property and liability insurance

Property and Liability Insurance

1.1 INTRODUCTION

Let us examine the origin of man, his habits and way of living. He lived in caves at the dawn of civilization. Have we ever thought as to why he searched for a hidden place to live in? The simple reason was his instinct to do so. Man has always been in search of security and protection. Perhaps to protect himself from wild animals he chose to live in caves and to feel more secure, started living with tribes. Why security? Obviously for quality of life. Human needs are in the form of pyramids. Basically there are two types of needs- one is basic or primary and other is secondary need. Why are they in the shape of pyramids? That means that the needs are in order of priorities.

Human Needs

I

Food

Primary Needs

III

Cloth etc.

Security

Secondary Needs

I Financial Status etc.

In case of primary needs like the supply of oxygen, food, sleep etc., they are never satisfied. Secondary needs like security, social status and esteem etc. do not crop up. Man does not bother about primary needs as they are abundantly available. Need is felt only when they are not available. One feels need of oxygen when his throat is choked. Normally nobody bothers how oxygen is going in. Once primary needs are met, one starts thinking about secondary ones.

1.2 WHAT IS INSURANCE?

Human being is always in search of security and protection and his urge for security is tremendous. A continuous desire for it had lead him to think and develop the concept of insurance. Historically, the idea of insurance was made in Babylonia and India at quite an early period. The provision of sharing future losses was also advised in the codes of Manu. In India, Aryans shared loss or profit through their village co-operatives. Thus man has always been in search of security and protection.

In olden days, the insurance contract took the form of a bargain between those people interested in a marine adventure and those traders who were willing to take a share of risk for money- "Premium". Marine Insurance started with this. It grew in the 14th century due to the increase of trade.

Later on, individuals or companies formed to undertake assurances on human life and the risk of fire. After 1700 BC, life and fire business grew and prospered.

Unit 1 Introduction

Insurance is a business which protects the economic value of an asset as every asset has a value. This asset may generate some income and satisfy the needs of the owner. For example, in a manufacturing unit, production is sold and income generated. In case of a motor vehicle, it provides convenience in transportation and hence comfort to society.

Every asset has some life span and is expected to perform during it. The owner of the asset being aware of this, makes alternative arrangements at the end of the life of the asset to ensure continuous flow of income. However, due to accident or any unforeseen event, the asset may be destroyed or lost, with the result that the owner suffers. Insurance is a mechanism that helps to reduce adverse consequences like these.

The legal definition of insurance is that, it is a contract between the insurer and the insured, whereby, in consideration of the payment of premium by the insured, the insurer agrees to make good any financial loss which the insured may suffer due to the operation of an insured peril. This contract is governed by the Indian Contract Act, Insurance Act and Common Law.

Activity A :

Give any two incidences for which you feel that insurance is certainly needed.

1.3 AIM AND NECESSITY OF INSURANCE

The development of miscellaneous (accident) insurance is linked with the Industrial Revolution. The social and economic changes increased the hazards of life and property, giving rise to miscellaneous accident insurance. The social, economic and environmental changes after World War II have resulted in many types of new coverages like oil, space, computer, information and bio-technology. Anew concept of package policy has been introduced.

Various liability policies are introduced to provide indemnity to the insured in respect of the financial consequence of legal liabilities. Increase in awareness about the rights and globalization, the complexity of risks in today's industries, commerce and public environments have resulted in constant review and changes in many types of coverages.


Several disasters, gave rise to new liabilities. For example, flood losses in Maharashtra, an earthquake in Kashmir, the terrorist strikes on 1 1th September, 200 1 in America, etc.

In 2000 BC, the concept of General Insurance emerged to support the financial transactions involved in overseas trade due to commercial globalization

The basis of insurance was the sharing of losses of a few amongst many. This insurance provides financial stability and strength to the individuals and organizations by the distribution of loss of a few among many by, building a fund over a period of time. Assets may be destroyed or made nonfunctional due to peril or accident, but they can be insured. Flood, fire, earthquakes, breakdowns are called perils. The risk is the damage caused to assets due to these perils.

Risk is the only possibility of loss or damage; it may or may not happen. There must be uncertainty about the risk, only tnen fs trie insurance is relevant. Tnere cannot insurance iT there is no uncertainty about the occurrence of an event. The word risk may be used for exposure to danger, peril or loss producing event. For example, motor insurance covers the risk of accident, theft etc. In case of property insurance, the presence of hazardous material is treated as bad risk in the case of fire insurance .

Activity B ;

List the assets in your house for which insurance is required.

1.4 THE MECHANISM OF INSURANCE

People who are exposed to common risks come together and share the loss and make good to the person who suffers it. For example, people using motor vehicles are exposed to the risk of road accidents, jewelers face the risk of robbery, theft and burglary. With this, the risk is spread among the society and the loss is reduced to a manageable amount.

The loss is shared by each person proportionally and this share can be collected from the members after the loss has occurred or may be collected in advance. Insurance companies collect it in advance and create a fund from which the losses are paid.

Unit 1 Introduction

A human being is also an income generating asset. This asset may be lost due to an unexpected early death or the inability to earn due to disability as a result of accident or illness. If an alternative arrangement is not there, insurance takes care of all the dependents.

Insurance does not protect the asset or prevent the loss due to peril or help to avoid the peril. It only reduces the impact of the risk and compensates the loss. Only economic or financial losses can be compensated.

Insurance covers tangible assets and intangible assets. Exporters may suffer losses due to sudden changes in the currency as a result of political disturbances or economic changes. Doctors, contractors, chartered accountants may be held responsible for negligence while performing their duties and the liability which arises is quite substantial. These liabilities are covered by the insurance company.

The concept of insurance become popular because one can share the loss with other people who are exposed to a similar risk. Also, nobody deliberately causes damage to his own property and asks others to share the loss. Thirdly, the occurrence must be sudden, accidental and fortuitous in nature.

J$ Activity C:

"Insurance covers tangible as well as intangible assets." Explain.

1.5 CONCEPT OF INSURANCE WORKING

The primary function of insurance is to act as a risk transfer mechanism. For example, there are thousands of two wheelers in a town. Suppose ten vehicles meet with an accident in a year and cost of repair is Rs. 20,0007- each; the total cost works out Rs. 2,00,0007-If each owner of the vehicle contributes Rs. 2007- every year, Rs.2,00,0007- will be contributed towards the common fund and the loss paid from this fund. Thus the risk of ten people will be shared by a thousand.

The value of a Mercedes Benz is Rs. 24,00,0007- and this is one of the largest investments made by the car owner. The car could be stolen, damaged in an accident or catch fire.


There may be serious injuries to the pedestrians due to accident.

How the car owner face these financial consequences? Insurance itself will not prevent any of above risks from occurring but can provide some financial security. The owner of the car can transfer the financial consequences of the risk to the insurance company and in return, pay a premium.

Thus sharing of risks is the fundamental basis of working of insurance.

1.6 CREATION OF A COMMON POOL

An insurer who does the business of insurance and the insurance,bring together people of common interest,collecting the share or contribution (premium) from all of them and paying compensations (claims) to those who suffer a loss. The contributions have to be enough to meet total losses in any year but in addition will have to cover the other costs of operating the pool, including profit to the insurer. Even taking into consideration all costs, insurance is a still a very attractive proposition in most cases.

From an individual point of view, insurance is an economic device whereby the individual can substitute a small cost (premium) for a large uncertain financial loss that would have be borne if insurance had not been available. It has two fundamental characteristics:

a)Transferring or shifting of a risk from one individual to a group.

b)The sharing of losses, on some equitable basis, by all the members of a group.

Thus people who suffer a loss get compensated and who do not suffer are relieved as they have abstain from losses.

The insurer manages the common fund on behalf of the society and ensures that no one takes advantage of it.

JS$ Activity D;

"The characteristics of insurance are interdependent". Is this a true statement? Explain with reasons.

Unit

Introduction

1.7 INSURANCE AS SOCIAL SECURITY

To widen the scope of general insurance in the national economy, the industry operates Social Security Schemes. Social security and social insurance is included in the Indian Constitution with workmen's compensation, personal accident insurance, Social Security Scheme (PASS), Solatium Fund, Hut Insurance Scheme, Crop Insurance, etc., which are some social schemes operated by the insurance industry.

