Risk Management in Banking and Insurance · Introduction to Insurance Business

Concept and Principles of Insurance for CMA Final

Updated 11 October 2026 · Fact-checked

Insurance is a contract in which an insurer, for a premium, agrees to compensate or pay the insured on a defined loss event. Many people pool small premiums to meet the few large losses. To answer questions, name the principle, state its rule, then apply it to the facts and give a conclusion.

Understand Concept and Principles of Insurance

Insurance is a contract of risk transfer. You pay a premium. The insurer promises to pay a sum, or make good a loss, if a specified event happens. The risk moves from you to the insurer.

It works through risk pooling. Many people face the same kind of risk, such as fire or death. Only a few will suffer a loss in a year. Everyone pays a small premium into a common fund, and the fund pays the few who suffer loss. The insurer relies on the law of large numbers: the more similar exposures it holds, the closer actual losses come to the expected losses. This is what lets it price premiums.

For the contract to work, the law applies some basic principles. Utmost good faith (uberrima fides) requires both sides to disclose all material facts honestly. A fact is material if it would influence the insurer's decision to accept the risk or fix the premium. Insurable interest means you must stand to lose financially if the insured subject matter is damaged or lost. Without it, the contract is a wager.

In general (non-life) insurance, indemnity limits the claim to the actual loss. You must not profit from insurance. It is not applied to life insurance in the same way, because the value of a life cannot be measured. Contribution applies when the same risk is insured with more than one insurer. Each insurer shares the loss rateably, so the insured does not recover more than the loss. Subrogation lets the insurer, after paying, step into your shoes against a third party who caused the loss. Proximate cause asks which cause actually led to the loss and whether that cause is covered.

A point on law: the Insurance Act, 1938 once had a section on insurable interest (Section 68), but it is omitted with effect from 26-12-2014. So do not cite Section 68 as the present law. Answer on the general principle of insurable interest instead.

Key rules to remember

Indemnity limit: Claim payable = least of (actual loss, sum insured); Subject to policy terms such as deductibles. The insured cannot recover more than the actual loss.
Contribution (rateable share): Insurer's share = (its sum insured ÷ total of all sums insured) × actual loss; Each insurer's share is also capped at its own sum insured. Applies to the same subject matter, same risk and same insured.
Average (underinsurance): Claim = (sum insured ÷ value of property at loss) × actual loss; Applies only if the policy has an average clause and the sum insured is below the value. Claim cannot exceed the sum insured.
Insurable interest test: Insurable interest exists if loss of the subject matter causes you financial loss; For life insurance, interest must exist when the policy is taken. For general insurance, it must exist at the time of loss.
Utmost good faith: Duty = disclose every material fact, truthfully; Material fact: one that would influence a prudent insurer in accepting the risk or fixing the premium.

How to solve Concept and Principles of Insurance questions

Principle questions are tested as application to a case. Use the same sequence each time so you do not miss marks.

1Read the facts and list who is the insured, the insurer, the subject matter and the event.
2Identify which principle the facts test: good faith, insurable interest, indemnity, contribution, subrogation or proximate cause.
3State the rule in one or two plain sentences, with its condition.
4Check each condition against the facts one by one, such as whether interest existed, whether a fact was material, or whether the policies cover the same risk.
5If numbers are given, compute the claim: apply indemnity, average or contribution as the facts require, and respect the sum insured cap.
6Check whether the type of insurance changes the answer, for example life versus general.
7Write a clear conclusion: who pays, how much, or whether the contract is voidable.

Quickest way: Rule, facts, result

When to use it: Use for 2-mark MCQs and for short scenario questions where time is tight.

Match the keyword in the facts to a principle: non-disclosure means good faith; no financial stake means insurable interest; double insurance means contribution; recovery from a wrongdoer means subrogation.
For numbers, first take the lower of loss and sum insured, then apply any average or share ratio.
Eliminate options that let the insured gain more than the actual loss in general insurance.
Check the cap: no insurer pays more than its own sum insured.

