Human life is an income generating asset. This asset can be lost through unexpected death or made non functional through sickness or disability caused by an accident. On the other hand there is a certainty that death will happen, but its timing is uncertain. Life insurance protects against loss.
Life insurance contract may be defined as the 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. The definition of the life insurance contract is enlarged by Section 2(ii) of the Insurance Act 1938 by including annuity business. Since, the life insurance contract is not an indemnity contract; the undertaking on the part of the insurer is an absolute one to pay a definite sum on maturity of policy at the death or an amount in installment for a fixed period or during the life.
Features of Life Insurance Contract
Followings are the features of life insurance contract:
- Nature of General Contract
- Insurable Interest
- Utmost Good Faith
- Proximate Cause
- Assignment and Nomination
In life insurance contract the first three features are very important while the rest of them are of complementary nature.
1. Nature of General Contract
Since the life insurance contract is a sort of contract it is approved by the Indian Contract Act. According to Section 2(H) and Section 10 of Indian Contract Act, a valid contract must have the following essentialities:
- Agreement (offer and acceptance)
- Competency of the parties
- Free consent of the parties
- Legal consideration
- Legal objective
1.1 Agreement (offer and acceptance)
An offer or proposal is intimation to another of ones intention to do or to abstain from doing anything with a view to obtaining the assent of that other person to such an act or abstinence. When the person to whom the proposal or offer is made signifies his assent to it, the offer is said to be accepted. The offer and acceptance in life insurance is of typical nature. The Agents canvassing or publication of prospectus and of uses of insurance constitutes invitation to offer because the public in general and individual in particular are invited to make proposal for insurance. Submission of proposal along with the premium is an offer and the dispatch of acceptance-letter is the acceptance. The risk will commence as soon as the acceptance letter is dispatched by the insurer. When the proposal is not accompanied with the first premium, it would be an invitation to offer by the prospect and the letter of insurer (generally acceptance letter with modification is sent) asking the proposal to pay the first premium without any alteration is an offer and the payment of first premium by the prospect is acceptance. As soon as premium is dispatched, acceptance is made provided there was no alteration in the terms and conditions. Another case may be when the insurer desires to accept the proposal only on certain modifications. The letter (generally the acceptance letter) sent to the prospect about the desire of change in terms and conditions are an offer if the first premium was not sent along with the proposal. But if the first premium was sent along with the proposal, it would be a counter-offer. If the premium was not already sent, it would be an acceptance. Thus the acceptance letter sent by the insurer is not always acceptance. It would be acceptance only when the first premium was accompanied with the proposal and the proposal is acceptable on normal rates and terms. In other cases it would be an offer or counter-offer.
1.2 Competency of the Parties
The essential element of a valid Contract is that the parties to it must be legally competent to contract. Every person is competent to contract who is of the age of majority according to the law, who is of sound mind, and who is not disqualified from contracting by any law. The insurer will be competent to contract if he has got the license to carry on insurance business. Majority is attained when a person completes age of 18 years. A minor is not competent to contract. A contract by a minor is void excepting contracts for necessaries. The minor can repudiate the contract at any time during his minority. If the life insurance policy is issued to a minor, the insurer cannot repudiate it but the minor can repudiate it during his minority. At the attainment of majority, he has to exercise the option, within a reasonable time, whether he would continue to carry on the policy or not. Generally, insurer accepts the proposal forms completed by the guardians of the minors. So, the incompetence of contract does not arise. Persons of sound mind can enter into a contract. 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. A person who is usually of unsound mind, but occasionally of sound mind may make a contract when he is of sound mind. A person usually of sound mind, but occasionally of unsound mind, may not make a contract when he is of unsound mind. So, an intoxicated person cannot enter into a contract. The contract may be avoidable at his option, but in order to be avoided, it must be repudiated by the insured within a reasonable time of his becoming sober. Similarly, when an originally valid contract has been entered into, it will not be affected by one of the parties becoming lunatic afterwards. A contract with an alien enemy is void. An alien enemy is disqualified from, and is incapable of entering into contract or enforcing it. When an alien with whom an insurance contract has been entered into becomes an enemy afterwards, the contract is either suspended or terminated as from the declaration of war.