Special insurance schemes are devised at subsidized rates of premium for rural families to cover cattle and other livestock and for the benefit of financial institutes and other sponsored government schemes.

To support to the government, various insurance schemes have been introduced, like Bhavishya Arogya, Janata Personal Accident, Jan Arogya etc.

According to national policy, the state government also has to make provision for sickness and disablement. Thus for social security, the state government passed various laws and the use of compulsory or voluntary insurance. According to Employees State Insurance Act, the expenses for sickness, disablement, death and for maintenance of dispensaries, hospitals, etc. for industrial employees have to be paid.

All these schemes are helpful to the community as a whole, including farmers, to maintain agricultural production and hence contribute to the economic growth of the nation.

$ Activity E:

"The insurance industry has achieved a goal of Social Security and Social Insurance." Comment.

1.8 ROLE OF INSURANCE IN ECONOMIC DEVELOPMENT

Insurance plays a very vital role in the economic development of the country. For economic development, investment is vital, for which savings are needed. A huge amount is collected by way of premium from the policy holder. This fund is invested in various schemes for the benefit of society.


Various direct and indirect benefits are provided by insurance to the individual, his family, industry, commerce, to the community and to the nation as a whole. Insurance provides protection from loss to individual and corporates, thus protecting the capital of the industry and releasing the capital for further expansion and development of business and industry as a whole.

It provides stability to individuals and organizations. Aflourishing business can be brought down overnight due to some disaster. It is the insurance cover which provides security and the feeling of psychological support. It stands by in odd hours by the side of those insured. It takes care of financial institutions/bankers so that they can make advances or sanction loans, as their assets have been covered by insurance policies. It saves societies in the face of catastrophic losses.

Insurance companies established the Loss Prevention Association of India which creates awareness for loss prevention and preventive measures in various sectors of economy, thus increasing productivity and saving national wealth.

It also closely associated with fire and cargo loss prevention, industrial and road safety. The salvage corps of Loss Prevention Association of India works in collaboration with fire brigades to save property from damage by smoke, water and heat.

Pre-acceptance survey is also arranged, which suggests and recommends various improvements in the risk, thus attracting lower rates and reducing the potential of loss. For example, building a fire proof wall near the furnace to protect the material from fire damage, or installing a burglar-proof safe in the bank to avoid robbery and theft.

Indian insurance industry operates in more than 30 foreign countries and earns foreign exchange.

In a nutshell, insurance activities provide a big support to industries, businesses and organizations and help in the development of economy of the country.

Since insurance companies are selling a promise to stand on the side of insured, it is important for the insurer to come up to the expectations of the client. Insurers should remember that they are selling promises - on paper - to standby in odd hours. With this, the responsibilities of insurance companies become multifold.

Unit 1 Introduction

JS$ Activity F;

"Insurance plays a vital role in the economic development of a country." State your views.

1.9SUMMARY

In this unit we have discussed how the concept of insurance developed. It provides one of the basic needs of human beings. Basically, insurance is the sharing of the losses of a few among many.

With various policies, insurance provides financial stability and security to the individual and society as a whole.

it contributes in the economic development of the country through a large investment of funds accumulated through premiums. Through overseas business, it helps to increase the foreign exchange of a country.

1.10KEY WORDS

\ccident

Claim Amount Consideration Contract of Insurance

Any unforeseen and unexpected event is considered an accident. For insurance purposes, it has to be due to external, physical and violent means.

It is the amount payable by the insurer under a policy on a claim arising.

Price, token, or other matter used as an inducement for the completion of a contract, as an insurance premium.

An agreement between the insurer and one or more parties, called the insured, whereby the insurer undertakes to pay to the insured a certain sum of money or to grant certain compensation on the happening of a specified event, in return for the payment of a certain consideration, called the premium.


Insurable Interest

Insurance

Insurance Company

Insurance Entities

An interest which might be damaged if the peril insured against occurs; the possibility of a financial loss to an individual which can be protected against through insurance.

An economic device whereby the individual substitutes a small certain cost (the premium) for a large uncertain financial loss (the contingency insured against) which would exist if it were not for the insurance contract; an economic device for reducing and eliminating risk through the process of combining a sufficient number of homogeneous exposures into a group in order to make the losses predictable for the group as a whole.

1 ) An organization chartered to operate as an insurer.

2) Any corporation primarily engaged in the business of furnishing insurance protection to the public.

Any corporate body or individual which is operating as an insurer, re-insurer or insurance intermediary and which is subject to insurance regulation.

ct\% dd^

Insurance Policy

Insured

Insurer

Lloyds

Legal document issued to the insured setting out the terms of the contract of insurance.

The person to whom or on whose behalf benefits are payable under the policy.

Alicensed legal entity, which underwrites insurance, including a mutual insurance company (but note the exemption of pure re-insurers).

A voluntary unincorporated association of individuals organized for the purpose of writing insurance; normally refers to Lloyd's of London, a group of individual underwriters and syndicates that underwrite insurance risks severally, using facilities maintained by the Lloyd's of London Corporation.

Unit 1

Introduction

Peril Policy

Policy Holder

Policy Term Pool

Premium

The event insured against; the cause of possible loss.

The legal document issued by the company to the policy holder, which outlines the conditions and terms of the insurance; also called the policy contract for the contract.

The person (or persons) whose risk of financial loss from an insured peril is protected by the policy; a person who pays a premium to an insurance company in exchange for the insurance protection provided by a policy of insurance.

The period for which an insurance policy provides coverage.

A risk-sharing mechanism in which the members of a group agree to be collectively responsible for losses.

The sum paid by a policyholder to keep an insurance policy in force. It is the amount paid to secure an insurance policy

1.11 SELF-ASSESSMENT QUESTIONS

Ql. Describe the mechanism of insurance.

Q2. What benefits does insurance bring to the community as a whole?

Q3. Write a note on the role of insurance in the economic development of India.

Q4. "Nowadays insurance is one of the basic needs of human life." Comment.

11


2.1 INTRODUCTION

No individual, firm, organization or society can know all that the future holds. Uncertainty is a fundamental truth of life. To a common man, uncertainty and risk are synonymous. Individuals and families are exposed to the chances of loss due to disease, accidental injury and death, unemployment etc. Firms may suffer loss due the destruction of property, marketing risk, financial risk, distribution risk and so on. The risk is inherent in developed and developing countries. Human life and material possessions are vulnerable to losses or to damage by a number of destructive forces. It is beyond doubt to say that there is a great deal of uncertainty in life, commerce and industry. It is not that man is unaware of uncertainty about what the future holds for him - he is very well conversant and hence exhibits a strong desire for security both for lives and material possessions. The urge for security is satisfied only when one takes all possible precautions to avoid the consequences of risk. Inspite of this, accidents do occur.

The dictionary meaning of risk is chances of injury, loss or damage. In simpler terms, the possibility of adverse result from any event or occurrence is termed as risk. Risk arises out of uncertainty. If uncertainty is known there is no risk.

2.2 RISK AND UNCERTAINTY

Uncertain events fall into two broad categories. The first category is those for which the probability of occurrence is calculated either on a priori grounds or through the statistical analysis of a series of similar events which have occurred in the past. The remainder does not have such measurements because they are unique in nature. The first group is called as RISKS and latter is called as UNCERTAINTY.

Risk can be defined in many ways as follows

Risk is the possibility of an unfortunate occurrence.

Risk is a combination of hazard.

Risk is an uncertainty of loss.

Risk is the possibility of loss.

There are different levels of risk. All risks do not always occur. Some are riskier than others.

Let us imagine a house by the side of the river. This river always overflows its banks. This is risky as there is uncertainty regarding the overflow of the river and damage to the house.

Unit 2 Conceptual Framework of Risk

The fact is that the river is known for flooding and so frequency of damage will be high and so it is risky.

If we imagine a second house which is on a slight hill and far from the river bank, it is less risks. The possibility of flooding will not be altered but the chances of damage to the house are lower. So when we consider a risk, it must be recognized that it is a combination of event- occurrence and it can cause damage.

For examples, Risks- accidental death, injury, loss due to fire, flood, etc. Uncertainty- unexpected gain, large wins on football pools.

Three points may be made regarding the nature of uncertain events:

the occurrence of some events may result in either gain or loss, whereas others causeonly loss;

some events are the results of human behaviour, others are beyond human control;

of those events what can be the results of human action (or inaction),

In some cases the originator and the victim are the same person, whereas in other cases they differ.

