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Insurance as a contract (key takeaways)

An insurance contract is generally a bilateral agreement between 2 parties. Namely, the insurer and the insured. The insurer agrees to bear a certain kind of risk for a fee (known as a premium). While the insured gets peace of mind knowing that he is covered against uncertainty.

A contract can be termed as an insurance contract if it has valid characteristics under the Indian Contracts Act, 1872. What are these characteristics? They are:-

  • Competent to contract: Both parties should be of sound mind, not minor, and be competent to enter into a contract.
  • Free consent of parties: Both parties should enter into a contract without the influence of coercion, fraud, or misrepresentation of any type.
  • Lawful consideration: The nature of consideration should be lawful (example: legal tender of a nation)
  • Lawful object: Object of the contract should not be forbidden by law.

If a contract fulfills all the characteristics above and deals with the object of insurance, it can be termed as an insurance contract.

Let us talk about the two important aspects of an insurance contract below:-

  • Types of insurance contracts
  • Principles of an insurance contract

Insurance contract types

Contract of indemnity vs contract of certainty

A contract of indemnity is where the insurer is insuring the insured against an event that may or may not happen. For example, a Motor insurance policy is a contract of indemnity, where the insurer will only pay the insured in case of an accident.

A contract of certainty is where the insurer is insuring the insured against an event that is certain to happen. For example, a life insurance policy, where the insured is certain to die. Thus the payment will certainly happen in the event of death.

Principles of an insurance contract

There are 7 principles of an insurance contract, they are:-

  • Utmost Good Faith
  • Indemnity
  • Subrogation
  • Proximate cause
  • Contribution
  • Loss minimization
  • Insurable interest

Utmost good faith

Both parties, the insurer and the insured have to act in utmost good faith with each other. This means that there should not be any falsification of information by either party. The contract will be liable to be void in case utmost good faith is not maintained.


The insurer will only indemnify the insured against the actual loss caused by an event, and will not go beyond that. For instance, Mr. Mukesh has purchased a motor insurance policy with a coverage of 1 lac. Mr. Mukhes has met with an accident and the damages to his car cost 50000. In this case, the insurance company will pay Mr. Mukesh no more than 50000, even though his policy coverage is 1 lakh.


The principle of subrogation states that after the insured has been paid by the insurer, there is a transfer of ownership of the insured property. For example, Mr. Jay has insured a building and that building has caught fire. Mr.Jay will get his compensation from the insurance company, and the insurance company will now have ownership of that building. The insurance company may now choose to sue any party that they feel caused the fire and recover the dues.

Proximate cause

The principle of proximate cause states that if multiple causes are causing the loss. The closest cause will be considered.


The principle of contribution states that in the event that a person takes 2 or more insurance policies for the same insured object, he will only be indemnified against the actual loss suffered and not beyond. For example, Mr. Harish has bought 2 car insurance policies (the first policy has a cover of 2 lacs and the second has a cover of 3 lacs) for his Honda City. Let us assume that he has met with an accident and the cost is 2. Mr. Harish on this occasion can only make a claim for INR 2 lakhs, even though he has a coverage of 5 lakhs across 2 policies.

Loss minimization

The principle of loss minimization states that in the event of an unfortunate event, the insured person will take all measures to reduce the damage caused to the insured object. For example, a person who has bought a fire insurance policy for his home should attempt to extinguish the fire (in case of a fire) if it can be safely done.

Insurable interest

what is insurable interest? The Principle of insurable interest means that there should be financial value attached to the insured property. The policyholder should stand to lose financially in the event that the insured object is damaged, lost, or stolen. If there is no insurable interest the insurance contract becomes compromised.

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Frequently asked questions about insurance contracts

  • Is an insurance policy a contract?

    Yes, an insurance policy is a contract between the insurer and the insured.

  • What happens if you breach the principles of insurance?

    If you breach the principles of insurance, your insurance policy can be terminated.

  • Do both parties need to be of sound mind to enter into an insurance contract?

    Yes, both parties need to be of sound mind under the Contracts Act of India.

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