Principles of Insurance

THE DEFINITION OF INSURANCE

There is no comprehensive or exhaustive definition of the terms “Insurance” or “Contract

of Insurance” in any Act. One therefore has to refer to case law in order to find a definition.

Prudential Insurance Company v. IRC (1904) 2 KB 658

This case considered the essential elements of a Contract of Insurance.

Facts – A person by contract undertook to pay an amount periodically until his death or his
reaching 65 years of age, whichever occurs earlier. In turn, the company undertook that if
he dies before, his estate would receive 30 pounds. On the other hand, if he lived up to the
age of 65, he would receive 95 pounds. The question arose about the nature of the contract,
since there was a payment to be made if the person lived.

Held – A Contract of Insurance must have 3 elements.

a) The payment of one or more payments by one party (the “Policy Holder”).
b) In return, the other party undertakes to pay a sum of money on the happening of an
event (the “Insurer”).
c) The event must be one which is adverse to the interests of the policy holder (the
“Insurable Interest”).

However, this case does not completely address the issue in relation to the situation
regarding the payment being made to a person who lives, although it was held that the
aforesaid contract was in fact, a Contract of Insurance. A case decided shortly thereafter
provided an answer to this issue.

Gould v. Curtis (1913) 1 KB 84

This case distinguished between two types of policies.

1) Indemnity Policies – in this type of policies one receives no more than an

indemnity for the loss which one actually suffers. In such policies it is relevant to
look at the prospect of loss to consider the validity of the policy.

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 2) Contingency Policies – in such policies, the intention is simply that the assured
will receive a specific sum of money on the happening of a specified event. Life
policies are generally of this type.

The concept of Insurable Interest is considerably more important in Contingency Policies,

as this determines who may validly take out such a policy.

INSURABLE INTEREST

There is no statutory definition of the term. Therefore, again, one has to turn to case law,
to find a definition for this term.

Lucena Vs Craufurd (1806) 1 Taunt 325

In relation to tangible property, the Policy Holder must stand in some legal or equitable
relationship, to the property at risk (i.e. – the property insured).

Therefore, this “legal or equitable relationship” is what is termed or identified as the

Insurable Interest. As to what is a ‘legal or equitable relationship’, is a question of fact.

It is this Insurable Interest that creates the distinction between a wagering contract and an
Insurance Policy.

Courts generally lean in favour of finding an Insurable Interest, as it is somewhat shocking

for an Insurer to deny the validity of the policy for lack of an Insurable Interest, after
collecting premiums.

The consequences of the lack of an Insurable Interest.

- Policies effected without an insurable interest are considered “null and void”.
- No claim can be made thereunder.
- However, nothing prevents a policy from being written. Nor is it impossible for the
policy to be honoured.
- Neither the placing of such policy nor effecting a policy nor paying benefits under
such a policy, are considered criminal offenses.
- Nevertheless, courts will not assist in the recovery of benefits under a policy that is
illegal.
- If the issuer of the policy does not raise illegality in an action, it is the duty of court
to do so, as illegality is a matter of public policy.
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 Can premiums paid be recovered, if the insurer refuses to honour the policy on
the basis of a lack of insurable interest?
Until recently, courts held that as a contract of insurance placed by a person who does
not have an insurable interest is illegal, courts would not assist the policy holder even to
recover the premium.
However in the case of Patel v. Mirza (2016) UKSC 42, the Supreme Court of the United
Kingdom held that such premiums can be recovered.

Insurable Interest in particular cases

a) In the following instances, the existence of an insurable interest in generally
presumed. In some instances, insurable interest in such cases are termed as being
“automatic”.
o A person has an insurable interest in his own life. The extent of such
insurable interest is unlimited (Wainewright v. Bland).
o A wife has an insurable interest in the husband (Reed v. Royal Exchange
Assurance Company).
o A husband has an insurable interest in the wife (Griffiths v. Fleming)

b) In the following instances, an insurable interest may exist. However, such interests
are not automatic but would depend on the specific circumstances.
o Children in parents.
o Parents in children.
o Siblings.
o Creditor in debtor – to the extent of the debt.
o Employer in employee – particularly in special situations where the business
would depend on the skill of a particular employee
o Partners in each other

PRINCIPLE OF INDEMNITY

In Indemnity Policies, the policy is issued for the purpose of indemnifying the policy holder
against losses arising from the insured event. The policy holder cannot generally profit from

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it. However, there are a few exceptions such as ‘new for old’ policies in household insurances
and marine insurance policies.

