General insurance concept and importance different types General Insurances
Insurance ‐‐‐ Mechanism of Covering Risk
Insurance is a mechanism by which the person exposed to the potential risk, arising out of the events beyond his control, transfers the financial loss; in part or in full to a third party.
The party which transfers the potential loss is termed as the ‘Insured’ and the party which indemnifies or undertakes to compensate the other party of such potential loss is termed as ‘Insurer’.
The Insurer provides the coverage for the potential financial loss for a fee or a consideration which is called the ‘Premium’.
Thus Insurance is a special type of contract between the Insurer (the Insurance Company) and the Insured (the client) wherein:
a) The client agrees to pay a premium to the Insurance Company. Such premium may be a fixed amount payable as a single payment or it may be paid as periodical payments. This will depend upon the type of Insurance and the terms thereof.
b) In lieu of the payment of such premium the Insurance Company agrees to make some payment to the client or bear the costs of the client due to financial loss incurred on the occurrence of certain events.
For example, in vehicle insurance, the Insurance Company pays the cost of repairing the vehicle if it is damaged in an accident.
Types of Insurance
Insurance in India is mainly of two types viz. Life Insurance and Non Life Insurance which is termed as General Insurance.
These are described as follows:
a) Life Insurance
Under Life Insurance the Insured pays the premium at specified times and in turn the Insurance Company undertakes to pay the specified fixed amount to the legal heirs in the event of death of the Insured. Thus life insurance is a mechanism whereby the life of the Insured is insured.
b) General Insurance
Insurance other than Life Insurance falls under the category of General Insurance. The different types of General Insurance are fire, marine, Motor Vehicle, accident and other types of non life insurance.
General Insurance
As explained in the preceding para Insurance Contracts that do not come under the ambit of Life Insurance are called General Insurance or Non Life Insurance Contracts.
General Insurance comprises of:
● Insurance of property against fire, theft etc.
● Personal Insurance such as Accident & Health Insurance.
● Liability Insurance which covers legal liability arising out of third party claims such as claim from a person injured in a motor accident etc.
● Other types of Insurances such as Credit Insurance, Crop Insurance, etc.
Thus General Insurance provides indemnity against loss arising from damage to property or assets, expenditure or loss of earning arising from injury to a person, legal liabilities etc.
Importance of General Insurance
General Insurance is the best practical option for every person who would like to cover himself from loss arising out of risks.
Risk is associated with everything that we do or are involved in. Immovable Properties that we own are prone to fire and damage / destruction due to natural calamities such as Earthquakes, Floods etc.
Movable properties including personal effects such as jewelry are prone to theft and burglary.
Vehicles are also prone to accidents. Similarly human beings are prone to injuries resulting from accidents and illnesses.
All the incidents enumerated above would result in financial losses. Then there could be Third Party Claims on you.
For instance, you are driving a car and unfortunately you meet with an accident in which a pedestrian is injured. Such person will have a Claim on you.
Also there could be claims on you while you are performing your professional duties. A Doctor may be subject to a claim for negligence in treating a patient.
General Insurance, wherever applicable, would provide cover against such losses. The modern day General Insurance covers practically all losses arising out of risks.
The primary risk that is not covered by General Insurance is death of a person which is covered by Life Insurance.
Needless to say, when the losses due to risks are covered a person would lead a peaceful life. The Security provided by General Insurance would improve the quality of life of a person.
Apart from the peace of mind General Insurance also covers Business Losses and Personal Losses in case the unfortunate incident happens resulting in the loss. This would help the person who has suffered loss to run his business smoothly.
Illustration Let us take an example where a fire occurs in a factory. As a result of the fire certain stocks are damaged and are unusable. In case fire insurance has been taken for such stocks, the Insurance Company would pay, to the entity which suffered the loss, an amount equivalent to the loss or the amount of insurance whichever is less.
