In a world where the future is uncertain and risky, insurance coverage is an essential financial tool. It is a contract signed between a policyholder and an insurance company that works as a financial safety net for individuals and businesses. It promises reimbursement to the insured in case of an unexpected calamity. To obtain this coverage, policyholders pay premiums, tailoring their policies to suit their needs and risk tolerance, and to ensure that they are adequately covered in times of need.

Insurance provides financial protection and peace of mind by covering a wide range of contingencies, including accidents, illnesses, property damage, and liability. However, it has its own set of principles that ensure its smooth functioning. In this article, we will understand the 7 principles of insurance that the insurer and policyholder both must uphold, for the insurance contract to function properly.

The 7 principles of insurance

Insurance coverages work on the basic principle of ‘risk pooling’ or risk sharing among the several policyholders. To ensure that the policies are fair and effective, and to safeguard the interests of both the insurer and the insured, several principles are followed. These principles are:

1. Utmost good faith The idea behind this basic principle is that both parties involved in the insurance contract should have good faith towards each other. Both sides should be honest in disclosing all material facts. The insurer must provide clear and concise information about the terms and conditions of the contract, and the insured must reveal all the relevant personal details. This ensures that both parties have all the necessary information that may affect the terms and conditions of the deal.

Example - If Mr. X is applying for health insurance, he must reveal all his pre-existing medical conditions. He must also disclose any habits that may negatively affect his health, like smoking. If he fails to provide the relevant details, the contract can be voided.

Get Free Quote in Minutes

2. Insurable interest: As per this principle, the insured individual or business must have an ‘insurable interest’ in the subject matter of the insurance policy. Insurable interest is an economic stake in the subject matter, for which the policy is purchased. The insured must get a financial gain from the insurance and must also suffer loss in case of damage or destruction of the said subject matter. To claim the coverage, the insured must be the owner of the subject matter both at the time of signing the contract and when the damage to the property happens.

Example - If Mr. Dinesh wishes to insure a car, he must have a financial interest, such as ownership. He can't insure someone else's car unless they permit him. In the case of life insurance, you must have an insurable interest in the life being insured. Meaning, you will suffer financially if the insured dies.

3. Indemnity: Indemnity is a promise to help a party reach the same stage financially that they were in before the occurrence of a covered peril. Thus, this principle guarantees that the insured will be covered for any losses suffered in an accident. The insurance company performs thorough checks to calculate the losses suffered. The insured cannot make any profit from the insurance and is paid the exact amount lost due to the accident. This principle is not applicable in life insurance and critical health policies but, is strictly enforced for property insurance.

For example - for homeowners’ insurance, the principle of indemnity will apply if a house initially valued at ₹30,00,000 is damaged in a covered event, such as a fire that causes₹10,00,000 in damage. The insured would receive ₹10,00,000 to repair the property to its pre-loss condition, rather than the full worth of the property, or the insurance company will reconstruct the damaged areas of the house using its contracts.

4. Proximate Cause (causa proxima): Causa proxima stands for the nearest cause. This principle comes into the picture when an accident is caused due to more than one factor. While calculating the coverage for the losses suffered, the insurance company will consider the proximate cause, meaning the cause that is the nearest and main factor in the loss to the property. The insurer pays the compensation only if this proximate cause is covered in the contract, else no payment is made. This principle is not brought into effect in the case of life insurance.

Example - Suppose your policy covers water damage but excludes flood damage. If a rainstorm leads to water entering your basement, the proximate cause is the storm. Thus, the damage will be covered. However, if a nearby river overflows due to heavy rainfall, causing flooding, the proximate cause becomes the flood, and your insurance may not cover the damage due to the specific exclusion for floods.

5. Subrogation: In a legal situation, subrogation refers to the practice of replacing one party for another. This principle applies when a loss is caused by someone or something other than the insured. As per the principle of subrogation, once the insured has been paid for the losses incurred in an accident, the insurance company gains the right to pursue legal action against any third party responsible for the loss.

Example - If your vehicle is damaged in a collision caused by the recklessness of another driver and your insurance company pays for the repairs, your insurer can then seek reimbursement from the driver at fault, or their insurance company. This would ensure you, or your insurance company, are not unfairly burdened with the expenditure.

6. Contribution: As per the principle of contribution, if a person has taken insurance coverage for the same subject matter, from more than one insurance company, then all the insurers will share the coverage for the loss suffered in the same proportion of their respective coverage. In the case where one company covers the entire loss, it has the legal right to reach out to the other insurance companies to receive the proportionate amount. The idea behind this principle is that the insured can not profit from the accident, and the coverage of losses has to be shared.

Example - Imagine you have two home insurance policies covering the same property, one with CompanyA and another with Company

B. A has coverage limits of ₹100,000, and B has limits of ₹2,00,000. If your house sustains ₹60,000in damages, you can't collect₹120,000 in total. The principle of contribution applies, and each company shares the loss proportionally. In this case, Company A would pay

₹20,000 (one-third of the loss), and Company B would be the other

₹40,000, preventing you from profiting from the dual coverage.

7. Mitigation of loss: The principle of loss minimization says that it is the duty of the insured to take reasonable steps to minimize the extent of loss to the insured property after an insured event occurs. The idea behind this principle is to ensure that you are not negligent and must take all the necessary precautions to prevent the loss even after purchasing the insurance.

For example - if you have house insurance and your home gets flooded due to heavy rain, you should take steps to prevent further damage, such as turning off the water supply or relocating valuable belongings to higher ground. Failing to do so might affect the amount of your insurance payout.


In essence, the seven insurance principles serve as the foundation of the insurance sector. They require insurers and policyholders to be transparent, honest, and fair. Utmost Good Faith calls for full disclosure, which fosters trust. Insurable Interest ensures that the subject has a true financial stake in the subject matter. Indemnity ensures that actual losses are fairly compensated.

The closest cause of a loss for coverage is determined by Proximate Cause. Subrogation allows insurers to recover damages from responsible parties. Contribution avoids dual coverage and overcompensation. Policyholders are responsible for minimizing losses under Mitigation of Loss. These principles, when combined, support the integrity of insurance, providing financial stability and peace of mind.

Frequently Asked Questions:

1.) What are the 7 principles of insurance?

In insurance, there are 7 basic principles that should be upheld, ie insurable interest, utmost good faith, proximate cause, indemnity, subrogation, contribution, and loss of minimization.

2.) In life insurance policies, which principles are followed, and which are avoided?

Life insurance follows principles of utmost good faith and insurable interest for honesty and financial stake. However, it avoids principles like indemnity, proximate cause, contribution, and mitigation of loss, as it provides a predetermined death benefit.

3.) What are proximate causes and root causes in insurance?

Proximate cause in insurance refers to the immediate or most direct reason for a loss, determining coverage. For instance, if a fire caused by a short-circuit damages a building, the proximate cause is the fire.

The root cause, on the other hand, delves deeper into the fundamental reason behind an incident, like identifying the faulty wiring in the above example.

Proximate cause influences insurance principles by determining coverage eligibility, whereas root cause is more relevant for addressing underlying issues and preventing future losses.

4.) What is the need for the principles of insurance?

The principles of insurance are necessary to establish fairness, transparency, and ethical conduct in insurance contracts. They prevent moral hazards, and over-insurance, and ensure that both insurers and policyholders fulfill their obligations. These principles form a legal framework, protecting consumers and promoting risk management in an unpredictable world.

Read more about D&O insurance