INSURANCE

Basics of Insurance
Meaning of Insurance
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.
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.

Definition
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 'assurer' and the party whose risk is
covered is known as the 'insured' or 'assured'.
Insurance has also been defined as a promise of compensation for specific potential future losses
in exchange for a periodic payment. Insurance is designed to protect the financial well-being of
an individual, company or other entity in the case of unexpected loss. Some forms of insurance
are required by law, while others are optional. Agreeing to the terms of an insurance policy
creates a contract between the insured and the insurer. In exchange for payments from the
insured (called premiums), the insurer agrees to pay the policy holder a sum of money upon the
occurrence of a specific event. In most cases, the policy holder pays part of the loss (called the
deductible), and the insurer pays the rest. Examples include car insurance, health insurance,
disability insurance, life insurance, and business insurance.

Concept of Insurance / How Insurance Works

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The concept behind insurance is that a group of people exposed to similar risk come together and
make contributions towards formation of a pool of funds. In case a person actually suffers a loss
on account of such risk, he is compensated out of the same pool of funds. Contribution to the
pool is made by a group of people sharing common risks and collected by the insurance
companies in the form of premiums.
Lets take some examples to understand how insurance actually works:
Example 1

Example 2

SUPPOSE
Houses in a village = 1000
Value of 1 House = Rs. 40,000/-

SUPPOSE
Number of Persons = 5000
Age and Physical condition = 50
years & Healthy

Houses burning in a yr = 5

Total annual loss due to fire = Rs.

2,00,000/-

Contribution of each house owner =

Rs. 300/-

Number of persons dying in a yr = 50

Economic value of loss suffered by

family of each dying person = Rs.
1,00,000/-

Total annual loss due to deaths = Rs.

50,00,000/-

Contribution per person = Rs. 1,200/-

UNDERLYING
ASSUMPTION UNDERLYING
ASSUMPTION
All 1000 house owners are exposed to a All 5000 persons are exposed to common
common risk, i.e. fire
risk, i.e. death
PROCEDURE
PROCEDURE
All owners contribute Rs. 300/- each as Everybody contributes Rs. 1200/- each as
premium to the pool of funds
premium to the pool of funds
Total value of the fund = Rs. 3,00,000 (i.e. Total value of the fund = Rs. 60,00,000 (i.e.
1000 houses * Rs. 300)
5000 persons * Rs. 1,200)
5 houses get burnt during the year

50 persons die in a year on an average

Insurance company pays Rs. 40,000/- out of Insurance company pays Rs. 1,00,000/- out
the pool to all 5 house owners whose house of the pool to the family members of all 50
got burnt
persons dying in a year
EFFECT

OF

INSURANCE EFFECT

OF

INSURANCE
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Risk of 5 house owners is spread over 1000 Risk of 50 persons is spread over 5000
house owners in the village, thus reducing people, thus reducing the burden on any one
the burden on any one of the owners.
person.

General Principles of Insurance

Insurance is based on certain principles which form the foundation of an insurance policy. These
principles have evolved over the decades. While in several countries, some of them may be
adopted after modifications, to provide for better service levels, most of the basic principles
would generally still hold good. In many countries also, Insurance is slowly evolving into a
financial instrument, especially for large businesses and it would remain to be seen as to how far
this aspect can really be taken to.
Insurance is the means whereby the losses of a few are transferred to many. If a calamity or loss
were to befall an individual, it would be difficult for him to bear it and maintain the standard of
living or economic well being for his family or business entity. It would also be apparent that
such losses and calamities would be far and few in between and would befall only a minority.
Therefore, by everybody paying a small premium, a common fund can be created out of which
losses that befall the minority can be reimbursed or met. In view of wide diversity, there would
arise several different types and nature of individuals and business entities, as well as different
types of risks and losses resulting there from. Thus categorization is quite inevitable and we have
different types of insurances attempting to cover the different risks faced by individuals and
business entities - like fire, health, liability, marine, engineering, business interruption, etc.
An insurance policy is also a contract. This insurance contract between the insurer and the
insured has many basic contract principles. It is often considered a personal contract where the
loss that is payed is based on the loss to the person that holds the policy. The policy is also
conditional contract where the insured has certain conditions that they must meet before the
insurer is required to pay any benefit. Also, since the insured typically cannot negotiate terms of
terms of the contract, any uncertainties in the contract will usually conclude to the advantage of
the insured party. Finally, insurance contracts are usually considered contracts of indemnity.
There are several principles that govern what is insurance and what isn't an insurance. These are
the basic principles of insurance.
First, insurance is a repayment of a random loss. The timing or occurrence of the loss must be
uncertain. For example, one cannot know his house is going to be destroyed in three weeks by a
demolotion team and still get home owner's insurance.
Overall losses by the insurance company must be somewhat predictable. In other words the
insurance company needs to be able to rely on the law of averages. By pooling in a number of
insured, the insurance company can be sure that a given percentage of the insured will never
place claims allowing the company to make a profit on the overall business. They must also be
able to understand what the costs will be for benefits over a large number of policies.
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To be able to fully service major claims, small claims are not covered. This is what the
deductable is for. Only damage or loss over the amount of the deductable is covered by the
insurance policy.
The loss cannot be so large as to put the insurance company out of business.
Large volumes and texts have been written on the principles of insurance, and they continue to
be discussed in industry. It may not be possible to extensively cover the subject and their finer
points and hence an attempt is made to give the salient points of these principles. This will help
understanding and providing an insight into their effect on claims and their processing.
The basic and general principles of insurance are:
Contract
Utmost Good Faith
Insurable Interest
Indemnity
Subrogation
Contribution
Proximate Cause
General Conditions

