Wednesday, February 9, 2011

Some basics of Insurance - the concept of "Insurable Interest"

The contract of Insurance is based on some fundamental principles.  Insurable Interest is a basic requirement. 

In very simple terms, the party to Insurance contract (the Insured – the policy holder) should have a particular relationship with the subject matter of insurance.  The absence of required relationship would render the contract illegal, void or simple unenforceable.  The commonest example is ‘policy on the life of an important person – say M S Dhoni’ by somebody not related to him. 

To understand this rudimentary concept, one needs to start with Wager – an agreement under which each bettor pledges certain amount to the other depending on the outcome of an unsettled matter.  Really classic definition of the act of gambling.  Insurance contracts are not wagering contracts.

The concept of Insurable interest puts restrictions on what can be insured and by whom.  For concluding a policy of insurance some of the essential ingredients are :
-          there must be some person or thing exposed to a loss or some potential liability
-          that must  be the subject matter of the insurance
-          the proposer / policy holder  must bear some relationship to the insured thing whereby he stands to benefit by its safety or be prejudiced by its loss or by incurring liability
-          there must be offer and acceptance
-          there  has to be consideration.

From this angle, the insurable interest commonly arises out of Ownership, Finance, Lease, Bailment, Mortgage, Trust, Will, Execution, Legal liability, contractual right  and more.   In property insurance, it is something loss of which would cause financial suffering to the insured.  For eg., if house is the subject matter – damage by fire or any other insured peril would render the reduction in value of the property or bring financial loss or would make them incur financial loss in reconstructing, repairing, refurbishing, renovating.  When the house is not owned, the loss at best might evoke sympathy but not any financial suffering.

Insurance is a contract of indemnity and upon an  occurrence, the Insured would at best be put back in the same position he was prior to the loss and would not be allowed to make a gain out of the misfortune.   Thus where the Insured does not suffer any pecuniary loss, there would not be any consideration even where there is a loss caused by an insured peril.  Apart from the right in the property or a right derivable out of some contract on the property there can also be interest created by the existence of a legal obligation to bear any loss arising from loss, damage or destruction of such insured property.  Again the loss has to be accidental and not intentional.
The purpose of taking an Insurance policy would be to get compensation at the time of loss but it should not allow a Third party to obtain financial benefit, as it would create a moral hazard.  Irrespective of the other aspects of existence of policy, payment of premium etc., in such a situation the policy holder would be making money out of the deal and hence without this insurable interest concept, the taking of insurance would only be gambling – paying  premium in the hope of gaining which is against public policy also.

When insurable interest parts or ceases, there would no longer be any tenable claim as there would be no pecuniary loss.  The concept is not one of moral certainty but the right to the legal or equitable interest or a right under the contract.

In marine it is somewhat complicated as the issue of insurable interest would further be determined  by  application of the principle of property and risk passing to the buyer, the terms of the particular contract, and the terms of the policy.

Fortunately, the Indian  Marine Insurance Act of 1963 makes many things easily understandable with crystal clear definition.

Marine insurance is defined as  :  “ A contract of Marine Insurance is an agreement whereby the Insurer undertakes to indemnify the assured in the manner and to the extent thereby agreed, against marine losses, that is to say, the losses incidental to marine adventure ”.  

The subject matter or the insurable property could be  “Ship, goods or other movables which are exposed to maritime perils”.  Marine adventure includes any adventure where any insurable property is exposed to perils ; the earnings or acquisition of any freight, passage money, commission, profit or other pecuniary benefit or the security for any advances, loans or disbursements is endangered  by the exposure of insurable property to maritime perils. 

The maritime perils mentioned here are perils consequent on or incidental to the navigation of the sea, that is  perils of the seas, fire, war perils, pirates, rovers, thieves, captures, seizures, restraints and detainments of princes and people, jettison, barratry and any other perils which are either of the like kind or may be designated by the Policy.

The following Sections are most relevant and significance wrt “Insurable Interest” :-
Sec 6.   Avoidance of wagering contracts
    (1) Every contract of marine insurance by way of wagering is void.
    (2) A contract of marine insurance is deemed to be a wagering contract-
        (a) where the assured has not an insurable interest as defined by this Act, and the contract is entered into with no expectation of acquiring such an interest; or
        (b) where the policy is made "interest or no interest", or "without further proof of interest than the policy itself", or "without benefit of salvage to the insurer" , or subject to any other like term:
    Provided that, where there is no possibility of salvage, a policy may be effected without benefit of salvage to the insurer".

Sec 7 :  Insurable interest defined
    (1) Subject to the provisions of this Act, every person has an insurable interest who is interested in a marine adventure.
    (2) In particular a person is interested in a marine adventure where he stands in any legal or equitable relation to the adventure or to any insurable property at risk therein, in consequence of which he may benefit by the safety or due arrival of insurable property, or may be prejudiced by its loss, or by damage thereto, or by the detention thereof, or may incur liability in respect thereof.

Sec 8. When interest must attach
    (1) The assured must be interested in the subject-matter insured at the time of the loss, though he need not be interested when the insurance is effected:
    Provided that, where the subject- matter is insured "lost or not lost", the assured may recover although he may not have acquired his interest until after the loss, unless at the time of effecting the contract  of insurance the assured was aware of the loss, and the insurer was not.
    (2) Where the assured has no interest at the time of the loss, he cannot acquire interest by any act or election after he is aware of the loss.

In a Marine voyage there would be varied interest and there could different entities with differential interests with different percentage of share.  Some could be :  Owner of Ship, Owner of Cargo (Seller / Buyer depending on contractual terms), Freight recipient, Charterer,  Mortgagor & mortgagee, Master and Crew, Agent, Carrier, Lien holders and pawnors, Trustees and executors,  persons expecting profit from the adventure, lender of money, Port Marine Operator, CFS / ICD operators, Bailees etc.,

With regards – S. Sampathkumar

PS:  Just a beginning as I have some more thoughts to be shared on this concept of ‘insurable interest’ – rudimentary it may sound but not so easily discernible.  Look forward to more views from experts.

4 comments:

  1. very interesting insights - Steve

    ReplyDelete
  2. lots to learn from this post - thanks - Divya

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