&$ Activity A;

A firm has launched a new soap in the a market. List the risks and uncertainties faced by the firm.

There can be the following types of risks

Classification of risk

1 Pure

Speculative

34

Dynamic Static

Fig 2.1

ii

56

Fundamental Particular


Now let us study the risks in detail.

2.3 PURE AND SPECULATIVE RISKS

2.3 fUKJi, mxu ox a^vxvj*^~~.~ ,

;i

Those risks in which the occurrence of the event results in a loss with no possibility of gain, i" -j^c,i,i

Pure risks involve a loss, hence the outcome can only be unfavorable.

fureriMvs mvuivw *~^,

The risk of motor accident, fire at a factory, theft of goods from a store, injury at work are all pure risks. There is no possibility of gain in this situation. There will be accident, fire, theft, injury or not. If the events do not take place then the situation is unaltered and no one has gained.

There are risks which insurers offer to insure. In such situations, there may or may not be the possibility of loss. But for certain cases, there is no gain to the insured or the insurer.

For example, storms and motor accidents. Some take insurance policies for their motors or factories, incase there is a fire in the factory or that policy can go claim free. A motor car may meet with an accident during the currency of policy or may go claim free throughout the currency of policy. But no one stands to gain out of this incident.

Classification of pure risks

a) Personal risks: An individual has to face the following pure risks:

i) Unemployment

ii) Premature death

iii) Dependent old age

iv) Sickness or disability.

b) Liability Risks:

Unintentional injury to other people or damage to others' property due to negligence or carelessness. c) Risks arising from failure of others:

Risk of obligation may arise due to the failure of others.


d) Property Risks: Direct losses or consequential losses:

The risks which are not of an individual nature are also called pure risks.

The loss of property.

Loss of use of property.

Additional expenses due to loss of property.

Speculative Risks :

Those risks where the outcome may be either a profit or a loss, the risk is called speculative risk. These are those risks which insurance companies refuse to accept. In these, there are chances of gain. For example, changes in fashion, all gambling transactions, either profit or loss (events), investing of money in shares.

In the world of business, there are both, pure and speculative risks. Let's look at a case study to understand the pure and speculative risks of a food manufacturer. He has a large factory with sophisticated machinery and production lines. He produces a range of foodstuffs for domestic use and foreign export. Let us look at some of the risks to which he is exposed.

Pure Risks :

There could be damage to the factory, machinery and stock due to fire, storm, flood,malicious damage or any other peril.

The manufacturer is also exposed to the risk of theft of finished stock, raw material oreven machinery.

There may also be liability due to injury to employees, visitors, or for injury or sufferingdue to consumption of products.

Machinery may break down and take time to repair or replace, thus involving thecost of repair, the loss of production resulting in loss of profit.

Speculative Risks :

Wrong pricing of the product may render the product uncompetitive, or not yieldsufficiently high returns and thus not result into increase of profit.

Marketing decisions are also speculative risks as correct interpretation of the marketgenerates profits. If not, it leads to loss.


Any decision regarding expansion, acquisition or diversification, may result in profitor loss.

Providing credit to the customers is also risky as although the goods are sold, customersmay not pay.

So the world of business is full of risk and uncertainty. While stressing the differencesbetween pure and speculative risks, let's highlight the fact that "pure risks are normallyinsurable while speculative risks are not insurable.",

JS$ Activity B;

Write down two examples each for pure and speculative risks.

2.4 DYNAMIC AND STATIC RISKS

Dynamic risks:

These arise from the changes that take place in every society, which are the economic, social, technological, environmental and political changes. Changes in the price level, consumer tastes, income and output, urban unrest, technological changes which cause financial loss to the members of the economy, are examples of this.

In the long run, dynamic risks are beneficial to society as they are due the result of adjustments to the misallocation of resources. These are less predictable as they affect the society at large and do not occur regularly.

Dynamic risks are closely related to speculative risks. Static Risks :

They occur even if there is no change in the economy. These losses occur for reasons other than the change in economy, such as material damage to property, loss in business profit due to fire, dishonesty of the other individual, etc.


Static risks do not give any profit to society. They involve losses due to the destruction of assets, human failure, or change in possessions due to dishonesty. Static risks are predictable because they occur regularly.

That is why static risks are insurable while dynamic risks are not insurable. JS$ Activity C:

After a market survey, a biscuit manufacturer launched a product with both, a sweet and a salt taste. After a few months, he found that suddenly, tastes had changed to biscuits mixed with chocolate. Identify the risks faced by the manufacturer.

2.5 FUNDAMENTAL AND PARTICULAR RISKS

isons siness

These are the risks which affect the whole of society or a major part of it. These involve losses that are impersonal in cause and effect. Fundamental risks are those which arise from causes outside the control of any individual or even a group of the individuals. It includes uncertainties which arise due to political intervention, economical and social changes, war, flood, earthquakes, famine, volcanoes and other natural disasters. All are impersonal in both, cause and effects.

Particular Risks:

These risks mainly affect the individual or firm rather than a group. It involves losses that arise out of individual events and from factors over which he may be exert some control. They may be static or dynamic in nature. For examples, the burning of a house, robbery of a house, motor accidents, fire, theft, work related injury.

It may be argued that society should accept responsibility for losses incurred by an individual, arising from fundamental risks. An individual has to make his own arrangements for dealing with particular risks. Over time, division between fundamental and particular risks have changed. In the past, unemployment was regarded as a personal matter, but now a days is recognized as the responsibility of the government.


Similarly, Injury in motor accidents, injury at work and injury caused by faulty products -in each of these cases, society has decided that those who are injured should be able to receive financial compensation. Suitable legislation has been passed to ensure that suitable insurance is in force or that who are injured need not have the burden of proving the fault.

Fundamental risks are caused due to conditions which are not within the control of the individuals who suffers the losses without fault. It is argued that society should collectively take responsibility for such losses and so social insurance is there for such losses. For example, the "Hit and Run" scheme. Particular risks are insured individually, though some fundamental risks like earthquakes are covered by individual insurance.

& Activity D:

"Fundamental risks are normally so uncontrollable, widespread and indiscriminate that it is felt they should be the responsibility of society as a whole." Comment.

JS$ Activity E;

List the various risks faced by the government as well as individuals, due to the heavy rains of 26* July, 2005 in Mumbai.

2.6 CHARACTERISTICS OF INSURABLE RISK

Insurance is a contract between the insured and the insurer. The legal right to insure, arising out of the financial relationship recognized under law, between the insured and the subject matter of insurance.


Characters of insurable risks are as follows:

1.It should be measurable in terms of money: Sometimes the market value is lessthan the sentimental value of a product, but the sum insured for the purpose is equalto the market value as the sentimental value cannot be measured in terms of money.For example, paintings, works of art, antique pieces, etc..

Valuation from professional experts is the basis for sums insured in all these cases, because the sentimental value is more than market value.

2.There should be pure risk : After the occurrence of a certain event, the ownermust suffer loss with no possibility of gain. For example, theft, burglary, lightening,fire. There is no element of gain in any of these situations and the outcome can only beunfavourable to us.

3.It should not be against public policy: If any matter is proved dangerous orcatastrophic to society, then it cannot be insured. For example, if a percentage ofalcohol in a drug is more than specified by the drug association, then the publicliability policy is not issued as it is dangerous to health.

4.Existence of the subject matter of the insurance : The insurance is given to asubject matter which is in existence and not to fictitious and imaginary objects. Forexample, for a common man, an Individual Personal Accident Policy to cover ajourney to the moon is not possible.

5.Occurrence of the incidence should be accidental: Loss of property must bedue to accident and it should not be intentional. For example, suicide or attemptedsuicide is not covered.

6.There must be some property, right, interest or potential liability capable ofbeing insured: Changes in price levels cannot be insured as due to this, there maybe loss or gain. For example, political changes can bring greater governmentintervention in employment, marketing, investment and thus these cannot be insured.

7.The insured must stand to lose in case property is damaged: The basic principleof insurance is insurable interest. It must be observed while taking insurance and aloss should be suffered when property is damaged. For example, fire in a factory,theft of money. In all these cases, there is the possibility of loss.