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Insurance Principles
Insurance is Essentially a Contract
The Insurance Policy is ultimately a contract and as such general law of contract would be
applicable as modified by specific enactments in India such as Stamp Act, Insurance Act, etc.
A contract of Insurance is governed by the general law of the contract. In the contract of
Insurance there should be Offer and acceptance, Consideration, Capacity to Contract, Legality of
consideration of object, Consent of the parties to the contract. As a general rule the terms of
contracts are ascertained from the document embodying the contract. In Life Insurance, the
policy is the document which expresses the contract between the insurer and insured. The
contract comes into existence when the proposal from a party is accepted by the insurer and the
terms of the acceptance are complied with by the party. The contract will have to be interpreted
according to the policy document, though in certain circumstances, the life assured may rely on
the prospectus published by the insurer.
Contract Elements
Insurance policies are legal contracts and are subject to the general law of contracts. This is a
distinct body of law that is separate from criminal law (crimes against society) and tort law (legal
liability issues usually involving damages for negligence). A contract is a legal agreement
between two or more parties promising a certain performance in exchange for a valuable
consideration.

The basic aspects that exist for all contracts would also be relevant here such as:
Offer and Acceptance
There can be no contract without the agreement or mutual assent of the parties. A common
intention on all terms of the contract is essential to an agreement and no essential terms of the
contract may be left unsettled. Further, the intention of the parties to a contract must be
communicated to one another.
The parties to an insurance contract are the insurance company and the applicant, who may
become the insured or may name another person to be insured. Unless otherwise indicated, it is
assumed that the applicant is the prospective insured.
There should be an offer by one of the parties to the contract with an acceptance by the other
party. This is usually embodied by the proposal form and when this is accepted by the Insurer,
the Policy is issued which forms a valid contract, enforceable by law.
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Capacity to Contract
Both the parties should be legally competent to enter into the contract. Mentally unsound
persons, minors, etc. are generally deemed incapable of entering into a contract.
For a contract to be binding, both parties must have the legal capacity to make a contract. To
have the legal capacity to make insurance contracts, an insurance company must have authority
under its charter to issue contracts and be authorized by the state to issue contracts. The
company's representative must also be licensed by the state.
The insured or applicant must be of legal age and be mentally competent to make an insurance
contract. Applications of minors must usually be signed by an adult parent or guardian to comply
with the legal age requirement for making contracts.
Flow of Consideration
Consideration should flow for both parties. In the insurance policy, the premium payment forms
the consideration by the Assured and the promise for indemnification, in the event of loss due to
an insured peril forms the consideration by the Insurer.
Each party to the contract must give valuable consideration. In the insurance contract, the value
given by the insurer consists of the promises contained in the policy contract. The consideration
given by the insured consists of the statements made in the application and the payment of the
initial premium.
The consideration may consist of any of the following:

A monetary payment

An act

A forbearance from action

The creation, modification, or destruction of a legal right

A return promise

It is important to know that part of the applicant's consideration consists of the statements in the
application. A great deal of importance is placed on the representations in the application because
the insurance company's entire decision of whether to contract is based on its evaluation of the
information in the application.
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Absence of Fraud
Just as in case of normal contracts which can be rendered void due to any fraud or
misrepresentation, the Insurance Policy or contract also would similarly be rendered void in the
event of any fraudulent acts by either party. Misrepresentation may make it voidable at the
instance of the injured party.
Legality
Any contract cannot be enforced if it violates any statute or public policy. To be valid, a contract
must be for a legal purpose and not contrary to public policy. An insurance contract is not against
public policy where an insurable interest exists.
The above are only some of the basic and important contract principles for all contracts in
general with some examples reflecting their application in case of Insurance Contracts or
Policies. Other specific aspects pertaining to insurance and certain amplification of some of the
aspects above are given elsewhere in this Study material.

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Insurance is essentially a contract of utmost good faith:One of the important basic principles of insurance is known as 'utmost good faith'. The Insurance
contract being a promise to pay in the case of a peril operating is a unique type of contract
between the Assured and the Insurer. A contract of insurance is a contract requiring utmost good
faith of the parties. This means that each party is entitled to rely on the representations of the
other and each party should have a reasonable expectation that the other is acting in good faith
without attempts to conceal or deceive. In a contact of utmost good faith, the parties have an
affirmative duty to each other to disclose all material facts relating to the contract. That is not
just a duty not to lie, but also a duty to speak up.So all, the material facts which are likely to
influence the insurer in deciding the amount of premium payable by the insured must be
disclosed by the insured. Failure to disclose material facts renders the contract void able at the
option of the insurer.
Very often, the Insurer has to rely only on the description and details filled in the proposal form.
The Insurer has no way of verifying these details and after an insured peril has operated, the
subject matter of the insurance may very well have gone up in smoke or washed away. Therefore
any mis-description, misrepresentation or blatantly false declarations made by the Assured would
result in the Insurer paying wrong claims.
Obviously, in the longer term no Insurer can survive payment of wrong claims or charging of
wrong premiums for the risk. Such payment of claims also imposes a burden on the rest of the
premium paying community, since ultimately claims have to be paid out of the premium pool.
It is therefore an implied condition or principle of insurance that the Assured be required to make
a full disclosure of all material particulars within his knowledge about his risk.
However today, especially with imminent privatization, it would be logical to expect that
insurers would attempt to become increasingly more customer friendly and provide risk survey
and assessment, appraisal, etc. services, either directly or through brokers, surveyors, etc.
Whether these factors may dilute this principle and to what extent remains to be seen. The
general opinion yet would be that the Assured knows his business and risk best and whenever in
doubt, must attempt to disclose that particular aspect.
A corollary to this would be that even after taking out an insurance policy, during its validity
period, if there are any alterations or changes to the business or risk - say alteration of process or
storage of any hazardous material - which increases the risk, the Assured must inform the Insurer
of the same and get their acceptance for the same. At times, additional premium payment may be
required.
If it is found that an Assured has not disclosed or attempted to conceal any material aspects of the
risk, the Insurer would obviously be entitled to avoid any payment of claims or monies under the
Policy.

