Insurance is a legal contract between the insurance company(insurer) and the policyholders(insured) in which the insureds transfer their risk to the insurance company and for taking risk of the insureds, the insurance company charge certain amount of money as a premium from the insureds periodically or in the lump sum.
Fundamental Principles of Insurance
The basic principles of insurance are as follows:
1. Utmost Good Faith: According to principle of utmost good faith, both the insurer and the insured requires to act with honesty, fairness and transparency towards each other. The insured must provide complete and accurate information to the insurer about the risk being insured, including all material facts and circumstances that could impact the insurer's decision to accept or reject the policy. The insurer must evaluate the risk in good faith and fairly determine the price of insurance premium based on the information provided by the insured. If either party fails to act in good faith, it can void the insurance contract.
2. Insurable Interest: According to principle of Insurable interest , the insured must have a financial interest in the subject matter being insured. In other words, the insured must stand to gain or lose financially as a result of a loss happened. Without an insurable interest, the insurance contract is considered a form of gambling, which is illegal. For example, if you own a car, you have an insurable interest in it and can take out a car insurance policy to protect your financial interest in the vehicle but if you sell the car and accident happened you will not get any compensation against that accident because you will not have insurable interest at that time.
3. Proximate Cause: According to principle of proximate cause, the cause of the loss must be the direct and immediate cause of the loss for the insurance to cover it. In other words, the cause of the loss must be the event that set off a chain of events leading directly to the loss. If the cause of the loss is too far, the insurance will not compensate it. For example, if your car is damaged in an accident and the cause of the accident is a road defect, the insurance will compensate the loss as the road defect is the nearest cause of the accident.
4. Indemnity: According to principle of indemnity, the insured should be put back in the same financial position as before the loss occurred, but not more than actual loss. The purpose of indemnity is to restore the insured to the same financial position as before the loss, not to make them better off. The insured should not be profited from a loss. For example, if your car is damaged in an accident and you make a claim, the insurance company will compensate you for the cost of repairing the car, but not for the value of a brand new car.
5. Subrogation: According to principle of subrogation, the insurer allows to take over the rights of the insured to recover their losses from a third party who is responsible for causing the loss. This principle prevents the insured from collecting double compensation for the same loss. For example, if your car is damaged in an accident caused by another driver, your insurance company can claim the amount from that driver to recover the cost of repairs and prevent you from collecting double compensation.
6. Contribution: According to principle of contribution, if two or more insurance policies cover the same loss, the insurance companies are responsible for paying their share of the loss on the base of proportion. The idea behind contribution is that no insurance company should bear more than its fair share of the loss. For example, if you have both a home insurance policy and a car insurance policy that covers theft, both insurance companies will contribute to covering the loss if your car is stolen from your garage.
7. Loss Minimization: According to principle of loss minimization, the insured has a responsibility to take steps to minimize their losses in the event of a loss. This principle helps to take reasonable steps by insured to prevent or reduce the extent of a loss. For example, if your house is caught fire, you must take reasonable steps to prevent the fire and further damage, such as calling the fire department and using a fire extinguisher. By taking these steps, you are fulfilling your responsibility to minimize your losses.
In conclusion, the seven fundamental principles of insurance helps in protecting the fairness of both the insurer and the insured. The principles of utmost good faith, insurable interest, proximate cause, indemnity, subrogation, contribution and loss minimization are integral to the functioning of the insurance industry and help to ensure that insurance contracts are enforceable and provide the intended protection to policyholders. These principles are considered as the guidelines for both insurers and policyholders
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