UNIT 3: INSURANCE: AN OVERVIEWUNIT 3: INSURANCE: AN OVERVIEW

ContentsContents

3.0 Aims and Objectives3.0 Aims and Objectives

3.13.1 IntroductionIntroduction

3.23.2 DefinitionsDefinitions

3.33.3 The Functions of InsuranceThe Functions of Insurance

3.3.13.3.1 Primary FunctionsPrimary Functions

3.3.23.3.2 Secondary FunctionsSecondary Functions

3.43.4 The Roles and Importance of InsuranceThe Roles and Importance of Insurance

3.53.5 Insurance, Gambling and SpeculationInsurance, Gambling and Speculation

3.5.13.5.1 Insurance and GamblingInsurance and Gambling

3.5.23.5.2 Insurance and SpeculationInsurance and Speculation

3.63.6 Legal Principles of Insurance ContractsLegal Principles of Insurance Contracts

3.73.7 Classification of InsuranceClassification of Insurance

3.7.13.7.1 Life InsuranceLife Insurance

3.7.1.13.7.1.1 Essential Features of Life Insurance Essential Features of Life Insurance

3.7.1.23.7.1.2 Basic Types of Life InsuranceBasic Types of Life Insurance

3.7.1.33.7.1.3 Life Insurance Premium CalculationsLife Insurance Premium Calculations

3.7.23.7.2 Non Life InsuranceNon Life Insurance

3.7.2.13.7.2.1 Personal Accident InsurancePersonal Accident Insurance

3.7.2.23.7.2.2 Permanent Health InsurancePermanent Health Insurance

3.7.2.33.7.2.3 Motor InsuranceMotor Insurance

3.7.2.43.7.2.4 Marine and Transport InsuranceMarine and Transport Insurance

3.7.2.53.7.2.5 Comprehensive Insurance Comprehensive Insurance

3.83.8 Limitation of InsuranceLimitation of Insurance

3.93.9 Summary Summary

3.10 Answer to Check Your Progress Exercise3.10 Answer to Check Your Progress Exercise

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3.0 AIMS AND OBJECTIVES3.0 AIMS AND OBJECTIVES

Dear student, considering what has been said in chapter one, it is difficult to see why anyoneDear student, considering what has been said in chapter one, it is difficult to see why anyone

should want to venture outside his/her own front door, let alone put his/her money into someshould want to venture outside his/her own front door, let alone put his/her money into some

form of business venture. It is easy to become rather paranoid about the whole business of riskform of business venture. It is easy to become rather paranoid about the whole business of risk

and forget that life, particularly business life, must continue in the face of all the risks that weand forget that life, particularly business life, must continue in the face of all the risks that we

are surrounded of. However, such feelings will be mitigated by some mechanisms of handlingare surrounded of. However, such feelings will be mitigated by some mechanisms of handling

risks like the purchase of insurance. In line with this, the unit focuses on the role of insurancerisks like the purchase of insurance. In line with this, the unit focuses on the role of insurance

in attempting to address some of the problems created by risk.in attempting to address some of the problems created by risk.

3.1 INTRODUCTION3.1 INTRODUCTION

Insurance plays an extremely important part in ensuring the economic well being of theInsurance plays an extremely important part in ensuring the economic well being of the

country, but it does not have a high profile and therefore many people have little idea of thecountry, but it does not have a high profile and therefore many people have little idea of the

full role it plays. For many, a knowledge of insurance is limited to their own personal house,full role it plays. For many, a knowledge of insurance is limited to their own personal house,

motor or life insurance. These forms of domestic insurances are all important, but are amotor or life insurance. These forms of domestic insurances are all important, but are a

relatively small part of the overall activity within the insurance industry. We will see in thisrelatively small part of the overall activity within the insurance industry. We will see in this

chapter that the insurance service provided to industry, and individuals, has far reachingchapter that the insurance service provided to industry, and individuals, has far reaching

benefits, both for those who insure and for the country as a whole.benefits, both for those who insure and for the country as a whole.

3.2 DEFINITIONS3.2 DEFINITIONS

Insurance can be defined in several ways and probably no one brief definition does autistic toInsurance can be defined in several ways and probably no one brief definition does autistic to

its many new features. It may be defined from economic, legal, business, social andits many new features. It may be defined from economic, legal, business, social and

mathematical point of views. In economic sense, for instance, insurance is a mechanism ofmathematical point of views. In economic sense, for instance, insurance is a mechanism of

providing certainty or predictability of loss with regard to pure risk. It accomplishes these byproviding certainty or predictability of loss with regard to pure risk. It accomplishes these by

policy or charity of risk. By reducing uncertainty in the business environment, it will createpolicy or charity of risk. By reducing uncertainty in the business environment, it will create

peace of mind that enables businessmen focus on their primary activities instead of worryingpeace of mind that enables businessmen focus on their primary activities instead of worrying

about the existence of possibility of loss so that societies can grow more.about the existence of possibility of loss so that societies can grow more.

From legal point of viewFrom legal point of view, insurance, insurance is a contract whereby, a consideration (price) paid to a is a contract whereby, a consideration (price) paid to a

party adequate to the risk, becomes security to the other that he shall not suffer loss, damageparty adequate to the risk, becomes security to the other that he shall not suffer loss, damage

or prejudice by the happening of risks specified in the contract for which he may be exposedor prejudice by the happening of risks specified in the contract for which he may be exposed

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to. The contracting parties are the insured, who is responsible to pay the price for obtainingto. The contracting parties are the insured, who is responsible to pay the price for obtaining

the security (premium), and the insurer, who will assume the risk transferred. This makesthe security (premium), and the insurer, who will assume the risk transferred. This makes

insurance a means of transferring risk for a premium (price) from one party known as theinsurance a means of transferring risk for a premium (price) from one party known as the

insured to another called insurer.insured to another called insurer.

From business perspective insurance is defined as a cooperative device to spread the lossFrom business perspective insurance is defined as a cooperative device to spread the loss

caused by a particular risk over a number of persons who are exposed to and who agree tocaused by a particular risk over a number of persons who are exposed to and who agree to

ensure themselves against that risk. Every risk involves the loss of one or other kind. Theensure themselves against that risk. Every risk involves the loss of one or other kind. The

function of insurance is to spread the loss over a large number of persons who agreed tofunction of insurance is to spread the loss over a large number of persons who agreed to

cooperate each other at the time of loss. The risk cannot be averted but loss occurring due to acooperate each other at the time of loss. The risk cannot be averted but loss occurring due to a

certain peril can be distributed amongst the agreed persons. They agree to share the losscertain peril can be distributed amongst the agreed persons. They agree to share the loss

because the chance of loss, i.e, the time and amount, to a person is not known.because the chance of loss, i.e, the time and amount, to a person is not known.

