Insurance policies may seem complicated, but most are based on just 7 core principles. Understanding these fundamental concepts can help you better evaluate insurance products and file claims.
This article will explain the purpose and practical application of the 7 foundational insurance principles:
- Utmost Good Faith
- Insurable Interest
- Indemnity
- Proximate Cause
- Subrogation
- Contribution
- Loss Minimization
The Principle of Utmost Good Faith
Also called the principle of “uberrimae fidei”, utmost good faith requires all parties to act honestly and not withhold information. Both the insurer and the policyholder must disclose all material facts.
For the insurer, this means clearly explaining policy terms, coverages, and exclusions. The applicant must provide accurate details about their risk profile, without misrepresentation.
Examples where an applicant violates good faith include:
- Lying on an application about their medical history or driving record.
- Hiding previous claims or losses from the insurer.
- Not mentioning business activities not stated on the application.
If a policyholder breaches the duty of utmost good faith, the insurer can void the policy and deny all claims.
Why Insurable Interest Matters
Insurable interest guarantees that the policyholder stands to suffer financially from a loss. You need to prove insurable interest both when applying for a policy and when filing a claim.
For property insurance, insurable interest exists when you own or lease the property. For life insurance, you must have an economic interest in the person being insured.
Without insurable interest, people could take out policies on random lives or properties, hoping to profit if something happened to them. This creates perverse incentives contrary to public policy.
Examples where insurable interest is lacking include:
- An ex-spouse keeping a life insurance policy on their former partner.
- A company insuring a competitor’s factory that they want to see destroyed.
- A thief insuring stolen merchandise.
Lacking insurable interest can nullify the entire policy and any associated claims.
How the Indemnity Principle Works
Indemnity limits insurance compensation to the actual cash value of the loss. You cannot profit from a claim or receive more than it costs to repair or replace your insured property.
With indemnity, claim payments aim to put you back in the same financial position as before the loss. You don’t get rewarded for more than your actual damages.
Exceptions include life insurance and policies with guaranteed replacements costs. But most property, casualty, and liability policies follow strict indemnity.
Say your rare coin collection worth $20,000 gets stolen. The insurer will reimburse you $20,000 under indemnity, not a higher “agreed value”. Or if a fire causes $50,000 in home damages, that’s your claim limit, even if rebuilding costs end up higher.
Determining Proximate Cause of Loss
Proximate cause looks at the primary cause of damage when filing an insurance claim. The proximate cause must be a covered peril for the claim to be paid.
If the proximal cause is something excluded or not covered, the insurer will deny the claim. They don’t pay for secondary effects stemming from uncovered events.
For example, say a massive storm knocks out power across town. During the blackout, a power surge fries your home electronics when the electricity comes back on. But the real proximate cause was the storm, not power restoration. So if your policy excludes storm damage, you can’t claim for the resulting power surge losses.
Proximate cause is why insurers always investigate claims thoroughly. They need to find the true originating source of the damage before issuing payment.
How Subrogation Works
With subrogation, the insurer can recover claim costs from negligent third-parties. If someone else caused your loss, subrogation means the insurer pursues legal action against them in your name.
For example, say another driver crashes into your car. You make a collision claim with your insurer. They pay to repair your vehicle then use subrogation to get reimbursed from the at-fault driver.
Subrogation has three major benefits:
- It prevents the policyholder from profiting twice from one incident
- It holds negligent parties financially accountable
- It keeps insurance costs lower by recovering payouts
However, you must cooperate with your insurer during subrogation. Typically, your policy requires notifying them of potential third-party claims and agreeing not to independently settle with the at-fault party.
How Contribution Applies with Multiple Policies
The contribution principle adjusts claim payments across all policies covering the loss. It prevents excessive compensation from overlapping coverage.
Contribution comes into play when you have two or more insurers on the risk. The insurers share payment on a pro-rated basis up to the full loss amount.
For example, say your home is insured for $300,000 under two separate policies. If you have a $150,000 fire loss, each insurer owes only $75,000 under contribution, not the full $150,000.
Contribution ensures you receive no less, but no more, than your total loss amount. It also designates the lead insurer who handles the claims process on behalf of all carriers.
Implementing Loss Minimization Strategies
Loss minimization means taking proactive steps to avoid or reduce insurance claims. It’s a key principle for both insurers and policyholders.
For insurers, only accepting risks they can properly underwrite helps minimize potential losses. Maintaining adequate reserves also reduces the financial impact of claims.
Policyholders can minimize losses through preventative measures like:
- Installing smoke detectors and alarm systems
- Following manufacturers’ maintenance instructions
- Securing properties against theft and natural disasters
- Performing regular equipment inspections
- Correcting unsafe conditions
- Following loss control recommendations
Implementing strong loss control helps lower claim frequency and severity. It leads to more affordable premiums and productive long-term insurer-client relationships.
The Bottom Line
While insurance law differs across jurisdictions, most carriers follow these 7 fundamental principles. Understanding these core concepts helps you know what to expect from your insurer and how to protect your interests.
If you have questions about how these principles apply to your specific policy or claim situation, don’t hesitate to consult your insurance agent or company representative. They can provide guidance on translating general insurance rules into your unique circumstances.