Introduction to Insurance

Insurance is a form of contract or an arrangement where one party agrees in return for a
consideration to pay an agreed amount of money to another party to make good the loss, damage
or injury to something of value in which the insured has an interest. Being a contract of indemnity,
it is based on the principle of utmost good faith.
The insurance industry safeguards the assets of its policyholders by transferring risk from an
individual or business to an insurance company. Insurance companies act as financial
intermediaries in that they invest the premiums they collect for providing this service. Insurance
company size is usually measured by net premiums written, that is, premium revenues less
amounts paid for reinsurance
In today’s world, insurance companies offer retail insurance policies of varied nature including
life, health, fire, marine, etc. Individuals purchase such policies either in their individual capacity
or the employee friendly organizations may extend such cover as perks of the employment. The
business of insurance extends to protection of the economic value of assets. The owner of an asset
attaches a value to the property since it gives them some benefit in the form of income or the loss
of which could cause irreparable loss to the owner. For example, owning a car for self-use may not
give any monetary benefit but it is more for the pleasure of comfort it provides to the owner. If the
vehicle is damaged due to say, water logging due to heavy rains, the Car will have only scrap value
- a need for covering this risk arises in such unforeseen situations.
Alternatively, a Company which is in the business of transportation may own a fleet of lorries
which are given on lease for others who want to transport goods. In this scenario, there could be a
reduction on the revenue if there is an accident to the lorry due to which the transportation business
is affected - need for insurance as a risk management tool arises. Similarly, disablement –
permanent or temporary nature or a death of a sole breadwinner in a family may bring down the
standard of living of the family. Therefore there is a need to give financial protection in the form
of monetary compensation on disablement or death of the breadwinner to the members of the
family – need for life insurance arises.
History
You need to know that insurance is a form of risk management, primarily used to hedge against
the risk of a contingent loss. In essence, insurance is simply the equitable transfer of a risk of a
loss, from one entity to another, in exchange for a premium.
In India, insurance has a deep-rooted history. It finds mention in the writings of Manu
(Manusmrithi), Yagnavalkya (Dharmasastra ) and Kautilya (Arthasastra). The writings talk in
terms of pooling of resources that could be re-distributed in times of calamities such as fire, floods,
epidemics, and famine. This was probably a pre-cursor to modern day insurance. Ancient Indian
history has preserved the earliest traces of insurance in the form of marine trade loans and carriers’
contracts. Insurance in India has evolved over time heavily drawing from other countries, England
in particular. Now, we will be discussing in brief about the history of Life Insurance and General
Insurance in India.
This millennium has seen insurance come a full circle in a journey extending to nearly 200 years.
The process of re-opening of the sector had begun in the early 1990s and the last decade and more
has seen it been opened up substantially. In 1993, the Government set up a committee under the
chairmanship of RN Malhotra, former Governor of RBI, to propose recommendations for reforms
in the insurance sector. The objective was to complement the reforms initiated in the financial
sector. The committee submitted its report in 1994 wherein, among other things, it recommended
that the private sector be permitted to enter the insurance industry. They stated that foreign
companies be allowed to enter by floating Indian companies, preferably a joint venture with Indian
partners. Following the recommendations of the Malhotra Committee report, in 1999, the
Insurance Regulatory and Development Authority (IRDA) was constituted as an autonomous body
to regulate and develop the insurance industry. The IRDA was incorporated as a statutory body in
April, 2000. The key objectives of the IRDA include promotion of competition so as to enhance
customer satisfaction through increased consumer choice and lower premiums, while ensuring the
financial security of the insurance market. The IRDA opened up the market in August 2000 with
the invitation for application for registrations. Foreign companies were allowed ownership of up
to 26% in the equity share capital of the Insurer. This limit was later raised to 49% during the year
2016. The Authority has the power to frame regulations under Section 114A of the Insurance Act,
1938 and has from the year 2000 onwards various regulations ranging from registration of
companies for carrying on insurance business to protection of policyholders’ interests were framed.