Any of the insureds may suffer loss to a given risk; so, the rest of the persons who haveAny of the insureds may suffer loss to a given risk; so, the rest of the persons who have

agreed will share the loss. The larger the number of such persons, the easier the process ofagreed will share the loss. The larger the number of such persons, the easier the process of

distribution of loss. In fact, they share the loss by payment of premium, which is calculated ondistribution of loss. In fact, they share the loss by payment of premium, which is calculated on

the basis of probability of loss. the basis of probability of loss.

From the social point of view insurance is defined as a device to accumulate funds to meetFrom the social point of view insurance is defined as a device to accumulate funds to meet

uncertain losses of capital, which is carried at through the transfer of the risk of manyuncertain losses of capital, which is carried at through the transfer of the risk of many

individual to one person or, to a group of persons. individual to one person or, to a group of persons.

Mathematically, insurance is the application of certain actuarial principles (insuranceMathematically, insurance is the application of certain actuarial principles (insurance

mathematics). Law of probability and statistical techniques are used to achieve predictability.mathematics). Law of probability and statistical techniques are used to achieve predictability.

In summary insurance is an economic system for reducing uncertainty of loss through poolingIn summary insurance is an economic system for reducing uncertainty of loss through pooling

of losses together, a legal method of transferring risk from the insured to the insurer in aof losses together, a legal method of transferring risk from the insured to the insurer in a

contract of indemnity, a business undertaking for profit that provides many jobs in a freecontract of indemnity, a business undertaking for profit that provides many jobs in a free

enterprise economy, a social device in which the loss of few is covered by the contribution ofenterprise economy, a social device in which the loss of few is covered by the contribution of

many, or an actuarial system of applied mathematics.many, or an actuarial system of applied mathematics.

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3.3 THE FUNCTIONS OF INSURANCE3.3 THE FUNCTIONS OF INSURANCE

The functions of insurance can be studied in two parts: primary and secondary functions.The functions of insurance can be studied in two parts: primary and secondary functions.

3.3.13.3.1 Primary FunctionsPrimary Functions

Insurance executes the following functions primarily.Insurance executes the following functions primarily.

a.a. Providing certainty. Providing certainty. Insurance provides certainty of payment at theInsurance provides certainty of payment at the

uncertainty of loss. The uncertainty of loss can be reduced by better planning anduncertainty of loss. The uncertainty of loss can be reduced by better planning and

administration. Insurance removes all uncertainties and assurance is given to payment ofadministration. Insurance removes all uncertainties and assurance is given to payment of

compensation at the time of loss. The insurer charges premium for providing the saidcompensation at the time of loss. The insurer charges premium for providing the said

certainty.certainty.

b.b. Protection.Protection. The main function of insurance is to provide protection against the The main function of insurance is to provide protection against the

probable chances of loss. Insurance guarantees the payment of loss and this protects theprobable chances of loss. Insurance guarantees the payment of loss and this protects the

assured from sufferings.assured from sufferings.

c.c. Risk-sharing. Risk-sharing. When the risk takes place, all the persons who are exposed toWhen the risk takes place, all the persons who are exposed to

the risk share the loss.the risk share the loss.

3.3.23.3.2 Secondary FunctionsSecondary Functions

In addition to the aforementioned primary functions, insurance plays the following:In addition to the aforementioned primary functions, insurance plays the following:

a.a. Prevention of loss. Prevention of loss. Insurance is primarily concerned with the financial consequences ofInsurance is primarily concerned with the financial consequences of

losses, but it would be fair to say that insurers have more than a passing interest in losslosses, but it would be fair to say that insurers have more than a passing interest in loss

control. It could be argued that insurers have no real interest in the complete control of loss,control. It could be argued that insurers have no real interest in the complete control of loss,

as this would inevitably lead to an end to their business. This is a rather shortsighted view.as this would inevitably lead to an end to their business. This is a rather shortsighted view.

Insurers do have an interest in reducing the frequency and the severity of loss. In a practicalInsurers do have an interest in reducing the frequency and the severity of loss. In a practical

way, buyers of insurance will normally come into contact with the loss control servicesway, buyers of insurance will normally come into contact with the loss control services

offered by an insurer when they meet the surveyor. The surveyor may be employed by theoffered by an insurer when they meet the surveyor. The surveyor may be employed by the

insurer, or indeed the insurance broker, and part of his job is to give advice on loss control.insurer, or indeed the insurance broker, and part of his job is to give advice on loss control.

Many insurers employ specialist surveyors in fire, security, liability and other types of risk;Many insurers employ specialist surveyors in fire, security, liability and other types of risk;

others will employ people with broader, but less detailed, knowledge.others will employ people with broader, but less detailed, knowledge.

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The surveyor will assess the extent of the risk to which the insurance company is exposed.The surveyor will assess the extent of the risk to which the insurance company is exposed.

In doing so he will also offer advice, which could take the form of pre-loss controlIn doing so he will also offer advice, which could take the form of pre-loss control

(minimizing the chance that something will happen) or post-loss control (after an event(minimizing the chance that something will happen) or post-loss control (after an event

has occurred). Traditionally, the expertise of surveyors was concentrated on risks forhas occurred). Traditionally, the expertise of surveyors was concentrated on risks for

which commercial insurance was available. Increasingly, risk control surveyors employedwhich commercial insurance was available. Increasingly, risk control surveyors employed

by insurers and insurance brokers have extended the services they offer to includeby insurers and insurance brokers have extended the services they offer to include

identification and control of all risks faced by organizations, as part of a wider riskidentification and control of all risks faced by organizations, as part of a wider risk

management service.management service.

The best time for a surveyor to be consulted is at the planning stage of a project. He canThe best time for a surveyor to be consulted is at the planning stage of a project. He can

then incorporate features which may minimize risk and control loss. A good example ofthen incorporate features which may minimize risk and control loss. A good example of

this is the installation of automatic fire-sprinkler systems. It is obviously far simpler andthis is the installation of automatic fire-sprinkler systems. It is obviously far simpler and

cheaper to include a sprinkler system in the design of a building, rather than to alter acheaper to include a sprinkler system in the design of a building, rather than to alter a

building once it has been constructed to add sprinklers. Most builders are alert to the valuebuilding once it has been constructed to add sprinklers. Most builders are alert to the value

of fire prevention and control, but the same principle applies to safety and security.of fire prevention and control, but the same principle applies to safety and security.

The insurance assist financially to the fire brigade, educational institutions and otherThe insurance assist financially to the fire brigade, educational institutions and other

organizations, which are engaged in preventing the losses. In short, the function oforganizations, which are engaged in preventing the losses. In short, the function of

insurance is not merely compensating those who suffered loss at the time the riskinsurance is not merely compensating those who suffered loss at the time the risk

materializes. However, insurance must make sure that adequate loss prevention and lossmaterializes. However, insurance must make sure that adequate loss prevention and loss

control mechanisms were implemented by the insured to minimize the probability andcontrol mechanisms were implemented by the insured to minimize the probability and

severity of the loss.severity of the loss.

b.b. Providing Capital. Providing Capital. Insurance companies have, at their disposal, large amounts of money.Insurance companies have, at their disposal, large amounts of money.

