To understand the mechanism of insurance as a risk transfer system, a business and a contract To understand the application of the provisions of the Indian Contract Act to insurance contracts To study the fundamental principles governing general insurance contracts To examine the various provisions required for enforcement of an insurance contract
INTRODUCTION OF INSURANCE
Every individual family and business organization needs insurance, for inherent risk exposures to which they are exposed. Insurance seeks to redress the assured from the financial consequences of the loss exposures in the event of the uncertain event happening, resulting in a loss of his assets, or properties or even income earnings.
Insurance is actually a combination of three elements
A transfer system A business A contract Insurance as a Transfer System As a transfer system, insurance enables a person, family or business to transfer the costs of losses to an insurance company. In turn the company pays for the insured
losses and distributes the costs of losses among all insureds. Thus, the key elements of insurance as a transfer system refers to the transferring of risks from the insured to the insurance company which is financially sound and has the capacity and willingness to take risks. The person transfers the consequences of a loss to the company, thereby exchanging the possibility of a large loss for the certainty of a much smaller periodic payment (premium). For transferring a cost of loss it is not necessary for a loss to occur or exist. A mere possibility of a loss constitutes a loss exposure that can be insured or transferred.
A Loss exposure can give rise to three types of losses, namely:
Property loss (including net income loss),
Liability loss, and
Human and personnel loss.
On the other hand, sharing of risks implies the pooling of premiums paid by the insureds into a fund out of which the losses are paid as and when they occur.
Thus, the role of insurance is to protect insured’s assets from the financial consequences of loss. But, not all risks are insurable. Insurance covers only pure risks. (Discussed in Chapter I of Module I).
Insurance as a Business
As a business, insurance primarily attempts to meet its costs and expenses from the premium that it earns and also make a reasonable margin of profit for its own sustainability. As a business organization, it provides jobs to millions of people in life and non-life insurance companies, agencies, brokerage firms. The various operations of these companies include marketing, underwriting, claims handling, ratemaking and information processing. As a business concern, it also needs to satisfy the regulators, insureds and others of its financial stability. Therefore, to protect the consumers, the regulator monitor the rates, policy forms, solvency margins, and also investigate complaints and consumers’ grievances. In addition to payment of losses, the business of insurance offers several benefits to individuals and families and to the society as a whole such as:
Payments for the costs of covered losses
Reduction of the insured’s financial uncertain
Efficient use of resources
Support for credit Satisfaction of legal requirements
Satisfaction of business requirements
Source of investment funds for infrastructure development
Reduction of social burden
However, the benefit of insurance is not cost free. There are some direct costs as well as indirect costs which are incurred, such as the premiums paid, operating costs of the insurers, opportunity costs, increased losses, and increased law suits.
Insurance as a contract
As a contract, an insurance policy is a legally enforceable contract. The contract is between the insurance company and the insured. Through insurance policies, the insured transfers the costs of losses to insurance company. In return for the premiums paid by the insured, the insurers promise to pay for the losses covered under the policy.
The policy contains all the terms and conditions for its enforceability, and the benefits payable by the insurer. The breach of these conditions by either party will result in the invalidation of the contract. Thus, through the coverage provided by insurance polices, the individuals, families and businesses are enabled to protect their assets, and minimize the adverse financial affects of losses. Hence, an insurance contract needs to be interpreted and carefully designed so that, all fortuitous losses are covered and insured against.
The most common four basic types of insurance (property, liability, life and health) are generally divided into two broad categories:
1. Property/Liability insurance
2. Life/Health insurance
1. Property insurance provides coverage for property and net income loss exposures. It protects an insured’s assets by paying to repair, or replace property that is damaged, lost, or destroyed or by replacing the net income lost and extra expenses incurred as a result of property loss. Liability insurance covers the liability loss exposures. It provides for payments on behalf of the insured for injury to others or damage to others’ property for which the insured is legally liable.
2. Life and health insurance cover the financial consequence of human (personal) loss exposures. Life insurance replaces the income-earning potential lost through death and also helps to pay expenses related to insured’s death. Health insurance provides additional income security by paying for medical expenses. Disability income as popular in most of the Western countries, replaces as insured’s income if the insured is unable to work because of injury or illness.
DEFINITION OF CONTRACT
An agreement enforceable by law is called a contract. It creates certain rights and obligations for parties agreeing to it. A valid contract is one, which the court enforces.
Requirements of an insurance contract
Insurance contracts are also governed by the provisions of the Indian Contract Act, 1872. In general, there are four requirements that are common to all valid contracts. To be legally enforceable, an insurance contract must meet these four requirements:
1. Offer and acceptance
2. Consideration
3. Capacity
4. Legal purpose
1. There must be valid offer and acceptance:
The first requirement of a binding insurance contract is that there must be an offer and an acceptance of its terms. In most cases, the applicant for insurance makes this offer, and the company accepts or rejects the offer. An agent merely solicits or invites the prospective insured to make an offer. A legal offer by an applicant for insurance must be supported by a tender of the premium and it should always be prior to commencement of the ‘coverage’. The agent usually gives the insured a conditional receipt that provides that acceptance takes place when the insurability of the applicant has been determined by the Insurer. In property and liability insurance, the offer and acceptance can be oral or written.
2. Promises must be supported by the exchange of Consideration:
A consideration is the value given to each contracting party. The insured’s consideration is made up of the monetary amount paid in premiums, plus an agreement to abide by the conditions of the insurance contract. The insurer’s consideration is its promise to indemnify upon the occurrence of loss due to certain perils, to defend the insured in legal actions, or to perform other activities such as inspection or collection services, or loss prevention and safety services, or as the contract may specify.
3. Parties must have legal capacity to contract:
This requirement of a valid insurance contract is that each party to a contract must be legally competent. This means the parties must have legal capacity to enter into binding contract. Parties who have no legal capacity to contract include: l Insane persons who cannot understand the nature (obligations and liabilities) of the agreement l Intoxicated persons l Corporations acting outside the scope of their charters, bylaws, or articles of incorporation, or authority l Minor
NOTE:Minors normally are not legally competent to enter into binding insurance contracts; but most states have enacted laws that permit minors, such as a teenager age 15, to enter into valid life or health insurance contract.
4. Agreement must be for legal purpose: For insurance policies, this requirement means that the contract must neither violate the requirements of insurable interest nor protect or encourage illegal ventures. In other words, an insurance policy that encourages or promotes something illegal and immoral is contrary to public interest and cannot be enforced.
EXAMPLE: A street pusher of heroin and other illegal drugs cannot purchase property insurance policy that would cover seizure of the drugs by the police.
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