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PART II
INSURNANCE

C H A P T E R I I I- I N S U R A N C E: A N O V E R V I E W

3.1. THE NATURE AND FUNCTIONS OF INSURANCE

INTRODUCTION:
It is probably impossible to completely avoid risk, but there are things people can do to reduce the risk that they face.
For example, they can save money or other assets in order to have a cushion when their incomes decline. This is
called self-insurance. They can also make formal or informal insurance arrangements with other people that reduce
risk.

The prime responsibility for the sound and prudent management of an insurer rests with the board of the insurer.
Since insurance is a risk taking activity, insurers should evaluate and manage the risks that they underwrite and have
the tools to establish an adequate level of premiums. An insurer’s systems and practices relating to insurance activity
may differ depending on the size and complexity of the insurer and the nature of the insurer’s risk exposures.

Insurance: why it is interesting:

Because one recurring legal issue is who will bear the costs if something goes wrong--i.e. who is insuring whom.
For example:

ƒ Contracts. Something changes, so either I don't want to produce what I agreed to or you
don't want to buy it. Who bears the costs resulting from such problems?
ƒ Auto accidents: Who pays for them?
ƒ Product defects and the associated costs. When a coke bottle explodes, injuring someone, is
Coca Cola liable for the resulting medical costs?
ƒ Wider political issues of welfare, unemployment insurance, health insurance, etc.

Insurance Activities
-Underwriting is the process by which an insurer determines whether and under what conditions to accept a risk.
Weaknesses in the controls and systems surrounding the underwriting process can expose an insurer to the risk of
unexpected losses which may threaten the capital position of the insurer.

-Insurers use actuarial, statistical, or financial methods for estimating liabilities and determining premiums. If these
amounts are materially underestimated, the consequences for the insurer can be significant and in some cases fatal.
In particular, premiums charged could be inadequate to cover the risk and costs, insurers may pursue lines of
business that are not profitable, and liabilities may be underestimated, masking the true financial state of the insurer.

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Underwriting policy
¾ Insurers manage the risks they take on through a range of techniques including pooling and diversification.
Every insurer should have in place strategic underwriting policies (underwriting guidelines) approved and
reviewed regularly by the board of directors.

¾ It is important that the board of directors and management of an insurer recognize that they have the prime
responsibility for the sound and prudent management of an insurer’s underwriting strategy.

¾ Insurers should evaluate the risks that they underwrite, and establish and maintain an adequate level of
premiums. Insurers should also have systems in place to control their expenses related to premiums and
claims, including claims handling and administration expenses. Management on an on-going basis should
monitor these expenses.

¾ Insurers should establish premiums based on reasonable assumptions to enable the insurer to meet its
commitments.
¾ Insurers may be involved in derivative activities in connection with their insurance activities or through the
transformation of the exposure into a derivative. An insurer should ensure that all derivatives underwritten,
including embedded options in life insurance products, have been properly identified and properly priced.

How insurance works

Insurance is an agreement where, for a stipulated payment called the premium, one party (the insurer) agrees to pay
to the other (the policyholder or his designated beneficiary) a defined amount (the claim payment or benefit) upon the
occurrence of a specific loss. This defined claim payment amount can be a fixed amount or can reimburse all or a part
of the loss that occurred. The insurer considers the losses expected for the insurance pool and the potential for
variation in order to charge premiums that, in total, will be sufficient to cover all of the projected claim payments for
the insurance pool. The premium charged to each of the pool participants is that participant’s share of the total
premium for the pool. Each premium may be adjusted to reflect any special characteristics of the particular policy.

Normally, only a small percentage of policyholders suffer losses. Their losses are paid out of the premiums collected
from the pool of policyholders. Thus, the entire pool compensates the unfortunate few. Each policyholder exchanges
an unknown loss for the payment of a known premium.

Under the formal arrangement, the party agreeing to make the claim payments is the insurance company or the
insurer. The pool participant is the policyholder. The payments that the policyholder makes to the insurer are
premiums. The insurance contract is the policy. The risk of any unanticipated losses is transferred from the
policyholder to the insurer who has the right to specify the rules and conditions for participating in the insurance pool.

The insurer may restrict the particular kinds of losses covered. For example, a peril is a potential cause of a loss.
Perils may include fires, hurricanes, theft, and heart attack. The insurance policy may define specific perils that are
covered, or it may cover all perils with certain named exclusions (for example, loss as a result of war or loss of life
due to suicide).
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Hazards are conditions that increase the probability or expected magnitude of a loss.

In summary, an insurance contract covers a policyholder for economic loss caused by a peril named in the policy. The
policyholder pays a known premium to have the insurer guarantee payment for the unknown loss. In this manner, the
policyholder transfers the economic risk to the insurance company. Risk is the variation in potential economic
outcomes. It is measured by the variation between possible outcomes and the expected outcome: the greater the
standard deviation, the greater the risk.

¾ Insurance is one of the basic tools of risk management.

Two fundamental characteristics of insurance are:
(a) Transferring or shifting risk from an individual to a group.
(b) Sharing losses, on some equitable basis, by all members of the group.

Illustration:
Assume that there are 1000 houses in a given community and the value of each house is birr 10,000. If a fire should
break out, a financial loss of up to birr 10,000 could result. The probability that one house may catch on fire is
1
= 0.001 .
1000

Assume that if the house is a total loss each of the 1,000 owners will pay birr 10 and the owner of the destroyed
house will be indemnified for the birr 10,000 loss. Through the agreement to share the losses, the economic burden
these impose is spread throughout the group. This is essentially the way insurance works, for what we have
described is a pure assessment of mutual insurance operation.

Insurance plays an extremely important part in insuring the economic well being of the country, but it does not have a
high profile and therefore many people have little idea of the full role it plays. For many, knowledge of insurance is
limited to their own personal house, motor or life insurance. These forms of domestic insurances are all important, but
are a relatively small part of the overall activity within the insurance industry.

INSURANCE DEFINED

Insurance can be defined in several ways and probably no one brief definition does autistic to its many new features.
It may be defined from economic, legal, business, social and mathematical point of views.

i. Economic point of view

- Insurance is a mechanism of providing certainty or predictability of loss with regard to pure risk.
i.e: Insurance is an economic system for reducing uncertainty of loss through pooling of losses together.
a. Insurance is a pooling device
b. Aiming in reducing uncertainty in pure risks. i.e. providing peace of mind to the individual and society.

ii. Legal point of view

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- It is a contract involving two parties, the insured and the insurer, where the insured is responsible to pay the
price (premium) for obtaining the security and the insurer will protect the risk (or will assume the risk
transferred).

iii.Business point of view:

- Insurance is defined as a cooperative device to spread the loss caused by a particular risk over a number of
persons who are exposed to and who agree to ensure themselves against that risk. The function of insurance
is to spread the loss over a large number of persons who agreed to cooperate each other at the time of loss.
i.e:
a. It is a plan in large No of people in association,
b. Transfer loss over a large No of persons,
c. Each individual will pay the premium,

¾ Insurance is not a charity organization, but a profit oriented organization / business oriented organization.

iv.Social point of view

- Insurance is defined as a device to accumulate funds to manage uncertain losses of capital, which is carried
at through the transfer of the risk of many individual to one person or, to a group of persons.

v. Mathematical point of view:

- Insurance is the application of certain actuarial principles (insurance mathematics). Law of probability and
statistical techniques are used to achieve predictability.