1.3 Free Consent of the Parties
In life insurance, both parties must know the exact nature of the risk to be underwritten. If the consent is not free, the contract is generally avoidable at the option of the party whose consent was not freely given.
1.4 Legal Consideration
The presence of a lawful consideration is essential for a legal contract. The insurer must have some consideration in return of his promise to pay a fixed sum at maturity or death whichever may be the case. The consideration need not be money only. It should be anything valuable or to which value may be assigned. It may be interest, right, dividend, etc. The first premium is consideration and subsequent premiums are merely conditions to contract.
1.5 Legal Objective
The contract would be legal only when the object is legal. The object of a legal life insurance contract is to protect oneself or ones family against financial losses at the death of the insured. The contract is, sometimes, to provide for financial emergencies that may occur in old age. In brief the contract will be lawful only when the objective is legal. The objective will be legal only when there is insurable interest. Without having this interest, the object of the contract would not be legal. It would be wager contract and against public policy.
2. Insurable Interest
Insurable interest is the pecuniary interest. The insured must have insurable interest in the life to be insured for a valid contract. Insurable interest arises out of the pecuniary relationship that exists between the policy-holder and the life assured so that the former stands to loose by the death of the latter and/or continues to gain by his survival. If such relationship exists, then the former has insurable interest in the life of the latter. The loss should be monetary or financial. Mere emotion and expectation do not constitute insurable interest in the life of his friend or father merely because he gets valuable advice’s from them.
Insurable interest in life insurance may be divided into two categories.
- Insurable interest in own life and
- Insurable interest in other‟s life.
The latter can be sub-divided into two classes:
- Where proof is not required and
- Where proof is required
Again this insurable interest where proof is required can be divided into two classes:
- Insurable interest arising due to business relationship, and
- Insurable interest in family relationship
2.1 Insurable interest in own’s Life
An individual always has an insurable interest in his own life. Its presence is not required to be proved. Bunyon says “Every man is presumed to possess an insurable interest in his estate for the loss of his future gains or savings which might be the result of his premature death”. The insurable interest in own life is unlimited because the loss to the insured or his dependents cannot be measured in terms of money and, therefore, no limit can be placed to the amount of insurance that one may take on ones own life. Thus, theoretically, a person can take a policy of any unlimited amount on his own life but in practice no insurer will issue a policy for an amount larger than amount seems suitable to the circumstances and means of the applicant.
2.2 Insurable interest in other’s life
Life insurance can be affected on the lives of third parties provided the proposed has insurable interest in the third party. There are two types of insurable interest in others life. First where proof is not required and second, where proof is required.
2.2.1 Proof is not required
There are only two such cases where the presence of insurable interest is legally presumed and therefore need not be proved.
- Wife has insurable interest in the life of her husband: It is presumed and decided by Reed vs. Royal Exchange (1795) that wife has an insurable interest in the life of her husband because husband is legally bound to support his wife. The wife will suffer financially if the husband is dead and will continue to gain if the husband is surviving. Since, the extent of loss or gain cannot be measured in this case; the wife has insurable interest in the husbands life up to an unlimited extent.
- Husband has insurable interest in the life of his wife: It was decided in Griffith vs. Fleming (1909) that the husband has insurable interest in his wife‟s life because of domestic services performed, by the wife. If the wife is dead, husband has to employ other person to render the domestic services and other financial expenditures will involve at her death which are not calculable. The husband is benefited at the survival of his wife, so it is self proved that husband has insurable interest in his wife‟s life. Since the monetary loss at her death or monetary gain at his survival cannot be measured, there is unlimited insurable interest in the life of wife.
