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CHAPTER FOUR
LEGAL PRINCIPLES OF INSURANCE

4.1. Introduction
Before we go on to detailed discussion of insurance principles, consider the following
illustration:

Tamiru is a carpenter who wants to specialize in making office furniture by establishing his
own firm. He has been engaged in similar works with some other firms but now he wants
to run his own firm and wants to control his destiny. He has hired three workers that he
knows are hard working and is now acquiring an office, a display, and a machine shop. He
hopes to begin operations within a month or so.

One of the issues in getting started is that of identifying and managing some of the pure
risks that will be associated with the new business. Tamiru was a distance learner at St.
Mary’s College and has taken a course on risk and insurance and thus is familiar with the
risk management process. Accordingly he has identified numerous risks with which he will
be faced, but he is not sure of the best alternatives for dealing with all of them. Because his
business is just getting started, Tamiru has very little extra capital to experience any losses
and thus he thinks that he will need to utilize insurance to a greater extent than might a
larger, more established firm needs. As he thinks more about this issue, he realizes that he
has never given the concept of insurance a great deal of thought. He has always taken for
granted that it could be obtained to cover anything, but now Tamiru wonders if that is true.
He starts asking himself whether there are some risks for which insurance is not available.
Then there are various legal questions that Tamiru is also pondering.

Can he buy insurance now to cover a business that is not yet operational? Does it matter
whether he deals with an insurance agent or an insurance broker in arranging the
coverage? If Tamiru accidentally buys more insurance than he really needs, how will that
have the impact on his recovery for a loss? And given all the uncertainties in his life now,
what if Tamiru unwittingly provides a wrong answer or two on the application for
insurance? Will all of his insurance be void?

The discussion we make in this section will enable you to get clear answers to these and
other related issues.

You should bear in mind though that there are some situations in which the purchase of
insurance is the best way to manage a particular risk, due to the insurer’s ability to handle
risk efficiently through the law of large numbers. But it must be stressed that insurance
should never be automatically assumed to be the only way to deal with a given risk. Rather,
it should be considered as one of many potential techniques available through the risk
management process. In fact, many risk managers consider insurance as a method of last
resort, to be used only when other risk management techniques are not sufficient. Let’s
now go on to see many of the important principles underlying the insurance mechanism.

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4.2. The principle of Indemnity

The principle of indemnity is one of the most important precepts for many types of
insurance particularly for property insurance.

But what do we mean by the principle of indemnity?

According to this principle, an insured may not collect more than the actual loss in the
event of damage caused by an insured peril. This means that the very purpose of
insurances is just indemnification and it does not allow the insured to make profit out of it.
We can say that this principle serves to control moral hazards that might otherwise exist.
Because insurance designed to merely indemnify, or restore those insured to the situations
that existed prior to a loss, the likelihood of intentional losses is greatly reduced. This is
because payment for losses will not in any ways exceed the value of the property
destroyed, as the very objective of insurance is to compensate those who have suffered
losses and restore their property to its former position.

 The principle of indemnity states that the purpose of insurance is to restore the subject
matter insured to its former position.

What if a person purchases two insurance policies?

That is technically impossible, as there is a typical inclusion in property insurance
contracts of clauses inquiring the existence of other insurance. The purpose of such clauses
is to prevent the insured from taking out duplicate policies with different insurers in the
expectation of recovering more than the actual loss. Typically, such clauses provide that all
policies covering the same loss will share losses that occur. This by itself is another
principle of insurance, about which we will discuss shortly.

There are some exceptions to the application of the principle of indemnity in property
insurance. One issue involves the appropriate method to measure losses. For example,
suppose Ethiopian Airlines has 10-year-old office furniture that is destroyed by fire.

How do you think should the loss be valued? Should it be valued at what it would cost to
replace the furniture with new furniture or with comparable 10-year-old furniture (if such
could be found)?

