Tài liệu Bảo hiểm và sản phẩm bảo hiểm Insurance document

Academy of Finance

INSURANCE
FUNDAMENTALS
In English
Co- compiled by Dr. Hoang Manh Cu
MA. Vo Thi Pha

HA NOI, 2009

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Table of Contents
Table of Contents....................................................................................................................2
PREFACE...............................................................................................................................7
CHAPTER 1...........................................................................................................................8
OVERVIEW OF INSURANCE.............................................................................................8

1.1 Risks and insurance...............................................................................8
1.1.1 Concept of risk......................................................................................................8
1.1.2 Concept of Risk Management.............................................................................12
1.1.3 Concept of Insurance...........................................................................................16
1.1.4 Insurance Contracts.............................................................................................19

1.2 Principles of insurance........................................................................22
1.2.1 Insurable interest.................................................................................................23
1.2.2 Utmost Good Faith ............................................................................................25
1.2.3 Principle of Indemnity.........................................................................................26
1.2.4 Subrogation.........................................................................................................28
1.2.5 Contribution / Double insurance.........................................................................30

1.2.6 Proximate cause...................................................................................................31
Foreseeability: It determines if the harm resulting from an action was reasonably able
to be predicted..............................................................................................................32
Direct Causation: The main thrust of direct causation is that there are no intervening
causes between an act and the resulting harm. An intervening cause has several
requirements - it must:..................................................................................................32
○ be independent of the original act,...........................................................................32
○ be a voluntary human act or an abnormal natural event, and..................................32
○ occur at some time between the original act and the harm......................................32

1.3 Insurance market.................................................................................33
1.3.1 The buyers of insurance......................................................................................34
1.3.2 The intermediaries...............................................................................................34
1.3.3 The sellers............................................................................................................38
1.3.4 Other insurance related professions and bodies..................................................43

Actuaries are essential to the insurance and reinsurance industry,
either as staff employees or as consultants. Insurance actuaries can be
defined as qualified professionals concerned with the application of
probability and statistical theory to problems of insurance, investment,
financial management and demography..................................................43
CHAPTER 2.........................................................................................................................45
GENERAL INSURANCE....................................................................................................45

2.1 Overview of general insurance...........................................................45
2.2 Commercial general insurance...........................................................46
2.2.1 Marine Insurance and Oil & Gas Insurance........................................................46
2.2.2 Non - marine General Insurance.........................................................................54
Reduction in turnover...................................................................................................58

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Increased cost of working.............................................................................................58
2.2.2.3 Motor Vehicle Insurance...................................................................................59
- Insurable risks............................................................................................................61
Commonly, insurable risks in the construction and erection insurances include:........61
Many exclusions exist under the construction/ erection insurance policies, commonly
such as:.........................................................................................................................62

- Overview...................................................................................................64
- Types of liability insurance........................................................................................65
As we have seen, the concept of liability insurance concerns a wide range of various
types of liability. However, in this section we focus on the types of policies that not
yet discussed.................................................................................................................65
Professional liability insurance protects professionals such as architectural corporation
and medical practice against potential negligence claims made by their
patients/clients. Professional liability insurance may take on different names
depending on the profession. For instance, professional liability insurance in reference
to the medical profession may be called malpractice insurance. Notaries public may
take out errors and omissions insurance (E&O). Other potential E&O policyholders
include, for example, real estate brokers, Insurance agents, home inspectors,
appraisers, lawyers and website developers.................................................................66
▪ Public liability insurance...........................................................................................66
▪ Product liability insurance........................................................................................66
- Hull "All Risks".........................................................................................................67
- Spares insurance.........................................................................................................67
- Hull War Risks...........................................................................................................68
- Hull Total Loss Only Cover.......................................................................................69
This is similar to Hull All Risks cover given above but will respond only to total

losses of aircraft, whether actual, constructive or arranged. This is particularly given
for old aircraft since the old aircraft are heavily depreciated and insured for low sums
and premium on such low sums would result in low premium, which would be
inadequate for the partial losses. The ratio of partial losses to total losses in such old
aircraft is distorted........................................................................................................69
- Liability Insurance.....................................................................................................69

2.3 Personal general insurance.................................................................69
2.3.1 Personal accident insurance.................................................................................70
2.3.2 Medical and health insurance..............................................................................71
2.3.3 Worker compensation insurance..........................................................................72
2.3.4 Consumer credit insurance..................................................................................73
CHAPTER 3.........................................................................................................................75
LIFE INSURANCE..............................................................................................................75