The idea of insurance took birth thousands of years ago. Insurance practices in earlier days used
to be based on the concept of ‘pooling of risks’. A common fund was created, often at the Village
Panchayat or equivalent levels into which small contributions from many people was pooled and
the amount so collected be used to compensate for the loss suffered by the unfortunate few out of
those who contributed. The contribution to be made by each person is determined on the
assumption that while it may not be possible to tell beforehand which person will suffer, it will be
possible to tell, on the basis of past experiences, how many persons on an average may suffer
losses. For example, in a Village, there are 500 houses, each valued at `200,000. Every year, on an
average 4 houses get burnt, resulting into a loss of `800,000. If all the 500 house-owners come
together and contribute `1,600 each, that will be sufficient to cover the risk of up to 4 houses getting
damaged on fire. Thus the risk of 4 house-owners gets distributed to 500 house-owners. In other
words, the risk of suffering an economic loss and its consequence could be transferred from one
individual to many, through the mechanism of pooling. Thus, insurance is often described as a
Risk Transfer through Risk Pooling
Hammurabi. The Hammurabi Code was one of the first forms of written laws. The basic insurance
gave the Babylonian traders protection against loss of cargo. If a merchant received a loan to fund
his shipment, he would pay the lender an additional sum in exchange for the lender’s guarantee to
cancel the loan should the shipment be stolen or lost at sea. The law of general average is a legal
principle of maritime law according to which all parties in a sea venture proportionally share any
losses resulting from a voluntary sacrifice of part of the ship or cargo to save the whole in an
emergency. For instance, when the crew throws some cargo overboard to lighten the ship in a
storm. The first codification of general average was the York Antwerp Rules of 1890. American
companies accepted in 1949. General average requires 3 elements as follows: (i) A common danger
in which a vessel, cargo and crew all participate – a danger which is imminent or inevitable, except
by voluntarily incurring the loss of a portion of the whole to save the remainder. (ii) There must
be a voluntary jettison, jactus or casting away of some portion of the joint concern for the purpose
of avoiding the imminent peril. (iii) Attempts to avoid the imminent common peril must be
successful. In 1666, the Great Fire of London destroyed more than 13,000 houses. To counter such
events in future, Fire Office, the first insurance company was started in 1680. Traders in London
used to gather at Lloyd’s Coffee House and agree to share losses of goods due to piracy or the ship
sinking due to bad weather or other reasons. Edward Lloyds coffee house became recognised as
the place for obtaining marine insurance this is where the Lloyds as an Insurance market began.
From those beginnings in a coffee house in 1688, Lloyds has been a pioneer in insurance and has
grown over 332 years to become the world’s leading marketing for specialist insurance. A contract
of insurance is an agreement whereby one party, called the insurer, undertakes, in return for an
agreed consideration, called the premium, to pay the other party, namely the insured, a sum of
money or its equivalent in kind, upon the occurrence of a specified event resulting in a loss to him.
The policy is a document, containing the terms and conditions, which is an evidence of the contract
of insurance. As per Anson, a contract is an agreement enforceable at law made between two or
more persons by which rights are acquired by one more persons to certain acts or forbearance on
the part of other or others.
History of insurance in India can be studies in the following 5 important stages
1. Period of Mushroom growth (1900-1912) – during this period there was a mushroom growth of
Indian companies and this was mainly due to the swadeshi movement which prompted the boycott
of British goods, British institutions and everything British. The indiscriminate mushroom growth
of insurance companies led to the appearance of some evil which had to be checked by passing
Indian Life Assurance Act, 1912. For the first time publishing of returns of life insurance began
from 1914.
2. Period of struggle & steady growth (1913-1938) – the period between two world wars. The
indigenous companies had to pass through tough time. Sudden growth of companies due to impetus
given by swadeshi movement brough with it evil of accumulation of wealth and inexperience in
business. This has led to economic slump, business had to struggle for its growth. Many small
offices had to be wound up and few that survived had to face the competition of many flourishing
foreign offices. Government was compelled to protect the interest of Indian insurance business and
hence in 1934 Sri SC Sen was appointed as special officer to investigate and report on reform of
insurance law in India. In 1936 a committee under chairmanship of Sri NN Sircar was appointed
to examine the report of special officer, which led to 8 the passing of Insurance Act, 1938 which
provides for uniform control by government over all insurers. Foreign offices discontinued their
business in India.
3. Period of stability & Consolidation (1938-1950) – being free from foreign competition Indian
offices gained stability. After second world war swadeshi movement gained strength and national
spirit increased. Large amounts of capital were available with them for investment in the
developing industries. In 1945 Cowasji Jehangir committee condemned the malinvestment by
insurance companies, this led to regulation of investment and Insurance Act 1938 had to be
amended several times. Partition of the country had made situation worse. Sri SR Ranganathan
committee reviewed the entire insurance law and based on this report amendment of 1950 was
carried out which made far reaching changes to make insurance institutions more useful for the
country’s economic growth.
