What Is Insurance?

Insurance is the protection

granted to an individual,
institution or indeed the
traders against financial
losses that may be caused by
of the occurrence of risks
It is based on probabilities
the risks may or may not
occur
Insurance aims at
restoring/indemnifying/compe
nsating the insured should the
risk occur
Common Terminologies Used In
Insurance
Proposer: One applying for or seeking
insurance cover.
Insured: One who is covered by an
Insurance Company
Insurer: Insurance company providing
the insurance cover
Proposal Form: Application form for
insurance
Common Terminologies Used In
Insurance Cont.
Policy: A written contract of insurance between the
insurer and the insured, containing all the terms,
conditions and warranties of the insurance cover, and
as well as the amount of premium, sum insured and the
expiry date of the contract among others.
Premium: Non-refundable small amount of money
contributed to the Insurance Company in return for
insurance cover.
Third Party: One who is affected, but not part of the
insurance contract.
The Importance Of Insurance
It protects the insured
against financial loss
by providing compensation
thereby providing traders with the
confidence to engage in big
business ventures
Insurance is an invisible export that
brings foreign exchange.


I received my
new car from
my insurer as
compensation
The Importance Of Insurance Cont.
Life assurance provides a
family saving plan as it
mostly benefits the
dependants, should the
assured die.
Insurance protects the
insured against claims from
the injury, death or damage to
property of the third parties.
It protects employers against
financial loss arising from
claims from employees who
may die or be injured while on
duty.
A house bought after receiving
monetary compensation from an
Insurance company.
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The Nature of Insurance
Insurance involves not only risk transfer but also pooling
and risk reduction
Pooling: The sharing of total losses among a group
Risk reduction: A decrease in the total amount of uncertainty
present in a particular situation
Insurers accomplish this by combining a group of objects situated so that
the aggregate losses become predictable within narrow limits
Overall risk for the group is reduced, and losses that result
are pooled
Usually through the payment of an insurance premium
Insureds transfer various risks to the group and exchange a
potentially large uncertain loss for a relatively smaller
certain payment (the premium)
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The Nature of Insurance
Gambling and insurance are exact opposites
Gambling creates a new risk where none existed before
Insurance is a method of eliminating or greatly
reducing an already existing risk
Insurance is usually implemented through legal
contracts, or policies
Insurer promises to reimburse the insured for losses
suffered during the term of the agreement
Implicit is the assumption that the insurer will be able to
pay whatever losses may occur
Important to consider the financial condition of the insurer
How Insurance Operates.
Insurance operates on the basic rule of Pooling Of
Risks.
Pooling of risks is:
when many insured persons pay premium to the
insurance company, thereby creating a pool
(piling up/collection) of funds, from which the
company pays out compensation to those who
suffer losses.
How Insurance Operates Cont.
Insurance is successful with the collection of
more premiums but the occurrence of fewer
risks
The lucky ones (the fortunate), who do not
receive anything, pay for the unfortunate.
The insured persons/institutions must not
all suffer a loss at the same time, as there
cannot be enough funds in the pool to pay
every one
Meaning of Risk
Risk is the potential that a chosen action or activity (including
the choice of inaction) will lead to a loss (an undesirable
outcome)
OR
Risk is an uncertainty concerning the occurrence of a loss
In insurance industry we define risk to identify the property or
life being insured
that driver is a poor risk, cancer patient is an unacceptable
risk


Types of Risk
1. Objective Risk: relative variation of actual loss from
expected loss
For eg: An insurer has 100000 cars insured for a long period of
time, and on the average 10000 cars meet with at least one accident
and claim for damages each year. However, for a particular year, it
is unlikely that there will be exactly 10000 claims. Under certain
assumptions, it can be proven that over a long period of time, the
deviation of the number of claim in a year from 10000 will, on the
average be 100.
Thus there is a variation of 100 claims from the expected number
of 10000 or a variation of 1%.
This relative variation of actual loss from expected loss is known
as objective risk

Types of Risk
2. Subjective Risk : an uncertainty in the
individuals personal estimate of the chance of
loss.
It can vary from one person to another.
For eg-Somebody who has lost a lot of money in the stock market
will probably feel more risk investing in the market than someone
who has profited handsomely.
Subjective risk may alter the behavior of the risk taker if it is an
undesirable risk

Types of Probabilities
Objective probability is the
probability of an occurrence,
calculated by either deduction or
induction
Subjective probability is a persons
perception of the likelihood of an
event.
Chance of Loss

is the probability that a loss will occur,
which can either be an expected loss or an
actual loss

