CENTRAL UNIVERSITY OF

SOUTH BIHAR

School of Law & Governance

INSURANCE LAW

Project Work on the Topic

ESSENTIALS OF CONTRACT WITH SPECIAL

REFERENCE TO CONTRACT OF INSURANCE

Submitted to: - Dr. Deo Narayan

Singh
Assistant Professor
School of Law and Governance
Central University of South Bihar
Submitted by: - Sudhanshu Sachan
CUSB1813125106
B.A.LL.B. (Hons.)
8th Semester
School of Law and Governance
Central University of South Bihar

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 ACKNOWLEDGEMENT

I, Sudhanshu Sachan, take extreme pleasure in expressing my profound gratitude towards my

esteemed faculty Dr. Deo Narayan Singh for inspiring and giving me the invaluable guidance
and constant support throughout the course of my project work. I have taken efforts in this kind
project. However, it would not have been possible without the kind support of my teacher, friends,
colleagues and many more individual persons, writers, college staffs, librarians and other sources
of e-resource. I would like to sincerely thank all of them. I thank my parents for providing me
everything whatever be required for the completion of this project. Finally, I would like to thanks
all Kith & Kins who are a little bit part in helping me for this kind project.

TABLE OF CONTENT

S. No. Topic Page

No.
1. INTRODUCTION 03
2. LEGAL NATURE OF CONTRACT OF INSURANCE 04
3. THE RISK FACTOR 05
4. THE PRINCIPLE OF INDEMNITY 06
5. INSURABLE INTEREST 07
6. PRINCIPLE OF UTMOST GOOD FAITH/UBERIMMA FIDES 09
7. CONTRACT OF INSURANCE DISSIMILAR TO CONTRACT OF 09
WAGERING
8. PRINCIPLE OF SUBROGATION 11

9. PRINCIPLE OF CONTRIBUTION 13

10. CONCLUSION 15

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 Essentials of Contract with special reference to Contract of Insurance

Introduction

Insurance means the act of securing the payment of a sum of money in the event of loss or damage
to property, life, a person etc., by regular payment of premiums. Insurance is a method of
spreading over a large number of persons a possible financial loss too serious to be
conveniently borne by an individual. The aim of all insurance is to protect the owner from a
variety of risks which he anticipates. The happening of the specified event must involve some loss
to the assured or at least should expose him to adversity which is, in the law of insurance, called
commonly the ‘risk’.

The nature of insurance depends on the nature of the risk sought to be protected. The chief and
classical varieties of insurance contracts are

(i) Life Insurance

(ii) Fire Insurance
(iii) Marine Insurance &
(iv) Motor Insurance

In the modern times new varieties have been added from time to time like liability insurance, third
party risk. In fact, in modern times, the happening of any event may be insured against at a
premium directly proportional to the risk involved on its happening. An element of uncertainty
must be present in the course of the happening of the event insured against; in some cases, in
almost all non-life insurance contracts, the happening of the event itself is uncertain while in life
insurance the event insured, that is, the death of an individual is a certain event, but the uncertainty
lies in the time when it happens.

The fundamental function of insurance is to shift the loss suffered by a sole individual to a
willing and capable professional risk-bearer in consideration of a comparatively small
contribution called premium. In this process the professional risk-bearer, the insurer collects
some small rate of contribution from a large number of people and if there is any unfortunate
person among them, the risk-bearer, the insurer relieves the sufferer from the effects of the
loss by paying the insurance money. Thus, it serves the social purpose; it is “a social device
whereby uncertain risks of individuals may be combined in a group and thus made more certain;

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small periodic contribution of the individuals providing a fund out of which those who suffer losses
may be reimbursed. The insurers collect the contributions of numerous policyholders and those
funds are invested in organized commerce and industry. They help the running of giant industries
and mobilize the capital formation.

Life insurance business is the business of effecting contracts of insurance upon human life, by
which they will acquire peace of mind and can become carefree. So, it has been rightly said “Life
insurance is one of those agencies which improves the mental, moral and national circumstances
and raises the conditions of the community of which they are members.” These observations apply
to all branches of insurance. The insurers will have large funds available with them which they
may utilize in helping the formation of big industries directly or by underwriting securities of those
companies which tend to grow the commercial prosperity of the nation. There is no denying of the
fact that growth of industrialization is an adventure in which the triumvirate namely, industry,
credit and cover of insurance make a sojourn in each other’s championship.