SUMMARY OF INSURANCE DEFINITION:

Insurance is an economic system for reducing uncertainty of loss through pooling of losses together,
Insurance is a legal method of transferring risk from the insured to the insurer in a contract of indemnity,
Insurance is a business undertaking for profit that provides many jobs in a free enterprise economy,
Insurance is a social device, in which the loss of few is covered by the contribution of many,
Insurance is an actuarial system of applied mathematics.

ADVANTAGE OF INSURANCE:
- Indemnification
- Use fund for investment
- Aids to small business
- Creates peace of mind
- Keep families and business together
- Increases marginal utility of assets
- Provides a base for credit
- Stimulates savings

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LIMITATION OF INSURANCE:
- Limited to pure risks
- Non-insurable pure risks have no insurance coverage
Basically, insurance is a device used to deal with pure risks only .Even then, not all pure risks are insurable. A clear
example is fundamental risks such as flood, earthquake, etc…Such risks are normally tackled by the society. Also,
speculative risks are not insurable. It is, therefore, clear that insurance doesn’t provide protection against a wide
range of risks. Generally, insurable risks have to exhibit the following characteristics:

- There must be a sufficient number of risks of similar class being insured so as to produce an average of loss
experience.
- It must be possible to calculate the chance of loss.
- The occurrence of the loss must be fortuitous.
- There must be an insurable interest to protect.
- The possible loss must not be catastrophic

PLANNING INSURANCE ACQUISITION

Insurance is a risk-financing tool used to transfer insurable risk of the exposed party (the insured for example) to the
insurer upon payment of the required price (premium). An insurance contract is a one-sided contract. It is the
insurer that formulates the policy provisions, conditions and exception. The insured is not consulted in the drafting of
the policy. Moreover, the insured will have to fulfill his obligation (payment of premium) in advance while the fulfillment
of obligation by the insurer (payment of claims) is conditional. i.e.: claim is paid only upon the occurrence of the
specified risk subject to policy terms and conditions.

Insurance policy provisions and conditions could be confusing to ordinary people due to the technicality of the
wording used. Lots of intricacies are involved in premium determination, claim settlement, etc. Consequently, to
secure the full advantage of an insurance policy, the risk (insurance) manager must be fully familiar with and
knowledgeable about the nature of insurance contracts and the respective policy provisions, conditions and
exceptions.

The risk (insurance) manager must realize that not all types of risks are amenable to insurance. In planning the
purchase of insurance policies, the risk manager as a first step may make a general classification of risks into
INSURABLE and NON-INSURABLE risks.

RISKS

INSURABLE RISKS NON-INSURABLE RISKS

-Can be handled by -Tot be handled by
Insurance other tools

Exercise
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Is it logical to say that purchasing insurance is just a waste of money unless a loss occurs and indemnity is received?

The primary function of insurance is the creation of counter part of risk, which is security. Insurance does not
decrease the uncertainty for the individual as to whether or not the event will occur, nor does it alter the probability of
financial loss connected with the event. From the individual’s point of view, the purchase of an adequate amount of
insurance on a house eliminates the uncertainty regarding financial loss in the event that the house should burn
down. i.e: Insurance: - Provides peace of mind to individuals and society.
- Provides feel of security.

3.2. INSURANCE, GAMBLING AND SPECULATION

3.2.1. INSURANCE AND GAMBLING
The purchase of insurance is sometimes confused with gambling.
Both insurance and gambling have one character in common. i.e. Both the insured and the gambler may collect more
dollars than they pay out, the outcome being determined by some chance event (or when they earn more money by
chance).

The difference between insurance and gambling can be illustrated as follows:

i. The man who gambles creates a risk, which did not exist previously where as the man who purchases
insurance minimizes a risk which was already in being and which is not in his power to avoid.
i.e.: Gambling creates new risk where none existed before where as purchasing insurance minimizes a risk which
was already in being.
ii. The gambler with hope of gain goes out his way to bring a risk into being while the man, who insures for the
purpose of avoiding loss, goes out of his way to hedge against a risk which already exists.
iii. The man who gambles accepts deliberately the risk of loss in exchange for the possibility of profit: the man
who insures accepts deliberately the certainty of a small loss in exchange for the freedom from risk of
devastating catastrophic loss.
iv. The gambler bears the risk while the insured transfers the risk.

3.2.2. INSURANCE AND SPECULATION

Speculation is a transaction under which one party, for a consideration, agrees to assume certain risks, usually in
connection with a business venture. Every business accepts the possibility of losing money in order to make money.

Speculation on the other hand involves doing some kind of activity with the expectation of profit in the future. For
instances, a businessman who purchases and sells goods, stocks and shares, etc. with the risk of loss and hope of
profit through changes in their market value in a clear case of speculation. Through speculation individuals create a
risk deliberately in the anticipation of profits. However, an insurance transaction normally involves the transfer of risks
that are insurable, since the requirements of an insurable risk generally can be met. On the contrary, speculation is a
technique for handling risks that are typically uninsurable, such as protections against a substantial decline in the
price of agricultural products and draw material.

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Note: Charity is given without consideration, but insurance is not possible without premium. Insurance is a profession
of providing certainty and predictability and safety to the individuals, business or society. It provides adequate finance
at the time of damage only by charging a normal premium for the service.

3.3. REQUISITES OF INSURABLE RISKS

Unfortunately not all risks are insurable. Insurers are not willing to accept all the risks that others may wish to transfer
to them. To be considered a proper subject for insurance, there are certain characteristics that should be present.

Those requirements should not be considered absolute, as iron rules, but rather as guides.
1. There must be a sufficiently large number of homogenous exposure units to make the losses reasonably
predictable.
- Insurance is based on the operation of the law of large numbers.
- There must be a large No of exposures and those exposures must be homogenous. Unless we are
able to calculate the probability of loss, we cannot have a financially sound program.

2. The loss produced by the risk must be definite and measurable.

- The loss must have financial measurement or financial implication.
Example: For instance a person may purchase disability insurance. How do we know that the person
is unable do? Thus, the risk must be definite and measurable.

