PRINCIPLES OF INSURANCE: Explained With Examples

Principles of insurance

Insurance plans are contracts that offer consumers financial security and protection against future unpredictability. However, in order for the relationship between the insurer and the insured to work, several important principles must be followed. Continue reading to learn about the seven insurance contract principles.

What is Insurance?

Insurance, which is represented in the form of a policy, is a contract in which an individual or an entity receives financial protection. In other words, it is compensation from the insurance company for damage (large or small) caused to their property. The insurer and the insured engage in a formal contract for insurance, known as an insurance policy. This policy provides financial security against future uncertainty.

In layman’s terms, insurance is a contract, a legal arrangement between two parties, namely the individual termed the insured and the insurance company known as the insurer. In this agreement, the insurer promises to assist the insured with any damages incurred as a result of the occurrence of the contingency. The insured, on the other hand, pays a premium in exchange for the insurer’s commitment.

The insurance contract between an insurer and an insured is founded on specific principles; Let’s explain the insurance principles in detail below;

7 Principles of Insurance

Insurance is the spreading of risk among a group of people. As a result, cooperation is one of the fundamental principles of insurance. To ensure the correct operation of an insurance contract, both the insurer and the insured must adhere to the 7 insurance principles listed below:

  1. Utmost Good Faith
  2. Proximate Cause
  3. Insurable Interest
  4. Indemnity
  5. Subrogation
  6. Contribution
  7. Loss Minimization

Let’s break down each of the 7 insurance principles with an example.

#1. The Utmost Good Faith Principle

In an insurance contract, both parties—the insured (policyholder) and the insurer (the company)—must act in good faith towards one another. The insurer and the insured must give clear and simple information about the contract’s terms and conditions.

Because the purpose of the service is for the insurance company to provide a particular level of security and solidarity to the insured person’s life, this is a very basic and primary premise of insurance contracts. However, the insurance company must also keep an eye out for anyone attempting to con them out of free money. As a result, each party is expected to act in good faith toward the other.

If the insurance company presents you with fabricated or misrepresented information, they are accountable if the deception or falsification causes you to lose money. If you have misrepresented information about the subject matter or your personal history, the insurance company’s liability is null and void (revoked).


Jacob purchased a health insurance policy. He was a smoker at the time he applied for insurance and failed to mention this fact. He then developed cancer. In such a case, the insurance company will not be obligated to incur the financial burden because Jacob withheld critical information.

#2. The Proximate Cause Principle

The loss of insured property might be caused by more than one occurrence, even if they occur in quick succession. Some, but not all, causes of loss may be insured against. When a property is not covered against all causes, the closest cause must be determined. If the proximate cause is one for which the property is insured, the insurer is obligated to compensate. If it is not a reason for which the property is insured, the insurer is not required to pay.

When purchasing insurance plans, you will most likely go through a procedure in which you will pick which situations you and your property will be protected for and which will not. This is where you decide which proximate causes will be covered. If you are involved in an event, the proximate cause must be investigated. This is so that the insurance company can confirm that you are insured for the incident.

This can lead to disagreements if you have an occurrence that you thought was covered but your insurance company says it isn’t. Insurance firms want to make sure they are protecting themselves, but they can also utilise this to avoid liability in particular situations. This could be a case when you’ll need the assistance of a lawyer to argue your case.


A building’s wall was destroyed by fire, and the local authority ordered that it be dismantled. The adjacent structure was destroyed during the destruction. The adjacent building’s owner claimed the loss under the fire policy. The court determined that fire is the most likely cause of loss to the next building and that the claim is valid because the wall’s collapse is an unavoidable effect of the fire.

In the same case, a building wall was destroyed by fire, then collapsed owing to a storm before it could be restored, causing damage to a nearby building. The adjacent building’s owner claimed the loss under the fire policy. The fire was a remote cause in this case, and the storm was the proximate cause; so, the claim is not payable under the fire policy.

#3. Insurable Interest

The insurable interest concept demands that the owner of a certain insurance policy have an ownership interest in the insurance policy’s subject matter. The owner of a hot dog cart, for example, has an insurable interest in the cart because he owns it and earns money from it. However, if he sells the hot dog cart, he will lose his insurable stake in it. Creditors have an insurable interest in debt as well. The lack of an insurable interest can render the insurance policy null and void.


The owner of a vegetable cart has an insurable interest in the cart because it earns him money. If he sells the cart, however, he will no longer have an insurable interest in it.

To be able to claim the insurance amount, the insured must be the owner of the subject matter both at the time of contracting and at the time of the accident.

#4. The Indemnity Principle

Indemnity is a guarantee that the insured would be returned to the position he or she was in before the uncertain incident that resulted in a loss for the insured. The insured is compensated by the insurer (provider) (policyholder).

