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2 Insurance and Risk Management Lecture SlidesChapter Chapter Contents 2.1 Nature of Insurance Contract 2.2 Elements of Insurance Contract 2.3 Principles of Insurance Insurance 2.3.1 Insurable Interest 2.3.2 Utmost Good Faith 2.3.3 Principles of IndemnityContract and 2.3.4 Doctrine of Subrogation 2.3.5 Warranties 2.3.6 Proximate Cause Principles 2.3.7 Assessment or Transfer of Interest 2.3.8 Return of Premium 2.3.9 Contribution Prepared By: Md. Moulude Hossain Faculty Member, Department of Business Administration
Insurance as Contract• As we earlier define (contractual definition) insurance as a contract between two parties whereby one party called insurer undertakes, in exchange for a fixed sum called premiums, to pay the other party called insured a fixed amount of money on the happening of a certain event.• It is good news for me that you are studying Commercial Law in the same semester, so I can hope that you certainly know about the fundamental law of contract. May I have the Pleasure………. Or I need to have my footstep on the Law of Contract
Insurance as Contract• According to the Law of Contract “All agreement are contracts if they are made by free consent of the parties, competent to contract, for a lawful consideration and with a lawful object and which are hereby declare to be void.”• Thus for a insurance contract: free consent of the parties – free consent of insurer and the insured competent to contract – are legally eligible to enter into the contract for a lawful consideration – the consideration is said to be exchange of risk in exchange of premium a lawful object – it may be someone’s life or property declare to be void – both to declare all the material facts with utmost good faith
Distinct Legal Characteristics of Insurance Contracts• Aleatory Contract: where the values exchanged may not be equal but depend on an uncertain event . For e.g..- ?????????? (Commutative Contract?)• Unilateral Contract: only one party makes a legally enforceable promise. Only the insurer makes a legally enforceable promise to pay a claim . After the first premium is paid, the insured can not be legally forced to pay the premiums (Bilateral Contract?)• Personal Contract: the contract is between the insured and the insurer
Distinct Legal Characteristics of Insurance Contracts• Conditional Contract: Insurer’s obligations to pay a claim depends on whether the insured has compiled with all policy conditions• For e.g. In a homeowner’s policy , the insured must give immediate notice of loss. If the insured delays for an unreasonable period in reporting the loss, the insurer can refuse to pay the claim• Contract of Adhesion: means the insured must accept the entire contract, with all of its terms and conditions
Insurance as Contract• The insurance contract involves A. The elements of General Contract B. The elements of special contract relating to insurance
General Parts of ContractA. General parts of a contract :- The general parts of a insurance contract contain the following parts- – Offer & acceptance – Free consent – Legal consideration (Premium) – Competency – Legal object
General Parts of Contract1. Offer & acceptance • Generally comes from the insured • Insurer may also propose to make the contract • Any act precedes it is an offer or counter-offer • All that precede the offer or counter-offer is an invitation to offer • In insurance, the publication of prospectus, the canvassing of the agents are invitation to offer
General Parts of Contract2. Free consent – The consent will be free when it is not caused by 1. Coercion 2. Undue influence 3. Fraud or 4. Misrepresentation – When there is no free consent except fraud the contract becomes voidable at the option of the party whose consent was so caused – In case of fraud the contract would be void.
General Parts of Contract3. Legal consideration – As we know form the law of contract that, “no consideration no contract.” – Thus in case insurance there need to be a consideration for the validity of the contract. – The promiser (insurer) pay a sum at given contingency – It need not to be money only but it must be valuable, it may be sum, rights, interest or benefits
General Parts of Contract– On the other side (insured), premium is a valuable consideration for starting an insurance contract.– The fact is that without payment of premium (consideration) the insurance contract cannot be start. For Insured: Payment of For insurer: Promise to first premium plus an do certain things as agreement to abide by the specified in the contract. conditions specified in For e.g.: paying for a loss the policy from the insured peril
General Parts of Contract4. Competency• Every person is competent to contract: a) Who is of the age of majority according to the law b) Who is of sound mind and c) Who is not disqualified from contracting by any law to which he is subject• Thus the competency to contract implies that, a) A minor is not competent to contract b) A person of sound mind means, he/she is capable to understand it and forming a rational judgment about it and the effects upon his/her interests. c) A person of unsound mind occasionally can enter into contract when he/she is in sound mind d) An alien enemy, undercharged insolvent and criminals cannot enter itno a contract.