8. Existence of a legally enforceable relationship: There must be a legal right to insure some property. This insurable interest may arise due to common law, by contract or by status. For example, the corporation has given permission for a seven story building, but the builder built a nine story building illegally, hence the illegal construction cannot be covered under insurance.

J$ Activity F:

Give two examples for each of the characteristics of insurance.

2.7 WAYS OF HANDLING RISKS

Several methods are in everyday use for the handling of both, pure and speculative risks. They include avoidance, risk reduction, risk retention, combination, transfer, heading and research.

1. Avoidance: Avoidance is the most drastic way of handling risk. It involves ceasing to undertake the activity which creates the risk, or performing it in another way or at some another place. For example,

L An escape of highly toxic gas may be so catastrophic that a chemical factory may decide to avoid this risk by ceasing to produce or use it.

iL A risk of damage by flooding may be avoided by moving to another site well above recorded flood levels.

iii. A firm may seek to avoid the risk of employees being attacked when carrying wages in cash from the bank by changing over to payment by cheque or by credit transfer.


& Activity G:

Write down examples of situations in which risk cannot be avoided and hence you have performed it in another way so that the risk was minimized.

2. Risk Reduction : It covers all methods employed to reduce either the probability of the occurrence of loss-producing events or the potential size of losses that do occur. It is rarely possible to totally eliminate a risk. For example,

i. Machine guards designed to prevent operatives coming into contact with moving parts.

ii.

.

v.

Safety valves on pressure vessels reduce the chances of accidents. Wearing a car seat belt while driving reduces the severity of the accident. Fire proof wall near the furnace to avoid fire spreading to a nearby location.

at

Loss-reduction activity is a contingency planning to minimize the extent of losses caused by occurrence of loss producing events. Also in case of emergencies, people should trained to handle the situation. For example, alternative arrangements should be there for power or material supply or manufacturing facility.

The above steps have to be taken to avoid losses or reduce their frequency of occurrence or severity, but some possibility remains of loss producing events which can be handled by using the following methods.

$ Activity H:

Find out two examples in which the risk is reduced by using mechanical devices.


3. Risk Retention: The easiest and often the cheapest way of dealing with relatively small losses is to pay for them out of one's own resources when they occur, or possibly to set aside a contingency fund to pay for large losses.

Such a retention of risk may either be a deliberate decision or the result of a failure either to recognize that such a risk exists, or to deal with it in some other way. Events of high frequency and low severity fall in the self retention category. For example,

L Small shopkeepers retain the losses instead of paying the insurance premium.

ii. Only big machines of high value are being insured and losses due to small machines are retained by corporate clients.

iii. The excess imposed by insurance companies is a form of retention to bear small losses to the insured.

^Activity I:

"Generally fleet owners create a fund to pay for small losses instead of paying a premium. "Express your views.

4. Combination: By combining a large number of independent exposure units in one portfolio, an insurance company is able to share the losses of a few among many. By collecting money, a sort of a pool of funds is prepared and out of this, the loss is made good. For example,

i. A large retail group, by centrally pooling the risk of breakage of it's shop windows, can afford to carry the risk by itself instead of insuring.

ii. A housing society collets charges from all members every month and if there is failure of water supply to anybody's house, can bear the expense from this fund.


ygT Activity .T :

Suggest any plan which uses combination as a way of handling risk, so that losses can be paid through it.

5.Transfer: Risks may be transferred in two ways. A firm may seek to transfer theactivity which creates the risks, or contractual arrangements may be made to transferresponsibility for any losses from one party of the contract to the other party. Forexample,

i. A civil engineering contractor may sub-contract particularly hazardous jobs like underwater operations, to a specialist firm.

ii. Exclusion and indemnity clauses in contracts of sale, building etc. are common examples.

iii. The most important form of risk transfer is insurance.

6.Hedging : Firms that enter into contracts to supply goods at fixed prices in thefuture, face the risk that a rise in prices between entering into the contract and thedelivery date may involve them in a loss. In such cases, some protection can beobtained by hedging against exchange movements by entering into forward contracts.For example,

The foreign exchange regulation of India permits importers to enter into the forward purchase of specific foreign currencies for a specified period. Then, regardless of the exchange rate prevailing on the date of payment, the importer's liability will be limited to the cost of purchasing the foreign currency at the time of entering into the forward purchase contract, thus limiting his loss, if any.

7.Research: Research designed to improve the information on which decisions aretaken, can help to reduce risk. For example,

i. Marketing of a new product may seek to reduce the uncertainty by conducting market research.


iL A search for good packing material reduces the risk of evaporation of volatile substances.

Activity K:

Identify the risks in a chemical factory and give your suggestions regarding handling these risks.

2.8 SUMMARY

In this unit, we have learnt what is risk and what is uncertainty. Risk may be classified into pure, speculative, dynamic, static, fundamental and particular. We have discussed in detail about these risks with the help of various examples.

\

We have also discussed the essential characteristics of insurable risk.. These are necessary to obtain insurance.

Various ways of handling risks have also been introduced. Generally, in practice, two or more methods may be employed in handling risks.

For example, loss prevention and insurance are usually complements, not substitutes. Although a firm may spend a large amount to reduce the incidence or severity of industrial accidents, the employer's liability must be to insure.

2.9 KEYWORDS

Dynamic Risks Pure Risk

Risk Speculative Risk

Those risks which results from changes in economy.

A condition in which there is the possibility of either loss or no loss.

Adverse results from any occurrence is called as risk. A condition in which there is a possibility of loss or gain.


Static Risks types of Risks

Types of handling Risks

Uncertainty

: Those risks which result in other than changes in economy. : Pure, speculative, dynamic, static, fundamental, particular.

: Avoidance, risk reduction, retention, combination, transfer, hedging and research.

: Losses which are due to unique events.

2.10 SELF-ASSESSMENT QUESTIONS

itutes. strial

Q1. What do you understand by the term "Risk"? How is it different from uncertainty? What are the characteristics of insurable risk?

Q2. How do you differentiate between Pure Risk and Speculative Risk? Why don't insurers insure speculative risk?

Q3. Discuss at length the methods to handle risks. Can we eliminate risks? Explain.

Q4. Fill in the blanks:

a) Insurers do not insureproducts.

b)Events of

category.

c)Insurance is.

frequency andseverity fall in the self retention

of risk.

also.

or

d)In speculative risk, there can be

e)Pure risks may result in

a)Trading risk

b)Impersonal in nature

c)Insurance

d)No risk

e)Insurable risk.

Q5. Match the following:

1.Transfer of risk

2.Change in fashion

3.Fundamental risk

4.Pure risk

5.Known event


Q6. Write two examples of each:

a)Pure risk

b)Speculative risk

c)Particular Risk

d)Fundamental Risk

e)Dynamic Risk

f)Static Risk.

g)Risk avoidance,h) Reduction.

i) Transfer, j) Retention.


3.1 INTRODUCTION

A contract may be defined as an agreement between two or more parties to do or to abstain from an act and this agreement is intended to create a legally binding relationship. This could be summarized as 'an agreement designed to have legal consequences'. All contracts, including the insurance contracts, are governed by the general principles of the law of contract as codified in the Indian Contract Act, 1872. This Act provides that all contracts must have certain essential elements in order to be legally valid. Insurance contracts are also subject to the essential elements applicable to any commercial contract. However, insurance contracts have certain peculiar or special characteristics which have led to the development of a special body of common law. These special legal principles which evolved under the common law, relate to:

(i) the existence of insurable interest to support the insurance contract.

(ii) compensation or indemnity for actual loss, and no more, under the insurance contract.

(iii) observance of utmost good faith by both parties to the contract.

3.2 NATURE OF INSURANCE CONTRACTS

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 j event resulting in loss to him.

3.3 ELEMENTS OF INSURANCE CONTRACTS

All contracts, including insurance contracts, must have the following essential elements in j order to be legally valid:

1) Offer and acceptance

Like any other contract, the contract of insurance is completed when one party ace the offer made by the other party. The offer usually comes from the proposer andt offer is known as the proposal. The proposal may be made orally, on the telephonej or it may be made in writing, by means of a letter or by means of a proposal form. I fire insurance, proposal forms are invariably used. Separate forms are usedl residential premises, offices, shops and for industrial risks, godowns etc. fort convenience of the proposer. In accident insurance too, the offer is invariably requ to be made by the completion of a proposal form. Insurers indicate acceptance!:

Unit3

Essential Features and Fundamentals of General Insurance

the issue of a cover note or a letter of acceptance. In the latter event, the acceptance letter becomes another offer which is accepted by the payment of premium by the insured.