4. Period of Boom & Nationalization (1950- up to date) – by Five-Year Plans India has grown
from agrarian society to industrialised society. Confidence in domestic companies increased. All
this contributed to a boom in insurance business. Huge amount of capital was available with
insurers and government found in handy to utilise these funds for its developmental plans and also
to ensure the investing public, a better security. Later in 1956 Life Insurance Act, 1956 was passed
nationalising life insurance business in India. Further in 1972 the General insurance was
nationalised by passing of General Insurance (Emergency Provisions) Act, 1972. General
insurance corporation was formed with four subsidiaries.
5. Era of Privatization (1991 onwards) – insurance sector open to private entities on the
recommendations of Malhotra Committee. Both public and private companies played important
role simultaneously. Growth of more private entities has led to the passing of Insurance Regulatory
and Development Authority Act, 1999 to control and regulate insurance sector in India.
Definition of Insurance
Man on earth always had an eye on the avoidance of ill-luck and has tried in all ages somehow to
ensure himself and to take out a policy of some sort on which he paid a regular premium in some
form of social denial and sacrifice. – Summer and Keller
It existed in some form of mutual or communal protection in the Aryan tribes some 3000 years
back. – Stone and Cox
The word “Bima” was derived from the Persian word “Bim” meaning “Fear” and “Bima” means
“expense” incurred to get rid of fear. – Persian Dictionary
From the beginning, human societies have tried to find ways to soften the shocks of existence. Our
ancestors were very much aware that no individual could do it alone, only by pooling the resources
of the many; the unfortunate few could be helped.
This simple idea of mutual cooperation persists like a welcome footpath through the incredible
tangle of human history.
A contract of insurance is an agreement whereby one party, called the insurer, undertakes, in return
for an agreed consideration, called the premium, to pay the other party, namely the insured, a sum
of money or its equivalent in kind, upon the occurrence of a specified event resulting in a loss to
him. The policy is a document which is an evidence of the contract of insurance. As per Anson, a
contract is an agreement enforceable at law made between two or more persons by which rights
are acquired by one more persons to certain acts or forbearance on the part of other or others. The
Indian Contract Act, 1872, sets forth the basic requirements of a Contract. As per Section 10 of the
Act:
  “All agreements are contracts if they are made by the free consent of parties competent to
contract, for a lawful consideration and with a lawful object, and are not hereby expressly declared
to be void…..”.

 An Insurance policy is also a contract entered into between two parties, viz., the Insurance
Company and the Policyholder and fulfills the requirements enshrined in the Indian Contract Act
Essentials of a valid Insurance contract
1. Proposal: When one person signifies to another his willingness to do or to abstain from doing
anything, with a view to obtaining the assent of that other to such act or abstinence, he is said to
make a proposal (“Promisor”). In Insurance parlance, a Proposal form (also called application for
insurance) is filled in by the person who wants to avail insurance cover giving the information
required by the insurance company to assess the risk and arrive at a price to be charged for covering
the risk (called “premium). The insurance company, based on the information furnished in the
proposal form, assesses the risk (also called underwriting), and conveys the decision – if accepted,
at what premium and on what terms and conditions. This is also called “counter offer” in insurance
terminology by the insurance company to the Customer. A medical examination is also conducted,
where necessary, before making the counter offer. Where the insurance company cannot accept the
risk, the proposal is declined. Where the insurance company conveys its decision to accept the risk
quoting a premium, a proposal is made.
2. Acceptance: When a person to whom the proposal is made, signifies his assent thereto, the
proposal is said to be accepted (“Promisee”). A proposal, when a accepted, becomes a promise;
3. Consideration: When, at the desire of the promisor, the promisee or any other person has done
or abstained from doing, or does or abstains from doing, or promises to do or to abstain from doing,
something, such act or abstinence or promise is called a consideration for the promise; As can be
seen from the above, amount equal to Premium paid by the Customer becomes the consideration
for the contract. Every promise and every set of promises, forming the consideration for each other,
is an agreement;
4. Competency to contract: Every person is competent to contract who is of the age of majority
according to the law to which he is subject, and who is sound mind and is not disqualified from
contracting by any law to which he is subject. In the case of Insurance the person with whom the
Contract is entered into is called “Policyholder” or “Policy Owner” who could be different from
the subject matter which is insured. In Life insurance contracts, for example, the person whose life
is insured could be different. For example, the Policyholder could be the Father and the Life
assured could be the son. In the case of Fire insurance, the Policy owner could be the Owner of a
building and the subject matter of insurance would be the building itself. The Policyholder must
have attained the age of majority at the time of signing the proposal and should be of sound mind
and not disqualified under any law. However, the life assured could suffer from the above
infirmities.