Insurance thus reduces the fears of the future risk to the individual insured and by capital formation
it helps the growth of industrialization, accelerates production, lubricates the machinery of
production and distribution and improve the economy of the nation. It mobilizes the resources,
accelerates and stabilizes growth and helps in the establishment of a welfare state, as envisaged in
the Constitution of India.

Legal Nature of Contract of Insurance

The concept of insurance as an effective mechanism for risk transference was first introduced in
the marine trade. Later on, the utility of the concept was realized in its expansion to the non-marine
types like life and fire insurance. The applicability of the principle of insurance has been found to
be wider and at the present day, besides the various types like motor, accident and fidelity
insurance, its scope is extended in no small a measure to crop and cattle insurance. Insurance has
become the usual mode of providing security against future contingencies and it plays a significant
role in the social and commercial life of all modern communities. Particularly in the field of
commerce its benefits are most conspicuous.

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In the commercial world profits are often considered as the reward for undertaking of risks.
Therefore, the aspect of the risk is of paramount importance in all commercial enterprises and
insurance as a technique of management of risk is bound to be of invaluable help.

The law of insurance forms part of the general law of contract and whatever type of contract of
insurance maybe it invariably represents the agreement between the assured and the insurer. The
essential ingredients of a contract under law, for example, offer and acceptance,
consideration, capacity of the parties, mutuality of understanding, legality of object is of
equal application to a contract of insurance. But it is the existence of a separate set of
principles distinctly applicable to a contract of insurance that furnishes the correct appraisal
of the nature of insurance contract.

Though insurance has been differentiated into marine, fire, life etc., there are certain general
principles applicable to all forms of insurance. These general principles have a two-fold purpose.
They serve as a guide to the sound interpretation of the purport of the insurance contracts in their
diversified forms. For example, the principles of indemnity, insurable interest, uberrima fides,
cause proxima, subrogation, contribution, reinstatement, the existence of risk are some of the
principles having common application.

The Risk Factor

It is sine qua non to every contract of insurance that the subject matter should be exposed to
the contingency of loss or risk. Risk involves the happening of an uncertain event adverse to
the interest of the assured.

Exempli Gratia, in marine insurance the ship or cargo is exposed to the loss by perils of the sea.
In fire insurance the risk is destruction of property by fire. In life insurance the risk in the death of
the assured is, though a certainty, uncertain as to the time of its happening.

In an abstract sense risk may be defined as the chance of loss. It can either be an uncertainty as to
the outcome of some event or events, or loss as the result of at least one possible outcome. In any
case, the promise of the insurer is to save the assured against the uncertain consequences.

The Principle of Indemnity

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Insurance is essentially a contract of indemnity. All the claims of the assured will be adjusted only
with reference to the actual loss sustained by him. Thus, it is implicit in every contract of insurance
that the assured in case of a loss against which the policy has been made, shall be fully indemnified
but shall never be more than fully indemnified.

The effect of the principle of indemnity, in laying down that the satisfaction ought not to exceed
the actual loss, is to prevent fraud on the part of the assured. It checks the temptation to gain by
unfair means and willful causing of loss. However, the real basis for the application of the principle
of indemnity is not the prevention of crime or consideration of public policy but it derives from
the intrinsic nature of the bargain.

In assessing the amount payable on a contract of insurance, the principle of indemnity

though a guiding principle, is not an unqualified one. It is common that insurers limit their
liability to a particular amount of money known as the ‘sum assured.’ In case of loss, the
‘sum assured’ is all that the assured is entitled to even if the value of the thing is far in excess
of it. But in all other cases, excepting the valued policies (in Marine Insurance) the insurer is
liable to indemnify only to the tune of the actual loss, even though the ‘sum assured’ is a
higher amount. In ‘valued policies,’ the parties agree that the value of the subject-matter
shall be agreed. The object of the valued policies is to avoid dispute after the loss occurs as
to the quantum of the assured’s interest.