2)Consideration

No contract is valid unless there is due consideration. Consideration is the "act or promise offered by one party and accepted by the other as the price of that other's promise." Consideration consists of some profit or benefit accruing to the one party or some loss or responsibility suffered or undertaken by the other. In the case of insurance contracts, 'premium' is the consideration from the insured and the 'promise to indemnity' is the consideration from the insurer. According to the Insurance Act 1938 as amended in 1968, prior payment of premium is a pre-requisite for assumption of cover by insurers.

3)Agreement between the parties

This is the principle of "consensus ad idem." Both parties should be of the same mind. In other words, there must be consent arising out of a common intention. For example, if the proposer desired a Mediclaim insurance, and the insurers issued a personal accident policy, there is no consent arising out of common intention. If the contract is entered into with an intention to deceive the other party or with a fraudulent intention, then the contract becomes void.

4)Capacity of the parties

As per the Indian Contract Act, 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 of sound mind and is not disqualified from contracting by any law to which he is subject. The persons to the contract should be competent to contract. Minors and persons of unsound mind cannot enter into insurance contracts. The legal capacity of an insurer to contract has to be explicit in its Memorandum and Articles of Association.

5)Legality of the contract

The subject matter of the contract must be legal. Section 23 of the Indian Contract Act, states: "The object of an agreement is lawful unless

(a)it is forbidden by law,

(b)it is of such a nature that, if permitted, it would defeat the provisions of any lawor is fraudulent,


(c)involves or implies injury to the person or property of another, or

(d)the court regards it as immoral or opposed to public policy".

For example, stolen vehicles and smuggled goods cannot be insured as the insurance of smuggling ventures or stolen goods would be regarded by courts as opposed to public policy.

3.4 PRINCIPLES OF INSURANCE

All Insurance Contracts are governed by the following four basic principles of insurance:

(1)Insurance Interest

(2)Indemnity

(3)Utmost Good Faith

(4)Proximate Cause

(1) Insurable Interest

The owner of property has a right under law to affect insurance on the property if he is likely to suffer financially when the property is lost or damaged. This legal right to insure is called insurable interest. Without insurable interest, the contract of insurance will be void. There are three essentials of insurable interest:

i There must be a property, rights, interest, life or potential liability capable of being insured.

i Such a property, rights, life, etc. must be the subject matter of insurance.

I The insured must bear a legal relationship to the subject-matter whereby he stands to benefit by the safety of the property, rights, interest, life or freedom of liability and stands to lose by any loss, damage, injury or creation of liability.

Insurable interest could arise in a number of ways, for example,

a) Interest arising from Ownership: The clearest and most common example of the existence of an insurable interest is that of an owner of a property. An owner of a building would suffer financial loss if it is destroyed or damaged by fire or by any other peril. The law therefore gives him a right to insure his property.

nit 3 Essential Features and Fundamentals of General Insurance

ice of ublic

f if he is insure is

be void.

of being

,dsto bilitv and

npK- ui iii. 3Vv ner of a or by any

b)Interest arising out of a Mortgage: One who has advanced money on the securityof property has an insurable interest in that property as he would suffer financial lossby loss or damage to the property.

c)Interest arising from law as a Trustee: The insured will have an insurable interestin not only the goods owned by him but also the goods held by him in trust or oncommission for which he is responsible.

d)Interest arising from law as a Bailee : Motor traders like garage proprietorshave as bailees, an insurable interest in respect of loss or damage to the customer'svehicles which are in their custody for repairs.

e)Interest arising from contract as a Lessee: An owner may rent his building to alessee with a provision in the contract that the lessee shall continue to pay rent even incase of fire. Lessee in such circumstances would wish to insure the loss of rent.

We shall now see some more clear examples of insurable interest:

Ownership of property (and joint ownership) is a clear example of insurable interest.

t A bank or other financial institutions have insurable interest in the property by reason of a loan granted by them. The interest is limited to the amount of the loan. Usually under such circumstances, the policies are issued in the joint names of the insured and the bank.

A ship owner has insurable interest in the ship owned by him. Cargo owners, both sellers and buyers, have insurable interest in the goods owned by them.

The owner of a motor vehicle has insurable interest in the vehicle; he also has insurable interest in a potential third party liability. If a third party is injured in the accident, the damages payable to the third party would be a financial loss to the insured. Hence, he can insure his third party liability.

Aperson has an insurable interest in his own life as it is assumed that any person's life is valuable to himself and he is deemed to have unlimited financial interest in it.

A creditor has insurable interest in the life of the debtor to the extent of the loan repayable by the debtor.

The service conditions, or special agreements with staff, sometimes provide that the employer shall pay a specified sum of compensation to their employees in the event of accidental disablement or to their legal heirs in case of death of the employee. Under such circumstances an employer will have an insurable interest in the life of the employee and he can take a group personal accident policy for his employees.

"Property anQ~LAatnUty ^insurance

Activit A :

Visit the nearest New India Assurance Co. Ltd. office and request for a policy in your name for a vehicle which is registered in your sister's / brother's name as the vehicle is always being used by you. Note down the reply given by the insurance company. Which is the principle of insurance applicable here?

Situations and times when insurable interest must exist:

In fire and miscellaneous insurance, it should be present at both times, at the time of buying and at the time of loss. If a fire has occurred in a shop and it is sold later, there is no insurable interest. Hence the owner cannot recover the amount.

In marine cargo, insurable interest is required at the time of loss. It may not be present at the time of effecting insurance. Ownership of the goods passes from the exporter to the importer when the payment is made. Although insurable interest is not required at the time of the issue of the policy, the importer must have a genuine expectation of acquiring insurable interest.

We shall now see how the insurable interest changes after the assignment of the polic\.

Assignment means transfer of rights and liabilities of an insured person to another person who has acquired insurable interest in the property insured. This person called the assignee, becomes the new insured to whom the benefit of insurance is passed. He is then entitled to deal with the insurers in his own name and recover directly any claim under the policy.

Fire and miscellaneous policies are assigned only with the consent of the insurers. Marine cargo policies are, however, freely assignable without the previous knowledge or consent of the insurer. The reason is that the ownership of the goods insured under a marine cargo policy frequently changes when the goods are still in transit. A marine hull policy cannot be assigned without the consent of the insurers. For example, during the currency of the policy, if the insured person sells his motor vehicle to another person and gets the vehicle duly transferred on the vehicle documents through the R.T.O., benefits under the policy

1.

Unit 3


vlarine onsent .? cargo mot be ^..y of the jhe vehicle r the policy

will not be transferred to the new owner unless the policy is transferred in the name of the new owner.

(2) Indemnity

The principle of indemnity arises under common law and requires that an insurance contract should be a contract of indemnity only and nothing more. The object of insurance is to place the insured in the same financial position as he was just before the loss. This principle prevents the insured from making a profit out of a loss and ensures public interest at large. The measure of indemnity for loss of or damage to the insured property is generally the intrinsic market value of the property at the place and on the date of loss or damage. The measures of indemnity applied to some types of property are explained below:

Building under fire insurance : In these cases, the cost of reinstating the building or repairing the damaged portion is assessed, and from that, an appropriate allowance is made towards depreciation, depending upon the age and condition of the building.

Machinery under fire insurance: The measure of indemnity is the market value, at the place and date of loss or damage, of the machinery of similar age, model and condition.

Stocks under fire insurance: In respect of the stocks of wholesalers and retailers, the measure of indemnity is not the selling price of the wholesaler or the retailer, but it is the price at which he can replace the goods.

Vehicles under Motor Insurance : The subject matter of motor insurance could be

physical property (the vehicle), and/or legal liability for third party injury or property damage.

The indemnity shall not exceed for total / constructive total loss of the vehicle, the insured's lared value of the vehicle (including accessories thereon) for partial losses, costs of .iir/ replacement as per depreciation limits specified in the policy. Claims for liability

are indemnified as per law, subject to limits, if any, under the policy.

