If insurance were a process of producing something, the five requirements for insurable risks as explained in Gambling vs insurance: requirements for insurable risks are screening over raw materials. What we will discuss below, on the other hand, are to do with the production process. They are basic principles that must be fulfilled in the production process of insurance as a risk transfer mechanism. These points are known as basic principles of insurance. As with requirements for insurable risks, these basic principles play a very important role in fencing insurance practices from being abused and misused for gambling or other forms of speculation.
There are four basic principles of insurance, namely: insurable interest, utmost good faith, proximate cause and indemnity. For insurance that meets the basic principles of indemnity, there are two further basic principles that must also be followed, known as the principle of subrogation and contribution.
Without further a due, let’s discuss them one by one.
1. Insurable interest
This principle requires the insured has an insurable interest in the subject of insurance. Insurable interest is the interest of the insured on the subject of insurance which can be measured in financial terms and most importantly, relationship between the insured and the subject of insurance must be legal and recognized by law. You have the right to insure your house or car because you have insurable interest in the house or car. In this example, insurable interest arises from the relationship of ownership between you and your house or car. This ownership is legal in the eyes of the law and can be valued in money that is equal to the value of the house or car. This principle also prevents a wife from insuring the soul of her neighbor’s husband.
2. Utmost good faith
This principle requires both parties (the insured and the insurer) to have the highest honesty in executing the insurance agreement. The highest form of honesty that is most important in an insurance contract is the obligation of the two parties to honestly disclose and declare all material facts related to insurance, whether requested or not by the other party. Material facts are facts that influence decision making of either parties. In other words, material facts will determine risk owner decision whether to buy insurance or not. Other material facts will determine whether insurance companies are willing to accept risk or not.
In life insurance, for example, the insured must be honest that he is actually a smoker or he has had a mild stroke once. The insurance companies, on the other hand, as a manifestation of the highest sincerity, is obliged to explain as clearly as possible the facts about the insurance product such as what is covered, what is not, the limits of coverage, exclusions, provisions for filing claims and so on.
Utmost good faith principle is extremely important in insurance contracts, considering the subject of insurance (risk) is intangible (cannot be seen, touched and felt), so that the facts associated with it cannot be presented physically and are highly dependent on the honesty and sincerity of both party to express or disclose them.
3. Proximate cause
Proximate cause means the most dominant cause. This principle is closely related to the situation when loss occurs, decision has to be made whether the loss is covered or not by the insurance policy. In most cases, the loss is not caused by a single event, but rather the result of a series of successive events. In this situation, it is crucial to determine which event is the proximate cause, which play the most dominant role in causing loss. The insurance company will only be responsible for paying the loss if the proximate cause is the risk or event that is covered by the insurance policy. And vice versa, to be able to reject a claim, basically the insurance company must be able to prove that the proximate cause of the loss is actually excluded by the policy.
However, this does not mean that only the proximate cause can be excluded. If it is clearly stated in the policy, an event, behavior, or circumstances may be excluded. This means that as long as it is in the chain of events, even if it is not a proximate cause, the claim will not be paid.
Determination of the proximate cause is not always easy because every loss occurs in different ways and sequences, and in different situations. So it is not surprising that insurance claims disputes often occur.
Enough for now, next article will discuss the principle of indemnity and its derivatives.