PRINCIPLES OF LIFE INSURANCE CHAPTER 3
LIFE INSURANCE CONTRACTS What is a contract? ♠ A contract is an agreement between two or more parties to do, or not to do something, so as to create a legally binding relationship. Insurance contracts involves two parties – the insured and the insurer.
The term ‘insured’ refers to the party effecting the insurance, may be an individual, partnership firm, a corporate body or any institution with legal status. Prior to the completion of the contract, the insured is known as the ‘proponent’. • The term ‘insurers’ refers to the party granting the protection under an insurance policy. • 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 upon the occurrence of a specified event resulting in loss to him.
LIFE INSURANCE CONTRACTS Essentials of a simple contract: ♦Offer and Acceptance. ♦ Consideration ♦Capacity to contract
Continued ♦ Consensus “ad idem” ♦ Legality of Object or purpose ♦Capability of performance ♦ Intention to create legal relationship
How different is Life Insurance Contract? ◘ A Life Insurance Policy is a contract, in terms of the Indian Contract Act, 1872. ◘ Insurance is a specialised type of contract. ◘ Principle of Utmost Good Faith & Principle of Insurable Interest are applicable to both life and non-life contracts apart from the usual aforesaid essentials of a valid contract.
Offer & Acceptance • The Proposer offers his proposal to be accepted by the Insurer. If the Insurer, after considering the proposal and other related information, is willing to insure a policy, he sends a letter termed “Letter of Acceptance”. The letter of acceptance is counter offer.
Consideration • In Insurance contract, the payment of the premium is consideration for the contract on the part of the life assured and the undertaking of the insurer to pay a sum of money when the claim arises is consideration on the part of the insurer.
Capacity to Contract • The parties to an assurance contract must be capable of entering into contracts. Every person is competent to contract who is of the age of majority, who is of sound mind and is not disqualified from contracting by any law to which he is subject. Thus, minors and persons of unsound mind cannot enter into insurance contracts.
Consensus • Two or more persons are said to consent when they agree upon the same thing in the same sense. A contract must be founded on a true agreement and the parties must be of one mind. There will be no consensus if either of the parties or both of them are under a wrong impression as to some circumstance affecting the contract.
Legality of object or purpose • Every agreement wherein the consideration or object is unlawful, is void. Therefore, for a valid contract there should be proper consideration and legally valid object. The object or the purpose of an agreement must be lawful i.e. it should not be forbidden by law or it should not be fraudulent. For example, stolen goods cannot be insured.
PRINCIPLE OF UTMOST GOOD FAITH – UBERRIMAE FIDES • Commercial contracts are normally subject to the principle of Caveat emptor i.e. let the buyer beware. Each party can verify the correctness of the statements of the other party and proof can be asked for.
continued • The seller under a commercial contract has no duty to disclose any information about the subject-matter of the contract to the buyer. The seller cannot deliberately mislead the buyer but it is the duty of the buyer to inspect the goods to see if there are any defects. Example:For a purchase of a car, the buyer has to take all precautions by inspecting the car for any defects. The seller has no duty to disclose the defects.
continued • However, Life Insurance contract is a contract of Uberrimae Fides i.e. contracts in which the Utmost Good Faith is required. The proposer has a legal duty to disclose everything that is relevant to the subject-matter of insurance, because the insurer knows nothing about it.
continued • The duty of full disclosure rests on both parties. • The duty exists on the part of the proposer to disclose and furnish all material information for proper assessment of the risk by the insurer. The insurer cannot possibly be aware of all the details of the health, family history, habits and other matters relevant to the assessment of the risk and has frequently no means of verifying them.
continued • It is true that the underwriter can have a survey for fire insurance or medical examination of life for health insurance, carried out, but even then there are certain aspects of the risk which are not apparent at the time of survey or medical examination, for example, the previous loss or medical history and so on.
continued • Duty on the part of the Insurer: The proposer also because of his lack of technical knowledge has to depend on the good faith of the Company to ensure that the terms of the contract are fair and equitable. The insurer or his agent has to make true statements at the time of sale of insurance, advise the proposer properly about the terms and conditions of the policy without withholding any information.
continued • An insurer must disclose the precise terms of the contract and make no untrue statements in negotiations with the proposer. It is customary for insurer to issue ‘prospectus’ or leaflets setting out briefly the terms and conditions of the contract. Lack of good faith on the part of the insurer would arise if the terms and conditions of the policy issued differ from those advertised.
