Principles of Insurance PDF

Principles of Insurance

Principles of insurance is an important part of the general awareness section of different

competitive exams. Types and principles of insurance is one of the most commonly asked topics for

insurance exams like the LIC, IRDA, NIACL, NICL, and so on. In the following banking awareness

study material, we shall explore in detail the different types and principles of insurance in the

industry. Let’s begin with knowing what Insurance is.

What is Insurance?

Insurance is a contract in which an individual or a ﬁrm avails ﬁnancial protection from an insurance

company. It is represented in the form of policy. Insurance is a policy, wherein, reimbursements can

be claimed from the insurance company for any kind of damage caused to the property of the

insured.

There are two parties to insurance, that is, the insurer and the insured. Both the insurer and the

insured enter into a legal contract for the purpose of availing and providing insurance, called the

insurance policy. The insurance policy assures ﬁnancial security from unforeseen uncertainties.

Simply put, insurance is a legal agreement between the insured and the insurance company. In the

agreement, the insurer promises to provide ﬁnancial help to the insured at the time of any

contingency. On the other hand, the insured pays a premium in exchange for the assurance by the

insurer.

What are the Principles of Insurance?

As we have learnt, the insurance is a contract wherein there are two parties involved, the insurer and

the insured. Hence, there are certain insurance principles that are bound to the contract to ensure its

validity. It is important for both the parties to abide by the following 7 principles of insurance:

● Utmost Good Faith

● Proximate Cause

● Insurance Interest

● Indemnity

● Subrogation

● Contribution

● Loss Minimization

Let’s learn about each of the above 7 principles of insurance in detail with the help of relevant

examples.

Principle of Utmost Good Faith

It is the fundamental principle of insurance in which both the parties should act in good faith

towards each other. Both the insurer and the insured must provide clear and concise information

with regards to the terms and conditions of the insurance policy.

Example of Utmost Good Faith Principle: Mr. X took a health insurance policy. However, at the time of

taking the policy, he was a chainsmoker, but did not inform the insurance company. Later, he was

diagnosed with cancer. In this situation, the insurance company does not become liable to bear the

ﬁnancial burden as Mr. X hid the fact that he was a chainsmoker.

Principle of Proximate Cause

It is also called ‘Causa Proxima’ or the nearest cause. Proximate cause implies when the loss is the

result of two or more causes. The insurance provider shall investigate the nearest cause of the loss

to the property. If the proximate cause is the one in which the property is insured, then the insurer is

liable to pay the compensation. However, if it is not the cause to which the property is insured, then

the insurer is not liable to pay the compensation.

Example of Proximate Cause Principle: A wall of a building was damaged due to ﬁre and the

authorities ordered it to be demolished. During the demolition, the adjoining wall also gets damaged.

The owner of the adjoining wall’s building would claim the loss under ﬁre policy. The court considers

ﬁre as the nearest cause of loss to the adjoining wall of the building, hence the claim becomes

payable as the damage to the wall is considered as an inevitable cause of ﬁre.

Principle of Insurable Interest

As per the principle of insurance interest, the insured must have an insurable interest in the property.

Insurable interest of the insured property means that such property must be of some ﬁnancial

beneﬁt to the insured, as well as, lead to a ﬁnancial loss in case there is any damage or destruction

caused to it.

Example of Insurable Interest Principle: The owner of a stationery shop has an insurable interest in

the shop as he is earning money from it. However, if he sells or leases his shop, he will no longer

have an insurable interest in it. In order to claim the insurance amount, the insured should be the

owner of the property both at the time of entering into the contract and at the time of any loss taking

place to it.

Principle of Indemnity

It implies that the insurance is done only to cover the loss, hence the insured should not derive any

proﬁt from the insurance contract. The insured should only be compensated to the extent of the

actual loss incurred and not the amount exceeding the loss. The principle of indemnity aims to set

back the insured at the same ﬁnancial position he was before incurring the loss. Principle of

indemnity strictly implies for property insurance and is not applicable to life insurance.

Example of Indemnity Principle: The owner of a residential building takes an insurance contract to

recover the costs for any loss or damage to the property in the future. If the building faces any kind

of structural damage due to ﬁre, the insurance company shall make an indemnifying compensation

to the owner for the costs to repair the building. The compensation is the exact amount spent on the

repair or reconstruction of the damaged areas by the authorized contractors.

Principle of Subrogation

Subrogation refers to the situation when one party stands on behalf of another. Under the principle

of subrogation, once the insured is compensated for the losses incurred to him for the insured

property, the rights of the ownership of such property transfers to the insurer. Thus, subrogation

gives the right to the insurer to claim the amount of loss from the third-party.

Example of Subrogation Principle : Mr. X sustains injuries in a road accident due to irresponsible

driving of a third party. The insurer shall compensate Mr. X for the losses incurred as well as sue the

third party for the recovery of the compensated amount.

Principle of Contribution

It applies when the insured entity takes more than one insurance policy for one and the same

property. Principle of contribution is similar to the principle of indemnity, such that the insured shall

not be able to derive proﬁts through an insurance claim on one insured property by opting for

different policies and/ or companies.

Example of Contribution Principle : The owner of a property worth INR 5 lakhs insures it for INR 1

lakhs from Insurer A and INR 3 lakh from Insurer B. In case of any damage to the property, the owner

can claim the full amount of INR 3 lakh from Insurer B but not from the other. Besides, Insurer B can

claim the proportional amount reimbursed value from Insurer A.

Principle of Loss Minimization

As per the principle of loss minimization, it is obligatory for the insured to take necessary actions to

minimize the loss to the insured property. The principle of loss minimization states that the owner

cannot be irresponsible or negligent about their insured property.

Example of Loss Minimization Principle: In case ﬁre breaks out at a commercial building, the insured

owner of it should take necessary actions to minimize the loss by putting out the ﬁre. The owner

should not take it easy and allow the ﬁre to engulf the property knowing that it is ensured and that

the insurer shall pay for it.

The above banking awareness study material on Principle of Insurance is intended to guide

candidates for various competitive exams. If you’re looking for more such study resources,

download our Testbook App and get started now! The app provides instant access to over hundreds

of mock tests, practice sets, live coaching classes, doubt clearing sessions, and much more at your

ﬁnger tips!