Thus such an entity would be fully or partly compensated for the loss incurred by it. Even though the fire may result in disruptions this would help it in running its operations smoothly even after some time. Thus from the above it is amply clear that General Insurance plays an extremely important role in our lives.
Different types of General Insurance
As stated earlier General Insurance currently covers most of the risks that we are subjected to. However, the major type of General Insurances are as under:
1. Fire Insurance
Fire insurance is a contract under which the insurer in return for a consideration (premium) agrees to indemnify the insured/assured for the financial loss which the Insured may suffer due to destruction of or damage to property or goods, caused by fire, during a specified period.
Thus the basic ingredients of Fire Insurance are as follows:
i. The financial loss should be on account fire resulting in damage or destruction of property or goods.
ii. The maximum amount which the Insured can claim as compensation in the event of loss is agreed to between the parties at the time of entering into the contract. It should be understood here that the event that results into financial loss would be fire and not an accident.
2. Marine Insurance
Marine Insurance is an Insurance against loss or damage or destruction of Cargo, freight, merchandise or means or instruments of transportation whether by sea, land or air.
Thus marine insurance provides indemnity for loss or damage to ship, cargo or mode of transport by which the property is taken, acquired or held between the point of Origin and point of destination.
3. Motor Vehicle Insurance
Motor Vehicle Insurance, also referred to as ‘Automotive Insurance’, is a contract of Insurance under which the Insurer indemnifies the Insured, who is the owner or an operator of a Motor Vehicle, against any loss that he may incur due to damage to the property (i.e. the Motor Vehicle) or any other person (i.e. Third Party) as a result of an accident.
There are two types of Motor Vehicle Insurance:
a. Mandatory
In India it is mandatory, i.e. required by Law, for every owner or operator of a Motor Vehicle to take insurance that provides for payment of compensation to a Third Party who dies or suffers injuries due an accident caused by the said motor vehicle. Thus the objective of such a policy is prevention of public liability to protect the general public from any accident that may take place on the road.
It may be noted here that in Insurance the Insured is the First Party, the Insurance Company is the Second Party and all others are third parties. Such a policy is also known as ‘Act Only’ Policy as it is mandatory by Law.
b. Comprehensive
Under a comprehensive motor insurance policy apart from the coverage of Third Party Liability (as provided in the mandatory policy)
various other risks are also covered. These include damage to the Motor Vehicle caused by fire, accident, theft
etc.
As a single policy is issued to cover all risks, such type of policy is called Comprehensive Policy.
4. Health Insurance Policy
The Health Insurance for MediClaim Policies, as it is also referred to, are those policies which cover hospitalization expenses for the treatment of illness/ injury as per the terms and conditions of the policy. These policies may also cover pre hospitalization expenses prior to hospitalization and also post hospitalization expenses for the period specified in the policy. Some of the Insurers also cover the following expenses in this policy:
a. Ambulance Charges
b. Day Care treatment charges i.e.
treatment by using advanced technologies when even 24 hours of hospitalization is not required.
5. Personal Accident Insurance
The purpose of personal insurance is to provide for payment of a fixed compensation for death or disability resulting from injury to the body of a human being caused due to an accident.
Thus under the contract of personal accident insurance if at any time during the tenure of the said contract or policy, the insured (i.e. the person who has taken the policy) sustains any bodily injury resulting from an accident, the Insurer shall pay to the insured or to his legal representatives, as the case may be, a specified sum in the event of specified contingencies such as permanent disability, death etc.
6. Burglary or Theft Insurance
Theft Insurance Contract covers losses from burglary, robbery and other forms of theft. Theft generally refers to the act of stealing. Burglary is defined to mean the unlawful taking of the property within the premises that have been closed and in which there are visible marks evidencing forceful entry.
Principles of General Insurance
The main motive of insurance is Co operation. Insurance is defined as the equitable transfer of risk from one Entity to another in exchange of Premium.
