Fire Insurance: Basic principles essential to Govern Fire insurance

The basic principles that govern Fire Insurance are:

 

(i) Utmost good faith – In insurance contracts, the legal doctrine of utmost good faith applies. The insured has the duty to disclose all material facts, which have a bearing on the insurance. A breach of this duty may make the contract void or voidable. The duty of disclosure continues throughout the policy period.

The fire proposal form also includes a declaration by the insured saying that the statements declared by him are true, and that they can form the basis of the insurance contract. This principles also expect the insured to act as if he is uninsured all the time, and takes care and safeguards his assets from the perils. Following a loss, he is then expected to salvage as much of the property as possible.

(ii) Insurable Interest – The requirement of insurable interest gives legal validity to insurance contracts and distinguishes them from wagers. It may be defined as the legal right to insure, where the right arises out of a pecuniary relationship between the insured and the subject matter of insurance.
The destruction or damage to the latter involves the insured in financial loss. Absolute legal ownership is a clear example of insurable interest. For e.g, a bank or a financial institution which has advanced money on the security of a property, has insurable interest in that property.

In Fire insurance policy, the insurable interest should exist at the time of taking the policy, throughout its currency period and also at the time of loss/claim. Fire insurance policies are personal contracts,  so if the property is sold or transferred, the policy is not transferred automatically.

(iii) Indemnity – The objective of the principle is to place the insured , as far as possible, in the same financial position after a loss, as that occupied by him, immediately before the loss.

In simple words, the principle of indemnity means the insured is indemnified only to the extent of his loss, no profit or undue benefit is extended. The indemnity is subject to the sum insured and other terms of the policy. The sum insured can be fixed on the basis of Reinstatement Value or Market Value. The term ‘Market value’ means, for insurance purposes, the present cost of construction of similar buildings, after deducting depreciation based on age, usage, maintenance etc.

Similarly for plant and machinery, market value is arrived at by deducting suitable depreciation for age, usage, wear and tear etc, from the current replacement costs. In all the cases, depreciation refers to the actual intrinsic physical depreciation and not those used for accounting purposes.

(iv) Subrogation – The principal of subrogation is the corollary of the principle of indemnity. If the loss suffered by the insured can be recovered from third parties who are responsible for the loss, the insured’s rights of recovery are transferred or subrogated to the insurers , when they indemnify the loss.
(v) Contribution – The principle of contribution, which is also a corollary of the principle of indemnity, provides that if the same property is insured under more than one policy, the insured can recover a rate able proportion of the loss under each policy. Under no circumstances can he recover more than his loss, and make a profit.

(vi) Proximate cause – A cause which immediately precedes and produces the effect, as distinguished from the remote, mediate, or predisposing cause. An act from which a loss or injury results as a natural, direct, uninterrupted consequence and without which the loss or injury would not have occurred.

It is the primary cause of a loss or injury. It is not necessarily the closest cause in time or space nor the first event that sets in motion a sequence of events leading to an injury.

Proximate cause produces particular, foreseeable consequences without the intervention of any independent or unforeseeable cause. It is the active, direct, and efficient cause of loss in insurance that sets in motion an unbroken chain of events which bring about damage, destruction, or injury without the intervention of a new and independent force. It is also called legal or direct cause.

Extracts from “Guide for Fire and Consequential Loss Insurance (IC – 57)” by Dr. Rakesh Agarwal. Copyright of Sashi Publications, kolkata www.sashipublications.com and www.bimabazaar.com