Basics of Insurance

Course Instructor: Nusrat Farzana

Definition

Insurance is nothing but a system of spreading the risk of one

onto the shoulders of many.
Insurance is a promise made by the insurer to the insured to
compensate against any significant potential losses which are
financial in nature, in exchange of a periodic payment the
insured makes to the insurer.
It is a social device in which a group of individuals (insured)
transfer risk to another party (insurer) in order to combine
loss experienced, which permits statistical prediction of losses
and provides for payment of losses from funds contributed
(premium) by all members who transferred risk
Definition
In legal sense: It is a contract by which one party (Insurer)
in consideration of price paid to him proportionate to
risk provides security to the other party (Insured) that he
shall not suffer loss, damage or prejudice by the
happening of certain specified events. Insurance is meant
to protect insured against uncertain events which may
cause disadvantage to him.
Elements in Insurance
Insurance as a Transfer System - Transferring of risks
from Insured to Insurance company which is financially
sound and has capacity and willingness to take risks. A
loss exposure can give rise to three types of losses,
namely: Property loss (including net income loss), Liability
loss, and Human and personnel loss.
Elements in Insurance
Insurance as a Business - Insurance primarily attempts to
meet its costs and expenses from premium that it earns and
also make a reasonable margin of profit for its own
sustainability .Other benefits to society as a whole such as:
o Payments for the costs of covered losses
o Reduction of the insureds financial uncertain
o Efficient use of resources,
o Support for credit,
o Satisfaction of legal requirements
o Satisfaction of business requirements
o Source of investment funds for infrastructure development
o Reduction of social burden
Elements in Insurance

Insurance as a Contract - an insurance policy is a legally

enforceable contract. The contract is between IC and the
Insured.
An insurance contract must meet these four requirements:
o Offer and acceptance
o Consideration
o Capacity
o Legal purpose
Principles of Insurance
1. Insurable interest
Insurable interest means that the person opting for insurance must have
pecuniary interest in the property he/she is going to get insured and will
suffer financial loss on the occurrence of the insured event. This is one of
the essential requirements of any insurance contract. Therefore , a person
can go for insurance of only those properties where he stands to benefit by
the safety of the property, and will suffer loss, damage, injury if any harm
takes place to such property.

Example: If the house you own is damaged by fire, the value of your
house has been reduced by the damages sustained in the fire. Whether you
pay to have the house rebuilt or you and up selling it at a reduced price.
You have to suffered a financial loss resulting from the fire. By contrast, if
your neighbors house, which you do not own, is damaged by fire, you may
feel sympathy for your neighbor and you may even be emotionally upset,
but you have not suffered a financial loss from the fire, but in this example
you do not have an insurable interest in your neighbors house.
2. Uberrima fides Almost good faith
The insurance contract must be based on good faith. If the insurance
contract is obtained by way of fraud or misrepresentation it is void. When
an individual apply for life insurance, it is important to answer all questions
truthfully and to volunteer any information even if not asked, if in doubt,
just disclose it. Failure to disclose material facts could render the entire
contract void.

Example: If a person was suffering from sinusitis but did not disclose it, the
entire contract could be cancelled when the insurer discover non-
disclosure. Some financial advisors who in their enthusiasm in closing the
sale advice their clients not to disclose their pre-existing conditions for
fear that the underwriter would reject the case. Therefore it is important
to engage an ethical financial advisor. To avoid any conflict of interest,
ensure you pay a fee for consultation.
3. Material facts disclosure
In the insurance contract, the proposer is required to disclosure to the
insurer all the material facts in respect of the proposed insurance. This
duty of disclosing the material facts not only applies to the material
facts which are known to him but also extends to material facts which
he is supposed to know.
Examples
Acquisition of new companies and/or mergers
Changes to your business description.
Additional product lines and/or new services
Hazardous trade processes, or storage of hazardous matter, including
changes or additions to processes or storage already declared
Incidents not reported to insurers that might otherwise have led to a
claim e.g theft or small fires.
4. Indemnity
The insurance contract should always be a contract of
indemnity only and nothing more.
Insured cant make any profit from the insurance contract.
Insurance contract means for coverage of losses only.
Indemnity means a guarantee to put the insured in the position
as he was before accident.
This principle does not apply to life insurance contracts.
The main object of this principle is to ensure that the insured is
not able to use this contract for speculation or gambling.
5. Contribution

In case the insured took more than one insurance policy for same
subject matter, he/she cant make profit by making claim for same
loss more than once.

For example: Raj has a property worth Rs 5 lakhs. He took

insurance from company A worth Rs. 3 lakhs and from company B
Rs 1 lakhs. In case of accident, he incured a loss of Rs. 3 lakhs to the
property. Raj can claim Rs 3 lakhs from company A but after then he
cant make profit by making a claim from company B. Now company
A can make a claim from company B to for proportional loss claim
value.
6. Subrogation
Subrogation is defined as a legal right that allows one party (e
g, your insurance company) to make a payment that is actually
owed by another party (e g, the other drivers insurance
company) and then collect the money from the party that
owes the debt after the fact.
Example : Suppose another driver runs a red light and your
car is totaled. You have insurance on your car, so you call your
insurance carrier and they pay you for all of your expenses
related to the accident. Your insurance company realizing that
the other driver had an insurance policy, then seeks
reimbursement from the as fault partys insurance carrier. Your
insurer is subrogated to the rights of your policy and can
step in your shoes to recover any amount paid out on your
behalf.
7. Loss minimization
This principle states that the insured must take all the
necessary steps to minimize the losses to insured assets.
For example Ram took insurance policy for his house.
In an cylinder blast, his house burnt. He should have called
nearest fire station so that the loss could be minimized.
What is a risk
Risks are basically the consequential losses or damages to assets
making them non-functional before their expected life time or entire
destruction of the assets. The risk actually only means that there is a
possibility of a loss or damage. It may or may not happen. Insurance
covers such risks if they do happen. Although the word possibility
implies uncertainty , it has a great relevance to Insurance which
applies only in such cases where there is an amount of uncertainty
and predictability.
Classification of risks
Risks are classified into speculative and pure risks. Speculative
risks are never insurable. Pure risks are further classified into
fundamental and particular risks. Pure risks are always
insurable as they are specific and static. Fundamental risks can
affect many people at a time and may be caused due to natural
calamities, wars, epidemics etc and hence are not always
insurable.