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CHAPTER 2
PRINCIPLES OF LIFE
ASSURANCE
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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.
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The term insured refers to the party effectingthe insurance, may be an individual, partnershipfirm, a corporate body or any institution with legal
status. Prior to the completion of the contract, theinsured is known as the proponent.
The term insurers refers to the party grantingthe protection under an insurance policy.
A contract of insurance is an agreement wherebyone party, called the insurer, undertakes, inreturn for an agreed consideration, called thepremium, to pay the other party, namely, theinsured a sum of money upon the occurrence ofa specified event resulting in loss to him.
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LIFE INSURANCE
CONTRACTS
Essentials of a simple contract:
Offer and Acceptance.
Consideration
Capacity to contract
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Continued
Consensus ad idem
Legality of Object or purpose
Capability of performance
Intention to create legal relationship
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How different is Life Insurance
Contract? A Life Insurance Policy is a contract, interms 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 validcontract.
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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 Letterof Acceptance. The letter of
acceptance is counter offer.
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Consideration
In Insurance contract, the payment of
the premium is consideration for thecontract on the part of the life assured
and the undertaking of the insurer to
pay a sum of money when the claimarises is consideration on the part of the
insurer.
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Capacity to Contract
The parties to an assurance contract
must be capable of entering intocontracts. Every person is competent tocontract who is of the age of majority,who is of sound mind and is notdisqualified from contracting by any lawto which he is subject. Thus, minors andpersons of unsound mind cannot enter
into insurance contracts.
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Consensus
Two or more persons are said to consent
when they agree upon the same thing in thesame 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 undera wrong impression as to some circumstance
affecting the contract.
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Legality of object or purpose
Every agreement wherein the consideration
or object is unlawful, is void. Therefore, for avalid 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 lawor it should not be fraudulent. For example,
stolen goods cannot be insured.
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PRINCIPLE OF UTMOST GOOD
FAITH UBERRIMAE FIDES
Commercial contracts are normally
subject to the principle of Caveatemptor i.e. let the buyer beware. Each
party can verify the correctness of the
statements of the other party and proofcan be asked for.
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continued
The seller under a commercial contract has
no duty to disclose any information about thesubject-matter of the contract to the buyer.The seller cannot deliberately mislead thebuyer 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 buyerhas to take all precautions by inspecting thecar for any defects. The seller has no duty todisclose the defects.
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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 isrelevant to the subject-matter of
insurance, because the insurer knows
nothing about it.
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continued
The duty of full disclosure rests on bothparties.
The duty exists on the part of the proposertodisclose and furnish all material informationfor proper assessment of the risk by theinsurer. The insurer cannot possibly be aware
of all the details of the health, family history,habits and other matters relevant to theassessment of the risk and has frequently nomeans of verifying them.
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continued
It is true that the underwriter can have a
survey for fire insurance or medicalexamination of life for health insurance,carried out, but even then there arecertain aspects of the risk which are not
apparent at the time of survey ormedical examination, for example, theprevious loss or medical history and so
on.
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continued
Duty on the part of the Insurer:
The proposer also because of his lack oftechnical knowledge has to depend on thegood faith of the Company to ensure that theterms of the contract are fair and equitable.
The insurer or his agent has to make truestatements at the time of sale of insurance,advise the proposer properly about the termsand conditions of the policy without
withholding any information.
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Disclosure of Material Facts
In the event of failure to disclose material
facts, the contract can be held to be void abinitio 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.
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continued
The proposer cannot defend non-disclosure
by contending that he did not think that thefact was material to be disclosed (correctionon page 27, point 7, last line- the fact wasmaterial)
Facts of common knowledge, facts of law,facts revealed by a survey or facts whichcould be reasonably discovered by referenceto previous policies and records available
with the insurer need not be disclosed.
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Duty of Disclosure
The duty of disclosure in life insurance,operates till the risk commences.
However, if the policy is issued with acondition that any change in occupation mustbe notified to the insurer or if the terms of thepolicy are to be altered or if a lapsed policy is
to be revived or a surrendered policy is to bereinstated, there would be a duty to discloseall material facts at that time since whatfollows is a contract novell or a newcontract.
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Breach of Principle of Utmost
Good Faith
The breach of the principle of utmost good faitharises due to misrepresentation or non-disclosure of material facts.
Any statement made in the Proposal forinsurance or any report of a Medical Examiner orrefree or friend of the insured or any other
document leading to the policy, was on a materialmatter fraudulently suppressed by the policyholder who knew at the time of making it that thestatement was false, amounts tomisrepresentation or non-disclosure.