In contracts of life insurance, personal accident and sickness insurances and in some forms of
contingency insurance, the loss is seldom measured in monetary terms. They are to be
distinguished from contracts of indemnity like marine and fire insurance. It is now well established
that life insurance in no way resembles a contract of indemnity.

Not infrequently the contract of life insurance is considered as an arrangement for profitable
investment. It is because the assured by paying the premiums is affecting a saving, the
cumulative sum which he can recover after the expiry of the fixed period. Life insurance may
properly be considered as an investment of money because it enables to secure an ultimate fund to
those persons who have no greater opportunity of making savings or which left to themselves, they
would have found it beyond their means. Yet, the objective of a contract of life insurance is mainly
to provide for the risk of death happening at an uncertain time. Though to consider it as a sort of

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investment holds good in some cases, it is departing from the essential feature of insurance security
against risk. It is, therefore observed that a life policy is not a contract of indemnity.

Generally, a contract of indemnity is entered into for the sole purpose of making good a loss
incurred. The value of a life, however, is incapable of estimation and except, in a limited sense,
cannot be “made good” by insurance. An important distinction which thus arises between life
insurance and other forms of insurance is that the principle of “subrogation,” under which the
insurer (i.e., the company) takes the right of recovery against the third party causing the loss,
has no application to life insurance.

Insurable Interest

Another test for a valid insurance contract is the existence of insurability interest. The ‘insurable
interest’ may be defined thus:

“Where the assured is so situated that the happening of the event on which the insurance money
is to become payable would, as a proximate result involve the insured in the loss or the diminution
of any right recognized by law or in any legal liability, there is an insurable interest to the extent
of the possible loss or liability.”

Here again we see that such interest should exist at the time of happening of the event in the general
insurance contracts, but is not necessarily so in the case of the life insurance contracts. This is
because the former is a contract of indemnity and the latter is a contract of assurance. Taking an
example of fire insurance, it is clear that an insured person suffers no loss under a policy if at the
time of loss or damage to the property he has no interest in it either as full or partial owner.
McGillivray says, “if the assured has no interest at the time the event happens it is clear that he
cannot recover anything, because he suffers no loss, and therefore has no claim to an indemnity.
Similarly, if he has an interest which is limited to something less than the full value of the
subject-matter, he suffers no greater loss than the value of his interest at the time of the loss,
and therefore, his claim to an indemnity cannot exceed the value of his interest.” He further
continues: “An interest is required by the terms of the contract itself if the promise of the insurer
is merely to indemnify the assured against pecuniary loss arising from the event insured
against.” If the above was not so, insurance would prove to be a good inducement to the deliberate
destruction of insured property with a view to making a profit out of the loss.

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In this connection life insurance stands on different ground. No value can be assigned to human
life in the same way as is done in respect of tangible property. But all the same it is possible to
measure the extent of loss that would be caused by the failure of a given life. Insurable interest of
some kind is necessary to every contract of insurance of whatever kind and any insurance made
without such interest is illegal and void.

It is clear from the above discussion that an insurable interest as defined above is an indispensable
feature of contracts of indemnity. Life insurance, however, stands on a different footing and it is
now established that provided a bona fide interest exists at the date of the contract no interest need
be shown at the date of loss. Similarly, the amount recoverable under a life policy refers to the
interest at the time of making of a contract. These conclusions are based on judicial interpretation
and are now universally recognized.

The guiding factor is that an insurable interest is a reasonable expectation of financial benefit from
the continued life of the subject or an expectation of loss if the subject dies. For instance, a parent
has a clear insurable interest in the life of a minor child, since he is entitled to the services and
earnings of that child.

The concept of insurable interest primarily appears to be an invention of the courts. It may be
necessary for the assured to show interest but common law contains no general prohibition of
contracts in which no insurable interest exists. It was perhaps introduced to curb insurances by
way of wager, and obtained statutory recognition.

The presence of insurable interest is insisted for two reasons:

(1) the assured cannot be taken to have suffered any damage if he has no interest in the property
insured at the time of loss.

(2) Secondly, if the interest of the assured is limited to something less than the full value of the
subject-matter, no greater damage than his interest in the subject matter will result.

In both cases the interest in the subject-matter is required by the terms of the contract itself since
the promise of the insurer will be only to compensate the actual loss.