The basic principles insurance are as follows:
1. Nature of Contract
Nature of a contract is a fundamental principle of an insurance contract. An insurance contract comes into existence when one party makes an offer or proposal of the contract and the other party accepts the proposal. The contract should be simple to be understood by each party. The person entering into the contract should enter with his free consent.
2. Principle of Utmost Good Faith
In the case of a contract both the parties to the contract are required by law to observe good faith. However, in general transactions, say a transaction where a person has gone to a store to buy some products, the buyer is supposed to satisfy himself about the features of the product that he is buying.
The seller is supposed to disclose all material facts about the product and also the facts so disclosed should not be misleading. However the is not obliged to disclose each and every fact of the product. This casts a responsibility on the buyer to satisfy himself about the quality and other features of the product.
If after the purchase of the product the buyer is not satisfied by it, he does get a legal right to go back to the seller and return the goods. Now the discretion is with seller whether to accept the goods or not. The seller would be well within his right to refuse the return of goods on the contention that the buyer had satisfied about the quality and other relevant features of the product before buying the product.
This principle is known as Principle of ‘Caveat Emptor’ which means that let the buyer beware. This principle is applicable to all commercial contracts.
However Insurance Contracts are different from General Contracts. While general contracts work on the principle of ‘simple good faith’ insurance contracts work on the principle of
‘utmost good faith’. The principle of utmost good faith is also known as principle of Uberrima Fides’. Let us now see as to why the insurance contracts must follow the principle of utmost good faith and not simple good faith.
a. In an insurance contract the seller is the Insurer and the buyer is the insured. In this case the buyer or the insured has the full knowledge of the property being insured and the seller is ignorant about it. This is a situation which is opposite of a general purchase contract. In a general purchase contract it is the seller who would have full knowledge and details of the property and not the buyer.
Thus in case of insurance contracts the seller would be dependent upon the buyer to provide complete information about the property. In view of this there is a need of utmost good faith of the insurer on the insured that the later has provided full information of the property.
It could be argued here that the insurer has the option to examine the property. But such examination may not bring forth all facts and especially the history of the property.
Let us examine a situation where a person is seeking medical insurance. In such a case the Insurance Company would insist on the medical examination of the said person to know full facts about the health and the medical history of that person i.e. past illness, accidents etc.
However, such medical examination may not reveal the complete medical history of the said person. Hence notwithstanding the medical examination, the insurance company would expect the proposed insured person to disclose full details about his
medical condition so that the insurance company is able to take a prudent decision on firstly whether to provide insurance cover and if so, at what cost i.e. should be the premium.
b. Insurance is an intangible product. It cannot be seen or felt. It is simply a promise on the part of the Insurer to make good the loss incurred by the insured if and when it occurs.
Hence, while the insured must disclose all information about the property for which he is seeking insurance. It is also the duty of the Insurance Company not to make any false promises during negotiation. The Insurer must exactly appraise the insured about the circumstances in which and the extent to which it would be compensated by the Insurance Company in case of damage.
For instance, in the case of an earthquake in Gujarat (Latur) a number of disaster victims failed to get any relief from the Insurance Company as the risk of earthquake was not covered.
Thus the term ‘Utmost Good faith’ can be defined as ‘ A positive duty to voluntarily disclose accurately and fully all facts material to the risk being proposed whether requested for or not.
In an Insurance contract utmost good faith means that ‘each party to the proposed contract is legally obliged to disclose to the other all information which can influence the others to decide to enter the contract.
In case it is found that full and true disclosures were not made at the time of the contract the affected party will have the right to regard the contract as void.
From the above we can arrive at the following conclusion:
✓ Each party is required to tell the other the truth and the whole truth and
nothing but truth.
✓ Failure to reveal information even if not asked for gives the aggrieved party the right to regard the contract void.
3. Principle of Insurable Interest
One of the essential ingredients of a Insurance Contract is that the insured must have insurable interest in the subject matter of the contract.