Cargo under Marine Insurance: Marine insurance policies are issued as valued policies greed value policies. The agreed amount is payable in the event of total loss, irrespective msiderations of depreciation.

Methods of Indemnification:

Cash payment: This is the simplest method which is adopted by the insurer in most cases. When the insurers are satisfied in regard to the cause and extent of the loss, the loss is settled by a cash payment, that is, by cheque.


2.Repair : It may be more convenient to both parties of a contract of insurance, tosettle loss or damage claims by repair as is done in case of motor insurance claims.On receipt of final bill of repairs and a satisfaction note from the insured, the repaireris paid.

3.Replacement: The insurer sometimes arranges for the replacement of valuableitems like jewellery, and other special items. This method is rarely met in practice.

4.Reinstatement: Occasionally, an insurer may undertake to reinstate buildingdestroyed or damaged by fire or other insured perils when it is found that the amountclaimed by the insured is exorbitant. This option of reinstatement lies only to theinsurer under a specific condition of a policy but it is rarely exercised by the insurer inpractice. The reason being once this method is chosen by the insurers they cannotsubsequently withdraw and offer cash settlement.

Fire, accident, and marine hull policies are provided with true indemnities but under marine cargo, it is a commercial indemnity i.e. some amount of profit is allowed. However personal accident insurance is not at all a strict contract of indemnity as man has unlimited interest in his own life.

Effect of loss on the sum insured

When a payment has been made by the insurer in respect of a loss under a policy of insurance, it may be said that he has discharged his liability under the contract to the extent of the amount of the loss. Whether or not the sum insured under the policy is reduced by the amount of claims depends upon the terms and conditions of the policy. The position varies according to the type of the insurance.

Fire Insurance:

When a loss is paid, the sum insured under a fire policy stands reduced by the amoui paid, from the time of loss until the renewal date. The sum insured may be restored to original figure by an endorsement, on payment of the appropriate premium calculated on pro-rata basis from the date of reinstatement of the sum insured to the next renewal

Marine Insurance:

Under the Marine hull policy, any number of repair claims are payable under the policy, Sum insured does not get reduced and the question of restoration of sum insured does no! arise.

Unit 3


mce, to claims.

repairer

valuable actice.

building ; amount

lly to the

insurer in nnot

br marine r personal interest in

,cy of > the extent educed by ie position

mount .tored to the culatedona newal date.

a-me policy. tp.i does not

Motor Insurance:

Sum insured under the motor policy is the maximum limit per accident hence question of reinstatement does not arise.

Liability Insurance:

Reinstatement of the sum insured arises only if the policy stipulates an annual limit of

liability.

1'ersonal Accident:

Reinstatement of sum insured is not applicable. On payment of capital sum insured (death, loss of limbs) policy gets cancelled.

Valued Policies

A valued policy may be defined as a policy in which the sum insured is agreed between the insurer and the insured as the value of the property insured, which amount becomes payable in the event of total loss, irrespective of the considerations of the depreciation etc. These policies are issued for marine insurance and to cover some types of special properties which are difficult or impossible to replace or where it is difficult to establish the value at the time of loss. Valued policies are recognized by law and their issue is not considered as the violation of the principle of indemnity.

Limitations on the Insurer's Liability

Every policy of insurance contains a sum insured which is the maximum limit of liability under the policy. This value is not the agreed value of the property (except under agreed value policies) nor is it the amount which will be automatically paid in the event of loss or damage. The amount payable under the insurance contract is the actual loss or the sum insured whichever is less.

i The property insurances are generally subject to the condition of average, and if there has been underinsurance, only that proportion of the loss is payable, which the sum insured bears to the market value of the insured property at the time of loss.

Some policies are subject to 'excess' or 'franchise' which means that under certain circumstances; a part of the loss may have to be borne by the insured. In these circumstances the insurer's liability is the measure of indemnity less the amount of 'excess' or 'franchise'. For example, excess (also known as compulsory deductible)


for motorized two wheelers is Rs. 50/-. In case of each and every own damage claim, settlement of the claim will be done after deducting Rs. 50/- from the claim amount.

There are two corollaries of principle of indemnity:

Subrogation and Contribution.

SUBROGATION

Subrogation is a principle which is applied to all contracts of indemnity. It may be defined as the transfer of rights and remedies of the insured to the insurer who has indemnified the insured in respect of the loss. It means that after payment of the loss the insurer gets the right of taking all steps to recover any money in compensation from a third party. For example,

a. Insured property may be destroyed by fire caused by the negligence of a third party who is at law responsible to make good the loss. The insurer having indemnified the insured is entitled to the insured's right of recovery against the third party.

b.

If the cargo is damaged due to the negligence of a carrier (for example, railways, 1truck operators, shipping companies etc.) who have an obligation to make good theloss of the insured, the benefit of this obligation pass to the insurer.:

c.

In case of a theft claim, the vehicle may be traced after the settlement of the claim. As, a total loss claim is settled by the insurers, rights of the insurers are subrogated to the. insurance company. To preserve this right, the insured has to sign a subrogation bond! prior to the release of the claim cheque.

CONTRIBUTION

Indemnity is also governed by the principle of contribution. An insured may have severalinsurances on the same subject-matter. The insurer is liable to contribute proportionatelythe loss to the extent of its interest. If a property has been insured with more than oneinsurer, in the event of a loss the insured will get a proportionate part of the loss from each-insurer, so that the insured does not make a profit out of the settled claim.|In order to understand the application of the principle of contribution in practice, letuslconsider the following examples:J

Unit 3 Essential Features and Fundamentals of General Insurance

Sum Insured Amt. of Loss Assessed Policy ARs. 100007-Rs.l 20007-PolicyBRs. 200007-Policy C Rs. 300007-TotalRs. 600007-

The amount payable under Policy A, B and C will be as follows:

Amount Payable

Policy ARs. 20007-

Policy BRs. 40007-

Policy CRs. 60007-

TotalRs. 120007-

The amount payable under each policy is arrived at by the following formula :

Sum insured under each policy

X Loss Assessed

Total sum insured under all policies

-Contribution by each policy towards the total loss assessed.& Activity B;

Mr. X had insured his Maruti Zen for the period 12.05.2005 to 11.05.2006. The vehicle

was stolen from the parking lot between 20.01.2006 to 25.01.2006 when the insured

was out of station. He lodged a F.I.R. and submitted all the documents to the insurance

;npany. After completing the formalities, the claim was settled on 15.04.2006. On

15.06.2006, the vehicle was traced by the police. Police authorities informed the insurance

company, who had settled the claim as the insurers had informed the police station about

the settlement of the total loss claim for theft of the vehicle. Insurers had also taken

subrogation bond from the insured. Someone who noticed the vehicle informed the insured

! he went to the police station to claim the vehicle.


Answer the following with reasons:

1. Can the insured take the possession of the vehicle?

2. Is the insurer's right of subrogation protected?

(3) Utmost Good Faith

The parties to a commercial contract, according to law, are required to observe good faith. The seller cannot mislead the buyer in respect of the transaction, but he has no obligation to disclose all information about the subject of the contract. It is the buyer's duty to be careful whilst entering into the contract. 'Let the buyer beware' is the legal rule.

In insurance contracts good faith is required to be observed. The proposer has a legal duty to disclose all material information about the subject matter of insurance to the insurers who do not have this information. The material information is that information which enables the insurers to take an underwriting decision, that is, the decision whether to accept the risk, the rate of premium and terms and conditions of acceptance or reject the risk. This is called the legal duty of utmost good faith arising under common law. The following are some examples of material facts:

Fire Insurance:

Construction of the building,

Occupancy of the building i.e. whether occupied as factory, godown, shop etc.

Nature of goods, that is, non-hazardous, hazardous, extra hazardous.


good he has no

ie buyer's legal rule.

legal .surers ich enables > eptthe This is Bowing are

Marine Insurance:

Method of packing

The nature of goods

The vessel carrying the goods

The ports of shipment and destination etc.

Motor Insurance:

Registered owner's name and address

Cubic capacity of engine

The year of manufacture, carrying capacity of vehicle

Whether CNG kit installed

The purpose for which the vehicle is used

The geographical area in which it is used

The owner's or driver's convictions for traffic offences etc..

Personal Accident Insurance:

The exact nature of occupation Age, height and weight Physical disabilities vlonthly income.

