six main principles in the property insurance

In property insurance, there are six main principles that govern a contract of insurance. If one of those requirements is not met by the insured or the insurer, the contract could be avoided. The main six principles that apply to property insurance include; Insurable interest, utmost good faith, indemnity, contribution, subrogation and proximate cause.

In an Insurance contract, a person is not insuring the property as such, but the interest in that property. If a person is said to have an insurable interest on a property, he should enjoy benefits from its existence and would suffer a financial loss from its destruction .The case, Lucena v. Crauford expresses this point well; ‘A man is interested in a thing to whom advantage may arise or prejudice happen from the circumstances which may attend it… To be interested in the preservation of a thing is to be so circumstanced with respect to it as to have benefit from its existence, prejudice from its destruction’.

When an owner of a factory wants to insure his premises, he must demonstrate to the insurer that he has an insurable interest in the factory. He should benefit from the existence of the factory and would suffer a financial loss if it is damaged.

The law requires that a person has a real interest in a property. A mere hope or expectation of acquiring an interest in the future does not create an insurable interest. The interest must also be a legal interest. The Macaura case held that ‘An insured had an interest in his shares not in the property of the company for which he held shares in’. Insurable Interest may arise by common law, by contract and by statue.

The most common example of insurable interest is the interest which a person has in property which they own. Ownership is an interest which is recognised and protected by law. However, holding title of property is not necessary. Thus, a bailee has an insurable interest in its customer’s goods. A tenant has an insurable interest in the leased premises which he occupies.

Other types of persons who have an interest to insure are; Mortgagees, mortgagors, lessees, shared or joint owners, trustees, legal guardians and people living together. Possession gives you also the legal interest to insure.

According to the Marine Insurance Act 1906, Insurable Interest must exist at the time of the loss but not necessarily at inception. In fire and accidental policies, the Acts require that there must be insurable interest also at inception. A policy without interest is generally void and premiums could be recovered. The rationale behind the principle of insurable interest is to ensure that contracts of insurance are not taken as gambling transactions. 

Insurance contracts are defined as contracts of utmost good faith or contracts of “uberrimae fidei”. The insurer relies on the truthfulness and integrity of the proposer whilst the insured relies on the company’s promise to provide adequate cover and to pay claims. In commercial contracts, the doctrine of ‘Caveat Emptor’ (let the buyer be aware) applies.

The proposer knows more about the risks which are linked with a property, whilst the insurer knows nothing. The proposer needs to positively disclose all information, even if not asked. This principle applies also to the insurer. This doctrine emerged from the case Carter v. Boehm; ‘…the special facts, upon which the contingent chance is to be computed, lie more commonly in the knowledge of the insured only: the underwriter trusts to his representation, and proceeds upon confidence that he does not keep back any circumstance in his knowledge, to mislead the underwriter into a belief that the circumstance does not exist, and to induce him to estimate the risqué as if it did not exist’.

The duty of the proposer is to disclose all facts or circumstances that are material to the risk. A material fact, as stated in the Marine Insurance Act 1906 is; ‘every circumstance is material which would influence the judgment of a prudent insurer in fixing the premium or determining whether he will accept the risk or not’. Material facts hold the basics of a decision.

Insurance companies use proposals forms to help the insured in giving the right information. A surveyor may also be sent to a property to inspect clearly the risk. Insurance slips are used in the case of brokers to gather material facts.

If for example, a factory is located near a fireworks factory, the fact needs to be disclosed by the owner when filling the proposal form. The fireworks factory is an external factor that makes the risk higher. If the fact is not disclosed and damage is caused to the factory, the insurer has a right to avoid paying the claim and will also be entitled to avoid the contract.

The fact must be material at the date at which it should be communicated to the insurer. A fact which was not material when the contract was made but becomes material later on; need not be disclosed. However, the insured has an obligation to disclose the material facts which he has control of. Facts which by their nature improve the risk need not be disclosed.

At common law, the duty of disclosure continues until the contract is formed. At renewal the duty of disclosure is revived. A warranty is a promise by the insured to do certain things or to satisfy certain requirements. If the insured breaches the warranty, the insurer can void the contract and refuse to pay for a claim.

