Formation of Insurance Contract

Insurance may be defined as a social device that reduces or eliminates the risk of life and property by providing financial compensation for any uncertain misfortune. It is basically a contract between two parties, i.e the insurer and the insured, wherein one party promises to save the other, for compensation called the premium, from the loss caused to him due to some specified contingency. In legal aspects, it is a contract whereby one party agrees to indemnify the other against the loss caused to him due to the occurring of one particular event. An insurer is a company selling the insurance[i], an insured or a policy holder[ii] is a person buying the insurance, and the premium is the amount that is to be charged for insurance coverage.

BRIEF HISTORY OF INSURANCE IN INDIA

The concept of insurance had been deep-rooted in the Indian history. We may find the mention of the concept of insurance in the Manusmrithis, Dhrmashastras, Arthshastras[iii], etc. These writings talk in terms of pooling of resources which could be redistributed in the time of uncertainty like a flood, drought, etc.

Insurance law in India was initially developed by British firms. The Oriental Life Insurance Company was the first British Insurance firm established in India in 1818. The first statutory step that India took on the roads of life insurance business was in 1912 by passing the Indian Life Assurance Companies Act, 1912[iv]. The general insurance business on the other hand was primarily carried on by Triton Insurance Company Ltd. which was established in 1850 at Calcutta. The first concrete step that India took on the roads of general insurance was in 1907 by the establishment of Indian Mercantile Insurance Company Ltd.

Eventually, with the growth of the insurance business in India, there was a need felt to bring the other insurances like fire, accident, etc under the preview of Life Assurance Companies Act, 1912. And thus, after various failed efforts, finally in 1938, after the introduction of the Insurance Act, 1938[v], a comprehensive legislation governing the insurance business in India came into existence.

On January1956, the central government nationalized the Insurance Business in India, and took over the management of all the Life Insurance Companies practicing in India. There were around 245 Indian and foreign insurance companies which were taken over by the GoI. Subsequently in September 1956, with the enactment of The Life Insurance Corporation Act, 1956[vi], LIC was granted monopolistic control over the life insurance business in India. After the enactment of the LIC Act, the life insurance was taken out of the preview of the Insurance Act, 1938, and that the reason we find so many provisions being repealed in that act. On January 1973 the general insurance business was also nationalized, by the introduction of the General Insurance Business (Nationalization) Act, 1972. Due to this act the control of over 100 companies was handed over to the government.

Since, 1991, by way of liberalization and privatization various financial reforms were introduced in India. Consequently there was a need felt to let the private players enter in the insurance business in India, as a result of which the Central Government set up the Malhotra committee[vii] to recommend the changes in the insurance business in India. This was a eight member committee which was chaired by, former RBI Governor of RBI. The committee recommended privatization of the insurance sector and establishment of Insurance Development Regulatory Authority (IRDA). Thus, finally by the virtue of Section 30-A[viii] of the LIC Act, 1956 the monopolistic control of LIC on Life Insurance Business was abolished and IRDA Act, 1999[ix] was passed.

FUNDAMENTAL PRINCIPLES OF INSURANCE

Contract of Indemnity:

• The word indemnity has been defined under Section 124 of the Indian Contract Act, 1872 as a contract wherein one party promises to save the other from the loss caused to him, either due to the conduct of the promisor himself or any other person[x]. It is pertinent to note here that, the scope of section 124 is very narrow. It only covers the loss caused due to some human conduct. Therefore, to come up with this lacuna under the Indian Contract Act, and to broaden the scope of indemnity, special legislations governing the insurance in India were brought forward. It had been made clear by the court in the case of Gajanan Moreshwar v. Moreshwar Madan Mantri[xi], that every insurance contract, except Life Insurance, is a contract of indemnity.

Aleatory Contract:

• Aleatory is a word of French origin, which literally means an event with equal chances of, gain or loss. All the insurance contracts are aleatory in nature, as they are purely based on the chances of happening of an uncertain event. As it is generally said that ‘insurance is a contract of speculations‘, it is based on some uncertain event that may or may not happen. Thus, it must be borne in mind that insurance contracts are legally recognized aleatory contracts.

A contract of Utmost Good Faith:

• Insurance contracts are the contracts of Uberrimae Fide, which means that they are based on the principle of utmost good faith. Good faith is one of the most essential conditions for the validity of an insurance contract. This principle of Good faith had been derived from the landmark case of Carter v. Bohem[xii]. The doctrine of utmost good faith implies two duties: the duty of disclosure and the duty of representation.

