Unit 3: Insurance

- Twesha Chharia

Introduction to insurance

Insurance can be defined in both Financial and Legal terms.

 Financial Term: Insurance is a social device in which a group of individual (Insured) transfer risk to another party (Insurer) in order to combine loss experience, which permits statistical prediction of losses and provides for payment of loss from funds contributed by all members who transferred risk.

 Focus on arrangement of funds and redistribution on forms of loss payment. (Sources and uses of funds)

 Legal Term: Insurance is a contract by which one party in consideration of the price paid to him proportionate to the risk provides security to the other party that he shall not suffer any loss by the happening of certain events.

 Focus on legal rights, contractual arrangement, one part agrees to compensate another party for loss.

Terminologies related to insurance

Insurer-The insurer is the insurance company who will provide the cover to the insured against any financial losses. Insured or Beneficiary- The insured may be an individual person or a group of people like an employer, members of a society, etc.

 Benefit (Sum of money) Policy-A policy is the contract between the insurer and the insured, which states the risks covered, the exclusions, if any, and the benefits reimbursed on the happening of an event like death, illness etc.

 Premium The policy is paid through what is called a premium, which is a set amount that must be paid by the insured on a monthly, semi-annual or annual basis.

Benefits of Insurance
1. Reimbursement of Losses 2. Reduction in Tension and Fear 3. Avenue for Investments (Life Insurance investments offers attractive returns) 4. Prevention of loss 5. Credit Multiplication

Elements of insurable risk

1. The loss must be due to chance. Regular recurring losses such as shoplifting in a supermarket are built into the price and would not be insurable. 2. The loss must be definite and measurable. This means that there must be bills to establish "proof of loss," not just casual references. 3. The loss must be predictable, meaning it must be of such a nature that its frequency and average severity can be readily determined to establish the required premium.

 4. The loss cannot be catastrophic. All individual losses are personal catastrophes. The reference here is to national or area disasters, such as floods, riots, wars, earthquakes, etc. 5. The loss exposures must be large. To avoid adverse selection, there must be enough exposure to losses for the frequency to be predictable and to be grouped for the purpose of establishing rates.

 6. The loss exposures must be randomly selected. Concentration of risks by area, age groups, occupations, economic status, etc., can lead to adverse selection.

Principles of insurance
1) Principle of Uberrimae fidei (Utmost Good Faith), 2) Principle of Insurable Interest, 3) Principle of Indemnity, 4) Principle of Contribution, 5) Principle of Subrogation, 6) Principle of Loss Minimization, and 7) Principle of Causa Proxima (Nearest Cause).

Principle of Uberrimae fidei (Utmost Good Faith)

Both the parties i.e insurer and insured should have absolute good faith in each other. The person getting insured must willingly disclose and surrender to the insurer his complete true information regarding the subject matter of insurance.

 The insurer's liability gets void (i.e legally revoked or cancelled) if any facts, about the subject matter of insurance are either omitted, hidden, falsified or presented in a wrong manner by the insured. The principle of Uberrimae fidei applies to all types of insurance contracts.

Principle of Insurable Interest

The principle of insurable interest states that the person getting insured must have insurable interest in the object of insurance. A person has an insurable interest when the physical existence of the insured object gives him some gain but its non-existence will give him a loss.

In simple words, the insured person must suffer some financial loss by the damage of the insured object.

 For example :- The owner of a taxicab has insurable interest in the taxicab because he is getting income from it. But, if he sells it, he will not have an insurable interest left in that taxicab.

Principle of Indemnity
Indemnity means security, protection and compensation given against damage, loss or injury. According to the principle of indemnity, an insurance contract is signed only for getting protection against unpredicted financial losses arising due to future uncertainties. Insurance contract is not made for making profit else its sole purpose is to give compensation in case of any damage or loss.

 In case of life insurance, the principle of indemnity does not apply because the value of human life cannot be measured in terms of money.

Principle of Contribution
Principle of Contribution is a corollary of the principle of indemnity. It applies to all contracts of indemnity, if the insured has taken out more than one policy on the same subject matter. According to this principle, the insured can claim the compensation only to the extent of actual loss either from all insurers or from any one insurer.

 For example :- Mr. John insures his property worth 100,000 with two insurers "AIG Ltd." for 90,000 and "MetLife Ltd." for 60,000. John's actual property destroyed is worth 60,000, then Mr. John can claim the full loss of 60,000 either from AIG Ltd. or MetLife Ltd., or he can claim 36,000 from AIG Ltd. and 24,000 from Metlife Ltd.

Principle of Subrogation
Subrogation means substituting one creditor for another. Principle of Subrogation is an extension and another corollary of the principle of indemnity. It also applies to all contracts of indemnity. According to the principle of subrogation, when the insured is compensated for the losses due to damage to his insured property, then the ownership right of such property shifts to the insurer.

 For example :- Mr. John insures his house for 1 million. The house is totally destroyed by the negligence of his neighbour Mr.Tom. The insurance company shall settle the claim of Mr. John for 1 million. At the same time, it can file a law suit against Mr.Tom for 1.2 million, the market value of the house.

 If insurance company wins the case and collects 1.2 million from Mr. Tom, then the insurance company will retain 1 million (which it has already paid to Mr. John) plus other expenses such as court fees. The balance amount, if any will be given to Mr. John, the insured.

Principle of Loss Minimization

According to the Principle of Loss Minimization, insured must always try his level best to minimize the loss of his insured property, in case of uncertain events like a fire outbreak or blast, etc. The insured must take all possible measures and necessary steps to control and reduce the losses in such a scenario.

 The insured must not neglect and behave irresponsibly during such events just because the property is insured. Hence it is a responsibility of the insured to protect his insured property and avoid further losses.