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If it is found that the Assured had misrepresented any aspect of the risk, then the Insurer would
again obviously be entitled to avoid any payment of claims or monies under the Policy. However,
in certain cases of misrepresentation, where the effect may only have been increased premium, it
is possible that the Insurer may partly pay the claim.
It is therefore apparent that the correct filling up of a proposal form is quite important for the
Assured and should not be taken lightly1.

Insurance contracts are characterized by information asymmetries between the parties.

Generally the insured knows more about the risk to be insured than the insurer. To rectify
this imbalance the law compels disclosure of information between the parties.
To act in good faith entails that parties must deal openly and honestly with each other
without suppressing material facts that may influence the judgment of the other party.
The duty to act in good faith applies to all types of insurance contracts. In contracts of sale
the maxim caveat vendito applies meaning let the buyer beware. This maxim places an
obligation on the buyer to take all reasonable steps to verify that the item he intends to buy
meets his expectations. In insurance this maxim does not apply.

In England the doctrine of utmost good faith is incorporated in the Marine Insurance Act
1906.
The requirement of utmost good faith is complimented by the duty of disclosure which
places an obligation on both parties to the insurance contract to disclose material facts
relevant to the contract to each other.
In England the Marine Insurance Act 1906 defines a material fact as every circumstance
that would influence the judgment of a prudent insurer in fixing the premium or
determine whether he will take the risk. Hence in England a material fact is defined from
the perspective of a prudent insurer. This can result in a heavy burden on the insured.
In SA Courts have accepted the need for disclosure but have rejected the definition of
materiality as used in English law.
In Mutual and Federal Insurance Co v Oudshoorn Municipality 1985 1 SA 419 the Court
rejected the expression uberrima fides as being alien to our law. The Court also went
further to hold that the proper test of materiality should be the standard test of a
reasonable man and not that of a prudent insurer.
Failure to disclose material facts renders the contract void-able at the instance of the
insurer. Of course the insured is only expected to disclose facts that he knows or ought to
know.
In life insurance facts commonly regarded as material include-medical history; financial
status; family medical history; state of health; life style etc.
In short term insurance common material facts would include-previous convictions;
financial status; whether another insurer has cancelled insureds policy in the past.
Some facts though material need not be disclosed. Thus the insured has no obligation to
disclose the following facts:
(1)
Any circumstance that diminishes the risk.

Available at http://www.padamsey.com/insurance_principles.htm visited last on 29/09/09

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(2)
Any fact known or presumed to be known by the insurer.
(3)
Facts on which insurers have waived information.
The duty of disclosure lasts for the duration of the negotiations and terminates when the
contract is concluded. Material facts that come to light after the contract has been
concluded are deemed to be part of the risk that the insurer would have assumed.
Naturally in short-term contracts the duty to disclose material facts is revived at renewal
of the policy. Life insurance contracts are continuing contracts hence the duty to disclose
is not revived unless there is a specific duty in the policy obliging the insured to do so.
To avoid liability on grounds of non-disclosure the onus is on the insurer to prove that:
(1)
The undisclosed facts were material.
(2)
That the facts were within the actual or presumed knowledge of the insured.
(3)
That the facts were not communicated to the insurer.
Upon discovering the non-disclosure the insurer must exercise the right to repudiate the
contract within a reasonable time. Thus if upon discovering the non-disclosure the insurer
continues to accept the premium for example, the insurer would be deemed to have
waived the right to repudiate and the contract will be binding as if there was no nondisclosure.
In summary therefore the duty of disclosure is justified on the following grounds:
(1)
There is information asymmetry between the insured and the insurer. The insured
knows more about the risk than the insurer hence the law must compel disclosure.
(2)
Without the duty of disclosure the insurance market cannot operate efficiently
such that the supply side of insurance can be disrupted.
(3)
Disclosure enables the insurer to quantify and price the risk appropriately.
(4)
Disclosure also enables the insurer to determine appropriate policy terms and
conditions to be incorporated in the policy. It enables the insurer to determine the
extent to which the risk being presented deviates from the norm.
(5)
Disclosure also helps insurers manage the problem of adverse selection.
On the other hand critics of the duty of disclosure point to the following in support of their
argument:
(1)
The duty is unduly burdensome on the insured depending on the test used to
determine what constitutes material facts.
(2)
Insurers rarely warn the insured about the consequences of non-disclosure.
(3)
Given the current technological advances it is no longer true to say insurers know
less about the risk than the insured. The reverse may well be true.
(4)
The duty of disclosure may be abused by insurers seeking to avoid their
obligations.
(5)
There is an element of self-serving hypocrisy by insurers by insisting that facts
that lessen the risk need not be disclosed yet these may benefit the insured by way
of reduction of premium. Why are insurers only interested in the bad and not the
good?2

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29/09/09

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INSURABLE INTEREST
The assured must have, what is called "insurable interest" in the subject matter of the contract
of insurance. He must be so situated with regard to the thing insured that he would have benefit
from its existence loss from its destruction.