A breach of good faith may take the form of misrepresentations and non-disclosure. Whether there is fraud or not, insurers have the right to avoid the contract ‘ab-initio’. If fraud is discovered, the insurer can sue for damages and keep the premium. Insurers can also waive their rights and allow the contract to stand. If the insurers are in breach of their duty, the insured will be entitled to avoid the contract.

Indemnity requires that the insured is placed in the same financial position as he occupied immediately before the loss. In effect, this principle aims to prevent the insured from making a profit out of his loss.

This principle is applied where the loss suffered is measurable in terms of money. It does not apply where it is not possible to measure the financial loss caused by the death of the insured or bodily injury sustained by him. Indemnity is important as it deals in part with moral hazard. In the case Castellian v. Preston, Mr. Justice remarked: “…the contract of insurance … is a contract of indemnity only, and this contract means 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…”

Sometimes, property loses value for reasons other than depreciation. In many of these cases, market value is used to calculate cash value. If an insurer pays a replacement cost deducting depreciation, that is higher than the market value, then some property owners would be tempted to destroy their property to get the higher value over what they would get selling it in the market.

Indemnity is a contractual principle and not a statutory one. The policy can be varied to provide either more or less than a strict indemnity. The Sum insured is usually the maximum recovery possible. If the sum insured is less than the value of the property, the principle of average is applied. The person who underinsures is considered his own insurer for the difference. Excesses, franchises and policy limits are other factors that limit the insured’s entitlement to full indemnity. When cover is on a new for old or reinstatement basis, insurers pay for the full cost of rebuilding ‘as new’ with no deduction for wear and tear. Agreed value policies enable also the insured to recover more than a strict indemnity.

The methods of providing indemnity are; repair, replacement, reinstatement and cash. Indemnity is applied at the date and place of loss. Under property insurance, the policyholder can recover only the amount of the value of the property.

As regards to buildings, the basis of indemnity is the repair or rebuilding cost at the time of loss, with a deduction for betterment. With a reinstatement clause, no reductions are applied for depreciation. Insurers are entitled to receive any salvage left. The goods become the property of the insurers if they make a full indemnity payment.

The principle of indemnity is closely related to both the requirements of an insurable interest; an insured can only be indemnified to the extent of his insurable interest and insurance is not gambling; the insured doesn’t win or lose.

Contribution is about the sharing of losses between insurers when double insurance exist. Contribution is another principle that aids indemnity. Since indemnity forbids the insured from recovering more than the loss, then he cannot recover the full value of the loss from each of the two policies. The law does not forbid people from engaging in double insurance; it only forbids making a profit from a loss.

Contribution is likely to arise when there is more than one policy. It does not matter that the policies do not cover precisely the same perils or property. They do not have to be identical but there must be an overlap. For example; one policy covering building A only and one covering buildings A and B. It the case American Surety Co of New York v. Wrightson (1910); it was held that for contribution to apply, the two policies involved must cover the same interest, same subject manner; same peril and same period.

An overlap is quite common when there is home insurance overlapping with travel insurance, since certain items of property are insured under household insurance as well as insured whilst the policyholder travels abroad under the travel policy.

There is a case law relative to the question of a common insurable interest. The case is North British & Mercantile v. Liverpool & London & Globe (1877) – The King and Queen Granaries case. As there were different interests, one as owner and one as a bailee, it was held that North British had to pay the loss in full and there was no right of contribution.

Under the common law, a person who has more than one policy can look to any of the insurers involved for compensation. The insurer, who would have paid in full, can then claim contribution from the other insurer involved. However, the majority of policies include some form of contribution condition. With this condition, insurers will be liable for their rateable share only. When the two policies contain the contribution condition, the insured must proceed with the claim against the two insurers.

Some policies may even contain a non-contribution clause. This prevents an insurer from being liable if the insured is covered under another policy. If there are two policies with this condition, the clauses in effect cancel out each other and contribution arises in the usual away, as in accordance with the case Gale v. Motor Union (1928).