This arises due to the fact that there is a time gap between the receipt of a premium and theThis arises due to the fact that there is a time gap between the receipt of a premium and the

payment of a claim. A premium could be paid in January and a claim may not occur untilpayment of a claim. A premium could be paid in January and a claim may not occur until

December, if it occurs at all. The insurer has this money and can invest it. In fact, theDecember, if it occurs at all. The insurer has this money and can invest it. In fact, the

insurer will have the accumulated premiums of all insureds, over a long period of time. insurer will have the accumulated premiums of all insureds, over a long period of time.

We have listed investment as one of the benefits of insurance in later discussions and theWe have listed investment as one of the benefits of insurance in later discussions and the

benefit lies in the use to which the money is put. Insurers invest in a wide range of differentbenefit lies in the use to which the money is put. Insurers invest in a wide range of different

forms of investment. By having spread of investments, the insurance industry helpsforms of investment. By having spread of investments, the insurance industry helps

national and international businesses in their borrowing. It also helps industry andnational and international businesses in their borrowing. It also helps industry and

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commerce, by making various forms of loan and by taking up shares which are offered oncommerce, by making various forms of loan and by taking up shares which are offered on

the open market. Insurers make up part of what are termed the institutional investors; thethe open market. Insurers make up part of what are termed the institutional investors; the

others include banks, building societies and pension funds. Investment is also made inothers include banks, building societies and pension funds. Investment is also made in

property. property.

3.4 THE ROLES AND IMPORTANCE OF INSURANCE 3.4 THE ROLES AND IMPORTANCE OF INSURANCE

The role and importance of insurance can be discussed in three phases:The role and importance of insurance can be discussed in three phases:

i.i. Uses to individualUses to individual

ii.ii. Uses to special group of individuals, business or industryUses to special group of individuals, business or industry

iii.iii. Uses to the societyUses to the society

i.i. Uses to an individualUses to an individual

a.a. Insurance provides security and safety. Insurance provides security and safety. Insurance reduces the physical and mentalInsurance reduces the physical and mental

stress that insureds face concerning the possibility of death, disability and financialstress that insureds face concerning the possibility of death, disability and financial

loss. Insureds, through transfer of their risk to the insurer reduce their worry about anyloss. Insureds, through transfer of their risk to the insurer reduce their worry about any

financial loss they may face due to accidental misfortune. This means that insureds arefinancial loss they may face due to accidental misfortune. This means that insureds are

to a large extent certain that the loss, if at all occurs will be recovered from the insurer.to a large extent certain that the loss, if at all occurs will be recovered from the insurer.

Insurance provides security against loss due to fire in fire insurance. In other types ofInsurance provides security against loss due to fire in fire insurance. In other types of

insurance, security is provided against loss at a given contingency. Moreover itinsurance, security is provided against loss at a given contingency. Moreover it

provides safety and security against the loss of earning at damage, destructions orprovides safety and security against the loss of earning at damage, destructions or

disappearance of property, goods, furniture etc.disappearance of property, goods, furniture etc.

b.b. Insurance affords peace of mind. Insurance affords peace of mind. The knowledge that insurance exists to meet theThe knowledge that insurance exists to meet the

financial consequences of certain risks provides a form of peace of mind. This isfinancial consequences of certain risks provides a form of peace of mind. This is

important for private individuals when they insure their car, house, possessions and soimportant for private individuals when they insure their car, house, possessions and so

on, but it is also of vital importance in industry and commerce. on, but it is also of vital importance in industry and commerce.

The security provided by insurance banishes fear and uncertainty of fire, windstorm,The security provided by insurance banishes fear and uncertainty of fire, windstorm,

automobile accident and damage that are almost beyond the control of a human being.automobile accident and damage that are almost beyond the control of a human being.

The possibility of occurrence of any of these may frustrate or weaken the human mindThe possibility of occurrence of any of these may frustrate or weaken the human mind

that would otherwise be obsessed with productive areas. The existence of insurancethat would otherwise be obsessed with productive areas. The existence of insurance

helps individuals to have peace of mind and give them relief that eventually makeshelps individuals to have peace of mind and give them relief that eventually makes

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them stimulated to more work.them stimulated to more work.

c.c. Insurance protects mortgaged property. Insurance protects mortgaged property. At the death of the owner of the mortgagedAt the death of the owner of the mortgaged

property, or at the time of damage or destruction of the property, the insurer willproperty, or at the time of damage or destruction of the property, the insurer will

provide an adequate amount to the dependents at the early death of the owner to payprovide an adequate amount to the dependents at the early death of the owner to pay

off the unpaid loans, or the mortgage gets a deflated amount at the destruction of theoff the unpaid loans, or the mortgage gets a deflated amount at the destruction of the

property.property.

ii.ii. Uses to Business Uses to Business

a.a. Reduction of uncertainty Reduction of uncertainty

Why should a person put money into a business venture when there are so many risksWhy should a person put money into a business venture when there are so many risks

which could result in the loss of the money? Yet, if people did not invest in businesseswhich could result in the loss of the money? Yet, if people did not invest in businesses

then there would be fewer jobs, less goods, the need for even higher imports and athen there would be fewer jobs, less goods, the need for even higher imports and a

general reduction in wealth. Buying insurance allows the entrepreneur to transfer atgeneral reduction in wealth. Buying insurance allows the entrepreneur to transfer at

least some of the risks of being in business to an insurer, in the manner we haveleast some of the risks of being in business to an insurer, in the manner we have

described earlier. Uncertainty of business losses is reduced in the world of business. Indescribed earlier. Uncertainty of business losses is reduced in the world of business. In

commerce and industry a huge number of properties are employed.commerce and industry a huge number of properties are employed.

With a slight carelessness or negligence, they may be turned in to ashes. Owners of theWith a slight carelessness or negligence, they may be turned in to ashes. Owners of the

business or managers might foresee contingencies that would bring great loss. To meetbusiness or managers might foresee contingencies that would bring great loss. To meet

such situations, they might decide to put aside annual reserve, but it may not besuch situations, they might decide to put aside annual reserve, but it may not be

economical for the money could have been invested in other activities. Instead, byeconomical for the money could have been invested in other activities. Instead, by

making an annual or even immediate payment, insurance policy can be taken.making an annual or even immediate payment, insurance policy can be taken.

b.b. Increasing business efficiencyIncreasing business efficiency

Insurance also acts as a stimulus for the activity of businesses which are already inInsurance also acts as a stimulus for the activity of businesses which are already in

existence. This is done through the release of funds for investment in the productiveexistence. This is done through the release of funds for investment in the productive

side of the business, which would otherwise require to be held in easily accessibleside of the business, which would otherwise require to be held in easily accessible

reserves to cover any future loss. Medium sized and larger firms could certainly createreserves to cover any future loss. Medium sized and larger firms could certainly create

reserves for emergencies such as fires, thefts or serious injuries. However, this moneyreserves for emergencies such as fires, thefts or serious injuries. However, this money

would have to be accessible reasonably quickly and hence the rate of interest whichwould have to be accessible reasonably quickly and hence the rate of interest which

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the company could obtain would be much less than the normal rate. Quite apart fromthe company could obtain would be much less than the normal rate. Quite apart from

this is the fact that the money would not be available for investment in the businessthis is the fact that the money would not be available for investment in the business

itself.itself.

