The very foundation of the Insurance Industry as a risk-pooling social system is
based on two theories - The Theory of Probability and the Theory of Cooperation.
Insurance law as a branch of law makes optimum usage of the objectives of the
two theories in day to day Insurance Contracts. From cooperation clauses that
promote transparency to evaluation policies that mitigate policy risks, the
practical application of these theories allow insurers i.e. insuring companies
to avoid fraudulent claims and other mala fide acts that go against the
objectives under the IRDAI and other international insurance statutes.
of this paper lies in understanding the theories of probability and cooperation
in general parlance and further understanding the need of the theories in
modern-day insurance contracts. Furthermore, the paper explores the various ways
that the theories are implemented in statutory provisions and whether or not
those provisions are aligned with the legal principles of insurance such as
subrogation, contribution, indemnity, etc.
The detailed analysis of the theories
also assist in recognising the gaps present in the statutory implementation of
the theories and ways in which the gaps can be addressed for creating better
Concept Of Theory Of Probabilty
A statistical strategy for predicting the possibility of a future occurrence is
the theory of probability (also known as probability theory or theoretical
probability). Insurance firms utilise this strategy to create policies and
determine premium rates. The goal of probability theory is to use mathematical
or statistical approaches to identify patterns for the occurrence of different
sorts of events. Data scientists frequently use probability to explain scenarios
where experiments conducted under similar conditions generate diverse outcomes
(as in the case of throwing dice or a coin).
One of the major applications of probability is in clinical trials, which are
used to find novel illness therapies, medications, or surgical treatments. The
clinical study tries to evaluate whether the new treatment is more successful
than the current treatment standard in determining whether a treatment is
regarded a success or failure.
Testing the efficacy of a novel vaccination, such as the poliomyelitis testing
for the Salk vaccine in 1954, which involved nearly two million children, is an
example. The vaccine, which was developed by the United States Public Health
Service, almost eliminated polio as a public health issue in the industrialised
It also has a wide range of applications in the commercial world. Take the
insurance sector, for example, where actuarial data track the life expectancy of
people of a specific age. Rather than predicting what will happen to a single
person, the goal is to capture a collective outcome involving a huge number of
people. In order to develop and price policies, insurance companies employ this
method. When it comes to health insurance, for example, a smoker's coverage will
almost certainly cost more than a non-smoker. Smokers who are habitual or have a
history of smoking have a stronger link to a variety of health concerns,
according to statistical data.
As a result, ensuring a smoker is a larger
financial risk due to their increased likelihood of serious disease and, as a
result, of filing a claim. So, in insurance Actuaries, who are frequently
employed in this sector, use probability, statistics, and other data science
methods to calculate the likelihood of uncertain future occurrences occurring
over time. They then use additional data concepts to calculate how much money
should be set aside to cover potential losses.
Theory Of Probability In Insurance
The theory of probability is a statistical method used to predict the likelihood
of a future outcome as discussed earlier. This method is used by insurance
companies to study statistics to calculate and manage risk as a basis for
crafting a policy or arriving at a premium rate.
Statistics and Probability Theory
Probability theory is an area of mathematics that involves examining enormous
amounts of prior similar events in order to anticipate random events.
Probabilities are the mathematical probability that an event will occur in
statistics. The number of favorable results in a set is divided by the total
number of possible results in the set to get a probability ratio. The
probability ratio expresses the probability of an event occurring. For insurance
companies, this ratio is critical.
When reviewing policy applications, insurance underwriters apply probability
theory. Policyholders who smoke cigarettes, for example, are more likely to
suffer major health problems. According to statistics, this frequently leads to
a rise in health insurance claims. The underwriter can also forecast future
claims based on the applicant's age and geographic area.
Pensions and life Insurance
When calculating mortality rates, the insurer considers the policyholder
lives as well as the socioeconomic aspects that influence his or her current age
and health. Using probability theory to anticipate the number of years a
policyholder will live; this analysis assists the insurer in determining rates
and options for life insurance policies and annuities.
Liability and Property
Property and liability insurance companies utilize probability to analyses
risks. According to statistics, the driver's age and gender play a factor in the
chance of an auto collision. When determining premium rates based on likelihood,
the insurer examines the type of vehicle insured, the driver's geographic
location, and the number of miles travelled on a regular basis.
For example, the
more miles a policyholder drives, the more likely he is to be involved in an
accident. Homeowners insurance rates are also based on likelihood. The type of
heating system in the home, the location and age of the property, and any
additional security features are all taken into account.
Concept Of Theory Of Cooperation
The idea of co operation is a primitive one, existence of humas living a society
has its very basis in the theory of cooperation. Us as individuals in a society
do not have access to all the resources, so due to this lack of resources we
depend on each other. Human have been pooling their limited resources for the
purpose of achieving some kind of common goal since ages. This is essentially
the idea of the theory of cooperation. This theory was suggested by an early
anthropologist Edward B. Taylor and later Claude Lvi- Strauss and Leslie A.
worked on expanding it.
