CHAPTER SIX

INTRODUCTION TO CONTRACT OF INSURANCE

There are various catastrophes or risks or perils faced by individual traders or

businesses from numerous sources that will force the trader or the
businesses to stop or close the businesses.
The perils or catastrophes are related to body, life or property of the person.
When the abnormality or risk surrounds or victimizes the life , property or
bodily constitution of the person, insurance remedies the problem as the
curative measure. Insurance does not prevent the occurrence of the
risk/catastrophe. Rather it cures the problem.
 Definition of Insurance

• From the view point of the policy holder(subscriber, insured, assured),

insurance is the mechanism of risk transfer or it is an economic device
whereby a person called the insured transfers risk of financial loss
resulting from unforeseeable events affecting life, property or body to
the person called insurer for consideration (payment of premium).

• From the perspective of the insurer(assurer), insurance it is the

mechanism via which risk is distributed among the insured who are
exposed to the same type of risk.
 Cont’d
• Insurance is a cooperative economic device which spreads
risk over a number of persons who are exposed to it.
• Insurance provides a pool to which persons contribute a
certain amount of money called premium and out of which
the insurer compensates to few who suffer from loss.
• Insurance does not and cannot prevent loss of property,
incurring civil liability, death, injury or illness, rather it
financially compensates the effect of misfortune. In other
words, Insurance does not prevent the insured property
from loss or damage, the insured from incurring civil
liability, death, illness or injury.
 Cont’d
• Rather, insurance provides financial compensation to the
insured or beneficiary suffer pecuniary loss as the result of
loss or damage of property, incurring civil liability, death,
illness or injury of the insured.
• Insurance is advantageous to the insured since it enables him
to protect himself from heavy(unbearable) losses likely
caused by uncertain events by paying comparatively much
smaller premium.
• Insurance is a curative but not preventive remedy which
provides financial compensation to the effect of misfortune.
 Nature of Insurance contract
• A, Insurance is contingent or conditional contract. It is a
contract in which the performance of the obligations by
parties or one of them is dependent up on the
occurrence of the condition or contingency agreed by
the parties in the contract.
• B, Insurance is a contract, as a result the essential
validity requirements of contract are applicable.
• C, Contract of insurance is Aleatory contract not
cumulative contract. An aleatory contract has a chance
element( not all subscribers would be paid) and uneven
exchange (may not be always win-win).
 Cont’d

