Lecture slide chapter 2 insurance and risk management

2
Insurance and
Risk Management
Lecture Slides
Chapter
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 Indemnity
Contract 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

• 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

• The insurance contract involves
A. The elements of General Contract
B. The elements of special contract relating to
insurance

General Parts of Contract
A. 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

1. 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

2. 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.

3. 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

– 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

4. 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.

5. 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 Insurance
B. 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

1. 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

• 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.

2. 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.

– 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.

• 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.

• 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

3. 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

** 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

• 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.

Methods of Indemnity
A. 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 insurance
C. 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

4. 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”

** 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


5. 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

• 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

6. Proximate cause :- The proximate cause
describe the rule that immediate and not the
remote cause is to be regarded i.e. see the
proximate 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.

• 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.


7. 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

** 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

8. 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 Wager
1.Contract of insurance( 1.In case of wagering
except life, accident and agreement, however, there is
sickness insurances) is a no question of indemnify as
contract of indemnity. the parties do not intend to
cover any risk.
2. A contract of insurance 2. In the wagering
is a contract requiring agreement good faith need
utmost good faith by the not be observed.
parties of the contract.

Difference Between-
Insurance and Wager
Insurance Wager
3. A contract of insurance is 3. A wagering agreement is
legally enforceable and is void, because it is against
encouraged as it benefits the public policy.
the community as a whole.
4.The object of contract of 4.Where as, the object of
insurance is to protect the wagering agreement is to
assured against the losses on earn speculative gains.
the happening of some
uncertain 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-
– 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-
• 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.

Lecture slide chapter 2 insurance and risk management

Lecture slide chapter 2 insurance and risk management

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Lecture slide chapter 2 insurance and risk management