Principles of Insurance
1. Principle of Insurable Interest
Homeowners insurance compensates a policyholder who suffers a major financial loss in the event that a fire or other destructive force destroys his or her home. The homeowner has insurable interest in the property; losing that home would create a catastrophic loss for the policyholder.
An individual cannot purchase homeowners insurance on a neighbour's house. There is no insurable interest in a neighbouring property because another entity owns it. Purchasing homeowners insurance for a neighbour’s house creates an incentive to cause damage to that house and collect the insurance proceeds — appropriate underwriting would not create such an incentive. This represents moral hazard.
Insurable Interest is also necessary in life insurance.
Possible combinations -
• Parents can buy insurance for their children
• Spouse can buy insurance for spouse
• Employers can buy insurance for their employees
Not possible combinations -
• Sister cannot buy insurance for brother and vice versa
• Children cannot buy insurance for parents
2. Principle of Utmost good faith
Utmost good faith is a common law principle (sometimes called Uberrimae Fidei). The principle means that every person who enters into a contract of insurance has a legal obligation to act with utmost good faith and reveal all facts regarding health of a person towards the company offering the insurance.