3.1 Overview...............................................................................................75
3.2. Term/Temporary Term Insurance.....................................................76
3.2.1 Concept................................................................................................................76
3.2.2 Annual renewable term........................................................................................77
3.2.3 Level Term Life Insurance..................................................................................78

3.3 Permanent life insurance.....................................................................79
3.3.1 Concept................................................................................................................79

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3.3.2 Whole life insurance............................................................................................79
- Participating policy....................................................................................................81
- Indeterminate Premium..............................................................................................82

- Economic...................................................................................................................82
3.3.2 Universal life insurance.......................................................................................83

Types of universal life insurance:.............................................................84
- Single Premium..........................................................................................................84
- Flexible Premium.......................................................................................................84
3.3.4 Variable universal life insurance.........................................................................84

- Characteristics of variable life insurance..............................................86
Premium Flexibility...................................................................................86
Investment choices/ Investment options..................................................87
- Risks of Variable Universal Life.............................................................87
3.4 Endowment Insurance and Pure endowment...................................88
3.4.1 Endowment Insurance.........................................................................................88

- Traditional With Profits Endowments...................................................89
- Unit-linked endowment...........................................................................89
- Full endowments......................................................................................90
- Low cost endowment...............................................................................90
- Traded endowments.................................................................................90
3.4.2 Pure endowment..................................................................................................91

3.5 Income stream products......................................................................91
Annuities can be clarified also into follows:............................................92
Fixed and variable annuities.....................................................................92
Guaranteed annuities....................................................................................................92
Joint annuities...............................................................................................................93
Impaired life annuities..................................................................................................93

3.6 Group life insurance policies...............................................................94

Beside the basic covers that are listed above, life insurance companies
always offer many Riders or Optional Benefits or Supplementary
benefits to insurance buyers. These are modifications to the insurance
policy and change the basic policy to provide features desired by the
policy owner. Depending on the types of life insurance, the
riders/optional/ supplementary benefits are diverse. The following
brings out the main point of some these benefits:...................................95
CHAPTER 4.........................................................................................................................96
REINSURANCE..................................................................................................................96

4.1 Overview...............................................................................................96
4.1.1 The Concept........................................................................................................96
4.1.2 Functions of Reinsurance....................................................................................97
- Risk transfer...............................................................................................................97
- Income smoothing......................................................................................................97
- Reinsurer expertise.....................................................................................................97

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- Creating a manageable and profitable portfolio of insured risks...............................98
- Surplus relief and Managing cost of capital for an insurance company....................99

4.2 Methods of reinsurance.....................................................................100
4.2.1 Facultative Reinsurance....................................................................................101
4.2.2 Treaty Reinsurance............................................................................................102
4.2.3 Facultative/ Obligatory Treaty...........................................................................104

4.3 Types of Reinsurance.........................................................................105
4.3.1 Proportional Reinsurance..................................................................................105

4.3.2 Non – Proportional Reinsurance.......................................................................109

4.3.2.1 Excess of Loss reinsurance..........................................................109
Risk-attaching Basis...................................................................................................112
Loss-occurring Basis..................................................................................................112
Claims-made Basis.....................................................................................................112

▪ Paid Basis, such as: 15/12: Incurred in 15 month period / paid in 12
month contract period. For example, Policy Period: 1/1/07 - 12/31/07;
Incurred Dates: 10/1/06 to 12/31/07 -> Paid Dates: 1/1/07 to 12/31/07.
....................................................................................................................113
4.4 Non - Traditional Reinsurance..........................................................113
4.4.1 The Concept.......................................................................................................113
4.4.2 Types of Financial Reinsurance Contract..........................................................116
CHAPTER 5.......................................................................................................................120
FINANCE AND ACCOUNTING IN INSURANCE.........................................................120

5.1 Implementing the IASs/IFRS in the insurance industry ...............120
5.1.1 Overview...........................................................................................................120
5.1.2 Financial statements of insurance companies in accordance with IAS/IFRS...129
5.1.2.2 Financial statements in accordance with the IAS / IFRS...............................133
▪ Objective of financial statements............................................................................133
▪ Underlying assumptions..........................................................................................133
▪ Qualitative characteristics of financial statements..................................................133
▪ Elements of financial statements............................................................................133
▪ Recognition of elements of financial statements....................................................134
▪ Measurement of the Elements of Financial Statements..........................................134
▪ Concepts of Capital and Capital Maintenance........................................................135
▪ Content of financial statements...............................................................................135