Although replacement with new furniture would technically violate the principle of
indemnity, such is done in many property policies. You may know someone in your
surrounding who might have suffered losses due to a car accident. The car that has been
destroyed could be old but when the insurer pays compensation to the insured, a new car
might be bought; hence violation of the principle of indemnity.

4.3. The principle of Contribution

Contribution is the corollary of Indemnity. An individual may have more than one policy on
the same property and in case there was a loss and he were to claim from all the Insurers

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then he would be obviously making a profit out of the loss which is against the principle of
Indemnity. To prevent such a situation the principle of contribution has been evolved
under common law.

Contribution may be defined as the “right of Insurers who have paid a loss to recover a
proportionate amount from other Insurers who are also liable for the same loss”. The
common law allows the insured to recover his full loss within the sum insured from any of
the insurers. Condition of Contribution will only arise if all the following conditions are
met:
1) Two or more policies of Indemnity should exist
2) The policies must cover a common interest
3) The policies must cover a common peril which is the cause of loss
4) The policies must cover a common subject matter
5) The policies must be in operation at the time of loss
It is not necessary that the policies be identical to one another. What is important is that
there should be an overlap between policies, i.e. the subject matter should be common and
the peril causing loss should be common & covered by both.

As said earlier common law gives the right to the insured to recover the loss from any one
insurer who will then have to effect proportionate recoveries from other insurers, who
were also liable to pay the loss. To avoid this, the Insurers modify the common law
condition of contribution by inserting a clause in the policy that in the event of a loss they
shall be liable to pay only their “Rate-able proportion” of the loss. It means that they will
pay only their share and if the Insured wants full indemnity he should lodge a claim with
the other Insurers also.

Rate-able Proportion
The accepted way to interpret the term Rate-able Proportion is exhibited. First being that
the Insurers should pay in the proportion to the sum insured for example
Sum Insured Policy A = 10,000/-
Sum Insured Policy B = 20,000/-
Sum Insured Policy C = 30,000/-
Total = 60,000/-

In case of a claim of Rs.6000/- the three insurers would be liable to pay in the proportion
1:2:3 i.e. ‘A’ pays Rs.1000/- ‘B’ pays Rs.2000/- and ‘C’ pays Rs.3000/-. However, the
drawback of this simplistic method is that the terms and conditions of the policies may be
different and it would not be prudent to ignore these terms and conditions.

For example, the condition of average may apply to one or more policies or there may be an
excess clause in one policy which may effect their share of contribution to the loss. It would
therefore be correct to assess the loss as per the terms and conditions of the individual
policy and pay the claims accordingly. If by following this method the total sum of the
liability of the Insurers is more than the claim amount then the Insurers shall pay in
proportion to the amount of liability of each.

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4.4. The principle of Subrogation

What do we mean by the principle of Subrogation?

The principle of subrogation grows out of the principle of indemnity. Under the principle of
subrogation, one who has indemnified another’s loss is entitled to recovery from any liable
third parties that are responsible. Suppose somebody by the name Daniel negligently
causes damage to some other person’s property, say, Hanna’s. If Hanna has already insured
her property against accidental losses, her insurance company will indemnify her to the
extent of the loss. And now the insurer would have the right to proceed against Daniel for
any amounts it has paid out under Hanna’s policy. In other words the insurer, after
compensating the insured, would have every right to claim payment from the party that is
responsible for the loss.

Can you mention some reasons of Subrogation?

One of the important reasons for subrogation is to reinforce the principle of indemnity that
is, to prevent the insured from collecting more than the actual amount of the loss. In the
example we have mentioned above, if Hanna’s insurer did not have the right of
subrogation, it would be possible for her to recover from the policy and then recover again
in a legal action against Daniel. In this way Hanna might collect twice. It would also be
possible for Hanna to arrange an accident with Daniel, Collect twice, and then split the
profit with him. This obviously would result in a moral hazard; that is making insurance
contract an instrument of fraud rather than what it has been intended for.
 Had it not been for principles of subrogation, not only would the principle of indemnity
be violated, but also the whole concept of insurance would have been undermined as it
ends being an instrument of fraud.
Another reason for subrogation is that it keeps insurance premiums below what they
would otherwise be. In some lines of insurance, particularly liability insurance, recoveries
from negligent parties through subrogation are substantial. Although no specific provision
for subrogation recoveries is made in the rate structure other than through those
provisions relating to salvage, the rates would tend to be higher if such recoveries were not
permitted. But due to this principle, insurance companies know that they are going to get
part of what they have paid out as compensation and hence tend to charge lower
premiums.

