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5 Principles of Insurance and It's Applications

Posted At May 11th, 2018

5 Principles of Insurance and It's Applications

In regard to insurance, there are five basic principles to understand and honor by the insured and the insurer in order for the insurance contract to become legal. Those principles of insurance are as follows.

Utmost Good Faith

Utmost Good Faith is a positive responsibility of the insured (the owner of the insured objects) to submit facts in regard to the insured objects (material facts) which are important in nature and are needed to be complete and accurate by the insured, whether on demand or voluntarily.

If there are any material facts deliberately hidden, the insurer will consider it as fraudulent, and reserves the right to refuse to compensate in the event of a claim, or to terminate the insurance contract.

On the other hand, the insurer will also be truthful in terms of the ability or inability to cover the said insured objects.

The following are a couple of examples of its application in insurance.

  • Informing about a chronic or hereditary disease suffered when applying for health insurance.
  • Informing about the use of a motor vehicle, whether it is for personal or commercial use.

 Insurable Interest

The second basic principle in insurance is insurable interest. Based on this principle, the insured has the right to insure an insured object due to the relationship of financial interest that is legal by law between the insured and the insured object.

The financial interest upon that insured object will then become the basis of the insurance contract.

The followings are few examples of its application.

  • Motor vehicle, place of residence, or other valuable properties insured by the owner.
  • The head of the family or the main wage earner insures him or herself in life, health, or personal accidental insurances for the sake of the family in case he or she may no longer be productive in earning income.
  • A business person insures his or her commercial business.

Indemnity

Indemnity is an insurance principle that regulates the mechanism of compensation. This mechanism is the insurer’s effort to grant compensation to the insured to restore the financial position of the insured back to the way it was right before the loss occurred.

This means, in the event of a loss or claim, the insurer will give compensation according to the financial loss suffered by the insured, without adding to it or being influenced by profit seeking factors.

A couple of examples of its application in insurance:

  • Renovation to a house damaged by fire. Renovation is done only to the parts of the house which are affected by the fire.
  • Compensation for a lost car maximized according to the insured value if the car is not under-insured.

This indemnity principle does not apply to the types of insurance in which the insured object is the life of a person, such as: life, health, personal accidental, or travel insurances.

Subrogation

Subrogation is an insurance principle which gives the right of indemnification of the insured to the insurer to request compensation from a third party which causes a loss. That right to claim is given if the insurer has settled the compensation to the insured.

Examples of its application in insurance:

  • In motor vehicle insurance, the insurance company is entitled to submit a written claim of compensation for the insured to the third party that causes a loss to the insured.
  • In fire insurance, the same applies. If the fire affecting the insured asset is caused by the spreading of a fire by a third-party asset to its surroundings, the insurance company is entitled to obtain its subrogation rights.
  • In an accident caused by a third party, the insurance company can also claim its subrogation rights upon the insured.

Therefore, subrogation rights are absolutely claimable by the insurance company if the loss incurred is caused by negligence of a third party. However, not all subrogation rights can be claimed. The insurance company surely has its own considerations whether to use its subrogation rights or not.

Contribution

Contribution is a principle of insurance which applies if an insured object is insured by two or more insurers. In this case, the loss incurred will be covered together according to the liability of each insurer. This principle only applies to indemnity insurance contracts.

The application in insurance is as follows.

  • A luxury car insured by three different insurance companies.
  • A house insured by several different insurance companies.

The insurance company with the biggest liability portion becomes the leader while the rest become the members. The leader is responsible to collect the premiums from the members and to determine whether to accept a claim and the amount of the compensation for the claim.

In such a case, it is appropriate that all members follow the leader. This is known as the follow the fortune principle.

In addition to these five basic principles, there are two other principles; the Law of the Large Numbers and the Proxima Causa principle.

All those principles of insurance, especially the basic principles, must be thoroughly applied in every insurance contract because each of those principles correlates with each other and cannot be separated from one another.

This is to ensure the validity and legal certainty of the insurance contract, so that each party, both the insured and the insurer, will not be harmed and most importantly, no dispute will occur between both parties regarding the insurance contract in the future.

Learning about certain things we need in daily life, like insurance will surely give us knowledge which will be useful when needed.


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Topics Article

insurance utmost good faith insurable interest indemnity principle subrogation contribution