Insurance
What insurance does
Insurance transfers the risk of a large, uncertain loss from one person to a pool of persons who each pay a small premium. It is a contract of utmost good faith: the proposer must disclose every material fact, and concealment makes the policy voidable.
Core principles
- Insurable interest - a financial loss if the event occurs. In life insurance it is presumed for self and spouse; in fire it must exist both at the time of the contract and at the time of the loss.
- Indemnity - general insurance restores the insured to the pre-loss position, never to profit. Life insurance is not indemnity but assurance, because a life cannot be valued.
- Contribution - under double insurance, insurers share the loss rateably.
- Subrogation - after paying, the insurer steps into the insured's right to recover from the wrongdoer.
- Causa proxima - the nearest effective cause decides whether the loss is covered.
- Mitigation of loss - the insured must act to reduce the loss.
Types and regulation
Life: term, whole life, endowment, money-back, ULIP. General: fire, marine, motor, health, crop and cattle. IRDAI, set up under the IRDA Act, 1999 and operational in 2000, licenses insurers and protects policyholders.
Worked example
A factory worth ₹20 lakh is insured with two insurers for ₹10 lakh each. A fire causes a ₹6 lakh loss. Reasoning: this is double insurance; each insurer pays rateably ₹3 lakh, and the insured recovers ₹6 lakh, not ₹12 lakh, because indemnity forbids profit.
Traps that cost marks
- Applying indemnity strictly to life insurance.
- Saying the insured may keep both amounts under double insurance.
- Forgetting that insurable interest in fire must exist at the time of loss.
- Writing that a premium is a deposit.