Tips & Advice

Layperson's Guide to Understanding Insurance's Seven Basic Principles

Insurance is a crucial component of your financial planning. Learn why it's important to understand its seven basic principles.

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Tips & Advice


Insurance is more than just boring policies; it's a crucial component of your personal financial planning, ready to assist you when you need it most.

To understand the world of insurance, it is important to understand its seven basic principles. Here, we'll explain what these principles are and why they matter in simple terms.

Insurance Principles: The Seven Basics

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Principle 1: Utmost Good Faith – Because Trust Matters

This principle emphasizes honesty and transparency between the insured and the insurer. To obtain insurance, it is essential to provide accurate and complete information about your risks. Similarly, insurance companies must disclose all relevant policy details. This principle ensures a fair and trusting relationship between insurers. While online purchases have become the norm, it's crucial for customers to be aware of data privacy and theft. Learn how we keep your data safe.

Example: Imagine you’re buying a home insurance plan for a sub-sale apartment. By truthfully sharing material details, especially those known to you, about your property, your insurer can appropriately ensure that you receive sufficient coverage and support in case of damage or theft. At the same time, the insurer is also obligated to provide all the necessary details of the policy they have offered you.

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Principle 2: Insurable Interest – Protect Only What’s Yours

To purchase insurance, you must have a financial interest in the insured item or person. In other words, you must be at risk of financial loss if the insured event occurs. The principle prevents individuals from insuring unrelated parties or properties.

Example: Upon purchasing a home in your name. Hence you took on a fire policy over your home, with you as its beneficiary. In this context, there is a clearly established ownership of the item, and the insurer can understand why you would want to safeguard it against losses.

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Principle 3: Indemnity – No Profit from Your Loss

The principle of indemnity ensures that you are compensated for your actual loss but not allowed to profit from it. This principle emphasizes that insurance is not a pathway to amassing wealth but rather a vital safety net designed to protect you from the financial obstacles that life may throw your way.

Example: If a business owner's office is damaged by an unexpected fire, the insurance payout helps in rebuilding without allowing for financial gain.  This emphasizes equity and fairness in the Malaysian insurance landscape while helping restore the business to its pre-loss state.

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Principle 4: Contribution – No Profiting from Multiple Policies

Contribution is applicable when you have multiple insurance policies covering the same risk. In such cases, the insurers share the costs proportionally. Similar to the principle of Indemnity, you cannot collect more than the actual loss from multiple insurers. The main idea behind this principle is to prevent over-insurance or profiting from an insurance claim.

Example: Let's say the Bank has purchased an insurance policy for your house, and you have also done the same. In this scenario, if your house is damaged by a fire, you will be compensated for that loss by both insurers proportionally for their share of the risk.

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Principle 5: Subrogation – Ensuring the Responsible Parties Are Liable for Your Loss

This principle means that, upon compensating you for your loss, the insurance company may take legal action against the responsible third parties who caused the loss. The purpose of this principle is to ensure that the party responsible for the loss, not the insurance company, bears the financial burden.

Example: If a faulty electrical system caused a fire in your business premises, your insurer is expected to pay for the claim you filed. In return, the insurer has the legal right to pursue the supplier or contractor at fault for recovery, fostering equity among all involved parties.

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Principle 6: Proximate Cause – Finding the Root Cause

To make a successful claim, you need to understand what triggers protection and what doesn't in an insurance policy. Direct or proximate causes typically activate coverage (the Root Cause), while remote or indirect ones do not.

Example: You have a car insurance policy, and you find yourself rear-ended in an accident. At first glance, it might seem like a simple collision caused by the car behind you. However, if the accident occurred due to a truck hitting the car behind you first, the proximate cause principle comes into play. The root cause of the incident is the truck’s failure to stop. This is to ensure that your insurance coverage remains precise and accurate, covering the real causes of the accident and not any unrelated factors.

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Principle 7: Loss Minimization – You are Responsible Too!

Loss minimization recognizes policyholders as active partners in protecting their assets. It's not just about having insurance; it's a collaborative effort for your well-being, where your actions enhance your peace of mind and overall security.

Example: If your house catches fire due to an electric short circuit. It is expected that reasonable steps should be taken to put out the fire or minimize the loss, and not merely standing back and watching it burn because you know the insurance company will compensate for it.

Why These Principles Matter to You

Understanding these basic insurance principles is vital for several reasons:

  • Informed Decision-Making: Knowledge of these principles empowers you to make informed decisions when choosing coverage. You can evaluate policies more effectively and select the one that best suits your needs while avoiding certain pitfalls that may render your coverage void or any risk events unclaimable.
  • Fair Claims Processing: When you know the principles of indemnity and proximate cause, you can navigate the claims process more effectively, ensuring that you receive appropriate compensation when needed.
  • Risk Management: Embracing the principles of insurable interest and loss minimization means taking steps to protect your assets and reduce potential losses, ultimately leading to lower premiums and better coverage.

In summary, the insurance sector is based on these seven fundamental ideas. They ensure that policyholders and insurers alike receive fair and equal treatment, transparency, and efficient risk management. Understanding these concepts as a layperson will enable you to make knowledgeable choices because insurance is a tool for protecting your finances.

So, the next time when you think about insurance, remember, insurance is not a boring topic. There is so much to learn and understand. When used properly, it can become a trusty sidekick, always there to keep you safe and push you on to make your life more enjoyable with that extra peace of mind.