The final reason for subrogation is that it makes possible placement of the burden of loss
more on the shoulders of those responsible for the loss. In other words, negligent parties
should not escape penalty because of the insurance mechanism. But had it not been for this
principle of subrogation, the loss caused by someone will be paid for by the insurer and the
party causing the loss might not be made to pay for the pain he/ she has caused.

 The principle of subrogation also serves in offering the possibility of holding

accountable those responsible for a loss and thus negligence.

Are there exceptions to the principle of subrogation?

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The principle of subrogation does not normally exist in such lines as life insurance and
most types of health insurance. Also, subrogation does not give the insurer the right to
collect against the insured, even if the insured is negligent. Thus, a homeowner who
negligently, but accidentally, burns down the house while thawing a frozen water pipe with
a blowtorch can collect under a fire policy, but the insurer cannot proceed against the
owner of the policy for compensation. Otherwise, there would be little value in having
insurance. Sometimes, an insurer might agree to waive his right of subrogation. Another
interesting point we may raise her in connection with this principle is about the interesting
ethical issues for the insurer and the insured that the interaction between the subrogation
clause and the need to waive subrogation rights can raise. For illustrative purposes,
consider the case of an insured who owned property, of which a portion was leased to
another individual, named Mohammed. Say, as part of the lease agreement, there was a
waiver excusing Mohammed from liability for destruction of the property by fire.

On the date within the insured’s policy period, a fire destroyed the property. The insured
made a claim for recovery of the damages from the insurer. After an investigation of the
blaze, the insurer determined that the damages were caused as a direct result of
Mohammed’s negligence. Thus, the insurer paid the amount of the damages to the insured
and then started proceedings against Mohammed defended on the grounds that the
contract between him and the insurer constituted a waiver-of –subrogation clause.

Say the court decided in favor of Mohamed. The court held that the owner’s fire insurer was
not entitled to subrogation against Mohammed for the fire loss paid to the owner. The
insurer’s right to subrogation could not extend beyond the insured’s own rights, and the
lease agreement limited the ability to subrogate for fire losses. Thus, because the owner
had no rights to collect from Mohammed, the insurer had no subrogation rights against him
either.

Finally, note that the insurer is entitled to subrogation only after the insured has been fully
indemnified. If the insured has borne part of the loss (perhaps due to inadequate coverage),
the insurer may claim recovery only after these costs have been repaid. The only exception
to this rule is that the insurer is entitled to legal expenses incurred in pursuing the
subrogation process against a negligent third party. For example, assume that X Company’s
building, valued at 600,000 Birr and insured for 500,000 Birr, is totally destroyed through
the negligence of contractor Y. X Company’s insurer subrogates against Y and collects
200,000 Birr and has legal expenses of 50,000 Birr. The insurer receives 50,000 Birr for
legal expenses, Company X receives the 100,000 by which he was underinsured, and the
insurer receives the remaining 50,000 Birr.

4.5. Principle of Insurable Interest

A fundamental legal principle that strongly supports the principle of indemnity is that of
insurable interest, which states that the insured must have a clear interest in the subject
matter being insured, i.e. the insured must suffer loss in case the expected accident
materializes. Thus the principle holds that an insured must demonstrate a personal loss or
else be unable to collect amounts due when a loss caused by an insured peril occurs.

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What do you think is the rationale of this principle?