This principle operates in addition to the principle of insurable interest. Therefore, in

indemnity policies, this principle would operate to prevent a person from recovering in a
situation where he has suffered no loss. Therefore, a person who has no insurable interest
in the property insured will also not be entitled to recover due to the application of this
principle, since the person has suffered no loss.

It should be noted that this principle has no application in respect of contingency policies.

Principle of Uberrima Fides (Principle of Utmost Good Faith)

A Contract of Insurance is a contract of Utmost Good Faith. This means that all parties to
an insurance contract must deal in good faith, making a full declaration of all material facts
in the insurance proposal. This contrasts with the legal doctrine caveat emptor ("let the buyer
beware").

A higher duty is expected from parties to an insurance contract than from parties to most
other contracts, in order to ensure the disclosure of all material facts so that the contract
may accurately reflect the actual risk being undertaken.

The principles underlying this rule were stated by Lord Mansfield in the leading case of
Carter v Boehm (1766) 97 ER 1162.
Carter was the Governor of Fort Marlborough. Carter took out an insurance policy with
Boehm against the fort being taken by a foreign enemy. A witness, Captain Tryon, testified
that Carter was aware that the fort was built to resist attacks from natives but would be
unable to repel European enemies, and he knew the French were likely to attack. The French
successfully attacked, but Boehm refused to honour the indemnifier Carter, who sued
Boehm.

In the Judgment Lord Mansfield states (at Page 1164),

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 “Insurance is a contract of speculation... The special facts, upon which the contingent chance
is to be computed, lie most commonly in the knowledge of the insured only: the under-writer
trusts to his representation, and proceeds upon confidence that he does not keep back any
circumstances in his knowledge, to mislead the under-writer into a belief that the circumstance
does not exist... Good faith forbids either party by concealing what he privately knows, to
draw the other into a bargain from his ignorance of that fact, and his believing the contrary.”

In Carter v Boehm, Lord Mansfield went on to hold that the duty was reciprocal and that if an
insurer withheld material facts, the example cited being that an insured vessel had already
arrived safely, the policyholder could declare the policy void and recover the premium.

Lord Mansfield proceeded to qualify the duty of disclosure:

“Either party may be innocently silent, as to grounds open to both, to exercise their judgment
upon.... An under-writer cannot insist that the policy is void, because the insured did not tell
him what he actually knew.... The insured need not mention what the under-writer ought to
know; what he takes upon himself the knowledge of; or what he waives being informed of.
The under-writer needs not be told what lessens the risque agreed and understood to be run
by the express terms of the policy. He needs not to be told general topics of speculation.”

Lord Mansfield found in favour of the policyholder on the grounds that the insurer knew
or ought to have known that the risk existed as the political situation was public knowledge.
He states:
“There was not a word said to him, of the affairs of India, or the state of the war there, or
the condition of Fort Marlborough. If he thought that omission an objection at the time, he
ought not to have signed the policy with a secret reserve in his own mind to make it void.”

Therefore, the insured must reveal the exact nature and potential of the risks that he
transfers to the insurer (which may, in turn, be sold onto a reinsurer), while at the same time
the insurer must make sure that the potential contract fits the needs of, and benefits, the
insured.

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As such, there is a Duty of Disclosure on the Proposer, who has knowledge of all material
facts relating to the risks. The duty is to disclose facts to the Insurer, which he may consider
to be relevant in deciding;
- Whether or not to undertake the risks; and
- If so, at what premiums.