The insurance company offers to compensate the policyholder for the amount of the loss up to the contract limit.

Essentially, this is the most important portion of the contract for the insurance policyholder since it states that she or he has the right to be compensated or, in other words, indemnified for his or her loss.

The amount of compensation is proportional to the amount of loss suffered. The insurance company will pay up to the amount of the suffered loss or the agreed-upon insured amount, whichever is smaller. For example, suppose your car is insured for $10,000 but the damage is only $3,000. You only receive $3,000, not the entire amount.

When the incident that produced the loss does not occur within the time frame specified in the contract or from the precise agreed-upon sources of loss, compensation is not given (as you will see in The Principle of Proximate Cause). Insurance contracts are intended primarily to give protection against unexpected catastrophes, not to profit from a loss. As a result, the insured is protected from losses not only by the principle of indemnification but also by requirements that prevent him or her from being able to swindle and benefit.


Suppose the owner of a business building enters into an insurance policy to collect the costs of any future loss or damage. If the building receives structural damage as a result of a fire, the insurer will reimburse the owner for the costs of repairing the building, either by reimbursing the owner for the exact amount spent on repairs or by reconstructing the damaged portions using its own authorised contractors.

#5. The Subrogation Principle

This notion can be a little perplexing, but the example should help clarify it. Subrogation is defined as the substitution of one creditor (the insurance company) for another (another insurance company representing the person responsible for the loss). After the insured (policyholder) has been reimbursed for the loss on an insured piece of property, ownership of that property passes to the insurer.

Assume you are in a car accident caused by a third party and file a claim with your insurance company to cover the damages to your automobile as well as your medical expenditures. Your insurance company will take ownership of your car and medical expenditures in order to intervene and file a claim or lawsuit against the person who caused the accident (i.e. the person who should have paid for your losses).

The insurance company can only gain from subrogation if it is able to recoup the money it paid to its policyholder as well as the costs of obtaining this money. Anything additional paid by a third party is returned to the policyholder. Assume your insurance company initiated a case against the negligent third party after it had already compensated you for the entire amount of your damages. If their action recovers more money from the negligent third party than they paid you, they will use the difference to cover court costs, with the remainder going to you.

For example, if Mr A is injured in a car accident caused by the reckless driving of a third party, the company with which Mr A purchased the accidental insurance will compensate Mr A for his losses and will also prosecute the third party to recover the money paid as a claim.

#6. The Contribution Principle

Contribution creates a symbiotic relationship between all insurance contracts involved in an incident or with the same subject.

Contribution permits the insured to seek indemnity from all insurance contracts implicated in his or her claim to the amount of real loss.


Assume that you have taken out two insurance policies on your used Lamborghini to ensure that you are fully covered in any eventuality. Assume you have an Allstate policy that covers $30,000 in property damage and a State Farm policy that covers $50,000 in property damage. If you are involved in an accident that costs $50,000 in damage to your vehicle. Then Allstate will cover around $19,000, and State Farm would cover $31,000.

This is the contribution principle. Each policy you have on the same issue pays its part of the policyholder’s loss. It is an extension of the indemnity principle that allows for proportional liability for all insurance coverage on the same subject area.

#7. The Loss Minimization Principle

This is our final and most basic basis for creating an insurance contract.

It is the insured’s responsibility to take all efforts to limit the loss on the insured property in the case of an unforeseeable event.

Insurance contracts should not be used to grab free items whenever something unpleasant happens. As a result, the insured bears some responsibility to take all reasonable steps to reduce the loss on the property. This principle is questionable, therefore see a lawyer if you believe you are being unfairly evaluated based on it.


If a fire breaks out in your factory, you must take reasonable steps to put it out. You can’t just sit back and let the fire burn down the plant because you know the insurance company will cover it.

The insurance principles outlined in this article assure the fairness of insurance contracts. If you suspect there was wrongdoing or unfairness in the execution of an insurance contract, you should seek legal counsel. Make contact with a knowledgeable insurance law attorney in your area.

Principles of Insurance FAQ’s

What are the benefits of insurance?

  • Cover yourself against unpredictability. It is one of the most visible and important benefits of insurance. … 
  • Cash Flow Management. The possibility of having to pay for losses out of pocket has a huge influence on cash flow management.
  • Investment opportunities

What are the components of insurance?

There are three critical components of any sort of insurance (premium, policy limit, and deductible).

What are the 4 elements of an insurance contract?

Any lawful contract, including insurance contracts, must meet four requirements:

  • consideration,
  • offer and acceptance
  • competent parties and
  • lawful intent
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