5. Consensus ad idem: Two or more person are said to consent when they agree upon the same
thing in the same sense. Both the insurance company and the Policyholder must agree on the same
thing in the same sense. The Policy document issued to the Policyholder (“Customer”) clearly
defines the obligations of the insurer and the terms and conditions upon which the Insurance
contract is issued. Free consent: Consent is said to be free when it is not caused by – 1. Coercion,
or 2. Undue influence or 3. Fraud, or 4. Misrepresentation, or 5. Mistake
6. Lawful object: The consideration or object of an agreement must be lawful, The consideration
or object of an agreement is unlawful under the following circumstances: (a) Where a contract is
forbidden by law or (b) Where the contract is of such nature that, if permitted, it would defeat the
provisions of any law or is fraudulent; (c) Where the contract involves or implies, injury to the
person or property of another; or (d) Where the Court regards it as immoral, or opposed to public
policy. Every agreement of which the object or consideration is unlawful is void. The object of an
insurance contract, i.e. to cover the risk by taking out an insurance policy, is a lawful object.
7. Agreement must not be in restraint of trade or legal proceedings: Every agreement by which
anyone is restrained from exercising a lawful profession, trade or business of any kind, is to that
extent void. Every agreement, by which any party thereto is restricted absolutely from enforcing
his rights under or in respect of any contract, by the usual legal proceedings in the ordinary
tribunals, or which limits the time within which he may thus enforce his rights, is void to the extent
8. Agreement must be certain and not be a wagering contract: Agreements, the meaning of which
is not certain, or capable of being made certain, are void. Agreements by way of wager are void;
and no suit shall be brought for recovering anything alleged to be won on any wager, or entrusted
to any person to abide the result of any game or other uncertain event on which may wager is
made.
Important Terminologies
Proposal (or) Proposal form denotes the application for insurance contains which solicits
information from the Proposer to enable the Insurer to take a decision on whether to accept the
risk or not. Proposer is the person who submits Proposal form for insurance to the insurance
company and who is interested in taking an Insurance Policy.
Underwriting is the process of assessment of risk on a proposal by the Insurance company and
arriving at the decision (to accept, reject, rate-up, postpone) and the terms and conditions upon
which an insurance contract may be accepted.
Policyholder is the person who is issued an Insurance Policy document by the Insurance Company
consequent to underwriting and issuance of Insurance Policy to cover the risk stated in the Proposal
form on such terms and conditions as mentioned in the Insurance Policy document issued by the
Insurer to the Policyholder.
Insurance Policy document (or) Policy document (or) Policy constitutes the contract between the
Insurance company and the Policyholder, stating the terms and conditions of the Insurance
coverage provided by the Insurance company to the Policyholder.
Subject matter of insurance is the Person or object upon whose loss or upon the loss of which
object the insurance company agrees to pay a specified sum as the compensation to the
Policyholder. Life insured (or) Life assured under a Life insurance Policy is the subject matter of
insurance on whose death a specified sum of money is paid by the Life insurance company.
Sum Assured (or) Sum Insured means the amount promised to be paid by the Insurer upon the
death of the Life insured.
Nominee is the person appointed, only for Policies taken on one’s own Life, by the Policyholder
to receive the Sum Assured or any other policy benefit upon death of the Life assured. Where
Policyholder and Life assured are different persons, upon death of the Life assured, the
Policyholder is the person entitled to receive the Sum assured or other Policy benefits. In General
insurance, since the subject matter of insurance can be anything other than one’s life, the
Policyholder always receives the benefit upon loss or damage to the subject matter of insurance,
subject to establishing the insurable interest at the time of claim.
Objectives of insurance
Insurance serves two-fold purpose
1. Immediate – short ranged & proximate purpose Loss/risk/damage spread over large number of
risk bearers and the immediate beneficiary is the insured.
