C M A ALPHA

Business Studies Department

PRINCIPLES OF BUSINESS
5th Form
Lesson Notes: INSURANCE
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Purpose of Insurance
All individuals and organizations face a wide variety of risks, but only some of them actual
suffer a loss during the course of a year. Insurance offers a system of providing compensation
(money awarded) to those who suffer a loss.
Simply put, insurance is an agreement between an insurance company (the insurer) and
someone who wants financial protection (the insured – the proposer) that compensation
(indemnity) will be paid if a particular loss occurs. The charge the insurance company makes is
called premium and the contract drawn up between the insurer and the insured is known as the
policy. An insurance company will only agree to provide cover if it can predict the frequency
with which an event could occur.
The purpose of insurance is to uphold the principle of indemnity, that is to put someone who
has suffered a loss back into the position that they would have been in had the loss not been
suffered. Or
The purpose of insurance is to provide a sum of money to compensate for any damage to the
thing or person insured.
Insurance is vital not only to individuals, but also to all forms of business and the economy as a
whole. If as individuals we have to face all the risks of life ourselves that we would not do, and
at times we would even hesitate about leaving the safety of our homes. Similarly, many
businesses would not be formed if individual entrepreneurs and their backers (for example,
shareholders) had to face all the risk of enterprise themselves. Insurance relieves individuals and
businesses of some of the risks they face.
Role of Insurance
1. Insurance companies encourage industry to by taking on many of the risks of firms.
2. Insurance provides coverage against personal risks which individuals would not be able to
manage.
3. Insurance companies provides a source of capital since they are institutional investors.
4. Insurance companies allow us to enjoy an improved standard of living because they allow us
to get a wider range of goods and services.
Distinguish between Insurance and Assurance
Insurance provides cover for events which may happen, that is insurance deals with
compensation for loss of property in events such as fire, hurricanes and motor vehicle accidents.
On the other hand Assurance relates to coverage for events which will happen or must happen
such as death which is regarded as certain or reaching a particular age.
Examples of Insurance Companies
Protecting a business against possible risks and a family against the consequences of the death of
a parent for example, is the work of insurance companies such as:
 British Caribbean Insurance Co.
 SAGICOR
 Guardian Life

Insurable Risk, Non-Insurable Risks/Uninsurable Risks

Risk are either insurable or non-insurable. Insurance companies will only insure against risks
they can calculate. Insurable risks are risks that can be calculated by an insurance company.
There must also be a large number of persons requiring insurance for that risks. The following
are insurable risks:
 a) Employer’s liability – injury to employees while on the job. Firms are liable to
compensate their employee for loss.
b) Public Liability – accidental injury to the general public i.e. this provides coverage for
firms which may have to pay claims for injury to persons or property caused by their
shortcomings or negligence.
c) Fidelity bond or fidelity insurance – (embezzlement or fraud) is used particularly by
business to protect against loss by fraud or stealing, including theft by employees.
d) Product liability: protects the business against claims by customers as a result of faulty
products being supplied by the business.
e) Key personnel insurance: provides compensation to a business if a key member of staff
dies or is severely incapacitated.
f) Cash in transit insurance: covers money being carried by an employee to the bank
(including injury to the carrier)
g) Goods in transit: covers property against loss while it is being in transit from one place
to another, or being stored during the journey.
h) Event insurance: any event that could cause the organizer to or participant to have to
make a claim must be insured. For example, any events where large number of people
congregates (for example, outdoor shows, exhibitions, demonstrations or celebrations)
carry a risk that must be covered by insurance.
i) Accident damage to property/ premises insurance: covers damage to the business, the
stock it holds and the equipment it uses. There are two types of business premises
insurance: building insurance covers the cost of repair or rebuilding the premises as a
result of damage (but not expected to wear and tear), while contents insurance covers the
cost of replacement of stock and equipment that is damaged or stolen.
j) Consequential loss insurance: covers the indirect loss (consequential loss) caused by
being unable to use the business property (business interruption) as a result of fire, floods
and storms, vandalism etc. Some types of this insurance can cover loss of business
income as well as replacement of material items.
k) International traders: businesses involved in international trade (for example,
exporters) need special forms of insurance in addition to those identified above. For
example, credit insurance (also referred to as export credit insurance) protects businesses
against default by a customer on the amount due for a consignment exported.
l) Theft and robbery
m) Fire and flood
n) Motor vehicle accident