3. The loss must be fortuitous or accidental.

i.e. the loss must be the result of a contingency, i.e., it must be something that may or may not happen.
It must not be something that is certain to happen.
Wear and tear or depreciation which is a certainty should not be insured. No protection is given by
insurance.
We should not be certain as to the occurrence of a loss.
4. The loss must not be catastrophic
- All or most of the objects in the group should not suffer loss at the same time because the insurance
principle is based on a notion of sharing losses.
Example: Damage which results from war, flood, windstorm and so on would be catastrophic in nature
and hence do not have insurance.
5. The loss must be large loss.
- The risk to be insured against must be capable of producing a large loss which the insured could not
pay without economic distress.

- Incase the loss occurs, it must be severe that must be transferred to the insurer. Those recurring
and minor types of losses are not transferred to the insurance company.

6. Reasonable cost of transfer:

- i.e: the probability of loss must not be too high because the cost of transfer tends to be excessive.

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- To be insurable the chance of loss must be small. The more probable the loss, the more certain it is
to occur. The more certain it is, the greater the premium will be. But to make insurance attractive, the
premium has to be far less than the face of the policy.

For instance, a life insurance company to issue a birr 1000 policy on a man aged 99. The net
premium would be about birr 980.

3.4. BENEFITS AND COSTS OF INSURANCE

Benefits:
1. Indemnification
The direct advantage of insurance is indemnification for those who suffer unexpected losses. Society also gains
because these persons are restored to production, and tax revenues are increased.
==>Financial compensation

2. Reduced reserve requirement

If there is an insurance protection, the amount of accumulated funds needed to meet possible losses is reduced.
For example: a birr 60,000 residence can be insured against fire and other physical perils for about birr 200 a year.
If insurance were not available, the individual would probably feel a need to set a side funds at a much higher rate
than birr 200 a year.

3. Capital freed for investment or provision of funds for investment

Cash reserves that insurers accumulate are freed for investment purposes. Thus brings about a better allocation of
economic resources and increasing production.
Insurance mechanism encourages new investment. For instance, if an individual knows that his family will be
protected by life insurance in the event of premature death, the insured may be more willing to invest savings in a
long-desired project, such as a business venture.

4. Reduced Cost of Capital

Since the supply of investable funds is greater than it would be without insurance, capital is available at lower cost
than otherwise be true.
Therefore, the lower the interest rate, investment will be encouraged. ==> It leads to the increased of the living
standards.

5. Loss Control
==>Loss prevention activity.
Insurance are actively engaged in loss- prevention activities by spread losses among members of the insured group.
Insurers are vitally interested in keeping losses at a minimum.

By charging extra for bad features and less for good, insurance can induce the insured to make improvements, which
have beneficial effect on losses. This can clearly be seen, for example, in fire insurance, where the installation of
good-fighting equipment, such as a sprinkler system, receives considerable reward by way of reduced premiums.
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6. Business and Social Stability

Insurance contributes to business and society stability and to peace of mind by protecting business firms and the
family breadwinner.

A business venture can be continued without interruption even though a key person or the sole proprietor dies.

Old-age dependency can be avoided by retirement insurance. Loss of a firm’s assets by theft can be reimbursed.

7. Aid to Small Business

Insurance encourages competition because without an insurance industry, small business would be a less effective
competitor against big business. Big business may safely retain some of the risks that, if they resulted in less, would
destroy most small businesses. Without insurance, small business would involve more risks and would be a less
attractive outlet for funds and energies.
==>Insurance improves the competitive position of small business in the economy.
8. Invisible Export
A valuable contribution towards Ethiopia’s balance of payments is made by invisible exports. Overseas insurance as
an export is enhanced when the insurer is selling a commodity, namely security, to an overseas buyer. Although this
commodity is invisible it is an export in the same way as any material goods.
- Security is invisible insurance

Costs of Insurance Company / Costs of insurer

1. Operating Expense
Insurers incur expenses such as:
ƒ Loss control costs,
ƒ Loss adjustment expenses
ƒ Expenses involved in acquiring insureds,
ƒ State premium taxes and
ƒ General administrative expenses.
2. Moral Hazard
3. Morale Hazard

3.5. FUNCTIONS OF INSURANCE COMPANIES

The major activities of all insurers may be classified as follows:
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A. Production (selling)
B. Underwriting (selection of risks)
C. Rate making
D. Managing claims
E. Investment
In addition to these functions, there are various other activities common to most business firms such as accounting,
personnel management, market research and soon.
A. Production
- Production in an insurance company corresponds to the sales function in an industrial firm.
- Insurance is an intangible item and does not exist until a policy is sold (or purchased by insured).
- The production department of any insurer supervises the relationships with agents in the field.
- The production department recruits, trains and supervises the agents or salespersons.

B. Underwriting
- Underwriting is the process of selecting risks offered to the insurer (or which can be covered by the insurance
company).
- Unless the company selects from among its applicants, the inevitable result will be adverse to the company.
Hence, the main responsibility of the underwriter is to guard against adverse selection.
- Underwriting is performed by home office personnel who scrutinize applications for coverage and make
decisions as to whether they will be accepted, and by agents who produce the applications initially in the field.
- The underwriters are the decision makers.
There are four sources from which the underwriter obtains information regarding the hazards inherent in an exposure:
i.The application containing the insured’s statements.
ii. Information from the agent or broker.
iii. Investigations
iv. Physical examinations or inspections.

C. Rate Making
- An insurance rate is the price per unit insurance or exposure.
- Like any other price, it is a function of the cost of production. However, in insurance, unlike other industries the
cost of production is not known when the contract is sold, and will not be known until some time in the future,
when the policy has expired.
- One of the fundamental differences between insurance pricing and the pricing function in other industries is
that the price for insurance must be based on a prediction.
- Insurance, the cost of production is not known at the time where we are selling the contract or policy.
- The process of predicting future losses and future expenses, and allocating these costs among the various
classes of insured’s is called ratemaking.
- A second important difference between the pricing of insurance and pricing in other industries arises from the
fact that insurance rates are subject to government regulation. The main reason why government interferes on
insurance is because insurance is vested on public interest.
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- In enacted laws require that insurance rates must not be excessive, must be adequate and may not be unfairly
discriminatory.
- The premium should not be unfairly discriminatory.
- The rates should be relatively stable overtime, so that the public is not subjected to wide variations in cost from
year to year. At the same time, rates should be sufficient responsive to changing conditions to avoid
inadequacies in the event of deteriorating loss experience.

Making of the Premium

- A “rate” is the price charged for each unit of protection or exposure.
Pr ice Pr ice
Rate = =
Unitof exp osure Exposure
- A “premium” is determined by multiplying the rate by the No of units of protection purchased.

