Insurance is an essential part of financial planning that protects you and your loved ones from unforeseen circumstances and financial losses. While many types of insurance policies are available, all insurance policies fundamentally operate on the same principles. Before you invest in any insurance policy, it is imperative that you understand the basic principles of your insurance coverage.
In this blog, we break down the key concepts that form the foundation of any insurance policy
7 basic principles of insurance
1. Insurable interest
This is one of the primary principles of insurance.
According to this principle, to purchase insurance, you are required to have an insurable interest. For instance, if you own a car, you have an insurable interest in it because you stand to lose financially if some damage is done to your car. In other words, the need for insurance coverage does not arise if there is no insurable interest.
2. Utmost good faith
As per the name, this principle requires both the insurer and the insured to act in good faith, with honesty and transparency, in their dealings. This is a basic tenant of any insurance policy as the ultimate aim of the coverage is to provide a level of security and reliability in case of unforeseen events.
The insured must share all relevant information, details, and associated risk factors, while the insurer should explicitly explain all policy terms and conditions. Violating this principle of insurance can result in the contract being deemed void.
3. Indemnity
This principle is the essence of insurance, meaning that the insured individual has a right to compensation. However, insured individuals cannot misuse this principle to enrich themselves. In other words, this principle emphasises that the insured is restored to the same financial position they were in before the loss occurred but not to give them more money than the damages.
This principle helps keep at bay fraudulent claims and ensures transparency between both parties
4. Contribution
This principle is applicable when an individual has multiple insurance policies covering the same loss. As per this principle, different insurers will share the cost of the loss in proportion to the coverage each policy provides. This is an extension of the principle of indemnity and ensures that the insurer is not paying more than they are liable for.
5. Subrogation
This principle allows insurers to assume ownership and step into the insured’s shoes to pursue third parties for damages covered under insurance. This implies in case an insured suffers losses due to a third party, the insurer can seek reimbursement from such parties on behalf of the insured.
6. Proximate cause
The proximate principle requires that there must be a direct connection between the loss and the event that the insurance policy covers.
If a covered event does not directly cause the loss, the insurer is not liable to pay a claim.
7. Loss minimisation
This principle of insurance places responsibility on the shoulders of the insured.
Per this principle, the insured must take reasonable steps to prevent or mitigate a loss. For instance, if you draw insurance for your home, you must ensure that it is well-maintained and protected from all kinds of damages. In case of failure, your house may suffer damages which are not payable by the insurer.
Conclusion
Before you buy insurance, it is important to understand the tenets of the insurance industry and its principles. This can ensure you better understand various insurance policies and are prepared for their terms and conditions. Analyse the principles mentioned above in depth to understand how insurance works.