What is insurance?
Insurance is a promise (contract) in which the insurer (insurance company) agrees to pay the insured for a loss from a named risk. In return, the insured pays a small fee called the premium. The written contract is the policy.
It works by pooling of risk: many people pay premiums into one fund, and the few who suffer a loss are paid from it. Insurance does not stop a loss; it shares the money burden.
Principles of insurance
1. Utmost good faith
Both sides must tell all important facts honestly. If the insured hides an illness or a past fire, the insurer may cancel the policy.
2. Insurable interest
You can insure something only if you would suffer a money loss when it is harmed: your own house, your own life, goods you own. You cannot insure a stranger's car.
3. Indemnity
The insurer only puts you back where you were before the loss; you cannot make a profit. It applies to fire, marine and general insurance, not to life insurance (a life has no exact price).
4. Contribution
If the same thing is insured with two or more insurers, they share the loss in the ratio of their policy amounts. The insured cannot collect more than the actual loss.
5. Subrogation
After paying the claim, the insurer steps into the shoes of the insured. It gets the salvage (what is left of the damaged property) and the right to recover money from whoever caused the loss.
6. Causa proxima (nearest cause)
The claim is paid only if the nearest, main cause of the loss is a risk covered by the policy.
7. Mitigation of loss
The insured must act like a careful owner and try to reduce the loss (for example, call the fire brigade), not sit back because the thing is insured.
Types of insurance
Life insurance
The insurer pays a fixed sum on the death of the insured or when the policy ends (maturity). Since one of these events is sure to happen, it is called life assurance. Main forms: whole life policy (paid on death) and endowment policy (paid at maturity or on earlier death).
Health insurance
It pays hospital and treatment bills (a mediclaim policy). The insured may get cashless treatment at listed hospitals.
Fire insurance
It pays for loss or damage caused by fire. For a claim there must be actual fire, and it must be accidental, not on purpose. Usually for one year.
Marine insurance
It covers risks at sea. Hull insurance covers the ship, cargo insurance covers the goods, and freight insurance covers the transport charge the ship owner may lose if goods are not delivered.
Key formulas and definitions
- Premium: the price paid for insurance.
- Policy: the written insurance contract.
- Pooling: many pay a little; the few who suffer loss are paid.
- Indemnity: claim ≤ actual loss (≤ sum insured).
- Contribution: each insurer pays = loss × (its policy ÷ total policies).
- Subrogation: after paying, the insurer gets salvage and rights against others.
- Causa proxima: pay only if the nearest cause is covered.
- Life insurance = assurance (event is certain).
Worked examples
1. Ravi insures his house for ₹10 lakh. A fire causes a loss of ₹3 lakh. How much will he get?
₹3 lakh. By indemnity he gets only his actual loss, not the full ₹10 lakh.
2. A shop's goods are insured with Company A for ₹60,000 and Company B for ₹30,000. A fire causes a loss of ₹45,000. How much does each pay?
Total policies = ₹90,000. A pays 45,000 × 60/90 = ₹30,000; B pays 45,000 × 30/90 = ₹15,000. Together ₹45,000, equal to the loss (contribution).
3. An insurer pays ₹2 lakh for a car wrecked in an accident. The scrap sells for ₹20,000. Who keeps the ₹20,000?
The insurer, by subrogation: after paying the claim, rights over the salvage pass to it.
4. Meena hid that she had diabetes when she took health insurance. What can happen?
Her claim can be rejected and the policy cancelled because she broke the principle of utmost good faith.
5. Goods were insured against fire. A fire broke out; while saving the goods, rain damaged them. Is the rain damage covered?
Yes. The nearest main cause was the fire (the goods were moved out because of it), so by causa proxima the loss is covered.
Common mistakes
- Thinking you can earn a profit from insurance. By indemnity you only get your actual loss.
- Believing indemnity applies to life insurance. It does not, because a life cannot be priced exactly.
- Thinking you can insure a friend's shop. You need insurable interest: you must lose money if it is damaged.
- Confusing contribution with subrogation. Contribution is sharing between insurers; subrogation is the insurer getting your rights after paying.