A person is supposed to have Insurable Interest in something when the loss or damage to that thing would cause the person to suffer financial or any other kind of loss. Thus insurable
interest means that the Insured must stand to suffer a direct financial loss if the event against which the insurance policy is taken does actually occur.
The insurable interest is generally established by ownership, possession or direct relationship.
For example people have insurable interest in their own houses and vehicles and not in neighbour’s houses and certainly not that of strangers.
For an insurance company the insurable interest is the basic reason for issuing a legal insurance cover to an insured (or the beneficiary) as it gives legal right to enforce an
insurance claim.
There are four essential components of Insurable interest:
✓ There must be some property, right, interest, life, limb or potential liability which is capable of being insured.
✓ Any of the above i.e. property, right, interest etc must be subject matter of insurance.
✓ The insured must have a formal or legal relationship with the matter which is the subject of insurance.
✓ The relationship between the insured and the subject matter of insurance must be recognized by law.
Examples of Insurable Interest
a. If the house you own is damaged by fire, the value of your house has been reduced by damages sustained in the fire. Whether you pay to have the house re-built or you end up selling it at reduced price, you have suffered a financial loss from the said fire.
On the contrary if your neighbor’s house which you don’t own is damaged by fire you may feel sympathetic for your neighbor and you may also be emotionally upset, but the fact is that you have not suffered any financial loss from the fire. You have an insurable interest in your own house but in this example you do not have an insurable interest in your neighbor’s house.
b. In Life Insurance everyone is considered to have an insurable interest in his own life and that of his spouse.
c. At times the insurable interest may be subjective. For instance the Employer has an insurable interest in the lives of their employees. The reason for this is that if the employee dies or becomes incapacitated due to an accident there will be a cost of training of the employees who would replace the existing employees who have expired.
In such a case the amount of insurable interest cannot be exactly determined but it should be reasonable and proportionately related with the salary of the employee.
Insurable interest is one of the foundations of insurance business because in its absence the insurance contract would not constitute a binding contract. Absence of Insurable Interest would make the contract of Insurance Null & Void.
4. Principles of Indemnity
Indemnity according to Cambridge International Dictionary means ‘Protection against possible damage or loss. Thus Indemnity means security, protection and compensation given against damage, loss or injury.
In context of Insurance indemnity is defined as ‘Financial Compensation sufficient to place the Insured in the same financial position after the loss as he enjoyed immediately before the
loss was incurred’. Thus under the principle of indemnity the insured should be compensated only for the loss that has been incurred by him as a result of the event in respect of which the insurance has been taken.
It will not be in order if the Insured should make any profit out of such an event (such as fire, motor accident etc.)
Since the compensation of loss, and only the loss, is the basic factor under the principle of indemnity, it will be essential that the evaluation of loss is done as precisely as possible.
Though the financial evaluation of loss is possible in most of the cases, in case of loss of life and disability it may not be precisely possible to determine the loss in monetary terms.
In certain cases the amount of compensation given by the Insurer may be less than the actual loss that has been incurred. However under no circumstances the compensation to the Insured should be more than the loss that has been incurred. This is more adequately explained by the following two examples:
a. “A” has insured his bike for Rs 50,000. Unfortunately he meets with an accident and the bike is extensively damaged. This results in total loss of the bike. Though ‘A’ must get a compensation of Rs 50,000 as his bike has been totally destroyed in the accident but this may not always be the case.
There could be a possibility that either he has estimated the value of the bike at a higher price than its real value or that the prices of the bile have been reduced.
In both the cases Insurer will pay compensation of an amount that is equal to the value of the bike at the time of Insurance. In such case if the Insurer finds that a bike of the same make and model and in the same condition as existed immediately before the loss is available for Rs 30,000, he will be liable to pay only Rs 30,000 and nothing more than this.
b. Suppose in the case mentioned above in the said accident the bike is only partially damaged & can be adequately repaired to bring it back to its condition immediately prior to the loss. However during the process of repairs certain parts are replaced.
