LECTURE 12

Insurance and Assurance

Insurance: A legal contract in which an insurer promises to pay a specified amount to another
party, the insured, if a particular event happens and the insured suffers a financial loss as a result.

Insurance is a means of protection from financial loss. Insurance is generic for all types of
insurance and assurance. However, insurance differs from assurance in that insurance covers
risks that may occur e.g. theft, fire, accident etc., and assurance covers events that will occur
such as death (that must occur).

The parties to the insurance contract are the insurer (the company offering protection) and the
insured (the person seeking protection). Payments are made by the insured for this service. The
price charged for insurance is called a premium. The contract is known as the policy.

Insurance Principles

The purpose of insurance is to compensate persons insured who suffer loss. It is based on the
principle of indemnity, that is, to restore the insured to his original position before he suffered
loss. Insurance therefore as a principle neither makes the insured worse off or better off than
before loss was incurred. For example, if Mr. Green suffered damages valuing $500,000
subsequent to a fire at his home, he will be compensated exactly $500,000 to repair his house.

Principles of Insurance

Indemnity- Restoring the insured to his original position

Insurable interest- The insured must have a vested interest in what is being insured. For
example, someone is not allowed to insure his neighbour’s house.

Utmost Good Faith- The insured must be truthful concerning the information pertaining to the
policy contract.

Proximate Cause - The damage caused must be close or proximate to the event insured
against. For example, if someone has an accident policy that includes death occurring as a result
of an accident, this person will not be compensated if death is caused by disease.

Contribution – This principle prevents persons insuring identical risks on the same property
with several companies and thus profiting if they suffer loss. For example, an individual may
insure his car with three insurance companies hoping to be compensated by all three. He will not
succeed as the insurance companies will each only pay a portion of the claim.

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Average Clause – This clause sets a limit to the size of the compensation, which depends on the
proportion of the true value of the asset paid up by the insured. For example, a homeowner
insures his home for $100,000 which is half the true value of $200,000. His house was partially
destroyed by fire on the insurance company for $50,000 worth of damage. The insurance
company only paid him $25,000 as he was only insured for 50% of the true value of the house
presently.

Subrogation -This is an extension of the principle of indemnity, that is, the insured should be
reinstated to his exact position before the loss. For example, if a vehicle is totally wrecked and
the insurance company pays the insured the value of the car, the wrecked vehicle will be claimed
by insurance company.

How does insurance Work?

How are insurance companies able to pay its clients large sums of money to compensate them for
loss? They operate on the basis of risk pooling. Premiums from large numbers of persons with
the same risks are pooled and only those who suffer loss are compensated. The insurance
company can predict the percentage of losses based on past data. The premiums charged are
based on the number of losses predicted plus the cost to operate the business and profits to be
realized. For example, a particular insurance company may insure one thousand persons for risk
against car theft. Only two percent of those insured may suffer loss and therefore the insurance
company can afford to assist those persons.

Types of Insurance Policies

1.Life Assurance
(a)Whole Life Assurance
Payment will be made upon the death of the insured. The beneficiaries of the insured will be
paid.

(b) Endowed Assurance

Payments are made at the end of specific periods. The Endowment policies may be paid at the
end of twenty or thirty years or at the age of retirement. If death occurs before the end of the
endowment period insured, then the beneficiaries of the insured will be paid.

2.Term and Business Insurance

(a) Fire Insurance
Covers loss or damages to assets by fire

(b) Burglary Insurance

Covers loss due to goods stolen and damages to property caused by theft

(c) Bad Debts Insurance

Covers debts that cannot be collected

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(d) Plate Glass Insurance
Covers the replacement of shop windows as well as any injury to staff and customers that may be
caused by its breakage

(e) Fidelity Guarantee Insurance

This protects a firm against loss due to the misappropriation of funds by employee, customers or
other persons.

(f) Employers’ Liability Insurance and Public Liability

Covers injury incurred by staff or visitors on a business location due to the negligence of the
firm, e.g., customers slipping on a wet floor.

(g) Motor Insurance

Third party – Only third parties e.g. passengers are covered. The driver and car is not covered.
Comprehensive – Covers loss due to damages to the driver and third parties.

(h) Marine Insurance

This policy covers loss due to damages of ships and cargo at sea.

Importance of Insurance to Businesses

Entrepreneurs invest a wealth of resources into the start-up and continuous operation of a
business. If the entrepreneur suffers any form of loss such as fire or burglary etc. the business may
take a long time to recover. Insurance is therefore very important to the business community. The
principle of indemnity ensures that an entrepreneur receives enough compensation to continue the
business with minimum effects.

 It encourages enterprise or industry by covering risk of business firms

 Facilitates trade between countries whereby, businesses would be compensated for losses
during transit.
 Provides a source of capital for business investors.
 Provides coverage against personal risk when an individual is not able to manage it.