This principle serves various advantages. For one thing it makes sure that insurance is not
considered as gambling. I hope you very well remember the distinction we’ve made
between insurance and gambling. As the very concept of insurance is to provide
compensation for accidental losses insurers should pay only for those who have suffered
losses due to the insured peril. If anyone could collect insurance payments without having
an insurable interest, a moral hazard would exist, and the contract would be deemed
contrary to public policy.
 The principle of insurable interest states that the relationship between the insured and
the subject matter insured must be clear enough in that the insured must suffer
financially or otherwise from loses occurring to the subject matter insured.

But what constitutes insurable interest?

One important issue is determining which persons or organizations can have insurable
interests. The legal owner of property having its value diminished by loss resulting from an
insured peril surely has an insurable interest and can collect if he or she is able to
demonstrate that a financial loss has occurred. But ownership is not the only evidence of
insurable interest. For example, St. Mary’s College might have leased a building under a
long-term lease whereby the lease may be cancelled if a fire destroys a certain percentage
of the value of the building. In this case the College has insurable interest though it does not
own the building.
There are also other rights that are sufficient to establish an insurable interest in a
property. For instance the holder of a contract to receive oil royalties has an insurable
interest in the oil property so that in the event of an insured loss, indemnity can be
collected, the amount of the indemnity being measured by the reduction in royalty
resulting from the insured loss. Likewise, legal liability resulting from contracts establishes
insurable interest in property. For example, garage operators have an insurable interest in
the stored automobiles for which they have assumed liability. Secured creditors, such as
mortgagees, have an insurable interest in the property on which they have worked because
they have a mechanic’s lien. In each of these latter two cases, loss of the building would
endanger the ability to collect amounts due. However, general creditors---ones without
specific liens on the property are not regarded as having a sufficiently great property right
to give them an insurable interest.

Is the principle of insurable interest applicable in the case of life insurance, too?
An insurable interest is always presumed to exist in life insurance for persons who
voluntarily insure their own lives. An individual may procure life insurance and make
anyone the beneficiary (the one who receives the insurance proceeds when death occurs),
regardless of whether the beneficiary has an insurable interest. But one who purchases life
insurance on another’s life must have an insurable interest in that person’s life. Thus, a
business firm may insure the life of a key employee because that person’s death would
cause financial loss to the firm. A wife may insure the life of her husband because his
continued existence is valuable to her and she would suffer a financial loss upon his death.
Likewise, a husband may insure the life of his wife because her continued existence is
valuable to him and he could suffer a financial loss upon her death. The same statement

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may apply to almost anyone who is dependent on an individual. A father may insure the life
of a minor child, but a brother may not ordinarily insure the life of his sister. In the latter
case there would not usually be a financial loss to the brother upon the death of his sister,
but in the former case the father would suffer financial loss upon the death of his child. A
creditor has an insurable interest in the life of a debtor because the death of the debtor
would subject the creditor to possible loss.

Activity 2
1) Suppose two individuals met while traveling in the same plane and after a short
acquaintance, one agreed to insure his/her life and then assign the policy to the
other to be reimbursed for the premium. Say, the insured person died, and the
insurance company from which the policy is purchased refused to pay when the
facts surrounding the application became apparent and the case is brought to the
court. What, in your opinion, should the court decide? Why?

Is insurable interest transferable?

Basically, insurable interest is not transferable. For example, suppose X Company owns and
insures an automobile. Later X sells the car to Y Company, and shortly thereafter the auto is
destroyed. X Company, which has no further financial interest in the car, cannot collect
under the policy. Further, Y has no protection under the policy because insurance is said to
follow the person and not the property. In other words, the policy purchased by X company
is not transferred to Y when the car is sold. Y would have to obtain its own coverage to be
able to collect when the loss occurs.

