Essentials and

principles of
insurance contract
Insurance Contract
In the words of E. W. Patterson, “Insurance is a
contract by which one party, for a compensation
called the premium, assumes particularly risks of the
other party and promises to pay him or his nominee a
certain or ascertainable sum of money on a specified
contingency.’’
 Essentials of
Insurance Contract
The valid contract, according to Section 10 of Indian
Contract Act 1872, must have the following essentialities:
 Agreement (offer and acceptance) – it is the first
requirement in formation of the valid contract. The offer
in insurance is the intimation of proposer’s intention to
purchase an insurance policy. When the insurer is ready
to undertake the stated risk , it is called acceptance. In
insurance,'offer’ is known as 'proposal'. It generally
comes from the insured. If the insurer accepts the
proposal , it is transformed into an agreement. In
insurance contract, potential policy holder who wants to
get his risk insured is required to fill a prescribed form.
 Intention to create legal relation - The second
basic principle of valid insurance contract is that both
the parties must act to create the legal relationship
between the parties. The intention of both the parties
is to make a legal relationship between themselves.
Under the insurance contract, an insured expresses his
intention while making a valid offer and the insurer
expresses his intention on the acceptance of offer
which will bind both the parties in accordance with the
terms and conditions of the insurance policy.
 Parties competent to make contract - Both the
parties to Insurance contract should be
competent/capable of entering into contract. Section
11 of Indian Contract Act,1872,lays down that every
person is competent to contract who is of age of
majority of law, has sound mind and who is not
disqualified from entering into contract by any law to
which he is subject to.
 A valid contract requires that both the parties should
understand the legal implications of each Other's conduct.
A minor is not competent to contract.A person is said of
sound mind,who can understand the contract at the time of
making the contract.An alien enemy,an insolvent and
criminals cannot enter into contract.Contract made by
incompetent party/parties will be void.
 Free consent - :When both the parties have agreed to a
contract on the terms and conditions of the agreement in
the same sense and spirit, they are said to have a free
consent. U/S 14 of Indian Contract Act,1872 the consent
is to be free when it is not caused by:
a) coercion
b) undue influence
c) fraud
d) misrepresentation
Contract without free consent is voidable at the option
of the party whose consent is not free except fraud. In
case of fraud contract is void.

 Lawful consideration – When a party to an agreement

promises to do something in return. This is called
consideration. In insurance contract the payment of
premium is consideration on part of the insured. The
contract of insurance is contract of indemnity under
which a insurance company, in consideration of
premium, undertakes to compensate the loss of
insured against a specific risk, eg.
Fire,marine,accident.The consideration for which the
insurance company undertakes to compensate the
risk of insured is called the ‘premium’..
 Lawful object - Another important basic principal of
insurance contract is the legality of objects. If object
of an insurance, like consideration is found to be
unlawful, policy is void. The object of the insurance
contract should be lawful. An object is lawful when:
(a) it is not forbidden by Iaw ; or
(b) it is not immoral ; or
(c) it is not opposed to public policy ; or
(d) it is not against the provisions of any law.

 Certainty and possibility of performance - The

parties to a contract must agree on the terms of their
mutually arrived agreement. They have to make their
intention clear in their contract. The terms of contract
must be definite or certain and capable of
 Fundamental Principles of
insurance contract

 Principle of Utmost Good faith - Both parties

involved in an insurance contract—the insured (policy
holder) and the insurer (the company)—should act in
good faith towards each other.The insurer and the
insured must provide clear and concise information
regarding the terms and conditions of the
contract.This is a very basic and primary principle of
insurance contracts because the nature of the service
is for the insurance company to provide a certain level
of security and solidarity to the insured person’s life.
However, the insurance company must also watch out
for anyone looking for a way to scam them into free
money. So each party is expected to act in good faith
if the insurance company provides you with falsified or
misrepresented information, then they are liable in
situations where this misrepresentation or falsification
has caused you loss. If you have misrepresented
information regarding subject matter or your own
personal history, then the insurance company’s liability
becomes void (revoked).
 Principle of insurable interest - The person getting an
insurance policy must have an insurable interest in
the property or life insured. A person is said to have
an insurable interest in the property if he is benefited
by its existence and be prejudiced by its destruction.
The presence of insurable interest is a legal
requirement. So an insurance contract without the
existence of insurable interest is not legally valid and
cannot be claimed in a Court. The object of this
principle is to prevent insurance from becoming a
gambling contract.
An insurable interest is that legal or equitable
relationship between the insured and the subject matter
of the insurance, separate from the existence of the
insurance relationship, by which the insured would be
prejudiced by the occurrence of the event insured
against, or conversely would take a benefit from its non-
occurrence.
Life insurance: insurable interest must exist when
policy is purchased.
Fire insurance: insurable interest must exist when
insurance is effected as well as when loss occur.
Marine insurance: insurable interest must exist only
when loss occurs.
 Principle of indemnity - The essence of insurance is the
principle of indemnity that the person who suffers a
financial loss is placed in the same financial position
He neither profits nor is disadvantaged by the loss. In
practice, this is much more difficult to achieve in life
insurance than in property insurance. No life insurance
company would provide insurance in an amount
clearly exceeding the estimated economic value of the
covered life. Limiting the amount of life insurance sold
to reflect economic value gives recognition to the rule
of indemnity. Additionally, only persons exposed to the
potential loss may legitimately own the insurance
covering the insured’s life.
The principle of indemnity is applicable to all types of
insurance policies except life insurance. Indemnity
means security, protection and compensation given
against damage, loss or injury. The insurer promise to
help the insured in restoring the financial position
before loss has occurred.
 Whenever there is a loss of property, the loss is
compensated. The compensation payable and the loss
suffered should be measurable in term of money. The
insured will be compensated only up to the amount of
loss suffered by him. He will not earn profit from the
contractor. The maximum amount of compensation will
be up to the value of the policy which is fixed at the
time of contract. The courts rely upon the principle of
indemnity to hold that an insured may not recover
more than his true loss.
 Liability of insurer to pay
compensation

a) Sum insured or value of policy : the actual amount

payable is actual loss or sum insured, whichever is
less.
b) Excess and franchise clause : this clause provides
that under certain conditions a part of loss shall be
borne by insured himself. The liability of insurer is
limited by imposition of excess or franchise clause.
c) Pro-rata average : the compensation payable by
insurer is proportionately reduced
Insurance in case
policy takenof under
Actual loss of goods or property. Formulae for this is –
insurance
Market value of property at time of loss
d) Salvage : Anything left after occurrence of loss is
known as ‘salvage’. The salvage or scrap left of
destroyed goods is to be reduced from amount
payable to insured.
e) Subrogation : Subrogation literally refers to the act of
one person or party standing in the place of another
person or party. Subrogation effectively defines the
rights of the insurance company both before and after
it has paid claims made against a policy. Subrogation
is a term describing a legal right held by most
insurance carriers to legally pursue a third party that
caused an insurance loss to the insured. This is done
in order to recover the amount of the claim paid by
the insurance carrier to the insured for the loss.
f) Contribution : Some times a person gets a subject
matter insured with more than one insurer called the
“Double Insurance ” whereby in the event of damage
he can not claim anything more than the total loss from
all insurer together. In such case, the total loss suffered
by the insured is contributed by different insurers in the
ratio of the value of policies issued by them for the
same subject matter.