2. Far-sighted – long-range & remote purpose, where it accelerates economic growth of nation
through investment by Insurance Companies the in development of commerce & industry of the
nation.

Basic principles of insurance

Though insurance has been differentiated into marine, fire, life etc., there are certain general
principles applicable to all forms of insurance. These general principles serve as a guide to the
sound interpretation of the purpose of the insurance contracts in their diversified forms. The
principles of indemnity, insurable interest, uberrima fides (utmost good faith) and the existence of
risk are some of the principles having common application. Following are the some of the
important principles of insurance:
(a) Existence of risk: It is vital to every contract of insurance that the subject matter should be
exposed to the contingency of loss or risk. Risk involves the happening of an uncertain event
adverse to the interest of the assured. In marine insurance the ship or cargo is exposed to the loss
by perils of the sea. In fire insurance the risk is in the destruction of property by fire. In life
insurance, the risk is in the death of the assured, though a certainty, but uncertain as to the time of
its happening. In an abstract sense, risk may be defined as the chance of loss. It can either be an
uncertainty as to the outcome of some event or events, or loss as the result of at least one possible
outcome. In any case, the promise of the insurer is to save the assured against the uncertain
consequences.
(b) Principle of indemnity: Insurance is essentially a contract of indemnity. All the claims of the
assured will be adjusted only with reference to the actual loss sustained by him. Thus, it is implied
in every contract of insurance that the assured in case of a loss against which the policy has the
actual loss, is to prevent fraud on the part of the assured. It checks the temptation to gain by unfair
means and the wilful causing of loss. However, the factual basis for the application of the principle
of indemnity is not the prevention of crime or consideration of public policy but it derives from
the inherent nature of the bargain. In assessing the amount payable on a contract of insurance, the
principle of indemnity is a guiding principle. It is common that insurers limit their liability to a
particular amount of money known as the ‘sum assured.’ In case of loss, the ‘sum assured’ is all
that the assured is entitled to even if the value of the premium paid is less than it. But in all other
cases, except in the valued policies (in Marine Insurance) the insurer is liable to indemnify only to
the tune of the actual loss, even though the ‘sum assured’ is a higher amount. In ‘valued policies,’
the parties agree that the value of the subject-matter shall be agreed. The object of the valued
policies is to avoid dispute after the loss occurs as to the quantum of the assured’s interest. In
contracts of life insurance, personal accident and sickness insurances and in some forms of
emergency insurance, the loss is frequently measured in monetary terms. They are to be
distinguished from contracts of indemnity like marine and fire insurance. It is now well established
that life insurance in no way resembles a contract of indemnity. Not seldom the contract of life
insurance is considered as an arrangement for profitable investment. It is because the assured by
paying the premiums increases the habit of saving, the cumulative sum which he can recover after
the expiry of the fixed period. Life insurance may properly be considered as an investment of
money because it enables to secure an ultimate fund to those persons who have no greater
opportunity of making savings or which left to themselves, they would have found it beyond their
means. Yet, the objective of a contract of life insurance is mainly to provide compensation for the
risk of death happening at an uncertain time. Though, it is considered as a sort of investment, it
holds good in some cases, it is departing from the essential feature of insurance security against
risk. It is, therefore, observed that a life policy is not a contract of indemnity. Generally; a contract
of indemnity is entered into for the sole purpose of making good a loss incurred. The value of a
life, however, is incapable of estimation and except, in a limited sense, cannot be “made good” by
insurance. The important distinction which thus arises between life insurance and the other forms
of insurance is that the principle of “subrogation,” under which the insurer (i.e., the company)
takes the right of recovery against the third party causing the loss, has no application to life
insurance.
(c) Difference between the contract of insurance and wager agreement: The basic principle of
indemnity on which the greater part of the law of insurance is based, prima facie, negatives any
treatment of insurance on par with wagering contracts. The wagering contracts are those, wherein
“two persons, professing to hold opposite views touching the issue of a future uncertain event,
mutually agree that, dependent upon the determination of that event, one shall win from the other,
and that the other shall pay and hand over to him, a sum of money”. Again, the difference between
a wagering agreement and a contract depends upon whether the person making it has or has not an
interest in the subject matter of the contract. That means, “if the event happens the party will gain
an advantage, if it is frustrated he will suffer a loss”. Probably, the common feature of the two
types of agreement – the element of uncertainty, gave rise to the misconception of insurance in
terms of gamble. According to Sir William Anson, the Father of the “Law of Contract” - ‘Insurance
was placed on a different ground from a pure wager merely because it is permitted by law.
