Module 1

Insurance may be defined as a social device providing financial compensation for the effects of
misfortune, the payments being made from the accumulated contribution of all parties
participating in the scheme. – D.S. Hansell

An insurance is a legal agreement (contract) between an insurer (insurance company) and an

insured (individual), in which an insured receives financial protection from an insurer for the
losses he may suffer under specific circumstances.

For example, you met with an accident on your way to the office in your car and the car suffers
damage. Your insurer can reimburse the repair expenses in this case.

Legally insurance has been defined as a contract where the insurer agrees to compensate the
insured against the losses incurred due to any unforeseen contingency. The contract also involves
a consideration which is called a premium.

Nature or Characteristics of Insurance

On the basis of the definitions of insurance discussed above, one can observe the following
nature or characteristics:

1. Contract Insurance is a contract between the insurance company and the policyholder
wherein the policyholder (insured) makes an offer and the insurance company (insurer) accepts
his offer. The contract of insurance is always made in writing.

2. Consideration Like other contracts, there must be lawful consideration in insurance also. The
consideration is in the form of premium which the insured agrees to pay to the insurer.

3. Co-operative Device All for one and one for all is the basis for cooperation. The insurance is
a system wherein large number of persons, exposed to a similar risk, are covered and the risk is
spread over among the larger insurable public. Therefore, insurance is a social or cooperative
method wherein losses of one is borne by the society.

4. Protection of financial risks An insurer is protected from financial risks which can be
measured in terms of money. As such insurance compensates only financial or monetary loss or
risks.

5. Risk sharing and risk transfer Insurance is a social device for division of financial losses
which may fall on an individual or his family on the happening of some unforeseen events.
When insured, the loss arising out of the events are shared by all the insured in the form of
premium. Therefore the risk is transferred from one individual to a group.

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6. Based upon certain principles The insurance is based upon certain principles like insurable
interest, utmost good faith, indemnity, subrogation, causa-proxima, contribution, etc.

7. Regulated by Law Insurance companies are regulated by statutory laws in almost all the
countries. In India, life insurance and general insurance are regulated by Life Insurance
Corporation of India Act 1956, and General Insurance Business (Nationalization) Act 1972, and
IRDA Regulations etc.

8. Value of Risk Before insuring the subject matter of the insurance contract, the risk is
evaluated in order to determine the amount of premium to be charged on the insured. Several
methods are being adopted to evaluate the risks involved in the subject matter. If there is an
expectation of heavy loss, higher premiums will be charged. Hence, the probability of occurrence
of loss is calculated at the time of insurance.

9. Payment at contingency An insurer is liable to pay compensation to the insured’s only when
certain contingencies arise. In life insurance, the contingency — the death or the expiry of the
term will certainly occur. In such cases, the life insurer has to pay the assured sum. In other
insurance contracts, the contingency — a fire accident or the marine perils, may or may not
occur. So, if the contingency occurs, payment is made, otherwise no payment need to be made to
the policyholders.

10. Insurance is not gambling An insurance contract cannot be considered as gambling as the
person insured is assured of his loss indemnified only on the happening of such uncertain event
as stipulated in the contract of insurance, whereas the game of gambling may either result into
profit or loss.

11. Insurance is not a charity Premium collected from the policyholders under an insurance is
the cost of risk so covered. Hence, it cannot be taken as charity. Charity lacks the element of
contract of indemnity and compensation of loss to the person whosoever makes it.

PRINCIPLES OF INSURANCE

The concept of insurance is risk distribution among a group of people, hence cooperation
becomes the basic principle of insurance in addition to probability.

However to ensure fairness and proper functioning of the Insurance contract the following seven
principles are essential:

1. Principle of Utmost Good Faith: The very basic principle is that both the parties in an
insurance contract should act in good faith towards each other i.e. they must provide clear
and concise information related to the terms and conditions of the contract. The Insured
should provide all the information related to the subject matter and the insurer must give
clear details regarding the contract.

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 Eg – Jacob took a health insurance policy. At the time of taking insurance, he was a
smoker and failed to disclose this fact. Later, he got cancer. In such a situation the
Insurance Company will not be liable to bear the financial burden as Jacob concealed
important facts.