Assuming that the bike was two years old. In such case the parts that need to be replaced would have suffered wear and tear.
In this if the Insurer gives the value of the new part as compensation to the Insured, it would mean that the Insured is making a profit out of it. This will be against the Principle of Indemnity.
Hence in this case the Insurer will make a suitable deduction from the cost of the new part in respect of wear and tear of the part that has been damaged and accordingly pay
the balance amount to the Insured.
Exceptions
However there are certain exceptions to the ‘Principles of Indemnity’. These are as follows:
a. As discussed above in case of Life and Personal Accident (ie accident to an individual) Insurance it is not possible to make financial evaluation of the loss.
Hence the Principle of Indemnity cannot be strictly made applicable to this case.
b. There are certain Insurance Policies called ‘Agreed Value Policies’. In case of such policies at the time of entering into contract the Insurer agrees that it will accept the value of the property as stated in the contract of insurance or the Insurance Policy as the true value and indemnify the insured to this extent in case of total loss. Such policies are obtained for Jewellery, Antiques, and valuable pieces of Art etc. This amount will be the sum assured. In this case also the Principle of Indemnity cannot be strictly followed.
c. There is another type of policy where the principle of indemnity cannot be strictly followed. Such policies are called ‘Reinstatement Policies’ issued for Fire Insurance etc.
In case of such a policy Insured is required to insure the property for its Replacement Value i.e. the value at which it will be replaced.
In this case the Insurer agrees that in the event of a total loss he shall replace the damaged property with new one or shall pay for the replacement of the same.
Except for the exceptions stated above the principle of indemnity is strictly Followed in Insurance.
5. Principle of Subrogation
The Principle of Subrogation is basically a corollary or an offshoot of the Principle of Indemnity.
We have already seen in the preceding sections that the purpose of indemnity is to ensure that the Insured does not make any profit or gain in any way or as a consequence of loss. He should, at the maximum, in the same financial position which he had occupied immediately before the loss had been incurred.
However, in case the Insured gets compensated for the loss by the Insurer and, simultaneously or subsequently, also gets compensated, fully or partly, for the same loss from a third party, the insurer is entitled to recover such additional compensation from the insured.
In case the insured, after having received compensation for loss (i.e.indemnity) from the Insurer also receives from another person any amount towards such loss then he will be placed in a position of gain which is against the Principle of Indemnity.
Hence the Insurer will have the right to recover the indemnity or the compensation paid to the Insured to the extent the same has been received by the Insured from a person other than the Insurer though limited to the compensation paid by the Insurer.
The theory discussed above forms the premise or the objective of the ‘Principle of Subrogation’. Subrogation may be defined as ‘transfer of legal right of the Insured to recover to the
Insured’.
However there is a limitation to the right of the Insurer to recover the compensation paid by it to the Insured.
The Insurer can only claim the amount of compensation paid by it to the Insured. If the Insured has received an amount of compensation which is higher than the compensation paid by the Insurer, the Insurer will get the right to recover the compensation given by it and nothing over and above that. The principle is that if the insured is not allowed to make profit the insurer is also not allowed to make profit and he can only recover to the extent he has indemnified the insured.
Exception
There is an exception to the ‘Principle of Subrogation’. This principle does not apply to Life and Personal Accidents as in respect of these insurances the ‘Principle of Indemnity’ is not strictly applicable to these insurances.
In case the death of a person is caused by the negligence of another person then the legal heirs of the deceased can initiate proceedings to recover from the guilty party a compensation which will be in addition to the proceeds of the Life Insurance Policy of the deceased.
In such cases the Insurance Company providing the Life Insurance Policy does not get the right to receive compensation from the legal heirs in respect of such additional compensation.
6. Principle of Contribution
Contribution is also a Corollary or Offshoot of Principle of Indemnity. An individual may have more than one policy for the same in respect in of the same property and in case of a loss if the Insured is able claim compensation for the said loss from all Insurers it is but obvious that he would be making a profit from this loss. This is against the Principal of Indemnity.