Business efficiency is increased with insurance when the owner of a business is freeBusiness efficiency is increased with insurance when the owner of a business is free

from botheration of losses, hence, certainly devote much time to the business. Thefrom botheration of losses, hence, certainly devote much time to the business. The

carefree owner can work better for the maximization of profit. The uncertainty of loss,carefree owner can work better for the maximization of profit. The uncertainty of loss,

damage, destruction or disappearance of a property, may affect the mind of thedamage, destruction or disappearance of a property, may affect the mind of the

businessmen adversely. The insurance, removing the uncertainty, stimulatesbusinessmen adversely. The insurance, removing the uncertainty, stimulates

businesspersons to work hard.businesspersons to work hard.

iii.iii. Uses to society Uses to society

a.a. Wealth protectionWealth protection

With the advancement of the society, the wealth or the property of the society attractsWith the advancement of the society, the wealth or the property of the society attracts

more hazards resulting in the creation of new types of insurance invented to protectmore hazards resulting in the creation of new types of insurance invented to protect

them against the possible losses. The present, future and potential property resourcesthem against the possible losses. The present, future and potential property resources

are well – protected through insurance in which each and every member will haveare well – protected through insurance in which each and every member will have

financial security against damage and destruction of wealth. Through prevention offinancial security against damage and destruction of wealth. Through prevention of

losses, insurance protects the society against degradation of resources and ensurelosses, insurance protects the society against degradation of resources and ensure

stabilization and expansion of business and industry. stabilization and expansion of business and industry.

b.b. Economic growth Economic growth

Insurance provides strong hand and mind and protection against loss of property. InInsurance provides strong hand and mind and protection against loss of property. In

addition to these, insurance companies accumulate large sum of money available foraddition to these, insurance companies accumulate large sum of money available for

investment purpose. Such money accumulated may be invested by the insuranceinvestment purpose. Such money accumulated may be invested by the insurance

companies themselves or lent to others to produce more wealth. This will have itscompanies themselves or lent to others to produce more wealth. This will have its

contribution to the economic growth of a country. contribution to the economic growth of a country.

The fact that the owner of a business has the funds available to recover from a lossThe fact that the owner of a business has the funds available to recover from a loss

provides the stimulus to business activity that we noted earlier. It also means that jobsprovides the stimulus to business activity that we noted earlier. It also means that jobs

may not be lost and goods or services can still be sold. The social benefit of this is thatmay not be lost and goods or services can still be sold. The social benefit of this is that

people keep their jobs, their sources of income are maintained and they can continuepeople keep their jobs, their sources of income are maintained and they can continue

to contribute to the national economy. We all know the effects on a community whento contribute to the national economy. We all know the effects on a community when

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a large employer moves or ceases operation; the area runs the risk of being depressed,a large employer moves or ceases operation; the area runs the risk of being depressed,

people have less money to spend and the consequences of this can be far reaching.people have less money to spend and the consequences of this can be far reaching.

To a lesser extent, a major loss resulting in the closure of a business can have the sameTo a lesser extent, a major loss resulting in the closure of a business can have the same

impact on a community. It may not be as noticeable as the shut-down of a coal mine orimpact on a community. It may not be as noticeable as the shut-down of a coal mine or

large factory, but when losses are aggregated throughout the country the effect islarge factory, but when losses are aggregated throughout the country the effect is

considerable. It is not suggested that insurance alone keeps people in jobs, but it doesconsiderable. It is not suggested that insurance alone keeps people in jobs, but it does

play a significant role in ensuring that there are not unnecessary economic hardships.play a significant role in ensuring that there are not unnecessary economic hardships.

The three dimensions of benefits that we have already looked at, all follow on from theThe three dimensions of benefits that we have already looked at, all follow on from the

protection offered by insurance. These benefits may be to the buyer of insurance or to theprotection offered by insurance. These benefits may be to the buyer of insurance or to the

economy as a whole, but they relate in some way to the basic idea of providing a risk transfereconomy as a whole, but they relate in some way to the basic idea of providing a risk transfer

mechanism. mechanism.

3.5 INSURANCE, GAMBLING AND SPECULATIONS3.5 INSURANCE, GAMBLING AND SPECULATIONS

3.5.1 3.5.1 Insurance and GamblingInsurance and Gambling

The essential feature about gambling is that it creates a risk where there existed none hitherto.The essential feature about gambling is that it creates a risk where there existed none hitherto.

When a gambler buys a lottery ticket, for instance, or places a bet on a horse, he puts moneyWhen a gambler buys a lottery ticket, for instance, or places a bet on a horse, he puts money

at risk that was not in jeopardy before. The difference between insurance and gambling can beat risk that was not in jeopardy before. The difference between insurance and gambling can be

illustrated as follows.illustrated as follows.

The man who gambles creates a risk, which did not exist previously whereasThe man who gambles creates a risk, which did not exist previously whereas

the man who purchases insurance minimizes a risk which was already in being andthe man who purchases insurance minimizes a risk which was already in being and

which is not in his power to avoid.which is not in his power to avoid.

The gambler with hope of gain, goes out his way to bring a risk into beingThe gambler with hope of gain, goes out his way to bring a risk into being

while the man who insures, for the purpose of avoiding loss, goes out of his way towhile the man who insures, for the purpose of avoiding loss, goes out of his way to

hedge against a risk which already exists.hedge against a risk which already exists.

The man who gambles accepts deliberately the risk of loss in exchange for theThe man who gambles accepts deliberately the risk of loss in exchange for the

possibility of profit: the man who insures accepts deliberately the certainty of apossibility of profit: the man who insures accepts deliberately the certainty of a

small loss in exchange for the freedom from risk of devastating catastrophic loss.small loss in exchange for the freedom from risk of devastating catastrophic loss.

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The gambler bears the risk while the insured transfers the risk.The gambler bears the risk while the insured transfers the risk.

Considering the many risks we are exposed to in our daily life, such as fire, motor accident,Considering the many risks we are exposed to in our daily life, such as fire, motor accident,

etc there is certainly no complete escape from the hazards, and the man who gamble, by notetc there is certainly no complete escape from the hazards, and the man who gamble, by not

insuring against them is gambling against frightful odds. The man who insures pays a fixed,insuring against them is gambling against frightful odds. The man who insures pays a fixed,

certain and relatively small loss (the premium), and in doing so, doesn’t gamble which wouldcertain and relatively small loss (the premium), and in doing so, doesn’t gamble which would

have been ruinous to his and his family.have been ruinous to his and his family.

