Important
of Insurance
Every individual
business faces risks. It could
be the risk of loss and damage to property, vehicles and stock due to fire,
burglary, flood, accident and even theft by its own employees. It could be the
risk of being sued for claims by members of the public, its customers and even
by its own employees due to damages and losses suffered by these people as a
result of its negligence. It could also be the risk of financial loss due to
bad business decisions or unanticipated changes in demand for the business' goods.
In return for a small premium, insurance
underwriters are willing to offer a wide variety of insurance cover (see Types of Insurance) to the ordinary business to protect it against some of these eventualities. Should the insured risk occur, the business will be
indemnified and protected?
It must be
realized, however, that not all risks faced by the business is insurable. Some,
such as loss due to bad business decisions and unanticipated changes in demand,
are non-insurable. The insurance
premiums collected by the various insurance companies in the country forms a
very important pool of liquid funds in
the country. Apart from setting a certain proportion aside to meet the claims of those who do
eventually suffer loss as a result of the insured risk occurring, the rest of
the funds provide an important source
of finance for the development of the national economy which are shown
on the figure on the next page:
(a) Invested in shares in industry and
commerce, at home or abroad;
(b) Lent out to businesses and families for
example to purchase property;
(c) Lent out to central governments and local councils.
Insurance is of
particular importance to the UK. Sale of general and life insurance policies of
British Insurance companies abroad via overseas branches forms a very important
part of her (UK) invisible exports. The repatriation of interest, dividends and
profits from these overseas branches back to the UK also helps in her Balance
of Payments.
Insurance is a pooling of risks to enable people to
share risks. In life, everyone including businessmen, faces risks, resulting in
losses. Any loss due to the insurer's risk materializing will be compensated for out of the common
pool. The amount of compensation will be just enough to indemnify or restore the insured to the position he was in
immediately before the loss. The indemnity will not exceed the amount
originally insured for. The insurance company will have to study the risk
involved for each insurance proposal. It will consider all factors that may
make the insured risk more likely to happen. The basic principle is: The higher the risk, the higher the premium
charged. The premium finally payable by the insured can be calculated
based on:
(a) The insured value of the
property;
(b) The tariff rate or the rate
of premium quoted by the insurance company.
Illustration
After studying the risks involved
for a certain proposal for fire insurance, the insurance company quoted a rate
of 20 cents per $100. Suppose the value of property was $100,000, the total
amount of insurance premium payable would be:
Rate quoted to insure property
against fire 20 cents per $100
Insured value of property
$100,000
Amount of premium payable 0.20 x 100,000 = $200
100
The premium payable ($200 per
year) is so small compared to
the amount of possible compensation payable, i.e. $100,000. 'This is because
the total number of people who face the risk of loss due to fire is very great.
It incorporates all owners of properties in the country. Therefore, the number
of those who are willing to contribute to the central pool is very great.
Consequently, the central pool is very
big even though each insured pay a small premium. But only a small percentage of the total population
who buys fire insurance will eventually suffer a loss. So, it is possible to
pay the few unfortunate from the central pool. It is a case of the fortunate
many (who did not suffer any loss due to fire) who help the unfortunate few
(who did suffer a loss due to fire). This is the whole principle of 'pooling of
risks'.
How
Insurance Company Make Profit?
Insurance underwriters are in
business providing an essential service to the public. In return, they hope to
make a profit for their shareholders. Insurance
underwriters sell insurance cover to their clients in return for insurance premiums. In order to reduce
competition amongst themselves and to introduce stability into the business,
they have introduced uniform practices such
as adopting standard tariffs or rates of premium and standard forms of policy,
especially in fire insurance. The proper
management of funds will ensure that while there is sufficient liquid funds
out of which claims can be promptly paid, the rest of the funds will be
skillfully invested to earn an income in excess of their expenses so that the
insurance company will make a profit.
Insurable
and Non-Insurable Risks
Insurers (i.e. insurance
companies and insurance underwriters) will only undertake to cover anyone
against insurable risks. Insurable
risks are those whose chances of occurring can be mathematically calculated by statisticians and actuaries from
available statistical records. The calculated risk is then used as a basis for
computing the premium to be charged. This must be high enough to ensure that
the insurance company will not run at a loss in the long run, in order to meet
the various claims from the central pool. The insurer is able to cover such a risk
because:
a) A
large number of people who are subjected to the risk, are willing to pool their
risks, by contributing premiums to a central fund;
b)
Only
a small number actually suffers loss;
c)
Claims
in the long run are less than the funds available to meet them.
Examples of
insurable risks are perils at sea, fire, burglary, personal liability, motor accident
and flood. Some risks are non-insurable because it is not possible to calculate
the chances of their occurring as no statistical records of their occurrence
are available. Hence, no insurer can calculate the premium. Examples of
non-insurable risks are war and trade risks like business losses due to bad management,
failure of demand, rise in costs, changes in fashion and bad debt.