Insurance was regarded as no better than a wagering contract despite the presence of insurable
interest. But this view has been modified by him later on and now he affirms insurance is described
as having only a ‘superficial resemblance’ to a wager. Though the distinction is subtle, it is the
intention of the parties rather than the form of the contract that distinguishes insurance from
wager’. A wagering contract is made normally with a view to secure profit. The probability of the
happening of an event is completely irrelevant to the interests of the parties except for the chance
of gain. A wager is concerned with the happening of an event per se and the consequential
determination of the conflicting interests. The purpose is to win or lose in lieu of the mere
probability of an event. In insurance, the interest of the assured in the subject matter of risk known
as the insurable interest and is of the utmost importance in the insurance contract.
(d) Principle of Insurable Interest: The test for a valid insurance contract is the existence of the
insurable interest. The ‘insurable interest’ is nothing but an interest of such a nature that the
occurrence of the event insured against would cause financial loss to the insured and such an
interest which can be or is protected by a contract of Insurance. This interest is considered as a
form of property in the contemplation of law. The insurable interest should exist at the time of
happening of an event in the general insurance contracts, but is not necessarily so in the case of
the life insurance contracts. This is because the former is a contract of indemnity and the latter is
a contract of assurance. Taking an example of fire insurance, it is clear that an insured person
suffers no loss under a policy, if at the time of loss or damage to the property; he has no interest in
it either as full or partial owner.
According to McGillivray If the assured has no interest at the time the event happens it is clear
that he cannot recover anything, because he suffers no loss, and therefore has no claim to an
indemnity. Similarly, if he has an interest which is limited to something less than the full value of
the subject-matter, he suffers no greater loss than the value of his interest at the time of the loss,
and therefore, his claim to an indemnity cannot exceed the value of his interest. In this context of
insurable interest, life insurance stands on different ground. No value can be assigned to human
life in the same way as is done in respect of tangible property. But all the same, it is possible to
measure the extent of loss that would be caused by the failure of a particular life. An insurable
interest of some kind is necessary to every contract of insurance of whatever kind and any
insurance made without such interest is illegal and void. The guiding factor in this regard is that
an insurable interest is a reasonable expectation of financial benefit from the continued life of the
subject or an expectation of loss if the subject dies. For instance, a parent has a clear insurable
interest in the life of a minor child, since he is entitled to the services and earnings of that child.
The concept of insurable interest primarily appears to be an invention of the courts. It may be
necessary for the assured to show interest but common law contains no general prohibition of
contracts in which no insurable interest exists.
It was perhaps introduced to curb insurances by way of wager, and obtained statutory recognition.
The presence of insurable interest is insisted for two reasons: - (1) An assured cannot be taken to
have suffered any damage, if he has no interest in the property insured at the time of loss. (2)
Secondly, if the interest of the assured is limited to something less than the full value of the subject
matter, no greater damage than his interest in the subject matter will result. In both the cases, the
interest in the subject-matter is required by the terms of the contract itself, since the promise of the
insurer will be only to compensate the actual loss. To have insurable interest, it is essential that
there should be some contractual or proprietary right, whether legal or equitable so long as it is
enforceable in the courts. Accordingly, the main principles determining the existence of insurable
interest are (a) the interest must be enforceable at law (b) the continued existence of the interest
will be beneficial to the assured. Strict legal or pecuniary interest is not necessary. Under the
contract of life insurance, the assured has insurable interest in his own life to an unlimited extent.
But, where a person takes insurance on the life of another, the criteria applied in assessing the
insurable interest is of great importance. It is not the legal or beneficial interest, as in the case of
marine and fire insurance, but the person insuring the life of the other must stand in such
relationship as will justify a reasonable expectation of advantage or benefit from the continuance
of the life of the person on whom the insurance is affected. The test applicable is whether there
was actual dependence of the person affecting the insurance, whose life is insured, or he had an
expectancy of some advantage from the continued existence of the person insured. The effect of
the requirement of insurable interest in all contracts of insurance seems to be two-fold. Its absence
makes a contract of insurance equivalent to a wager. Also, the principle of indemnity cannot be
applied unless there be some interest in the subject-matter, because, the actual loss alone will be
indemnified. Thus, it became a preventive of wagering policies and also limited the amount
recoverable to the loss sustained by the assured.
