O Level Revision : Commerce - Insurance

Insurance

• Insurance is a form of risk management used to hedge against the risk of an uncertain or unforeseen loss.
• The insured is guaranteed of compensation in the event of financial or personal loss.
• An insurer is the insurance company.
• The insured is the policyholder.
• The policyholder gets an insurance policy and pays a premium.
• A premium is an amount of money charged to compensate or indemnify in case of financial or personal loss.

Pooling of risks

• Many people likely to suffer financial loss pay regular premiums into an insurance pool or fund.
• Those likely to suffer pay a small premium regularly.
• In the event of a financial loss the unfortunate are paid compensation from the pool.
• The financial loss is shared among a large number of people.
• The remainder, after settling claims, is invested in stocks and shares to earn profit and thus adding to the size of the pool.

Insurable risks

• These can be assessed or calculated from past records, events or experiences.
• Examples include fire, theft and burglary.
• Statistics are the sources of data for assessing the risks.
• Actuaries base the calculation of premiums on the laws of averages and they fix premiums for insurance companies.
• Changes in fashion and bad management are non-insurable risks. These risks cannot be assessed from past records.

The principles of insurance

1. Utmost good faith

• Both parties to a contract of insurance must disclose all relevant facts or materials truthfully to enable a fair premium to be charged.
• In the event of risk occurring compensation can be made.
• If utmost good faith is not observed the contract may be void.

2. Insurable interest

• The insured must directly suffer financial loss if a risk, like theft of a car, occurs.
• A person can insure own property but cannot insure the property of another because the person has no insurable interest. The person does not own the property.
• If one insures the property of another person, one might deliberately cause the
• risk to occur in order to make a profit.
• Insurable interest principle applies to both assurance and insurance. The family head can insure the spouse, their children and property.

3. Indemnity

• The insured is compensated for the financial loss suffered.
• One is restored or placed to the same position as before the event or accident occurred.
• No profit may be made out of the loss.
• Compensation will be limited to the amount for which the item was insured.
• A house valued $50 000, if insured for $30 000, can be compensated for $30 000, if completely destroyed.  If paid $50 000, the insured would make a profit of $20 000 from under-insurance.
• Indemnity does not apply to life or personal accident policies. A person killed in an accident cannot be restored to his/her previous situation but only a benefit payment can be made to the next of kin as a form of compensation.

a) Contribution

A house valued at $70 000 is insured against fire with two or more insurance companies. In the event of total damage by fire the companies share the amount of financial loss and pay proportionally the insured total sum of $70 000.The insured would make profit by insuring one product against the same form of loss with many insurers.

b) Average clause

The average clause prevents the insured from making a profit from under insurance. Should the insured undervalue the property, the loss will be shared between the insured and the insurer. For example, if stock worth $2 000 was insured for $1 000 and 20% of the stock was completely destroyed by fire, the insurer will pay:

 $20 x 1 000
     100

=  $200

$200 was proportional to the loss of the insured stock worth $1000. The stock was underinsured. $400 would cause the insured to make a profit of $200 from underinsurance.

c) Subrogation

• insurer indemnifies the insured for the loss of item
• damaged item proceeds pass on to the insurer

• the insurer takes place of  an insured in ownership of the item when the loss occurs

• the insurer can sue or claim against the third party who would have caused the accident

4. Proximate cause

• Nearest cause of loss is determined before compensation.
• The loss must be directly caused by the risk insured against.
• If the immediate cause of the loss was due to risks excluded by insurance policy, no claim can be made.

Consequential  loss

• Is loss resulting from outcome of a loss e.g. loss of goods leads to loss of profits on the destroyed goods.
• Businesses obtain cover on loss of profits, standing charges, charges incurred such as renting alternative sites during renovation interim.

Export Credit Guarantee Department (ECGD)

• Is British sponsored.
• Encourages international investment guaranteeing investors against risks abroad.
• The risks are due to nationalisation, restrictions on remittances, wars, or civil arrests.
• Provides insurance cover for non-payment or delayed payment by importers.

-      Importer may fail to pay due to:

• mere stubbornness
• failure to get foreign currency
• hyperinflation in their country
• exchange rate not being pegged
• war in own country
• import licence  expiring, being cancelled, or withdrawn
• ECGD lends money to finance export trade.

Types of insurance

1. Marine insurance

• Deals with risks connected with the sea.

2. Hull insurance

• Provides cover for loss or damage of the vessel and its fixtures.

3. Cargo insurance

• Provides cover for loss of damage of the cargo while in transit.
• Provides indemnity to the purchaser of the cargo.

4. Freight insurance

• Provides the carrier with indemnity in case there is need to repay the delivery charge because of failure to deliver the cargo.

5. Ship owner’s liability insurance

• Gives the ship owner cover for a variety of possible liabilities that include injury or death to crew or passengers; collision with other vessels; and pollution of the water caused by the ship.

6. Fire insurance

• Provides cover for loss due to: fire and explosions; floods; burst pipes; burglary; consequential loss.

