Insurance
GOOD DAY to all. Insurance is the final topic in Section 4 of the syllabus: Legal aspects of business. Three specific objectives will be covered over two weeks, as follows.
Students should be able to:
■ Evaluate the principles upon which insurance is based.
■ Explain the various types of insurance policies.
■ Explain how insurance facilitates trade.
I will start by giving an overview of insurance. It is often seen as:
“The unfortunate paid by the fortunate”. Insurance is a specialty contract. It is an agreement between an insurance company (insurer) and someone who wants financial protection for loss (insured).
In business, there is always some unexpected event that may cause financial losses since businesses involve risks. When these risks occur, individuals may not be able to afford to restore their losses themselves. They, therefore, make arrangements for some kind of financing that will offer them protection should certain losses occur. This protection is important since, without it, no one would bother to invest in a business.
Insurance is based on the principle of ‘pooling of risks’. It assumes that many persons engaged in business will want to seek protection against financial loss, but that losses during a year will only occur in a few instances. Businesses contribute to a common fund. The contribution is known as a premium.
Insurance companies are very large investors. They invest from the pool of funds provided by the insured in all types of securities. They can earn considerable amounts on their investments which help them to pay claims and dividends to cover all their costs, to lend money on the capital market, and to make a profit.
An insurance company must be able to estimate fairly accurately the probability of loss, and insurance is granted on risks that can be calculated. These risks are known as insurable risks.
Premiums are usually fixed, but can vary according to the incidence of losses. If high losses are sustained in one year, the probability of loss will be increased and with it the premium.
PRINCIPLES OF INSURANCE
The following guidelines govern insurance:
1. Utmost good faith: The person taking out the insurance must give all relevant information, truthfully and accurately. This enables the company to make an accurate assessment and enables them to calculate the premium to be paid. If false information is given or any information is withheld, the company will refuse to pay the claim. On the other hand, the insurance company must also show utmost good faith by explaining to their prospective clients the terms of the insurance and the exact amount of coverage being provided. They normally do this in the form of the fine print on the policy contract.
2. Insurable interest: This means that the insured must personally be the one to suffer the loss. Thus, the insured can take out a policy on his house or car, but not on his neighbour or friend’s house or car. This prevents persons from profiting from insurance.
3. Indemnity: The person insured should be placed in the same position after a loss as he was before, though cases of personal accident and death are exceptions.
4. Subrogation: This principle further extends the principle of indemnity by ensuring that the insured does not profit from a loss, e.g., if your car was completely wrecked in an accident, then the insurance company would compensate you but would keep the wreck; otherwise, you could sell the wreck and profit.
5. Contribution: This is another extension of the principle of indemnity. Losses are shared between insurance companies if an individual is insured with more than one insurance company for the same thing.
6. Proximate cause: When there is damage or loss, the insurance company will only honour the claim if that particular loss was insured against. For example, if a man insures his house against fire only, he cannot get compensation if his house is damaged by flood rains or if burglary occurs.
7. The legality principle: This principle states that illegal acts cannot be insured against, e.g., a field of ganja. These must be the responsibility of the person undertaking these acts.
8. The average clause: This principle sets a limit for the payment of claims by the insurance company. It states that the insured will be compensated in the same proportion or ratio that he is insured. Assume a man insured his house five years ago for $1,200,000, but it now values $2,400,000. Under the average clause, if the roof of his house is damaged and the estimated cost is $160,000, then he will be paid $80,000, since he insured for half the true value of the house.
9. The principle of arbitration: Many insurance policies are referred to arbitration for a final decision when there are differences which cannot be easily settled between the insurer and the insured.
10. The Principle of cancellation: The insurance can be cancelled at any time by either party. The premiums paid after the notice of cancellation may be recovered.
If there is suspicion of fraud or some sort of underhanded dealings on the part of the insured person or company, the cancellation clause will be acquired.
Okay, that’s it for this week. Next week, we will highlight the differences between assurance and insurance, look at the types of insurance and discuss the importance of insurance. Take care, and see you all then.