(e) Principle of utmost good faith: In the case of ordinary commercial transaction, the legal maxim
“Caveat Emptor” (let the purchaser beware) prevails. In the absence of an enquiry the other party
to the contract is under no obligation voluntarily to furnish detailed information regarding the
subject matter of the contract. It is, however, understood that one party to the contract should not
be misled by the other by any false declaration. All the same, it is open to both the parties to the
contract to satisfy them and each party is entitled to make the best bargain that he can make. As a
contrast to such commercial contracts the insurance contract is dominated by the legal maxim “the
utmost good faith”. The observance of the utmost good faith by the parties is vital to a contract of
insurance. Insurance is also called as an uberrima fide contract because the parties are required to
confirm to a higher degree of good faith than in the general law of contract. Good faith and honesty
though principles of equity and justice are equally applicable to every agreement, yet in contracts
other than insurance, the parties are free to settle their own terms. In a contract of sale of goods,
“Caveat Emptor” is the principle and the sellers are under no obligation to make known to the
purchaser all the facts that might affect his decision.
But in insurance there is something more than an obligation to treat the insurer honestly and
frankly. An insurance being a device of risk transference stands on a separate basis. The non-
disclosure of a material fact by the assured whether fraudulent or innocent, has the same effect of
avoiding the contract. A stringent duty is imposed on the assured to provide all the material facts
that might influence the decision of the insurer. The fact that the assured believed as a reasonable
man certain information as immaterial to the purpose does not provide a defence. The materiality
of a particular fact will be considered independently of the belief of the assured. This fundamental
principle applies to all branches of insurance. It may be summarized from one of the several
judgments pronounced, it is the duty of the assured to disclose all material facts within their
knowledge. In cases of life insurance, certain specific questions are proposed as the points affecting
in general to all mankind. But there may be circumstances also affecting particular individuals,
which are not likely to be known to the insurer, and which had they been known, would no doubt,
have been made subject to specific enquiries. The onus of good faith lies equally on both the parties
to the contract, but in the nature of things the assured has to pay more particular attention to the
observance of the principles. The selection of a life for insurance by the company depends to a
large extent on the information supplied by the proposer. As the company solicits proposals from
the general public whose members are total strangers to the company, there is an urgent need for
disclosing all material facts within the knowledge of the proposer to enable the company to come
to a decision. The proposer has within his knowledge all the facts, which are material to the risk.
The proposer is morally and legally bound to disclose all matters, which in point of fact are material
to the contract. The question as to which information is material to the contract is wide one. In
case of a dispute, a court or a committee of arbitrators may decide it. But this cannot certainly be
left to the opinion of the proposer. Every circumstance is material which would influence the
judgment of a prudent insurer in fixing the premium or determining whether he will take the risk.
This definition has been embodied in the Marine Insurance Act, 1906 and is equally applicable to
the life insurance. Nevertheless, the proposer is excused from explicitly disclosing certain facts.
These are:
(1) What the insurer already knows?
(2) What the insurer ought to know?
(3) What the insurer waives being informed of? And
(4) Features, which lessen the risk?
Thus, in an insurance contract each party acts on the good faith of the other. If the proposer
conceals or misrepresents material facts, the contract is vitiated. Deliberate concealment or
misrepresentation amounts to fraud, and the policy is legally void. The innocent misstatement or
misrepresentation renders the policy voidable at the option of the insurer up to two years. In
practice, however, policies are usually allowed to continue, subject to adjustment, if the company
is satisfied that there was no intention on the part of the assured to defraud it. As stated before, full
disclosure of the material information having a bearing on the risk is necessary on the part of the
proposer. This is due to the principle of uberrima fides that governs the insurance business. The
statements made by the proposer in the proposal and his statement before a medical examiner is,
in legal language, either representations or warranties. A warranty in insurance is a statement or
condition incorporated in the contract relating to the risk, which the applicant presents as true and
upon which it is presumed that the insurer relied in issuing the contract. Marine insurance, the first
branch of insurance to develop commercially, evolved the doctrine of warranty. The Marine
Insurance Act, 1906 (England), gives the following definition of a warranty ‘A warranty is a
statement by which the assured undertakes that some particular thing shall or shall not be done, or
that some condition shall be fulfilled, or whereby he affirms or negatives the existence of a
particular state of fact. This Act states further that a warranty as above defined is a condition which
must be exactly complied with, whether it be material to the risk or not’. The other replies given
by the proposer, which are not intended to have the force of warranty, are known as representations.