2. Principle of Insurable interest: This principle says that the individual (insured) must
have an insurable interest in the subject matter. Insurable interest means that the subject
matter for which the individual enters the insurance contract must provide some financial
gain to the insured and also lead to a financial loss if there is any damage, destruction or
loss.
Eg – the owner of a vegetable cart has an insurable interest in the cart because he is
earning money from it. However, if he sells the cart, he will no longer have an insurable
interest in it.
To claim the amount of insurance, the insured must be the owner of the subject matter
both at the time of entering the contract and at the time of the accident.

3. Principle of Indemnity: This principle says that insurance is done only for the coverage
of the loss hence insured should not make any profit from the insurance contract. In other
words, the insured should be compensated the amount equal to the actual loss and not the
amount exceeding the loss. The purpose of the indemnity principle is to set back the
insured at the same financial position as he was before the loss occurred. Principle of
indemnity is observed strictly for property insurance and not applicable for the life
insurance contract.
Eg – The owner of a commercial building enters an insurance contract to recover the
costs for any loss or damage in future. If the building sustains structural damages from
fire, then the insurer will indemnify the owner for the costs to repair the building by way
of reimbursing the owner for the exact amount spent on repair or by reconstructing the
damaged areas using its own authorized contractors.

4. Principle of Proximate Cause: This is also called the principle of ‘Causa Proxima’ or
the nearest cause. This principle applies when the loss is the result of two or more causes.
The insurance company will find the nearest cause of loss to the property. If the
proximate cause is the one in which the property is insured, then the company must pay
compensation. If it is not a cause the property is insured against, then no payment will be
made by the insured.
Eg Due to fire, a wall of a building was damaged, and the municipal authority ordered it
to be demolished. While demolition the adjoining building was damaged. The owner of
the adjoining building claimed the loss under the fire policy. The court held that fire is
the nearest cause of loss to the adjoining building and the claim is payable as the falling
of the wall is an inevitable result of the fire.

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 In the same example, the wall of the building damaged due to fire, fell down due to storm
before it could be repaired and damaged an adjoining building. The owner of the
adjoining building claimed the loss under the fire policy.

5. Principle of Subrogation: Subrogation means one party stands in for another. As per this
principle, after the insured i.e. the individual has been compensated for the incurred loss
to him on the subject matter that was insured, the rights of the ownership of that property
goes to the insurer i.e. the company.
Subrogation gives the right to the insurance company to claim the amount of loss from
the third-party responsible for the same.
Eg – If Mr A gets injured in a road accident, due to reckless driving of a third party, the
company with which Mr A took the accidental insurance will compensate the loss
occurred to Mr A and will also sue the third party to recover the money paid as claim.

6. Principle of Contribution Contribution principle applies when the insured takes more
than one insurance policy for the same subject matter. It states the same thing as in the
principle of indemnity i.e. the insured cannot make a profit by claiming the loss of one
subject matter from different policies or companies.
Eg – A property worth Rs.5 Lakhs is insured with Company A for Rs. 3 lakhs and with
company B for Rs.1 lakhs. The owner in case of damage to the property for 3 lakhs can
claim the full amount from Company A but then he cannot claim any amount from
Company B. Now, Company A can claim the proportional amount reimbursed value from
Company B.

7. Mitigation of Loss (Minimisation) This principle says that as an owner, it is obligatory

on part of the insurer to take necessary steps to minimise the loss to the insured property.
The principle does not allow the owner to be irresponsible or negligent just because the
subject matter is insured.
Eg – If a fire breaks out in your factory, you should take reasonable steps to put out the
fire. You cannot just stand back and allow the fire to burn down the factory because you
know that the insurance company will compensate for it.

Evolution of insurance in India

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

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marine trade loans and carriers’ contracts. Insurance in India has evolved over time heavily
drawing from other countries, England in particular.

