7 Most Important Principles of Insurance/ Principles of Insurance Indemnity (2020)

Most Important Principles of Insurance


There are seven basic principles of Insurance that create an insurance contract between the insured and the insurer:
  1. Principle of Insurable Interest
  2. Principle of Utmost Good Faith
  3. Principle of Proximate Cause
  4. Principle of Indemnity
  5. Principle of Subrogation
  6. Principle of Contribution
  7. Principle of Loss Minimization
These principles insurance also known as principle of indemnity/principles of insurance indemnity.

1. Principle of Insurable Interest

Under this principle of insurance, the insured must have interest in the subject matter of the insurance. Absence of insurance makes the contract null and void. If there is no insurable interest, an insurance company will not issue a policy.

  • The insured must have an insurable interest in the subject matter of the insurance contract.
  • The owner of the subject is said to have an insurable interest until s/he is no longer the owner.

An insurable interest must exist at the time of the purchase of the insurance. For example, a creditor has an insurable interest in the life of a debtor, A person is considered to have an unlimited interest in the life of their spouse etc.

2. Principle of Utmost Good Faith

Under this insurance contract both the parties should have faith over each other. As a client it is the duty of the insured to disclose all the facts to the insurance company. Any fraud or misrepresentation of facts can result into cancellation of the contract.
  • Both parties involved in an insurance contract—the insured (policy holder) and the insurer (the company)—should act in good faith towards each other.
  • The insurer and the insured must provide clear and concise information regarding the terms and conditions of the contract

3. Principle of Proximate Cause

Proximate cause literally means the ‘nearest cause’ or ‘direct cause’. This principle is applicable when the loss is the result of two or more causes. The proximate cause means; the most dominant and most effective cause of loss is considered. This principle is applicable when there are series of causes of damage or loss.
  • The loss of insured property can be caused by more than one incident even in succession to each other.
  • Property may be insured against some but not all causes of loss.
  • When a property is not insured against all causes, the nearest cause is to be found out.
  • If the proximate cause is one in which the property is insured against, then the insurer must pay compensation. If it is not a cause the property is insured against, then the insurer doesn’t have to pay.

4. Principle of Principle of Indemnity

Indemnity means security or compensation against loss or damage. The principle of indemnity is such principle of insurance stating that an insured may not be compensated by the insurance company in an amount exceeding the insured’s economic loss.

In type of insurance the insured would be compensation with the amount equivalent to the actual loss and not the amount exceeding the loss.

  • Indemnity is a guarantee to restore the insured to the position he or she was in before the uncertain incident that caused a loss for the insured. The insurer (provider) compensates the insured (policyholder).
  • The insurance company promises to compensate the policyholder for the amount of the loss up to the amount agreed upon in the contract.
This is a regulatory principal. This principle is observed more strictly in property insurance than in life insurance.

The purpose of this principle is to set back the insured to the same financial position that existed before the loss or damage occurred.

5. Principle of Subrogation

The principle of subrogation enables the insured to claim the amount from the third party responsible for the loss. It allows the insurer to pursue legal methods to recover the amount of loss, For example, if you get injured in a road accident, due to reckless driving of a third party, the insurance company will compensate your loss and will also sue the third party to recover the money paid as claim.
  • After the insured (policyholder) has been compensated for the incurred loss on a piece of property that was insured, the rights of ownership of this property go to the insurer.

6. Principle of Contribution

Contribution is a similar principle to indemnity, and it applies to situations where you have more than one insurance policy for the same asset or entity. For example, imagine that you own a truck that is insured by both Company A and Company B. If another driver hits your truck and it will cost you $5,000 to fix it, you can submit your claim to Company A, Company B, or to both companies. If Company A compensates you fully, then it can claim a proportionate contribution from Company B. However, if both companies compensate you fully, you can't keep the full amount and turn a profit, because this would amount to an unfair windfall.
  • Contribution establishes a corollary among all the insurance contracts involved in an incident or with the same subject.
  • Contribution allows for the insured to claim indemnity to the extent of actual loss from all the insurance contracts involved in his or her claim.

7. Principle of Loss Minimization

As the owner of an insurance policy, you have an obligation to take necessary steps to minimize the loss of your insured property. The law doesn't allow you to be negligent or irresponsible just because you know you're insured. For example, if a fire breaks out in your kitchen, you have an obligation to take reasonable steps to put it out, like using a fire extinguisher or calling the fire department. You can't just stand back and allow the fire to burn down your house because you know that insurance will pay for it.
  • In an uncertain event, it is the insured’s responsibility to take all precautions to minimize the loss on the insured property.

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