3.5.2 3.5.2 Insurance and SpeculationInsurance and Speculation

SpeculationSpeculation on the other hand involves doing some kind of activity with the expectation of on the other hand involves doing some kind of activity with the expectation of

profit in the future. For instance, a businessman who purchases and sells goods, stocks andprofit in the future. For instance, a businessman who purchases and sells goods, stocks and

shares, etc with the risk of loss and hope of profit through changes in their market value is ashares, etc with the risk of loss and hope of profit through changes in their market value is a

clear case of speculation. Through speculation individuals create a risk deliberately in theclear case of speculation. Through speculation individuals create a risk deliberately in the

anticipation of profits. However, an insurance transaction normally involves the transfer ofanticipation of profits. However, an insurance transaction normally involves the transfer of

risks that are insurable, since the requirements of an insurable risk generally can be met. Onrisks that are insurable, since the requirements of an insurable risk generally can be met. On

the contrary, speculation is a technique for handling risks that are typically uninsurable, suchthe contrary, speculation is a technique for handling risks that are typically uninsurable, such

as protection against a substantial decline in the price of agricultural products and rawas protection against a substantial decline in the price of agricultural products and raw

material.material.

The other difference between the two is The other difference between the two is that insurancethat insurance can reduce the objective risk of an can reduce the objective risk of an

insurer by application of the law of large numbers. In contrastinsurer by application of the law of large numbers. In contrast , speculation, speculation typically involves typically involves

only risk transfer, not risk reduction. The risk of an adverse price fluctuation is transferred toonly risk transfer, not risk reduction. The risk of an adverse price fluctuation is transferred to

a speculator who feels he or she can make a profit because of superior knowledge of forcesa speculator who feels he or she can make a profit because of superior knowledge of forces

that affect market price. The risk is transferred, not reduced, and the speculator’s prediction ofthat affect market price. The risk is transferred, not reduced, and the speculator’s prediction of

loss generally is not based on the law of large numbers.loss generally is not based on the law of large numbers.

At this point, we may ask ourselves if insurance is a charity. Is insurance a charity? Please At this point, we may ask ourselves if insurance is a charity. Is insurance a charity? Please

write down your responses in the spaces provided below.write down your responses in the spaces provided below.

______________________________________________________________________________________________________________________________________________________

______________________________________________________________________________________________________________________________________________________

______________________________________________________________________________________________________________________________________________________

______________________________________________________________________________________________________________________________________________________

______________________________________________________________________________________________________________________________________________________

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Charity is given without consideration but insurance is not possible without premium.Charity is given without consideration but insurance is not possible without premium.

Insurance is a profession of providing certainty and predictability and safety to the individual,Insurance is a profession of providing certainty and predictability and safety to the individual,

business or society. It provides adequate finance at the time of damage only by charging abusiness or society. It provides adequate finance at the time of damage only by charging a

normal premium for the service.normal premium for the service.

3.6 LEGAL PRINCIPLES OF INSURANCE CONTRACTS3.6 LEGAL PRINCIPLES OF INSURANCE CONTRACTS

Insurance is affected by legal agreements called contracts or policies. A contract cannot beInsurance is affected by legal agreements called contracts or policies. A contract cannot be

complete in effect, but must be interpreted in light of the social environment of the society incomplete in effect, but must be interpreted in light of the social environment of the society in

which it is made. The legal principles of insurance that are generally applicable are discussedwhich it is made. The legal principles of insurance that are generally applicable are discussed

as follows. as follows.

i.i. The principle of insurable interest. The principle of insurable interest. A fundamental legal principle underlying allA fundamental legal principle underlying all

insurance contracts is insurable interest. Under this principle an insured must demonstrateinsurance contracts is insurable interest. Under this principle an insured must demonstrate

the existence of financial relationship to the subject matter insured; otherwise the insuredthe existence of financial relationship to the subject matter insured; otherwise the insured

will be unable to collect amounts due when the insured peril occurs. The principle applieswill be unable to collect amounts due when the insured peril occurs. The principle applies

to both life and non-life insurance. The subject matter insured may include property ofto both life and non-life insurance. The subject matter insured may include property of

value, life of a person, or an event that may cause a legal liability. For instance, in the casevalue, life of a person, or an event that may cause a legal liability. For instance, in the case

of a property, the owner has a financial interest in the safety of the property for he willof a property, the owner has a financial interest in the safety of the property for he will

suffer a financial loss in the event of destruction of the property by accidental misfortune.suffer a financial loss in the event of destruction of the property by accidental misfortune.

In the case of life insurance, a clear example is the insurable interest of a wife in the life ofIn the case of life insurance, a clear example is the insurable interest of a wife in the life of

a husband and the vice versa. In the business environment a creditor has a financiala husband and the vice versa. In the business environment a creditor has a financial

interest in the life of a debtor. Thus he has the right to purchase life insurance policy forinterest in the life of a debtor. Thus he has the right to purchase life insurance policy for

the life of the debtor to protect his financial interest. The doctrine of insurable interest isthe life of the debtor to protect his financial interest. The doctrine of insurable interest is

also necessary to prevent insurance from becoming a gambling contract. also necessary to prevent insurance from becoming a gambling contract.

Insurance follows the person insured and not the property. A policy can be writtenInsurance follows the person insured and not the property. A policy can be written

covering a certain piece of property and an individual may be named as the one whocovering a certain piece of property and an individual may be named as the one who

would suffer a financial loss if the perils were to occur and cause damage. However, if atwould suffer a financial loss if the perils were to occur and cause damage. However, if at

the time of the loss the individual named no longer had an interest in the property, therethe time of the loss the individual named no longer had an interest in the property, there

would be no liability under the policy. For example suppose that A owns and insured awould be no liability under the policy. For example suppose that A owns and insured a

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car, later he sells his car to B and shortly there after the car is destroyed. A cannot collectcar, later he sells his car to B and shortly there after the car is destroyed. A cannot collect

under the policy, because he has no further financial interest in the car.under the policy, because he has no further financial interest in the car.

When the insurable interest must exist?When the insurable interest must exist?

