Previous article Gambling vs Insurance: Basic Principles of Insurance (part 1) briefly discussed the first three of the basic principles of insurance, namely insurable interest, utmost good faith and proximate cause. We continue now with remaining three principles namely indemnity, subrogation and contribution.
This principle asserts that insurance will only pay claim for the amount of the loss actually suffered by the insured, not more, but may be less. Thus, the insured is not justified to gain any profit from the payment of insurance claim, in case of amount paid by the insurer exceeds the actual value of the loss.
However, claim payment from insurance company may be smaller than the actual loss amount. This may happen, among other things, if the insurance agreement imposes deductible or excess. It could also be because the implementation of the average. Deductible or excess is part of the loss that is not covered by insurance, but is borne by the insured instead. So, it becomes a deduction from claim payment from insurance company. If the actuall loss happens to be lower than deductible or excess, too bad, no payment from insurance company at all.
Meanwhile, the average is a situation where the insurer only pay a portion of the actual loss, according to proportion of sum insured stated in the policy against actual value of the insured subject or property. Average is a direct consequence of under insurance, where the insured insures his property with an sum insured lower than the actual value of the property. For example, a house worth Rp. 1 billion rupiah, but the owner insure with sum insured of Rp. 600 million (60% of the actual value). So, for any claim regardless of the amount, the insurance company will only pay 60% of the amount of the loss.
The principle of indemnity is trying to prevent a person from making profit from insurance since the purpose of insurance is basically to compensate for damage or loss. This principle aims to close opportunities or at least suppress one’s attempt to misuse the insurance for personal gain.
The principle of indemnity is extremely important, so that it has two derivative principles to support its implementation. i.e. the principle of subrogation and contribution.
According to the principle of subrogation, if the insurance company can prove that the loss suffered by the insured is due to intentional acts or negligence by a third party, the insurance company is entitled to sue the offending third party and ask for compensation. However, it is important to note that the insurer can exercise this right only if it has paid the claim in full to the insured. Thus, the insurer is not allowed to postpone payment of claims on the ground of not getting compensation from the guilty third party. The principle of subrogation supports the principle of indemnity in terms of preventing someone who causing a loss or harm to other party from walking away without being responsible for his/her wrongdoing.
The principle of contribution applies in situation where an insurance subject is covered by two or more different policies. Suppose someone has a house worth Rp. 1 billion. He insured his house to two different insurance companies with sum insured of Rp. 1 billion each, hoping that if anything happens he will receive double compensation. In fact, let’s say there was a fire in his home that caused a loss of Rp. 200 million. Instead of receiving a total compensation of Rp. 400 million, by virtue of principle of contribution, he will only receive exactly as much as the amount of actual loss because each insurer will only pay (contribute) half of the loss (prorated on the sum insured). Again, it is clear that the principle of contribution supports the principle of indemnity in preventing someone from making a profit from a disaster.
It is important to note that the principle of indemnity and its two derivatives, subrogation and contribution, apply to general insurance only, but not life insurance. Life insurance is bound to the first three principles only, namely insurable interest, utmost good faith and proximate cause.
Having said that…
You might begin to see that the requirement for insurable risks and the basic principles of insurance are forming legal protection to insurance from abusing practices including gambling or speculation. They come from recognition on how vital the role that insurance is playing in providing peace of mind to the people and financial protection to the economy. Further elaboration leads us to the view that those principles actually brings conventional insurance closer to sharia principles. However, it is not sufficient to conclude that conventional insurance is fully in line with Sharia, especially in relation to the concept of risk transfer, which according to Shariah, still leaves elements of speculation.
We shall discuss this in the next opportunity.