PRINCIPLES OF INSURANCE

Business studies study module

Principles of insurance provide guidance to the insurance firms at the time they are entering into a contract with the person taking the cover. These insurance principles include:

  1. Help to determine whether a valid insurance contract exists between the two parties at the time claims are made.
  2. Provide checks and controls to ensure successful operations of insurance for the benefit of both the parties

It is therefore important that a prospective insured (person wishing to take insurance policy) has basic knowledge of these principles as stated in the insurance law.

The insurance principles include;

Insurable Interest

This principle states that an insurance claim cannot be valid unless the insured person can prove that he has directly suffered a financial loss and not just because the insured risk has occurred.

Going this principle one cannot insure his parents or friends or other people’s property since he/she has no insurable interest in them. If such properties are damaged or completely destroyed, he/she will not suffer any financial loss.

For example, Mr.x has no insurable interest in the property of his neighbours.He does not suffer any financial loss should they be destroyed. This principle ensures that people are not deliberately destroying other people’s properties/life in order for them to receive compensation.

In life insurance (life assurance) it is assumed that a person has unlimited interest in his/her own life. Similarly it is assumed that one has insurable in the life of spouse and children e.g. a wife may insure the life of her husband, a father the life of his child because there is sufficient insurable interest.

Indemnity

The essence of this principle is that the insurer will only pay the “replacement value” of the property when the insured suffers loss as a result of an insured risk.

This principle thus puts the insured back to the financial position he enjoyed immediately before the loss occurred.

It is therefore not possible, then, for anybody to gain from a misfortune getting compensation exceeding the actual financial loss suffered as this will make him gain from a misfortune.

This principle does not apply in life assurance since it is not possible to value one’s life or a part of the body in terms of money. Instead, the insurance policy states the amount of money the insured can claim in the event of death.

Utmost good faith (uberrima fides)

In this principle the person taking out a policy is supposed to disclose the required relevant material facts concerning the property or life to be insured with all honesty. Failure to comply to this may render the contract null and void hence no compensation.

e.g.

-A person suffering from a terminal illness should reveal this information to the insurer.

-One should not under-insure or over-insure his/her property.

Subrogation

This principle compliments the principle of indemnity. It does so ensuring that a person does not benefit from the occurrence of loss.

According to this principle, whatever remains of the property insured after the insured has been compensated according to the terms of the policy, becomes the property of the insure.

Example

Assuming that Daisy’s car is completely damaged in an accident and the insurance compensates for the full value of the loss, whatever remains of the old car (now scrap), belongs to the insurance company

Scrap metal can be sold for some values and should Daisy take the amount she would end up getting more amount than the value of the car which will be against the principle of indemnity.

Note: This principle cannot be applicable to life assurance since there is nothing to subrogate.

Proximate cause

This principle states that for the insured to be compensated there must be a very close relationship between the loss suffered and risk insured i.e. the loss must arise directly from the risk insured or be connected to the risk insured.

Example

  1. If a property is insured against fire then fire occurs and looters take advantage of the situation and steal some of the property, the insured will suffer loss from ‘theft’ which is a different risk from the one insured against, so he/she will not be compensated.

However if the property burns down as a result of sparks from the fire-place, the proximate cause of the loss is sparks which are directly related to fire. So the insured is entitled for compensation.



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