This situation is taken care of by the Principle of Contribution.
Contribution may be defined as the right of the Insurer who has for a loss to recover a proportionate amount from other insurers who are also liable for the same loss.
The condition of contribution will arise if the following conditions are met:
√ Two or more policies should exist.
√ The policies must cover a common interest.
√ The policy must cover the same cause or event which results into a loss.
√ The policies must cover a common subject matter i.e. the same property.
√ All the policies must be in operation at the time of loss.
It may be noted here that it is not essential that the policies should be identical to each other.
The essential condition for the principle of contribution to come into force is that the two policies should overlap each other. The subject matter should be common and the event causing the loss should be common and covered by both the policies. The same principle will be applicable if there is more than one policy.
The Insured has the right to recover the loss from any one insurer. The Insurer who compensates the Insured for the loss will have the right to recover a proportionate amount from other insurers.
In order to make the Principle of Contribution enforceable the insurers generally insert a clause in the policy that in the event of loss they shall be liable to pay only ‘ Rate – able proportion’ of loss.
It means that each Insurer will pay only its share and if the Insured wants full indemnity he should make a claim with other Insurers also.
Let us try to understand this by the following example:
Westin Industries Ltd has taken three Insurance Policies to cover the risk of fire in respect of the same office building.
The sum assured under these three insurance policies is as under:
Sum Assured Policy A Rs 10,00,000
Sum Assured Policy B Rs 20,00,000
Sum Assured Policy C Rs 30,00,000
Total Rs 60,00,000
Assuming that the claim is for Rs 6lacs, the same will be paid by each of the three insurers in proportion of the sum assured by them.
The amount of claim to be borne by each of the three Insurers would be as follows:
A Rs 1,00,000
B Rs 2,00,000
C Rs 3,00,000
Total Rs 6,00,000
7. Principle of Causa Proxima (Proximity Clause)
Principle of Causa Proxima is a Latin phrase in English which means Principle of Proximity.
The loss to a property can be caused by more than one cause. Under this principle in such a situation the nearest or the closest or the proximate cause shall be taken into consideration to decide the liability of the insurer.
Example:
A cargo ship’s base was punctured due to rats. This resulted in the sea water entering the ship and accordingly the cargo was damaged.
Here there are two causes for the damage of the cargo ship:
✓ The Cargo ship getting punctured because of rats.
✓ The sea water entering the ship through the punctures.
In this case the risk of sea water is covered but the first cause i.e. damage due to rats is not covered. Since the nearest cause of damage is the sea water which is insured, the insurer must pay the compensation.
However, in the case of Life Insurance, the principle of Causa Proxima does not apply.
Whatever be the reason of the death (whether natural or unnatural) the insurer is liable to pay the amount of insurance
Summary
● Insurance is a mechanism by which the person exposed to the potential risk, arising out of the events beyond his control, transfers the financial loss; in part or in full to a third party.
● Insurance can be divided in two categories viz. Life and Non Life, Non Life Insurance is also referred to as General Insurance. Different types of General Insurance are: Fire Insurance, Marine Insurance, Health Insurance, Motor Vehicle Insurance, Theft and Burglary Insurance etc.
● The principle of indemnity and their corollaries and proximate cause has been formulated so that any person does not make profit out of the insurance transaction.
The basic purpose of insurance is that the insured is put in the same financial position as he was before the loss.
Key Words:
• Insurance
• Insured
• Risk
• Indemnity
• Premium
• Life Insurance
• General Insurance
• Fire Insurance
• Marine Insurance
• Motor Vehicle Insurance
• Mandatory Insurance
• Comprehensive Insurance
• Health Insurance
• Personal Accident Insurance
• Burglary & Theft Insurance
• Nationalization
• Liberalization
• IRDA
• Utmost Good Faith
• Insurable Interest
• Subrogation