Chance of Loss =
Expected or Actual Loss

Number of Possible Losses
Categories of Risks
Pure and Speculative Risks
Fundamental and Particular Risks
Enterprise Risk
Pure Risk & Speculative Risk
Pure risk : there are only the possibilities of loss or no
loss
Examples: Damage to property from fire, lightning,
flood or earthquake etc
Speculative risk : either profit or loss is possible
Examples: investment in shares or real estate, betting on
horse race
ONLY Pure Risks are insured but exceptions always
exist.. Like some insurers will insure institutional
portfolio investments
Fundamental & Particular Risks
Fundamental risk affects the entire economy or
large number of persons or groups within the
economy rapid inflation, cyclical
unemployment, war, natural disaster, terrorist
attack
Particular Risk affects only individuals and not
the entire community . For e.g.. Car thefts,
bank robberies, dwelling fires

Enterprise Risk
Relatively new term that encompass major risks faced
by a business firm
Pure Risk
Speculative Risk
Strategic Risk: uncertainty regarding the firms
financial goals and objectives
Operational Risk: results from the firms business
operations like a bank that offers new online banking
services may incur losses if hackers break into the
bank s computers

Enterprise Risk cont
Financial risk: refers to the uncertainty of loss
because of adverse changes in commodity
prices, interest rates, foreign exchange rates, an
the value of money
Examples
A food company that agrees to deliver a
commodity at a fixed price to a supermarket in
six months may lose money if grain price rises

Types of Pure Risks
Premature Death
Insufficient income during retirement
Poor health
Unemployment
Property risks
Liability risks


Insurable Risks:
The are risks that;
can easily be assessed and
whose frequency of occurrence
can be estimated
can have premiums fairly
calculated
have past statistical records
can be accepted for coverage
by the insurance company
Examples of insurable risks
include; fire, theft, death,
claims from third parties,
damage to property,
burglary, bad debts, etc


Non-Insurable Risks:
These are risks that;
can not be easily assessed and
their frequency of occurrence can
not be estimated
whose premium can not be fairly
calculated
do not have any past statistical
record of occurrence
can not be accepted to be covered
by the insurance company
Examples of Non Insurable risks
include: Bad Management, Illegal
acts such as theft, losses due to
change of fashion, natural calamities
such as earth quakes, etc.
The risk of being caught for
performing an illegal act such
as robbery is non insurable.
Peril and Hazard
peril is something that can cause a loss.
Examples include falling, crashing your car,
fire, wind, hail, lightning, water, volcanic
eruptions, choking, or falling objects


Hazard is a condition that creates or increases
the chance of loss

Types of Hazards
Physical hazard
Moral Hazard
Morale hazard
Legal hazard
Physical Hazard
Physical condition that increases the chance
of loss
Examples-
Icy roads that increase the chance of an auto
accident
Defective wiring in a building that increases
the chance of fire
working from heights, including ladders,
scaffolds, roofs, or any raised work area
Moral Hazard
Dishonesty or character defects in an
individual that increase the frequency or
severity of loss
Examples-
Submitting a fraudulent claim,
inflating the amount of a claim,
Intentionally burning unsold merchandise
that is insured

Morale Hazard
Carelessness or indifference to a loss because of the
existence of insurance
Examples
Leaving car keys in an unlocked car which increases
the chance of theft
Leaving a door unlocked that allows a burglar to
enter
Its insured so why should I worry about safety of
my house/property/own health. If anything goes
wrong, insurer is there to indemnify me. So, Why
should I worry about safety?
Legal Hazard
Characteristics of the legal system or
regulatory environment that increase the
frequency or severity of losses
Examples:
Laws that require insurers to include
coverage for certain benefits in health
insurance plans, such as alcholism

















































A Contract

An agreement between two or
more parties to do or abstain from
doing an act

Create a legally binding
relationship

Essentials of a valid Contract

The intention to create legal relations
Offer and acceptance
Consideration
Certainty of terms
Consensus ad idem (a genuine meeting of
minds)
Legality of purpose
Possibility of performance
Requirements of an Insurance Contract
Offer and acceptance
Consideration
Competent parties
Legal Purpose
Requirements of an Insurance Contract
Offer and Acceptance: Applicant for insurance makes the
offer and the company accepts or rejects the offer
An agent merely solicits the prospective insured to make the
offer
In property & Liability insurance especially personal line
insurance auto , home insurance , the agents typically have
the power to bind the insurer through the use of binder.
Binder is a temporary contract for insurance
In life insurance, agent does not have the power to bind the
insurer
A conditional premium receipt is given to the applicant after
filling the application form





