Unit -1

Introduction –

Life is a chain of uncertain events that can never be predicted. Many

uncertain events can occur in a person’s life causing damage to his life
and property. This incites a need to protect oneself from the losses
incurred from such events. This is what the concept of insurance is
based on.

Insurance may be described as a social device to reduce or

eliminate risks or loss to life and property. It is a provision which a
prudent man makes against inevitable contingencies, loss or misfortune.
Insurance provides financial protection against a loss arising out of
happening of an uncertain event. A person can avail this protection by
paying premium to an insurance company.

In this concept a pool is created through contributions made by

persons seeking to protect themselves from common risk. Premium is
collected by insurance companies which also act as trustee to the pool.
Any loss to the insured in case of happening of an uncertain event is
paid out of this pool. Insurance works on the basic principle of risk-
sharing. A great advantage of insurance is that it spreads the risk of a
few people over a large group of people exposed to risk of similar type

Defination –

Insurance is a contract between two parties whereby one party agrees

to undertake the risk of another in exchange for consideration known as
premium and promises to pay a fixed sum of money to the other party
on happening of an uncertain event (death) or after the expiry of a
certain period in case of life insurance or to indemnify the other party on
happening of an uncertain event in case of general insurance.

The party bearing the risk is known as the ‘insurer’ or the

‘assurer’ and the party whose risk is covered is known as the
‘insured’ or ‘assured’.

According to Ghosh an Agarwal, “Insurance is a co-operative form of

distributing a certain risk over a group of persons who are exposed to
it.”

History of the insurance sector in India-

1. Ancient times

The concept of insurance was loosely practised in ancient Indian

society. It also finds mention in some religious scriptures such
as Dharmasastra and Arthasastra. The scriptures mention that
communities pool their resources and redistribute them when natural
calamities hit them.

2. British rule

With the advent of the British, the concept of insurance in India

changed. India had its first British insurance firm with the
establishment of the Orental Life Insurance Company in 1818 , which
later failed in 1834. Subsequently, the British Insurance Act was
enacted in 1870. Most of the insurance companies in India were owned
and operated by foreigners. In 1912, the Government of India passed
the first statute called Indian Life Assurance Companies Act, 1912 . For
the first time, in 1914, the Government of India started to publish
the returns of insurance companies in India . And, in 1928, the Indian
Insurance Companies Act was enacted, empowering the government to
collect data on the business of both Indian and foreign insurers. In
1938, Insurance Act, 1938, was enacted, whose importance was
diminished by subsequent legislation.

3. Post-independence

In the 1950s, the Government of India started to nationalize the

insurance sector of the country. In 1956, the Life Insurance Corporation
Act, 1956 was enacted which led to the establishment of Life Insurance
Corporation, popularly known by its abbreviation LIC, which has a
monopoly over the life insurance business in India. After the enactment
of this Act, life insurance fell out of the purview of the Insurance Act,
1938. In 1973, the General Insurance Business (Nationalisation) Act,
1972 came into effect, nationalizing general insurance business.

4. Liberalization policy

In 1991, liberalization and privatization brought forth many changes in

the Indian economy. When the need to reopen the insurance sector to
private parties arose, the central government set up a committee
headed by R.N. Malhotra, former governor of RBI, to examine the
changes to be made in the insurance sector. The eight-member
committee recommended privatization of the insurance sector and the
establishment of the Insurance Development Regulatory Authority
(IRDA), an autonomous body to regulate the insurance sector. Finally,
the monopoly of LIC over the life insurance sector ended and the IRDA
Act, 1999 was enacted.

Classification of Insurance-

There are two type of insurance namely life and non-life insurance. In
life insurance, the protection is given for the life of a human being
while in the case of General (non-life) insurance the protection is
extended for assets and properties.

Life Insurance General Insurance

 This is not a contract of This is essentially an
indemnity. arrangement of indemnity

Because it is very difficult to It is easy to ascertain the

ascertain the financial or economic value of an asset.
monetary value of human life.

Intention may be Risk cover and Intention is only to cover the

or savings. risk

It is life time contract. It is yearly contract, subject to

renewal.

Death is certain, only timing is Event is totally uncertain.

uncertain.