5.2 Assessing Financial Strength of insurance companies....................136
5.2.1 Financial strength ratings methodologies of rating agencies............................136
5.2.2 Capital adequacy and solvency of insurance companies...................................141
5.2.3 Ratios used in assessing insurance company’s financial condition...................144
5.2.4 Roles of Actuaries, independent Auditors, internal audit and internal control in
the financial management...........................................................................................148
CHAPTER 6.......................................................................................................................152
LEGAL ASPECTS OF INSURANCE...............................................................................152

6.1 Overview.............................................................................................152
6.2 Legal aspects of insurance contract..................................................153
6.2.1 Concept of insurance contract...........................................................................153

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Generally, in comparison with others contracts, the insurance contracts
have following characteristics :..............................................................154
6.2.2 Essentials of a Valid Insurance Contract...........................................................154
6.2.3 Content of an insurance contract.......................................................................156

Generally, an insurance contract consists of:........................................156
6.2.4 Entering into contracts of insurance.................................................................157

Industry association rules and “best practice” codes...........................157
Law - Either common law, statutory law, or both.................................157
- Insurer’s legal obligations.....................................................................157
An insurer will normally have obligations to provide the applicant with
a copy of the proposed contract terms as well as a document which
includes the following information if relevant:.....................................158

Depending on local law and custom, an insurer may have additional
obligations as follows:..............................................................................159
Provide required disclosures and notices...............................................159
Avoid misleading or deceptive conduct..................................................159
Express documentation in plain language.............................................159
Ensure that products sold are suitable for the applicant’s circumstances
...................................................................................................................159
Post-inception obligation........................................................................159
An insurer will normally have obligations to:.......................................159
Interpret its contract terms with utmost good faith.............................159
Comply with the terms of its own contract............................................159
6.2.5 Cancellation of insurance contract....................................................................162

6.3 Insurance Regulation and supervision.............................................164
6.3.1 Objectives of Insurance Regulation and supervision........................................164

It is important to recognise that any participant in the insurance
market has taken the necessary actions to meet regulatory
requirements.............................................................................................165
6.2.2 Prudent supervision of insurance company solvency........................................167
6.3.3 Globalisation of the regulatory framework.......................................................175

Appendix 1................................................................................................184
Appendix 2................................................................................................186
Appendix 3................................................................................................194

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PREFACE

“Insurance Fundamentals” is a module of the training program for students
of the Insurance Department of the Academy of Finance prepared to provide a
fundamental knowledge of the insurance in English. This textbook is a
lecturer training framework designed to provide students with fundamental
insurance and risk management knowledge. The content of the textbook
focuses on issues closely related and greatly impacted by international
integration in the insurance markets, issues which have achieved basic
unification and become international standards in insurance business.
The module aims:
-

to improve knowledge of insurance and risk management;

-

to provide knowledge of international insurance issues;

-

to provide the basic knowledge needed in practice of international

insurance business.
The Academy endeavors to provide the most accurate and useful information
possible. Every attempt has been made to ensure that the information
contained in the textbook is current at the time of printing of the text.
However, the information of this publication may be affected by changes in
law or industry practice.
We would like to thank Mr. Michael Abadie, Director of Risk Management
Services, ADI Joint Stock Company, for sharing his experience and advice to
complete this textbook.

This textbook is provided for training program of the AOF. The writer and
AOF are not engaged in other uses such as professional advice.
Written by Dr. Hoang Manh Cu and Ma. Vo Thi Pha;
Published by Academy of Finance, Hanoi, 2009

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CHAPTER 1
OVERVIEW OF INSURANCE
1.1 Risks and insurance
1.1.1 Concept of risk
- Definition of risk
In general, risk is defined as:
“The probability of something happening that will have an adverse impact
upon people, plant, equipment, financials, property or the environment and
the severity of the impact.”
Basically, the concept of risk has three elements:
-

The perception that something could happen

-

The likelihood of something happening

-

The consequences if it happens

Risk implies some form of uncertainty about an outcome in a given situation
and the outcome is not favorable.
In the insurance area, as a basic insurance term, risk may be definned as “the
chance of something happening that may have an unfavorable financial
impact upon subject matter of insurance”. However, the term “Risk” is also
used in various senses, notably:
-

The subject matter of insurance;

-

Uncertainty as to the outcome of an event;

-

Probability of loss;

-

The peril insured against;

-

Danger;

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-

A particular unfavorable outcome such as fire damage or a broken

arm
The term “risk” can be used as a noun as in the above examples or as a verb in
which the usual meaning is to “take a chance” on something. For example a
mountain climber risks a broken arm and even risks death if he were to fall.
- Types of risks
Risk takes many forms, normally being classified into two main types being:
▪ Speculative (or Dynamic) Risk and Pure (or Static) Risk
Speculative (dynamic) risk is a situation in which either gain or loss is
possible. Examples of speculative risks are betting on a horse race, investing
in stocks/, bonds and real estate. In these situations, both gains and losses are
possible. In the daily conduct of its affairs, every business establishment
faces decisions that entail elements of risk. The decision to venture into a
new market, borrow additional capital, etc., carry risks inherent to the
business.

