What is Liability Insurance? – How it Works, History, Features Principles and Types

Liability Insurance is a class of Insurance which provides coverage to the Insured Party for against claims arising from Bodily Injury or Property Damage or for Financial Losses suffered by Third Parties on account of negligence, errors or omissions or breach of duty by the Insured Party.

A Liability Insurance Policy provides cover for legal costs and damages that the Insured Party becomes legally liable to pay on account of lawsuits filed against the Insured.

Liability Insurance is also known as Third-Party Insurance because Liability Insurance Policies pay Third Parties and not the Policyholder.

What is the need for Liability Insurance?

There are many circumstances and scenarios in conducting everyday situations where Bodily Injury, Property Damage or Financial Losses suffered by third parties due to negligence of a company or their personnel. Even if there is no explicit intention of doing harm, losses are suffered by third parties and they may sue the company as a result.

Defending against such lawsuits entails substantial legal expenses and in case of an adverse ruling, the Company may also need to pay damages and settlement costs to the affected party.

Thus, it is recommended that businesses purchase adequate Liability Insurance Coverage to protect themselves against various risks they are exposed to, for which they may be held liable for.

How does a Liability Insurance Policy Work?

Any business or professional which can be sued as a result of its operations, services, employment practices should purchase a Liability Insurance Policy. Liability Insurance Policies protect the Insured against legal claims made by Third Parties. The Insurance Policy gets triggered when there is a lawsuit filed against the Insured for a Bodily Injury or Property Damage or if there is a Claim alleging a Wrongful Act. The Liability Insurance Policy will pay for the defence costs and the compensatory damages to defend the lawsuit.

For Example: A Commercial General Liability Insurance Policy will protect the Insured against Claims alleging Bodily Injury or Property Damage caused within the business premises while a D&O Liability Insurance Policy will protect against claims alleging Wrongful Acts by the Directors and Officers of the Company in their Managerial Capacity.

History of Liability Insurance

Liability Insurance Policies were first issued in the UK in 1875 when a Public Liability Insurance Policy was issued to cover liabilities to Third Parties arising from the use of horse driven vehicles. By 1876, Boiler Policies issued by the engineering department included a clause for indemnity for damage to surrounding property.

Employers’ Liability Insurance originated as a result of Employer’s Liability Act, 1880 and Workmen’s Compensation Act 1897. Both these Acts held the Employer liable for accidents suffered by employees in the course of their Work.

The passing of the Employers Liability Act 1880 created a demand for Public Liability Insurance Policies as Employers held potential liabilities towards Third Parties as well. As a result, various General Liability Insurance Policies came into effect. The Origin of Product Liability Insurance Policy can be traced to the period when Public Liability Insurance Policies were extended to cover Foods and Beverage Risks for Hotels and Dermatitis Risks in respect of Fur and Woollen Clothing.

There was a steady increase in Common Law Claims against the employers which necessitated the need for compulsory Insurance. The Employers’ Liability (Compulsory Insurance) Act, 1969 became operative from 1^st Jan, 1979 and this Act mandated employers to take Insurance Coverage against liability for Bodily Injury or Disease sustained by employees in the course of their employment. The Act further provided that a fixed amount of insurance coverage can be taken for claims relating to any one or more of the employees arising out of any one occurrence.

History of Liability Insurance in India

In India, the passing of the Workmen’s Compensation Act 1923 contributed to the need for a Workmen’s Compensation Insurance Policy while the passing of Motor Vehicles Act necessitated the need for Third Party Liability Insurance in Motor Insurance on a compulsory basis. The Bhopal Gas Tragedy of 1984 led to an increased demand for Public Liability Insurance due to increased public awareness of legal rights and remedies.

Other Acts such as Public Liability Insurance Act, 1991 and Consumer Protection Act, 2019 also contributed to the growth of Liability Insurance in India.

Features of Liability Insurance

The important features of Liability Insurance Policies are as follows:

1. A Liability Insurance Policy provides indemnity to the Insured against the potential legal liability ie liability arising under statutory law or common law
2. A Liability Insurance Policy provides coverage for Legal Costs and Compensatory Damages that the Insured Party becomes legally liable to pay in the event of a claim alleging Bodily Injury or Property Damage or Wrongful Act.
3. Liability Insurance pay claims to the Third Parties on behalf of the Insured
4. The Territory and Jurisdiction Cover can be extended to provide worldwide coverage under Liability Insurance Policies.

Principles of Liability Insurance

Liability Insurance is also subject to similar principles as other lines of insurance. The Principles of Liability Insurance are listed below:

Principle of Insurable Interest in Liability Insurance

The 3 essentials of Insurable Interest are as follows:

1. The existence of a potential legal liability which is capable of being insured;
2. The potential liability must be subject of insurance
3. The Insured must bear a legal relationship to the Subject Matter whereby he will benefit on freedom of liability and will lose financially on creation of liability.

