Insurance: 7 principles to protect policyholder's interests

We all have a lot of questions when it comes to buying an insurance, Be it a life insurance policy or health insurance policy or an insurance policy for your car, we are simply not convinced whether the insurance company would cover the losses as and when the claim arises. Few common questions asked in case of life insurance is “How will the company pay Rs. 1 crore for a premium of Rs. 15,000 per annum.”

While all the questions typically asked by people are genuine, there are certain principles that guide the entire functioning of the insurance industry.

In this article, we are going to discuss seven principles on which the insurance industry runs.

Insurance is a contract between an individual or entity (the "insured") and an insurance company (the "insurer"). In exchange for a premium, the insurer agrees to pay for losses that the insured experiences, up to the limits of the policy. The seven principles of insurance are essential to the functioning of the insurance industry and help to ensure that both the insurer and the insured are treated fairly.

Principle of utmost good faith

The principle of utmost good faith means that both the insured and the insurer must be honest and truthful with each other when entering an insurance contract. This includes providing accurate information about the insured property or person, as well as any known risks that could lead to a loss. In case of applying for a term insurance, one must disclose the facts about his lifestyle.

For example, drinking or smoking habits, medical history, pre-existing medical conditions. This information assists insurance companies to calculate a fair amount of premium to be charged for underwriting this policy.

Principle of insurable interest

The principle of insurable interest means that the insured must have a financial interest in the insured property or person. This means that the insured must stand to lose something if the property is damaged, or the person is injured.

For example, you can take insurance against your own house to cover the damages if any that can occur in future. However, you cannot take insurance against your neighbours’ house as you have no insurable interest in the same.

Principle of proximate cause

The principle of proximate cause means that while calculating the claim for loss of an insured object, the cause which is closest and the main reason for the loss should be considered. Suppose a car accident is caused due to drunk driving, the insurance company would not pay the damages as the proximate cause is the driver's own action. However, if a tree falls on a standing car, then the insurance company will cover the claim if the cause is an uncertain event.

Principle of indemnity

The principle of indemnity means that the insurer will only pay the insured for the actual losses they have incurred, up to the limits of the policy. One cannot make profit from an insurance policy.

For example, if a person earns Rs. 2 lakhs per month, then an insurance of Rs. 3-4 crore is sufficient for him, however if he cannot apply for an insurance of Rs. 50 crores just because he can afford the premiums since the intention is not to insure but to profit.

Principle of subrogation

This principle means that once the insurer has paid a claim, they are subrogated to the rights of the insured to collect damages from the person or entity responsible for the loss.

For example, if your car is damaged in a hit-and-run accident, your insurer will pay for the repairs. Once the repairs are completed, your insurer will then try to track down the person who hit you and collect the money from them.

Principle of contribution

This principle means that if the insured has multiple insurance policies that cover the same loss, the insurers will contribute to the payment of the claim in proportion to the amount of coverage each policy provides.

For example, if you have two health insurance policies, each with a limit of Rs. 500,000, and you incur a claim of Rs.150,000, each insurer will pay Rs. 75,000. If you make a claim at any single company, then that company is eligible to reimburse the claim for the other company for a partial amount.

Principle of loss minimization

This principle means that the insured must take all reasonable steps to minimise their losses. This includes things like taking precautions to prevent accidents, keeping your property in good condition, and reporting any losses to your insurer as soon as possible.

For example, if a house catches fire, the owner should take all the necessary steps to ensure that the fire is being controlled and losses are reduced.

By understanding the seven principles of insurance, you can be sure that you are making an informed decision when you purchase an insurance policy.

Rohit Gyanchandani is Managing Director at Nandi Nivesh Private Limited