IMPORTANCE OF INSURANCE

1. 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.
2. In return for a small premium, insurance underwriters are willing to offer a
wide variety of insurance cover to the ordinary business to protect it against
some of these eventualities. Should the insured risk occur, the business will
be indemnified and protected.
3. 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.
4. 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.
NATURE OF INSURANCE: POOLING OF RISKS
Insurance is a pooling of risks to enable people to share risks. In life,
everyone including businessmen, faces risks, resulting in losses.
1. Those who wish to insure against loss in the event of a risk materializing,
will contribute periodical payments called premiums to a central pool which
is managed by an insurance
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company. The individual premium is small relative to the amount insured.

2. 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.
3. 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 charges.
4. 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
Amer 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

5. 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
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did suffer a loss due to fire). This is the whole principle of 'pooling of risks'.
INSURABLE AND NON-INSURABLE RISKS
1. Insurers (i.e. insurance companies and insurance underwriters) will only
undertake to cover anyone against insurable risks.
2. Insurable risks are those whose chances of occurring can be
mathematically calculated by statisticians and actuaries from available
statistical records.
3. 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.
4. 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
5. Examples of insurable risks are perils at sea, fire, burglary, personal
liability, motor accident and flood.
6. 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.
7. 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.
8. Examples of some risks involved in dispatch of goods by the foreign
traders through airways and seaways, risks involved with cargo can assist
foreign traders.
PRINCIPLES OF INSURANCE:
1. Utmost Good Faith
When an insurance policy is to be taken, the applicant must fill in a proposal
form, answering all the questions it contains, truthfully. This will form part of
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a legal contract between the applicant and the insurance company. The
contract will become invalid if the applicant hides any information, which
comes to light later. The company likewise must have good faith in its
clients by explaining all the terms of the insurance policy.
2. Insurable Interest
Insurance policies can be taken only if the applicant is to suffer directly from
the loss or liability. For example, if the applicants car were stolen he would
suffer a loss and so can insure his car. But if the applicants neighbours car
were stolen, the applicant will not suffer a loss and so cannot insure his
neighbours car.
3. Indemnity
The aim of the insurance company is to restore the insured to the position
he was in before the loss had occurred. The principle of indemnity prevents
the insured from making any loss or profit out of the accident. For example,
if the insureds 6 year old car is damaged, the insurance company will give
the insured money to buy another 6 year old car.
-

Rule of Subrogation: Sometimes the insured can make a

profit by selling the damaged car after receiving compensation.
This is ruled out by the rule of subrogation, which states that
the insurance company will become the owner of the damaged
car after paying compensation.

Rule of Contribution: Sometimes the insured may insure the

car with two companies and claim from both. This is ruled out
by the rule of contribution, which states that each company will
pay a certain proportion, so that no profit is made by the
insured.

4. Proximate Cause
The root cause of the event is known as the proximate cause. The
insurance company will first determine if the root cause is within the terms
of the policy and then make a payment. For example, a person might insure
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himself against death by accident when flying, but if he dies of a heart

attack, the insurance company is not required to make any payment.
Effecting insurance cover
When an individual or a business wishes to take out an insurance cover the
following are the procedures:
1. Should first contact the insurance brokers and tell about the proposal
2. The insurance brokers make a slip and forward it to the underwriters
3. The underwriters scrutinize the slip and express their willingness to
undertake the risks
4. Then the brokers give the proposal form to the person who wants to take
insurance cover
5. The individuals or the businesses should furnish all the true information
along with the necessary supporting documents with duly filled proposal
form and forward it back to the brokers
6. Sometimes the brokers themselves assist the individual and the business
in the process of documentation
7. After a thorough inspecting of the proposal form the underwriters ask the
insured to pay the first premium
8. The underwriters prepare a provisional certificate confirming that the risk
has duly been undertaken by the insurance company. The provisional
certificate is known as cover note.
MAIN DOCUMENTS
Proposal Form
This is the application form, which has to be filled in by a person wishing to
take out insurance. All details about the person and the risks to be covered
have to be filled in truthfully in the proposal form.
The key information in a standard proposal form are as follows:
1. The name and address of the insurance company
2. A clear statement of the type insurance cover offered by the
insurance company, including any 'extensions' to the policy
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3. Questions designed to elicit facts concerning:

(i) the proposed assured or the property to be insured
(ii) the nature of the risk
(iii) the circumstances affecting the risk
(iv) the insurance record of the proposed assured
The proposer has to answer all these questions TRUTHFULLY.
4. A statement of declaration by the proposer that all the statements
contained in the proposal form are true and correct and that he has not
concealed, misrepresented or mis-stated any material fact.
5. The signature of the proposer
6. The date the proposal is signed
The functions of the proposal form are as follows:
(a) An application form for insurance coverage by the proposer (customer).
It is not a contract of insurance. It is an offer from the proposer to the
insurance company to buy insurance coverage.
(b) The facts disclosed in the proposal form helps the underwriter to study
the risk so that he can decide on:
(i) whether or not to accept to give insurance coverage to the
proposer. After studying all the information given, the insurance
company may consider him a bad risk and refuse to accept the
proposal.
(ii) the amount of premium to be charged.
(c) The proposer will also know:
(i) exactly what type of cover he would get should he suffer a loss
(ii) the instances when he would not be covered. (the exclusion
clause)
(iii) his own liability in the event of a loss (such as the "excess" clause
in motor insurance policy)
(d) The proposal form provides documentary proof of what the proposer has
disclosed about the property/person insured. If it is subsequently proven
that what is written there is not true, then the insurance company can refuse
to pay when a claim for loss is made. This is because the insurance
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contract is based on utmost good faith'. It can be declared null and void if
one of the parties is not acting in 'good faith', that is, he has lied or
misrepresented or concealed the material facts.
Cover Note
Sometimes while the policy is being prepared, the company will confirm that
the risks have been accepted, by issuing a temporary document called the
cover note.
The key information in a cover note are as follows:
1. The name and address of the Insurance company
2. The insurance policy number
3. The cover note number (it is called a certificate of insurance for a
motor policy)
4. The name and address of the policy holder, including his identity
card number
5. Details concerning the property insured (in the case of motor policy:
vehicle registration number, its make and model; the year of manufacture;
the engine number; the chassis number; its cubic capacity and estimated
value)
6. The period of cover
7. Any limitations as to the use of the property (in the case of a motor
policy, it will be clearly stated that the vehicle is only for social domestic or
pleasure use only. Cover will not be given if the vehicle is used for other
purposes such as for business, racing, etc.)
8. Any other conditions as set by the insurance company (in the case of
a motor policy, the person (s) who are allowed to drive the vehicle will be
clearly spelt out)
9. The signature of the General Manager of the insurance company
10. The amount of premium paid