Life insurance, however, is an exception to this as courts view life insurance as an

investment contract. To illustrate, assume that a wife who owns a life insurance policy on
her husband later obtains a divorce. If she continues to maintain the insurance by paying
the premiums, she may collect on the subsequent death of her former husband even though
she is remarried and suffers no particular financial loss upon his death. It is sufficient that
she had an insurable interest when the policy was first issued.
 Except in cases of life insurance, the principle of insurable interest is not transferable.

4.6. The Principle of Utmost Good Faith

The Principle of utmost good faith states that both the insured and the insurer must act in
good faith based on mutual trust. Insurance is said to be a contract of utmost good faith, in
which a higher standard of honesty is imposed on parties to an insurance agreement than
is imposed through ordinary commercial contracts.

By a principle of good faith we are referring to the importance of fully disclosing material
facts that have bearings on the assessment of risk. This is true for both the insured as well
as the insurer. Both parties should not engage in intentional concealment,
misrepresentation, and fraud. The application of this principle may best be explained in a
discussion of representations, warranties, concealment, and mistakes.

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 The principle of utmost good faith states that insurance requires mutual trust from both
the insurer and the insured.
Representations
A representation is a statement made by an applicant for insurance before the policy is
issued. Although the representation need not be in writing, it is usually embodied in a
written application. An example of a representation in life insurance would be answering
yes or no to a question as to whether or not the applicant had been treated for any physical
condition or illness by a doctor within the previous five years. If a representation is relied
on by the insurer in entering into the contract and if it proves to have been false at the time
it was made or becomes false before the contract is signed there exists a legal ground for
the insurer to avoid the contract as the insured has violated the principle of utmost good
faith.
But every misrepresentation does not lead to avoidance of the contract. The
misrepresentation must be material enough for the insurer to cancel the contract.
What do we mean by material misrepresentation?

Misrepresentation is said to be material if the information concealed or misrepresented

significant that, if the truth had been known, the contract either would not have been
issued would have been issued on different terms. Therefore, the insurer will waive the
subrogation clause in the manufacturer’s insurance policy because to enforce it would
mean that the insured would not be compensated at all. Inserting a waiver of subrogation
clause in the manufacturer’s insurance policy can perform this waiver. It is common
practices in insurance contracts include such clauses.

An insured who acts in such a way as to destroy or reduce the value of the insurer’s right of
subrogation violates the provisions of most subrogation clauses and forfeits all rights
under the policy. For instance, suppose Abebe collides with Eyob in an automobile accident.
Abebe writes Eyob term. If the misrepresentation is inconsequential, its falsity will not
affect the contract. However, a misrepresentation of a material fact may make the contract
voidable at the option of the insurer. The insurer may decide to affirm the contract or to
avoid it. Failure to cancel contract after first learning about the falsity or a material
misrepresentation may operate to defeat the insurer’s rights to cancel at a later time.

What if the misrepresentation is unintentional?

Sometimes an insured might give wrong information unintentionally and this information
might be material enough to affect the contract. Thus if they make an innocent mistake
about a fact they believe to be true, they are held accountable for their carelessness. Thus,
suppose W/o Tsehay applies for insurance on her automobile and states that there is no
driver under age 25 in her family. However, it turns out that her 16-year-old son has been
driving the family car without his mother’s knowledge. Lack of this knowledge is no
defense when the insurance company refuses to pay a subsequent claim on the grounds of
material misrepresentation. It is not necessary for the insurer to demonstrate that a loss
occurred arising out of the misrepresentation in order to exert its right to avoid the
contract. Thus, in the preceding case, assume Tsehay has an accident and it is then learned
for the first time that she has a 16-year-old son driving. Since this situation is contrary to

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the information Tsehay had previously stated, the insurer might legally refuse payment in
most of the cases.

