FUNDAMENTALS/PRINCIPLES OF GENERAL INSURANCE

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MODULE - 2Principles of General InsurancePrinciples of Insurance5NotesFUNDAMENTALS/PRINCIPLES OFGENERAL INSURANCE5.0 INTRODUCTIONAfter studying, the life insurance and its importance, the overaspect of insurance other than ‘Life Insurance’ would isGeneral Insurance. In this chapter, we cover various aspect ofGeneral Insurance such as Principles of utmost Good faithsmaterial fact Principle of Insurable Insures and Principle ofIndemnity.General Insurance comprises of insurance of property againstfire, burglary etc, personal insurance such as Accident andHealth Insurance, and liability insurance which covers legalliabilities. Suitable general Insurance covers are necessary forevery family. It is important to protect one’s property, whichone might have acquired from one’s hard earned income. Lossescreated to catastrophes such as the tsunami, earthquakes,cyclones etc. have left many homeless and penniless. Suchlosses can be devastating but insurance could help mitigatethem. Property can be covered, so also the people againstPersonal Accident. A Health Insurance policy can providefinancial relief to a person undergoing medical treatmentwhether due to a disease or an injury.5.1 OBJECTIVESAt the end of this lesson you will be able to know:54zVarious additional principles applicable to life insurancecontractzIn case any of these principles are missing the insurancecontract will become voidDIPLOMA IN INSURANCE SERVICES

Principles of General InsuranceMODULE - 2Principles of Insurance5.2 PRINCIPLES OF UTMOST GOOD FAITHBoth the parties to a commercial contract are by law requiredto observe good faith. Let us say that you go to a shop to buyan electrical appliance. You simply will not enter, pay andpick up any sample piece but will check two, three or evenmore pieces. You may be even ask the shopkeeper to give ademonstration to ensure that it is in working condition andalso ask several questions to satisfy yourself about what youare buying. Then when you go home you find it does not workor is not what you were looking for exactly so you decide toreturn the item but the shopkeeper may well refuse to take itback saying that before purchasing you had satisfied yourself;and he is possibly right. The common law principle “CaveatEmptor” or let the buyer beware is applicable to commercialcontracts and the buyer must satisfy himself that the contractis good because he has no legal redress later on if he hasmade a bad bargain. The seller cannot misrepresent the itemhe has sold or deceive the buyer by giving wrong or misleadinginformation but he is under no obligation to disclose all theinformation to the buyer and only selective information inreply to the buyers queries is required to be given. But inInsurance contracts the principles of “Uberrima fides” i.e. ofUtmost Good Faith is observed and simple good faith is notenough. Why this difference in Insurance contracts?NotesFirstly, in Insurance contracts the seller is the insurer and hehas no knowledge about the property to be insured. Theproposer on the other hand knows or is supposed to knoweverything about the property. The condition is reverse ofordinary commercial contracts and the seller is entirelydependent upon the buyer to provide the information aboutthe property and hence the need for Utmost Good Faith onthe part of the proposer.It may be said here that the insurer has the option of gettingthe subject matter of Insurance examined before covering therisk. This is true that he can conduct an examination in thecase of a property being insured for fire risk or of getting amedical examination done in the case of a health policy. Buteven then there will be facts which only the insured can knowe.g., the history of Insurance of the property whether it hasbeen refused earlier for Insurance by another company orwhether it is also already insured with another company andthe previous claim experience. Similarly a medical examinationDIPLOMA IN INSURANCE SERVICES55

