Life insurance is a contract, whereby the insurer in consideration of a premium undertakes to pay a certain sum of money either on the death of the insured or on the expiry of a fixed period (term of insurance).
Insurance interest may otherwise be termed as pecuniary interest. Hence, the insured person must have an insurable interest in the life to be insured for a valid contact period.
Insurable interest mainly arises from the pecuniary relationship that exists between the policy holder and the life assured so that the policy holder stands to loose by the death of the life assured; he / she may continue to gain by the survival.
When dealing with the insurable interest in life insurance, two points have to be kept in mind. They are insurable interest in their own life and insurable interest in other’s life. When insurable interest in other’s life is discussed, the requirement of proof is a criterion.
In some cases it is required and in others not. Where proof is required, the relationship has to be studied in respect of family or business relation.
There is a general contract between the insured and the insurer in the case of life insurance and they are as follows.
- Agreement (Offer and acceptance)
- Competency of the parties
- Free consent of the parties
- Legal consideration
- Legal objective
1. Offer and acceptance
The term offer and acceptance is the typical nature of the life insurance policies. An offer is made to the insured by the insurer in the form of a proposal and if the former gives his / her assent, it is considered as an acceptance in the insurance parlance. It is the duty of the insured to complete the proposal form in full shape and submit the same to the insurer and once the terms and conditions are agreed, the contract is made. Submission of proposal along with the premium is considered as an offer and the dispatch of the acceptance letter signifies the acceptance. The commencement of risk takes place with the dispatch of the acceptance letter by the insurer.
2. Competency of the parties
The contract executed by the parties must be legally tenable and a person (insured) is considered competent to enter into a contract if he / she is an adult (the age of attaining adulthood varies depending on the country where you are living), possesses sound mind (not mentally retarded) and not debarred by the court of law from entering into any kind of agreement. The insurer is considered as a competent authority to enter into a contract when he / she has the required valid license to carry out the life insurance business. The nature and number of companies doing life insurance business differ depending on the country and the states.
This is the term that is used to denote the attainment of adulthood and as already discussed, it varies depending on the country and in most states, completing the age of 18 is considered as adult. A minor, i.e. any one less than 18 years old is not competent to enter into an agreement with the insurer and the minor can repudiate the contract anytime before the age of 18 years whereas the insurer has no right to renounce. But when the insured attains adulthood, he / she has to exercise the option of whether continuing with the policy or rejecting it, within a reasonable time frame. The life insurance companies are clever in doing business with the minors through their guardians, in which case the insurer has the final say and the minor has no right to repudiate the agreement because the contract is made after the consent of the guardian.
4. Mental status of the insured
This is very important because the contract executed by a person of unsound mind is considered null and void. Hence it is the duty of the insurer to see that the insured is of sound mind and mentally stable before entering into any agreement. Whenever a person becomes mentally deranged for short duration, e.g. alcohol consumption, he / she is not eligible to sign the agreement during the period because he is incapable of understanding and making a rational judgment as to its effects upon his interests. When an originally valid contract has been entered into, it will not be affected by one of the parties becoming mentally upset at a later period.
Cardinal principles governing the insurable interest in life insurance
At the time of proposal, the insurable interest shall exist. However, it is not essential that the insurable interest must be present at the time of filing the claim.
The service of the wife is considered as essential and that of the others need not essentially of insurable interest. The financial relationship between the proposer and the life assured must be sound.
Insurance is generally limited to the amount of insurable interest.
The validity of the insurable interest is important. Hence, the consent of the life assured is very important before a policy is issued and the insurable interest should not be against public policy.
The insurable interest shall be present definitely at the time of proposal. Speculative gain or support will in way form the insurable interest.
The nature of the insurable interest shall be valid and legal. Without that, it would become null and void.
ASSESSING THE RISK
The evaluation of risk in life insurance is an art and by scrupulously following the procedures, the inferior lives are weeded out. The idea behind assessing the risk of the insured is to see whether the degree of risk represented by the applicant for insurance is commensurate with the premium designed for persons in his / her category or some additional premium is required or else whether the application form may be rejected outright.
What is the need to assess the risk?
- The foremost need is to check whether the proposal may be accepted or not.
- The second objective is to calculate the rate of premium to be charged from the life assured. The premium varies depending on the risk. It is quite natural that higher the risk, greater the premium. Hence every proposal is thoroughly analyzed for the existence of risk and accordingly suitable premium is arrived at.
- The risk varies greatly depending on the person and hence it is impossible to charge different premiums for different persons and for practical purposes, the risks are classified and premiums are determined accordingly. On the basis of selection, the risk in insurance is classified into standard and sub standard. It is possible to determine what risks are classified as normal and for which a normal rate of premium is charged and for extra risks, additional premium apart from the normal rate is charged. If the risk assessed is too great, chances are that the proposals will not be accepted at all.
- The fourth objective is to avoid any discrimination on the part of the life assured. Since the risk varies greatly based on individuals, premiums are designed for a group involving similar risks. It is unjustified to collect the same premium for the different groups. For e.g. it would be foolish to charge the same premium for two individuals where one is involved in a hazardous occupation and the other one is robustly built and engaged in a conducive occupation.
The selection of risk also helps to avoid adverse selection. Risk selection is very essential to check the anti selection or adverse selection which means the selection of persons for insurance who are not insurable and charging of lesser premium for those who are to be charged higher. There is every likelihood that the persons who are about to die may come into the insurance fold at any cost just to make windfall profit. This is an unhealthy practice and shall be strictly avoided; otherwise not only the insurer looses a lot of money but also the honest insured would be required to pay a higher premium to compensate the total loss of the insurer.
Hence calculation of premium is very important that decides the business strategy of the insurer; while charging a low premium for high risk individuals will lead to financial loss of the insurer, a deliberately higher premium will make it unpopular and if more people are not going to purchase the policy, the insurer will naturally loose a sound business which is again a loss. Hence the principle should be to select the standard risk at standard cost and substandard risk at extra premium to avoid inequality of cost and unfavorable selection of risk.
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