Insurable interest distinguishes contracts of insurance from gambling in order to define

the legitimate area of insurance business.
Insurable interest is required for all types of insurance and its absence renders the
contract void and hence unenforceable.
The leading Roman-Dutch law case on insurable interest is Littlejohn v Norwich Union Fire
Insurance Society 1905 TH 374 where it was held that if the insured can show that he stands
to lose something of an appreciable commercial value by the destruction of the thing insured
then his interest will be an insurable one. The Court went further to state that as a general rule
insurable interest should exist at the time of taking the policy and at the time the loss is
incurred.
If a person has insurable interest in an asset at the time of taking the policy but loses the
interest thereafter e.g. if he sells the car, the policy ceases to have any validity.

Insurable interest can be acquired in various ways notably:

(1)
Ownership
(2)
Legal possession
(3)
Custody of property belonging to others e.g. bailees.
(4)
Marriage-spouses have an insurable interest in each others life.
(5)
A lien-holder has insurable interest in the property subject to the lien.
(6)
A debt creates insurable interest between debtor and creditor.
(7)
An employer has an insurable interest in the life of an employee.
In life insurance the general rule is that insurable interest need only exist at the time of
taking the policy. Thus if A who is married to B takes a life policy on his life and they
later divorce the policy will pay on Bs death even if technically insurable interest no
longer exists because the parties divorced.
As far as insurable interest of parents in the lives of their children is concerned the
position in SA is largely governed by legislation.

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INDEMNITY:Every contract of insurance such as car Insurance, fire insurance is a contract of indemnity. So,
the insurer pays the actual loss suffered by the insured. He does not pay the specified amount
unless this amount is the actual loss to the insured.
Insurance policies are contracts of indemnity. Well just what is indemnification? The
word "Indemnify" is defined as to secure against loss, damage, or hurt or to compensate
for loss, damage or hurt. Therefore, in insurance, a policy insures that the insurer will
indemnify the insured against specific loss, damage, or hurt. This policy may cover all
sorts of loss including loss of life, loss or damage of property such as house or car, and
more.
Indemnity means and :

Is perhaps the most fundamental principle of insurance law. Object of indemnity is to

place the insured after the loss in the same position he occupied immediately before the
loss. He is not to be placed in a better or worse position.
Not all insurance contracts are contracts of indemnity e.g. life insurance. Indemnity is
important as it deals in part with moral hazard.
Indemnity does not imply that the insured will be indemnified to the full value of his loss
e.g. a person whose factory is destroyed by fire cannot recover for loss of profits or
against any liability that may arise from the fire unless he has appropriate policies in
place specifically designed to deal with these losses.
Indemnity can be achieved through the following methods:
1.
Cash
2.
Reinstatement e.g. where a building is destroyed, insurers may reinstate it.
3.
Repair e.g. where a motor vehicle is partially damaged.
4.
Replacement-instead of paying cash a replacement item may be tendered.
5.
New for old-used for household contents. This is not a violation of the principle
of indemnity as there is no principle of law that requires indemnity to be
determined in terms of the market value of the asset.
6.Valued policies-in terms of which the insurer and the insured agree before hand on the
value to be paid should a particular asset be destroyed or stolen. This method of
indemnity is used for assets with a sentimental rather than a commercial value e.g.
jewellery, works of art etc.

The principle of indemnity is supported by 2 corollaries namely-subrogation and

contribution.

Mitigation of Loss:

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The insured must take reasonable precautions to save the property, in the event of some mishap
to the insured property. He must act as a prudent uninsured person would act in his own case
under similar circumstances to mitigate or minimize losses.
Risk must attach:
The insurer must run the risk of indemnifying the insured. If he does not run the risk, the
consideration for which the premium is paid, fails and consequently, he must return the premium
paid by the insured.

SUBROGATION:According to the rule of "Subrogation", when the loss is caused to the insured by the conduct of
a third party, the insurer shall have to make good such loss and then have a right to step into the
shoes of the insured and bring an action against such third party who caused the loss to the
insured. The right of subrogation is enforceable only when there is an assignment of cause of
action by the insured in favor of the insurer. Subrogation:

Literally means to stand in place of. It is the right of one person to stand at law in the
place of another and to avail him of all rights and remedies of that other person.
Often when a claim occurs there may be 2 avenues of recovery. Suppose A drives
negligently and causes an accident damaging Bs car. If Bs car is insured 2 options are
open to him to recover his loss-he can sue A in delict
for damages or he can claim from his insurer. If B pursues both avenues he will receive
double compensation.
To prevent B from profiting from his loss subrogation is used in terms of which once the
insurer has paid B the insurer assumes all Bs rights to sue A. This ensures that the
principle of indemnity is preserved.
Subrogation has a number of sub-principles namely:
The insurer cannot be subrogated to the insureds right of action until it has paid the
insured and made good the loss.
The insurer can be subrogated only to actions which the insured would have brought
himself.
The insurer must not prejudice the insurers right of subrogation. Thus the insured may
not compromise or renounce any right of action he has against the 3 rd party if by doing so
he could diminish his loss.
Subrogation against the insurer. Just as insured cannot profit from his loss the insurer
may not make a profit from the subrogation rights. The insurer is only entitled to recover
the exact amount they paid as indemnity nothing more. If they recover more the balance
should be given to the insured.
Subrogation gives the insurer the right of salvage.

