Insurance Fundamentals and Principles of Insurance
What this domain tests
This domain tests the principles that decide whether a loss is covered and how much is paid: insurable interest, utmost good faith, indemnity, subrogation, contribution and proximate cause. It also tests risk pooling and the meaning of hazard.
Core rules
- Insurable interest: a legal or financial relationship to the subject matter. In general insurance it must exist at inception and at the time of loss; in life insurance it must exist at inception.
- Utmost good faith: the proposer must disclose all material facts. Non-disclosure or misrepresentation can let the insurer avoid the policy.
- Indemnity: the insured is restored to the pre-loss financial position, not better off. It applies to general insurance, not to life insurance benefits.
- Subrogation: after paying, the insurer steps into the insured's shoes to recover from a third party, but not beyond the amount paid.
- Contribution: where two or more policies cover the same interest, risk and peril, insurers share the loss rateably; the insured cannot recover twice.
- Proximate cause: the dominant, effective cause of the loss, not merely the last event.
- Pooling: premiums reflect expected losses, expenses and margin; moral hazard and adverse selection raise costs.
Worked example
A factory has fire policy A for 10 lakh and policy B for 10 lakh on the same property. A fire causes a 6 lakh loss. Indemnity caps recovery at 6 lakh, not 12 lakh. Because both policies cover the same interest, risk and peril, contribution applies. With equal sums insured, each insurer pays 3 lakh. If one policy had a deductible, that policy's share would be reduced accordingly before settlement.
Traps that cost marks
- Applying indemnity to life insurance.
- Saying insurable interest for life insurance must exist at the time of death.
- Treating subrogation as available before the insurer pays.
- Confusing contribution with double insurance for different interests.
- Choosing the last event rather than the proximate cause.