Disclosure of Material Facts • In the event of failure to disclose material facts, the contract can be held to be void ab initio i.e. from the beginning itself. • Material Fact: Every circumstance that would have a bearing on the judgment of a prudent insurer in fixing the premium or determining the acceptability of the proposal for insurance is a material fact.
continued • The proposer cannot defend non-disclosure by contending that he did not think that the fact was material to be disclosed (correction on page 27, point 7, last line- the fact was material) • Facts of common knowledge, facts of law, facts revealed by a survey or facts which could be reasonably discovered by reference to previous policies and records available with the insurer need not be disclosed.
Duty of Disclosure • The duty of disclosure in life insurance, operates till the risk commences. • However, if the policy is issued with a condition that any change in occupation must be notified to the insurer or if the terms of the policy are to be altered or if a lapsed policy is to be revived or a surrendered policy is to be reinstated, there would be a duty to disclose all material facts at that time since what follows is a contract “novell” or a new contract.
Breach of Principle of Utmost Good Faith • The breach of the principle of utmost good faith arises due to misrepresentation or non-disclosure of material facts. • Any statement made in the Proposal for insurance or any report of a Medical Examiner or refree or friend of the insured or any other document leading to the policy, was on a material matter fraudulently suppressed by the policy holder who knew at the time of making it that the statement was false, amounts to misrepresentation or non-disclosure.
Declaration • In a proposal for life insurance, the proposer makes a declaration to the effect that all the statements in the proposal form are true and that he agrees that these statements as also any further statement made or to be made by him before the medical examiner shall be the basis of the contract between him and the insurer and if any untrue statement be contained therein, the insurer would be entitled to treat the contract as null and void and forfeit all the moneys paid therefor.
Section 45 of the Indian Insurance Act,1938 • The effect of the declaration at the foot of the proposal form by the proposer is to turn the representations in the proposal into warranties which must be complied in toto. • Any incorrect or inaccurate answers to a question on the proposal form will render the contract voidable at the option of the insurer, irrespective of the fact whether it is material to the risk or not. The answers are required to be literally true and absolutely correct.
continued • However, section 45 of the Indian Insurance Act, 1938 stipulates that a policy cannot be called in question after 2 years, on the grounds of inaccurate or false statement, unless it is proved to be material and fraudulent. After expiry of a period of 2 years from the date of acceptance of risk the burden of proof rests with the insurer.
Insurable Interest • “Insurable Interest” is necessary for a valid contract of insurance, the insured who is to benefit from the proceeds must be in a relationship with the subject of insurance, whereby he benefits from its safety and well-being and would be prejudiced by its loss or damage.
continued • Insurable interest is required to support the contract of insurance in order to make it enforceable at law. In absence of insurable interest, no contract of insurance can come into existence. Lack of insurable interest will render the contract void.
continued • The subject matter of insurance can be any type of property or any event that may result in a loss of a legal right or the creation of a legal liability. Eg. Under a fire policy it can be a building, stock or machinery; with a life insurance policy it is the life being assured; in marine insurance it could be the ship, its cargo etc.
It is not the house, ship, machinery or life that is insured but it is the pecuniary interest of the insured in that house, ship, machinery, etc. which is insured.
Difference between Wagering Contract and Insurance Contract • Wagering contract involves a speculative risk which is not insurable. This type of contract is illegal in terms of section 30 of the Indian Contract Act and therefore invalid. • In an Insurance contract, the insured must have an insurable interest in the subject of insurance and the event insured against is not subject to the control of the Insured.
Examples of Insurable Interest • A person has unlimited insurable interest in his own life. • A husband has insurable interest in the life of his wife and vice-versa. • An employer has insurable interest in his employee to the extent of the value of his services. • An employee has insurable interest in the life of his employer to the extent of his remuneration for the period of notice.
continued • A creditor has an insurable interest in the life of the debtor, to the extent of the debt which he may lose if the debtor dies before repaying the loan. • Partners have insurable interest in the lives of each other because they stand to lose in the event of death of any of them.
continued • A surety has an insurable interest in the life of his co-surety to the extent of the debt and also on the life of the principal debtor. • A company has an insurable interest in the life of key valuable employee. • Parents have insurable interest in the life of a child till the policy vests in him on attainment of majority.
Features of Insurable Interest • In case of life insurance policies, insurable interest must exist at the inception of the policy and is not required at the time of claim under the policy. • In case of Marine policies, insurable interest must exist at the time of claim under the policy and there need not be insurable interest at the inception of the policy. • In other insurances, insurable interest must exist at the time of inception as well as at the time of claim.