7. Personal accident insurance

• Covers the insured against temporary or permanent disability.
• Insurer covers by payment of a large capital sum for a given period of time.
• Compensation  covers  hospital  fees  and  loss  of  earnings  to  the  extent  of quantified disabilities incurred and assessed.

8. Public liability insurance

• Covers claims against the insured.
• The insured might be an organisation: businesses, religious groups, schools or municipalities.
• Business actions might cause damage, injury or loss to the public: wet slippery floors, large potholes along the roads, broken windows etc. may cause damage to the public.

9. Fidelity guarantee insurance

• Covers loss of money due to embezzlement by workers.
• Covers senior workers who handle money.
• Insurer guarantees against dishonesty of the insured`s workers.
• Insurer assists the insured to take legal action against the offenders and recover the value lost.

10. Pluvial policies

• Cover open air or outside activities against bad weather.
• Cover loss of revenue due to bad weather.
• Musical shows, galas,  fairs or displays are covered against bad weather.

Life assurance

• Insurance is cover for a risk that may not occur. Theft and damage of property are common events.
• Assurance covers against risks that will occur. Death befalls all humans.
• Life assurance is a saving.
• One pays premiums for a specific period and gets a lump sum of money at the end.
• The policy can be used as collateral to get a loan from a financial institution.

1. Whole life assurance

• The premiums are payable throughout life or to an agreed age.
• Sum assured is payable at death to the beneficiary or agreed period to the assured.

2. Endowment assurance

• The policy is for a fixed period and payable at that fixed date or on the death of the assured if this were to be sooner.

3. Mortgage policies

• In the event of the premature death of the assured, the insurance company pays off the mortgage of the assured.

4. Funeral assurance

• Provides cover for a decent burial.
• Offer services such as collection of deceased from home or hospital to the funeral parlour; washing and dressing of the deceased; coffin; transport for coffin and mourners; and lowering of coffin.
• Examples of companies that offer funeral services are Doves, First Funeral, Moonlight and Nyaradzo.

Insurance brokers

• Are  intermediaries  acting  between  their  clients  and  underwriters  or  insurance companies.
• Give advice to clients.
• Obtain best terms for their clients.
• Earn commission called brokerage on contracts.

Obtaining an insurance cover

1. A proposal form

• A proposal form is an application for insurance.
• The applicant gives details of the item to be insured in utmost good faith.
• The insurance assesses the details, accepts the insurance and fixes a premium.
• The insurer may reject the application.
• The accepted form becomes the basis of the contract of insurance.

2. A cover note

• -     A cover note is issued to the insured.
• -      It gives a temporary insurance cover against risks prior to the issue of a policy document.
• -      After the issue of a cover note, the company may make enquiries about the insured or item.

3. A policy

• It is a contract of insurance.
• It gives the details of the risks covered, the sum assured, the conditions of the contract, and the premium payable.

Making a claim

• The insured reports the occurrence of the risk by completing a claim from and submitting it to the insurance company.
• The insurance company investigates and assesses the value of the damage.
• The insurer decides compensation and honours the claims.

Multiple choice questions

1. Which statement is not true about insurance?

Use the following information to answer questions 3 to 5.

Property valued at $70 000 was insured with two companies, Assets Company and Bonus Company, in the ratio of 4:1 respectively. Later the property was completely destroyed by fire.

3. Total compensation paid was
4. $70 000  B.   $56 000
5. $35 000  D.   $14 000
6.  Assets  Company paid
7. $70 000  B.   $56 000
8. $35 000  D.   $14 000

6. Which is the order for obtaining an insurance cover?
7. Complete a proposal form, make a claim and pay premiums.
8. Pay premiums, obtain a quotation and make a claim.
9. Contact an insurance broker, obtain a quotation and pay premiums.
10. Claim compensation, pay premiums and get a quotation.
11. An insurance company covers against

(i)   bad debts.

(ii) bad management.

(iii) change in the popularity of a product.

1. (i)  B.   (ii)
2. (iii)                                             D.   (i), (ii) and (iii)
3. Who calculates risks and premiums for insurance companies?
4. Actuaries  B.   Agents
5. Brokers     D.   Underwriters

Essay questions

1. Why is insurance a pooling of risks?
2. What is indemnity?
3. State, with reasons, five risks against which a business might insure against and two

risks against which it cannot insure.

4. Mrs Dube would like to insure her house valued at $50 000 for $80 000. State, with reasons, how much Mrs Dube would receive in the event of the house being completely destroyed by fire.
5. a)   Describe the procedures for obtaining insurance cover for a house.
6. b) Give reasons why an insurance company might refuse to arrange cover for the house.
7. Distinguish between insurance brokers and underwriters.
8. a)   Explain the steps you would take to obtain an insurance cover.
9. b) What information would the insurance company require before deciding to issue a cover  note?
10. Shop premises were insured against the risk of fire for $50 000. The premises were completely destroyed by fire. State with reasons the size of compensation if the cost of rebuilding was:
11. a) $45 000 b)   $60 000