for a promise. However, in a unilateral contract, the promise of one party is exchanged for a specific act of the other party. Insurance contracts are unilateral; the insured performs the act of paying the policy premium, and the insurer promises to reimburse the insured for any covered losses that may occur. It must be noted that once the insured has paid the policy premium, nothing else is required on his or her part; no other promises of performance were made. Only the insurer has covenanted any further action, and only the insurer can be held liable for breach of contract. (f) ConditionalA condition is a provision of a contract which limits the rights provided by the contract. In addition to being executory, aleatory, adhesive, and of the utmost good faith, insurance contracts are also conditional. Even when a loss is suffered, certain conditions must be met before the contract can be legally enforced. For example, the insured individual or beneficiary must satisfy the condition of submitting to the insurance company sufficient proof of loss, or prove that he or she has an insurable interest in the person insured.(g) Personal contractInsurance contracts are usually personal agreements between the insurance company

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and the insured individual, and are not transferable to another person without the insurer's consent. (Life insurance and some maritime insurance policies are notable exceptions to this standard.) As an illustration, if the owner of a car sells the vehicle and no provision is made for the buyer to continue the existing car insurance (which, in actuality, would simply be the writing of the new policy), then coverage will cease with the transfer of title to the new owner.(h) Warranties and RepresentationsA warranty is a statement that is considered guaranteed to be true and, once declared, becomes an actual part of the contract. Typically, a breach of warranty provides sufficient grounds for the contract to be voided. Conversely, a representation is a statement that is believed to be true to the best of the other party's knowledge. In order to void a contract based on a misrepresentation, a party must prove that the information misrepresented is indeed material to the agreement. According to the laws of most states and in most circumstances, the responses that a person gives on an insurance application are considered to be a representations, and not warranties. (i) Misrepresentations and ConcealmentsA misrepresentation is a statement, whether written or oral, that is false. Generally speaking, in order for an insurance company to void a contract because of misrepresented information, the information in question must be material to the decision to extend coverage.Concealment, on the other hand, is the failure to disclose information that one clearly knows about. To void a contract on the grounds of concealment, the insurer typically must prove that the applicant willfully and intentionally concealed information that was of a material nature.(j) FraudFraud is the intentional attempt to persuade, deceive, or trick someone in an effort to gain something of value. Although misrepresentations or concealments may be used to perpetrate fraud, by no means are all misrepresentations and concealments acts of fraud. For instance, if an insurance applicant intentionally lies in order to obtain coverage or make a false claim, it could very well be grounds for the charge of fraud. However, if an applicant misrepresents some piece of information with no intent for gain (such as, for example, failing to disclose a medical treatment that the applicant is personally embarrassed to discuss), then no fraud has occurred.(k) Impersonation (False pretenses)When one person assumes the identity of another for the purpose of committing a fraud, that person is guilty of the offense of impersonation (also known as false pretenses). For instance, an individual that would likely be turned down for insurance coverage due to questionable health might request a friend to stand in for him (or her) in order to complete a physical examination.

(l) Parol (or Oral) evidence ruleThis principle limits the effects that oral statements made before a contract's execution can have on the contract. The assumption here is that any oral agreements made before the contract was written were automatically incorporated into the drafting of the contract. Once the contract is executed, any prior oral statements will therefore not be 17 | P a g e

allowed in a court of law to alter or counter the contract.

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