A Contract of Adhesion:

• Most of the terms of an insurance contract are not a result by the mutual consent of parties. The terms of an insurance policy are already printed. Insurer writes the contract and insured gives consent to it, there is no scope of negotiation of terms. Thus it can be said that insurance contracts are unilateral in nature, wherein the insurance company are at a dominant position. Every insurance company have different sets of policy, and a person willing to take insurance has to select out the best suited policy, there is no scope of negotiation in it. There is no scope of Bargain.

Principle of Subrogation:

• Subrogation is a word which originates from the Roman Laws; it simply means ‘substitution’. Subrogation is an essential attribute of indemnity, and since all the general insurance contracts are a contract of indemnity, thus it is applicable to the insurance law as well. The principle of Subrogation gives power to the insurer to insurer to receive all the rights which the insured has against the third party. In simple words, according to the principle of Subrogation, once the claim are settled by the insurance company, the insurer steps into the shoes of the insured, and receives all the rights and duties that the insured had against the third party.

Insurable Interest:

• When there is no insurable interest, the contract is merely a wagering contract and not an Insurance contract. Insurable Interest is one of the legal requirements to validate an insurance contract. It basically means that the insured must have an actual interest in the subject matter of insurance. Any person is said to have an interest if he suffers the loss on the happening of an uncertain event and must be benefited from the existence of that property, this loss must be financial and not emotional.

Double Insurance:

• There might be few instances wherein an insured gets multiple insurances for the same risk by the same or different insurer. These instances are called double insurance or multiple insurances. It is a method of getting insurance for the same matter from one or more insurers under different policies. No provision of insurance law forbids double insurance. Every insured is at liberty to take as many as insurances as he wishes to take. Section 34[xiii] provides for the same. Double insurance is possible for all types of insurance, where life or general. Sums Recoverablein Double Insurance: Since a life insurance contract is contingent in nature, thus full amount may be recovered; but as the general insurance contract is a contract of indemnity, thus nothing more than the actual loss can be suffered. Thus, in double Life Insurance full amount may be recovered, but in double general insurance, nothing more than the loss can be recovered.

Re-insurance:

• It is insurance for insurance. Re-insurance is an act of insurer, by which he gets an insured property, re-insured by some other insurer. It is an arrangement between the original insurer and the subsequent insurer. Sometimes what happens is an insurance company receives an insurance proposal that is above its capacity and thus, in such a scenario what the insurer does is, arranges with some other company as co-insurer of the way of re-insurance. The concept of re-insurance can also be resorted for all kinds of insurance whether life or general. Section 101(A)[xiv] deals with the concept of re-insurance.

FORMATION OF INSURANCE CONTRACT

Every insurance contract satisfies all the essentials of a valid contract as stated in the Indian Contract Act, 1872. Section 10 of the Contract Act[xv], provides all the essential elements which are necessary to convert an agreement to a contract. On carefully analyzing Section 10 of the Contract Act, we may find the following essential elements of a contract:

1. An Agreement
2. Competency of the Parties
3. Free Consent
4. Consideration
5. Lawful Object

1. Agreement:

As stated under Section 2(h) All contracts are agreements that are enforceable by law.

Contract = Agreement which are enforceable by law

Now a question might arise what an agreement is? The word agreement is defined under Section 2(e) of the Contract Act as every promise or set of promises forming consideration for each other, is an agreement.

Agreement = Promise + Consideration

Now another question might arise, what a promise is? The word promise has been defined under Section 2(b) of the contract act as a proposal when accepted becomes promise

Promise = Proposal + Acceptance

An insurance contract satisfies all the need of a valid agreement. As an agreement requires two parties mutually agreeing to some manifestation, in insurance contract those two parties are the insurer and the insured who agree on the same object i.e. insurance which may be of life, fire, marine, etc. It is also essential that the assent must be communicated, as without communication there can be no consensus ad idem. Now a question might arise as to when is proposal said to be accepted, the answer to this question was given by the court in the case of SR Kharidya vs Max Newyork Life Insurance Company Ltd[xvi]. wherein it was held the mere submission of proposal form and the payment of first premium doesn’t concludes a insurance contract, an insurance contract is said to be complete when the acceptance of the proposal is communicated to the insured as per the mode agreed in the contract. Mere encashment of first premium doesn’t concludes the contract.