Premium = Rate X No of units of protection Purchased

- The insurance rate is the amount charged per unit of exposure.

∴Premium = Insurance Rate X No of units of exposure

Example
In life insurance, if the rate is 25 birr per 1,000 birr (or for each 1,000 birr in protection) of face amount of insurance,
the premium for a 10,000 birr policy is:
Birr 25
Pr emium = xBirr10,000 = Birr 250
Birr1,000

Example:
If you have the rate $0.25 per $100 of face amount of insurance, how much premium will you pay for $10,000,000
value of an exposure for protection if the type of insurance is life insurance?
$0.25
Pr emium = x$10,000,000 = $25,000
$100

The premium is designed to cover two major costs:

i.The expected potential loss and
- Is also known as pure premium
Pure premium includes only potential losses.
ii. The cost of doing business
Or: Operating expenses and profit margin
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Or: is also known as loading

Loading==> The additional cost that the insured should cover

Gross premium = Pure Premium + Loading

TotalExpectedLoss ExpectedLoss
Pure Pr emium = o
=
TheN .ofExposure ExposureUnits

Usually the loading expected as a percentage of the expected gross premium.

The general formula for the gross premium, the amount charged customer, is:

Pure Pr emium Pure Pr emium

Gross Pr emium = =
1 − LoadingPercentage LostRatio

Last ratio = 1 - Loading percentage

Loading includes:
- Agent expenses
- Commissions
- General Company Expenses
- Taxes
- Allowance as profits etc.
Example 1
In automobile insurance if an insurer expects to pay 600,000 birr of collision loss claims in a given territory, and there
are 3,000 autos in the insured group,
a) What will be the pure premium for collision?
b) If 30 of the automobiles belongs to Ato Hailu, how much pure premium will the insurer demand
Ato Hailu to pay for his autos’ being protected?
c) If the loading percentage is 20%, how much will the Gross Premium be?
d) What will be the total amount of money to be paid by Ato Hilu for his automobiles?

Solution
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TotalExpectedLoss $ 600,000
a. Pure Pr emium = = = $ 200 / aut.
ExposureUnit 3000 auts
b. 30 autos x $ 200 / aut = $6,000
Pure Pr emium $ 200 / aut
c. Gross Pr emium = = = $ 250 / aut.
1 − LoadingPercentage 1 − 0.2
d. 30 aut x $ 250 = $ 7,500
aut

Example 2
If the Gross Premium charged the customer and the loss ratio are $ 500 and 80% respectively. How much will be the
pure premium and the loading?
Solution
PP
(GP )Gross Pr emium = ==> PP = GPxLR = $500 X 0.8 = $400
LR
Loading = GP − PP = $500 − $400 = $100
Example:
The Ethiopian Insurance Corporation develops a pure premium of 75 birr for residential fire insurance at the airport
region. The expense and profit allowance is calculated to be 25% of the gross premium. What should be the gross
premium?

Rate making Methods

Two basic approaches to rate making, class and individual rating:

i. Manual or Class Rating

The manual or class rating method sets rates that apply uniformly to each exposure unit falling within some
predetermined class or group.
Everyone falling within a given class is charged the same rate.

Example:
-A class rate might apply to all types of dwelling of a given kind of construction in a specific city.
-Rates which apply to all individuals of a given age and sex.

The major areas of insurance that emphasize use of manual rate making method include life, automobile, residential
fire, etc.

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For example: -in life insurance the central classifications are by age and sex.
-In automobile insurance the loss data are broken down territorially by type of automobile, by age of
driver, and major use of automobile.

Advantage of the class rating system

- It permits the insurer to apply a single rate to a large number of insured’s, simplifying the process of
determining their premiums.

Class rating is the most common approach in use by the insurance industry today.
Note: the rate maker does not decide the premium, but apply the already decided premium.

ii. Individual Rating

- Each insured is charged a unique premium based largely upon the judgment of the person setting the rate.
- This rating is supplemented by whatever statistical data are available and by knowledge of the premium
charged similar insured’s.

D. Managing Claims /Loss Adjustment/

- The basic purpose of insurance is to provide indemnity to the members of the group who suffer losses. This
is accomplished on the loss-settlement process. The payment of losses that have occurred is the function of
the claims department.

- Life insurance companies refer to those employees who settle losses as “claim representatives”, or “benefit
representatives.” Employees of the claims department in the field of property and liability insurance are
called “adjusters”.

The Adjustment Process / Claim Process/

In determining whether to pay or contest a claim, the adjuster follows a procedure with four main steps:
i. Notice of Loss
ii. Investigation
iii. Proof of loss
iv. Payment or denial of the claims

i. Notice of Loss
The first step in the claim process is the notice by the insured to the company that a loss has occurred. It can be
informed orally or in written form. In order to avoid unnecessary problems, the notice is better to be given in written
form.
In most cases the contract requires that the notice be given “immediately” or “as soon as practicable”.
The insured may also be expected to notify someone other than the insurer. Under theft insurance, for example, the
insured must tell the police as well as the insurer about the loss.

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ii. Investigation
The investigation is designed to determine if there was a loss covered by the policy.
Following the loss, the insured should assist the loss adjuster in the investigation. The adjuster must determine:
a) Whether the loss actually occurred
b) Whether it is covered by the contract, and
c) The extent of the loss
iii. Proof of Loss
After giving notice, the insured is required to file a proof of loss. This is a sworn statement that the loss has taken
place, and states the amount of the claim and the circumstance surrounding the loss.

The adjuster normally assists the insured in the preparation of this document.
iv. Payment or Denial
If all goes well, the insurance company draws a draft reimbursing the insured for the loss. If not, it denies the claims.

E. Investment Function
When an insurance policy is written, the premium is generally paid in advance for periods varying from six months to
five or more years. These advance payments for premiums gives rise to funds held for policyholders by the insurer,
funds that must be invested in some manner. These funds should not remain idle, and it is the responsibility of
finance department or a finance committee of the company to see that they are properly invested.

Not all the money collected by the insurer is to be invested. A certain proportion of it should be kept aside to meet
future claims.

3.6. LEGAL PRINCIPLES OF INSURANCE CONTRACTS

Insurance is affected by legal agreements known as contracts or policies. The legal principles of insurance that are
generally applicable are discussed as follows:

1. PRINCIPLE OF INSURABLE INTEREST

Insurable interest refers to the existence of a financial relationship to the subject-matter insured. It applies to
both life and non-life insurance. The subject- matter insured may be property of value, life of a person or an event that
may cause a legal liability. For example: In the case of property ownership, the owner has a financial interest in the
safety of the property. He suffers a financial loss in the event of destruction of the property by accidental misfortune.
He may, then, purchase insurance to protect his financial interest in the property.