Risks that cannot be calculated are non-insurable risks for example, a businessman cannot
insure against trade losses, because there are no statistics which will take into account all the
many possible causes of trading losses. However, he may get insured against a specific loss, for
example fidelity guarantee. Fidelity guarantee is where insurance companies will provide
compensation against theft by employees.
Uninsurable risk
The success of insurance is dependent upon the ability of the insurance companies to meet a loss
if it occurs. The companies are able to ensure they can meet any claims that arise by using
statistical analysis to predict the frequency of an event occurring. The people within insurance
companies who accept the risk involved (underwriters) use their records of past claims to
calculate the probability of the risk involved occurring. The specialist who calculates the
probability is called actuary. If it can calculate the probability of an event taking place, an
insurance company will be willing to take on the risk involved, and it will be able to calculate
how much to charge (the premium) the customer. But not all events are insurable. The following
are a typical example of uninsurable risks:
 When the loss is inevitable
 Where there is insufficient past experience to assess risks
 If the proposer does not have insurable interest
 Against wear and tear such as rust and corrosion
 That a business will be successful
Principles of Insurance
Compensation will only be provided to the insured if he/she has complied with the principles of
insurance. The following are the underlying principles that govern how insurance works:

1. The pooling of risks

Insurance is based on the principle of the fortunate assisting the unfortunate. Pooling of risks
refers to the principle that makes it possible for insurance companies to repay the policy
holder an amount that is far greater than what he or she has paid as premiums. That is those
at risk pay a premium into a pool, managed by an insurance company to compensate for
losses suffered by themselves or others. For example, the amount paid to insure the property
is known as premium. The agreement that enables the insured to promise to do this and the
insurer’s promise to pay a certain sum if a certain event happens is known as the policy.
This pooling of risks therefore means that each firm or individual must pay a relatively small
sum, but if a loss is suffered a much larger sum will be received in compensation.
Explanation #2: pooling of risk
To offset the possible effect of a loss, all those at risk can contribute a relatively small sum of
money (the premium) to a fund or pool operated by the insurance company. The small sums
of money people pay in premiums form a large pool of money. When the contributor to the
pool suffers a loss there is enough money in the pool to compensate (indemnity) them.

The result of co-operating with others in this way, through the insurance company, is that the
risks are spread or shared between the many people and organizations that have contributed
to the pool. It is for this reason that the process of insurance is sometimes said to be the
pooling of risks. For example, if a trader owns a shop worth $200,000 and it burns down, it
would cause a considerable hardship to replace it, and it could be in fact impossible if the
owner could not raise the money. However, if many shop owners agree to pay a regular,
relatively small amount of money into a pool to provide compensation for a possible loss,
then, if one of the shops of the contributors’ burn down, there will be enough money in the
pool to compensate for the loss. What has happened is that the risk has been spread between
the many shop owners.
2. Indemnity
Is the insurance principle by which the policy holder is compensated for the losses incurred?
The idea of indemnity is to restore the person to where he was before the loss or damaged
occur. This prevent the insured from profiting the loss or damage. The purpose of insurance
is not to maximize profit but to compensate for loss. There are several important aspect to
this principle:
 No profiteering: although we take out insurance to receive some money in
compensation should we experience a loss, we are not supposed to make a profit from
our claims of compensation.
 Overinsurance: if the insured overinsures an item (more than its true value), in the
event of a loss they will only be compensated for the true value.
 Underinsurance: if a loss occurs where an item is underinsured (less than its true
value) the policy holder will only be compensated for the true value.