2. Competency of the Parties:

Since insurance contracts are also enforceable contract, so it is important the all the parties to an insurance contract must be competent to contract. Section 10 of the Indian Contract makes it compulsory that all the parties to a contract must be competent to contract. Section 11[xvii] of the Act specifies the conditions that make the parties competent to contract. These conditions are:

• Age of Majority: In India a person is said to attain majority on the completion of age of 18 years. Even a minor can enforce an insurance contract, if it is for his benefit. Even a minor can contract if his guardians act on his behalf. It had been made clear by the court in the case of Great American Insurance Co. v Madanlal Sonulal[xviii] that minor’s property can also be insured by person competent to act for him (i.e his guardian)
• Of sound mind: Section 12[xix] defines the circumstances in which a person is deemed to be of sound mind. It states that a person needs to be of sound mind if he is capable of understating it and forming a rational judgment as to its effect on him.
• Not disqualified by law: No contract can be entered to with a person who is disqualified by law. People disqualified by law may include alien enemies, insolvent, etc. They are the people who are beyond the power conferred by the statute.

3. Free Consent:

It is pertinent to note that no contract can be entered by forcing someone into it. No compulsion needs to be there on either of the parties. Section 13 of the Contract Act defines that two or more person are said to consent when they agree upon the same thing in the same sense. Section 14 states that a contract is said to be free when it is not caused by:

1. Section 15 (Coercion)
2. Section 16 (Undue Influence)
3. Section 17 (Fraud)
4. Section 18 (Misrepresentation)
5. Section 20, 21, 22 (Mistake)

4. Consideration:

Section 2(d) of the Contract Act defines consideration. Section 25 says that an agreement made without consideration is void, it is nudam pactum. There has to be something for something (Quid pro Quo). In a contract of insurance the consideration is paid in the form of Premium. Bearing of the risk is another form of consideration in insurance contract. Generally consideration in an insurance contract is paid in installments. So now a question might arise that does the encashment of first premium constitutes a valid consideration. the answer to this question was given by the court in the case of SR Kharidya vs Max Newyork Life Insurance Company Ltd.[xx] wherein it was held the mere submission of proposal form and the payment of first premium doesn’t concludes a insurance contract, an insurance contract is said to be complete when the acceptance of the proposal is communicated to the insured as per the mode agreed in the contract. Mere encashment of first premium doesn’t concludes the contract.

5. Lawful Object:

When an object is forbidden by statute, or it is regarded as immoral by law, no contract can be entered into for such an object. Section 23 further gives the circumstances under which consideration or object is treated unlawful:

1. The act is forbidden by law
2. Defeats the provision of any other law
3. Involves fraudulent activity
4. Is injurious to a person or property
5. Is regarded as immoral or opposed to public policy.

PROCESS OF INSURANCE

Procedure for Life Insurance

Filling up of Proposal Form:

• This is the first step in formation of a life insurance contract. The proposal form consists of a number of questions which are asked so as to ascertain the amount of risk involved in the event insured. The insured needs to answer all the questions correctly, any deviance in the answer may lead to rejection of the proposal. Few details that need to be furnished in a proposal form are: Name, address, nationality, occupation, date of birth, place of birth, age proof, sum insured, premium paid, installments, nominees detail, family history, any disease, accident, operation, etc. At the end of the application, the applicant declares that the statements made in the proposal form are true to the best of his knowledge. He also agrees that the statements made by him in the form will be the basis of the insurance contract.

Submission of Documents:

• After the proposal form is filled and the decelerations are made the next step is of the submission of necessary documents of the proposer. The most important of these documents is age proof documents. Age proof is vital in an insurance contract because it validates the majority of the applicant and it also helps in determining the premium rates. The general principle is that more the age, more will be the premium, because the life of aged peoples are considered more uncertain.

Presentation of the proposal form to the agent:

• Now, after the filling of the proposal form and submission of the document the agent will verify the application and will see as to whether all the documents are submitted or not. If anything is left out he will get that furnished by the proponent. The agent need to verify all the details filled by the proposer.

Medical Examination:

• After the insurance agent scrutinizes the application, he will arrange a medical test of the proponent. An LIC authorized medical practitioner will check the medical condition of the proponent. There are certain situation wherein it may not be compulsory for the proponent to get the medical examination done. Few of such circumstances are: where the proposer is an commissioned officer of Indian Army and is below the age of 45, in case of reassurance, etc.