The Insured has an Insurable Interest due to the financial loss that may be caused to him due to the legal liability. The Insured Person would be liable for legal costs and compensatory damages in case of a legal liability.

Principle of Indemnity in Liability Insurance

The Principle of Indemnity in Liability Insurance provides that an Insured can recover his financial loss only to the extent of his Insurable Interest. This Principle provides that the Insured should not profit from his Insurance Policy. The object of this principle is to put the Insured in the same position after the loss that he was in before the loss. In case of Liability Insurance, if the Insured is legally liable to pay damages to Third-Parties, a Liability Insurance Policy will indemnify the Insured to the extent of Legal Costs, Expenses and Compensatory Damages incurred with the consent of the Insurance Company.

Principle of Subrogation in Liability Insurance

Principle of Subrogation in Liability Insurance is same as Principle of Subrogation in normal Insurance. Under the Principle of Subrogation, all rights of recovery that the Insured has against the Third Party, these rights stand transferred to Insurance Company, if the Insurance Company has paid the Claim. The Insurance Company is entitled to exercise these rights and recover the loss from the Third Party.

Principle of Contribution in Liability Insurance

The Principle of Contribution comes into the picture if the Insured has 2 or more Policies covering the same subject matter. The Principle of Contribution gives the Insurance Company the right to recover a proportionate amount of loss from the other Insurance Companies which have also insured the same subject-matter. Thus, in case of a Claim where 2 or more Insurance Policies have insured the same subject-matter, the Insured will recover his entire loss from one Insurance Company and that Insurance Company will then recover proportionate share of loss from the other Insurers.

Principle of Utmost Good Faith in Liability Insurance

Insurance Contracts are based on mutual trust and Common Law Principle of Utmost Good Faith. As per the Principle of Utmost Good Faith, the Insured is legally obliged to disclose all material facts about the risk and subject-matter to the Insurance Company. Material Information means all facts which can influence the decision of the Insurance Company to accept or reject the Proposal. In case, the Insured hides, suppresses or tweaks the material facts, the Insurance Policy can be null and void.

Types of Liability Insurance Policies

1. Commercial General Liability Insurance Policy: A CGL Insurance Policy provides coverage to the Insured for legal costs and compensatory damages for claims of Bodily Injury and Property Damage within business premises or because of using the Insured’s Products. A Commercial General Liability Insurance Policy is very useful for business establishments like hotels, cinemas, schools etc.
2. Product Liability Insurance Policy: A Product Liability Insurance Policy provides coverage to the Insured for legal costs and compensatory damages for claims of Bodily Injury and Property Damage that arise because of using the Insured’s Products. A Product General Liability Insurance Policy is very useful for automobile and auto component companies, pharma companies and food manufacturers.
3. Public Liability Insurance Policy: A Public Liability Insurance Policy provides coverage to the Insured for legal costs and compensatory damages for claims of Bodily Injury and Property Damage for accidents that happen within the Insured’s business premises or because Insured’s business operations. A Public Liability Insurance Policy is very useful for factories and manufacturing establishments.
4. Directors and Officers Liability Insurance Policy: A D&O Liability Insurance Policy protects the Insured against claims of Wrongful Acts committed by the Directors and Officers in their Managerial Capacity. A D&O Insurance Policy is a must for all companies, from start-ups to large organisations.
5. Cyber Liability Insurance Policy: A Cyber Liability Insurance Policy protects the Insured Party from financial losses incurred and third-party liability following a Cyberattack or a Breach of a Company’s Network Systems.
6. Workmen’s Compensation Insurance Policy: A Workers’ Compensation Insurance Policy covers the legal liability of the employer to pay compensation to the employee or their family members in case of accidental death or disablement of the employee in the course of their employment.
7. Professional Indemnity Insurance Policy: A Professional Indemnity Insurance Policy provides coverage to Professionals like Doctors, Lawyers, Architects against claims alleging breach of duty, negligence, errors or omissions in conduct of their Professional Duty.

Conclusion

Liability Insurance Policies are crucial in protecting businesses from potential financial losses due to risk exposures for which they may be held liable. It provides coverage for legal Costs and Compensatory Damages, ensuring that policyholders are financially secure and can focus on their core activities.

Businesses can mitigate their risk exposures by choosing the appropriate Liability Insurance Policy with the assistance of an experienced Insurance Broker. Qian is a licensed Liability Insurance Broker with experience of serving various clients over the years. If you wish to purchase any type of Liability Insurance Policy, you can email us at insurance@qian.co.in or call us on 022-22044989. We would be glad to assist you.