Compulsory Insurance

In one line

The State compels insurance where the person who will suffer the loss is not the person who can decide whether to insure against it.

In the wording a student can write in an exam: compulsory insurance is insurance a person is required by statute to take out, on pain of a penalty, and the State compels it in three situations: where the victim of the risk is a stranger who has no say in whether the risk is run, as in motor third party cover; where the activity is hazardous and the potential loss exceeds what the operator could pay, as under the Public Liability Insurance Act, 1991; and where the obligation is owed to a person the law wishes to protect against the obligor's insolvency, as with an employer's gratuity liability under section 57 of the Code on Social Security, 2020.

Why the State compels

Because the person who bears the loss is not the person who chooses the risk. A pedestrian does not choose whether the lorry that hits him is insured. Left to the market, a driver would insure his own vehicle, which is his loss, and not his liability to strangers, which is theirs.

Because the wrongdoer is usually not worth suing. A judgment against an uninsured driver, a small contractor or a bankrupt factory is a piece of paper. Compulsory insurance turns a right into money by putting a solvent defendant behind the liability.

Because the activity's risk exceeds the operator's capital. A chemical plant can destroy a neighbourhood and be worth less than the loss it causes, which is exactly the reasoning of M.C. Mehta v. Union of India, (1987) 1 SCC 395, and the reason the Public Liability Insurance Act, 1991, followed it.

And because a voluntary market fails by adverse selection. The people most likely to cause loss are the most eager to insure and the least able to pay, and the safest drop out first. Compulsion makes the pool universal, which is the same argument that supports social insurance.

The five conditions of a workable compulsion

A duty imposed on a named person, so that it is clear who must insure.

A minimum scope of cover fixed by law, or the duty would be satisfied by a worthless policy. Section 147 of the Motor Vehicles Act, 1988, does this for motor.

A direct route from the victim to the insurer, or the victim's recovery would still depend on the insured's cooperation. Sections 150 and 151 of the Motor Vehicles Act, 1988, and sections 8 and 9 of the Public Liability Insurance Act, 1991, do this.

A closed list of defences, or the insurer would escape on the insured's breaches, of which the victim knew nothing. Section 150(2) of the Motor Vehicles Act, 1988, does this.