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CONTRIBUTION:Where there are two or more insurances on one risk, the principle of contribution applies
between different insurers. The aim of the contribution is to distribute the actual amount of loss
among the different insurers who are liable for the same risk under different policies in respect of
the same subject matter. In case of loss, any one insurer may pay to the assured the full amount
of the loss covered by the policy. Having paid this amount he is entitled to contribution from his
co insurers in proportion to the amount which each has undertaken to pay in case of the loss of
the same subject matter. Essentially, Contribution

Is another principle that aids indemnity. Often a person has more than one policy on the
same asset. Following a loss the position of the 2 policies is governed by the principle of
contribution. Since indemnity forbids the insured from recovering more than the loss then
he cannot recover the full value of the loss from each of the 2 policies.
NB the law does not forbid people from engaging in double insurance it only forbids
profiting from a loss.
Under the common law a person who has double insurance can look to any of the insurers
involved for compensation. The insurer who would have paid can then claim contribution
from the other insurer involved.
It was held in American Surety Co of New York v Wrightson 1910 that for contribution to
apply the 2 policies involved must cover-same interests; same assureds; same adventure;
same risk; different or same amounts.
Essentially for contribution to apply the following conditions must be met:
(1)
The 2 policies must cover the same insured.
(2)
They must cover the same subject matter.
(3)
They must cover the same interest.
(4)
The peril causing the loss must be covered by both policies
albeit for different amounts.
(5)
Both policies must be current.
Normally the policies contribute pro-rata to the loss. In some markets the independent
liability method is used to determine the levels of contribution. Under this method if the
loss is within the sums insured of both policies they contribute equally to the loss.

CAUSE OF LOSS-THE DOCTRINE OF PROXIMATE CAUSE:The insurer is liable for loss which is proximately by the risk insured against. The rule "causa
proxima" that is the proximate but not the remote cause is to be looked to. So the loss must be
proximately caused in order that the insurer is to become liable.

The general rule is that for a loss to be paid under a policy of insurance, it must have been
caused by an insured peril. Unless the loss is proximately caused by an insured peril the
policy does not respond.
The proximate cause of loss is the most dominant and efficient cause in terms of bringing
about a particular result.
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The onus of proving that the loss was proximately caused by an insured peril rests with the
insured.
In Etherington v Lancashire and Yorkshire Accidental Insurance Co (1909) a man fell from a
horse and sustained injuries that prevented him from moving. As a result he contracted
pneumonia due to lying in the wet and died. The proximate cause of his death was held to be
the fall not pneumonia.
Similarly if furniture is thrown out of a burning house to arrest the spread of the fire and its
damaged in the process the proximate cause of the damage would be the fire.
If the insured makes a prima-facie case that the loss was proximately caused by an insured
peril the insurer is obliged to indemnify unless they can prove that an exception applies.

Parts of the Insurance Contract

Although it is not a legal requirement that all contracts be in writing, insurance contracts always
are because of their complex nature. The number of pages that make up an insurance contract
varies because of the types of insurance and the individual risks being insured, but all life/health
insurance contracts contain four basic parts:

Policy face (Title page)

Conditions

Insuring clause

Exclusions

Policy Face (Title Page)

The policy face is usually the first page of the insurance policy. It includes the policy number,
name of the insured, policy issue date, the amount of premium and dates the premium is due, and
the limits of the policy. The policy face also includes the signatures of the secretary and president
of the issuing insurance company. In addition, there are generally clauses required by law to give
the insured information on his or her right to cancel, and a warning to the insured to read the
policy carefully.
Insuring Clause
The insuring clause generally also appears on the policy face. It is a statement by the insurance
company that sets out the essential element of insurancethe promise to pay for losses covered
by the policy in exchange for the insured's premium and compliance with policy terms.

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Conditions
This section spells out in detail the rights and duties of both parties. Conditions are provisions
that apply to the insured and insurer. For example, the conditions include the reinstatement
provision, suicide clause, payment of claim provision, and similar standard policy provisions.
Exclusions
In this section, the company states what it will not do. The exclusions are a basic part of the
contract and a complete knowledge of them is essential to a thorough understanding of the
agreement. Certain risks must be excluded from insurance contracts because they are not
insurable.
Legal Requirements
When the courts have a case involving contracts, it looks at the "rules of construction" to
interpret the contract. The rules of construction help identify and establish the intent of the
parties to the contract.
Contract Construction
There are five major areas that the courts review in order to interpret the contract, establish the
intent of the parties, and hand down a ruling.
Plain Language and Word Definitions
If the language of the contract is clear the courts do not have to interpret the meaning of the
contract. The courts give the words in the contract their "ordinary meaning." In cases where
ordinary words have been used in a technical capacity, the technical meaning of the word is
accepted.
The Entire Contract
The courts look at the entire contract to determine the intent of the parties. It does not consider
material added to the basic contract, nor does it take only parts of the contract to make a
determination.
Interpretation in Favor of Valid Contract
Because the courts assume that when people make a contract they intend for it to be valid, the
courts will, if possible, render an interpretation of the contract that makes it valid rather than
invalid.

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Unclear Contract of Adhesion Interpreted Against the Insurer

If a contract contains wording that is unclear the courts will interpret the language used against
the writer of the contract, unless the wording used is required by law to be stated in a specific
manner. Insurance contracts are contracts of adhesion, which means the insured had no part in
determining the wording of the contract; therefore, the courts will interpret the contract in favor
of the policyholder, insured, or beneficiary.
Written Contracts
If a contract contains unclear or inconsistent material between printed, typed, or handwritten text
in the contract, the typed or handwritten material will determine intent.