If the court holds that a statement given in the application was one of opinion, rather than
fact, and it turns out that the opinion was wrong, it is necessary for the insurer to
demonstrate bad faith or fraudulent intent on the part of the insured in order to avoid the
contract. For example, say one of your friends goes to Africa Insurance Company to
purchase health insurance policy. And on the application form he was asked whether he
ever had cancer or not and he answers no. Later he discovers that he actually had cancer.
The court might well find that your friend has not told the exact state of his health and
thought that he had some other ailment. If the question had been phrased, “Have you ever
been told you had cancer?” a yes or no answer would clearly be a fact, not an opinion. An
honest opinion should not be a ground for rescinding an insurance policy.
 Whether intentional or unintentional, a material misrepresentation of information by
the insured might give the insurer legitimate ground for cancellation of contracts.

Warranties

What do we mean by a warranty?

A warranty is a clause in an insurance contract holding that before the insurer is liable, a
certain fact, condition, or circumstance affecting the risk must exist. For example, an
insurance policy covering a ship may state “warranted free of capture or seizure.” This
statement means that if the ship is involved in a war skirmish, the insurance is void. Or a
bank may be insured on condition that a certain burglar alarm system be installed and
maintained. Such a clause is a condition of coverage and acts as a warranty. A warranty
creates a condition of the contract, and any breach of warranty, even if immaterial, will
void the contract. This is the central distinction between a warranty and a representation.
A misrepresentation does not void the insurance unless it is material to the risk, whereas
under common law any breach of warranty, whether it is material or not, voids the
contract.
 Unlike representations which need to be material enough to lead to cancellation of
insurance policies, any breach or warranty gives sufficient ground to the insurer to void
insurance contracts.

Concealments
Concealment is defined as silence when obligated to speak. Concealment has approximately
the same legal effect as a misrepresentation of a material fact.

What difference do concealment and representation have?

Concealment is the failure of an applicant to reveal a fact that is material to the risk, while
misrepresentation refers to deliberate action of giving wrong information about the risk
being insured. As insurance is a contract of utmost good faith, it is not enough that the
applicant answers truthfully all questions asked by the insurer before the contract is
effected. The applicant must also volunteer material facts, even if the disclosure of such
facts might result in rejection of the application or the payment of a higher premium. The

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applicant is often in a position to know material facts about the risk that the insurer does
not. To allow these facts to be concealed would be unfair to the insurer. After all, the
insurer does not ask questions such as “Is your building no on fire?” or “Is your car now
wrecked?” The most relentless opponent of an insurer’s defense suit would not argue that
an insured who obtained coverage under such circumstances would be exercising even
elementary fairness. The important, often crucial, question about concealment lies in
whether or not the applicant knew the fact withheld to be material.

What sort of questions would you use to test whether or not the insured is concealing?

The following questions might be useful in testing concealment:

--- Did the insured know of a certain fact?
--- Was this fact material?
--- Was the insurer ignorant of the fact?
--- Did the insured know the insurer was ignorant of the fact?
The test of materiality is especially difficult because often the applicant is not an insurance
expert and is not expected to know the full significance of every fact that might be of vital
concern to the insurer. The final determination of materiality is the same as it s in the law
of representation, namely, would the contract be issued on the same terms if the concealed
fact had been known? There are two rules determining the standard of care required of the
applicant. The stricter rule, which usually applies only to ocean vessels and their cargoes,
holds that international concealment as well as innocent concealment can void the
contract. In this case, the fourth test for concealment is irrelevant. For most other risks,
however, the rule is that a policy cannot be avoided unless there is fraudulent intent to
conceal material facts. Thus, the intentional withholding of material facts with intent to
deceive constitutes fraud. In determining which facts must be disclosed if known, it has
been held that facts of general knowledge or facts known by the insurer need not be
disclosed. There is also the inference from past cases, though not a final determination, that
the insurer cannot void a contract on the grounds of concealment of those facts that are
embarrassing or self-disgracing to the applicant.
 In must cased insurance policies will be made void only in cases of intentional
concealments.

Mistakes
When an honest mistake is made in a written contract of insurance, steps can take to
correct it after the policy is issued. Generally, a policy can be reformed if there is proof of a
mutual mistake or a mistake on one side that is known to be a mistake by the other party,
where no mention was made of it at the time the agreement was made was not the one
stated in the contract.