Example of Insurance
Shop value $200,000
Insured for $160,000
Damage by fire $40,000 [i.e. one-fifth]
Compensation $32,000 [one-fifth]

3. Insurable interest
The principle that ensures the policy holder can only insure property that belongs to him or
her is called insurable interest. Whenever a house is destroyed by fire, a loss is sustained by
the house owner who alone can insure his or her property. An individual who has no
insurable interest in a house has no right to insure it. Hence insurable interest must exist
before anyone has the right to insure a property. For example: You can insure your own
house against fire but you cannot insure your neighbour’s house. The intention here is to
prevent individuals from profiting from insurance.

4. Utmost good faith

This principle of insurance states that the insured must give all relevant information about the
thing or person being insured. The insurance company will require information about what is
to be insured before issuing a policy. This information is given on a proposal form and this
becomes a legal contract between the insurer and the insured. The questions should be
 answered truthfully. Failure to give accurate information may mean the insurance company
can refuse to pay on the claim. For example, if one is seeking a car insurance one may have
to disclose if one is guilty of any motoring offences. Those seeking life insurance could be
asked if they have chronic illnesses. The older the individual, the greater the risk that he or
she will die soon. By doing so, the insurer can accurately assess premiums. This principle
applies to all forms of insurance.

In other words this principle of insurance means that the parties to insurance have a legal
obligation to be truthful in the declaration they make. They have:
 A duty to disclose all relevant information
 A duty not to make any misrepresentations.

5. Subrogation
Subrogation is an aspect of indemnity. This means to ‘take the place of’ i.e. the insurer
takes the place of the insured. It means that if your car was completely wrecked in an
accident then the insurance company would compensate you base on the car’s value just
before the accident but they would keep the wreck otherwise you would sell the wreck and
profit. For example, If John’s car hit Mary’s car then John’s insurance company ought to
compensate Mary. However, if Mary claims from her insurance company, when John’s
company compensates her she has to pass the compensation over to her insurance company
which had earlier taken her place. Or when an insurance company pays out compensation
against a claim, the money they pay out takes the place of the article damaged. For example,
if the truck of a business is ‘written off’ (too badly damaged to repair, or in other words, the
cost to repair exceeds the value of the item), the insurance company will indemnity the owner
for the value of the vehicle. The money paid to the policy holder takes the place of the
vehicle and the damage vehicle now becomes the property of the insurance company, who
will sell it and retain the scrap value.

6. Proximate cause
The principle of insurance states that a claim will only be honoured if the loss suffered was a
direct consequence of what you insured against or what was included in the terms of the
policy. If a person insures his house against fire only but it is destroyed by flood, then he
cannot expect compensation from the insurance company. Or if one insures oneself against
death by accident and dies of another cause such as cancer, the insurers would not be
required to meet any claim. Similarly, if a property is insured against earthquake damage but
not against fire the insurers are not liable to pay out a claim for fire damage. In the case of
the fire the insurance company will not only cover the fire but will also pay for damage
caused to doors by the firemen having to break into your house to fight the fire. However,
such a claim is only be allowed if the loss is closely related to the original event.
7. Contribution
This is another extension of the principle of indemnity. This means the insurers come
together to compensate the insured to ensure that no profit is made by the insured. It prevents
anyone person from making two claims after buying insurance coverage from more than one
insurance company for the same property. In the case of a damaged car which has been
insured by two companies, payment will not be paid by the two insurers but instead share it
between them. For example, if a building valued at $160,000 (insured with A for
$100,000and with b for $60,000) is burnt down, A will pay ten-sixteenths and B six-
sixteenths of the loss.

Example of a typical insurance case of damages and how it is calculated

Matthew insured his house 5 years ago for $200,000.00. His house now values
$400,000.00. Recently a hurricane damaged one section of his roof. The estimated
cost of repairs is $100,000. How much is the insurer willing to pay for the damage?

Old value × damages

Near value

200 000 x 100 000 = 50 000

400 000

Types of Insurance
 There are two main categories of insurance are:

1. Life Assurance
2. Non-Life Insurance

Life Insurance
Life insurance is sometimes referred to as assurance rather than insurance. Insurance was
protection against a risk that might or might not happen, while assurance concerned an event
that was inevitable (death or reaching a particular age). The aims of life insurance are
somewhat different from insurance in general. Life insurance coverage aims at paying claims to
the beneficiaries of the policy holder upon a certain time. This is so because the insured person
cannot be compensated.