Contract Characteristics :The insurance contract has certain characteristics not typically found in other types of contracts.
Aleatory
An insurance contract is said to be aleatory, or dependent upon chance or uncertain outcome,
because one party may receive much more in value than he or she gives in value under the
contract. For example, an insured who has a loss may receive a greater payment from an insurer
for the loss than he or she has paid in premiums. On the other hand, an insured might pay his or
her premiums and have no loss, so the insurer pays nothing.
Adhesion
In insurance, the insurer writes the contract and the insured adheres to it. When a contract of
adhesion is ambiguous in its terms, the courts will interpret the contract against the party who
prepared it.
Under most state laws, an applicant's statements or responses to questions on an application for
insurance (in the absence of fraud) are considered to be representations and not warranties.
An example would be a question on the application asking for your sex or date of birth. You
represent yourself to the insurance company as being male or female and a certain age. The
accuracy of these items is very important to the insurance company issuing the policy. If they are
incorrect, they may be considered misrepresentations, and the policy may be voided as a result.
There is a difference between representation of a fact and an expression of opinion. A good
example is a question on many applications: "Are you now to the best of your knowledge and
belief in good health?" If the applicant answers "yes" while knowing in fact that he or she is not,
there is a misrepresentation of actual fact. If, on the other hand, he or she has had no medical
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opinion and suffers from no symptoms recognizable to a layman, his or her answer is an opinion
and thus not a misrepresentation.
Impersonation
Impersonation means assuming the name and identity of another person for the purpose of
committing a fraud. The offense is also known as false pretenses. In the case of life insurance, an
uninsurable individual applying for insurance may ask another person to substitute for him to
take the physical examination.
Misrepresentation and Concealment
A misrepresentation is a written or oral statement that is false. Generally, in order for a
misrepresentation to be grounds for voiding an insurance policy, it has to be material to the risk.
Concealment is the failure to disclose known facts. Generally, an insurer may be able to void the
insurance if it can prove that the insured intentionally concealed a material fact.
Material information or a material fact is crucial to acceptance of the risk. For example, if the
correct information about something would have caused the insurance company to deny a risk or
issue a policy on a different basis, the information is material.
Fraud
Fraud is an intentional act designed to deceive and induce another party to part with something
of value.
NOTE
Fraud may involve misrepresentation and/or concealment, but not all acts of misrepresentation or
concealment are acts of fraud. If someone intentionally lies in order to obtain coverage or to
collect on a false claim, that would be a matter of fraud. If someone misrepresents something on
an application (perhaps a medical treatment the person is embarrassed to talk about) without any
intent to obtain something of value, no fraud has occurred.
Parol (Oral) Evidence Rule
The parol evidence rule limits the impact of waiver and estoppel on contract terms by
disallowing oral evidence based on statements made before the contract was created. It is
assumed that any oral agreements made before contract formation were incorporated into the
written contract. After contract formation, earlier oral evidence will not be admitted in court to
change or contradict the contract. An oral statement may waive contract provisions only when
the statement occurs after the contract exists.

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Unilateral
Insurance contracts are unilateral. This means that after the insured has completed the act of
paying the premium, only the insurer promises to do anything further. The insurer has promised
performance and is legally responsible. The insured has made no legally enforceable promises
and cannot be held for breach of contract. For example, the insured may stop paying premium
because he is not legally responsible to continue paying premium.
Executory
An insurance contract is an executory contract in that the promises described in the insurance
contract are to be executed in the future, and only after certain events (losses) occur.
Conditional
Insurance contracts are also conditional contracts because when the loss occurs certain
conditions must be met to make the contract legally enforceable. For example, a policyholder
might have to satisfy the test of having an insurable interest and satisfy the condition of
submitting proof of loss.
Personal Contract
Generally, insurance policies are personal contracts between the insured and insurer. Generally,
insurance is not transferable to another person without the consent of the insurer. Fire insurance,
for example, does not follow the property.
Warranties and Representations
A warranty is something that becomes part of the contract itself and is a statement that is
considered to be guaranteed to be true. Any breach of warranty provides grounds for voiding the
contract.
A representation is a statement believed to be true to the best of one's knowledge. An insurer
seeking to void coverage on the basis of a misrepresentation usually has to prove that the
misrepresentation is material to the risk.
Under most state laws, an applicant's statements or responses to questions on an application for
insurance (in the absence of fraud) are considered to be representations and not warranties.
An example would be a question on the application asking for your sex or date of birth. You
represent yourself to the insurance company as being male or female and a certain age. The
accuracy of these items is very important to the insurance company issuing the policy. If they are
incorrect, they may be considered misrepresentations, and the policy may be voided as a result.
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There is a difference between representation of a fact and an expression of opinion. A good

example is a question on many applications: "Are you now to the best of your knowledge and
belief in good health?" If the applicant answers "yes" while knowing in fact that he or she is not,
there is a misrepresentation of actual fact. If, on the other hand, he or she has had no medical
opinion and suffers from no symptoms recognizable to a layman, his or her answer is an opinion
and thus not a misrepresentation.

Period of Insurance:
Except, in case of life insurance, every contract of insurance comes to an end of the expiry of
every year, unless the insured continues the same and pays the premium before the expiry of the
year.

Profitability of Insurance Companies :

Insurance companies collect premiums from hundreds of thousands of customers. They
then pay out benefits to those customers you make claims. If they collect more premium than
they make payments, then they make what is called an underwriting profit. Some insurance
companies manage an underwriting profit, some don't. Many insurance companies make their
profit on what is called the float. This means that they invest the premiums they collect. Since,
with some types of insurance, premiums are typically collected many years before they have to
pay out benefits, the insurance company can have ample time to make significant investment
returns on the premium money. If the insurance company is good at investing, this can be where
they make the majority of their profit.