2.2.2 Proof is required
Insurable interest has to be proved in the following cases:
- Business Relationship: The policyholder may have insurable interest in the life of assured due to business or contractual relationship. In this case, the amount of insurance depends on the amount of risk involved. Example, a creditor may lose money if the debtor dies before the loan is repaid. The continuance of debtor‟s life is financially meaningful to the creditor because the latter will get all his money repaid at the former‟s survival. The maximum amount of loss to a creditor may be the amount of outstanding loan plus interest thereon and the amount of premium paid. So, the maximum amount of insurable interest is limited to the outstanding loan, plus interest and amount of premium expected to be paid. The interest is calculated on the estimation of duration of debt to be paid. The full amount of policy is payable irrespective of the payment of loan and interest. Since it is life insurance, the full policy amount is paid. A trustee has insurable interest in respect of the interest of which he is trustee because at the survival of the other person, the trustee is benefited and at his death he will suffer. A surety has insurable interest in the life of his principal. If the principal (the debtor) is dead, the surety is responsible for payment of outstanding loan, or obligated amount. At the survival of principal, he will not suffer this loss. Insurable interest is limited, up to the amount of outstanding loan, interest and premium paid. A partner has insurable interest in the life of each partner. At the death of a partner, the partnership will be dissolved and the surviving partner will lose financially. Even if the firm continues at the death of the partner, the firm has to pay deceased partner‟s share to his dependents. This will involve a huge financial loss to the partnership. Therefore, the firm collectively can purchase insurance policies in the life of each partner of the firm. Similarly all the partners have insurable interest in life of each partner because they will financially suffer at the death of partners.
- Family Relationship: The insurable interest may arise due to family relationship if pecuniary interest exists between the policyholders and life assured because mere relationship or ties of blood and of affection does not constitute insurable interest. The proposer must have a reasonable expectation of financial benefit from the continuance of the life of the person to be insured or of financial loss from his death. The interest must be based on value and not on mere sentiments. Similarly, mere moral obligation is not sufficient to warrant existence of insurable interest although legal obligation to get support will form insurable interest of the person who is supported in life of the person. Thus a son can insure his fathers life only when he is dependent on him and the father can take insurance policy on his son‟s life only when he is dependent on his son.
General Rules of Insurable Interest in Life Insurance:
- Time of Insurable Interest: Insurable interest must exist at the time of proposal. Policy, without insurable interest, will be wager. It is not essential that the insurable interest must be present at the time of claim.
- Services: Except the services of wife, services of other relatives will not essentially form insurable interest. There must be financial relationship between the proposer and the life-assured. In other words, the services performed by the son without dependence of his father, will not constitute insurable interest of the father in the life of his son. Vice-versa is not essential for forming insurable interest.
- Insurable Interest must be valuable: In business relationship the value or extent of the insurable must be determined to avoid wager contract of additional insurance. Insurance is limited only up to the amount of insurable interest.
- Insurable interest should be valid: Insurable interest should not be against public policy and it should be recognized by law. Therefore, the consent of life assured is very essential before the policy can be issued.
- Legal responsibility may be basis of insurable interest: Since the person will suffer financially up to the extent of responsibility, the proposal has insurable interest to that extent.
- Insurable Interest must be definite: Insurable interest must be present definitely at the time of proposal. Mere expectation of gain or support will not constitute insurable interest.
- Legal Consequence: Insurable interest must be there to form legal and valid insurance contract.Without insurable interest, it would be null and void.
3. Utmost Good Faith
Life insurance requires that the principle of utmost good, faith should be preserved by both the parties. The principle of utmost good faith says that the parties, proposer (insured) and insurer must be of the same mind at the time of contract because only then the risk may be correctly ascertained. They must make full and true disclosure of the facts material to the risk.
- Material facts: In life insurance material facts are age, income, occupation, health, habits, residence, family history and plan of insurance. Material facts are determined not on the basis of opinion, therefore, the proposer should disclose not only those matters which the proposer may feel are material but all facts which are material.
- Duty of both parties: It is not only the proposer but the insurer also who is responsible to disclose all the material facts which are going to influence the decision of the proposer. Since the decision is taken mostly on the basis of subject-matter, the life to be insured in life insurance, and the material facts relating to the subject-matter are known or is expected to be known by the proposer; it is much more responsibility of the proposer to disclose the material facts.
- Full and True Disclosure: Utmost good faith says that there should be full and true disclosure of all the material facts. Full and true means that there should be no concealment, misrepresentation, half disclosure and fraud of the subject matter to be insured.
- Legal Consequence: In the absence of utmost good faith the contract will be avoidable at the option of the person who suffered loss due to non-disclosure. The intentional non-disclosure amounts to fraud and the unintentional non-disclosure is voidable at the option of the party not at fault. Once the voidable contract has been validated by the party not at fault, the contract cannot be avoided by him later on. For instance, if the insurer has continued to accept the premium when, certain non-disclosure, say miss-statement of age, has been disclosed the insurer cannot invalid the contract and cannot refute to pay the amount of claim. If the party not at fault does not exercise its option, the contract will remain valid.
