Risk Management & Insurance

Chapter 5
ANALYSIS OF INSURANCE CONTACT
 Chapter 3: Agenda
2

1. Chapter Three :
2. INSURANCE: An Introduction
1. 3.1. Definition & function of insurance.

2. 3.2. Basic Characteristics of Insurance

3. 3.3. Requirement of insurable risk

4. 3.4. Insurance Vs (gambling,

( Speculation)

5. 3.5. Social and Economic Value of Insurance.

 Chapter 4: Agenda
3

Chapter four:
Fundamentals of Insurance contracts

4.1. Legal principles of insurance contract.

4.2. Requirements of an insurance contract.

4.4. Unique characteristics of insurance.

 Chapter 5: Agenda
4

Chapter Five:
Analysis of Insurance Contact
5.1. Basic Parts of insurance contract.
5.2. Co-insurance
5.3. Other insurance provisions
5.3.1. Pro-rata liability share
1.

5.3.2. Contribution by equal share

2.

5.3.3.Primary and excess liability share

3.
 After studying this chapter you should be able to:
5

1. Describe the different parts of insurance and their

basics features.

2. List and describe the need for and concept of co-

insurance.

3. Appreciate other insurance provisions with the

principles of indemnification
 5.1. BASIC PARTS OF INSURANCE CONTRACT
6

 Insurance contracts are complex legal documents that

reflect both on
 General rule of low and
 insurance lows (conditions).

 It creates a binding agreement between parties,

allowing one party to transfer an exposure to loss to
another party.

 Despite their complexities, insurance contracts

generally can be divided in to the following common
elements
 5.1. BASIC PARTS OF INSURANCE CONTRACT
7

5.1. Declarations
5.2. Insurance agreement
5.3. Deductibles
5.4. Definitions
5.5 Exclusions
5.6. Conditions
5.7. Endorsements or Riders
 All insurance contracts do not necessarily contain
all the above parts in the order given,
 Yet such a classification, as above, provides a simple
and convenient framework for analyzing most
insurance contracts.
 5.1.1. DECLARATION
8

 Usually appears on the first page of the policy

 Is a statement which provide Information about the

Insured:
 Insured person
 Insured Property
 Insured Liability

This information is used for :

1. Underwriting or classification.
2. Rating or premium determination.
3. Identifying who /what is insured & for how much.
Declaration Contents in property insurance

 Identification of the insurer

 Name of the insured
 Location of the properly
 Period of protection
 Amount of insurance
 Amount of the premium
 Size of the deductible (if any)
 Any other relevant information
Declaration Contents in life insurance

 Name of the insured

 Identification of the insurer
 The age of issue
 The premium
 The policy number
 The issue date of contract
 Any other relevant information
 5.2. Insurance agreement
11

Is the HEART of insurance contract.

It Summarizes:
 Major promises of the insurer.
 Conditions (Duties and responsibilities of the
insured)
The promise of the insurer and the conditions under

which loses are paid are described in the insuring

agreement.

It is of two form:
 Named perils policy ：
 All Risks policy:
 5.2. Insurance agreement…cont
12

I. Named perils policy ：

 Under this policy, only those perils specifically named in the
policy will have coverage.

 If the peril is not named or listed in the policy, it means it is not

covered.

Example: in homeowner policy, personal property is covered for fire,

lighting, windstorm, and certain other named perils.

 Otherwise it means excluded

 The burden of proof is on the insured

 5.2. Insurance agreement …cont
13

II. All Risks policy:

 Also called an open perils policy

 under this policy all losses are covered except those losses
specifically excluded.

 “All risk” coverage is generally preferable for insured

 Greater burden of proof is placed on the insurer to deny a

claim.
 5.1.3. DEFINITION
14

 Is a part which will give the EXACT MEANING of word,

phrase, or situation which is subject to misinterpretation or
which is very indispensable for the contract.

Example:
 Insured
 Child

 Defined Key words or phrases have quotation marks

(“…”) around them or will be bold or italic.
 It may appear at the beginning, middle or end of the
contract
5.1.4 EXCLUSION
 In this section, the insurance company states what losses
are not covered.

 it is a list of perils, losses, property location, duration or

time e.t.c that are exclude from coverage.

 The number of exclusions has a direct relationship to the

breadth or narrowness of the insuring agreement.
1. All risk policy basis
2. Peril policy
 5.1.4 EXCLUSION ….cont
16

1. It is a part which list of perils, losses, person, property, location (place),

duration (time) that are exclude from coverage.
17
Reasons for exclusions
 5.1.5. DEDUCTIBLES
18

Meaning
 Is an amount to be subtracted from the total loss payment that
otherwise would be payable
 Usually $ 250

Applicability
 A deductible is applied in property, health and auto insurance
 A deductible is not applied in life and personal liability insurance

Purposes
 A deductible eliminates small claims that are expensive to
handle
 To reduce moral and morale hazard
 To reduce premium
 5.1.6 CONDITION
19

Meaning
 provisions in the policy that qualify or place
limitations on the insurer’s promise to perform.
 In effect, the conditions section imposes certain
duties on the insured.
insured
 If the policy conditions are not met,
met the insurer can
refuse to pay the claim.