Determination of rates of premium:

Insurance premium rates are determined by all sorts of various factors depending on what is
being insured. In general, insurance companies use actuarial science to put numbers to the risk
they are taking on and to determine the premiums they need to collect. Actuaries use probability
and statistical mathematics to determine what the rate should be given certain factors over time
and
over
a
given
number
of
customers.
Factors that come into play when determining insurance premium rates may include (but are not
limited to) age, gender, tobacco use, and medical history for health and life insurance; age,
gender, driving history, type of car for auto insurance; cost of house, location, safety feature (for
home insurance); and so on. Each of the these factors are put into actuarial formulas where the
insurance company tries to make sure they will be able to make a profit over time, but also tries
to
maintain
competitive
rates
so
they
can
keep
customers.
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Most types of insurance also have a deductable. This is the amount of each claim that is not
covered by the policy. The lower the deductable the higher the insurance premium.
Another factor to consider in any insurance company is quality of service. How fast they get you
payment on claims, how responsive they are to questions, etc. These also can go into how much
a potential customer is willing to pay for insurance and if they are willing to stay with a given
insurance company over a long period of time. Therefore, these items will have some
determination on the premiums of some types of insurance.

Types of Insurance Companies:

Most insurance companies fall into two areas; those that sell life insurance and those that don't.
The two products are very different and usually fall under different types of laws and accounting
regulations. Also, the basic nature of the businesses are very different in that life insurance is a
long term business and coverage, where other types of insurance can be much shorter term.
Another type of insurance company is often referred as insurance consultants. These companies
do not actually provide the insurance, but act more as sales reps. They may represent or "resell"
insurance from a number of companies. They try to look at their clients needs and then get the
best
insurance
premium
available
for
them
in
the
marketplace.
One other type of insurance company is Reinsurance. These are giant insurance companies that
sell insurance to other insurance companies.
The Other Type of Classification of Insurance is as follows:

Life Insurance:
Life insurance is a policy that people buy from a life insurance company, which can be the basis
of protection and financial stability after one's death. Its function is to help beneficiaries
financially after the owner of the policy dies.
It can also be a form of savings in the long run if you purchase a plan, which offers the option of
contributing regularly. Additionally, a little known function of life insurance is that it can be tied
in with a person's pension plan. A person can make contributions to a pension that is funded by a
life insurance company. These are considered private pension arrangements.

Fire Insurance
Fire insurance provides protection against damage to property caused by accidents due to fire,
lightening or explosion, whereby the explosion is caused by boilers not being used for industrial
purposes. Fire insurance also includes damage caused due to other perils like strom tempest or
flood; burst pipes; earthquake; aircraft; riot, civil commotion; malicious damage; explosion;
impact.
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Marine Insurance
Marine insurance basically covers three risk areas, namely, hull, cargo and freight. The risks
which these areas are exposed to are collectively known as "Perils of the Sea". These perils
include theft, fire, collision etc. Marine insurance further includes:
Marine Cargo Marine cargo policy provides protection to the goods loaded on a ship against all
perils between the departure and arrival warehouse. Therefore, marine cargo covers carriage of
goods by sea as well as transportation of goods by land.
Marine Hull Marine hull policy provides protection against damage to ship caused due to the
perils of the sea. Marine hull policy covers three-fourth of the liability of the hull owner
(shipowner) against loss due to collisions at sea. The remaining 1/4th of the liability is looked
after by associations formed by shipowners for the purpose (P and I clubs).
Miscellaneous
As per the Insurance Act, all types of general insurance other than fire and marine insurance are
covered under miscellaneous insurance. Some of the examples of general insurance are motor
insurance, theft insurance, health insurance, personal accident insurance, money insurance,
engineering insurance etc.

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Insurance Regulators in India

Insurance is a federal subject in India. The primary legislation that deals with insurance
business in India is: Insurance Act, 1938, and Insurance Regulatory & Development
Authority Act, 1999.
Insurance Industry has ombudsmen in 12 cities. Each ombudsmen is empowered to redress
customer grievances in respect of insurance contracts, in accordance with the Ombudsmen
Scheme.
Insurance Regulatory & Development Authority (IRDA)
IRDA was constituted by an act of parliament. The Authority is a ten member team
consisting of:
(a) a Chairman
(b) five whole-time members
(c) four part-time members
(1) Subject to the provisions of Section 14 of IRDA Act, 1999 and any other law for the time
being in force, the Authority shall have the duty to regulate, promote and ensure orderly
growth of the insurance business and re-insurance business.
(2) Without prejudice to the generality of the provisions contained in sub-section (1), the
powers and functions of the Authority shall include, (a) issue to the applicant a certificate of registration, renew, modify, withdraw, suspend or
cancel such registration;
(b) protection of the interests of the policy holders in matters concerning assigning of
policy, nomination by policy holders, insurable interest, settlement of insurance claim,
surrender value of policy and other terms and conditions of contracts of insurance;
(c) specifying requisite qualifications, code of conduct and practical training for
intermediary or insurance intermediaries and agents;
(d) specifying the code of conduct for surveyors and loss assessors;
(e) promoting efficiency in the conduct of insurance business;
(f) promoting and regulating professional organisations connected with the insurance and
re-insurance business;
(g) levying fees and other charges for carrying out the purposes of this Act;