This is often called the ‘Pre-Contractual Duty of Disclosure’, as the obligation to disclose is
operative, prior to the formation of the Contract of Insurance. It should also be noted that
this is a bilateral duty (i.e. – imposing obligations on both the Proposer and the Insurer),
although the practical emphasis is more on the proposer’s obligation, as obviously, it is the
proposer who would normally be giving information to the Insurer for the purpose of
obtaining the policy.

When the Duty of Disclosure is breached by one party, the other party may avoid the
contract. This has been held to be the only remedy available for the breach of the Duty of
Disclosure. [Vide - Banque Financiere de la Cite Vs Westgate Insurance Company Ltd (1991) 2 AC
249]

In Sri Lanka, a policy can be avoided on the ground that a statement made in the proposal
or other document, was inaccurate or false, only within two years of affecting it, unless the
Insurer proves that the false or suppressed statement is on a material matter, which was
fraudulently made. Section 41 of the Regulation of the Insurance Industry Act No. 43 of
2000, provides as follows;

“41. No policy of long term insurance business shall after the expiry of two years from the
date of the issue of the policy, be called in question by any insurer on the ground that a
statement made in the proposal or other document on the faith of which the policy was issued
or reinstated, or in any report of a medical officer or referee, was inaccurate or false, unless
the insurer shows that such a statement was made on a material matter or suppressed facts
which it was material to disclose, and that it was fraudulently made by the policy holder and
that the policy holder knew at the time of making it that the statement was false or that it
suppressed facts it was material to disclose :

Provided that, nothing in this section shall prevent the insurer from calling for proof of age at
any time, if it is entitled to do so under the policy conditions, and no policy shall be deemed

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 to have been called in question merely because the terms of the policy are adjusted on
subsequent proof that the age of the life insured was incorrectly stated in the proposal.”

DOCTRINE OF SUBROGATION

A person who undertakes a contractual obligation to indemnify another against loss, is

entitled to stand in the shoes of the other, in relation to that other’s right to receive or claim,
any money which would go to diminish the loss.

Mason vs. Sainsbury (1782) 3 Doug KB 61

The Insured suffered losses as a result of civic disorder. They claimed on their insurance
policies and received payment from the Insurers. Then they claimed against their local
authority, which was statutorily liable for the losses. The local authority resisted the claim
on the basis that they had already been indemnified for the losses by the Insurers.

Held – This was no defence, as the Insurers will be able to recover from the Insured, the
amounts losses recovered from the local authority.

It should be noted that;

• Subrogation applies in respect of Indemnity Policies.

• Subrogation does not apply to Contingency Policies.
• The Doctrine of Subrogation has two limbs;
- The Insurer can require the Insured to join in an action to recover losses from
the party at fault;
- The Insurer can recover from the Insured, any losses or damages paid by the
party at fault or set off in diminution of amounts due under the policy.

INSURANCE COVER NOTE

• These are extensively used in Motor Vehicle Insurance.
• An Insurance Cover Note provides temporary cover, until the Insurer examines the
proposal and decides on the risk.

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 • A Cover Note does not amount to acceptance of the risk fully.
• The Insurer remains free after examination of the proposal in detail, to reject the
risk.

REINSURANCE

Reinsurance is a form of insurance purchased by insurance companies in order to mitigate

risk. Essentially, reinsurance can limit the amount of loss an insurer can potentially suffer.

Insurers pay part of the premiums that they collect from their policyholders to a reinsurance
company, and in exchange, the reinsurance company agrees to cover losses above certain
high limits.

Insurers purchase reinsurance for four reasons:

- To limit liability on a specific risk;

- To stabilize loss experience;
- To protect themselves and the insured against catastrophes; and
- To increase their capacity.

In terms of the Regulation of the Insurance Industry Act No. 43 of 2000, the Insurers in Sri
Lanka are required to reinsure a certain percentage of their insurance portfolio specified by
the Minister, which shall not exceed 50%, with the National Insurance Trust Fund of Sri
Lanka. At present, the relevant percentage has been specified as 30%.

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