 For example :- Assume, Mr. John's house is set on fire due to an electric short-circuit. In this tragic scenario, Mr. John must try his level best to stop fire by all possible means, like first calling nearest fire department office, asking neighbours for emergency fire extinguishers, etc. He must not remain inactive and watch his house burning hoping, "Why should I worry? I've insured my house."

Principle of Causa Proxima (Nearest Cause)

It means when a loss is caused by more than one causes, the proximate or the nearest or the closest cause should be taken into consideration to decide the liability of the insurer.

 For example :- A cargo ship's base was punctured due to rats and so sea water entered and cargo was damaged. Here there are two causes for the damage of the cargo ship - (i) The cargo ship getting punctured beacuse of rats, and (ii) The sea water entering ship through puncture.

 The risk of sea water is insured but the first cause is not. The nearest cause of damage is sea water which is insured and therefore the insurer must pay the compensation. However, in case of life insurance, the principle of Causa Proxima does not apply. Whatever may be the reason of death (whether a natural death or an unnatural death) the insurer is liable to pay the amount of insurance.

Kind of Insurance
1. Life Insurance 2. Non Life insurance

Life Insurance
Life insurance is a contract under which the insurer (Insurance Company) in consideration of a premium paid undertakes to pay a fixed sum of money on the death of the insured or on the expiry of a specified period of time whichever is earlier.

Benefits
Protection against untimely death Saving for old age. Promotion of savings Initiates investments Credit worthiness( raise loan) Social Security Tax Benefit

TYPES OF LIFE INSURANCE POLICIES

1.TERM POLICY: In case of Term assurance plans, insurance company promises the insured for a nominal premium to pay the face value mentioned in the policy in case he is no longer alive during the term of the policy.

 Features: It provides a risk cover only for a prescribed period. The amount of premium to be paid for these policies is lower than all other life insurance policies.

 2. WHOLE LIFE POLICY: This policy runs for the whole life of the assured. The sum assured becomes payable to the legal heir only after the death of the assured.

 The whole life policy can be of three types. (1) Ordinary whole life policy In this case premium is payable periodically throughout the life of the assured. (2) Limited payment whole life policy In this case premium is payable for a specified period (Say 20 Years or 25 Years) Only. (3) Single Premium whole life policy In this type of policy the entire premium is payable in one single payment.

 3.ENDOWMENT LIFE POLICY: In this policy the insurer agrees to pay the assured or his nominees a specified sum of money on his death or on the maturity of the policy which ever is earlier. The premium for endowment policy is comparatively higher than that of the whole life policy. The premium is payable till the maturity of the policy or until the death of the assured which ever is earlier.

 4. MONEY BACK POLICY: In this case policy money is paid to the insured in a number of separate cash payments. Insurer gives periodic payments of survival benefit at fixed intervals during the term of policy as long as the policyholder is alive.

 5. Pension Cover risk of old age 6. Ulip Unit link plans and investments in stock market

Non Life Insurance

1. Fire insurance:Scope of cover 1.Fire 2. Lightning 3. Explosion 4. Storm, cyclone, typhoon, hurricane, tornado, landslide except earthquake and volcanic eruption.

 5. Bush fire 6. Riot, strike, malicious, and terrorism damages 7. Aircraft damage 8. Overflowing of water tanks and pipes etc.

 2. Marine Insurance: A) Hull Insurance:-Hull refers to the ocean going vessels (ships trawlers etc.) as well as its machinery. The hull insurance also covers the construction risk when the vessel is under construction. A vessel is exposed to many dangers or risks at sea during the voyage. An insurance effected to indemnify the insured for such losses is known as Hull insurance.

 B) Cargo Insurance Cargo refers to the goods and commodities carried in the ship from one place to another. Cargo insurance covers the shipper of the goods if the goods are damaged or lost. It also cover risk with the transshipment of goods.

 The policy can be written to cover a single shipment. If regular shipments are made, an open cargo policy can be used that insures the goods automatically when a shipment is made.

 C) (c) Freight Insurance Freight refers to the fee received for the carriage of goods in the ship. Usually the ship owner and the freight receiver are the same person. Freight can be received in two ways- in advance or after the goods reach the destination.

 In the former case, freight is secure. In the latter the marine laws say that the freight is payable only when the goods reach the destination port safely. Hence if the ship is destroyed on the way the ship owner will loose the freight along with the ship. That is why, the ship owners purchase freight insurance policy along with the hull policy.

 (d) Liability Insurance It is usually written as a separate contract that provides comprehensive liability insurance for property damage or bodily injury to third parties. It is also known as protection and indemnity insurance which protects the ship owner for damage caused by the ship to docks, cargo, illness or injury to the passengers or crew, and fines and penalties.

HEALTH INSURANCE
A) Mediclaim policy (individuals and groups) Mediclaim policy is offered to individuals and groups exceeding 50 members. It covers the hospitalization for diseases or sickness and for injuries. Under group mediclaim policy, group discount is allowed to groups exceeding 101 people.

 B) Overseas Mediclaim Policy In 1984, the Overseas Mediclaim Policy was developed. This policy will reimburse the medical expenses incurred by Indians upto 70 years of age while traveling abroad. The premium will be charged based on their age, purpose of travel, duration and plan selected by the insured under the policy.

MOTOR INSURANCE
A) Liability only policy This covers third party liability and / or death and property damage. Compulsory personal accident covers for the owner in respect of owner driven vehicles is also included.

 B) Package policy This covers loss or damage to the vehicle insured in addition to 1 above. C) Comprehensive policy- Apart from the above-mentioned coverage, it is permissible to cover private cars against the risk of fine and / or theft and third party/ theft risks.