The advent of life insurance business in India

1818
Advent of life insurance business in India
1818 saw the advent of life insurance business in India with the establishment of the Oriental
Life Insurance Company in Calcutta. This Company however failed in 1834. In 1829, the
Madras Equitable had begun transacting life insurance business in the Madras Presidency. 1870
saw the enactment of the British Insurance Act and in the last three decades of the nineteenth
century, the Bombay Mutual (1871), Oriental (1874) and Empire of India (1897) were started in
the Bombay Residency. This era, however, was dominated by foreign insurance offices which
did good business in India, namely Albert Life Assurance, Royal Insurance, Liverpool and
London Globe Insurance and the Indian offices were up for hard competition from the foreign
companies..

1914
Government of India started publishing returns
In 1914, the Government of India started publishing returns of Insurance Companies in India.
The Indian Life Assurance Companies Act, 1912 was the first statutory measure to regulate life
business. In 1928, the Indian Insurance Companies Act was enacted to enable the Government to
collect statistical information about both life and non-life business transacted in India by Indian
and foreign insurers including provident insurance societies. In 1938, with a view to protecting
the interest of the Insurance public, the earlier legislation was consolidated and amended by the
Insurance Act, 1938 with comprehensive provisions for effective control over the activities of
insurers.

1950
The Insurance Amendment Act of 1950 abolished Principal Agencies
The Insurance Amendment Act of 1950 abolished Principal Agencies. However, there were a
large number of insurance companies and the level of competition was high. There were also
allegations of unfair trade practices. The Government of India, therefore, decided to nationalize
insurance business..

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1956
Life Insurance Corporation came into existance
An Ordinance was issued on 19th January, 1956 nationalising the Life Insurance sector and Life
Insurance Corporation came into existence in the same year. The LIC absorbed 154 Indian, 16
non-Indian insurers as also 75 provident societies—245 Indian and foreign insurers in all. The
LIC had monopoly till the late 90s when the Insurance sector was reopened to the private sector.

The history of general insurance

The history of general insurance dates back to the Industrial Revolution in the west and the
consequent growth of sea-faring trade and commerce in the 17th century. It came to India as a
legacy of British occupation.

1850
The British establish the Triton Insurance Company Ltd
General Insurance in India has its roots in the establishment of Triton Insurance Company Ltd.,
in the year 1850 in Calcutta by the British.

1907
The Indian Mercantile Insurance Ltd, was set up
In 1907, the Indian Mercantile Insurance Ltd, was set up. This was the first company to transact
all classes of general insurance business.

1957
General Insurance Council is formed
1957 saw the formation of the General Insurance Council, a wing of the Insurance Association of
India. The General Insurance Council framed a code of conduct for ensuring fair conduct and
sound business practices.

1968
Insurance Act was amended
In 1968, the Insurance Act was amended to regulate investments and set minimum solvency
margins. The Tariff Advisory Committee was also set up then.

1973
General insurance business was nationalized
In 1972 with the passing of the General Insurance Business (Nationalisation) Act, general
insurance business was nationalized with effect from 1st January, 1973. 107 insurers were

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amalgamated and grouped into four companies, namely National Insurance Company Ltd., the
New India Assurance Company Ltd., the Oriental Insurance Company Ltd and the United India
Insurance Company Ltd. The General Insurance Corporation of India was incorporated as a
company in 1971 and it commence business on January 1st 1973.

The Insurance Regulatory and Development Authority (IRDA) April, 2000

The IRDA was incorporated as a statutory body
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.

August 2000
The IRDA opened up the 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%. The Authority has the
power to frame regulations under Section 114A of the Insurance Act, 1938 and has from 2000
onwards framed various regulations ranging from registration of companies for carrying on
insurance business to protection of policyholders’ interests.

December, 2000
the subsidiaries of the General Insurance Corporation of India were restructured as
independent companies
In December, 2000, the subsidiaries of the General Insurance Corporation of India were
restructured as independent companies and at the same time GIC was converted into a national
re-insurer.

July, 2002
Parliament passed a bill de-linking the four subsidiaries from GIC in July, 2002.
Today there are 34 general insurance companies including the ECGC and Agriculture Insurance
Corporation of India and 24 life insurance companies operating in the country.
The insurance sector is a colossal one and is growing at a speedy rate of 15-20%. Together with
banking services, insurance services add about 7% to the country’s GDP. A well-developed and
evolved insurance sector is a boon for economic development as it provides long- term funds for
infrastructure development at the same time strengthening the risk taking ability of the country.

