FUNDAMENTALS OF ACCOUNTING AND MANAGEMENT –I MANAGEMENT – CONCEPTUAL FRAMEWORK
8. Outline of Insurance Insurance is as old as civilisation. The "Yogakshema" is the oldest form of insurance known, used in the Rigveda. Manu emphasised that a special charge be placed on goods carried from one town to another, to ensure their safe carriage. Today, insurance is an integral part of our lives. Insurance can be of various kinds, including Marine Insurance, Fire Insurance, Life Insurance and Miscellaneous Insurance.
Objectives With this lesson, you will be able to:
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Understand the Principles of Insurance Learn the essential elements of a valid Insurance Contract Understand the various kinds of Insurance available
Introduction Insurance, in law and business, is a contractual arrangement that provides for compensation by an insurer to an insured party if, or when, a specified set of circumstances occurs. Such circumstances may include death or personal injury, accident, unemployment or old age, loss of or damage to property, or any one of a number of instances that can be compensated for financially. The insurer conducts its operations by amassing relatively small contributions from many people who are exposed to the risk of occurrence of an unforeseen event, in order to create a fund that is used to reimburse those insured who actually suffer from such an occurrence. The contributions of the policyholder are called premiums. A Contract of Insurance is embodied in a policy that specifies the terms under which the insurer agrees to indemnify the policyholder for loss, in consideration of the payment of a stated premium or premiums.
Principles of Insurance
1. Principles of Co-operation - Within the scope of Insurance, a loss is shared by a group of persons who are willing to co-operate. The loss incurred by one member is shared by the other members of the group.
2. Theory of probability - The loss in the form of a premium can be distributed only on the basis of the theory of probability. The chances of loss are estimated in advance to affix the amount of premium charged. Since the degree of loss depends upon various factors, the affecting factors are analysed before determining the amount of loss. With the help of this principle, the uncertainty of loss is converted into certainty and used to determine the premium and value of a covered loss.
Insurance Contract Insurance is a contract between two parties, whereby one party called Insurer undertakes, in exchange for a fixed sum called premiums, to pay the other party called Insured. An insurance contract must have the following essential elements of a valid contract, as defined under section 10 of the Indian Contract Act 1872.
8.3.1 Elements of a General Contract (The Indian Contract Act 1872) 1. Offer and Acceptance â€“ An offer is given by the person who wants to be insured and acceptance is given by the Insurance Company. 2. Legal Consideration - This is the motive or reason for both parties to enter a legal contract. Amount of premium is a consideration for the insurer, whereas the promise to receive a fixed sum at a given contingency is a consideration for the insured. 3. Competent to Make a Contract - Both contracting parties should be competent to enter into a contract. The Insurer must be able to incorporate into the body of the contract, certain provisions of the Act. The insured must be of sound mind, of the age of majority according to the law, and should not be insolvent. 4. Free Consent - The consent of the parties entering into the contract should be free from coercion, undue influence, fraud, misrepresentation or mistake. 5. Legal Object - An object is considered lawful when is not forbidden by law, is not immoral, not opposed to public policy, and an act which does not defeat the provisions of any law. 8.3.2 Essentials of Insurance Contract 1. Insurable Interest - This is the pecuniary, or financial, interest whereby the policy holder directly benefits by the existence of the subject matter, and may suffer a financial or other loss by the death of or damage to the subject matter. 2. Utmost Good Faith - Both parties of the insurance contract must be in agreement when the contract is created. There should not be any misrepresentation, non-disclosure or fraud concerning the material facts. 3. Principle of Indemnity - All insurance contracts, except personal insurance contracts, are based on the principle of indemnity. According to this principle, the insured should not profit financially in the event of a covered loss. Only the actual value of the loss is compensated by the insurer. The insured is not entitled to make a financial gain from the incurred loss. 4. Doctrine of Subrogation - In the case of loss of the subject matter due to the negligence of a third party, this doctrine refers to the right of the insurer to 2
stand in the place of the insured, after the settlement of a claim, to the extent of the insured’s right of recovery from the alternative source. The insurer has the right to recover the claim from the third party responsible for the loss. 5. Warranties - Certain conditions and promises in an Insurance Contract are called warranties. Warranties which are mentioned in the policy are called “express warranties”. Other warranties which are not specifically mentioned in the policy are called “implied warranties”. If there is a breach of warranty, the insurer is freed from his liability. Therefore the insured must fulfill the conditions and promises stated in the insurance contract. 6. Proximate Cause - In case of loss to the subject matter, the immediate cause of loss must be seen at the time of payment for the loss. The remote causes are not regarded. If the immediate cause is covered in the insurance contract, compensation is paid by the insurer to the insured.
Self-Check Questions Fill in the Blanks 1. ___________________ ensures that the loss is shared by a group of persons who are willing to co-operate. 2. The _________________ determines the chances of loss in order to estimate the amount of premium. 3. Consideration of Insurance in a contract is motive for _____________ of the contract. (one party/ both parties) 4. In the case of _____________, the policy holder benefits by the existence of the subject matter. 5. According to ______________, the insured is not entitled to make a financial gain from an incurred loss.