In life insurance, there is a recital clause by which the answers given in the proposal and the replies
made to the medical examiner are made as the basis of the contract and thereby given the effect of
warranty. The present tendency of the offices is to treat the replies as representation. Any
misstatements are, therefore, judged from this approach and if the company thinks that the
misstatement is material, that is, the knowledge of the correct statement would have influenced the
decision of the company adversely; the insurer can seek to avoid the policy on the ground of non-
disclosure or misstatement and must also offer to return the premiums. The courts also do not
favour any unfair rigidity in the interpretation of answers to the questions in the proposal form.
Even then it is always desirable on the part of the proposer to warrant the answers to the best of
his knowledge and belief. This materially safeguards his interests.

FUNCTIONS OF INSURANCE:
The various functions of insurance like risk sharing, life insurance and annuities relief for members
of society, sharing burden of state to provide relief to destitute and aged citizens, making available
finance for social investment etc. The fundamental function of insurance is to shift the loss suffered
by a sole individual to a willing and capable professional risk-bearer in consideration of a
comparatively small contribution called premium. In this process the professional risk-bearer i.e.
the insurer collects some small rate of contribution from a large number of people and if there is
any unfortunate person among them, the risk-bearer i.e. the insurer relieves the sufferer from the
effects of the loss by paying the insurance money. Thus, it serves the social purpose and it is “a
social device whereby uncertain risks of individuals may be combined in a group and thus, made
more certain; small periodic contribution of the individuals providing a fund out of which those
who suffer losses may be reimbursed”. The insurers collect the contributions of numerous
policyholders and those funds are invested in organized commerce and industry. They help the
running of giant industries and mobilize the capital formation. In simple terms, “insurance is a
protection against financial loss taking place on the happening of an unexpected event”. All the
individuals have assets tangible i.e. the house, car, factory etc. or intangible like voice of a singer,
leg of a footballer, the hand of an author etc. All these can be insured because they run the risk of
becoming non-functional either through a disaster or an accident. The functions of Insurance can
be bifurcated as below: 1. Primary Functions, 2. Secondary Functions and 3. Other Functions The
primary functions of insurance include –
(a) Provide protection - The primary function of insurance is to offer protection against future risk,
accidents and uncertainty. Insurance is actually a shield against economic loss, by sharing the risk
with others.
(b) Collective risk - Insurance is a device to contribute to the financial loss of a few among many.
Insurance is a mean by which little losses are shared among larger number of people. All the
insured share the premiums towards a fund and out of which the persons exposed to a particular
risk is paid.
(c) Evaluation of risk - Insurance concludes the probable volume of risk by evaluating various
factors that give rise to risk. Risk is the origin for determining the premium rate also.
(d) Provide assurance - Insurance is a device, which helps to modify from uncertainty to certainty.
Insurance is a mechanism whereby uncertain risks may be made more certain. The secondary
functions of insurance include: - i. Avoidance of losses - Insurance alarms individuals and
businessmen to adopt suitable device to prevent unfortunate consequences of risk by observing
safety instructions; installation of automatic sparkler or alarm systems, etc. prevention of losses
causes smaller payment to the assured by the insurer and this will encourage for more savings by
way of premium. The condensed rate of premiums motivate for more business and better protection
to the insured. ii. Small capital to cover larger risks - Insurance relieves the businessmen from
security investments, by paying small amount of premium against superior risks and uncertainty.
iii. Encourage towards the development of larger industries - Insurance provides development
opportunity to those larger industries having additional risks in their setting up. Even the financial
institutions may be prepared to give credit to ailing industrial units which have insured their assets
including plant and machinery.
The other functions of insurance include: - 1. Way of savings and investment - Insurance serves as
savings and investment, insurance is a compulsory way of savings and it limits the unnecessary
expenses by the insured. For the reason of availing income-tax exemptions also people invest in
insurance. 2. Source of earning foreign exchange - Insurance is a worldwide business. The country
can earn foreign exchange by way of issue of marine insurance policies and various other ways. 3.
Risk-Free trade - Insurance promotes exports insurance, which makes the foreign trade risk-free
with the assistance of different types of policies under marine insurance cover.