Over-Insurance
A man insures
his property which is worth only $10,000 for $12,000. It is NOT to his
advantage to do this because:
(a)
He
has to pay a higher premium than
otherwise necessary.
(b) He can NEVER get
$12,000 even if his property is totally destroyed. The maximum compensation is
only $10,000 since insurance is a contract of indemnity.
(c)
He
should not knowingly over-inflate the value of his property since insurance is
a contract of utmost good faith.
Under-Insurance
A man insures
his property which is worth $10,000 for $8,000. He hopes to save on the
insurance premium since he will be paying a lower premium. However,
under-insurance is also not advantageous to him because:
(a)
His
property is not fully covered. If it is totally destroyed, the maximum
he could get is only $8,000, since premium is only paid for $8,000. If half of
the property is destroyed, the amount he would receive as compensation would be
half of the amount covered (i.e. ½ of $8,000), i.e. $4,000 even though the
replacement value of the property destroyed is 5,000. This is because insurance
is a contract of indemnity.
(b) He should not
knowingly deflate the value of his property since insurance is a contract of utmost good faith.
Principles
and Doctrines of Insurance
These
fundamental principles ensure that the whole basis of insurance — the pooling
of risks — runs properly. The insured would not be able to defraud the insurer
who will in turn be able to fulfill their obligations as contained in the
insurance contract.
1. Insurable Interest: This applies to
all contracts of insurance. We may only insure those things in which we have insurable
interest. To have insurable interest in something is to be in danger of
suffering loss or incurring some personal liability should the thing be
destroyed or damaged in any way or to be able to derive benefits
from its preservation. Examples:
(i)
I cannot insure my neighbor's house and property
since I have no insurable interest in them.
(ii) I can insure my
own –V property, house, life, even my spouse's life or the life of the man who manages
my business as I have insurable interest in these things.
(iii) I can insure my
stock stored in a rented premises against fire although I cannot insure the
premises (building) itself.
(iv) A creditor may
insure the life of his debtor up to the value of the amount owed.
2. Utmost Good Faith: This applies to
all contracts of insurance. The insured must disclose fully all material facts known
in answering all questions in the proposal form and in all dealings with the
insurance company. The insurance company must be informed of factors that are
likely to increase the chances of the insured risk occurring because it will
base the computation of the premium on the truth of the information supplied. Failure
to disclose the whole truth will make the policy void and the insurance company
will refuse to pay compensation should a loss occur. Example: When 1 apply to
insure my premises against fire, it is my duty to inform the insurance company
if my premises contains goods which are inflammable.
3. Indemnity: This Applies to all contracts of
insurance except life assurance and personal accident insurance. To indemnify'
means to restore a person to the position that he was in immediately before the
event concerned took place. Thus, all compensation to the insured who had suffered
a loss would be to indemnify him, and NOT to allow him to make a profit out of
his misfortune. Life assurance and personal accident policies are not contracts
of indemnity because it is not possible to restore the dead to life, or to
restore an amputated leg for instance, to one who has met with an accident. Instead,
a lump sum called the 'benefit' is paid to the beneficiary. Examples:
(i)
A new motor car was insured for $100,000.
After 6 months, it was totally wrecked in a motor accident.
(ii)
The owner would be paid compensation in the form of
a sum of money which will enable him to buy a 6 month-old car of the same make,
that is, depreciation on the car would be considered. If the current market
value of such a car is $85,000, then the owner would get a compensation of $85,000.
This is sufficient to indemnify him.
(iii) Mr X insured his
stock against fire for $3,000. One-third of it was destroyed. Even if the replacement
value of the stock destroyed was $1,100, Mr X, would only receive a
proportionate compensation of $1,000 (1/3 of $3,000) as he had paid premium
based on $3,000. If the replacement cost of the stock destroyed is $900,
then Mr X would be reimbursed $900 even though he had paid a premium based
on the higher figure. If Mr X's stock 5 p was totally destroyed, the maximum
compensation he could get would be only $3,000 even though the replacement
value might be $3,300.
- The First
Corollary of Indemnity — Contribution: This applies to all contracts of insurance
except life risks. Contribution' applies where a person has insured identical risks
on the same property with a number of companies, or when policies overlap. The
amount of the loss is shared proportionately between the insurance companies.
Examples:
Ø Suppose
Mr A insures his goods worth $1,000 against fire for $1,000 each with 3
insurance companies. In the event of a loss due to fire, Mr A would receive a
maximum of $1,000; each of the insurance companies paying $333V3. He cannot
receive $1,000 from each insurance company, or he would be making a profit.