Principle of Indemnity • Insurance is meant to compensate losses and cannot be used to make profit. • The amount paid out as a claim cannot exceed the amount of loss incurred. • Insurer should place the insured in the same financial position after a loss as he enjoyed before it, but not better.
continued • Indemnity is defined as “compensation for loss or injury sustained”. Insurance contracts promise “to make good the loss or damage.” However, payments for loss or damage are limited to the actual amount of the loss or damage subject to the sum insured.
continued • For example, if an insured takes a policy of Rs.1 lac on a house worth Rs.75,000/- and later sells it during the policy period, no payment is made under the policy if the house is destroyed by fire because the insured has suffered no loss. If the house is destroyed before it is sold, the insured will be paid only Rs.75,000/- because that is his actual loss.
continued • From the above example it is clear that an insured can recover a loss under a policy only if he has insurable interest and he can recover a loss only to the extent of his insurable interest. • The object of the principle of indemnity is to place the insured after a loss in the same financial position as far as possible, as he occupied immediately before the loss to prevent the insured from making a profit out of his loss or gaining any benefit or advantage.
continued • If it were possible to make profit out of the happenings of loss or damage, the insured would be tempted to deliberately cause the loss or damage. It would also tend to make the insured careless in maintaining the property in good condition and in preventing the loss.
Whether the Principle of Indemnity applicable to Life Insurance? • There is a link between indemnity and insurable interest in the sense that the amount of claim cannot exceed the extent of interest. • In case of life insurance however, because the insurable interest is assumed to be unlimited, the principle of indemnity does not apply.
continued • The Principle of Indemnity is applied in insurance where the loss suffered by the insured is measurable in terms of money. Thus the principle is applied to insurances of physical property (i.e. fire, burglary etc.) and in insurances of liabilities (employer’s liability)
continued • The Principle of Indemnity does not apply to life insurance where human life is the subject matter of these insurances, because of difficulty in putting monitory value on human life. It is not possible to measure the financial loss caused by the death of the insured or bodily injury sustained by him due to accident.
continued • However, in practice the spirit of the Principle of Indemnity is preserved in life insurance policies by restricting the sum insured to an amount which is commensurate to the financial status of the insured and by insuring that the monthly benefit for disablement is in line with the insured’s normal earning capacity.
continued • For example, a person whose monthly salary is Rs.1000/- will not be granted a personal accident policy of Rs.1,00,000/- which would provide a monthly benefit of Rs.4000/-. This amount is far in excess of his monthly income and, in the event of disablement due to accident, the insured would be tempted to prolong his recovery to derive undue financial advantage under his policy.
continued • Insurers also try to control over-insurance. A question is asked in the proposal form whether the proposer has already covered himself by previous policies on his life and the sun insured thereunder. The sum insured is fixed under the proposed insurance taking into account the amount already insured under the existing policy.
Difficulties in settlement of claims in General Insurance • Assessments of losses made by qualified surveyors are often disputed. • The damaged parts that have been replaced, called salvage, may have some resalable value. • The insurer may have the option to settle the claim by way of repair, reinstatement or replacement. • In cases of liability or damages the level of indemnity is vague and indeterminable.
continued • In General Insurance, property which is partially saved from loss or damage is called salvage. If a motor car is damaged to such an extent that it is not worthwhile to repair it, because the cost of repairs would exceed the sum insured or its value, in such cases the insurers would settle it as a total loss and take over the salvage. If the salvage is left to the insured, to that extent he would be benefited which is against the principle of indemnity.
continued • In General Insurance, the insurer may have option to settle the claim by way of repair, reinstatement or replacement. • Repair: Instead of making a cash payment, the settlement of claims for loss or damage may be effected by repair. This is the practice followed for damage claims. The procedure is for the insured to submit a detailed estimate of the cost of repairs to the insurer who will arrange an inspection of the damaged vehicle to see that the repairs are necessary and the cost reasonable.
continued • Thereafter, the insurer, will authorise the repair of the vehicle. On receipt of the final bill of repairs and a satisfaction note from the insured, the repairer is paid. • Replacement: The insurer may directly arrange with a dealer to replace the property (e.g. jewellery) lost or damaged. This method is rarely met with in practice.
continued • Reinstatement: This method would apply in respect of buildings or other property destroyed or damaged by fire. This method is rarely used by insurers because once this method is chosen, the insurers cannot subsequently withdraw and offer cash settlement. The responsibility for the way in which reinstatement is carried out will be that of the insurers.