Kinds of Insurance Insurance can be broadly classified in two ways, from the business point of view and from the risk point of view. Business point of view
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There are three categories of insurance from the business point of view: Life Insurance General Insurance Social Insurance
8.4.1 Life Insurance
Life Insurance is different from other insurance in the sense that, here, the subject matter of insurance is the life of a human being. The insurer will pay a fixed amount of insurance at the time of death or at the expiry of a certain period of time. At present, life insurance enjoys the maximum following because human life is the most important property of society or an individual. Each and every person requires this insurance. Life insurance provides protection to the family in the event of a premature death, or gives an adequate amount of cash at old age when earning capacities are reduced. Under personal insurance a payment is made in the event of an accident. This insurance is not only a protection, but also a type of investment, because a certain sum may be paid to the insured’s beneficiary in the event of death, or at the expiry of the policy period. 8.4.2 General Insurance General insurance includes property insurance, liability insurance and other forms of insurance. Fire and marine insurance are strictly property insurance. Motor, theft, fidelity and machine insurances include liability insurance to a certain extent. The strictest form of liability insurance is fidelity insurance, whereby the insurer compensates the loss to the insured when he is liable for payment to a third party. 8.4.3 Social Insurance Social insurance provides protection to the weaker sections of the society who may be unable to pay the premiums for adequate coverage. Pension plans, liability benefits, unemployment benefits, health insurance and industrial insurance are the various forms of social insurance. With the increase of socialistic ideas, social insurance is an obligatory duty of the nation. The Government of a country must strive to provide social insurance to its population. Risk Point of View
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There are three categories of insurance from the risk point of view: Property Insurance Liability Insurance Other Forms of Insurance
8.4.4 Property Insurance Under property insurance, property belonging to a person or persons, is insured against a certain specified risk. This risk may be fire or marine perils, theft of property or goods, damage to property due to an accident or cetain other specified events. •
Marine Insurance - Marine Insurance provides protection against loss from marine perils. Marine perils include collision with rock, ship attacks by enemies, fire, capture by pirates etc. These perils may cause damage, destruction or disappearance of the ship and cargo, resulting in non-payment
of freight. Marine insurance therefore insures the ship (Hull), the cargo and the freight. Previously, only certain nominal risks were insured but now the scope of marine insurance had been divided into two parts: (i) Ocean Marine Insurance and (ii) Inland Marine Insurance. The former insures only marine perils while the latter covers inland perils which may arise with the delivery of cargo (goods) from the godown of the insured, and may extend up to the receipt of the cargo by the buyer (importer) at his godown. Fire Insurance: Fire Insurance covers the risks of fire. Fire damage can affect not only the individual, but society as well. With the help of fire insurance the losses arising due to fire are compensated. The individual is protected from such losses and his property, business or industry can return to approximately the same financial position as before the loss. Fire insurance can also provide coverage for certain consequential losses. War risk, turmoil and riots may also be insured under this type of policy. Miscellaneous Insurance: Property, goods, machinery, furniture, automobiles, and valuable articles may be insured against damage or destruction due to an accident or disappearance due to theft. There are different forms of insurance for each type of property, such that not only is the property insured, but liability and personal injuries may also be insured.
8.4.5 Liability Insurance General insurance also includes liability insurance where the insured is found liable to pay for the damage of property or to compensate loss due to personal injury or death. This insurance is seen in the form of fidelity insurance, automobile insurance and machine insurance. Liability insurance is also called Third Party Insurance. 8.4.6 Other Forms of Insurance Besides property and liability insurance, there are certain other forms of insurance which are included under the term General insurance. Examples of such insurance are export-credit insurance and state employees insurance, whereby the insurer guarantees to pay a certain amount at certain events. This insurance is expanding rapidly. •
Personal Insurance: Personal insurance includes insurance of human life which may suffer loss due to death, accident or disease. Personal insurance is further sub-classified into life insurance, personal accident insurance and health insurance. Guarantee Insurance: Guarantee insurance covers a financial loss arising due to dishonesty, disappearance or disloyalty of an employee or a second party. For example, in export insurance, the insurer will compensate the insured the loss suffered due to the failure of the importers to pay the full amount of debt.
Self-Check Questions Answer True or False 6. 7. 8. 9.
Under Life insurance, only human life is insured. Consequential losses are also covered under Fire insurance. Personal Insurance is also called Life insurance. Liability Insurance is also called Third party insurance.
Fill in the Blank 10. ____________ insurance is considered insurance as well as an investment.
8.5.1 Class Assignments 1. What does Insurance mean? Discuss the Principles of Insurance. 2. Discuss the various elements of a General Contract and an Insurance Contract. 8.5.2 Home Assignments 1. Discuss types of Insurance from a Business point of view. 2. Discuss types of Insurance from a Risk point of view.
Summary Insurance is the contractual arrangement that provides for compensation by an insurer to an insured. For a valid insurance contract, essentials of the General Contract under Section 10 of the Indian Contract Act and under Insurance Act must be fulfilled. Insurance may be classified as Marine Insurance, Life Insurance, Fire Insurance and General Insurance.
8.7 1. 2. 3. 4. 5. 6.
Answers to Self-Check Questions Principles of Co-operation Theory of Probability Both Parties Insurable Interest Principle of Indemnity True
7. True 8. False 9. True 10. Life
1. Insurance Principles and Practice by Malhotra, M.N., S. Chand & Sons
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Glossary Insurance - This, in law and business, is a contractual arrangement that provides for compensation by an insurer to an insured party if or when a specified set of circumstances occurs. Indemnity - Payment or compensation for damages done. Warranties - A series of statements which one party to a transaction gives and upon which the other party relies when entering into the arrangement. Proximate - Close, near, adjacent, or contiguous. Marine - Of or relating to the sea.