What are the Main Principles applied in insurance Industry
Insurance may be defined as a contract of indemnity. It is a contract made by an insurance company and an individual person, where by the person undertakes to pay given amounts of money to the insurance company over a given period of time in return for indemnity upon suffering of loss arising from the risk that he has insured'.
Insurance can also be defined as the process of pooling risks. This is where a large number of people who are exposed to similar kinds of risk put the risks in one pool (insurance company). The group of people individually pays some little amounts of money to the insurance company (pool) from which the individual who suffers a loss resulting from the risk insured is indemnified.
Insurance is based on the fact that many people are exposed to similar risks, but only a small percentage of those risks ever occur, hence the insurance companies are able to indemnify those few who suffer losses out of the funds accumulated from the little amounts individually paid by the insured persons.
Principles applied in insurance
(a) Principles of indemnity
(b) Principles of contribution
(c) Principle s of 'utmost good faith' or 'uberrima fides'
(d) Principles of subrogation
(e) Principles of insurable interest
(f) Principles of proximate cause
(a) Principles of indemnity
The principles states that in the event of loss, arising from a risk that a person has insured his property against, the insurance company is under obligation to restore that person back to the financial position that he was in before the loss occurred. In simple language the insurance company is expected to compensate that person for the loss he has suffered.
(b) Principle of contribution
The principle states that where a person has insured the same subject matter with more than one insurance company, upon the occurrence of the event of loss, the insurance companies that have insured that subject matter will contribute towards the indemnification of the insured person. The insurance companies will share that loss proportionally.
(c) Principle of 'utmost good faith' or `uberrima fides'
The principle states that a person taking an insurance policy is expected to give all material and relevant information about the subject matter that he is insuring, whether such information has been asked for or not. It is also expected that all the information given will be absolutely truthful. If the in case insured entity suffer a loss thereafter and it is discovered that he did not acts in 'utmost goods faith', then the insurance company may refuse to indemnify.
This principle requires that the insured person must surrender the remains of an insured subject matter upon the event of loss, once the insurance company fully compensates him. This ensures that the insured person does not make a gain out of insurance.
(e) insurable interest
This principle means that an individual can only insure a subject entity for an insurable interest of that amount. Person with insurable interest to subjects if he would suffer some financial loss upon the occurrences of the events of loss resulting from the destructions of that matter.
(f) Principles of proximate cause
states that there must be a very close relationship between the risk insured and the actual cause of the loss in order for the insurance company to indemnify. In other words the loss suffered must arise directly from the risk insured against for the insurance company to indemnify.
-Some terms as used in insurance
Re- insurance Surrender value
(a) Over insurance
This occurs where a person has insured his property for a higher value than its true worth. Such a person pays higher premiums but in the event of loss, he is indemnified for the true worth of his property.
(b) Under insurance
This occurs where a person insures his property for a lower value than its actual value. Such a person pays lower premiums than would be the case if he had declared the true value. In the event of loss, such a person is only partially compensated, i.e. if he had only insured 80% of his property, he would only be indemnified to the tune of 80% of the loss. Hence, he would take responsibility for the 20% that he had not insured. This makes it necessary for the insurance company to add the average-clause to the policy. (An Average-clause is any additional clause to an insurance policy document aimed at protecting insurance companies against underinsurance).
(c) Double insurance
This occurs where a person insures the same subject matter with more than one insurance
company. In such a case the insured person pays double premiums, but in the event of loss, the companies that insured that common property will contribute towards the indemnification of such a person. Hence, the insured person does not benefit out of double insurance. He actually loses by paying double premiums but is only restored back to the economic point that he was in before the occurrences of the events of a loss.
There several insurance companies share the burden of insuring a common property. Takes place where the value of the property is very high or where the risks involved are very and one company feels that it may not be willing to take up all that risk. Such an insurance invites another insurance company so that they may insure that property together. In the of loss, each of the insurance companies that had insured the property would indemnify the person as per the proportion of the property they had individually insured.
occurs when one insurance company insures itself with another insurance company known as a re-insurance company. The reason for this is to spread risks, e.g. if an insurance company Insures a certain firm for a large sum of money, it may insure itself with another insurance company for that particular risk. In the occurrence of a loss, the re-insurance company will indemnify the insurance company, and the insurance company would then indemnify the owner of the property.
(f) Surrender value
This is the sum paid back by an insurance company in respect of a life assurance policy to a person who decides to terminate the policy contract before its maturity date. The insurance company will, however, pay the surrender value only if the policy has been in force for a given period of time.
This is the sum of money that insurance company requires that the insured person to pay from time to time in order for the insurance contract to be effective.
This is the contract document for an insurance cover. It is the document that shows that a contract of insurance exists between an insured persons and the insurance company’s.
(i) Cover note -
This is a temporary document issued by an agent of an insurance company to an insured person to show that the person is validly insured against the risk indicated there in. This document has a validity of30 days, and it is issued to await the processing of the policy documents.
Calculation of indemnity
A property with a value of Sh.1,000,000 is insured for Sh 800,000. The property is completely destroyed by fire. Calculate the indemnity due for a policy with the average clause.
Policy value = Sh. 800,000 Loss suffered = Sh. 800,000
Indemnity = policy value x loss suffered actual value of the property
Note that as far as the insurance is concerned, the loss recognized by the insurance company is the value that has been insured. Hence, the loss recognized in this case is Sh 800,000 and not 1,000,000, which is the gross loss.