A fundamental legal principle underlying all insurance contracts is insurable interest. Under this principle an
insured must demonstrate a personal loss or the insured will be unable to collect amounts due when a loss
due to the insured peril occurs.

The essential of insurable interest are as follows:

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i. Presence of subject matter to be insured

ii. Existence of monetary relationship between the subject matter and would be policyholder
iii. The relationship existing between the policy holder and the subject matter need to be legal
iv. The policyholder will economically benefited by the survival or suffer an economic loss from the damage
or destruction of the subject matter.

The principle applies to both life and non-life insurance i.e. life, property, or potential liability.

Life Insurance:
i. Self-Insurance: An individual has an insurable interest in his own life and there is no limit to the sum for which
a man may insure his own life. In practice, the sum insured is restricted by the insured ability to pay premium.
ii. Husband and wife: a wife may insure the life of her husband because his continued existence is valuable to
her and she would suffer a financial loss upon his death. Likewise, a husband may insure the life of his wife
because her continued existence is valuable to him and he could suffer a financial loss upon her death.
iii. Creditors and Debtors: a creditor stands to loss if his debtor dies without paying the debt. Thus, he has the
right to insure the debtor up to the amount of the loan.
iv. Partners: the death of a partner could well cause financial loss to the survivor(s), who therefore, have a right to
insure him. This could arise with a professional firm or perhaps with theatrical performers. The amount of
insurable interest would be difficult to ascertain, but legally it is limited to the financial involvement in the person
insured.

Property Insurance:
Insurable interest in property may arise as follows:
i. Ownership
- In addition to full ownership, part or joint ownership gives the right to insure.

ii. Husband and wife

- A husband has an insurable interest in his wife’s property as he is legally entitled to share her enjoyment of
it, and a wife similarly has an insurable interest in her husband’s property as their relationship is reciprocal.

iii. Administrators, Executors and Trustees

- These are all persons entrusted with the estate and affairs of others. They have a right to insure the
property for which they are responsible.

iv. Bailess
- These are persons or entities legally in possesses of goods belonging to others. For example, laundries,
cobblers, and the like have the right to insure for loss to goods in their custody representing interest of the
owner.

v. Agent
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- Provided the principal possesses an insurable interest, an agent may effect insurance on his behalf. The
insurance must, however, be authorized or ratified by the principal. A householder may effect a policy, which
extends to cover the belongings of members of his family. Another example is with a private car insurance,
which normally extends to cover the liability of other drivers using the vehicle with the insured’s permission.

vi. Mortgagees and Mortgagors

- The interest of the mortgagee is limited to the sum of money that he has advanced.
- Mortgagee: is a person or an organization that lends money in mortgage agreements.
Example: Bank, financial institution
- Mortgagor: is a person who borrows money in a mortgages agreement.

Generally, insurable interest should exist both at the time of application for insurance and at the time of loss. In the
absence of such interest insurance turns out to be gambling.

2. PRINCIPLE OF INDEMNITY
The principle of indemnity states that a person may not collect more than the actual loss in the event of
damage caused by an insured peril. Thus, while a person may have purchased coverage in excess of the value of
the property, that person cannot make a profit by collecting more than the actual loss if the property is destroyed.
Many insurance practices result from this principle. Only contracts in property and liability insurance are subject to this
principle. Life and most health insurance policies are not contracts of indemnity. No money payment can indemnity for
loss of life or for bodily injury to the insured, and that is why life insurance is an exception the general rule.

The principle of indemnity is closely related to insurable interest. The problem in insurable interest is to determine
whether any loss is suffered by a person insured, whereas in indemnity the problem is to obtain a measure of that
loss. In the basic fire insurance contract, the measure of “actual cash loss” is the current replacement cost of
destroyed property less an allowance for estimated depreciation. In liability insurance, the final measure of loss is
determined by reference to a court action concerning the amount of legal liability of the insured by negligence. In any
event, the purpose served by the principle of indemnity is to place the insured in the same position as before the loss.

This principle applies to non-life insurance only (not applicable to life and personal accident insurance).The principle
states that the insured, in the event of loss, receives financial compensation equal to the amount of the loss
or the face value of the policy, whichever is lower. The whole purpose is to restore the insured to his former
financial position. I.e his financial position before the happening of the loss. Thus, the principle eliminates the intention
of gambling which incorporates profit motive.

METHODS OF PROVIDING INDEMNITY

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There are four basic methods of providing an indemnity:

i. Cash Payment ==> Many claims are settled by means of a cash payment to the insured
ii. Repair==> this form of settlement is particularly common in motor insurance, where the insurer settles the
repair bill direct with the garage concerned.
iii. Replacement of the property ==> e.g. In glass insurance, it is the usual rule to replace, and all insurers
pride themselves on the speed with which they replace shop widows so that there is minimum disturbance
of trade.
iv. Reinstatement of the property==> this is a term usually found in fire insurance and concerns the
restoration or rebuilding of premises (not necessarily on the same site) to their former condition.

3. PRINCIPLE OF SUBROGATION
The principal of subrogation grows out of the principle of indemnity. i.e. it works on these areas where the principles
of indemnity is applied. It doesn’t apply to life and personal accident insurance.

Under the principle of subrogation one who has indemnified another’s loss is entitled to recovery from any liable third
parties who are responsible. Thus, subrogation in insurance is the transfer by an insured to an insurer of any
rights to proceed against a third party who has negligently caused the occurrence of an insured loss. The
objective behind such transfer of right from the insured to the insurer is to eliminate the profit motive. I.e to prohibit the
insured from collecting double payments: from the insurer and from the third party.

For example
1) Automobile insurer that has paid a collision insurance claim obtains the right to collect reimbursement from
any negligent third party who caused the accident.

2) If Daniel because of negligence damages Desta’s car, the insurance company claims Daniel so as to
collect reimbursement from Daniel (3rd party) who caused the accident.

Subrogation is a corollary of the principle of indemnity and the right of subrogation, therefore, applies only the
policies, which are contracts of indemnity. it is not applicable to life insurance.

4. PRINCIPLE OF UTMOST GOOD FAITH

Insurance contracts are based on mutual trust. This means that both the insured and the insurer must make
full disclosure of material facts that have a bearing on the assessment of the risk .Intentional concealment,
misrepresentation and fraud may lead to the avoidance of the insurance contract. The insured is bound to give
the facts for the questions posed by the insurer. However, insured’s may not give information on certain aspects
unless asked by the insurer

Insurance contracts are based upon mutual trust and confidence between the insurer and the insured. This
principle imposes a higher standard of honesty on parties to an insurance agreement than is imposed in ordinary
commercial contracts. Insurance contracts are based on mutual trust.