Earning capacity of the insured Economic value of asset is

is relevant. relevant.

Premium is based on sum It is not relevant.

insured, age at the time of entry

Premium is calculated with Premium is calculated with

reference to mortality table. reference to experience of past
losses, probable risk factors and
fixed tariff plans.

Purpose of insurance -
The following are the two main purposes of insurance contracts :

1. Protection against uncertain events: The main purpose of an

insurance contract is to make the insured person secure and
financially protected from certain uncertain contingencies that
would cause a huge financial burden.
2. Better management of finances: Many people have the
tendency to make poor financial decisions that could potentially
leave them without any support when faced with an unfortunate
situation. By subscribing to an insurance policy, the insured
would be able to make better financial decisions.

Principles of Insurance -

The concept of insurance is risk distribution among a group of people.

Hence, cooperation becomes the basic principle of insurance.

To ensure the proper functioning of an insurance contract, the insurer

and the insured have to uphold the 7 principles of Insurances
mentioned below:
 1. Utmost Good Faith
2. Proximate Cause
3. Insurable Interest
4. Indemnity
5. Subrogation
6. Contribution
7. Loss Minimization

Let us understand each principle of insurance with an example.

 Principle of Utmost Good Faith

The fundamental principle is that both the parties in an insurance

contract should act in good faith towards each other, i.e. they must
provide clear and concise information related to the terms and
conditions of the contract.

The Insured should provide all the information related to the subject
matter, and the insurer must give precise details regarding the
contract.

Example – Jacob took a health insurance policy. At the time of taking

insurance, he was a smoker and failed to disclose this fact. Later, he
got cancer. In such a situation, the Insurance company will not be
liable to bear the financial burden as Jacob concealed important facts.

 Principle of Proximate Cause

This is also called the principle of ‘Causa Proxima’ or the nearest

cause. This principle applies when the loss is the result of two or more
causes. The insurance company will find the nearest cause of loss to
the property. If the proximate cause is the one in which the property is
insured, then the company must pay compensation. If it is not a cause
the property is insured against, then no payment will be made by the
insured.

Example –

Due to fire, a wall of a building was damaged, and the municipal

authority ordered it to be demolished. While demolition the adjoining
building was damaged. The owner of the adjoining building claimed the
loss under the fire policy. The court held that fire is the nearest cause
of loss to the adjoining building, and the claim is payable as the falling
of the wall is an inevitable result of the fire.
In the same example, the wall of the building damaged due to fire, fell
down due to storm before it could be repaired and damaged an
adjoining building. The owner of the adjoining building claimed the loss
under the fire policy. In this case, the fire was a remote cause, and the
storm was the proximate cause; hence the claim is not payable under
the fire policy.

 Principle of Insurable interest

This principle says that the individual (insured) must have an insurable
interest in the subject matter. Insurable interest means that the
subject matter for which the individual enters the insurance contract
must provide some financial gain to the insured and also lead to a
financial loss if there is any damage, destruction or loss.

Example – the owner of a vegetable cart has an insurable interest in

the cart because he is earning money from it. However, if he sells the
cart, he will no longer have an insurable interest in it.

To claim the amount of insurance, the insured must be the owner of

the subject matter both at the time of entering the contract and at the
time of the accident.

 Principle of Indemnity

This principle says that insurance is done only for the coverage of the
loss; hence insured should not make any profit from the insurance
contract. In other words, the insured should be compensated the
amount equal to the actual loss and not the amount exceeding the
loss. The purpose of the indemnity principle is to set back the insured
at the same financial position as he was before the loss occurred.
Principle of indemnity is observed strictly for property insurance and
not applicable for the life insurance contract.

Example – The owner of a commercial building enters an insurance

contract to recover the costs for any loss or damage in future. If the
building sustains structural damages from fire, then the insurer will
indemnify the owner for the costs to repair the building by way of
reimbursing the owner for the exact amount spent on repair or by
reconstructing the damaged areas using its own authorized
contractors.

 Principle of Subrogation

Subrogation means one party stands in for another. As per this

principle, after the insured, i.e. the individual has been compensated
for the incurred loss to him on the subject matter that was insured, the
rights of the ownership of that property goes to the insurer, i.e. the
company.