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To have insurable interest, it is essential that there should be some contractual or proprietary right,
whether legal or equitable so long as it is enforceable in the courts. Accordingly, the main
principles determining the existence of insurable interest are

(a) the interest must be enforceable at law;

(b) the continued existence of the interest will be beneficial to the assured.

Strict legal or pecuniary interest is not necessary. Equitable interest is sufficient to give rise to
insurable interest.

Under the contract of life insurance, the assured has insurable interest in his own life to an
unlimited extent. But where a person takes an insurance on the life of another, the criteria applied
in assessing the insurable interest are of great importance. It is not the legal or beneficial interest
as in the case of marine and fire insurance, but the person ensuring the life of the other must stand
in such relationship as will justify a reasonable expectation of advantage or benefit from the
continuance of the life of the person on whom the insurance is affected. The test applicable is
whether there was actual dependence of the person effecting the insurance on the person whose
life is insured, or he had an expectancy of some advantage from the continued existence of the
person insured.

The effect of the requirement of insurable interest in all contracts of insurance seems to be
two-fold.

1. Its absence makes a contract of insurance equivalent to a wager.

2. Also, the principle of indemnity cannot be applied unless there be some interest in the
subject-matter, because, the actual loss alone will be indemnified.

Thus, it became a preventive of wagering policies and also limited the amount recoverable to the
loss sustained by the assured.

Principle of Utmost Good Faith / Uberimma Fides

In the case of ordinary commercial transaction, the legal maxim “caveat emptor” (meaning “let
the purchaser beware”) prevails. In the absence of an enquiry the other party to the contract is
under no obligation voluntarily to furnish detailed information regarding the subject matter of the
contract. It is, however, understood that one party to the contract should not be misled by the other

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by any false declaration. All the same it is open to both the parties to the contract to satisfy
themselves and each party is entitled to make the best bargain that he can make.

As a contrast to such commercial contracts the insurance contract is dominated by the legal maxim
“the utmost good faith”. The observance of utmost good faith by the parties is vital to a contract
of insurance. Insurance is called an UBERRIMAE FIDEI contract because the parties are required
to conform to a higher degree of good faith than in the general law of contract. Good faith and
honesty though principles of equity and justice are equally applicable to every agreement; yet, in
contracts other than insurance, the parties are free to settle their own terms. In a contract of sale of
goods CAVEAT EMPTOR is the principle and the seller has no obligation to make known to the
purchaser all facts that might affect his decision. But in insurance there is something more than an
obligation to treat the insurer honestly and frankly. Insurance being a device of risk transference
stands on a separate basis. The non disclosure of a material fact by the assured whether fraudulent
or innocent, has the same effect of avoiding the contract. A stringent duty is imposed on the assured
to provide all the material facts that might influence the decision of the insurer. The fact that the
assured believed as a reasonable man certain information as immaterial to the purpose does not
provide a defense. The materiality of a particular fact will be considered independently of the belief
of the assured. This fundamental principle applies to all branches of insurance. It may be
summarized from one of the several judgments pronounced:

“It is the duty of the assured to disclose all material facts within their knowledge. In cases of life
insurance, certain specific questions are proposed as the points affecting in general all mankind.
But there may be circumstances also affecting particular individuals, which are not likely to be
known to the insurer, and which had they been known, would no doubt, have been made subject to
specific enquiries.”

The onus of good faith lies equally on both the parties to the contract, but in the nature of things
the assured has to pay more particular attention to the observance of the principles. The selection
of a life for insurance by the company depends to a large extent on the information supplied by the
proposer. As the company solicits proposals from the general public whose members are total
strangers to the company there is an urgent need for disclosing all material facts within the
knowledge of the proposer to enable the company to come to a decision. The proposer has within

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his knowledge all the facts, which are material to the risk. He is morally and legally bound to
disclose all matters, which in point of fact are material to the contract.

