Each of the six principles of insurance defines a fundamental rule of action or conduct that addresses the legal side of the insurance industry. Each applies to both the insured and insurer throughout the life of an insurance contract, from the date of application to the date of cancellation. In total, the six principles of insurance make up legal, binding guidelines for entering into an insurance contract and for preparing, lodging and managing lawful insurance claims.
Utmost Good Faith
Utmost good faith, a principle dating back to Carter v. Boehm in 1766, is a principle based on precedent rather than on a set of defining codes or statutes. Utmost good faith requires honesty and full disclosure at all times, starting with the application phase. It prevents both the insured and insurer from concealing or misrepresenting facts during the application phase, prevents the insurer from ever altering the policy without full disclosure during the time the policy is in force and, in the event of a loss, requires the insured to provide a full, honest representation of the facts surrounding the event and loss. Violating this principle can be the basis of a case for fraud.
The principle of indemnity refers to the payment of money for claims. It says an insured should get no more and no less money than the insurance policy permits and the extent of the loss allows. Provisions in the policy dictate whether claims are valued at cash or replacement value – taking or not taking an allowance for depreciation – or the face value a policy defines for policies that insure valuables such as artwork or antiques. Indemnity does not apply, however, to life insurance policies.
Subrogation is a principle of substitution and recovery. It puts an insurance company in a middleman position when a third party causes a loss and in this way helps to control insurance costs. For example, in the case of an auto accident, subrogation stops an insured from collecting payment from two insurance companies for the same loss, places responsibility for the accident on the third party and gives an insurance company the legal right to demand recovery for any payments made to the insured as a result of the accident.
Contribution applies in a case where an insured holds more than one policy for the same thing. It allows insurance companies to share the cost of claims and prevents an insured from collecting in full on more than one policy. The principle of contribution states that an insured can make a claim equal to the extent of a loss from one or all insurers. If one insurer pays the claim in full, the insurer can then recover a percentage of the payment from the other insurers.
The principle of insurable interest states that in order for a loss to “count” an insured must have an interest in or own the item being insured. Interest can be subjective, as in life insurance, or it can be a physical thing, such as a car or home. Either way, insurable interest prevents a person from taking out a policy or an insured from making a claim or collecting payments for a person he doesn’t have a direct relationship with or an item he doesn't own.
Proximate cause – which does not apply to life insurance – addresses what perils an insured chooses to cover and identifies insurer liability when two or more perils come together to cause a loss. It states that the proximate, closest or most dominant cause determines liability. For example, if an insured has fire but no flood insurance and a fire causes water pipes to burst and flood the home, the insured is liable for damage the fire causes. However, because bursting water pipes are the dominant cause of the flood damage, the insurance company is not legally liable to pay any claims resulting from repairs.
- LMI Group: Mannings Six Principles of General Insurance
- University of California at Berkeley: The Common Law and Civil Law Traditions
- University of Nebraska-Lincoln: Principle of Indemnity
- International Risk Management Institute: Contribution by Limits
- International Risk Management Institute: Proximate Cause
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