- Indisputability of Policy: The doctrine of utmost good faith works as a great hardship for a long period on the plea of miss-statement at the time of proposal. In such cases, it would be very difficult to prove or disprove whether a particular statement made, at the time of policy was true. Therefore, to remove this hardship, certain sections in the concerned Act are provided. In India, Section 45 of the Insurance Act, 1938 deals with such dispute. It is called indisputable clause, “No policy of life insurance, after expiry of two years from the date on which it was effected, be called into question by an insurer on the ground that a statement made in the proposal for insurance or in any report of a medical officer or referee or friend of the insured or in any other document leading to the issue of the policy was inaccurate or false, unless the insurer shows that such statement was on a material matter or suppressed facts which it was material to disclose and that it was fraudulently made by the policy-holder and that the policyholder knew at the time of making it that the statement was false or that it suppressed facts which it was material to disclose. Provided that nothing in this section shall prevent the insurer from calling for proof of age at any time if he is entitled to do so.
Warranties are an integral part of the contract, i.e., these are the basis of the contract between the proposer and insurer and if any statement, whether material or non-material, is untrue, the contract shall be null and void and the premium paid by him may be forfeited by the insurer. The policy issued will contain that the proposal and personal statement shall form part of the Policy and be the basis of the contract. Warranties may be informative and promissory. In life insurance the informative warranties are more important. The proposal is expected to disclose all the material facts to the best of his knowledge and belief. Warranties relating to the future may only be statements about his expectation or intention, for instance, the insured promises that he will not take up any hazardous occupation and will inform the insurer if he will take the hazardous occupation.
4.1 Breach of Warranty
If there is breach of warranty, the insurer is not bound to perform his part of the contract unless he chooses to ignore the breach. The effect of a breach of warranty is to render the contract voidable at the option of the other party provided there is no element of fraud. In case of fraudulent representation or promise, the contract will be Void ab initio.
5. Proximate Cause
The efficient or effective cause which causes the loss is called proximate cause. It is the real and actual cause of loss. If the cause of loss (peril) is insured, the insurer will pay; otherwise the insurer will not compensate. In life insurance the doctrine of Causa Proxima (Proximate Cause) is not applicable because the insurer is bound to pay the amount of insurance whatever may be the reason of death. It may be natural or unnatural. So, this principle is not of much practical importance in connection with life assurance, but in the following cases the proximate causes are observed in the life insurance, too.
- War-risk: Where Policy is issued on exclusion of war and aviation risks, the proximate cause of death is important because the Insurer waives its liability if death occurred, in this case, while the insured was in field or is engaged in operation of war and aviation. Only premium paid or surrender value whichever is higher is payable and the total Policy amount is not payable.
- Suicide: If suicide occurs within one year of the policy, or there was intention to commit suicide, the payment of policy would be restricted, only up to the interest of the third party in the policy provided, the interest was expressed at least one month before the suicide.
- Accident Benefit: A problem arises when an insured under an accident Policy is killed or suffers an injury which has an immediate cause and also a remote cause. In accident benefit policy, double of the Policy amount is paid. So, the cause of death in this Policy is of paramount importance.
6. Assignment and Nomination
The Policy in life insurance can be assigned freely for a legal consideration or love and affection. The assignment shall be complete and effectual only on the execution of such endorsement either on the Policy itself or by a separate deed. Notice for this purpose must be given to the insurer who will acknowledge the assignment. Once the assignment is completed, it cannot be revoked by the assignor because he ceases to be the owner of the Policy unless reassignment is made by the assignee in favor of the assignor. An assignee may be the owner of the policy both on survival of the life assured, or on his death according to the terms of transfer. The life policies are the only Policies which can be assigned whether the assignee has an insurable interest or not. The holder of a policy of life insurance on his own life may, either at the time of affecting policy or at any subsequent time before the Policy matures, nominate the person or persons to whom the money secured by the policy shall be paid in the event of his death. A nomination can be cancelled before maturity, but unless notice is given of any such cancellation to the insurer, the insurer will not be liable for any bonafide payment to a nominee registered in the records. When the policy matures, or if the nominee dies, the sum shall be paid to the Policy-holder or his legal representatives.