CONTRACT OF INSURANCE DISSIMILAR TO CONTRACT OF WAGERING

The fundamental principle of indemnity on which the greater part of the law of insurance is based,
prima facie, negatives any treatment of insurance on par with wagering contracts. Wagering
contracts are those, wherein “two persons, professing to hold opposite views touching the issue of
a future uncertain event, mutually agree that, dependent upon the determination of that event, one
shall win from the other, and that other shall pay and hand over to him, a sum of money or stake.”
Again, “the distinction between a wagering contract and one which is not a wager, depends upon
whether the person making it has or has not an interest in the subject matter of the contract.” That
means, “if the event happens the party will gain an advantage, if it is frustrated, he will suffer a
loss.” Probably, the common feature of the two types of agreement – the element of uncertainty,
gave rise to the misconception of insurance in terms of a gamble. At one time according to Sir
William Anson, the father of the “Law of Contract insurance” was placed on a different ground
from a pure wager merely because it is permitted by law. Insurance was regarded as no better than
a wagering contract despite the presence of insurable interest. But this view has been modified by
himself later on and now he affirms insurance is described as having only a ‘superficial
resemblance’ to a wager.

PRINCIPLE OF SUBROGATION

An insured must have a complete understanding of the risks involved in transferring its rights
under the rule of subrogation. Subrogation is an important concept when it comes to understanding
the relationship between an insurer, an insured and a third party in case of loss suffered by the
insured. Will the insurer be liable to bear the entire loss claimed by the insured? Can the insurer
sue the third party/ wrong-doer responsible for the loss suffered by the insured? This article deals
with these major questions regarding subrogation.

The concept of subrogation involves one person or group substituting another in cases of insurance
claims by transfer of all the rights and duties associated with it. According to Black's Law
dictionary, subrogation is “the principle under which an insurer that has paid a loss under an

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insurance policy is entitled to all the rights and remedies belonging to the insured against a third
party with respect to any loss covered by the policy”.

The doctrine of subrogation lets one person to stand in another person's shoes and assert the rights
of that person against the third party. It comes into picture when an insurance carrier wants to take
legal action against a third party who was responsible for the loss caused to the insured and other
similar instances. Subrogation arises out of the existing relations between the party.

The doctrine of subrogation is based on the principle of indemnity. It is essential to ensure

that the insured is indemnified completely, but not more than that. In Krishna Pillai
Rajasekharan Nair (D) by Lrs. v. Padmanabha Pillai (D) by Lrs. and Ors. 1, the Supreme Court
held: “A subrogation rests upon the doctrine of equity and the principles of natural justice and not
on the privity of contract. One of these principles is that a person, paying money which another is
bound by law to pay, is entitled to be reimbursed by the other. This principle is enacted in Section
69 of the Contract Act2, 1872. Another principle is found in equity: ‘he who seeks equity must do
equity.”

Principles explained

Before taking up the rights and duties of another person under the principle of subrogation, it is
important to know its essentials. The Supreme Court elaborately discussed the principles of
subrogation in the landmark judgment Economic Transport Organization v. Charan Spinning
Mills (P) Ltd. and Ors. 2 The principles of subrogation as laid down by the Apex Court are
discussed as follows:

When an insurer settles an insured's claim for the loss incurred by it, an equitable subrogation right
arises in favour of the insurer. Equitable subrogation allows the insurer to assert rights against the
third party or the wrong-doer who caused damage to the insured. The doctrine of subrogation does
not put an end to the rights and duties of the insured. It only allows the insurer to recover the claims
paid by it to the insured from the third party. The insurer continues to enjoy the right to proceed
with legal actions against the wrong-doer.

1
(2004) 12 SCC 754.
2
(2010) 4 SCC 114

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The insurer and the insured may exchange a letter of subrogation limiting the subrogation terms.
In such a scenario, the letter of subrogation would govern the rights of the insurer vis-à-vis the
insured. The rule of subrogation gives the right to the insurer to take any legal action against the
third party/ wrong-doer, but only in the name of the insured. Any complaint, petition or plaint filed
in the court of law must be in the name of the insured. The insurer can also represent the insured
as subrogee-cum-attorney or the two of them can be co-complainants or co-plaintiffs. In any case,
the insurer cannot take legal action against the third party on its own.

In case the insured executes a subrogation-cum-assignment in favour of the insurer, the insurer
becomes completely entitled to the amount recovered from the third party. The terms mentioned
in the instrument would govern the rights and duties of the insurer and the insured. The insured
may also have to give up all its rights and would no longer be able to sue to the wrong-doer on its
own account. The insurance companies must keep these essential principles of subrogation in mind
while construing and finalizing the terms of subrogation with the insured.