MODULE - 2Principles of General InsurancePrinciples of Insurancemay not reveal the previous history i.e. details of past illness,accidents etc. Therefore Insurance contracts insist on thepractice of Utmost Good Faith on the part of the Insured.NotesSecondly, Insurance is an intangible product. It cannot beseen or felt. It is simply a promise on the part of Insurer tomake good the loss incurred by the Insured if and when itoccurs.Thus the Insurer is also obliged to practice Utmost Good Faithin his dealings with the Insured. He cannot and should notmake false promises during negotiations.He should not withhold information from the Insured such asthe discounts available for good features e.g., fire extinguishingAppliances discount in fire policies or that Earthquake risk isnot covered under the standard fire policy but can be coveredon payment of additional premium.In the recent Earthquake disaster in Gujarat a number ofInsured failed to get any relief from Insurance Companies asEarthquake risk was not covered.Utmost Good Faith can be defined as “A positive duty tovoluntarily disclose, accurately and fully all facts material tothe risk being proposed whether requested for or not”.In Insurance contracts Utmost Good Faith means that “eachparty to the proposed contract is legally obliged to disclose tothe other all information which can influence the othersdecision to enter the contract”.The following can be inferred from the above two definitions:(1)Each party is required to tell the other, the truth, thewhole truth and nothing but the truth.(2)Unlike normal contract such an obligation is not limitedto any questions asked and(3)Failure to reveal information even if not asked for givesthe aggrieved party the right to regard the contract asvoid.How is this duty of Utmost Good Faith to be practiced? Andwhat are the facts that the proposer has to disclose? The answerto both the question is simply the proposer must disclose tothe insurer all material facts in respect of the subject matterof Insurance.56DIPLOMA IN INSURANCE SERVICES

Principles of General InsuranceMODULE - 2Principles of Insurance5.3 WHAT IS A MATERIAL FACT?Material fact is every circumstance or information, which wouldinfluence the judgement of a prudent insurer in assessingthe risk.OrNotesThose circumstances which influence the insurer decision toaccept or refuse the risk or which effect the fixing of thepremium or the terms and conditions of the contract must bedisclosed.5.4 FACTS, WHICH MUST BE DISCLOSEDi.Facts, which show that a risk represents a greater exposurethan would be expected from its nature e.g., the fact thata part of the building is being used for storage ofinflammable materials.ii.External factors that make the risk greater than normale.g. the building is located next to a warehouse storingexplosive material.iii.Facts, which would make the amount of loss greater thanthat normally expected e.g. there is no segregation ofhazardous goods from non-hazardous goods in the storagefacility.iv.History of Insurance (a) Details of previous losses andclaims (b) if any other Insurance Company has earlierdeclined to insure the property and the special conditionimposed by the other insurers; if any.v.The existence of other insurancesvi.Full facts relating to the description of the subject matterof InsuranceSome examples of Material facts are(a)In Fire Insurance: The construction of the building, thenature of its use i.e. whether it is of concrete or Kuchahaving thatched roofing and whether it is being used forresidential purposes or as a godown, whether fire fightingequipment is available or not.DIPLOMA IN INSURANCE SERVICES57

MODULE - 2Principles of General InsurancePrinciples of InsuranceNotes(b)In Motor Insurance: The type of vehicle, the purpose ofits use, its age (Model), Cubic capacity and the fact thatthe driver has a consistently bad driving record.(c)In Marine Insurance: Type of packing, mode of carriage,name of carrier, nature of goods, the route.(d)In Personal Accident Insurance: Age, height, weight,occupation, previous medical history if it is likely toincrease the choice of an accident, Bad habits such asdrinking etc.(e)Burglary Insurance: Nature of stock, value of stock, typeof security precautions taken.As mentioned this is not an exhaustive list but only a fewexamples.Details of previous losses is a material fact which is relevant toall policies.5.5 FACTS, WHICH NEED NOT BE DISCLOSED58a.Facts of Law: Every one is deemed to know the law.Overloading of goods carrying vehicles is legally banned.The transporter can not take excuse that he was not awareof this provision.b.Facts which lessen the Risk: The existence of a good firefighting system in the building.c.Facts of Common Knowledge: The insurer is expectedto know the areas of strife and areas susceptible to riotsand of the process followed in a particular trade orIndustry.d.Facts which could be reasonably discovered: For e.g.the previous history of claims which the Insurer issupposed to have in his record.e.Facts which the insurers representative fails to notice:In burglary and fire Insurance it is often the practice ofInsurance companies to depute surveyors to inspect thepremises and in case the surveyor fails to notice hazardousfeatures and provided the details are not withheld by theInsured or concealed by him them the Insured cannot bepenalized.DIPLOMA IN INSURANCE SERVICES