General Parts of Contract5. Legal object• In order to make a valid contract, the object of the agreement must be lawful. An object is lawful if it is- Not forbidden by law, or Is not immoral, or Opposed to public policy, or Which does not defeat any provision of any law
Principles of InsuranceB. Principles of Insurance/Special parts of the contract :- The special parts of a insurance contract are described as the fundamental principles of Insurance. The principles of insurance are as follows: 1. Insurable Interest 5. Warranties 2. Utmost Good Faith 6. Proximate Cause 3. Principles of 7. Assignment or transfer Indemnity of interest 4. Doctrine of 8. Return of Premium Subrogation
Principles of Insurance1. Insurable interest:-Insurable interest means pecuniary relationship. There must be a pecuniary or monetary relation between insured and the insured object. • The principle of insurable interest is a pre-condition for a valid contract of insurance. The person getting an insurance policy must have an insurable interest in the subject matter to be insured. • The insured must positively stand benefited financially due to existence or continuance of life. • Ex – An employer has insurable interest in lives of his employees. A banker has an insurable interest in properties mortgaged to it against a loan. Insured Insured object Pecuniary relation
Principles of Insurance• Importance of Insurable Interest – If the insurer has not insurable interest in property insured, the contract of insurance would amount to a gambling or speculative contract. – Most clear and common case of existence of insurable interest is ownership of property being insured.• Essentials of Insurable Interest Subject matter of insurance must be certain. There must exist some property, rights, interest, like or potentially liability. The policy holder should monetary relationship with the subject-matter. The insured must bear a legal relationship to subject matter or he must be owner. He stands to benefit by safety. The insured must be owner or may posses the legal rights or interest in subject matter to be insured.
Principles of Insurance2. Utmost good faith :- The concept of utmost good faith describe that the contract of insurance is a contract of uberrimae fidei i.e. of absolute good faith where both parties of the contract must perform the following responsibility, these are, a) Material disclose b) Full & true disclose c) Duties of both parties Under the contract of insurance, the insured’s duty is bound to disclose all material facts relating to the risk to be covered. Without good faith, it shall be null and void.
Principles of Insurance– Materiality of Facts • A material fact is a fact which would influence the mind of prudent underwriter in deciding whether to accept a risk for insurance and on what terms. Examples: – Motor – details of young drivers – Household – details of commercial use of private dwelling – Commercials – previous hazards / loss – Life – details of heart disease– Ubereimae Fidei • It means the contracts which require absolute and utmost good faith on part of all the parties concerned with the contract.
Principles of Insurance• Material Information – Material information which enables the insurance company to decide whether to accept or not to accept any risk – If accepted, at what rate of premium and on what terms of and conditions. – The legal binding applies to insured, who is in possession of all material facts relating to subject matter.• Duty of Disclosure – Duty of disclosure applies to both proposer and insurer. – Duty of disclosure operates at inception, – Until the data cover is confirmed by insurers renewal – Up to the renewal date mid term alternation – Until the insurer confirm cover in respect of alternation.
Principles of Insurance• Facts need not be disclosed by the insured The following facts, however, are not required to be disclosed by the insured: • Facts which tend to lessen the risk • Facts of public knowledge • Facts which could be inferred from the information disclosed • Facts waived by the insurer • Facts governed by the conditions of the policy
Principles of Insurance3. Principle of indemnity :- Insurance contract is a contract of indemnity. Insurer will pay the claim just as the loss suffered by the insured, not more or less. • Indemnity means that the insured person is placed financially in the same position as he was before the loss. The principles of indemnity also applies to all contracts of insurance except life insurance where – Loss suffered by insured can be measured in monetary terms • The measure of indemnity is decided at the time of entering into contract itself in events of insured: – Prove that he has sustained a monetary loss – Prove the extent and value of his loss
Principles of Insurance** Use of indemnity Principles:- Claim not more than the actual loss To avoid the anti-social act To minimize the premium** Conditions of indemnity Principles :- 1. How to suffer loss 2. Claim not more than the actual loss 3. If claim>loss, residual to insurer 4. Third party compensation 5. Principle of indemnity does not apply to personal insurance
Principles of Insurance• Features – All contracts of insurance, except life insurance and personal accident insurance are contracts of indemnity. – There exists indirect relationship between principle of indemnity and principle of insurable interest, because insured has to prove amount of actual loss. – The amount of compensation shall never exceed the amount of actual loss or value of policy. – Valued policies are not covered under scope of principle of indemnity.
Principles of Insurance Methods of IndemnityA. Cash payment: – It’s the claim of insurance in easiest and common method. After receiving the claim form, make analysis of the surveyor’s report, and evaluate the amount of actual loss to be compensated.B. Repairs: – The subject matter may be partially damaged or not fully destroyed in such case, the insurer instead of cash payment prefers to settle claim of damage to get repair. – Ex – motor vehicle insurance, machine and building insuranceC. Replacement: – In case of fully destroyed or loss, there is no chance of repair, the insurer many arrange replacement. – Ex – Theft or burglary insurance.D. Reinvestment: – It is a rarely used method, where subject is destroyed is placed in its former position or condition as it existed just before loss. – Ex – Destroyed by fire
Principles of Insurance4. Doctrine of subrogation :- It means the substitution at a certain occurrence , of the insured by the insurer for the scrape value. Subrogation is, “Transfer of rights and remedies of insured to the insurer who has indemnified the insured in respect of loss.” Ex – Insurer of an importer of electrical goods receives a claim in respect of a faulty toaster. The insurer pays the claim but takes over insured’s right to claim back against manufacturer. Subrogation rights only apply where there is a “legal liability”
Principles of Insurance** Essentials of doctrine of subrogation :- 1. Corollary to the principal of indemnity 2. Subrogation is the substitution 3. Subrogation only up to the amount of loss 4. Subrogation may be applied before payment 5. Not applied in personal insurance
Principles of Insurance5. Warranties :- It is a commitment to do , or not to do something , by the insured to the insurer. It may be any of the following figure. Warranties Express Implied Affirmative Promissory
Principles of Insurance• Expressed Warranties – Warranties which are mentioned in the policy• Implied Warranties – Warranties which are not mentioned in the policy• Affirmative Warranties – Warranties which are answer to the questions• Promissory Warranties – Warranties fulfilling certain conditions or promise
Principles of Insurance6. Proximate cause :- The proximate causedescribe the rule that immediate and not theremote cause is to be regarded i.e. see theproximate cause not the distant cause. • The real cause must be seen while payment the loss. • It must be clearly mentioned in the contract only in what case payment will be made, otherwise the insurer will not responsible for a certain loss.
