Principles of Insurance (The 7 Principles)

Just buying insurance is not enough. The policy buyer also needs to know the rules of the game. The insurance industry and all participants need to adhere to certain principles while dealing with each other, these principles are the principles of insurance.

Insurance has 7 primary principles that both parties (insured and insurer) need to adhere to. We will be discussing these 7 principles in detail so you can get a complete understanding of the principles of insurance. They are:-

1. Principle of utmost good faith
2. Principle of insurable interest
3. Principle of proximate cause
4. Principle of subrogation
5. Principle of loss minimization
6. Principle of indemnity
7. Principle of contribution

Once you understand these insurance principles, you will be in a much better position when it comes to understanding your insurance contract.

1.) Principle of utmost good faith

The principle of utmost good faith elucidates that there should be complete honesty when it comes to sharing of information between the policyholder and the insurance company and vice versa.

All facts relating to the object of insurance must be completely and correctly provided by the policyholder to the insurance company. Similarly, the insurance company must also maintain complete transparency and honesty when it comes to the policy contract. There should be no falsification by either party when it comes to sharing information.

Example

Mr. Ramesh took a life insurance policy. At the time of filling the questionnaire, he did not mention he had a terminal illness. At the time of his demise, the insurance company found out that Mr. Ramesh willfully held back this information and canceled his policy. Due to willfully holding back correct information, Mr. Ramesh’s family did not get any life insurance benefits from their policy.

2.) Principle of insurable interest

This principle states that the policyholder should have an insurance interest in the insured object. This means that there should be a financial loss on part of the policyholder if the insured object gets damaged, destroyed, lost, stolen, etc.

Example

An individual has an insurable interest in his car and can take motor insurance for the same. This is because if his car gets damaged, destroyed, or stolen it will cause financial harm to him.  Thus there is a clear insurable interest of the policyholder in his car.

3.)Principle of proximate cause

The principle of proximate cause states that the closest cause for any particular loss will be considered when it comes to making a claim payment.  For instance, 2 causes caused an event. The nearest cause will be considered while claiming the settlement.

Example

Mrs. Jyoti took an accidental insurance policy from a company. While driving, Mrs. Jyoti had a heart attack, resulting in a car accident. While making her accident insurance claim, the insurance company stated that the nearest cause (Causa Proxima) of the accident was the heart attack and rejected her claim. As heart attack was not covered under her accidental policy.

4.) Principle of subrogation

Under the principle of subrogation, the insurer assumes control over the object of insurance once it has paid the policyholder his/her claim. This allows the insurer to recover any losses that he may have faced by way of legal recourse.

Example

Mr. Jatin has bought a motor insurance policy. Let us assume he meets with an accident with another rider, and totals his car. He was paid full insurance towards his damages by way of his claim.  Later, It was found that the other rider was driving without a valid license and under the influence of alcohol. The insurance company can step into the shoes of the insured and sue the other party for damages and recover their losses.

5.) Principle of loss minimization

Under the principle of loss minimization, it is the duty of the insured to ensure that he has taken all possible steps to minimize the damage caused by an event.

The principle states that even though the policyholder knows he is covered by insurance, he/she should try their level best to protect the insured object.

Example

Mr.Rishi bought motor insurance for his car. Let us assume that fumes are coming out of his engine. Mr. Rishi should make all attempts to extinguish the fumes by using a fire extinguisher and call for help to put the fire out.He should not simply stand idle while the fire consumes the car.

6.) Principle of indemnity

The principle of indemnity states that the insurance company will only reimburse the policyholder in accordance with the actual loss incurred, and not beyond that. This principle is also subject to certain terms and conditions of the policy. But in general, the insurance company will only indemnify the policyholder to the extent of their loss.

Example

Mr. Vikas has taken a health insurance policy worth 2 lakhs. He was admitted to the hospital for a minor condition and his hospital bill came to 1 lakh. The insurance company will only pay Mr. Vikas 1 lakh even though he is covered for 2 lakhs.

7.) Principle of contribution

The principle of contribution states that a person can insure the same object with 2 different insurers. The policyholder will however only be paid off the loss incurred and nothing beyond.

Example

Mr. Kumar has 2 health insurance policies for himself, each worth 2 lacs. Let us assume he was admitted to the hospital for a minor condition and his bill amount came to 2.35 lakhs.  He can claim 2 lakh from the first insurance company and the balance from the second insurance company. He however cannot claim 2 lakhs each from both the insurance companies, as that would lead to a profit on his part.