The purpose of insurance is to compensate persons insured who suffer loss. It is based on the principle of indemnity, that is, to restore the insured to his original position before he suffered loss. Insurance therefore as a principle neither makes the insured worse off or better off than before loss was incurred. For example, if Mr. Green suffered damages valuing $500,000 subsequent to a fire at his home, he will be compensated exactly $500,000 to repair his house.
Principles of Insurance
Indemnity-Restoring the insured to his original position
Insurable interest–The insured must have a vested interest in what is being insured. For example, someone is not allowed to insure his neighbour’s house.
Utmost Good Faith -The insured must be truthful concerning the information pertaining to the policy contract.
Proximate Cause - The damage caused must be close or proximate to the event insured against. For example, if someone has an accident policy that includes death occurring as a result of an accident, this person will not be compensated if death is caused by disease.
Contribution – This principle prevents persons insuring identical risks on the same property with several companies and thus profiting if they suffer loss. For example, an individual may insure his car with three insurance companies hoping to be compensated by all three. He will not succeed as the insurance companies will each only pay a portion of the claim.
Average Clause – This clause sets a limit to the size of the compensation, which depends on the proportion of the true value of the asset paid up by the insured. For example, a homeowner insures his home for $100,000 which is half the true value of $200,000. His house was partially destroyed by fire on the insurance company for $50,000 worth of damage. The insurance company only paid him $25,000 as he was only insured for 50% of the true value of the house presently.
Subrogation -This is an extension of the principle of indemnity, that is, the insured should be reinstated to his exact position before the loss. For example, if a vehicle is totally wrecked and the insurance company pays the insured the value of the car, the wrecked vehicle will be claimed by insurance company.
How does insurance Work?
How are insurance companies able to pay its clients large sums of money to compensate them for loss? They operate on the basis of risk pooling. Premiums from large numbers of persons with the same risks are pooled and only those who suffer loss are compensated. The insurance company can predict the percentage of losses based on past data. The premiums charged are based on the number of losses predicted plus the cost to operate the business and profits to be realized. For example, a particular insurance company may insure one thousand persons for risk against car theft. Only two percent of those insured may suffer lass and therefore the insurance company can afford to assist those persons.