In property and liability insurance it is possible to effect coverage on property in whichIn property and liability insurance it is possible to effect coverage on property in which

the insured doesn’t have an insurable interest at the time the policy is written, but in whichthe insured doesn’t have an insurable interest at the time the policy is written, but in which

such an interest is expected in the future. In marine insurance a shipper often obtainssuch an interest is expected in the future. In marine insurance a shipper often obtains

coverage on cargo it has not yet purchased in the anticipation of buying cargo for a returncoverage on cargo it has not yet purchased in the anticipation of buying cargo for a return

trip. As a result the courts generally hold that in property insurance, insurable interesttrip. As a result the courts generally hold that in property insurance, insurable interest

need exist only at the time of the loss and not at the time in caption of the policy. Whereasneed exist only at the time of the loss and not at the time in caption of the policy. Whereas

in life insurance, the insurable interest should exist at the time of inception of the policy.in life insurance, the insurable interest should exist at the time of inception of the policy.

ii.ii. Principle of indemnity. Principle of indemnity. The principle of indemnity states that a person may notThe principle of indemnity states that a person may not

collect more than the actual loss in the event of damage caused by an insured peril. Thus,collect more than the actual loss in the event of damage caused by an insured peril. Thus,

while a person may have purchased coverage in excess of the value of the property, thewhile a person may have purchased coverage in excess of the value of the property, the

person cannot make a profit by collecting more than the actual loss of the property that isperson cannot make a profit by collecting more than the actual loss of the property that is

destroyed. Many insurance practices result from this important principle. In general onlydestroyed. Many insurance practices result from this important principle. In general only

contracts in property and liability insurance are subjected to this doctrine, although therecontracts in property and liability insurance are subjected to this doctrine, although there

are exceptions where statutes have modified its application.are exceptions where statutes have modified its application.

The principle of indemnity is closely related to insurable interest. The problem inThe principle of indemnity is closely related to insurable interest. The problem in

insurable interest is to determine whether any loss is suffered by a person insured, whereinsurable interest is to determine whether any loss is suffered by a person insured, where

as in indemnity the problem is to obtain a measure of that loss. In the basic fire insuranceas in indemnity the problem is to obtain a measure of that loss. In the basic fire insurance

contracts, the measure of “actual cash loss” is the current replacement cost of destroyedcontracts, the measure of “actual cash loss” is the current replacement cost of destroyed

property loss plus an allowance for estimated depreciation. The whole purpose is toproperty loss plus an allowance for estimated depreciation. The whole purpose is to

restore the insured to his former financial position before the happening of the loss. Thus,restore the insured to his former financial position before the happening of the loss. Thus,

the principle eliminates the intention of gambling that incorporates profit motive.the principle eliminates the intention of gambling that incorporates profit motive.

Indemnity can take different forms: cash payment, replacement of the property orIndemnity can take different forms: cash payment, replacement of the property or

reinstatement of the property.reinstatement of the property.

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iii.iii. The principle of subrogation. The principle of subrogation. Under the principle of subrogation, one who hasUnder the principle of subrogation, one who has

indemnified another loss is entitled to recover from liable third parties, if any, who areindemnified another loss is entitled to recover from liable third parties, if any, who are

responsible. Subrogation is corollary to the principle of indemnity. Consequently, itresponsible. Subrogation is corollary to the principle of indemnity. Consequently, it

doesn’t apply to life and personal accident insurance. The essence is that the insurer, afterdoesn’t apply to life and personal accident insurance. The essence is that the insurer, after

claiming the amount of loss suffered obtains the legal right to take the place of the insuredclaiming the amount of loss suffered obtains the legal right to take the place of the insured

and demand for a recovery to the loss, wholly or in part, from the third party responsibleand demand for a recovery to the loss, wholly or in part, from the third party responsible

for the loss. The objective behind such transfer of right from the insured to the insurer isfor the loss. The objective behind such transfer of right from the insured to the insurer is

to eliminate the profit motive i.e. to prohibit the insured from collecting double payments:to eliminate the profit motive i.e. to prohibit the insured from collecting double payments:

from the insurer and from the third party. Thus if Mr. D negligently causes damage to Mr.from the insurer and from the third party. Thus if Mr. D negligently causes damage to Mr.

E’s property, E’s insurance company will indemnify E to the extent of its liability for E’sE’s property, E’s insurance company will indemnify E to the extent of its liability for E’s

loss and then have the right to proceed against D for any amount it has paid out under Esloss and then have the right to proceed against D for any amount it has paid out under Es

policy. One of the important reasons for subrogation is to reinforce the principle ofpolicy. One of the important reasons for subrogation is to reinforce the principle of

indemnity that is to prevent the insured from collecting more than the actual cash loss. Ifindemnity that is to prevent the insured from collecting more than the actual cash loss. If

E’s insurer didn’t have the right to subrogation it would be possible for E to recover fromE’s insurer didn’t have the right to subrogation it would be possible for E to recover from

the policy and then recover again in a legal action against D. In this case E would collectthe policy and then recover again in a legal action against D. In this case E would collect

twice. It would be possible for E to arrange an accident with D, collect twice, and split thetwice. It would be possible for E to arrange an accident with D, collect twice, and split the

profit with D. A moral hazard would exist and the contract would tend to become anprofit with D. A moral hazard would exist and the contract would tend to become an

instrument of fraud.instrument of fraud.

iv.iv. The principle of contribution. The principle of contribution. This also supports the principle of indemnity. It isThis also supports the principle of indemnity. It is

applied to a situation where a person or firm, for some reasons, purchase insurance fromapplied to a situation where a person or firm, for some reasons, purchase insurance from

two or more insurers to cover the same subject matter against loss or damage. Under suchtwo or more insurers to cover the same subject matter against loss or damage. Under such

circumstance, the insured cannot collect compensation from each insurer. If this happen,circumstance, the insured cannot collect compensation from each insurer. If this happen,

insurance becomes a profit making mechanism. So, the insured is paid only to the extentinsurance becomes a profit making mechanism. So, the insured is paid only to the extent

of the loss he has suffered. But, each insurer will make contribution to settle the claim.of the loss he has suffered. But, each insurer will make contribution to settle the claim.

The contribution may be a proportional amount based on the sum insured under theThe contribution may be a proportional amount based on the sum insured under the

respective insurers. However, to know if an insured has more than one insurer for therespective insurers. However, to know if an insured has more than one insurer for the

same risk, especially in countries like ours could be difficult. same risk, especially in countries like ours could be difficult.

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v.v. The principle of utmost good faith. The principle of utmost good faith. Insurance is said to be a contract of utmostInsurance is said to be a contract of utmost

good faith. In effect, this principle imposes a higher standard of honesty on parties ofgood faith. In effect, this principle imposes a higher standard of honesty on parties of

insurance agreement than is imposed on ordinary commercial contracts. Insuranceinsurance agreement than is imposed on ordinary commercial contracts. Insurance

contracts are based on mutual trust. This means that both the insured and the insurer mustcontracts are based on mutual trust. This means that both the insured and the insurer must

make full disclosure of material facts that have a bearing on the assessment of the risk.make full disclosure of material facts that have a bearing on the assessment of the risk.

Intentional concealment, misrepresentations and fraud may lead to the avoidance of theIntentional concealment, misrepresentations and fraud may lead to the avoidance of the

insurance contract. The insured is bound to give all the facts having material effect on theinsurance contract. The insured is bound to give all the facts having material effect on the

assessment of risk. The application of this principle can be expressed in representation,assessment of risk. The application of this principle can be expressed in representation,

concealment and warranties.concealment and warranties.