& Activity C:

The following proposals have been received for insurance by an insurance company: ) Residential flat for fire insurance 2) Factory building and contents for fire insurance }) Hyundai Santro for motor insurance 4! Mediclaim and personal accident insurance for a family of four members

! ,ist the information for each proposal that will be material for the acceptance of the risk by >mpany.


Examples of material facts applicable to all classes of insurance

a)The fact that previous insurers had rejected the proposal, or charged extra premium,cancelled, or refused to renew the policy.

b)Previous losses suffered by the proposer.

c)Whether he/she holds a similar policy with any other insurance company or in thesame insurance company.

The insured need not disclose the facts of the following nature:

a)Facts which would diminish the risk of insured peril for example, appointing a nightwatchman.

b)Facts which are presumed to have been known to the insurer for example, large-scale rioting in the area.

c)Facts which could be understood from the information already furnished for example.customary process in an industry.

d)Facts which ought to have been enquired into, but omitted by the insurer. This will beconstrued as warranty by the insurer.

JS$ Activity D ;

Purchase a dress from a readymade cloth shop and go to the shop the next day to return the same, as after washing, the dress had shrunk.

a) Note down the reply given by the shopkeeper.


Which is the principle applicable? How is the principle applied differently in insurance

contracts?

Contractual duty of Good faith

Invariably, in accident insurance and fire insurance, a proposer is required to answer

questions in a proposal form. This form incorporates a declaration to the effect that the

answers are warranted to be true and complete and shall form the basis of the contract.

legal effect of this declaration is to convert representations into warranties, which

ins that any incorrect or inaccurate answer to a question in the proposal form will

ier the contract voidable at the option of the insurer irrespective of the fact whether it

aterial to the risk or not. The answers are required to be literally true and absolutely

cct. This is the contractual duty of utmost good faith.

4) Proximate Cause

mition: "The active efficient cause that sets in motion a train of events which brings >ut a result, without the intervention of any force stated and working actively from a independent source."

principle of the legal doctrine of 'proximate cause' is based on the principle of cause effect which states that having proved the effect and traced the cause, it is not necessary o further. The law does not concern itself with the cause of causes. The immediate ise and not the remote or the distant one, should be regarded.

proximate cause means the direct, the most dominant and the most effective cause of ;ch the loss is the natural consequence. It is the cause which is most closely connected 11 the loss, not necessarily in time but in efficiency or effectiveness. Once this cause is ; itified, it is not necessary to go further into the cause of causes.

v object of insurance is to provide indemnity for such losses as are caused by insured

ils. If stocks are burnt, then the cause of loss is fire which is covered under a fire policy

! hence the claim is payable. If stocks are stolen, the loss is not payable under the fire

s 'burglary' is not a peril covered. The loss may be the result of two or more

J*.-'


causes, acting simultaneously or one after the other. Then, it becomes necessary to select the most important, the most effective, the most powerful cause which has brought about the loss. This cause is termed as the 'proximate cause', all other causes being considered as 'remote'.

The following examples will illustrate the distinction between 'proximate cause' and 'remote cause'.

a)A person insured under a personal accident policy went out hunting and met with anaccident. Due to shock and weakness, he was unable to walk. Whilst lying on thewet ground he contracted a cold which developed into pneumonia which caused hisdeath. The court held that the proximate cause of death was the original accident andpneumonia (a disease which is not covered under the policy) only a remote cause.Hence the claim was payable.

b)An insured person suffered accidental injuries and was taken to hospital. Whileundergoing treatment, he contracted an infectious disease which caused his death. Inthis case, the court gave a contrary ruling. The 'proximate cause' of death was thedisease and the original accident only a 'remote cause'. Hence, the claim was not;payable under a personal accident policy.

c)If an insured man meets with a motor accident while crossing the road, common!sense tells us that the immediate cause of accident was his being knocked down by acar. In seeking for the cause of accident, one would not try to find out why he wascrossing the road nor would one argue that if he had remained where he was, the taccident would not have happened. Thus, the 'cause of causes' is not be looked for.!

d)A man with heart disease sustains an accident which, coupled with his weak heart,'leads to his death. The proximate cause of death is the accident although a man witha normal heart would have recovered.

The doctrine of proximate cause helps in giving effect to the real meaning and intention of an insurance contract. In the absence of this rule, every loss could be claimed by the insured and every loss could be rejected by the insurers. It also helps in maintaining a balance between the rights of the those insured and the insurers. It not only defines the scope of coverage under the contract but serves also to protect the relative rights of the parties to the contract by preventing the insured from enlarging the scope of insurance and preventing the insurers from restricting its scope, thus maintaining the true intention of the parties when the contract was made.


3,5 SUMMARY

-.ential elements of insurance contracts are similar to commercial contracts. However, urance contracts are governed by four principles of insurance which are not applicable commercial contracts. Commercial contracts are subject to the principle of 'Good ;h' whereas insurance contracts are subject to the principle of' Utmost Good faith'. is principle requires the insured to disclose all the material information to the insurers. jsed on this information, insurers decide whether to accept the proposal or not. Invariably accident insurance and fire insurance, a proposer is required to answer questions in a iposal form. The answers are required to be literally true and absolutely correct. This an incorporates a declaration to the effect that the answers are warranted to be true and mplete and shall form the basis of the contract. Any incorrect or inaccurate answer to a estion in the proposal form renders the contract void at the option of the insurer, i-spective of the fact whether it is material to the risk or not. This is the contractual duty utmost good faith.

ie principle of insurable interest is strictly applicable to all contracts of insurance. Without Durable interest, a contract becomes void. It is applied differently only in marine cargo urance, where the insurable interest need not be present at the time of taking the policy ! must be present at the time of claim. Insurable interest arises in many ways. In case of ange in the insurable interest the same has to be intimated to the insurance company and e policy is assigned or transferred in the name of new owner who has acquired the urable interest.

H insurance contracts are contracts of indemnity only and nothing more. The object of principle is to place the insured in the same financial position as he was before the loss. lis principle ensures public interest at large by not allowing the insured to make profit out loss. In marine insurance, this principle is applied in a modified form i.e. marine insurance licies are agreed value policies. Personal accident policies are not strict contracts of lemnity as man has unlimited interest in his own life.

Abrogation and contribution are two corollaries of principle of indemnity. Subrogation msfers the rights and remedies of the insured to the insurance company after the payment ihe loss. According to the principle of contribution, if there exist more than one policy lyering the same subject matter all policies contribute to the loss in proportion to the sum

wed.

arious perils are covered under different covers. Object of the insurance contract is to -ovide indemnity for losses caused by the insured perils. The most important, effective n. Explain the fundamental principles of general insurance. Give detailed cases of proximate cause and contribution.

). List the facts which the insured is expected to disclose and the facts which he is not supposed to disclose, under the principle of Utmost Good Faith.

. Explain the importance of a proposal form in accident insurance. What is the contractual duty of good faith?

^. What is meant by 'material fact' ? Explain with examples for different classes of insurance.

ixplain why personal accident policies are not contracts of strict indemnity. !n Distinguish between 'proximate cause' and 'remote cause'.

Property and Liability Insurance"

Qll. State whether true or false.

a)Proposer is bound to disclose all material facts.

b)Previous history is not required if proposal is made to a new insurer.

c)A car holder has interest in third party liability.

d)The indemnity principles protect the profit element to be made by the insured.

e)Principle of Indemnity is not strictly followed in personal accident.

f)Right of Subrogation can be exercised before payment of claim.

g)Premium is also called consideration.

h)Contribution & subrogation are corollaries of Utmost Good Faith,

i)Insurance contracts are based on 'let the buyer beware.'

j)Owner of property may sometimes not have Insurable Interest,

k)In Marine Cargo Insurance insurable interest is required at the time of loss.

1)Part of Loss borne by the insured is known as 'excess or' franchise'.Qll. Match the following:

1.Marine Cargo Policies() a) Tariff Business

2.Fire Policies() b) Personal accident

3.Not strict contract of indemnity () c) Agreed valued policies

4.Commercial Indemnity() d) Cost of repairs less depreciatio

5.Motor() e) Marine cargo

Unit 3 Essential Features and Fundamentals of General Insurance

Q13. Fill in the blanks

1)Subrogation and contribution are the corollaries of principle of.

2)In marine insurance insurable interest must exist at the time of.

