Chapter 4

Insurance Contract

Slide prepared by: Abdullah Al Yousuf KhanAssistant Professor - IUBAT4

Chapter

McGraw-Hill/IrwinCopyright 2006 by The McGraw-Hill Companies, Inc. All rights reserved.

Insurance Contract

Insurance Contract

Elements of General Contract

Offer and AcceptanceOffer (for insurance) can come from either the insured or the insurer.Whether the offer is from either side, the main fact is acceptance.Prospectus, advertisement, canvassing by agents are offer by the insurer.When the prospect (the potential policy-holder) proposed to enter into contract it is an offer. If there is an alteration in the offer that would be a counter-offer. If this alteration or change (counter-offer) is accepted by the proposer, it would be an acceptance.

Legal ConsiderationThe insurer, for his promise, must have something in return for promising to pay a fixed sum for the contingency. Premium is considered as a valuable consideration must be given for starting the insurance contract. The amount of premium is not important to begin the contract but the fact is that without payment of premium, the insurance contract can not start.

Competent to Make ContractEvery person is competent to make contract;Who is of the age of majority according to the law.Who is of sound mind, andWho is not disqualified from contracting by any law to which he is subject.A minor cannot sign a contract or competent for a contract.a contract by a minor is void except contract for necessities.

Free ConsentParties entering into the contract should enter into it by their free consent.The consent will be free when it is not caused by;CoercionUndue influenceFraud Misrepresentation orMistakeWhen there is no free consent except fraud the contract would be voidable.In case of fraud the contract would be void.

Legal ObjectIn order to make a valid contract, the object of the agreement should be lawful.An object that is;Not forbidden by lawIs not immoralOpposed to public policy orWhich does not defeat any provision of any law, is lawful.If the object of an insurance is found to be unlawful, the policy is void.

Principles of Special Contract

Principle of Insurable Interest

Insurable InterestFor a valid insurance contract, the insured must possess an insurable interest in the subject matter of insurance. The insurable interest is the pecuniary interest whereby the policy holder is benefited by the existence of the subject matter.

Insurable InterestThe essentials of a valid insurable interest are the following;There must be a subject-matter to be insured.The policy-holder should have monetary relationship with the subject-matter.the relationship should be recognized by the law. In other words, there should be no illegal relationship between the policy-holder and the subject-matter.The financial relationship should be such that the policy-holder is economically benefited by the survival or existence of the subject-matter and/or will suffer economically at the death or damage/destruction of the subject-matter.

Principle of Utmost Good Faith

Utmost Good FaithThe doctrine Utmost Good Faith of disclosing all material facts applies to all forms of insurance. Both parties of the insurance contract must be of the same mind (ad idem) at the time of contract.There should not be any;MisrepresentationNon-disclosure orFraud concerning the material.An insurance contract is a contract of uberrimae fidei, i.e., of absolute good faith both parties of the contract must disclose all the material facts and fully.

Utmost Good FaithMaterial Facts;A material fact is one which affect the judgment or decision of both parties in entering to the contract. Facts which count materiality are those knowledge which influence a party in deciding whether or not to offer and accept such risk.And if the risk is acceptable, on what terms and conditions the risk should be accepted. In life insurance, the material facts or factors affecting the risk will be the Age, residence, occupation, health, income etc.In property insurance, it would be;Use, design, owner, and situation/location of the property.

Utmost Good FaithFull and True Disclosure;All material facts should be disclosed in true and full form.It means that the facts should be disclosed in that form in which they really exist.There should be no;ConcealmentMisrepresentationMistake or Fraud about the material factsThere should be no; False statement or Half truth norAny silence on the material facts.

Utmost Good FaithDuty of Both the Parties;The duty to disclose the material facts lies on both the insurer and the insured.But the assured/insured has to be more particular about the observance of the principle because he/she is usually in full knowledge of facts relating to the subject-matter which, despite all effective inspection of the insurer, would not be disclosed.

Utmost Good FaithFacts Need not to be Disclosed by the Insured;Facts which tend to lessen the riskFacts of public knowledgeFacts which could be inferred from the information disclosedFacts waived by the insurerFacts governed by the conditions of the policy

Principle of Indemnity

Principle of IndemnityAs a rule all insurance contracts except personal insurance are contracts of indemnity.According to this principle, the insurer undertakes to put the insured, in the event of loss, in the same position that he/she occupied immediately before the happening of the event insured against.In true sense of indemnity, the insured is not entitled to make any profit.

Principle of IndemnityUses of this Principle;In absence of this principle, the insured would tend to over-insurance and then intentionally cause a loss so that financial gain can be achieved. So to avoid this intentional loss, only the actual loss becomes payable, not the assured sum. If the property is under-insured, i.e., the insured amount is less than the actual amount of the property insured, the insured is generally regarded his own insure for the amount of under insurance and in case of loss one shall share the loss himself.

Principle of IndemnityTo Avoid Anti-social Act;If the assured is allowed to gain more than the actual loss, (which is against the principle of indemnity), he/she will be tempted to gain by destruction of hi/her own property after getting insured against a risk. He/she will be under temptation to destroy the property.Thus the whole society will be doing only ant-social act, i.e., everyone would be interested in gaining after destruction of the property.