• D, Insurance contract is contract of Adhesion. All the terms

and conditions of the contract are not results of negotiations of
the parties. The terms of the contract are articulated by the
insurer and the insured is required to accept or adhere it or
leave it
• E, Insurance works by the Law of Large Numbers or by
pooling premiums.
 Significance of Insurance
Indemnification of losses
Payment of compensation by the insurers to the losses permits
individuals and families to be restored in to their original
financial positions after the losses occurred.
Reduction of worry and Fear: It reduces or eradicates worry
and fear either before or after the happening of the losses.
Source of investment fund : The insurance industry is an
important source of capital investment and accumulation.
Premiums collected by the insurer and other funds which are
not needed to pay for immediate losses and expenses will be
lent to businesses or manufacturing or real estates.
 Cont’d
• Means of loss control: If no effort is made to control or
minimize the occurrence of insured risks or losses, the
premium has the tendency to rise. Hence, insurers should
participate in programes and sponsorship schemes to
minimize or reduce the chance of risks, such as road building
and fire safety standards. Thus, insurance should be
considered as mechanism of risk management.
• Enhancing credit: When a person is insured, the fact that a
person is insured enhances the person’s credit.
 The Major Principles of the Law of Insurance
• There are a number of principles that should be obeyed in
the law of insurance. These are ;
• A. The Principle of Insurable Interest
• Insurable interest means financial relation with someone or
something. It is a person’s legally recognized relationship to
the subject matters of insurance which gives them the right
to effect insurance on it. An insurance agreement without
insurable interest is void. Insurable interest is sometimes
legally presumed without the need to show financial
relationship. E.g the relationship of spouses.
 Cont’d
• One has an insurable interest on his own life, limbs, spouse ,
child or ward( in case of guardianship),.
• Owners, trustees, executors, administrators or mortgagees can
insure their property.
• B. The Principle of Utmost Good Faith
• Most types of contracts especially those involving fiduciary
relations are required to adhere the principle of good faith
which is to mean that they must behave in honesty. However,
they are not expected to disclose all material facts in the
absence of request by the other party.
 Cont’d
• In contract of insurance good faith is required to be applied
strictly that is to mean utmost good faith is the
precondition. All material facts or vital information should
be disclosed even without the direct claim of the party in
the contract. Material facts are circumstances that can
influence the decision of prudent insurer in determining
premiums and accepting or rejecting the risk.
• This principle can be breached either via
misrepresentation( giving of false information) or non-
disclosure in four dimensions.
 Cont’d
• Fraudulent misrepresentation : fraudulently giving false
information to the other party.
• Non-fraudulent misrepresentation: It is giving false material
facts to the other party which is done innocently or
negligently.
• Fraudulent non-disclosure: is fraudulent omission to give
material facts to the other party.
• Non-fraudulent non-disclosure: omission to give material
facts to the other party which is made innocently or
negligently.
 Cont’d
• There are material facts the non-disclosure of which will not
entail the breach of the principle of utmost good faith. These
are matters of common knowledge, facts known, or deemed
to be known or facts that diminish the risk.
• C. The Principle of Proximate Cause
• For the purpose of insurance claim, one dominant cause
should be singled out in each case, because not every cause
of loss is covered. For this purpose, risks are categorized into
three.
• I Insured perils: it is not common that all risks are covered in
the policy.
 Cont’d
• The risks that are covered by the contract of insurance are
considered as insured risks.
• Excluded/Excepted risks: are risks which would be covered
but due to its removal in the contract it is excluded.
• Uninsured risks: are the perils neither insured nor excluded.
The loss caused by an uninsured peril is irrecoverable unless
the insured peril has led to the happening of an uninsured peril.
• There must always be an insured peril involved: otherwise the
loss is definitely irrecoverable.
 Cont’d
• If a single cause is present, the rules are straightforward: If
the peril is insured, the loss is covered, if the peril is
uninsured or excepted, the loss is not covered. When the
loss is caused by several causes, there are different rules.
Uninsured peril arising out of insured peril is covered and
similarly an insured peril arising out of uninsured is
covered.
• D. The Principle of Indemnity
• Indemnity is the exact financial compensation to an insured
loss. ‘No more no less’.
Cont’d
• Indemnity is not applicable in life insurance and personal
accident insurance. However, it is applicable in medical expense
insurance. It is also applicable in other types of insurance. It can
be enforced through cash payment, repair, reinstatement or
replacement. If the thing which sustains risk has some
remaining part with economic value, the insurer will not pay for
such value(salvage).
• E. The Principle of Contribution
• The claims-related doctrine of equity as between insurers in the
event of double insurance, a situation where two or more
policies have been bought by or on behalf of the insured that
represent the same
Cont’d
• Interest or any part thereof whereby the aggregate of
sums in the insurance exceeds the legally allowed
indemnities.
• The insurers will contribute in rateable proportion till
the extent of indemnity not beyond the legally allowed
indemnity.
• F. The Principle of Subrogation
• Subrogation is the exercise, for ones own benefit , of
rights or remedies possessed by another against third
parties. As per the law, insurers subrogation action
must be conducted in the name of the insured.
Cont’d
• Subrogation can only apply if indemnity applies. Thus,
subrogation will not be applicable in case of life
insurance and personal accident insurance. However, it
can be applied for property insurance and medical
expense insurance.
 CHAPTER SEVEN
NEGOTIABLE INSTRUMENTS
• Meaning and Concept of Negotiable Instruments
• The term ‘negotiable’ means transferable by delivery and the
term ‘instrument’ is to mean written document by which a
right is created in favor person.
• Negotiable instrument is a document containing the right
transferable by delivery.
• Any a document containing a right to an entitlement in a
such manner it is not possible to enforce or transfer the right
separately from the instrument.
Cont’d
• The rights could be the rights for payment of money
that may arise from the contract of sale, lease, loan or
ownership in companies(shares), debt to the
government(bond) or debt made to the
companies(debentures).
• Negotiable instruments are issued after the fulfilment
of the requirements of essential elements of contracts.
• They hold property rights of ‘chose in action’ and the
rights incorporated in negotiable instruments do not
have physical existence and cannot be perceived by
senses.
Cont’d
Functions of Negotiable Instruments
Negotiable instruments are of various functions.
Facilitation of commercial transactions
Reduction of losses and theft
Raising capital
Creates convenance for business transaction.
Types of Negotiable Instruments
• Negotiable instruments are categorized in to three.
• A. Commercial Instruments
• Are negotiable instruments incorporating rights for
payment of a specified amount of money. They are
issued and negotiated based on and for the purpose of
performing obligations that can be performed by
certain amount of money. They serve as substitute to
money. E.g bill of exchange, promisory note, check,
travelers’ check etc.
• B. Transferable Securities
Cont’d
• They are negotiable instruments incorporating rights
for payment of money. The sources for such rights
may be investments made in companies or purchasing
of government bonds or company debentures.
• A person who purchases shares can share profits of the
company, i.e dividends and can share the assets of the
company if the company is going to be dissolved. A
person who purchases debentures or bonds has the
right to acquire the repayment of money plus interest.
 Cont’d

• C. Documents of Title to Goods

• These are negotiable instruments containing rights of
ownership over goods that are being transported or
warehoused and which enable the holders to receive such
goods.
• Requirements Promissory Note
• The term ‘promissory note’
• Unconditional order to payment of a certain sum in money
• The time and place of issuance
 Cont’d
• Time and place of payment
• The name of the person to whom the promissory note
issued
• The signature of the person who issued the promissory
note
• Requirements for Bill of Exchange
• The term ‘bill of exchange’
• Unconditional order to pay a certain sum in money
• Place of payment
• Time of payment
Cont’d
• Name of the person to whose benefit bill of exchange
is issued(Payee).
• The name of the person who is ordered to
pay( drawee)
• Time and place of issuance.
• The signature of the person who ordered the bill of
exchange.
• The requirements in checks are in case of checks are
similar to bill of exchange except the drawee is always
the banker in case of checks.
Cont’d
• Besides, checks are always on demand while bill of
exchange could be on demand, at fixed period of time
or determinable in the future.
• Bill of exchange or checks could be to order or to
bearer. To bearer documents are exposed to theft and
loss.