3) policies are freely assignable.

4)Transfer of rights and remedies from the insured to the insurers is known

as.

5)Most important, effective and powerful cause which has brought about the lossis known ascause.

6) Principle of indemnity is not followed strictly in.

insurance.


4.1 INTRODUCTION

According to the widest meaning, property means all the legal rights which a person has,] including the right to his reputation as well as rights in respect of material and immaterial J things. It signifies dominion or right of use, control and disposition which one may lawfully exercise over things, objects or land. In a narrow sense, the term 'property' refers to all < rights of a person in material objects owned or possessed by him.

There are different properties which are exposed to the risk of loss or damage due to fire,*explosion, earthquake, accidental damage to the vehicles. Valuables are also exposed to ithe risk of theft or burglary. With the industrial revolution, there is an increase in manufacturing]units, godowns, factories wherein large investments are made in respect of buildings, plant Jand machinery, electrical and electronic equipments in addition to manpower. Any majoloss will have a direct impact on the financial stability of the owner. With the urbanization!there is tremendous increase in the number of vehicles that run on the roads. With the!increase in the number of vehicles, accidents have also increased which can even lead to|the total loss of a vehicle. In addition to the risk of physical loss or damage to the various 1properties that a man possesses, there is a risk of injury to the people using these properties jtoo.v

4.2 TYPES OF PROPERTY

Property is commonly classified as either real property or personal property. Real property ] applies to those lands and items attached to land, such as a house or a tree. Personalf property comprises all other property.

Real Property .

Real property is the term applied to (1) unimproved land and (2) improved la Unimproved land is real property that does not include permanent improvements Unimproved land may contain valuable resources such as water, mineral resources, t soil, growing timber, or wildlife. The owner of unimproved land is still exposed to a reductiij in land value through such perils as contamination, pollution, erosion, flood, earthqu or fire (which may damage vegetation). Improved land is real property that conti something of additional permanent value, such as structures affixed to it. Structures indu not only buildings, but also such tangible property as in-ground swimming pools i equipment, underground lawn sprinkler systems, other underground piping or wiring, s tanks, wells, and paved driveways and walks.

Property, Insurance and its Underwriting

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mses and dwelling buildings are real property, because they are structures affixed to aprovedland. Dwellings include not only the living space, but also excavations, foundations, ;pes or other supports, underground flues and pipes, and plumbing and heating systems. Jwellings can take a variety of forms besides that of a single family house, including ondominiums, townhouses, apartments, and mobile homes. These dwellings may be ccupied by their owners or by tenants.

ixtures are personal property that become part of the land or the dwelling when installed ir attached to it. In general, if the personal property cannot be removed from land or a building without substantial damage to the land or building or was specifically designed for use on the land or in the building, it is a fixture. For example, custom-ordered drapes and wall lamps may be considered fixtures attached to a dwelling, but standard curtains and r lamps are not fixtures. Aflagpole cemented into the ground may be considered as a iixiure attached to the land because removing it may damage the surrounding turf.

Personal Property

l!" onal property encompasses all property that is not real. This property can be tangible itangible, and it can be owned or merely in one's possession.

onal property is tangible if it may be physically touched. For example, furniture, clothing, , money, securities, automobiles, motorcycles, snow-mobiles, boats, aircraft, jewellery,

furs.

onal property is intangible if it is not physical in nature. Examples of intangible personal perty include an insurer's promise under an insurance policy, a copyright, and a bank

land.

tillable ) a reduction hquake, ontains include )ols and wiring, septic

> nership of personal property establishes an exclusive right by the owner to use and . ioy the property. The owner also has the right to transfer rule by sale and the obligation pay outstanding debt on the property, such as a municipal tax or a mortgage on the operty. Ownership, or legal title, is the highest property right a person can possess.

is uu'ficult to list out the properties a man possesses. The range can be from a needle to >hip. We can make an attempt to list few of them although the list is illustrative, not

\haustive.

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Man can own:

I.Dwellings

3.Shops, godowns.

5.Household goods.

7.Automobiles.

9.Ships.

I1.Arms & Ammunition.13.Roads and bridges.

2.Factories.

4.Industries.

6.Plant and machinery.

8.Cargo in transit.

10.Aeroplanes.

12.Real Assets.

4.3 NEED FOR PROPERTY INSURANCE

In other words, man can have both, movable and immovable properties. Immovable meansj real assets and movable means vehicles etc. Since man has right from beginning a sense c security and possessiveness, he does his best to protect, first himself and then his possessio If the property which is the source of income is lost fully or partially, permanently c temporarily, the income too would stop. The purpose of insurance is to safeguard again such a misfortune by making good the losses of the unfortunate. In order to cater to t needs of the customer, insurance company has devised various covers to provide protectia to the property owned or possessed by him.

4.4 ORIGIN OF PROPERTY INSURANCE

Property insurance started in the U.K. In about 1700, early insurance companies started insuring houses for fire in major cities having reasonable water supplies. Insurance companiea| gradually expanded their portfolio and started insuring houses outside cities shops and manufacturing units. After the industrial revolution, there was an increase in the machines that could produce more and large premises were erected by the manufacturers. The industrial revolution brought about a great increase in material wealth in the form of factories. machinery and merchandise which had to be protected by fire insurance. Due to the complex manufacturing processes in industries, insurance also became complicated and there was a need for scientific classification of risks and uniformity in rates. Insurance companies thus extended their operations to cover the accidental risk, burglary, explosions, accidents to vehicles, etc. in addition to the fire risk. Specialized engineering insurance like boila explosion and machinery breakdown was also started to protect the investment of tk manufacturers in the form of boilers and machineries.

Unit 4 Property, Insurance and its Underwriting

.ant iiieans t a sense of ,sions. lanently or lard against cater to the ie protection

-.*nies started >mpanies hops an< nachine rers. Thi factorie ecompk there w ompant< .accider-.,,._ like boil /estment of

4.5 POLICIES COVERING PROPERTY INSURANCE

The main branches of insurance are "FIRE', 'MARINE' AND 'MISCELLANEOUS'. To understand the policies covering different properties firstly we shall see classification of property insurance on the basis of different branches of insurance.

Fire Insurance: Material property such as buildings, machinery, furniture, fixture and fitting, stocks etc. are covered for loss or damage due to the operation of fire and allied

perils.

Other than material damage, the fire policy also covers consequential losses such as loss >f net profit and standing charges.

Marine Insurance:

; Hull Insurance - loss or damage to the following properties is covered:

a)Iron, steel and or composite vessels classified in Indian Register of shipping,Lloyd's Register of shipping or other Classification Societies. These are largevessels carrying cargo.

b)Smaller crafts generally Indian built which are not classified in any classification1society.

Following are some examples:

1,Motor boats, mechanical barges, launches employed for cargo or passenges in inlandwaters.

a)Dredgers

b)Mechanized fishing travelers

c)Wooden fishing boats with diesel engines.

2.Cargo Insurance - loss or damage to the following properties is covered:

a)Machinery

b)Electric/Electronic items

c)Liquid cargo and liquid chemicals

d)All kinds of glass items

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e)Household goods

f)Refrigerated cargo

g)Paper, stationary goods, books

h)Pharmaceutical, toilet items & medicines

i)Metal bars, sheets other structural material

j)Automobiles, spare parts

Miscellaneous :

Burglary policy covers theft of any property including cash after forcible entry or exit.Burglary policy also covers damage to the property or premises by burglars.

Engineering policies cover loss or damage to plant and machinery, boilers & electronicequipments.

Motor policy covers loss or damage to Motor Vehicles.

Shopkeeper policy covers loss or damage to building, contents, plate glass, ]cycle, neon sign, personal baggage.

Householders Insurance covers loss or damage to building, contents like furnitiand fixtures,

In addition to the material damage these policies also cover legal liability and human 1 under third party policy or personal accident policy.

We shall now see classification of insurance on the basis of subject matter of insu A. Insurance of property:

Motor vehicles, residential premises, factory, godowns, plant & machinery, i and fixtures, stocks, plate glass, jewellery etc.

Here property, which has intrinsic value of its own, is insured against loss ore by various perils such as fire, burglary, accidents etc.

I 4 Property, Insurance and its Underwriting

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Jamaec

B. Insurance of liability:

Legal liability to third parties

Leg

property and liability insurance

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