The outcome of such speculative risk is either beneficial

(profitable) or loss.
In contrast to speculative risk, a pure risks involves possibility of loss only or
at best a “no gain” situation. The only outcome of pure risks are adverse (in a
loss situation) or neutral (with no loss), never beneficial. A pure risk does not
include the possibility of gain.
Examples of pure risks are premature death, occupational disability,
catastrophic medical expenses, damage to property and the loss ability to
generate revenue from the asset which has been lost or damaged.
It is important to distinguish between pure and speculative risks for three
reasons:

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-

First, through the use of general insurance policies, insurance

companies generally insure only pure risks. Speculative risks are not
considered insurable, with some exceptions.
-

Second, the “law of large numbers” can be applied more easily to pure

risks than to speculative risks. The law of large numbers is important in
insurance because it enables insurers to predict loss figures in advance.
-

Finally, society as a whole benefits from speculative risk even though

a losses sometimes occurs, but is only harmed by pure risk. This is to say,
society would not benefit when pure risks such as earthquakes occur but
benefits from speculative risks taken by entrepreneurs since jobs and wealth
are created by them in the process.
▪ Particular risk and Fundamental risk
Particular risks are risks that affect only a single or relatively few individuals,
not the entire communnity. Examples of particular risks are burglary, theft,
auto accident and dwelling fires. In contrast to particular risks, fundamental
risks affect the entire economy or large numbers of people or groups within
the community.

Examples of fundamental risks are high inflation,

unemployment, war and natural disasters such as earthquakes, hurricanes and
floods, etc.
The distinction between a fundamental and a particular risk is important, since
government assistance may be necessary in order to insure fundamental risks.
Social insurance, government insurance programs, and government
guarantees and subsidies are used to meet certain fundamental risks which are
not insurable by private insurance companies.
▪ Financial risk and Non - financial risk
A financial risk is the situation in which the outcome must be capable of
measurement in monetary terms. Example of financial risk: damage to the

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hull and machinery of a vessel. The financial value of the risk is the cost of
repairing or replacing the different portions of the vessel
In contrast to financial risk, non - financial risk is the situation in which the
outcome is not measurable in monetary terms. Examples of non financial
risks are choosing a spouse or deciding whether to leave one’s hometown to
live. Each of the above situations will involve a degree of uncertainty or risk
and the result may be satisfactory or disappointing.
It is important to distinguish between a financial risk and a non - financial
risk. For a risk to be insurable, the outcome must be capable of measurement
in monetary terms. Non financial risks are not insurable.
▪ Insurable and Non-Insurable Risks
For a risk to be insurable it must meets certain conditions as follows:
-

There must be an insurable interest in the object or person being

insured.
-

There must be a large number of similar risks being insured.

-

Any losses occurring must be accidental

-

It must be possible to calculate the risk of a loss occurring.

Further, for an efficient insurance system to exist, an insurable risk must
meets the ideal criteria as follows:
-

The insurer must be able to charge a premium high enough to cover not

only claims expenses, but also to cover the insurer's expenses.
-

The nature of the loss must be definite and financially measurable. That

is, there should not be room for argument as to whether or not payment is due,
nor as to what amount the payment should be.
-

The loss should be random in nature.

Also, risks that are not measurable, can not be rated properly. The insurer will
need to charge a conservatively high premium in order to mitigate the risk of