3.7 CLASSIFICATION OF INSURANCE3.7 CLASSIFICATION OF INSURANCE

From business point of view, insurance can be classified in to two categories. They are: lifeFrom business point of view, insurance can be classified in to two categories. They are: life

insurance and non life insurance.insurance and non life insurance.

3.7.1 Life Insurance3.7.1 Life Insurance

Some Definitions Some Definitions

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Definition 1Definition 1

Life insurance is a contract whereby the insurer for certain sum of money or premiumLife insurance is a contract whereby the insurer for certain sum of money or premium

proportionate to the age, profession, health and other circumstances of the person whoseproportionate to the age, profession, health and other circumstances of the person whose

life is insured engage that if such person dies with in the period specified in the policylife is insured engage that if such person dies with in the period specified in the policy

the insurer will pay the amount specified by the policy according to the term there of tothe insurer will pay the amount specified by the policy according to the term there of to

the person in whose favor the policy was entered to.the person in whose favor the policy was entered to.

Definition 2Definition 2

Life insurance is a social and economic devise by which a group of persons mayLife insurance is a social and economic devise by which a group of persons may

cooperate to ameliorate the loss resulting from the premature death of members of thecooperate to ameliorate the loss resulting from the premature death of members of the

group. The insuring organization collect contributions from each member, invest thisgroup. The insuring organization collect contributions from each member, invest this

contribution, grants both their safety and a minimum interest return and distributecontribution, grants both their safety and a minimum interest return and distribute

benefits to the estates of the members who die. benefits to the estates of the members who die.

The main purpose of life insurance is financial protection to the dependants of the insuredThe main purpose of life insurance is financial protection to the dependants of the insured

upon the premature death of the insured. The sum assured is, then, upon the death of theupon the premature death of the insured. The sum assured is, then, upon the death of the

insured will be paid to the beneficiaries. The financial compensation will provide security forinsured will be paid to the beneficiaries. The financial compensation will provide security for

a certain period of time. a certain period of time.

The insured may also purchase life insurance policy with such objectives as settling personalThe insured may also purchase life insurance policy with such objectives as settling personal

loans and other debts. If the insured dies before settling his debts, the insurer will settle theloans and other debts. If the insured dies before settling his debts, the insurer will settle the

debt outstanding to the creditors, hence protecting the family from financial loss.debt outstanding to the creditors, hence protecting the family from financial loss.

Life insurers are generally engaged in the provision of both protection and saving. TheLife insurers are generally engaged in the provision of both protection and saving. The

protection is against financial loss difficulty and is acquired for a consideration calledprotection is against financial loss difficulty and is acquired for a consideration called

premium, which is the price that keeps the policy in force. The protection given by the insurerpremium, which is the price that keeps the policy in force. The protection given by the insurer

is death benefits to the beneficiary of the insured, or in the case of survival of the insured,is death benefits to the beneficiary of the insured, or in the case of survival of the insured,

other financial benefits in accordance with the policy contract. other financial benefits in accordance with the policy contract.

3.7.1.1 Essential Features of Life Insurance3.7.1.1 Essential Features of Life Insurance

The benefits are determined in advance. The insured decides for himself theThe benefits are determined in advance. The insured decides for himself the

amount of insurance protection he needs. The insurer will then decide on theamount of insurance protection he needs. The insurer will then decide on the

corresponding reasonableness of the amount of coverage and sets the correspondingcorresponding reasonableness of the amount of coverage and sets the corresponding

premium.premium.

The amount of money required to pay the death benefits in a given period areThe amount of money required to pay the death benefits in a given period are

to be collected in advance so that there should not be shortage of funds to pay claims asto be collected in advance so that there should not be shortage of funds to pay claims as

they occur.they occur.

Each insured in the group should be charged an appropriate premium, whichEach insured in the group should be charged an appropriate premium, which

reflects the amount of risk he brings to the group. In other words, losses are to bereflects the amount of risk he brings to the group. In other words, losses are to be

distributed among the group of insureds in an equitable manner.distributed among the group of insureds in an equitable manner.

The probability of claim increases with the passage of time since insuredsThe probability of claim increases with the passage of time since insureds

exhibit deteriorating health condition as they grow old.exhibit deteriorating health condition as they grow old.

In addition to protection against uncertainty, life insurance has the function ofIn addition to protection against uncertainty, life insurance has the function of

accumulation of money/saving.accumulation of money/saving.

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Life insurance is not strictly a contract of indemnity for the value of a person cannot beLife insurance is not strictly a contract of indemnity for the value of a person cannot be

precisely put in financial terms. The provision of life assurance is a quite different processprecisely put in financial terms. The provision of life assurance is a quite different process

from the provision of non-life insurance. The main distinction is that in life assurance thefrom the provision of non-life insurance. The main distinction is that in life assurance the

event being assured is either certain to happen, in the case of those policies paying on death,event being assured is either certain to happen, in the case of those policies paying on death,

or scientifically calculable, in the case of policies not paying a benefit on death.or scientifically calculable, in the case of policies not paying a benefit on death.

In addition to these there are a number of special features, which are worth mentioning at this In addition to these there are a number of special features, which are worth mentioning at this

stage:stage:

a.a. Premium payments. Premium payments. Life assurance premiums are payable by level amountsLife assurance premiums are payable by level amounts

throughout the period of the policy. This means that each person pays the same amountthroughout the period of the policy. This means that each person pays the same amount

throughout, that amount being determined by his age on effecting the policy. Premiumsthroughout, that amount being determined by his age on effecting the policy. Premiums

can be paid annually, half-yearly, quarterly or monthly and are often met by standingcan be paid annually, half-yearly, quarterly or monthly and are often met by standing

orders with banks whereby the policyholder instructs his bank to make the appropriateorders with banks whereby the policyholder instructs his bank to make the appropriate

payments at the correct times. It is also possible for the insured to pay premiums for apayments at the correct times. It is also possible for the insured to pay premiums for a

specified period of time or even a single payment at lump sum at the time the policy isspecified period of time or even a single payment at lump sum at the time the policy is

purchased. (This will be discussed in detail in later section).purchased. (This will be discussed in detail in later section).

b.b. Participation in profits. Participation in profits. Life assurance companies value their assets andLife assurance companies value their assets and

liabilities at regular intervals, say every year or others every three years. This valuation ofliabilities at regular intervals, say every year or others every three years. This valuation of

their operation allows them to determine whether any surplus exists after calculating alltheir operation allows them to determine whether any surplus exists after calculating all

future liabilities and allowing for other contingencies. Should such a surplus exist, it isfuture liabilities and allowing for other contingencies. Should such a surplus exist, it is

distributed among those policyholders who have 'with-profits' or 'participating' policies.distributed among those policyholders who have 'with-profits' or 'participating' policies.