Common conditions of property insurance

1. To protect a damaged property from further damage
2. To file a proof of loss with in due time
3. To cooperate with insurer while determining the
amount of loss
4. To cooperate with insurer while legal low suit
 5.1.7.ENDORSEMENTS AND RIDERS
20

Meaning:
 Both means the same thing
 Used to adds to,
to deletes from,
from or modified the
provisions in the original contract
Difference
21

5.2. COINSURANCE
 5.2. COINSURANCE
22

 Often appears in property insurance contracts

 It requires the insured to insure the property for a stated
percentage(%) of its insurable value /sound value (actual cash
value).
 Usually 90 or 80 % of the actual cash value in return for a
reduced rate.
 If the insurer wishes to collect the full amount for a partial loss
the required percentage shall be purchased (carried).
 If the coinsurance requirement is not met at the time of loss,
the insured must share in the loss as a coinsurer.
coinsurer
 5.2. COINSURANCE( cont….)
23

 Coinsurance formula
 
Amount of insurance carried X Actual loss = Amount payable
Amount of insurance required (%)

 As long as the insured carries the insurance equal to the

required percentage, all losses covered by the policy will be
paid in full up to the face amount of the policy.
 Con’t
24

Illustration 1.
Assume the following (Given):
 A dwelling with an actual cash value (ACV) of $ 100,000
 A coinsurance close (requirement) is 80% of the actual cash value
 Insurance carried (purchased) is $ 40,000

Required
How much would the insurance company pay for the insured, if :
1. Actual loss was $ 50,000 incurred
2. If actual loss was 100, 000 (total loss of dwelling) Incurred

Answer
1. $25, 000
2. $ 50,000
 Con’t
25

Illustration 2.
Assume the following:
• A dwelling with an actual cash value (ACV) of $ 200,000
• A coinsurance close is 90% of the actual cash value
• Insurance purchased( carried )$ 180,000
• How much would the insurance company pay for the insured,
if :
1. Actual loss was $ 50,000?
2. If actual loss was 200, 000 (total loss of dwelling)?

Answer
1. $50, 000
2. $ 200,000
 Two major issues in a coinsurance clause
26

1. A coinsurance clause requirement applies at the time of loss,

loss
2. Burden of maintaining the proper amount of insurance is on
the insured, like updating the amount with the existing inflation,
Coinsurance problem
 Inflation can result in a serious coinsurance penalty if the amount
of insurance is not periodically increased for inflation.
 Insured may incur a coinsurance penalty if property values
fluctuate widely during the policy period
purposes
1. To achieve equity in rating (Premium determination)
2. To make underinsurance unattractive to the insured
3. To make the insured to pay a penalty based on the amount of
underinsured
 Con’t
27

Illustration II. To acquaint u with the problems and the 2 major

issues .
Assume the following
 A dwelling with an actual cash value of $ 100,000 @ the time of purchase.
 A coinsurance close is 90% of the actual cash value
 Insurance purchased $ 90,000 thorough the protection (no update is made)
 How much would the insurance company pay for the insured, if The actual cash
value of the dwelling was $200, 000 at the time of loss and :

1. Actual loss was $ 50,000

2. If actual loss was 200, 000 (total loss of dwelling)

Answer
1. $20, 000 ( Half of the actual loss will be paid)
2. $ 100,000 (Half of the actual loss will be paid)
28

5.3. OTHER INSURANCE PROVISIONS

 5.3. OTHER INSURANCE PROVISIONS
29

 provision applies when two or more insurers or

re insurer covers the same insurable interest (say
property)
 Applied on other than life and most health ins
 It strongly support the principle of indemnity
 Each insurers or the insurer and re insurer share of
the loss
How to
1. 5.3.1. Pro rata liability provision
2. 5.3.2. Contribution by equal share
3. 5.3.3. Primary and excess insurance
 5.3.1. Pro-rata liability provision
30

1. Most common of the other insurance provisions

2. Each insurers or the insurer and re insurer share of the
loss based on the proportion
3. Proportionally = pro rata share

Proportionally = pro rata share

 Con’t
31

Illustration
Assume the following given:
 Actual cash value of the dwelling $ 1,000,000
 A person purchase insurance amount of $ 200,000 , 300,000
and 500,000 from three insurance companies A, B, and C
respectively.
Required
 How much will be paid by each insurer if an actual loss of $
100, 000 was incurred.
 5.3.2. Contribution by equal share
32

 Each insurer share equally in the loss until the share paid by each
insurer equals the lowest limit of liability under any policy, or until
the full amount of the loss is paid.

ILLUSTRATION
For example, assume that the mount of insurance provided by Companies
A, B, and C is Birr 100,000, Birr 200,000, and Birr 300,000
respectively.
1. If the loss is Birr 150,000 each insurer pays an equal share, or Birr 50,000
2. What if a loss of 550 0000 was incurred?
 5.3.2. Primary and excess insurance
33

 The primary insurer will pay the loss up to the

maximum limit.

 The excess amount above the maximum limit will be

paid by the other insurer or the re insurer.
 5.3.2. Primary and excess insurance
34

ILLUSTRATION
 Auto insurance is an excellent example of primary and excess
insurance.
For example:
 Assume Mr. “X” and “Y” has liability insurance converges from their own
separate insurers.
 If Mr. X occasionally drives the car of Mr. Y.
 Mr. X’s policy has a liability insurance limit of birr 300, 000 per person for
bodily injury liability.
 Mr. Y policy has a limit of birr 500,000 per person for badly injury liability.
 5.3.2. Primary and excess insurance
35

ILLUSTRATION
 The normal rule is that the liability insurance on the borrowed car is primary
and any other insurance is considered as excess.
 Borrowed car is primary
 any other insurance is considered as excess/ secondary.
Thus
 If the court orders Mr. X to pay damage of birr 750,000,

 Then Mr. Y’s policy is primary and pays the first 500,000 birr Mr. X’s policy is excess
and therefore , pays the remaining birr 250,000
End !
Do Good,
Do It Well,
Do It Your Way!