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paying too large a claim. The premium will thus be higher than ideal, and
inefficient.
1.1.2 Concept of Risk Management
Risk Management involves the understanding and identification of a broad
spectrum of risks faced by individuals and businesses together with the ability
to make decisions with respect to methods to avoid, reduce and control risk to
the extent possible and to then make decisions with respect to determining the
most efficient way to treat the remaining risk which includes firstly to
determine the amount of risk that the organization has the ability to absorb
financially and then to plan for either insurance or other contractual transfer
of the remaining risk. “Risk” includes the full range of unfavorable outcomes
that may result from a chain of events involving hazards and perils all leading
to any one of the many possible unfavorable outcomes. Individual risks can
be studied and analyzed with the purpose to reduce its probability and its
effect. With respect to all individual risks there are chains of events that can
lead to the risk occurrence. It is important to understand these “chains” so that
risk can be most appropriately understood and managed.
All risk chains include hazards and perils. It is important to understand the
distinction among “hazard”, “peril” and “risk” as many people are confused
by these terms but in fact the succinct meaning of each is very different.
“Hazards” are states or conditions that increase the possibility of a “peril”

from happening. A “peril” is an risk event possibility that may lead to any
particular unfavorable final outcome. If a peril is incurred the risk of a
particular negative outcome is increased. For example a wet floor is a
“hazard” that may lead to the peril of a “fall” which may lead to the ultimate
risk of a “broken arm”. A wet floor does not always lead to a fall and a fall
does not always lead to a broken arm however where hazards exist then perils

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are more likely to occur and where perils occur then particular ultimate risk (a
type of loss event) such as the risk of a broken arm in this case is increased.
Thus by understanding this “chain” it is possible to manage or control the
hazard and to make perils that occur less likely to occur which in turn will
decrease the chance of suffering the ultimate particular risk (in this case is a
broken arm). Poor housekeeping is an example of a hazard that may lead to
the peril of fire. Fire may lead to complete destruction of a building.
However by ensuring good housekeeping the peril of fire is reduced. But if
the peril of fire is incurred then if there is a proper loss reduction system in
place such as a sprinkler system then the severity of the loss by fire will likely
be decreased or minimised.
The process of risk management is a systematic plan to identify risks,
evaluate the risks and to decide ultimately how to treat the risk. Risk should
be identified by formal methods such as risk questionnaires which ask basic
information about the risk such as size of risk, amount of value at risk, type of
structure, previous claim information etc. In addition physical inspection can
be made by a risk assessor who can look at housekeeping, maintenance logs,
physical condition of equipment especially boilers etc. Lastly review of the
operations process should be made to identify where any specific problems
could occur in the event of an interruption. Once risk is adequately identified

the process of determining appropriate treatment begins.
People, organizations and society usually try to avoid risk but where not
avoidable, then best to manage it. There are 5 major methods of handling risk:
avoidance, loss control, retention, noninsurance transfers, and insurance.
- Avoidance
Avoidance involves not participating in certain activities that involve risk. For
examples, the risk of a loss of investing in the stock market can be avoided by

13


not buying but the fact remains that not all risks can be avoided, and even
where they can be avoided, it is often not desirable. Avoiding risk may be
avoiding certain pleasures of life, or the potential profits that result from
taking risks. Those who minimize risks by avoiding activities are usually
bored with their life and don't make much money. Where avoidance is not
possible or desirable, loss control is the next best thing.
- Control
Loss control works by both loss prevention, which involves reducing the
probability of risk such as keeping a manufacturing facility clean and orderly,
or loss reduction, which minimizes the loss should the loss occur such as the
use of a sprinkler system.
Losses can be prevented by identifying the factors that increase the likelihood
of a loss, then either eliminating the factor or minimizing its effect. Most
businesses actively control risk because it is a cost-effective way to prevent
losses from accidents and damage to property, and generally becomes more
effective the longer the business has been operating.
- Retention
▪ Active retention (Risk assumption)
Risk retention, as active retention or risk assumption, is handling the

unavoidable or unavoided risk internally, either because insurance cannot be
purchased for the risk, because it costs too much, or because it is much more
cost-effective. Usually, retained risks occur with greater frequency, but have a
low severity. An insurance deductible is a common example of risk retention
to save money, since a deductible is a limited risk that can save money on
insurance premiums for larger risks.
▪ Passive risk retention

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Passive risk retention is retaining risk where the risk is unknown or
improperly understood.
- Transfer
▪ Non-insurance transfers of risk
Risk can also be managed by noninsurance transfers of risk. The 3 major
forms of noninsurance risk transfer is by contract, hedging, and, for business
risks, by incorporating. A common way to transfer risk by contract is by
purchasing the warranty extension that many retailers sell for the items that
they sell. The warranty itself transfers the risk of manufacturing defects from
the buyer to the manufacturer. Transfers of risk through contract is often
accomplished or prevented by a hold-harmless clause and other forms of
indemnity agreements which may limit liability for the party to which the
clause applies.
Hedging is a method of reducing portfolio risk and some business risks
involving future transactions. A Stockholders can reduce his risks by buying
“put options”. A business can hedge a foreign exchange transaction by
purchasing a forward contract that guarantees the exchange rate for a future
date. Airlines will typically hedge fuel prices by buying “forward contracts”
also known as “futures” to guaranty a maximum price for up to a certain

future period.
Investors can reduce their liability risk in a business by forming a corporation
or a limited liability company. This prevents the extension of the company's
liabilities to its investors.
▪ Insurance
Insurance is one major method that most people, businesses, and other
organizations can use to transfer certain risks. By using the law of large
numbers, an insurance company can estimate fairly reliably the amount of