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(h) calling for information from, undertaking inspection of, conducting enquiries and
investigations including audit of the insurers, intermediaries, insurance intermediaries and
other organisations connected with the insurance business;
(i) control and regulation of the rates, advantages, terms and conditions that may be
offered by insurers in respect of general insurance business not so controlled and regulated
by the Tariff Advisory Committee under section 64U of the Insurance Act, 1938 (4 of 1938);

(j) specifying the form and manner in which books of account shall be maintained and
statement of accounts shall be rendered by insurers and other insurance intermediaries;
(k) regulating investment of funds by insurance companies;
(l) regulating maintenance of margin of solvency;
(m) adjudication of disputes between insurers and intermediaries or insurance
intermediaries;
(n) supervising the functioning of the Tariff Advisory Committee; (o) specifying the
percentage of premium income of the insurer to finance schemes for promoting and
regulating professional organisations referred to in clause (f);
(p) specifying the percentage of life insurance business and general insurance business to be
undertaken by the insurer in the rural or social sector; and
(q) exercising such other powers as may be prescribed
Tariff Advisory Committee (TAC)
(Statutory Body under Insurance Act 1938)
Tariff Advisory Committee controls and regulates the rates, advantages, terms and
conditions that may be offered by insurers in respect of General Insurance Business
relating to Fire, Marine (Hull), Motor, Engg. and Workmen Compensation.
Effective 22/07/98,the TAC Board has been reconstituted with seven members representing
the present General Insurance Industry and eight members from government and
Industry.
The Controller of Insurance cum Chairman IRDA is the Chairman of TAC.
Unit Linked Plans and Annuities in Life Insurance
A unit linked plan is also an investment oriented product. As compared to other investment plans,
the investment portion of the unit linked plan functions like a mutual fund. It is invested in a
portfolio of debt and equity instruments, in conformity with the announced investment policy.
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Hence, it grows or erodes in line with the performance of that portfolio. Of course, throughout
the period of investment, the policy holder enjoys an insurance cover as stipulated.
Term Assurance:
This is a pure protection policy, which provides a benefit on the death of an individual within a
specified term for example, one, ten or twenty five years. Premiums may be paid regularly over
the term of the policy [or some shorter period] or as a single premium at outset. Generally, there
is no payment if the policyholder survives to the end of the policy. However there are term
assurance policies, which offer some proportion of premiums paid on survival to the maturity
date of the policy.
A popular variant of the term assurance policy is the decreasing term assurance policy under
which the sum assured decreases over the term of the policy. This type of policy can be used to
meet two such specific needs. First, it can be used to repay the balance outstanding under a loan
[e.g. credit life insurance] in the event of the death of the policyholder. Secondly, it can be used
to provide an income for the family of the deceased policyholder from the time of death to the
end of the policy term.
Term assurance policies are typically offered in the non-participating format. These policies are
usually structured with no surrender value and paid up policy options. The main attraction of a
term assurance policy is that it provides a death benefit at a lower cost than under an endowment
or whole life policy for the same level of benefit.
Immediate Annuity: This type of policy meets the policyholders need for a regular income, for
example after his or her retirement. The policy can also be structured to provide an income for a
limited period, for example to pay the school fees of the policyholders children. The regular
income is purchased by paying a single premium at the inception of the policy. Strictly speaking
the regular income ceases on the death of the policyholder. There are however variants of this
policy under which a reduced income may be paid to the spouse (of the policyholder) over his or
her life time; or the single premium may be returned to the dependents of the deceased
policyholder.
Immediate annuities can be offered either in the non-participating format or in the participating
format. In the case of a participating annuity the income paid to the policyholder is a guaranteed
amount plus a bonus added by the insurance company. Usually no payment is made to the
annuitant on withdrawal. Put differently, there is no surrender value option associated with this
type of policy.
Deferred Annuity: The usual structure of this policy is that the policy holder pays regular
premiums for a period up to the specified vesting date. These premiums buy amounts of regular
income, payable to the policyholder from vesting date. A single premium at the start of the policy
is a possible alternative to regular premiums.
A deferred annuity enables the policyholder to build up a pension that becomes payable on his or
her retirement from gainful employment. At the vesting date of the annuity, the alternative of a
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lump sum may be offered in lieu of part or all of the pension, thereby meeting any need for a
cash sum at that point, for example to payoff a housing loan.
Riders are add ons to the life insurance policies described above. These add-ons can be
purchased with the base policy on payment of a small additional premium. The commonly
offered riders in the Indian context are:
1) Accidental Death Benefit (ADB) Rider
2) Critical Illness (CI) Rider
3) Waiver of premium (WoP) Rider
4) Term Rider
Tax Breaks:
At the time of writing, the tax breaks from a policyholders perspective are as follows:
The premium payable under a life insurance policy can be deducted from taxable income under
Section 80 C of the Income Tax Act 1961, In the case of an individual, this insurance policy can
be on the life of the individual or on the life of the spouse of the individual or on the life of any
child of the individual. The deduction under Section 80 C is also available for premiums payable
under a non- commutable deferred annuity; and for contribution made by the individual to any
notified pension fund set up by a Mutual Fund or by the UTI.
The premium paid by an individual under an annuity plan of the Life Insurance Corporation of
India or of any other insurer (as approved by the IRDA) is deductible from the taxable income of
that individual subject to a maximum amount of Rs 10,000 [Section 80 CCC of the income Tax
Act]
Any sum received under a life insurance policy, including the sum allocated by way of bonus on
such policy is exempt from tax under Section 10 (10 D) of the Income tax Act.

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