Which one of the following is not a Contract of Indemnity ?

Correct — B, (b) Contract of Life Insurance. The booklet sets 'not' in bold italic — the item asks which contract is NOT one of indemnity — and life insurance is the standing exception.

A contract of indemnity makes good an actual loss and no more. The insured is put back in the position he occupied immediately before the loss, so he cannot profit from the event: the measure of the claim is the value of what was destroyed, subject to the sum insured, and where the property is only damaged the claim is the cost of repair. Fire, marine and motor insurance all work this way. If a warehouse insured for ₹ 50 lakh suffers ₹ 12 lakh of fire damage, the claim is ₹ 12 lakh, not ₹ 50 lakh.

Life insurance cannot work this way, for a reason that is more than technical: HUMAN LIFE CANNOT BE VALUED IN MONEY. There is no loss to measure, so there is nothing to indemnify. What the parties do instead is agree the sum in advance — the policy is for a fixed amount, payable on death or on maturity — which makes it a contingent contract, one whose performance depends on the happening of an uncertain event, rather than a contract of indemnity. That is also why the same class of policy is often called ASSURANCE rather than insurance: on a whole-life policy the event is certain to happen, only its timing is not.

The consequences of the distinction are the examinable part. Because life insurance is not a contract of indemnity:

the doctrine of SUBROGATION does not apply — a life insurer who pays on a policy acquires no right to sue the person who caused the death; the doctrine of CONTRIBUTION does not apply — a person may hold several life policies and recover the full sum under each, whereas a person who insures one warehouse with three fire insurers recovers his actual loss once, shared rateably between them; insurable interest is required only at the time the policy is TAKEN OUT, and need not exist at the time of the loss, whereas in fire insurance it must exist at both times.

Personal accident insurance shares the same character for the same reason, being a benefit policy that pays a fixed sum on a specified injury. Every other option in this set is a property or liability cover, and each is indemnity.

Why the others are wrong

• (a)Contract of Fire Insurance — Fire insurance IS a contract of indemnity, and it is the classical illustration of the principle. The insured recovers the actual loss suffered, subject to the sum insured, so a partial loss produces a partial claim and a total loss no more than the value of what was destroyed. Two features of the class follow from indemnity: an average clause reduces the claim proportionately where the property was insured for less than its full value, which prevents an under-insured person recovering as fully as one who paid a full premium; and the insurer, having paid a total loss, is entitled to the salvage, because leaving the wreckage with the insured would give him more than his loss. Subrogation and contribution both apply.
• (c)Contract of Marine Insurance — Marine insurance IS a contract of indemnity, and it is the oldest branch of the subject — the Marine Insurance Act, 1963 defines it in section 3 as a contract whereby the insurer undertakes to indemnify the assured against marine losses, that is, the losses incident to marine adventure. Its measure of indemnity is settled by the Act rather than by the market: for a valued policy the value fixed in the policy, for an unvalued policy the insurable value ascertained under the Act's rules. Insurable interest here must exist at the TIME OF LOSS, though not necessarily when the policy is effected, which is the opposite of the life-assurance rule and is a favourite of examiners for that reason.
• (d)Contract of Motor Insurance — Motor insurance IS a contract of indemnity, on both of its limbs. The own-damage cover indemnifies the owner for damage to his vehicle, subject to depreciation on parts and to the insured declared value, so an old car recovers less than a new one for the same damage. The third-party liability cover, which Chapter XI of the Motor Vehicles Act, 1988 makes compulsory, indemnifies the insured against his legal liability to another person — the loss being the liability itself. Subrogation applies in the ordinary way, which is why a motor insurer that has paid for damage caused by another driver may sue that driver in its insured's name; and contribution applies where the same vehicle is covered twice.

Indemnity is the organising principle of general insurance and the reason two other principles exist at all. A contract of indemnity restores the insured to the position he occupied immediately before the loss, and no better — so the claim is measured by the actual loss, capped by the sum insured. Subrogation exists to protect indemnity from the far side: once the insurer has paid, it takes over the insured's rights against whoever caused the loss, so that the insured does not recover both from the insurer and from the wrongdoer. Contribution protects indemnity from the near side: where the same subject matter is insured with more than one insurer, each may call on the others to share rateably, so that the insured recovers his loss once rather than several times over. Life assurance and personal accident insurance stand outside this structure because their subject matter cannot be valued. They are BENEFIT policies: the sum is agreed at the outset and paid on the happening of the event, with no inquiry into loss. Consequently subrogation and contribution have no application to them, and insurable interest is required only at inception. Two further distinctions are worth carrying alongside. Under the Indian Contract Act, 1872, section 124 defines a contract of indemnity as one by which one party promises to save the other from loss caused by the conduct of the promisor himself or of any other person, and section 126 defines a contract of guarantee as one to perform the promise or discharge the liability of a third person in case of his default — two parties in the first, three in the second. And an insurance contract is a contingent contract within section 31, since performance depends on an uncertain future event.

Key facts

• A contract of indemnity restores the insured to the position he was in immediately before the loss and no better; the claim is measured by the actual loss, subject to the sum insured.
• Fire, marine and motor insurance are contracts of indemnity; life assurance and personal accident insurance are not.
• Life assurance is a contingent or benefit contract because human life cannot be valued in money, so the sum is fixed in advance.
• Subrogation does not apply to life assurance; the insurer acquires no rights against the person who caused the death.
• Contribution does not apply to life assurance; a person may hold several life policies and recover the full sum under each.
• Insurable interest must exist at the time of taking the policy in life assurance, at the time of loss in marine insurance, and at both times in fire insurance.
• The Marine Insurance Act, 1963, section 3, defines marine insurance as a contract to indemnify the assured against marine losses.
• An average clause in a fire policy reduces the claim proportionately where the property was under-insured.
• Indian Contract Act, 1872, section 124 defines a contract of indemnity; section 126 defines a contract of guarantee, which involves three parties.
• Third-party motor liability cover is compulsory under Chapter XI of the Motor Vehicles Act, 1988.

Common traps

• Answering the positive question. Three of the four contracts are contracts of indemnity.
• Assuming personal accident insurance is indemnity. Like life assurance it pays a fixed sum on a specified event.
• Applying subrogation to a life claim. It has no application there.
• Getting the timing of insurable interest the wrong way round between life and marine insurance.

• practice — not a real PYQ

  A person holds three separate life policies of ₹ 10 lakh each with three insurers and dies during their currency. His nominee is entitled to :

  • (a)₹ 10 lakh in all, shared rateably between the three insurers
  • (b)₹ 30 lakh, being the full sum assured under each policy
  • (c)₹ 10 lakh from the earliest policy only
  • (d)Such sum as the insurers may agree between themselves

  Answer(b) ₹ 30 lakh, being the full sum assured under each policy

• practice — not a real PYQ

  In fire insurance, insurable interest must exist :

  • (a)Only at the time of taking the policy
  • (b)Only at the time of loss
  • (c)Both at the time of taking the policy and at the time of loss
  • (d)At neither time, the premium being sufficient

  Answer(c) Both at the time of taking the policy and at the time of loss