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The application of this principle may best be explained in a discussion of representations, concealment and
warrantees.

Representations:
- A representation is a statement made by applicant for insurance before the contract is effected. Although the
representation need not be in writing, it is usually embodied in a written application.
- The insurer may decide to affirm the contract or to avoid it. Avoiding the contract does not follow unless the
misrepresentation is material to the risk.

Concealment:
- Concealment is defined as silence when obligated to speak. Concealment has approximately the same legal
effect as a misrepresentation of a material fact. It is the failure of an applicant to reveal a fact that is material
to the risk.

Warrantees:
- A warranty is a clause in an insurance contract holding that before the insurer is liable, a certain fact,
condition, or circumstance affecting the risk must exist. For example, a marine insurance contract may state,
“Warranted free of capture or seizure.” This statement means that if the ship is involved in a war skirmish, the
insurance is void. Or a bank may be insured on condition that a certain burglar alarm system be installed and
maintained. Such a clause is condition precedent and acts as a warranty.

- A warranty creates a condition of the contract, and any breach of warranty, even if immaterial will void the
contract. This is the central distinction between a warranty and representation .A misrepresentation does not
void the insurance unless it is material to the risk, while under common law any breach of warranty, even if
held to be minor, voids the contract.

5. PRINCIPLE OF CONTRIBUTION
The loss compensated by the insurance companies is calculated by developing a ratio only in the amount of
the loss. i.e: The total amount of loss equal to the amount contribution payment.

The principle of indemnity still applies.

Contribution principle also supports the principle of indemnity. It is applied in a situation where a person or firm
for some reasons purchase insurance from two or more insurers to cover the same subject matter against
loss or damage. Under the same such circumstance the insured can’t collect compensation in full from each
insurer. If this happens, insurance becomes profit-making mechanism. So, the insured is paid only to the extent of
the loss he has suffered. But, each insurer will make contribution to settle the claim. The contribution may be a
proportional amount based on the sum insured under the respective insurers.

The principle of contribution is not applicable for life insurance and personal accident.

Contribution=Sum insured with the particular insurer x Loss

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Total Sums insured with all insurers
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Example:
Assume that Ato Kebede has insured his house, which is worth 80,000 birr against fire insurers X, Y, and Z for 60,000
birr, 40,000 birr, and 20,000 birr respectively. Ato Kebede’s house was completely destroyed by a fire caused by Ato
Alemu’s negligence. The amount of indemnity that Ato Kebede will be entitled to receive would be 80,000 birr, the
value of the actual loss or the amount of insurance carried. The amount that each insurer is entitled to contribute
would be as follows:

Br 60,000
X ' sShareoftheloss = xBr80,000 = Br.40,000
Br120,000
Br 20,000
Y ' sShareoftheloss = xBr80,000 = Br.26,667
Br120,000
Br 20,000 Br.13,333
Z ' sShareoftheloss = xBr80,000 =
Br120,000 Br 80,000

Total indemnity
Thus, the principle of indemnity is maintained.

3.7. LIFE AND HEALTH INSURANCE

Definition
Life insurance is a contract where by the insurance for certain sum of money or premium proportionate to the age,
health, profession and other circumstances of the person whose life is insured engage that, if such person dies with in
the period specific (limited), the insurer will pay the amount specified by the policy according to the term thereof to the
person in whose favor the policy was entered to.

Life insurance can also be defined as a social and economic device by which a group of persons may cooperate to
ameliorate the loss resulting from the premature death of members of the group. The insuring organization collect
contributions from each member, invest this contribution, grants both their safety and a minimum interest return and
distribute benefits to the estates of the members who die.

The main purpose of life insurance is financial protection to the dependents of the insured upon the premature death
of the insured. The sum assured is, then, upon the death of the insured will be paid to the beneficiaries. The financial
compensation will provide security for a certain period of time.

Unique Characteristics of Life Insurance

Life insurance is a risk pooling plan economic device through which the risk of premature death or superannuation is
transferred from the individual to the group. However, the contingency insured against has certain characteristics that

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make it peculiar; as a result, the contract insuring against the contingency is different in many respects from other
types of insurance.
i. The benefits are determined in advance
- The insured decides for himself the amount of insurance protection he needs. The insurer will then decide on
the corresponding reasonableness of the amount of coverage and sets the corresponding premium.
ii. The amount of money required to pay the death benefits in a given period are to be collected in advance so
that there should not be shortage of funds to pay claims as they occur.

iii. Each insured in the group should be charged an appropriate premium, which reflects the amount of risk he
brings to the group. In other words, losses are to be distributed among the group of insured in an
equitable manner.

iv. The probability of claim increases with the passage of time since insured exhibit deteriorating health
condition as they grow old.
v. In addition to protection against uncertainty, life insurance has the function of accumulation (saving).
• Saving==> premium will accumulate with interest till the date of maturity of the policy.
Life insurance is not strictly a contract of indemnity. it is impossible to place a value on human life. The provision of
life insurance is a quite different process from the provision of non-life insurance. The main distinction is that in life
insurance the event being assured is either certain to happen, in the case of those policies paying on death, or
scientifically calculable, in the case of policies not paying a benefit of death.

Life insurance contracts are long-term contracts. Nearly all life policies are intended to continue until the insured’s
death or at least for several years. Other forms of insurance policies may be renewed many times, but are usually
twelve months contracts, which may be terminated by either party.
In addition to these, there are number of special features, which are worth mentioning at this stage:

a) Premium Payments
Life insurance premium are payable by level amounts throughout the period of the policy. This means that each
person pays the same amount throughout, that amount being determined by his age on effecting the policy. Premium
can be paid annually, half-yearly, quarterly or monthly. It is also possible for the insured to pay premiums for a
specified period of time or even a single payment at lump sum at the time the policy is purchased.

b) Surrender Values
When a person no longer wants his policy, or for some reason cannot continue the premiums, he can ask for the
surrender value.

c) Investments
We have already identified the life insurance industry as being of considerable size by considering the number of
policies in force and value of premiums paid each year. These vast amounts of money are held by companies to meet
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future liabilities and are termed life insurance funds. These funds do not lay dormant waiting for claims to come in;
rather they are invested to provide income for the companies and so assist policyholders and shareholders.

3.7.1. BASIC TYPES OF LIFE INSURANCE CONTRACTS

Not all people need exactly the same kind of protection from life insurance. Their ages differ; their incomes and
financial obligations differ. To provide all the different types of protection that are needed, insurance companies offer
a variety of policies. The basic types of contracts are:
1) Term Insurance
2) Whole life insurance
3) Endowments insurance and
4) Annuities
1) Term Insurance
The insurance scheme provides compensation to the beneficiary if the insured dies within the stated period
mentioned in the policy. If the insured survives beyond the specified time limit in the policy, the policy will expire and
there will be no payment made by the insurer.