MODULE - 2Principles of General InsurancePrinciples of Insurancef.Facts covered by policy condition: Warranties appliedto Insurance polices i.e. there is a warranty that awatchman be deployed during night hours then thiscircumstance need not be disclosed.Duration of Duty of DisclosureThe duty of disclosure remains in force through out the entirenegotiation stage and till the contract is finalized. Once thecontract is finalized than the contract is subject to ordinarysimple good faith.NotesHowever when an alteration is to be made in an existingcontract then this duty of full disclosure recovers in respect ofthe proposed alteration.The duty of disclosure also revives at the time of renewal ofcontract since legally renewal is regarded as a fresh contract.For example: a landlord at the time of proposal has disclosedthat the building is rented out and is being used as an office.If during the continuation of the policy the tenants vacate thebuilding and the landlord subsequently rents it out to a personusing it as a godown then he is required to disclose this fact tothe Insurer as this is a change in material facts and effectsthe risks.(Note: Please note that in long term Insurance Business theInsurer is obliged to accept the renewal premium if the Insuredwishes to continue the contract and there is no duty ofdisclosure operating at the time of renewal. Normally Insurerarranges inspection on each renewal.)5.6 BREACHES OF UTMOST GOOD FAITHBreaches of Utmost Good Faith occur in either of 2 ways.(1)Misrepresentation, which again may be either innocentor intentional. If intentional then they are fraudulent(2) Non-Disclosure, which may be innocent or fraudulent. Iffraudulent then it is called concealment.It is important to distinguish betweenMisrepresentation and Non-DisclosureDIPLOMA IN INSURANCE SERVICESthetwo:59

MODULE - 2Principles of General InsurancePrinciples of InsuranceBreach ofUtmost Good ent)Misrepresentation :Innocent :This occurs when a person states a fact in the belief orexpectation that it is right but it turns out to be wrong. Whiletaking out a Marine Insurance Policy the owner states thatthe ship will leave on a specific date but in fact the ship leaveson a different date.Intentional : Deliberate misrepresentation arises when theproposer intentionally distorts the known information todefraud the insurer. The selfish objective is somehow to enterthe contract or to get a reduction in the premium e.g., If anapplicant for motor Insurance stated that no one under 18would drive the vehicle when in fact his 17 years old son drivesfrequently. Such a misrepresentation would be material as itwould effect the decision of the insurer.Non-DisclosureInnocent : This arises when a person is not aware of the factsor when even though being aware of fact does not appreciateits significance e.g.A proposer at the time of effecting the contract has undetectedcancer therefore does not disclose it orA proposer had suffered from Rheumatic fever in his childhoodbut he does not disclose this not knowing that people whohave this are susceptible to heart diseases at a later age.60DIPLOMA IN INSURANCE SERVICES

Principles of General InsuranceMODULE - 2Principles of InsuranceDeliberate : This is done with a deliberate intention to defraudthe insurer entering into a contract, which he would not havedone had he been aware of that fact.A proposer for fire Insurance hides the fact knowingly by notdisclosing that he has an outhouse next to his building, whichis used as a store for highly inflammable material.NotesHow To Deal With BreachesHow breaches are dealt with depends upon whether thebreaches are(1)Innocent(2)Deliberate(3)Material to the risk(4)Immaterial to the riskWhen Breach of Utmost Good Faith occurs the aggrieved partygets the right to avoid the contract. The contract does notbecome automatically void and it must decide on the courseto be taken. The options available are on case-to-case basislike: 1)The contract becomes void from the very beginning ifdeliberate misrepresentation or non-disclosure is resortedto with the intention of misleading the insurer to enterinto a contract.2)To consider the contract void, the bereaved party, mustnotify the offending party that breach has been noticedand as per the conditions of the contract he is no longergoverned with the terms of the contract agreed upon incovering the risk. In case the breach is discovered at thetime of claim he will refuse to honour his promise andwill not pay the claim. This again occurs when there hasbeen a deliberate breach.3)When the breach is innocent but it is material to the factthen the insurer may impose a penalty in the form ofadditional Premium.4)Where the breach is found to be innocent and is notDIPLOMA IN INSURANCE SERVICES61