Subrogation is the right of a person who has provided indemnity to another, to stand in the shoes of that person to recover from some third party. The main aim of this principle is to ensure that the insured obtains an indemnity but “no more than an indemnity”. According to the case Castellain v. Preston, Subrogation is; “…a doctrine in favour of the underwriters or insurers in order to prevent the assured from recovering more than a full indemnity’.

It is a corollary of indemnity and therefore does not apply to non-indemnity contracts.

If a third party causes damage to the insured’s factory, the insurer will settle with the insured. However, by virtue of the subrogation right and the subrogation condition, the insurer can sue the third party who has caused damage, in the name of the owner of the factory and subsequently make a recovery under the claim. Ex-gratia payments are payments outside the policy obligations and therefore are not recoverable.

Subrogation operates by means of tort where a third party causes the insured loss or damage. It arises out of the negligence of a third party. Subrogation could arise under a contract as in the case, a tenant causing damage to the landlord; the tenant is made liable to pay under the contract. Subrogation rights may also arise under statute as in the case of riot. For example, insurers have a right to sue the police who are responsible for civil order to make a recovery, if as a result of riot the property of the insured is damaged.

Insurers are also entitled to any materials left by the loss where they have agreed to pay the loss in full. This is expressed in Rankin v. potter (1873). Following indemnity, the insured ceases to be the owner. The case Scottish Union & National Insurance v. Davis (1970) shows that the insured must have been indemnified for an insurer to exercise subrogation rights. For this reason insurers always insert a condition which enables them to commence their rocevery against the other party before they have settled the insured’s claim.

Subrogation rights are modified under market agreements between insurers to try to reduce administration expenses in recovering money from each other. Subrogation rights can also be modified or cancelled through a contractual agreement.

Proximate cause is a claims related principle. The practical effect of this principle is to define the scope of the insurance contract and to protect the relative rights of the insured and the insurer. It allows for application of common sense to the interpretation of insurance contracts.

Proximate cause relates to the main cause of a property loss. It is not necessarily the first or last cause but the dominant cause. It must be the operative cause which is directly linked with the result. The cause must not be remote. Proximate cause was defined in a classic case of Pawsey v. Scottish Union and National (1907); “the active efficient cause that sets in motion a train of events which brings about a result without the intervention of any force started and working actively from a new and independent source.”

Property may be damaged but not directly by an insured peril. By the proximate cause rule, the loss will be covered. For example; smoke damage from fire, water damage from fire fighting, and damage caused by fire fighters.

Normally, the cause and effect of a loss is quite easy to recognize. For example, a fire occurs and property is damaged. But in real situations, the loss may be the result of two or more causes and it become more difficult to decide the proximate cause. Losses can occur due to different situations, such as; single cause, chain of events, or concurrent causes.

For example, if there is a storm that causes a wall to collapse, then a short circuit results in a fire and to extinguish the fire, water damage is caused by firemen. In this case, it is easy to determine that the storm was the proximate cause, since it started off a train of events causing water damage

In many law cases, it had been decided that the last cause in time was the proximate cause where there was a chain of events. However, the case Leyland Shipping Co. Ltd v. Norwich Union Fire Insurance Society Ltd (1918) changed this theory.

When there is a chain of events, insurers are liable where the loss flows in an unbroken chain directly from an insured peril. If the chain is broken, with no excluded perils, an insurer is liable only for that loss caused by an insured peril. When there is an excluded peril, the subsequent loss caused by an insured peril will be a new and indirect cause, interrupting the chain. Damage following ‘novus actus interviens’ is not covered.

Concurrent causes may be independent or interdependent. If one of the losses is not insured, then only the loss arising from the insured peril is covered, unless the causes cannot be separated and in which case all of the loss is covered. If one of the concurrent causes is excluded, then no cover operates, unless the other cause is insured and can be separated.

Insurers sometimes exclude losses caused ‘directly or indirectly’ by the peril in question. The effect will be to widen the exclusion and reduce the scope of cover. For example; If a policy excludes losses directly or indrectly caused by erathquake; it means that the policy will not cover neither the earthquake shock nor the fire damaage which might result.