Consideration
Consideration is the value that each party gives to the
other

For Insured: Payment
of first premium plus
an agreement to abide
by the conditions
specified in the policy
For insurer: Promise to
do certain things as
specified in the
contract. For e.g.:
paying for a loss from
the insured peril
Competent Parties
Each party must be legally competent/ must
have legal capacity to enter into a binding
contract
Most adults are legally competent to enter into
the insurance contracts but there are some
exceptions like
Insane persons, intoxicated persons, minors
Also, insurer must be licensed to sell insurance
in that country
Legal Purpose
An insurance contract that encourages
something illegal or immoral is contrary
to the public interest and can not be
enforced
For e.g. policy can not cover seizure of
the drugs by the police
Aleatory Contract
Unilateral Contract
Personal Contract
Conditional Contract
Contract of Adhesion

Distinct Legal Characteristics of
Insurance Contracts
Distinct Legal Characteristics of
Insurance Contracts
Aleatory Contract: where the values exchanged may not be
equal but depend on an uncertain event . For e.g..-
(Commutative Contract?)
Unilateral Contract: only one party makes a legally
enforceable promise. Only the insurer makes a legally
enforceable promise to pay a claim . After the first premium is
paid, the insured can not be legally forced to pay the premiums
(Bilateral Contract?)
Personal Contract: the contract is between the insured and the
insurer

Distinct Legal Characteristics of
Insurance Contracts
Conditional Contract: Insurers obligations to pay a claim
depends on whether the insured has compiled with all policy
conditions
For e.g. In a homeowners policy , the insured must give
immediate notice of loss. If the insured delays for an
unreasonable period in reporting the loss, the insurer can refuse
to pay the claim
Contract of Adhesion: means the insured must accept the
entire contract, with all of its terms and conditions
Principles Of Insurance
These are rules or guidelines in insurance which must
be strictly adhered to. The non-adherence to these
principles can render ones insurance contract being
declared null and void.
There are four main principles of insurance namely:
Principle of Indemnity
Principle of Proximate Cause
Principle of Insurable Interest
Principle of Utmost Good Faith (Uberrima Fides)
Principle of Indemnity
It states that should the insured suffer a
loss, he or she must be brought back to
the original (former) position without
being allowed to make profit out of it,
and that the sum insured is directly
proportional to the amount of
compensation.
Principle Of Indemnity Cont.
To ensure that principle of indemnity
performs its function, it is governed
by three rules namely;
Rule of Contribution
Rule of Subrogation
Rule of Average Clause or Under
Insurance
Rule Of Contribution
This rule states that: should one
insure the same item with more
than one insurance company, the
concerned insurers would each
equally contribute towards the
required sum of compensation.
Rule of Contribution Cont.
For example, Mr. Mumba decides to
insure his car against accident with
Zambia State Insurance Company,
Madison Insurance Company and
Goldman Insurance company for
$30,000,000.
Rule Of Contribution Cont.
If the risk occurs and he needs K30,000,000
to be brought back to the original position,
the three Insurance Companies will each
contribute K10,000,000 towards his
compensation.
This is to ensure that he is brought back to
his former position without being allowed to
make profit out of insurance.
Rule Of Subrogation
This rule states that: Should the
insured item be damaged beyond
repair, once the insured is
compensated in full, the remains of
the damaged item would now
belong to the insurance company.
Rule Of Subrogation Cont.
For example, if Mrs. Chilukushas car
(which was comprehensively insured) is
damaged beyond repair, the Insurance can
decide to buy her another car, and
thereafter assume ownership of the
damaged one.
Rule of subrogation therefore prevents her
from making profit by selling the spare
parts of the damaged vehicle.
Rule of Average Clause
This rule states that the insured is his/her
own insurer for the amount not covered by
the insurance company.
For example, if Mr. Ngambi insures his
house for only 65% of its value, the
Insurance Company can only compensate
him up to 65% of the total sum required as
compensation.
Rule Of Average Clause Cont.
Furthermore, if Mrs. Siwale comprehensively insures her car
valued at K20,000,000 for K15,000,000 and then the cost of
repair is estimated at K12,000,000.
Her amount of compensation will be as follows:
Sum Insured X Compensation Original Cost
$ 15,000,000 X $ 12,000,000
$ 20,000,000
= $ 9,000,000
This is what Mrs Siwale would receive, instead of
K12,000,000 to prevent her from making profit
out of insurance.
Principle Of Proximate Cause
It states that: Should the insured suffer a financial
loss, he/she can only be compensated if the risk
insured against is the nearest or immediate cause
of the loss, and if it is not deliberately caused by
any one.
For example, if Mr. Mumba insures his car against
theft, but an accident occurs, there would be no
compensation.
Proximate Cause therefore is What Caused The
Risk?
Principle Of Insurable Interest
It states that: Only the legal owner of the property has the
right to insure a property or life, as he/she stands to
personally experience a financial if a risk occurs.
Principle Of Insurable Interest Cont.
The importance of the insurable interest is that it
prevents people who are not legal owners from
deliberately destroying the insured items in order to
claim compensation and thus make profit out of
the loss.
For example, Mr. Simwinga cannot insure Mr.
Mumbas car. This is because Mr. Simwinga has no
insurable interest in Mr. Mumbas car.
Furthermore Mr. Simwinga may be tempted to
deliberately destroy the car in order to claim
compensation and make profit out of the loss.
Principle Of Utmost Good Faith (Uberrima Fides)
It states that: Both the Insurance Company and the
Proposer must tell the truth without leaving out
any material facts relating to the insurance
contract.
It must be applied at the time of filling details on
the proposal form, as the Insurance Company uses
this information to assess the risk, decide whether
to accept the risk or not and be able to fix a fair
premium.
Principle Of Utmost Good Faith Cont.
The proposal form therefore acts as a basis for
insurance cover.
Furthermore, principle of utmost good faith entails
that the Insurance Company must honour all its
promises reflected in the policy.
Where either the Insurer or the Insured fails to
follow the principle of utmost good faith, the
insurance contract is declared null and void.
Procedure Involved In Taking Out Insurance
Cover
The Proposer may approach the Insurance Broker
or the Insurance Company directly.
He/She then obtains a Proposal Form from either
the Broker or Insurance Company.
The Proposer completes the Proposal Form in
utmost good in faith, giving full, accurate and
detailed information about the property and risk
being insured against.
Utmost Good Faith
Uberrima fides is a Latin phrase meaning "utmost good faith
This means that all parties to an insurance contract must deal in
good faith, making a full declaration of all material facts in the
insurance proposal
A minimum standard that requires both the buyer and seller in a
transaction to act honestly toward each other and to not mislead
or withhold critical information from one another
A positive duty voluntarily to disclose ,accurately and fully, all
facts material to the risk being proposed ,whether requested or
not