As an illustration of this, consider an insurer that issued a 1,000 Birr life insurance policy
and, by an error of one of its clerks, included an option at the end of 20 years to receive
income payments of 1,051 Birr per year, rather than 10.51 Birr per year. The mistake was
discovered 18 years later. When the insurer tried to correct the error, the insured refused
to accept payment of the smaller amount. In a legal decision, the court held that the mistake

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was a mutual one that should be corrected. The error of the insurer was in misplacing a
decimal point, whereas the error of the insured was either in not noticing the error or, if
noticed, in failing to say anything. Thus, the correct, smaller payment was substituted for
the larger, incorrect one stated in the policy.

In contrast to the previous example, suppose Adam believes himself to be the owner of
certain property and insures it. He cannot later demand all of the premium back solely
because he discovers that, in fact, he was not the owner of the property. This was a mistake
in judgment or an erroneous supposition, and the courts will not relieve that kind of
mistake.

4.7. THE PRINCIPLE OF PROXIMATE CAUSE

There are three types of perils related to a claim under an Insurance policy
(1) Insured Perils: These are the perils mentioned in the policy as being insured e.g. Fire,
lightening, storm etc. in the case of a fire policy
(2) Excepted Perils: These are the perils mentioned in the policy as being excepted perils or
excluded perils e.g. Riot strike, flood etc. which may have been excluded and discount in
premium availed.
(3) Uninsured Perils: Those not mentioned in the policy at all either in Insured or excepted
perils e.g. snow, smoke or water as perils may not be mentioned in the policy. Insurers are
liable to pay claims arising out of losses caused by Insured Perils and not those losses
caused by excepted or Uninsured perils.

Example: If stocks are burnt then the cause of loss is fire which is an Insured Peril under a
fire policy and claim is payable. If the stocks are stolen the loss would not be payable as
Burglary is not an Insured peril covered in fire policy. Burglary policy is needed to take
care of ‘theft’. It is therefore important to identify the cause of loss and to see if it is an
Insured peril or not before admitting a claim.

Need to Identify Proximate Cause

If the loss is brought about by only one event then there is no problem in settlement of
liability but more often than not the loss is a result of two or more causes acting together or
in tandem i.e. one after another. In such cases it is necessary to choose the most important,
most effective and the most powerful cause which has brought about the loss. This cause is
termed the Proximate Cause and all other causes being considered as “remote”. The
proximate cause has to be an insured peril for the claim to be payable.

The following illustration may help in distinguishing between the proximate cause and the
remote cause. I. “A person was injured in an accident and was unable to walk and while
lying on the ground he contracted a cold which developed into pneumonia and died as
result of this. The court ruled that the proximate cause of death was the accident and
Pneumonia (which was not covered) was a remote cause and hence claim was payable
under the Personal Accident Policy.” II. “A person injured in an accident was taken to a
hospital where he contracted an infection and died as a result of this infection. Here the
court ruled that infection was the proximate cause of death and the accident was a remote
cause and hence no claim was payable under the Personal Accident Policy.

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The Meaning of Proximate Cause

The doctrine of proximate cause is based on the principle of cause and effect, which states
that having proved the effect and traced the cause it is not necessary to go any further i.e.
cause of cause. The law provided the rule “Cause Proxmia non Remote spectator”. The
immediate cause and not the remote one should be taken into consideration. Therefore the
proximate cause should be the immediate cause. Immediate does not mean the nearest to
the loss in point of time but the one most effective or efficient. Thus if there are a number of
causes and the proximate cause has to be chosen the choice should be of the most
predominant and efficient cause i.e. the cause which effectively caused the result.