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 History and Purpose of IRDAI?
The statutory body of IRDAI was established in the year 1999, deriving its powers and functions
from the IRDAI Act, 1999 and the Insurance Act, 1938. IRDAI works as an autonomous body
responsible for managing and regulating the insurance and reinsurance industry in India along
with registering and/or licensing insurance, reinsurance companies and intermediaries according
to the regulations. Some purposes of IRDAI are:

 To protect the interest of the policyholders

 To regulate and promote the orderly growth of the insurance and reinsurance industry
 To ensure speedy claim settlement and prevent Insurance frauds and other malpractices
 To better the standards of insurance markets
 To take action when established regulatory standards are ineffectively enforced

Powers and Functions of IRDAI in the Insurance Industry

To protect the interests of policyholders, the IRDAI was granted significant responsibilities. Here
are some of them.

 Efficiently conducting insurance business and protecting the interests of the policyholders in
matters concerning assigning of policy, nomination by policyholders, insurable interest,
settlement of insurance claim, surrender value of the policy and other terms and conditions of
contracts of insurance
 Approving product terms and conditions offered by various insurers
 Regulating investment of funds by insurance companies and maintaining a margin of solvency
 Specifying financial reporting norms of insurance companies
 Ensuring insurance coverage is provided in the rural areas and also to the vulnerable sections of
society

MISSION STATEMENT OF THE AUTHORITY

 To protect the interest of and secure fair treatment to policyholders .

 To bring about speedy and orderly growth of the insurance industry (including annuity and
superannuation payments), for the benefit of the common man, and to provide long term funds for
accelerating growth of the economy;
 To set, promote, monitor and enforce high standards of integrity, financial soundness, fair dealing and
competence of those it regulates;
 To ensure speedy settlement of genuine claims, to prevent insurance frauds and other malpractices and
put in place effective grievance redressal machinery;
 To promote fairness, transparency and orderly conduct in financial markets dealing with insurance and
build a reliable management information system to enforce high standards of financial soundness
amongst market players;
 To take action where such standards are inadequate or ineffectively enforced;
 To bring about optimum amount of self-regulation in day-to-day working of the industry consistent with
the requirements of prudential regulation.
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Duties, powers and functions of IRDAI

Section 14 of IRDA Act, 1999 lays down the duties, powers and functions of IRDAI..
Subject to the provisions of this Act and any other law for the time being in force, the Authority shall have the
duty to regulate, promote and ensure orderly growth of the insurance business and re-insurance business.

 Issue to the applicant a certificate of registration, renew, modify, withdraw, suspend or cancel such
registration;
 protection of the interests of the policy holders in matters concerning assigning of policy, nomination
by policy holders, insurable interest, settlement of insurance claim, surrender value of policy and other
terms and conditions of contracts of insurance;
 specifying requisite qualifications, code of conduct and practical training for intermediary or insurance
intermediaries and agents
 specifying the code of conduct for surveyors and loss assessors;
 Promoting efficiency in the conduct of insurance business;
 Promoting and regulating professional organisations connected with the insurance and re-insurance
business;
 Levying fees and other charges for carrying out the purposes of this Act;
 Calling for information from, undertaking inspection of, conducting enquiries and investigations
including audit of the insurers, intermediaries, insurance intermediaries and other organisations
connected with the insurance business;
 Control and regulation of the rates, advantages, terms and conditions that may be offered by insurers
in respect of general insurance business not so controlled and regulated by the Tariff Advisory
Committee under section 64U of the Insurance Act, 1938 (4 of 1938);
 Specifying the form and manner in which books of account shall be maintained and statement of
accounts shall be rendered by insurers and other insurance intermediaries;
 Regulating investment of funds by insurance companies;
 Regulating maintenance of margin of solvency;
 Adjudication of disputes between insurers and intermediaries or insurance intermediaries;
 Supervising the functioning of the Tariff Advisory Committee;
 Specifying the percentage of premium income of the insurer to finance schemes for promoting and
regulating professional organisations referred to in clause (f);
 Specifying the percentage of life insurance business and general insurance business to be undertaken
by the insurer in the rural or social sector; and
 Exercising such other powers as may be prescribed

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