57
Principle of Insurable Interest
Holds that an insured must demonstrate a
personal loss or else be unable to collect amounts
due when a loss caused by an insured peril occurs
If insureds could collect without having an
insurable interest a moral hazard would exist
Necessary to prevent insurance from becoming a
gambling contract
Necessary to remove a possible incentive for murder
58
What Constitutes Insurable Interest
The legal owner of property having its value
diminished by loss
Other rights exist that are sufficient to establish an
insurable interest in addition to ownership
The holder of a contract to receive royalties
Legal liability resulting from contracts
Secured creditors
Building contractors, etc.

59
What Constitutes Insurable Interest
Always presumed to exist in life insurance for
persons who voluntarily insure their own lives
However someone who purchases life insurance on
anothers life must have an insurable interest in
that persons life
For instance, a business firm may insure the life of a key
employee
A husband may insure the life of his wife
There are practical limits as to the amount of life
insurance an individual may obtain
60
When the Insurable Interest Must Exist
In property and liability insurance it is possible to
effect coverage on property in which the insured
does not have an insurable interest at the time the
policy is written
However such an interest is expected in the future
Courts generally hold that in property insurance,
insurable interest need exist only at the time of the
loss and not at the inception of the policy
However, if at the time of the loss the insured no longer
has an interest in the property
There is no liability under the policy
61
When the Insurable Interest Must Exist
In life insurance, the general rule is
that insurable interest must exist at the
inception of the policy
It is not necessary at the time of the
loss
Courts view life insurance as an
investment contract
Representations
Statements made by the
applicant for insurance
For e.g. If you apply for life
insurance, you may be
asked questions
concerning your age,
weight, height, occupation,
state of health, family
history etc. Your answers to
these questions are the
representations


Representation
(A)Material
(B)False
(C)Relied on by the insurer
Material - If the insurer knew the true facts, the
policy would not have been issued, or it would have
been issued on different terms
False-the statement is not true or misleading
Reliance the insurer relies on the representation in
issuing the policy at specified premium

Contract is voidable if
the representation is
Examples
Shriram applied for life insurance and states in the
application that he has not visited a doctor within the
last five years
However, six months earlier he had surgery for lung
cancer. So, the statement made by him is false,
material and relied on by the insurer

Misrepresentation in Motor Insurance
The insured misrepresented that she had no traffic
violations in the prior three-year period. After the
claim, a check of her record revealed that she had two
traffic violations in that period. The insurer denied the
coverage.
Court Decision-The insured claimed that she had
forgotten about the two violations she had made and
therefore, she had no intention to deceive. The court
ruled that it is unlikely she would forget both events .
Decision is for the insurer

Misrepresentation
If an applicant for insurance states an opinion that
later turns out to be wrong , the insurer must prove
that the applicant spoke fraudulently and intended to
deceive the company
An innocence misrepresentation of a material fact, if
relied on by the insurer , also makes the contract
voidable.