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loss for a given number of customers within a specific time. An insurance
company can pay for losses because it pools and invests the premiums of
many subscribers (customers) to pay the few who will have significant losses.
1.1.3 Concept of Insurance
Generally, insurance is the means whereby the losses of a few are transferred
to many. Insurance works on the basic principle of risk-sharing. While
community grain pools have probably existed for thousands of years, modern
organized risk sharing began in the coffee houses of London a few hundred
years ago where ship owners would meet and agree to share losses with each
other. A great advantage of insurance is that it spreads the risk of a few people
over a large group of people exposed to risk of similar type.
Insurance provides financial protection against a loss arising out of happening
of an uncertain event. A person can avail this protection by paying a fee
known as premium (or contribution) to an insurance company. A pool is
created through contributions (premiums) made by persons seeking to protect
themselves from common risk. Premium is collected by insurance companies
which also act as trustee to the pool. Any loss to the insured in case of
happening of an uncertain event is paid out of this pool.

In a legal respect, insurance is defined as: “a contract between two parties
whereby one party (insurer) agrees to undertake the risk of another (insured)
in exchange for “consideration” known as premium and promises to pay a
fixed sum of money to the other party on the happening of an uncertain event
or after the expiry of a certain period in case of life insurance or to indemnify
other parties on the happening of an uncertain event in case of general
insurance”.
- Benefits of insurance
Insurance brings many benefits to individuals and to society as a whole.

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▪ Provides financial stability
With insurance, even when losses occur, peoples have the assurance that their
assets can be restored after suffering losses. So, however unfortunate events
such as these may be, their finances will not be drained, and they and their
family’s financial stability will not be undermined. They will be able to keep
their present lifestyle and their future plans. With respect to commercial
business operations insurance allows for normal operations of the business to
continue to function normally after losses have occurred.
▪ Provides peace of mind and Stimulates business enterprise
By knowing that insurance exists to meet the financial consequences of
certain risks provides peace of mind for an individual. Anxiety is also reduced
when insured persons knows that insurance is available to indemnify them
when loss occurs.
The indemnity function of insurance also relieves businesses from the worry
of anxiety they may have about how they would meet the cost of risk. In the
case of businesses, this is a positive stimulus to their activities and allows
them to get on with their own business in the knowledge that they are

financially protected against many forms of risk.
Business people will be more inclined to risk their money by building
factories, making goods, sailing ships, flying planes, etc, with the knowledge
that they will not lose everything should they fall victim to risk. This is an
extremely important benefit which insurance brings – not only to the
individual insuring but to the whole country – as stimulating businesses
makes for a healthy economy and allows for additional employment.
The need for businesses to retain large sums of money to pay for potential
losses largely disappears. This helps the business cash flow and financial
planning as money does not need to be kept in reserve for losses which may

17


occur. Instead, there is known cost – the premium. The availability of
insurance, therefore stimulates enterprises as it makes it easier for existing
businesses to invest and expand..
▪ Encourages loss control
Insurance also can help in actually reducing losses. Insurers have an
interest in reducing the frequency and severity of losses, and

insurance

companies have a great deal of experience in risks of all kinds and, over many
years, they have found ways in which certain risks can be reduced. They
employ surveyors who go out and look at premises which people may want to
insure. They can, from that experience, often suggest ways in which the
likelihood of some risk occurring may be reduced. They might see some
hazard which could injure employees, or a host of other problems. The advice
and the recommendations they make on behalf of insurance companies

reduces the likelihood of many of the losses from ever occurring. An example
would be for a surveyor to point out that flammable liquids must be stored in
proper containers and only in proper locations. You would expect that the last
place that a flammable storage container should be stored is in a stairwell.
Correct? Remember this the next time you see motorcycles being stored in the
stairwell of a residential building! In fact there is a flammable liquids storage
container in every motorcycle and so keeping motorcycles at the bottom of a
stairwell is extremely dangerous not only because it blocks exit from the
building but that because in a fire situation the gasoline containers in the
motorcycles will explode creating heat and smoke in the stairwell. Insurance
companies will help the insured facilities identify these risks and make
recommendations to reduce or even eliminate certain aspects of risk.
▪ Encourages investment

