What is insurance? What are the elements of a contract of insurance?

In modern times every exchange is based on an agreement that is enforceable by law and hence is a contract. There are many types of contracts that people enter into. It may be a service contract with an employer or a lease rental contract with a landlord or a business contract with a seller/buyer. And like all these, insurance is also a legally valid contract.

What is Insurance

Simply put, insurance is a contract in which an insurance company agrees to pay to the policyholder a predetermined amount or the extent of the loss (which ever less) that the policyholder has incurred because of the happening of an untoward incident(s), that were agreed to be compensated for in terms of money, all in exchange of insurance premium that the policyholder should pay to the insurance company for the contract to begin. The total value of coverage provided by the insurance company to the policyholder is called total sum insured. Read more : Beginner’s Guide to Insurance

Features of an insurance contract

  1. Utmost good faith:
    Insurance contracts have a peculiar feature of UTMOST GOOD FAITH because here the insurance company issues a policy in the name of the proposer (policy holder) by believing that all the details provided by the policyholder are completely true and provided in good faith and in utmost gold faith because the details are best known only to the proposer. The same is true vice versa also that the insurance company is expected to issue the policy by providing all the relevant policy details as understandable by the policy holder.
  2. Indemnification:
    The insurance company agrees to compensate or indemnify the policy holder, a loss that can be quantified in terms of money and compensate him in such a way that it puts the insured back in the position as if the accident had not happened. An insured does not stand to make a profit from an insurance contact.
  3. Insurance interest:
    The person taking the policy should have an interest in the well being of the person for whom or property for which he is taking the policy. This is called insurable interest. The policy buyer may acquire interest by common law of ownership or by a statute. Eg: Life insurance in the name of self or spouse or children; insurance for the property or business owned; insurance taken for one's employees.
  4. Consideration:
    A prerequisite for a contract is exchange of something in return for something. So the insurer agrees to compensate the insured in return for a small sum of money called premium which may be paid at the onset of the policy contract or in installments during policy period depending on the country's insurance regulations.
  5. Contribution:
    If an insurer holds policies from multiple insurance companies for the same subject matter, the insurance companies are required to share the compensation to be paid to the insured in the same proportion as the sum insureds the different policies. This is true in case of all policies except of life insurance and health insurance policies where each insurer is required to pay the whole sum insured to the policyholder.
  6. Subrogation:
    This feature of an insurance contract means that in case the insurance company pays the insurance amount to a policyholder because of the negligence caused by a third-party, the company is entitled to be of compensation by the third party.
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