Types of Life Insurance

There are three (3) main types of life insurance:
a) Whole life policies – these policies are payable on the death of the insured. However, the
insured ceases the paying of premium at the age of 60. Typically, premiums are paid
quarterly or annually by the person whose life in insured, or by his or her spouse. The idea is
that when the insured person dies, someone will benefit from the policy (for example a
spouse or dependent).
b) Endowment policies – these policies allow for a specified sum of money to be made payable
on a specified date or on the death of the policy holder, whichever comes first. These
policies are a means of savings which the company uses to invest in various projects such as
the stock market or real estate. This provides not only for dependents, but also pays out a
useful sum of money for the insured if he or she survives the period covered by the policy. A
variation of this is one ‘with profits’ which for a higher premium entitles the insured to share
in the profits of the insurance company. Some endowment policies also pay out if the person
is critically ill.
c) Term policies – A term policy pays out if death occurs during the term of the policy. Such a
policy is typically taken out for a period of between one and thirty years. A level term policy
entitles the policy holder (or, more accurately whoever benefits from their estate) to a sum of
money (a death benefit) which stays the same throughout the life of the policy. Most term life
insurance policies are level term. A reducing term policy means that the sum of money will
reduce the longer the policy is held.
These policies are also payable during a specific period or during a period of mortgage on the
individual house in the event that the person dies the proceeds of the policy are used to pay
off the mortgage.

NB. Insurers use their statistical knowledge of life expectancy, occupation, leisure pursuits (for
example, lifestyles including activities such as daredevil sports and smoking), personal and
family medical history (for example, heredity illnesses such as hypertension), and even possible
driving records to assess the risk involved and to calculate premiums accordingly.

Non-Life Insurance
There are many types of non-insurance policies, which are relevant to business, which involve an
insurance contract between an insurance company and the insured. The size of the premiums will
depend on the likelihood of the risk and the possible outcome of compensation that the insurance
company may need to pay out.

Take a look at the following scenario:

 Wobbly Wheels is a company that provides replacement wheels and tyres. The company is
owned by two partners and employs eight people. The business has a large storage warehouse
that also includes service bays. It also has a separate office with rest areas for customers and a
large parking area. Customers respond to advertising and they visit the premises. The business
face several risks including:
 If one or both of the owners become ill for an extended length of time the business would
collapse.
 Employees and customers could be injured on the business site.
 A large amount of money is handled at a risk of theft.
 If a faulty product (for example a wheel or tyre) is supplied, it could prove dangerous and
lead to a claim against the company.

Key types of insurance are:

1. Marine insurance: is a special form of insurance used by those involve in shipping. It covers
the loss of, or damage to, ships, and their cargoes and personnel. There are four broad
categories of marine insurance:
a) Hull insurance: covers damage to vessel itself and all its machinery and fixtures. Or
damage caused by it to another vessel.
b) Cargo insurance: covers the cargo the ship is carrying i.e. goods or merchandise carried
by the vessel is insured to protect both importer and exporter.
c) Freight insurance: is customary insurance taken out to cover if, for some reason, the
shipper does not pay the transport (freight) charge to the ship’s owner. In other words,
this is the charge for carrying the cargo. The ship owner is paid this charge at the
beginning of the journey although he is not entitled to it until he delivers the goods. The
insurance company provides the ship owner with this indemnity in case he has to repay
the charge for failing to deliver.
d) Ship owner’s liability: refers to a vessel owner’s responsibility to insure against a wide
variety of events, such as collision with other vessels or a dock, injury to crew members
or passengers and polluting beaches. This insurance basically provides coverage for
damage/loss through the fault of the ship owner or his employees.
Loss adjusters are independent claim specialist that are used to ensure a claim is settled fairly. In
the event of a claim being made, for example, a substantial one, a loss adjuster will visit the site
of the claim to determine whether the claim is valid, and, if so, that the compensation paid is fair
and correct.
2. Aviation insurance: covers the aircraft against damage by accident and the operators
against claims from injury or death of passengers, crew or third party.
3. Accidental insurance:
 Property – covers a number of risks related to any type of property including accidental
damage to machinery, furniture, appliances, damages caused by vandalism.
 Personal accident insurance – this covers the insured against partial or total disability
arising from an accident.
4. Motor insurance
 Third party – this is compulsory under the law by all vehicles. It covers injuries to the
third parties (someone other than the insurer/insured) on public roads plus damage to
other peoples’ property and other legal expenses.
 Third party, Fire and Theft – same as above plus fire and theft of vehicle.]
 Comprehensive - this is an extension of third party, fire and theft to include total coverage
for damage to the insured vehicle, personal injury to driver and loss or damage to
personal possession while in the vehicle.
Vehicle insurance: this insures company vehicles and their drivers against damage caused
by accidents while on company business. The company will be able to make a claim
provided that the vehicles are properly serviced and used, and provide that drivers are
suitable trained and the company has checked that they are competent. Company vehicles
will also need to be taxed and have appropriate road worthiness certificates.
5. Fire Earthquake and Hurricane: coverage for fire maybe bought separately or along with
other insurance against natural disasters. Sometimes household buy policies that include all
or some of the above including insurance for burglary.
6. Building, fire and equipment insurance: these are important if a business does not want to
have to close down for extended periods of time if the insured event occurs. The
 compensation from an insurance claim will enable a business to repair, rebuild or buy new
equipment.
7. Product liability insurance: this will cover a company against harm resulting from the use
of one of its products, providing the company has complied with all the relevant legislation
relating to the development and production of that product.
8. Fidelity insurance: this will cover a company against harm resulting from dishonesty or
fraud committed by any of the company’s employee.
Liability insurance policies: provide coverage for events which may be made against the
insured. Motorist, ship owners and airline operators are required to have these policies.
9. Employer’s liability insurance: this covers accidents to employees on company premises or
while going about company business. Again providing the company has taken the necessary
steps (such as health-and-safety measures and adequate training of employees), then it will be
able to use its insurance to cover against claims by employees.
10. Public liability insurance: this is insurance against accidents or injury caused to the public
where the company has done everything in its powers to prevent this from happening, for
example, when a member of the public trips and hurts themselves on company premises. The
public liability insurance will enable the company to make a claim on the insurance to cover
damages owed to a member of the public.
11. Cyber and digital risk insurance: cyber-attacks on company data have become one of the
major cause of business loss in recent years. A business is able to take out insurance against
such risks, and will be covered provided it has put in place the checks required by the
insurance company, such as building firewalls and hiring specialists to protect them against
computer hacking.

Explain how insurance facilitates trades

The main advantage of insurance to business or person is that it reduces the risk that they are
taking. Business is by nature a very risky affair, and there are certain things that you cannot
insure against. For example, a company cannot insure against not making a profit. If you have a
good business idea and conduct business in a sound way, then you stand a good chance of
making a profit, but this is not guaranteed. However, there are many things you can insure
against which reduce your risks.
For example, transport firms such as airlines and shipping lines can insure their fleets by taking
out aircraft insurance or marine insurance. When trading internationally, a copy can take out
freight insurance so it can claim compensation if a parcel or container is lost or damaged. Armed
with this knowledge, a business person will be more inclined to engage in trade because
insurance has reduced the risks of financial loss.
Insurance can also provide protection against disastrous events such as accidents, fire,
employee injuries etc. All of these can be just as devastating to a company as not making enough
profit. Insurance ensure continuity for a company, since it helps in restoring a business to a
former position before the unforeseen events.
The pooling of risks principle explains how insurance risk can be shared. If there are 1 000
exporters exporting goods from Barbados every day, and each one of them is taking out
insurance associated with exporting, then the premiums they pay will help to cover the losses
made by individual firms, for example, when the cargo of one firm fails to arrive at its desired
location. The reality is that accidents will only happen in a relatively small number of cases, but
you can never be sure yours won’t be the one where the loss occurs. Therefore, insurance
reduces risks associated with doing business and trading.