Principles of Insurance• Determination of Proximate Cause – If there is a single cause of the loss, the cause will be the proximate cause and further if the peril was insured insurer will have to indemnify the loss – If there are concurrent causes, the insured perils and expected perils have to be segregated. The concurrent cause may be first, separable and second, inseparable. – If the causes occurred in from of chain, they have to be observed seriously • If there is unbroken chain the expected and insured perils have to be separated • If there is a broken chain of events with no expected perils involved, it is possible to separate the loss.
Principles of Insurance7. Return of premium :- Ordinarily the premium once paid cannot be refund. How ever , the following cases the refund is allowed. These are 1.By agreement in the policy 2.For reasons of Equity 3.Over insurance by double insurance
Principles of Insurance** For reasons of Equity has the following points:- • Non-attachment of ris • Undeclared balance of an open account • Payment of premium is apportionable • Assured has no insurable interest • Assured has over-insured under an unvalued policy
Principles of Insurance8. Assignment or transfer of interest :- It is necessary to distinguish between the assignment of a) The subject matter of insurance b)The policy c) The policy money when payable• The marine and life insurance can be freely assigned but assignment under fire and accident policies are not valid without the prior consent of the insurer- except change interest by will or operation of law. Moreover, assignment under fire and accident policies must be maid before the insured parts with his interest. Once he has loss the interest, the policy is void and cannot be assigned.
Difference Between- Insurance and Wager Insurance Wager1.Contract of insurance( 1.In case of wageringexcept life, accident and agreement, however, there issickness insurances) is a no question of indemnify ascontract of indemnity. the parties do not intend to cover any risk.2. A contract of insurance 2. In the wageringis a contract requiring agreement good faith needutmost good faith by the not be observed.parties of the contract.
Difference Between- Insurance and Wager Insurance Wager3. A contract of insurance is 3. A wagering agreement islegally enforceable and is void, because it is againstencouraged as it benefits the public policy.the community as a whole.4.The object of contract of 4.Where as, the object ofinsurance is to protect the wagering agreement is toassured against the losses on earn speculative gains.the happening of someuncertain events.
Difference Between- Insurance and Gambling• To most people, Insurance is Gambling. Some even see Insurance as legalized form of fraud. The question is: Is Insurance Not the same as Gambling? – Gamblers are risk-seekers whilst insurance policy holders are risk- averse. Whereas Gamblers seek risk in attempt to get more money, insurance policy holders buy insurance to reduce risk – Risk in gambling is Speculative but insurance is Pure risk. Gambling involves a risk situation of Gain or Loss whilst Insurance deals with Pure risk i.e. there is the possibility that the event (e.g injury to person) will occur.
Difference Between- Insurance and Gambling– Gambling is entertainment; insurance is business. People engage in gambling mostly for excitement and enjoyment.– In Gambling, the parties are only interested in the money earned or lost (stakes) and not the occurrence of the event whereas in insurance, parties are interested in the occurrence of the event since this is the main focus of attention.– The insurable interest is in the event in Gambling; in insurance, the insurable interest is in the non-occurrence of the event. The parties in a Gambling contract choose an arbitrary event on the occurrence of which one party wins whilst the other loses.– Gambling is unenforceable in court whereas Insurance is a valid contract.
Difference Between- Insurance and Gambling• An insured must have an insurable interest in the subject matter of a contract of insurance, which is not required in the case of a wager, where the interest is only restricted to the stake won or lost.• An insurance contract is guided by the principle of utmost good faith, which is not required in the case of a wager.• The insured event may or may not take place in the case of insurance (except life insurance). But in case of a wagering agreement the event takes place at a fixed future date.• Insurance is based on mathematical predictions but gambling is highly speculative in nature.• Insurance is enforceable by law whereas in gambling none of the parties has any legal remedy.
Insurance and hedging• Hedging is a process where risk is transferred to a speculator through ways like purchasing a futures contract. Though insurance is not hedging, one similarity that can be drawn between the two is that an insurance contract is used to transfer the risk, without creating any new risks.• Some distinctions that can be drawn between the two are: – the risk that can be transferred in insurance is an insurable risk; in the case of hedging, the risks are uninsurable. – by application of the law of large numbers, the insurer can reduce the risk, whereas in hedging risk can only be transferred and not reduced.