Term insurance provides protection only for a definite period (term) of time. A term insurance policy is a contract
between the insured and the insurer where by the insurer promises to pay face amount of the policy to a third party
(beneficiary) should the insured die within a given period of time. If the insured does not die during the period for
which the policy was taken, the insurance company is not required to pay anything. Protection ends when the term of
years expires. In other words, term life insurance resembles automobile insurance, fire insurance, and like which are
always term insurance.

Term insurance is sometimes called temporary insurance. Common types of term life insurance are 1-year term, 5-
years term, 10-years term, 20-years term, and term to age 60 to 65.

Term life policy gives temporary protection and there is no saving element involved.

Term policies do not provide the insured with loans, cash surrender or non-forfeiture options. Insurance coverage
terminates at the end of the period unless it provides an option for conversion into other insurance schemes. Term life
policies can be single or level premium policy.

There are different forms of term insurance available to the potential purchaser, namely, straight term insurance,
renewable term insurance, and convertible term insurance.

Straight term insurance: Is written for a year or for a specified number of years and terminates automatically at the
end of the designated period.

Renewable term insurance: Is a type of contract under which the insured may renew his policy before its expiration
date without making another medical examination or otherwise providing that he still is insurable. If the policy is
renewable, the insurer will renew the policy, regardless of the insurability of the insured, for the number of times
specified in the contract commonly to age 60 or 65.

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Convertible term insurance: Is available from most life insurance companies. This insurance may be converted at
any time during a specific period into a permanent form of insurance without taking a physical examination. Some
insurance companies write a convertible term policy which provides that at the expiration of certain period of time the
term insurance policy automatically will be converted into a permanent form of insurance. This is called automatic
convertible term insurance. Most term insurances are convertible into whole life or endowment insurance.

2) Whole Life Insurance

It is a permanent insurance that extends over the lifetime of the insured. The sum insured is payable on the death of
the life insured whenever it occurs. In other words, whole life insurance protects the beneficiary when the insured
dies, since the contract can be continued in force as long as the insured lives.

Whole life insurance contracts may be placed in two categories, depending upon the premium payment period:
i. Straight life insurance, and
ii. Limited payment life insurance

i. Straight Life Insurance

Under straight life insurance, the premiums are payable for the remainder of the insured’s lifetime.
It is also called as ordinary life insurance. Under this policy, premiums are to be paid at regular interval until the
death of the insured or until the achievement of a specified age limit, say 100 years.
==>Less premium than limited payment life insurance

ii. Limited Payment Life Insurance

Under this insurance, the premiums are payable for the remainder of the insured’s lifetime or until the expiration of a
specified period, if earlier.

A limited-payment life policy is one arranged so that the insured pays a higher premium than would be required on the
straight life contact. Thus, a definite termination date can be established beyond which no further payments are due.
Limited installment plans could be 20-payment life, 30-payment life, and life paid up at age 65.

Note: Under this insurance scheme, premiums are paid for a definite period of time which is determined in advance.
That is for 10, 15, 20, 25 and 30 years or up to age 85. ==>Higher premium than straight life insurance.

3) Endowment Insurance
Endowment insurance promises to pay a stated amount of money to the beneficiary at once if the insured dies
during the life of the policy called the “endowment period,” or to the insured himself if he survives to the end of the
endowment period. This is “You win if you live and you win if you die” contract. The endowment policy is, in a
sense, a saving plan, which also gives insurance protection.

Under this type of contract the sum insured becomes payable at a maturity date (on the expiry of a fixed term, say 10
or 20 years) or at death before the date.

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Endowment insurance may be a useful way for some persons to accumulate a specified sum over a stated period of
time whether they live or die. The objective may be funds to finance a child’s college education, to pay living
expenses during retirement, or to retire a date.

4) Annuity Contracts
The annuity contract is true life insurance. It is insurance against living too long-against one’s ability to provide an
income for himself. They have been called “upside-down life insurance,” and in a sense they are a reverse
application of the law of large numbers as it is used in life insurance. While life insurance is a method of scientifically
accumulating an estate; an annuity is designed for the scientifically liquidation of an estate.

An annuity may be defined as a periodic payment to commence at a stated or contingent date and to continue for a
fixed period or for the duration of life or lives. The person whose life governs the duration of the payments is called
the annuitant. If the payments are to be continued for the duration of the designed life or lives, the contract is called a
life annuity. If payments are to be for a specified period but only as long as the annuitant lives, the contract is known
as a temporary life annuity. The basic function of a life annuity is that of liquidating a principle sum, regardless of
how it was accumulated, and it was accumulated, and it is intended to provide protection against the risk of outliving
one’s income.

Annuity may be classified in various ways:

- An annuity may be immediate, i.e., the first annuity payment due one payment interval from the date of
purchase or it may be deferred, i.e., there is a spread of several years between the date of purchase and the
beginning of the annuity payments.
- Annuities may be classified according to the method of premium payment. If the annuity is paid up at once, it
is called a single-premium payment. If it is paid for in installments, it is known as an annual-premium
annuity.

3.7.2. LIFE INSURANCE PREMIUMS

There are three primary elements in life insurance rate making:
1) Mortality
2) Interest
3) Loading
The first two (i.e. mortality and interest) are used to compute the net premium. The net premium plus an expense
loading (which includes unit expense factor, profit factor, etc) is the gross premium, which is the selling price of the
contract and the amount the insured pays.

1) Mortality
The mortality table is simply a convenient method of expressing the probabilities of living or dying at any
given age. It is a tabular expression of the chance of losing the economic value of human life. Since the insurance
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company assumes the risk of the individual, and since this risk is based on life contingencies, it is important that the
company know within reasonable limits how many people will die at each age. On the basis of past experience
actuaries are able to predict the number of deaths among a given number of people at some given age.

For large number of people actuaries have developed mortality tables on which scientific life insurance rates may be
used. These tables which are revised periodically, state the probability of death both in terms of deaths per 1,000 and
in terms of expectation of life.

Table 6-1 illustrates the mortality experience in current use. It shows that a male age 20 has an expectation of
living 52.37 years. At age 20 only 190 men (105 women) in every 100,000 are expected to die before they become
21. The probability of death at age 20 is thus 0.19%. At age 96 the death rate is slightly over 38%, since 384 per
1,000 are expected to die during that year. At age 100 it is assumed that death is certain. The probability of death
expressed in a mortality table is based on insured lives and not the whole population.

2) Interest
Since the insurance company collects the premium in advance and does not pay claims until the future date, it has
the use of the insured’s money for some time, and it must be prepared to pay interest on it. The life insurance
companies collect vast sums of money, and since their obligations will not mature until some time in the future, they
invest this money and earn interest on it.

