CHAPTER :FIVE

INTRODUCTION TO INSURANCE

COURSE INSTRUCTOR : KAZI SIRAJUM MUNIRA

ASSISTANT PROFESSOR
DEPARTMENT OF MANAGEMENT
UNIVERSITY OF CHITTAGONG
 DEFINITION OF INSURANCE

• Insurance may be defined as a contract

between two parties where by one party
called insurer undertakes in exchange for a
fixed sum called premiums to pay the other
party called insured a fixed amount of
money on the happening of a certain event.

M. N. Mishra
 DEFINITION OF INSURANCE

• Insurance is a legal contract that transfers risk

from a policyholder to an insurance provider.
• Insurance is the pooling of losses by transfer
of such risks to insurers, who agree to
indemnify insured for such losses, to provide
other pecuniary benefits on their occurrence,
or to render services connected with the risk.
 NATURE OF INSURANCE
• Nature of insurance
• Sharing of risk.
• Co-operative device.
• Value of risk.
• Payment at contingency.
• Amount of payment.
• Large numbered or insured person.
• Insurance is not gambling.
• Insurance is not a charity.
 ROLE AND IMPORTANCE OF INSURANCE
Uses to an individual Uses to Business
1. Insurance provides security & 1. Uncertainty of business losses
safety. is reduced.
2. Insurance affords peace of 2. Business efficiency is
mind. increased
3. Insurance protects mortgaged 3. Key Man Indemnification
property. 4. Enhancement of credit
4. Insurance eliminates 5. Business continuation
dependency. 6. Welfare of employees
5. Life insurance encourages
savings & provides profitable
investment Uses to the Society
1. Wealth of society is protected
6. Life insurance fulfills the needs 2. Economic growth of the
of a person (e.g., family need, country
old-age needs, education need 3. Reduction in inflation.
for children etc)
 CLASSIFICATION OF INSURANCE
1. Life insurance
• Life insurance is different from other insurance in the
sense that, here the subject matter of insurance is life of
human being.
• The insurer will pay the fixed amount of insurance at the
time of death or at the expiry of certain period.
2. General insurance
• Fire insurance: covers the risk of fire.
• Marine insurance: provides protection against loss of
marine perils.
• Ocean marine insurance: insures only marine perils.
• Inland marine insurance: covers marine and inland perils (exporter’s warehouse
to importer’s warehouse)
 CLASSIFICATION OF INSURANCE
Miscellaneous Insurances Liability Insurance
1. Motor insurance 1. Employer’s liability/
2. Theft insurance workers compensation
insurance
3. Goods-in-Transit
2. Public liability
4. Money insurance
insurance
5. Personal accident
3. Product liability
6. Health insurance insurance
7. Engineering insurance 4. Professional indemnity
8. Contractors all risks insurance
9. Glass insurance 5. Credit insurance
10. All risk insurance 6. Fidelity Guarantee
 INSURANCE AS CONTRACT

The insurance contract involves :

The elements of general contract

The elements of special contract relating

to insurance
 GENERAL ELEMENTS OF CONTRACT
• Offer and acceptance :generally comes from the
insured .Insurer may also propose to make the
contract .In insurance ,the publication of
prospectus ,the canvassing of the agent are invitation
to offer. When offer accepted it is called acceptance.
• Free consent : the consent will be free when it is not
caused by coercion , undue influence ,fraud or
misrepresentation.
• Legal consideration (premium): as we know from the
law of contract “ no consideration no contract “
 GENERAL ELEMENTS OF CONTRACT
• Competency :every person is competent to
contract such sound mind , age of majority
and qualified from contracting by any law .
and minor , unsound mind ,an alien
enemy ,criminal , bankruptcy is not competent
to contract .
• Legal object: in order to make a valid contract,
the object of the agreement must be lawful .
an object is lawful if it is –not forbidden by law
,is not immoral ,or which does not defeat any
provision of law.
 ELEMENTS SPECIAL
CONTRACT /PRINCIPLES OF
INSURANCE

1.Utmost good faith

2.Insurable interest
3.Principles of indemnity
4.Doctrine of subrogation
5.Contribution
6.Proximate cause
 1) UTMOST GOOD FAITH

• Principle of “UBERRIMAE FIDEI” is a latin

phrase
• In English words the principle of utmost good
faith, is a very basic and first primary principle
of insurance
• According to this principles ,the insurance
contract must be signed by both parties (i.e
insurer and insured)in an absolute good faith
or belief or trust .
 1) UTMOST GOOD FAITH
• 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 insured.
• It applies to all types of insurance contract.
 1) UTMOST GOOD FAITH
Supported by three legal doctrines:
I. Representations
II. Concealment
III. Warranty
Representations are the statements made by the
applicants of the insurance .
(age ,weight ,height ,occupation ,state of health ,family
history and other relevant questions )
A concealment is intentional failure of the applicant for
insurance to reveal a material fact to the insurer .
A warranty is a statement that becomes part of the
maker to be true in all respects .
 2.INSURABLE INTEREST
The principle of insurable interest means that the
insured must stand to lose financially if a loss
occurs .
All insurance contracts must be supported by an
insurable interest to be legally enforceable.