MODULE - 2Principles of General InsurancePrinciples of Insurancematerial the insurer can choose to ignore the breach orwaive off the breach.5.7 PRINCIPLE OF INSURABLE INTERESTNotesOne of the essential ingredients of an Insurance contract isthat the insured must have an insurable interest in the subjectmatter of the contract. Insurance without insurable interestwould be a mere wager and as such unenforceable in the eyesof law.The subject matter of the Insurance contract may be a property,or an event that may create a liability but it is not the propertyor the potential liability which is insured but it is the pecuniaryinterest of the insured in that property or liability which isinsured.The concept is the basis of the doctrine of insurable interestand was cleared in the case of Castellain v/s Priston in 1883as follows.“What is it that is insured in a fire policy? Not the bricks andmaterials used in building the house but the interest of theInsured in the subject matter of Insurance.”The subject matter of the contract is the name given to thefinancial interest, which a person has in the subject matterand it is this interest, which is insured.Insurable Interest is defined as“The legal right to insure arising out of a financial relationshiprecognized under the law between the insured and the subjectmatter of Insurance”.There are four essential components of Insurable Interests621)There must be some property, right, interest, life, limb orpotential liability capable of being insured.2)Any of these above i.e. property, right, interest etc. mustbe the subject matter of Insurance.3)The insured must stand in a formal or legal relationshipwith the subject matter of the Insurance. Whereby hebenefits from its safety, well-being or freedom from liabilityand would be adversely affected by its loss, damageexistence of liability.DIPLOMA IN INSURANCE SERVICES

Principles of General InsuranceMODULE - 2Principles of Insurance4)The relationship between the insured and the subjectmatter must be recognized by law.5.8 HOW IS INSURABLE INTEREST CREATEDThere are a number of ways by which Insurable Interest arisesor is restricted.(a)By Common Law: Cases where the essential elementsare automatically present can be described as InsurableInterest having arisen by common law. Ownership of abuilding, car etc, gives the owner the right to insure theproperty.(b)By Contract: In some cases a person will agree to beliable for something which he would not be ordinarilyfor. A lease deed for a house for example may make thetenant responsible for the repair and maintenance of thebuilding. Such a contract places the tenant in a legallyrecognized relationship with the house or the potentialliability and this gives him the insurable interest.(c)By Statute: Sometimes an Act of the Parliament maycreate an insurable interest by granting some benefit orimposing a duty and at times removing a liability mayrestrict the Insurable Interest.NotesInsurable Interest is applicable in the Insurance of property,life and liability.In case of property Insurance, insurable interest arises out ofownership where the owner is the insured but it can arisedue to other situations & financial interests which gives aperson who is not an owner, insurable interest in the propertyand some of the situations are listed below.(i)Mortgagee and Mortgagers:The practice of Mortgage is common in the area of house& vehicle purchase. The mortgagee is the lender normallya bank or a financial institution, and the mortgager isthe purchaser. Both have an insurable interest; Themortgager because he is the owner and the mortgagee asa creditor with insurable interest limited to the extent ofthe loan.DIPLOMA IN INSURANCE SERVICES63

MODULE - 2Principles of General InsurancePrinciples of Insurance(ii) Bailee:Bailee is person legally holding the goods of another, maybe for payment or other reason. Motors garages and watchrepairers have a responsibility to take care of the items intheir custody and this gives them an insurable interesteven though he is not owner.Notes(iii) Trustees:They are legally responsible for the property under theircharge and it is this responsibility which gives rise toinsurable interest.(iv) Part Ownership:Even though a person may have only part interest in aproperty he can insure the entire property. He shall betreated as a trustee or the co-owners; and in the event ofa claim he will hold the money received by him in excessof his financial interest in trust for the others.(v)Agents:When the principal has an insurable interest then hisagent can insure the property.(vi) Husband & Wife:Each has unlimited interest in each others life and hencethey have an insurable interest in each others property.These parties can insure each others lives as they standto lose in the event of death of any of them.(vii) Creditor:Similarly a creditor may lose financially if a debtor diesbefore paying the loan so the creditor gets an InsurableInterest in the life of the debtor to the extent of the loanamount.(viii) Liability:In Liability Insurance a person has insurable interest tothe extent of any potential liability which may be incurreddue to damages and other costs. It is not possible to foretellhow much liability or how often a person may incurliability and in what form or shape it arises. In this wayInsurable Interest in Liability Insurance is different than64DIPLOMA IN INSURANCE SERVICES

Principles of General InsuranceMODULE - 2Principles of InsuranceInsurable Interest in life & property - where it is possibleto predetermine the extent of Insurable Interest.Therefore in liability assurance the insured is asked tochoose the amount of sum insured as the maximum figurethat he estimates is e

General Insurance comprises of insurance of property against fire, burglary etc, personal insurance such as Accident and Health Insurance, and liability insurance which covers legal liabilities. Suitable general Insurance covers are necessary for every family. It is important to protect one’s property, which