Thus, the present value (PV) of a future birr (1Br) is an important concept in the computation of premiums. To
simplify computation, the assumption is made that all premiums are collected at the beginning of the year and all
claims mature at the end of the year.

The future value (FV) formula with compound interest can be written as:

FV = PV [1 + i ] , Where n- No of years.
n

i – Interest rate
Examples:
1.You want to invest $1000 at 7% compounded annually. What will be the amount after 10 years?

Solution:
Given: Required: FV
PV = $1000
i = 7% FV = PV [1 + i ] = $1000[1 + 7 / 100 ] = $1000 x[1.07 ]
n 10 10

n = 10 years = $ 1967.20

2. If we invest Br. 0.97087379 at 3% compounded annually. What will be the amount at the end of the year?

Solution:
PV = PV [1 + i ] = Br.0.97087379[1 + 3% ] = Br1.00
n 1

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Thus, reading down the table, we can see that we should have to invest only about 55 cents at 3% to have Br. 1.00 at
the end of 20 years.

Net Single Premium / NSP /

The Net Single Premium is the amount the insurer must collect in advance to meet all the claims arising during the
policy period.

The rate maker in life insurance makes two assumptions in calculating the necessary premium:
1. All premiums will be collected at the beginning of the year and hence it will be possible to earn
interest on the advance payment for a full year.
2. Death claims are not paid until the end of the year in question. In practice, of course, death
claims are paid whenever death occurs.
The formula for NSP is:

Face Value x Mortality x Discount = NSP

of policy rate factor

Example:
1. Give the following information and determine the NSP.
Reference to the CSO 1980 table of mortality reveals that the probability of death at age 20 for a male is 0.0019 (i.e.
out of 100,000 men living at the beginning of the year, 190 will die during the year). If a 1,000 birr policy is issued to
each of the 100,000 entrants, death claims of 190,000 birr (190 x 1,000 birr) will be payable at the end of the year at
an interest rate of 3%.

Face Value Mortality Interest

NSP = of policy x rate x rate
= Br. 1,000 x 0.0019 x 0.9780==> Look table 6-2,the PV of Br.1.00 at 3% at
= Br.1.84 the end of a year
Thus, if each entrant pays 1.84 birr, the insurer will have sufficient funds on hand to pay for death costs under the
policy.

2. Give the following information and determine the NSP.

• 3 years term policy for Br.5, 000 to be issued at the beginning of the year.
• No of policyholders at age 30 is 958,000
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• Interest rate is 10%

• Single premium payment at the beginning of the year.
• Death claims to be paid at the end of the year in which the incident occur
• CSO 1980 mortality table for male shows the following.

Year Age No of Living No of Dying

1 30 958000 1657
2 31 1703
3 32 1747

Method 1

Face Value Mortality Discount

Age of policy x Rate x Factor (10%) NSP
30 5000 1657 0.90909 = Br.7.8618
958000
31 5000 1703 0.8265 = 7.3418
958000
32 5000 1747 0.7513 = 6.8497
958000
NSP = Br. 22.053

Alternatively the NSP payable by an individual entrant for Br.5000 policy of 3 years term could also be computed as
follows:
No of dying x Amount of Policy PV Expected
Year Age = Death Claims
1 30 1657 5000 8285000
2 31 1703 5000 8515000
3 32 1747 5000 8735000

Death PV factor PV of
Year Age Claims x at 10% = Death claims
1 30 8285000 0.9091 7531893.50
2 31 8515000 0.8264 7036796.00
3 32 8735000 0.7513 6562605.50
Total PV of death claims Br. 21131295.0

™ NSP = Total PV of death claims

No of Entrants

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Br.21131295.0
= ≈ Br. 22.053
958000
Exercise:
Calculate the NSP for a 5-year term insurance 100,000 entrants of age 31 for a Br. 5,000 insurance policy issued to
each entrant at an interest rate of 10%.

CSO 1980 morality table shows the following. (Female)

Age No of Living No of Dying

31 100,000 178
32 183
33 191
34 200
35 211

Health Insurance
Health insurance may be defined broadly as the type of insurance that provides indemnification for expenditures and
less of income resulting from loss of health. Health insurance is insurance against loss by sickness or bodily injury.
The loss may be the loss of wages caused by sickness or accident, or it may be expenses for doctor bills, hospital
bills, medicine, etc.

There are two types of insurance in the generic term health insurance:
1. Disability income insurance, and
2. Medical expense insurance

1. Disability Income Insurance

Disability income insurance is a form of health insurance that provides periodic payments when the insured is unable
to work as a result of illness or injury. It may pay benefits only in the event of sickness or only in the event of accident
bodily injury or it may cover both contingencies in one contract.

Certain type of accidents art excluded, for example, losses caused by war, suicide and intentionally inflicted injuries,
and injuries while in military service during wartime.

2. Medical Expense Insurance

Medical expense insurance provides for the payment of the cost of medical care that result from sickness and injury.
Its benefits help meet the expenses of physicians, hospital, nursing and related services, as well as medications and
supplies.

Medical expense insurance is divided into four major classes:

a. Hospitalization expense contract
b. Surgical expense contract
c. Regular medical expense contract
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d. Major medical expense contract

a. Hospitalization Contract
The hospitalization contract is intended to indemnify the insured for necessary hospitalization expenses, including
room and board in the hospital, laboratory fees, nursing care, use of operating room, and certain medicines and
supplies.

Exclusions under hospitalization contracts:

i. Expenses resulting from war or any act of war
ii. Expenses resulting from self- inflicted injuries
iii. Expenses payable under worker’s compensation or any occupational disease law.
iv. Expenses incurred while on active duty with the armed forces
v. Expenses incurred for purely cosmetic purposes
vi. Expenses incurred by individuals on an out patient basis
vii.Services received in any government hospital not making a charge for such services

b. Surgical Contract
The surgical contract provides set allowances for different surgical procedures performed by duly licensed
physicians. In general, a schedule of operations is set forth together with the maximum allowance for each operation.

c. Regular Medical Contract

The regular medical expense insurance pays part or physician’s entire ordinary bill, such as his calls at the patient’s
home or at a hospital or a patient’s visit to his office. It is a contract of health insurance that covers physicians’
services other than surgical procedures. Normally, regular medical insurance is written in conjunction with other types
of health insurance and is not written as a separate contract.

d. Major Medical Contract

The major medical expense insurance provides protection against the very large cost of a serious or long illness or
injury. The major medical policy is most appropriate for the large medical expenses that would be financially
unaffordable for the individual.
ASSIGNMENT: Write brief note on Non-life Insurance

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