Subrogation gives the right to the insurance company to claim the

amount of loss from the third-party responsible for the same.

Example – If Mr A gets injured in a road accident, due to reckless

driving of a third party, the company with which Mr A took the
accidental insurance will compensate the loss occurred to Mr A and will
also sue the third party to recover the money paid as claim.

 Principle of Contribution

Contribution principle applies when the insured takes more than one
insurance policy for the same subject matter. It states the same thing
as in the principle of indemnity, i.e. the insured cannot make a profit
by claiming the loss of one subject matter from different policies or
companies.

Example – A property worth Rs. 5 Lakhs is insured with Company A for

Rs. 3 lakhs and with company B for Rs.1 lakhs. The owner in case of
damage to the property for 3 lakhs can claim the full amount from
Company A but then he cannot claim any amount from Company B.
Now, Company A can claim the proportional amount reimbursed value
from Company B.

 Principle of Loss Minimisation

This principle says that as an owner, it is obligatory on the part of the

insurer to take necessary steps to minimise the loss to the insured
property. The principle does not allow the owner to be irresponsible or
negligent just because the subject matter is insured.

Example – If a fire breaks out in your factory, you should take

reasonable steps to put out the fire. You cannot just stand back and
allow the fire to burn down the factory because you know that the
insurance company will compensate for it.

Contract Of Insurance –

For an insurance contract to be valid it should fulfill all the

requirements mentioned in Section 10 of the Indian Contract Act, 1872
which are as follows:

 Offer and Acceptance

In the context of insurance, an ‘offer’ is called ‘proposal’. A proposal
can be put forth either by the insurer or the insured. Once the proposal
is accepted, it turns into an agreement. A proposal form or application
for insurance is filled by the insured by giving information required by
the insurance company to assess the risk and arrive at a price to be
charged for covering the risk. The insured goes through the application
by assessing the risk and gives it decision. Before giving a decision the
insured and the insurer may make some alterations in the proposal as
per their needs, such alterations amount to counter – offer. If this
counteroffer is accepted by the other party then it amounts to
acceptance.

 Legal consideration
In an insurance contract, amount equal to the premium paid by the
insured becomes the consideration of the contract. The insurer who
promises to pay a fixed sum at a given contingency must be given
something in consideration. Without the payment of the premium, the
contract cannot be established. The consideration need not be money
but it must be ‘valuable’ such as right, interest, profit or benefit
according to one party or some forbearance, detriment, loss or
responsibility given, suffered or undertaken by the other.

 Competent to make contract

Any person, either natural or artificial who has the legal capacity to
enter into a contract can become an insurer. The person must have
acquired the license for the purpose of conducting insurance practice
from the government authority. The insured can enter into a contract
provided he is not minor, not of unsound mind and is not disqualified
from contracting by any law. In the case of a minor, the natural legal
guardians enter into a valid contract on behalf of the minor, till the
minor attains 18 years of age.

 Free consent
The insured and the insurer should agree upon the same thing in the
same sense. The policy document clearly lays down the terms and
conditions that are to be followed by both parties. Consent is as free
when it is not caused by –

 Coercion
 Undue influence
 Fraud
 Misrepresentation
 Mistake
The insured should reveal all the information in the proposal form to
enable the insurance company to assess the risk properly. If the
insurer finds out that the insured has not truthfully disclosed the
information then the insurance company can cancel the contract.
When consent to an agreement is caused by the vitiating factors, the
agreement which forms the contract is voidable at the option of the
party whose consent was so caused.

 Legal object
While filling out the proposal form the parties should ensure that the
object of insurance is legal and should not be concealed. If the object
of an insurance agreement is found to be unlawful then the policy is
void.

Conclusion -

In India the practice of insurance developed through the joint family

concept of social security. The insurance sector developed immensely
and rapidly in our country and has many legislations on insurance as of
now. The whole concept of insurance can be explained with the help of
the other general contracts. With the principles of insurance, one can
understand how the practices of insurance work even though it is a
contract between the policyholders and the parties. Many courts have
taken these principles as the basis to resolve disputes regarding
insurance.