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One further benefit derived from the transaction of insurance is the use to
which the insurance company puts the money it holds in the common pool.
Insurers have, at their disposal, large sums of money. This arises from the fact
that there is the gap between the receipt of a premium and the payment of a
claims. The insurer can invest this money in a wide range of investments
which all go towards aiding government, industry, commerce and
consequently the whole of society.
▪ Enhance provision of credit facilities
Bankers and other financial institutions require the security of insurance in
financing properties and overseas trade. In this case, insurance enhances
borrower’s credit because it helps to guaranty the value of the borrower’s
collateral, or gives greater assurance that the loan will be repaid.
We could go on with the benefits of insurance, but those listed above are

enough to show that the insurance industry has a major importance to the
society. In the act of creating the common pool, security and peace of mind
are provided, the likelihood or severity of losses may even be reduced, vast
funds of money are invested for the prosperity of the economy, the country is
relieved from what it may look upon as a financial burden to compensate the
victims of loss and, finally, society gains large amounts of money from the
payment of premiums from overseas. Insurance companies contribute to the
efficiency of the economy.
1.1.4 Insurance Contracts
This section is intended to provide an overview of the structure of the
insurance contract. But first it is noted that Insurance contracts are normally
governed by the common law of contracts namely that any contract whether
the subject of insurance or any other matter require certain elements to
become enforceable. Section 6 will provide additional detail however simply

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said, the law of contracts require that there be a “meeting of the minds”
between “competent parties” with respect to legal subject matter which is to
say that the parties entering the contractual agreement be sufficiently
competent to understand the terms of the contract, that there must be
“consideration”, that the subject of the contract be of a “legal nature” nature
etc. With respect to “competent” parties, each side must normally be of a legal
age to enter contracts and be sane of mind to become enforceable. Thus a
contract entered into by an adult and a child or between a sane person and one
who is insane is not enforceable except in certain rare circumstances. Each
side must agree to exchange something of value as “consideration”. A simple
unilateral promise to give someone money or anything else is not enforceable
in the absence of the agreement of the other person to provide something of

value in return. Regarding the legality of the subject matter a contract to buy
and sell illegal drugs would not be enforceable. Insurance contracts are again
just like any another contract however as previously noted there is a special
duty to make each side aware of material information so that there is indeed a
proper understanding or “meeting of the minds” before the contract is
undertaken.
Insurance contracts have three main sections being the “declarations page”,
the main body of the policy, and a set of extensions. The following describes
these sections of the insurance contract in a bit more detail.
- The declarations page
The declarations page which can also be known as a “cover schedule”
includes basic summary information including the type of insurance, name
and addresses of the insurer and the insured, the subject matter and the
location of the risk, the jurisdiction of the risk, the effective period of the
insurance, and a policy number.

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- Policy wording
The policy wording is the full set of contractual wordings which normally
include a printed set of common wordings used by the insurer on all risks of a
similar nature together with the wordings of any particular extensions or other
modifications to the main wordings. The wordings are normally prepared by
the insurer or broker with the insurer’s final agreement. This distinction is
important since the courts normally provide that any vagaries in the contract
will be viewed in favor of the party which did not prepare the wording.
▪ The “Insuring Agreement”, general wording, conditions and exclusions
The main wording normally starts with a short sentence called the insurance
agreement. This provides for the main essence of the insurance contract.

Nearly everything else in the contract is modifying the main insurance
agreement . For example the insuring agreement found in an Industrial All
Risk property policy will typically state something like, “In consideration of
the payment of premium this policy covers all risks of loss or damage”. All
the remaining wording provides the framework of the risk by explaining that
which is required to effect the coverage, that which is required to keep the
coverage in place etc. The policy will then specify certain conditions which
must be met such as proper maintenance of equipment, the perils which are
excluded, the type of property which is excluded etc.
▪ Extensions and Modifications
Some of the perils or types of property that are excluded under the basic
policy may be covered or “bought back” by way of an “extension”. There
may be other modifications to the original wording which restrict the
coverage being provided under the basic form. For example the main policy
form may exclude losses occurring as a result of the risk of “faulty design”.
This particular exclusion is commonly “bought back” which is to say for