Just like in case mutual funds a pool money is created where several individuals
put money with a common goal earning the dividends and profits, in insurance the
common goal is willingly sharing the losses of an individual. If only one person
is bearing the loss without others sharing it with him then it can not be
strictly recognised as insurance because Insurance is co operative in nature and
its basis lies solely on the concept of cooperation, where a group of
individuals is able and willing to share losses of one of the members of the
group and are willing to co-operate.
Let's understand how this theory actually evolved – Ever since humans started
existing a society till the beginning of the Christian era, every household in a
society used to contribute in a common fund that would be used to pay to persons
facing property losses or to pay for livelihood of people who were dependant on
person who has died. So, they were willing to share the loss of a member of the
group or community.
This concept developed and has become the basis of cooperative societies ,
mutual funds and insurances in the modern times. Today while paying for a
society membership or insurance we just willingly agree to serve a common goal
of a group of individuals by paying a certain amount in advance so that we are
accepted as a member of the group.
When time of loss comes to one particular member in the society the group
guarantees payment of some amount from the pool of funds. This job of collecting
the amount from the individuals became job of the insurers and the basis of
insurance or the driving force behind this industry is the basic concept of
Today insurer bears the accountability and responsibility of obtaining adequate
funds from people in a society so as to cover the risks individuals carry and so
that the members of society pay for the member bearing losses at the occurrence
of the insured event or insured risk. Incentives like premium are in place to
make people join the scheme of insurance and cooperate to share the losses of
each other by paying premium in advance.
Theory Of Cooperation In Insurance
It is often presumed that an insurance contract like any other contract has two
active participants and does not require any third-party assistance. Although
the insurer and insured are the key parties in an insurance contract, their
interdependence to perform the contract is not entirely limited to them. As
described earlier, the theory of cooperation essentially binds an individual's
insurance contract with the society at large.
With the base motto of "All for
one and one for all", theory of cooperation in its current application can be
described as a mutual agreement between the insurer and the society, the insurer
has to obtain adequate funds from the members of the society and pay them back
from the collected funds at the occurrence of the insured risk. Insurance being
a cooperative device requires all insurance contracts to be based on an
interdependent model. Practical applications of this theory can be found in any
Now, if we shift the onus from society at large to just an
individual policyholder, the theory of cooperation between the insured and the
insurer can be found in the cooperation clause of the insurance contract.
The Cooperation clause or the 'Assistance and Cooperation Provision' refers to a
passage in an insurance contract that requires the policy-holder to assist the
insurer in case there is a claim. In case the insured risk takes place, the
insurer makes sure that the hazard that has taken place is aligned with the
insured risk and is covered under the policy.
The steps for doing that includes
investigation and assessing information of the incident. In case the incident
is prima facie unclear and the claim's validity is uncertain, policyholders tend
to skip out on a lot of details to avoid missing out on a chance to make a
profit. In other cases, if the policy-holder is at default, they might hide
actual details of the incident. In order to avoid these scenarios, the
cooperation clause acts as a legal asset that compels a policy holder to
disclose detailed information about the incident and mandates that the
information is correct.
Breach of Cooperation clause
In case the insured policy-holder does not disclose correct information the
insurer that will help to validate the claim, the insurer may not grant the
compensation claimed by the policyholder. In addition to that, if a court finds
out that the policyholder is not complying with the cooperation clause, it may
permit the insurance company to file a case against the policyholder for breach
of contract. Additional Court-related costs can also be imposed on the
policy-holder for the lack of transparency.
Theory of cooperation and the principle of Indemnity
The cooperation clause also helps in upholding the legal principle of indemnity
in contract in insurance. The principle lays down that in order for a claim to
be upheld, there must be an actual loss, the loss should have occurred through
the risk insured, and the loss must be capable of calculation in terms of money.
Furthermore, the principles lay down the following purposes,
The first purpose is to prevent the insured from profiting from a loss.
The second purpose is to reduce moral hazard.
Therefore, by ensuring that the policy-holder is transparent with the details of
the incident, the policy-holder fulfils objectives laid down by the theory of
cooperation and the legal principle of indemnity.
Insurance has been around for ages in some shape or another. Insurance, in its
broadest sense, is a method of risk transferring and risk spreading across
individuals. When prehistoric tribes pursued dangerous creatures in groups or
shared valuables among multiple members. These cooperative companies also sought
to disperse the risk by bringing together members for safekeeping to reduce the
risk of damage or loss within the tribe, and to shift the risk of loss from the
individual to the tribe the collective.
The theories of probability and theory
of cooperation have existed in the society ever since and developed in ways
forming the essential principles behind the existence of insurance industry.
Various cases have made these principles even stronger and undeniably important.
- Biniam G , Bonga University, Department of Management, "Legal Principle
of Insurance Contract'', Chapter IV.
- Shanuja Thakur
- Shivangi Banerjee