There is a specific trade insurance called ‘trade credit insurance’ that helps exporters. It works
in this way:
 The exporter pays a premium to the insurer
 The exporter then sells goods on credit to a foreign buyer.
 The exporter waits for payment from the buyer under the terms of the transaction.
However, if the buyer fails to pay up within a set period of time (often 180 days) then the
insurer will compensate the exporter up to a certain percentage of the sale price, such as
75 per cent of what is owed.
With trade credit insurance, exporters can have greater confidence that they will be able to make
a profit from trading (although not as much as if buyers pay up quickly). The benefits of trade
credit insurance are that:
 A country sells more exports, earning more international currency.
 Exporters face less exposure to risk.
  Exporters will make a return on their exports
 The earnings of exporters are more predictable.

The importance of insurance to the Economy

1. Insurance companies allow us to enjoy an improved standard of living because they allow us
to get a wider range of goods and services.
2. The insurance industry is also important to the country’s balance of payment as a sizeable
sum is earned by the industry re invisible trade.
3. Insurance companies are involved in real estate, providing buildings, offices, plazas and
shopping centres thus helping in the development of the construction and other related
industries.
4. Insurance provides a means of savings in the form of endowment policies.
5. It covers individuals against personal risk.
6. It covers individuals against personal risk they may not be able to otherwise bear.

Summary of key terms associated with insurance

1. Insurer: the insurance company that is offering the financial protection
2. The insured: the person who will compensate if a loss occurs.
3. Premium: the amount paid to get the benefits.
4. Policy: contract drawn up between the insurer and the insured.
5. Indemnity: restoring the insured to the original position of he or she was in before the
loss/damage occurred. Indemnity means that one would be restored at today’s value.

For example: Aston bought a car 2 years ago for $200,000 and it was destroyed by fire
today. The car now values at &150,000; this would be the amount the insurance company
would provide.

Insurance promoting trade

All businesses have to take some risks, but they also have to avoid any which are unnecessary.
Insurance helps to narrow down the number of risks. It encourages businesses to trade knowing
that at least some of the risk involved are taken care of, even if there are some cost to the
business.
Insurance promotes business confidence; entrepreneurs are reassured that they can claim
compensation should some unforeseen and costly event occur. This saves them from having to
set aside funds against such an occurrence, thus increasing the funds available to operate and
expand the business. Insurance also encourages them to take the reasonable operational risks
involved in successful business activity.

Insurance itself, is of course, a business (Fig. 10.5). It is not only a source of employment but is
also a source of investment for individuals and corporate investors in the money market. It is
particularly attractive to investors because it is generally a safe investment, especially in the long
term. This is because insurance companies are very good at planning for the long term. Insurance
companies invest the money they collect in premiums to provide income to meet insurance
claims. They invest in the capital market. This market is a source of finance of businesses. In
this way, insurance companies not only earn income for their own purposes, but they also
indirectly help to promote the formation of new businesses and help to expand existing ones.

Class Activity
CXC 2000 Past Paper Question #8

1. (a). Define TWO of following terms:

i. Insurance
ii. Assurance
iii. Indemnity (4 marks)
(b). Clairmont Fisheries Ltd. is a large Caribbean business with branches in five Caribbean
countries. The company is in the fishing business (canned mackerel, herrings, fish etc.) It
employs one thousand (1 000) persons and owns a fleet of fishing trawlers.
i. Identify FOUR (4) types of insurance policies to which Clairmont Fisheries Ltd.
could subscribe to protect itself and its employees.
ii. For each of the insurance policies identified (b) (i) above, explain the type of
protection or coverage it offers.
 (8 marks)
(c). Clairmont Fisheries Ltd. is seriously considering a merger with a competitor, Canneries
Ltd. which operates in Eight South American countries. Explain THREE (3) reasons
why Clairmont Fisheries Ltd. would wish to merge with Canneries Ltd. (6 marks)

(d). Explain ONE (1) reason why Canneries Ltd. might have reservation about the merger.
(2 marks)
(Total 20 marks)