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Declaration
In a proposal for life insurance, the proposermakes a declaration to the effect that all thestatements in the proposal form are true and thathe agrees that these statements as also anyfurther statement made or to be made by himbefore the medical examiner shall be the basis of
the contract between him and the insurer and ifany untrue statement be contained therein, theinsurer would be entitled to treat the contract asnull and void and forfeit all the moneys paidtherefor.
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Section 45 of the Indian
Insurance Act,1938
The effect of the declaration at the foot of theproposal form by the proposer is to turn therepresentations in the proposal into warrantieswhich must be complied in toto.
Any incorrect or inaccurate answers to aquestion on the proposal form will render the
contract voidable at the option of the insurer,irrespective of the fact whether it is material tothe risk or not. The answers are required to beliterally true and absolutely correct.
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Insurable Interest
Insurable Interest is necessary for a
valid contract of insurance, the insuredwho is to benefit from the proceeds
must be in a relationship with the
subject of insurance, whereby hebenefits from its safety and well-being
and would be prejudiced by its loss or
damage.
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continued
Insurable interest is required to support
the contract of insurance in order tomake 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.
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It is not the house, ship, machinery or
life that is insured but it is the pecuniaryinterest of the insured in that house,
ship, machinery, etc. which is insured.
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Difference between Wagering
Contract and Insurance Contract
Wagering contract involves a speculative risk
which is not insurable. This type of contract isillegal 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.
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Examples of Insurable
Interest
A person has unlimited insurable interest inhis own life.
A husband has insurable interest in the life ofhis wife and vice-versa.
An employer has insurable interest in hisemployee to the extent of the value of his
services. An employee has insurable interest in the life
of his employer to the extent of hisremuneration for the period of notice.
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continued
A creditor has an insurable interest in
the life of the debtor, to the extent of thedebt which he may lose if the debtor
dies before repaying the loan.
Partners have insurable interest in thelives of each other because they stand
to lose in the event of death of any of
them.
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continued
A surety has an insurable interest in the life of
his co-surety to the extent of the debt andalso 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.
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Features of Insurable Interest
In case of life insurance policies, insurableinterest must exist at the inception of thepolicy and is not required at the time of claimunder the policy.
In case of Marine policies, insurable interestmust exist at the time of claim under the
policy and there need not be insurableinterest at the inception of the policy.
In other insurances, insurable interest mustexist at the time of inception as well as at thetime of claim.
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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.
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continued
Indemnity is defined as compensation
for loss or injury sustained. Insurancecontracts promise to make good the
loss or damage. However, payments
for loss or damage are limited to theactual amount of the loss or damage
subject to the sum insured.
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continued
For example, if an insured takes a policy of
Rs.1 lac on a house worth Rs.75,000/- andlater 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 isdestroyed before it is sold, the insured will be
paid only Rs.75,000/- because that is his
actual loss.
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continued
From the above example it is clear that an insuredcan recover a loss under a policy only if he hasinsurable interest and he can recover a loss only tothe extent of his insurable interest.
The object of the principle of indemnity is to place theinsured after a loss in the same financial position as
far as possible, as he occupied immediately beforethe loss to prevent the insured from making a profitout of his loss or gaining any benefit or advantage.
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continued
If it were possible to make profit out of
the happenings of loss or damage, theinsured would be tempted to
deliberately cause the loss or damage.
It would also tend to make the insuredcareless in maintaining the property in
good condition and in preventing the
loss.
Wh th th P i i l f
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Whether the Principle of
Indemnity applicable to Life
Insurance?
There is a link between indemnity and
insurable interest in the sense that theamount of claim cannot exceed the extent of
interest.
In case of life insurance however, because
the insurable interest is assumed to beunlimited, the principle of indemnity does
not apply.
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continued
The Principle of Indemnity is applied in
insurance where the loss suffered bythe 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 (employers liability)
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continued
The Principle of Indemnity does not apply to
life insurance where human life is the subjectmatter 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 orbodily injury sustained by him due to
accident.
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continued
However, in practice the spirit of the
Principle of Indemnity is preserved inlife insurance policies by restricting thesum insured to an amount which iscommensurate to the financial status of
the insured and by insuring that themonthly benefit for disablement is in linewith the insureds normal earningcapacity.