Purposes:

• To prevent gambling
• To reduce moral hazard
• To measure the amount of the insured’s loss
 2.INSURABLE INTEREST
•An insurable interest can be supported by:
• Ownership of property
• Potential legal liability
• Serving as a secured creditor
• Contractual rights
•When must insurable interest exist?
• Property insurance: at the time of the loss
• Life insurance: only at inception of the
policy
• Marine :at the time of the loss
 3.PRINCIPLES OF INDEMNITY

• 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 .
• Purpose:
• To prevent the insured from profiting from a
loss
• To reduce moral hazard
 HOW INDEMNITY IS PROVIDED?
• Cash payment :in liability insurance ,payment always
made by cash
• Repair :insurer make extensive use of repair as a
method of providing indemnity. Example :motor
insurance
• Replacement :replacement is not a method of
providing indemnity ,but it may also be used in case of
expensive jewellery .
• Reinstatement :example :property insurance where an
insurer undertakes to restore or rebuild a building or
piece of machinery damaged by fire or a whole range of
different perils or by breakdown under an engineering
policy.
3.PRINCIPLES OF INDEMNITY
• Average : a method by which under-insurance is avoided.
• Pro-rata condition of average:
(Sum insured/actual value X loss)
• Condition of average :
Also known as 75% condition of average.
If the sum-insured is less than 75% value of the
property then the insurer will pay that proportion of
loss that the sum insured to the actual value.
If the sum insured is at least 75% or more of the
actual value then no average apply.
 4.DOCTRINE OF SUBROGATION
• Subrogation means substituting one credit 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 his insured
property,then the ownership right of such property shifts to
the insurer.
• The 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.
 5.PRINCIPLES OF
CONTRIBUTION
• The contribution principle states that if you
can hold more than one insurer liable for
your losses, they have to share the loss.
• If you take out two policies on your car,
you can't collect from both insurers.
• One company would pay you and then
collect from the second, or both
companies could cut you a check for part
of the loss.
5.PRINCIPLES OF CONTRIBUTION

• The formula applied is:

Sum-insured under policy

------------------------------------------------ ×
Loss
Total sum-insured under all policy
 6.PRINCIPLES OF PROXIMATE
CAUSE(NEAREST CAUSE )
• Insurance protects against some perils --
types of damage -- but not others.
• If your home is caught in a hurricane, for
instance, your homeowners insurance
protects against wind damage but not
flooding: if the proximate or primary cause
of damage was floodwater, your insurer will
refuse to pay.
• If you prove the proximate cause of the
damage was the wind, you can collect.
• Proximate cause can be understood by the
following example. A man was riding a bicycle
to his work, midway there was a riot going on
in the street for which curfew was declared, as
a result the man had to turn back and could
not attend office. Here the proximate cause is
the street riot that stopped the man from
attending office.
• Representation
• Is a statement made by the proposer to the insurer
relating to a proposed risk
• Includes every information given by the proposer for
insurance to the insurer during the negotiations
• If false or untrue, the contract may be voidable at the
option of the insurer.
• Warranties
• Is an undertaking by the insured to the effect that he
shall or shall not do a certain thing or that some
conditions shall be fulfilled or whereby he affirms or
negative the existence of a particular state of affairs.
• May be either expressed or implied
 “ACTS OF GOD”
FLOOD
HURRICANE
EARTHQUAKE
WINDSTORM
LIGHTENING
TYPES /KINDS OF INSURANCE
ORGANIZATION
8 TYPES OF INSURANCE ORGANIZATIONS ARE;
1.SELF-INSURANCE,
2.INDIVIDUAL INSURER,
3.PARTNERSHIP,
4.JOINT STOCK COMPANIES,
5.MUTUAL COMPANIES,
6.CO-OPERATIVE INSURANCE ORGANIZATION,
7.LLOYD’S ASSOCIATION,
8.STATE INSURANCE.
 STRUCTURE OF INSURANCE BUSINESS
The Buyer The The Seller The
(Insured) Intermediaries (Insurer) Reinsurers
Commerce Lloyd’s Broker Lloyd’s

Broker Property Co. Reinsurance

Broker
Industrial Life
Agent Assurance Co.

Consultants Provident
Industry Societies
Home service Reinsurance
Representative Companies
Cooperatives

Captive
Insurance Co.
Reinsurance
Self Insurance Broker
Public
State
• Reinsurance
• Is a contract which one insurer makes with
another to protect the first insurer from risk
already assumed.
• Is an agreement to indemnify the assured
(meaning reassured), partially or altogether,
against a risk assumed by it in a policy issued to
a third party.
• Reasons for reinsurance
• Risk minimization by spreading
• Risk transfer
• Flexibility in accepting risk beyond financial
strength
• Reduces accumulation of risks coming from
different sources.
• Growth of insurance company
 SELF STUDY

• Characteristics of an ideally insurable risk

• Insurance vs. Gambling
• Insurance vs. Hedging
• Role and importance of insurance
• Material facts need not be disclosed in case
of utmost good faith
 INSURANCE VS. GAMBLING

Insurance Gambling

• Insurance is a technique for • Gambling creates a new

handing an already existing pure speculative risk
risk • Gambling is not socially
• Insurance is always socially productive
productive: • The winner’s gain comes at the
• Both parties have a common expense of the loser
interest in the prevention of a
loss
 INSURANCE VS. HEDGING

Insurance Hedging

• Risk is transferred by a contract

• Risk is transferred by a contract
• Insurance involves the transfer of
pure (insurable) risks • Hedging involves risks that are
• Insurance can reduce the typically uninsurable
objective risk of an insurer • Hedging does not result in
• Through the law of large reduced risk
numbers