In Rahee Industries Ltd. v. Export Credit Guarantee Corporation of India Ltd. and Ors.3,
the Apex Court observed that the parties to an insurance contract may express and define the terms
of subrogation in the insurance policy which may be at variance from the ordinary principles of
subrogation. Only in case of ambiguity or doubt in the construction of the insurance policy, the
parties may invoke the principles of subrogation as a controlling authority or guide.

PRINCIPLE OF CONTRIBUTION

Doctrine of Subrogation is incidence of rule of indemnity & contribution is incidence of doctrine

of subrogation. This is also a corollary to the doctrine of indemnity. The rule is of ancient origin
& was recognized by the Chancery Courts in North British & Mercantile v. Liverpool and London
Glob4 it was held that the contribution exists where the thing is done by the same person against
the same loss, and to prevent a man first of all.

1. Recovering more than the whole less;

2. If he recovers the whole loss from one which he could have recovered rom the other, then
to make the parties contribute rateably.

3
(2009) 1 SCC 138
4
(1877) 3 Ch-D 569.

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Principle of contribution has application where there is the person insuring the same interests with
more than one office. The genesis of contribution lies in liberty of the assured to insure the same
property with more than one insurer which is called ‘Double Insurance’.

Contribution in relation to insurance has been defined as; “Contribution is the right of an insurer
who has paid a loss under a policy, to recover a proportionate amount from other insurer who are
liable for the loss.” This principle insures equitable distribution of losses between different
insurers. A policy holder is not entitled to claim from each insurer more than the relatable
proportion of loss to which one is liable.

Conditions for Contribution:

1. All the insurance must relate to the same subject – matter.

2. The insured must be the same individual.
3. The insurance must be of same interest.
4. The policies concerned must all cover the same peril which caused the loss.
5. The policies must be in operation at the time of loss.
6. The insurable interest must be the same for all policies.
7. All the policies must be legally enforceable.
8. This principle is applicable in indemnity insurance only.
9. This principle does not apply to life & personal accident policies.
10. The contribution shall be in proportion to total liability.
11. The insured who has paid first in full, the assured can claim contribution from other co-
insurers.

Calculation of Contribution:

The following formula is applicable to calculate the contribution by each:

Contribution (C) – Sum assured with each insurer/Total Sum assured * Loss

Example: A insures a building against fire with A, B & C insurer with Rs. 10,000, Rs, 20, 000 &
Rs. 10,000 respectively. A fire takes place during the period of policies & total loss is Rs. 30,000.
The contribution from A, B & C will be as under:

A’s Contribution: 10,000 * 30,000/ 40,000 = 7,500.00

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B’s Contribution: 20,000 * 30,000/ 40,000 = 15,000.00

C’s Contribution: 10,000 * 30,000/ 40,000 = 7,500.00

BIBLIOGRAPHY

Books:

1. R.N. Chaudhary, General Principles of Law of Insurance, Central Law Publications (2nd
Edition)
2. Gaurav Varshney, Insurance Laws, Lexis Nexis, (1st edition)
3. Avtar Singh, Law of Insurance, Eastern Book Company (3rd Edition)

Journal:

1. A K Sukla (2006), “The Journal of Insurance Institute of India”, Vol.XXXII

2. C.S. Rao (2007), “The Regulatory Challenges Ahead” Journal of Insurance Chronicle,
Vol.VII,
3. Dr.A.K. Jain (2004), “The Journal of Insurance Institute of India”, Vol.XXX,
4. Sabera (2007), “Journal of Insurance Chronicle”, Vol.VII, Issue-I
5. Taneja, Aruna, Kumar Narendera. “Insurance in India – Challenges and Opportunities”,
The Insurance Times

Internet Sources:

https://byjus.com/commerce/liberalisation/

https://files.eric.ed.gov/fulltext/EJ1119056.pdf

https://www.un.org/esa/socdev/rwss/docs/2010/chapter6.pdf

https://cleartax.in/s/insurance

https://www.irdai.gov.in/ADMINCMS/cms/NormalData_Layout.aspx?page=PageNo4&mid=2

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