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some additional premium the insurer will agree to cancel the exclusion. Other
modifications may be made on an individual basis. For example the insurer
may be aware that a fire sprinkler system is inoperable. The insurer may put
some restrictions to the coverage amount while the sprinkler system is
inoperable.
A proper review of any insurance contact begins with a review of the insuring
agreement, then a review of the assets items subject to insurance to be sure
that they are covered by the policy, then a review of the perils covered or not
covered, then lastly and assuming the property is found to be the subject of
the policy and that the peril causing the loss is also covered or not excluded

then a review of the policy conditions is made to ensure that all conditions
have been met. If there is a loss for example there is a sequence of items to
review in order to determine whether the loss is covered or not. The sequence
shown above would be typical of that done by loss adjusters to determine
whether the coverage is applicable. Once there is a determination that
coverage is applicable then the adjuster will determine the quantum of the loss
and settle the claim.
1.2 Principles of insurance
Insurance is based on certain principles which form the foundation of an
insurance policy... The basic and general principles of insurance are:
-

Insurable Interest

-

Utmost Good Faith

-

Indemnity

-

Subrogation

-

Contribution

-

Proximate Cause

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1.2.1 Insurable interest
- Concept
Insurable interest is a fundamental principle of insurance. It means that the
person wishing to take out insurance must be legally entitled to insure the
article, or the event, or the life. In other words, the happening of the event
insured against, or the death of the life insured must cause the
policyholder/insured financial loss. The policyholder/insured must stand to
lose financially if a loss occurs
An insurable interest in the life of another requires that the continued life of
the insured be of real interest to the insuring party. The connection may be
financial (as when a creditor insures the life of his debtor ), or it may consist
of familial or other ties of affection.
The principle of insurable interest demonstrates the difference between
insurance and a wager or bet.
- Purpose of the insurable interest requirement is
-

To prevent gambling

-

To reduce moral hazard

-

To be able to measure the amount of loss

- Existence of insurable interest
▪ Non - life insurance
Insurable interest varies according to the type of insurance policy. These
relationships give rise to insurable interest:
-

owner of the property;

-

vendor and vendee;

-

bailee and bailor;

-

life estates;

-

mortgagee and mortgagor;

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-

creditor of an insured has an insurable interest in property pledged as

security.
▪
Life insurance
-

Each individual has an unlimited insurable interest in his or her own

life, and therefore can select anyone as a beneficiary.
-

Parent and child, husband and wife, brother and sister have an

insurable interest in each other because of blood or marriage.
-

Creditor-debtor relationships give rise to an insurable interest.

-

Business relationships give rise to an insurable interest.

- When must insurable interest exist?
▪ Non - life insurance
Insurable interest has to exist both at the inception of the contract and at the
time of a loss. For instance, an insured can purchase a homeowners policy

because of insurable interest in a home. Upon selling it, the insured no longer
has an insurable interest because there is no expectation of a monetary loss
should the home burn down.
Note that in certain types of insurances such as marine cargo insurance, the
insured’s relationship with a thing that supports issuance may exist at the time
of loss only, not necessarily at the inception of the contract.
▪ Life insurance
Insurable interest must exist at the inception of the contract, not
necessarily at the time of loss. For example, because a woman has an
insurable interest in the life of her fiancé, she purchases an insurance policy
on his life. Even if the relationship is terminated, as long as she continues to
pay the premiums she will be able to collect the death benefit under the
policy.

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1.2.2 Utmost Good Faith
- Concept
One of the important basic principles of insurance is known as 'utmost good
faith'. The duty of utmost good faith is central to the buying and selling of
insurance - both the insured and the insurer are expected to disclose any
information, important to the contract. This means that the insurer and the
insured have a duty to deal honestly and openly with each other in the
negotiations which lead up to the formation of the contract. This duty
continues whilst the contract is in force. If one party is in breach of this duty,
the other party usually has the right to avoid the contract entirely.
- Duty of Disclosure
▪ Insured’s Duty of Disclosure
The insured is legally obliged to disclose all information that would influence

the insurer's decision to accept the risk. Very often, the insurer has to rely only
on the description and details filled in the proposal form. In the absence of a
formal verification through third party surveyors, the Insurer has no way of
verifying these details. After an insured peril has operated, the subject matter
of the insurance may very well have gone up in smoke or washed away. It is
therefore an implied condition or principle of insurance that the insured be
required to make a full disclosure of all material particulars within his
knowledge about his risk. After taking out an insurance policy, if there are
any alterations or changes to the business or risk which increases the risk, the
insured must inform the insurer.
Normally, a breach of the principle of utmost good faith arises when insured,
whether deliberately or accidentally, fails to divulge these important facts.
There are two kinds of non-disclosure:
-

Innocent non-disclosure or misrepresentation;

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