Common mistakes in Concept and Principles of Insurance

Applying indemnity to life insurance in the same way as to fire or motor insurance.
Students treat all insurance as compensation for loss.
Fix: Say that life insurance pays a fixed sum on the event. Life cannot be valued, so the strict indemnity principle is not applied.
Saying insurable interest must exist at the time of loss in every type of insurance.
Students remember the general insurance rule and apply it everywhere.
Fix: For life insurance, state that interest must exist when the policy is taken. For general insurance, it must exist at the time of loss.
Treating contribution as applicable to any two policies.
Students overlook the conditions.
Fix: Check that both policies cover the same insured, the same subject matter and the same risk, and that both are in force at the time of loss.
Paying the full sum insured when actual loss is lower.
Students confuse the sum insured with the amount payable.
Fix: Always take the lower of the actual loss and the sum insured first. Then apply average if the policy has such a clause.
Quoting Section 68 of the Insurance Act, 1938 as the law on insurable interest.
Old textbooks cite it.
Fix: That section is omitted from 26-12-2014. Explain the principle without citing a section.
Confusing subrogation with contribution.
Both prevent the insured from profiting.
Fix: Contribution is among insurers. Subrogation is the insurer's right against a third party after it pays.

Worked examples

Example 1

Ramesh insured his godown stock of ₹10,00,000 with Insurer A for ₹6,00,000 and with Insurer B for ₹4,00,000 against fire. A fire causes an actual loss of ₹5,00,000. Find each insurer's liability.

Show the solution

Both policies cover the same insured, same stock and same risk, so contribution applies.
Total sum insured = ₹6,00,000 + ₹4,00,000 = ₹10,00,000.
Actual loss ₹5,00,000 is below the total sum insured, so indemnity allows the full loss.
Insurer A's share = 6,00,000 ÷ 10,00,000 × 5,00,000 = ₹3,00,000.
Insurer B's share = 4,00,000 ÷ 10,00,000 × 5,00,000 = ₹2,00,000.
Check: 3,00,000 + 2,00,000 = ₹5,00,000, equal to the loss.

Answer: Insurer A pays ₹3,00,000 and Insurer B pays ₹2,00,000. Ramesh recovers exactly his loss of ₹5,00,000.

Example 2

Meena buys a life policy on her brother-in-law, who lives separately and is not financially dependent on her, without his knowledge. She does not disclose that he has a serious heart condition. Which principles are in issue, and what is the likely position?

Show the solution

Identify insurable interest: Meena must stand to lose financially from his death. Facts show no dependence or financial stake, so interest appears to be absent.
Without insurable interest, the contract is in the nature of a wager and cannot be enforced as a valid insurance contract.
Identify utmost good faith: a serious heart condition is a material fact. Non-disclosure of it breaches the duty of disclosure.
Even if interest existed, the insurer could treat the contract as voidable for non-disclosure of a material fact.
Conclude on both grounds.

Answer: The policy fails for lack of insurable interest, and separately the non-disclosure of a material fact breaches utmost good faith, so the insurer can avoid the contract.

Exam tips

In MCQs, one keyword in the facts usually points to the principle. Find it before reading the options.
In written answers, use the order rule, facts, conclusion. A conclusion line earns marks even when your arithmetic is partly wrong.
Show the total sum insured and each ratio in contribution sums, so marks can be given for method.
Know the exceptions: indemnity in life insurance, and the different timing of insurable interest for life and general insurance.
Do not cite a section number unless you are certain it is current. State the principle in words.

Practice questions from Introduction to Insurance Business

Concept and Principles of Insurance: frequently asked questions

What is risk pooling in insurance?

Risk pooling means many people contribute premiums to a common fund. The fund pays the few who suffer a loss. Because losses across a large group are predictable, the insurer can price premiums and stay solvent.

What is the difference between indemnity and contribution?

Indemnity limits the insured's recovery to the actual loss. Contribution comes in when the same risk is insured with more than one insurer. It makes the insurers share the loss rateably, so the insured is not paid more than the loss.

What is utmost good faith in insurance?

It is the duty on both parties to disclose every material fact honestly. A fact is material if it would influence the insurer in accepting the risk or setting the premium. Breach can let the insurer avoid the contract.

When must insurable interest exist?

In life insurance, it must exist when the policy is taken. In general insurance, it must exist when the loss occurs. Without it, the contract is a wager.