Proximate cause has been defined as “The active efficient cause that sets in motion a train
of events which bring about a result without the intervention of any force started and
working actively from a new and independent source”. (This definition comes from the
ruling given in the case Pawsey v/s Scottish Union and National Insurance Co. (1907). It is
important to note that in Insurance Proximate has got nothing to do with time even though
the Dictionary defines Proximity as ‘The state of being near in time or space’ (period or
physical) and the Thesaurus given the alternate words as “adjacency of” “closeness”,
“nearness” “vicinity” etc. But in Insurance Proximate cause is that which is Proximate in
efficiency. It is not the latest but the direct, dominant, operative and efficient cause.

Losses can occur in the following manners:

i. Loss due to a single cause.
ii. A series or chain of events one following and resulting from the other causing the loss
iii. A series or chain of events which is broken by a new event independently from a
different source causing the loss – Broken sequence and
iv. A contribution of two or more events occurring simultaneously and resulting in loss
1) In the case of a single cause being the cause of loss then if that peril is covered the claim
is payable and if not covered claim is not payable.
2) Loss due to a series or chain of events. This can be illustrated by the following example
event.
a) A driver of a car meets with an accident
b) As a result of the accident he suffers from concussion (shock)
c) Because of the concussion he strayed around not aware where he was going
d) While straying he fell into a stream
e) He died of drowning in the stream
It is clear that the above is a chain of events one leading to the other. The proximate cause
would be accident (covered under PA Policy) which resulted in concussion (Disease – not
covered) and hence the claim would be payable. Irrespective of the fact that subsequent
causes are covered or not if it is established that the event starting the chain is a covered
peril then claim is payable.

However if reverse were the case and the chain was started by an excepted or excluded
peril then the claim would not be payable. For e.g. a person suffers a stroke and falls down
the steps resulting in his death. He will not be entitled to any claim under his personal
accident policy as the chain was started by a stroke which is an excepted peril.

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3. In case of the Broken sequence or Interrupted chain of events if the chain of events is
started by an Insured peril but interrupted by an excepted or excluded peril then the claim
is paid after deducting the damage caused by the excluded peril. For example, the burglars
enter the house and leave the gas stove on leading to a fire and the house is damaged in the
fire. The “burglary Insurance” will only pay for the loss due to theft but exclude loss due to
fire, which is accepted peril under the burglary policy.

Peril is broken by an Insured peril, as a new and independent cause then there is a valid
claim for even the damage caused by exempted peril. The burglars enter the house and
after carrying out thefts put the house on fire. The fire policy will pay for the damages due
to theft as well (which is an excluded peril).

4. In the case of loss due to concurrent causes or two or more causes occurring
simultaneously then all the causes will have to be Insured perils only then the claim would
be payable but even if one of the causes is an excluded peril the claim will not be payable.

Example: A house collapses due to an earthquake, which results in fire. Under the fire
policy earthquake is not a covered risk, hence the claim will not be payable. To really
understand the complexities of proximate cause and its proper identification one must go
through the case studies and a few are being given hereunder.

Example I
An army officer insured under a personal accident policy, which excluded accident directly
or indirectly due to war during war time went to the railway line to inspect the sentries.
While on the visit he was hit by a train and he died as a result of the accident. It was ruled
that the policy did not cover as he was there on the line because of the war and the policy
did not cover accident due to war.
Example II
A surveyor on surveying a factory damaged in a fire came to the conclusion after detailed
investigation that the fire was caused by negligence as well as defective design and both
these causes worked together to cause the damage. While the Insurance policy covered
negligence it did not cover Defective Design and hence claim was denied.
Example III
In an incident where stocks of potatoes kept in a cold storage got damaged due to leakage
of ammonia gas. The stock was insured against contamination / Deterioration /
putrefaction due to rise in temperature in the refrigeration chamber caused by any loss or
damage due to an accident. The Insurance Company did not pay the claim saying that the
leakage of gas was not accidental and hence the risk was not covered. The aggrieved
approached the consumer forum which held that the leakage of gas was not foreseen or
premeditated or anticipated and loosening of the nuts and bolts of the flanges. The
consequential escape of gas was within the meaning of the word accident and hence
ordered the Insurance Co. to pay the claim.

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