Final Scrutiny by the Branch Office:

• After the medical examination is done, the agent will give his report attached with the report of the medical examiner to the branch office. The branch office then arranges for the verification of all the major information.

Deposition of Premium:

• The branch office then issues the premium notice to the proposer. Once the proponent pays the premium the branch office proceeds with the further formalities.

Registration of Proposal:

• Once the premium is paid the proposal is registered with the LIC in its register maintained for this purpose. After registration a registration number is allocated.

Sending the proposal to appropriate department and taking the final decision:

• After the registration is done the application is forwarded to appropriate department. This appropriate authority generally is the officer in the branch office or the divisional officer. After the completion of all this the divisional officers takes the final decision, as to whether the proposal is accepted or it is rejected.

Final Result:

• If the proposal is accepted, a letter of acceptance will be sent to the proponent, who now becomes the insured. If the proposal is rejected a regret letter is forwarded to the applicant.

Issuance of Insurance Policy:

• All those applicants whose proposals are accepted and to whom the acceptance is intimated, a leaf of policy, containing all the terms and conditions of the policy, bearing the seal of LIC and signature of competent authority is issued to the Insured.

Procedure for General Insurance

Selection of the insurer:

• The first and the foremost step is to select the Insurance Agent. There are a number of general insurance companies in India, the proposer/applicant/insured primarily needs to select the insurer who best suits his needs.

Presentation of Proposal and Evidence of Goodwill:

• As discussed in the above section, the applicant is asked few question in the proposal form which he needs to fill in good faith. Proposer also needs to present a certificate of his goodwill. Usually the goodwill of the proposer is certified by the insurance company itself.

Recommendation of agent:

• Next step is to give the recommendation by the agent on the proposal. Unless an agent certifies the proposal form it doesn’t becomes effective.

Survey of the Subject matter and the report of the Surveyor:

• Once the proposal form is filled, and recommended by an agent, the insurance company, if it finds it necessary, will get the subject matter verified by its surveyor. The surveyor will then determine the validity of the proposal. The surveyor looks at all the prospective hazardous to the property.

Acceptance of the Proposal and Determination of premium:

• Once the survey is done and the surveyor’s report is submitted, all the possible hazards of the subject matter will be calculated. If the report contains adverse remarks, the proposal will be rejected and a letter of regret will be issued to the applicant, and if everything looks fine then the proposal will be accepted and the rate of premium will be determined based on the surveyors report.

Depositing Premium:

• After the determination of the premium amount, the insured needs to deposit the premium. As provided under Section 64-UB the premium amount compulsorily needs to be paid in advance.

Issuance of Insurance Policy:

• On completion of all the above formalities, insurance company will issue a temporary cover note or insurance policy. After certain time the final insurance policy is issued and the temporary cover note expires.

[i] Section 2 (7A) of the Insurance Act, 1938

[ii] Section 2 (2) of the Insurance Act, 1938

[iii] R.N. CHOUDHARY, LAW OF INSURANCE, 1 (3 rd Ed. 2018)

[iv] Act No. 16 of 1912

[v] Act No. 4 of 1938

[vi] Act No 31 of 1956

[vii] The Recommendation of the Malhotra Committee can be seen here

[viii] Exclusive Privilege of Corporation to cease

[ix] Act No. 42 of 1999

[x] Section 124 of the Contract Act, 1872

[xi] AIR 1942 BOM 302

[xii] (1766) 3 Burr 1905

[xiii] Of the Marine Insurance Act, 1963 (Defines Double Insurance)

[xiv] Of the Insurance Act, 1938 (Defines Re-Insurance)

[xv] Section 10 – What agreements are contracts.—All agreements are contracts if they are made by the free consent of parties competent to contract, for a lawful consideration and with a lawful object, and are not hereby expressly declared to be void

[xvii] Section 11 – Who are competent to contract.—Every person is competent to contract who is of the age of majority according to the law to which he is subject,1 and who is of sound mind and is not disqualified from contracting by any law to which he is subject.

[xviii] (1935) 37 BOMLR 461

[xix] Section 12 – What is a sound mind for the purposes of contracting.—A person is said to be of sound mind for the purpose of making a contract, if, at the time when he makes it, he is capable of understanding it and of forming a rational judgment as to its effect upon his interests

Author: Rohit Jain,
Bharati Vidyapeeth University's New Law College, Pune (3rd Year)