Principle of IndemnityTo Maintain the Premium at Low Level;In absence of the principle, larger amount will be paid for small amount of loss which would increase the cost of insurance and the premium will have to be raised. Increasing premiums will cause; Less interest in insuranceUnscrupulous persons would get insurance to destroy the property to gain from such act.

Principle of IndemnityConditions for Indemnity Principle;The insured has to prove that he will suffer loss on the insured matter at the time of happening the event and the loss is actual monetary loss.The amount of compensation will be the amount of insurance and cannot be more than the insurance.If the assured gets more than the actual loss, the insurer has the right to get the extra amount back.If the insured gets some amount from third party after being fully indemnified by insurer, the insurer have the right to receive all the amount paid by the third party.This principle does not apply to personal insurance because the amount of loss not easily calculable there.

Doctrine of Subrogation

Doctrine of SubrogationThe doctrine of subrogation refers to the right of the insurer to stand in the place of the insured, after settlement of a claim, in so far as the insureds right of recovery from an alternative source is involved. If the insured is in a position to recover the loss in full or in part from a third party due to whose negligence the loss may have been precipitated, his right of recovery is subrogated to the insurer on settlement of the claim. The insurer, thereafter recover the claim from the third party.

Essentials of Doctrine of SubrogationCorollary to the principle indemnity;The doctrine of subrogation is the supplementary principle of indemnity.Prevent the insured from collecting twice for the same loss.

Essentials of Doctrine of SubrogationSubrogation is the substitution;The insurer, according to this principle, becomes entitled to all the rights of insured subject matter after payment because he has paid the actual loss of the property. He is substituted in place of other persons who act on the right and claim of the property insured.

Essentials of Doctrine of SubrogationSubrogation only up to the Amount of Payment;The insurer is subrogated all the rights, claims, remedies and securities of the damaged property after indemnification, but he is entitled to get these benefits only to the extent of his payments.The insurer, thus, subrogated to the alternative rights and remedies of the insured, only up to the amount of his payment to the insured.

Essentials of Doctrine of SubrogationThe Subrogation may be Applied Before Payment;If the assured got certain compensation from third party before being fully indemnified by the insurer, the insurer can pay only the balance of the loss.

Essentials of Doctrine of SubrogationPersonal Insurance; The doctrine of subrogation does not apply to personal insurance because the doctrine of indemnity is not applicable to such insurance. The insurers have no right of action against the third party in respect of the damage.For example, if an insured dies due to the negligence of a third party, his dependents have the right to recover the amount of the loss from the third party along with the policy amount. No amount of the policy would be subrogated by the insurer.

WarrantiesThere are certain conditions and promises in the insurance contract which are called warranties. According to Marine Insurance Act, A warranty is that by which the assured undertakes that some particular thing shall or shall not be done, or that some conditions shall be fulfilled, or whereby he affirms or negatives the existence of a particular state of facts.

WarrantiesWarranties which are mentioned in the policy are called express warranties. There are certain warranties which are not mentioned in the policy are called implied warranties. Warranties which are answers to the questions are called affirmative warranties. The warranties fulfilling certain conditions or promises are called promissory warranties.

Warranties Importance of Warranties;Warranty is a very important condition in the insurance contract which is to be fulfilled by the insured. On breach of warranty, the insurer becomes free from his liability.Therefore, insured must have to fulfill the conditions and promises during the insurance contract whether it is important or not in connection with the risk. The contract can continue only when warranties are fulfilled.

Proximate Cause

Proximate CauseThe rule of proximate cause is that immediate not the remote cause is to be regarded. The maxim is sed causa proxima non-remota spectature, i.e. see the proximate cause and not the distance cause. The real cause (peril) must be seen while paying for the loss. If the real cause (peril) of loss is insured, the insurer is liable to compensate the loss; otherwise the insurer may not be responsible for loss.

Proximate CauseDetermination of Proximate Cause;If there is a single cause of a loss, the cause will be the proximate cause and if the peril was insured, then insurer will have to indemnify the loss.If there are concurrent causes, the insured perils and the uninsured perils have to be separated. If the causes occurred in form of chain, they have to be observed seriously.If there is unbroken chain the expected and insured peril have to be separated.

Assignment or Transfer of Interest

Assignment or Transfer of InterestThe legal transfer of contractual rights and duties from one party to another. Marine and life policies can be freely assigned without prior consent of the insurer.Fire and accident policies cannot be transferred without prior consent of the insurer. The life insurance can be assigned whether the assignee has an insurable interest or not.

Return of Premium

Return of PremiumOrdinarily the premium once paid cannot be refunded. However in the following cases the refund is allowed;By agreement in the Policy; special packaging may reduce the risk. For Reasons of Equity; Non attachment of riskUndeclared balance of an Open PolicyPayment of Premium is ApportioanbleNo Insurable Interest of the insuredOver-insurance Over-Insurance by Double Insurance;

Difference Between Different Types of Insurance

Difference Between Fire and Life Insurance

Difference Between Fire and Marine Insurance

Insurance and GamblingNature of RiskInsurable Interest