Ø However,
should Mr A insure his life for $100,000 each with three insurance companies,
his next-of-kin can receive $300,000 altogether should he pass away. This is
because life policies are NOT policies of indemnity
- The Second
Corollary of Indemnity — Subrogation: This means that when the insurance
company has paid out the claims, it 'subrogates' or steps into the place of the
insured and inherits all his rights and remedies against third parties. Example:
Ø Mr
A's car was wrecked in an accident. He agreed to accept $4,000 in settlement as
indemnity. The wreck is then sold to a junk yard for $50. Mr A loses all rights
to this amount because the insurance company, after paying him, is now the owner
of the wreck. The $50 therefore goes to the insurance company.
4. The Doctrine of Proximate Cause: This applies to
all insurance contacts. The root cause of the event is known as the proximate cause.
This means that the insured will only be compensated if his loss was caused
directly by the risk he has insured against. If the immediate cause of the loss
was due to risks specifically excluded by the insurance policy, then no claim
can be made. Examples:
(i) I insure my
stock against floods. It is destroyed by flood waters. This is an insured
peril. I am therefore entitled to claim compensation form the loss incurred.
(ii)Suppose the
policy specifically excludes floods because my warehouse is near a big sluggish
river which is very susceptible to over-flooding its banks with every heavy
downpour. If flood is clearly the direct cause of the loss, then no claim can
be made.
(iii)Similarly, Mr B
may take a personal accident policy. One day, while driving, he had an accident.
Because of the shock, he died of a heart attack. The insurance company may not
pay because the root cause of his death was not due to the accident — but a heart
attack.
Effecting
an Insurance Policy
The buyer (or
proposer) may either approach an insurance company direct, or alternatively may
seek the assistance of an insurance agent or an insurance broker. The buyer
will have to complete a standard proposal
form which contains questions or instructions designed to obtain
information regarding the property or the person for which/whom insurance is
sought. All material facts known by the buyer must be disclosed otherwise the
contract of insurance may be declared null and void. Based on the information
given in the proposal form, the insurance company will study the risk involved
and then decide on the premium and the proportion of the risk it is prepared to
absorb. Bad risks will not be accepted by the company. For life assurance policies,
the client may sometimes have to pass a standardized medical examination before
the company accepts him. Normally, a risk is absorbed by a large number of
underwriters. When the whole risk is covered and the premium collected, a cover
note is issued to the
client. This is evidence of an insurance contract. For life policies, no cover
note is issued. Rather, the binding receipt of premium issued by the insurance
company is evidence of the insurance contract. The insurance company then
issues the client with an insurance
policy which is really the legal contract between the insured and the
insurance company.
Procedure
in Making a Claim
For a claim in
an insurance policy to be valid, the insured must follow certain procedures. Failure
to observe the instructions set down by the insurance company will prejudice
the claim. Below is an example of a typical procedure for a marine insurance claim
in the event of loss or damage to cargo. The principles involved are essentially
the same for other types of policy as well.
1. The
insured must inspect the goods before taking delivery if the loss or damage is apparent,
or as soon as the loss or damage is discovered.
2. The
insured must then inform the insurer immediately, and request for a survey of
the goods by the underwriter's agents or the surveyors named in the policy or
insurance certificate. It is important that the condition of the goods and its
packing must not be tampered with until the surveyor arrives. However, the
insured may take steps to ensure that there is no further damage to the goods. In
the case of a claim under other types of policies, say, motor, the insured must
inform the insurance company immediately of the event of the loss. He must also
make a report to the police within 24 hours after the accident. The police will
make an independent report after its investigation as to the probable cause of
the event. The vehicle will have to be towed to a workshop approved by the
insurance company.
3. The
insured must also request ship-owners, other carriers, forwarding agents,
Customs, the Port Authority and other bales to be present for a joint survey.
It is their responsibility to certify any loss or damage to preserve the
insurance companies' rights against third parties. If the latter is found to be
guilty of negligence, the insurance company can then sue them for damage or
loss incurred.
4. Notice
of the loss or damage must be made in writing to the bailees within the time limit
prescribed.
5. Together
with his claim form, the
insured must submit certain documents to substantiate his claim:
(a)
To
prove insurance — original copy of the policy or certificate of insurance
(b) To prove ownership
(i)
bill of lading (for cargo)
(ii) vehicle ownership card (for
motor)
(iii) charter party
(c)
To
prove value
(i) Invoices
(ii) Packing lists
(d) To prove loss/damage
(i) Survey
report
(ii) Landing/general
survey report
(iii) Sales receipt
(e) To enable the insurance company to
make claims on third parties
(i) The police report
Reference:
Betsy, L., & Tan, K. S. (1999). Insurance., Modern certificate guide: Elements
of Commerce (pp.216-223). Singapore: Oxford
University Press.