The functions of a cover note are as follows:

(a) The evidence of an insurance contract between the proposer and the
insurance company.
(b) A temporary cover for a limited period, until such time as the insurance
company can prepare and issue the insurance policy to the insured. The
insurance company then issues the client with an insurance policy which is
really the legal contract between the insured and the insurance company.
Policy
This is a contract of insurance between the insurance company and the
insured. Once the risk has been accepted and the premium paid, the
company will issue a policy. It sets out the terms and conditions of the
insurance.
The key information in an insurance policy are as follows:
1. The name of the insurance company
2. The policy number
3. The name and address of the insured
4. The extent of the insurer's obligation and the types of losses that are
covered under the policy and the period of the cover
5. Details of the property insured
6. The premiums to be paid
7. The signature of an officer who signs on behalf of the insurance
company
8. The procedure to be taken in the event of a claim and the method of
adjusting estimated premiums
9. Clear statements of the 'exclusions' or instances when the insurance
company will NOT pay compensation
The functions of an insurance policy are as follows:
(a) A written agreement or actual legal contract between the proposer and
the insurer.
(b) The original copy of the Insurance Policy has to be submitted when
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making a claim on the insurance company.

BROKERS
A member of the public can obtain insurance only through the brokers,
whose job is to find the best possible policy for their clients. The broker first
notes down the details of the cover required by the client. Next he finds
underwriters, who are willing to accept the risks. The first underwriter to
accept fixes the premium. The broker then contacts the other underwriters,
who accept part of the risk. The other underwriters accept the same
premium fixed by the first underwriter. Once all the risks are covered, the
policy is prepared and taken to Lloyds Policy Signing Office, where it is
checked and signed by the members of the appropriate syndicate. The
broker, who collects his commission after the premium is paid, then gives it
to the client.
PREMIUM
This is the amount paid by the insured on a periodical basis to cover
the risk insured. It may be on a weekly, quarterly, half-yearly or annual
basis. Before fixing the premium some factors have to be taken into
account and calculated. The experts who calculate the premium are called
actuaries. It is essential that the actuaries do their calculations correctly so
that the insurance company does not run out of money through excessive
claims.
Factors affecting premium:
The following are factors taken into account before fixing the premium for a
building:

The age of the building: If the building is old, the chances of

damage are high and so the premium will be high. But if the building
is new, the chances of damage are less and so the premium will be
low.

Type of building: If the building is strong, the chances of damage

are less and so the premium will be low. But if the building is weak or
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made of glass, the chances of damage are high and so the premium
will be high.

Value of the building: If the building is made of expensive material

or has historical value, the premium will be high. But if it is an
ordinary building, the premium will be low.

Cost of repairs: If the cost of repairs of the building is high, the

premium will be high and if the cost of repairs is low, the premium will
be low.

Location of the building: If the building is near an oil or sulphur

factory, the chances of accident are high and so the premium will be
high. But if the building is in a safe area, the chances of accident are
less and so the premium will be low.

Contents of the building: If the building has highly inflammable

contents, the chances of accident are high and so the premium will
be high. But if the building has non-inflammable contents, the
chances of accident are less and so the premium will be low.

Recent claims record: If the owner has already claimed money from
the insurance company, the chances of him claiming again will be
high and so the premium will be high. If the owner has never claimed,
the premium will be low.

Building record: If the building has a record of many accidents, the

premium will be high. If the building has a good record, the premium
will be low.

Precautionary methods: If the building has precautionary measures

like fire sprinklers, alarms, etc, the premium will be low. But if it has
no such precautionary measures, the premium will be high.

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PREMIUM CALCULATION:
The following information is extracted from an insurance company:
Number of motorcycles

12000

Compensation for each accident

8000

Percentage of accidents

4.5%

You are required to calculate the quarterly premium for each motorcycle.
Number of accidents

= 12000 x 4.5
100
= 540 motorcycles

Total compensation

= 540 x 8000
= 4320000

Annual premium for one motorcycle = 4320000

12000
= 360 p.a.
Quarterly premium

= 360 x
= 90.

CLAIM FORM
When the insured incurs a capital loss, he is entitled to claim compensation
from the insurance company. A claim form must be filled when the insured
is claiming compensation. This form facilitates accurate compensation from
the insurance company.

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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.
Note: 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 bailees 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:
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(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

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