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continued
For example, a person whose monthly salary
is Rs.1000/- will not be granted a personalaccident policy of Rs.1,00,000/- which wouldprovide a monthly benefit of Rs.4000/-. Thisamount is far in excess of his monthly incomeand, in the event of disablement due toaccident, the insured would be tempted toprolong his recovery to derive undue financialadvantage under his policy.
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continued
Insurers also try to control over-insurance. A
question is asked in the proposal formwhether 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 takinginto account the amount already insured
under the existing policy.
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Difficulties in settlement of claims
in General Insurance
Assessments of losses made by qualifiedsurveyors are often disputed.
The damaged parts that have been replaced,called salvage, may have some resalablevalue.
The insurer may have the option to settle the
claim by way of repair, reinstatement orreplacement.
In cases of liability or damages the level ofindemnity is vague and indeterminable.
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continued
In General Insurance, property which ispartially saved from loss or damage is calledsalvage. If a motor car is damaged to such anextent that it is not worthwhile to repair it,because the cost of repairs would exceed thesum insured or its value, in such cases the
insurers would settle it as a total loss andtake over the salvage. If the salvage is left tothe insured, to that extent he would bebenefited which is against the principle ofindemnity.
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continued
In General Insurance, the insurer may have option tosettle 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 beeffected by repair. This is the practice followed for
damage claims. The procedure is for the insured tosubmit a detailed estimate of the cost of repairs to theinsurer who will arrange an inspection of thedamaged vehicle to see that the repairs arenecessary and the cost reasonable.
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continued
Thereafter, the insurer, will authorise the
repair of the vehicle. On receipt of the final billof 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.
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continued
Reinstatement: This method would apply in
respect of buildings or other propertydestroyed or damaged by fire. This method is
rarely used by insurers because once this
method is chosen, the insurers cannot
subsequently withdraw and offer cashsettlement. The responsibility for the way in
which reinstatement is carried out will be that
of the insurers.
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Risk Management
The life insurance business deals with therisks of death and old age. Insurance doesnot prevent these risks but can only mitigatethe consequences in those circumstances.Sickness and accident risks, includingdisability are insurable as supplementary
benefits under life insurance policies. The risks of sickness, accident andunemployment are insurable in non-lifeinsurance.
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Three ways of Risk
Management
Prevention or Avoidance: Death, old age,accidents, sickness and unemployment are not
preventable. The simplest way to deal with theproblem of any risk is to avoid it altogether. E.g. Ifa factory is to be located on the banks of a riverwhich is prone to serious floods every year thenthe firm may decide to shift the site to a saferlocation to avoid the major risk of flood damage.This technique is not always possible nor is itpractical in all cases.
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continued
Retention of Risk: Having ones own
resources to take care of the needs, likeputting aside savings to be used for therainy day. A firm may decide to bear onits own account some of the financial
losses caused by pure risks. Usuallythis is done where losses are small andtheir occurrence can be closelyestimated.
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continued
E.g. if goods in transit suffer minor damage
losses, the firm may not insure the risk butmay decide to treat the losses as normal
operating expenses of running the business.
Medical expenses for illnesses of employees
of big organisations like Railways may bedealt with through this method as they find it
cheaper to bear the risks themselves on
account of large number of employees.
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continued
Transfer of risk:
Insurance is a
mechanism for transfer
of risk to another
person like the State
takes over the
responsibility formedical care of its
citizens, or pays
benefits to elderly and
the unemployed.
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Different Insurance Needs of
Individuals
Protection of the standard of living of thefamily which is at risk on early death.
Future expenses on account of childrenseducation, marriage, start of some businessand so on.
Continuance of business, when financiers ask
for life insurance policies as collateralsecurity, or partners need to rearrangefinances on the death of a partner.
Substitute income when earning capacity
ceases due to old age or disabilities.
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continued
Continuance of business, when
financiers ask for life insurance policiesas collateral security, or partners need
to rearrange finances on the death of a
partner. Substitute income when earning
capacity ceases due to old age or
disabilities.
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Agents Role
Agents have to convince the people to go forinsurance by making them aware of their
insurance needs. While selling life insurance, it is necessary to be
aware of the needs of people. Different plans aredesigned with different benefits, so that they may
cater to the different needs of people dependingupon personal values, demands of society,family, age, occupation, habits, place ofresidence, and so on.
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continued
In selling life insurance, a sale can be
accomplished only when an appeal is madeto sentiments of love, of affection and of
concern like protecting the loved ones,
affording a good start in life for the children or
a desire for self-preservation in old age. Theagent has to study the insurance needs of
individual prospect and persuade them to buy
.
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THANK YOUHAVE A GOOD DAY
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