Such policies allow the policyholder to participate in any profits the company makes. ItSuch policies allow the policyholder to participate in any profits the company makes. It

does not guarantee a bonus to each policyholder, as the company may not have a surplus,does not guarantee a bonus to each policyholder, as the company may not have a surplus,

but it does mean that any available surplus will be distributed.but it does mean that any available surplus will be distributed.

The policyholder pays an additional amount for the privilege of participating in profits.The policyholder pays an additional amount for the privilege of participating in profits.

The bonuses are then added to the sum assured and payable at the maturity date. They canThe bonuses are then added to the sum assured and payable at the maturity date. They can

be either simple reversionary bonuses, that are computed at a rate percent on the basicbe either simple reversionary bonuses, that are computed at a rate percent on the basic

sum assured, or compound reversionary bonuses, that are computed at a rate percent of thesum assured, or compound reversionary bonuses, that are computed at a rate percent of the

basic sum assured plus any existing bonus payments already declared.basic sum assured plus any existing bonus payments already declared.

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c.c. Surrender values. Surrender values. When a person no longer wants his policy, or for some reasonWhen a person no longer wants his policy, or for some reason

cannot continue the premiums, he can ask for the surrender value. (this is discussed incannot continue the premiums, he can ask for the surrender value. (this is discussed in

later sections).later sections).

d.d. Investments.Investments.We have already identified the life assurance industry as being ofWe have already identified the life assurance industry as being of

considerable size by considering the number of policies in force and the value ofconsiderable size by considering the number of policies in force and the value of

premiums paid each year. These vast amounts of money are held by companies to meetpremiums paid each year. These vast amounts of money are held by companies to meet

future liabilities and are termed life assurance funds. These funds do not lie dormantfuture liabilities and are termed life assurance funds. These funds do not lie dormant

waiting for claims to come in; rather they are invested to provide income for thewaiting for claims to come in; rather they are invested to provide income for the

companies and so assist policyholders and shareholders. Not only do these two groupscompanies and so assist policyholders and shareholders. Not only do these two groups

benefit, but the country as a whole benefits, as we have already seen in section 2 of thisbenefit, but the country as a whole benefits, as we have already seen in section 2 of this

unit.unit.

3.7.1.2 Basic Types of Life Insurance3.7.1.2 Basic Types of Life Insurance

There are three basic types of life insuranceThere are three basic types of life insurance

1. Whole Life Insurance 1. Whole Life Insurance

In this kind of life insurance, the sum assured is payable on the death of the life assuredIn this kind of life insurance, the sum assured is payable on the death of the life assured

whenever it occurs. Premiums are payable either throughout the life of the assured or canwhenever it occurs. Premiums are payable either throughout the life of the assured or can

cease at a certain age, often 80 or 85. cease at a certain age, often 80 or 85.

This policy provides protection to the dependants of the insured upon the event of his/herThis policy provides protection to the dependants of the insured upon the event of his/her

death. I.e. the sum assured is payable only upon the death of the insured. One option is thatdeath. I.e. the sum assured is payable only upon the death of the insured. One option is that

the insured pays annual premiums as long as he lives. The second option is that premiumthe insured pays annual premiums as long as he lives. The second option is that premium

payments are made for a specified number of years or up to a certain age limit, normally up topayments are made for a specified number of years or up to a certain age limit, normally up to

the age of retirement. Premium payments after retirement are discontinued because of athe age of retirement. Premium payments after retirement are discontinued because of a

decline in the income of the insured. The policy provides permanent protection to thedecline in the income of the insured. The policy provides permanent protection to the

insured’s dependants in the case of death. Besides this protection, whole life insurance allowsinsured’s dependants in the case of death. Besides this protection, whole life insurance allows

for the accumulation of savings over the life of the insured. In essence, the policy encouragesfor the accumulation of savings over the life of the insured. In essence, the policy encourages

saving.saving.

Whole life policy acquires cash value after two or three years of premium payment. When aWhole life policy acquires cash value after two or three years of premium payment. When a

person no longer wants his policy, or for some reason cannot continue the premiums, he canperson no longer wants his policy, or for some reason cannot continue the premiums, he can

ask for the surrender value. He ceases payment and receives not a proportion of the sumask for the surrender value. He ceases payment and receives not a proportion of the sum

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assured, but a proportion of the premiums already paid. Not all policies allow a surrenderassured, but a proportion of the premiums already paid. Not all policies allow a surrender

value and surrender within the first few years of any policy will not normally produce anvalue and surrender within the first few years of any policy will not normally produce an

amount for the policyholder. This is because surrender value is calculated using the premiumsamount for the policyholder. This is because surrender value is calculated using the premiums

paid, less expenses incurred in issuing and renewing the policy, and less the cost of the lifepaid, less expenses incurred in issuing and renewing the policy, and less the cost of the life

assurance cover provided during the years it was in force. In view of the level premiumassurance cover provided during the years it was in force. In view of the level premium

system, any surrender value in the early years will be low, if any accrues at all.system, any surrender value in the early years will be low, if any accrues at all.

The cash value gradually grows to equal the sum assured upon maturity or at the time theThe cash value gradually grows to equal the sum assured upon maturity or at the time the

insured attains age 100. If the assured, for some reasons, discontinues premium paymentsinsured attains age 100. If the assured, for some reasons, discontinues premium payments

after the policy accumulates cash value, then the cash value can be used to keep the policy inafter the policy accumulates cash value, then the cash value can be used to keep the policy in

force under the automatic premium loan provision. Moreover, the assured can apply for loansforce under the automatic premium loan provision. Moreover, the assured can apply for loans

when the policy acquires cash value.when the policy acquires cash value. In some cases, an alternative to the surrender value is theIn some cases, an alternative to the surrender value is the

paid-up policy. The premiums cease and the policy continues, but on maturity a smaller sumpaid-up policy. The premiums cease and the policy continues, but on maturity a smaller sum

than would originally have been paid will be due to the policyholder. Depending on the policythan would originally have been paid will be due to the policyholder. Depending on the policy

and the company concerned, these paid-up policies may or may not continue to participate inand the company concerned, these paid-up policies may or may not continue to participate in

profits.profits.

In general, whole life insurance has two salient features:In general, whole life insurance has two salient features:

i.i. Protection Protection – It protects the insured in the case of premature– It protects the insured in the case of premature

death. If the insured died prematurely the face amount is paid to the beneficiary.death. If the insured died prematurely the face amount is paid to the beneficiary.

ii.ii. Saving Saving - premium will accumulate with interest till the date- premium will accumulate with interest till the date

of maturity of the policy (age 100) the face value of the policy will be paid to theof maturity of the policy (age 100) the face value of the policy will be paid to the

beneficiary.beneficiary.

Depending upon the manner of premium payments, whole life insurance contracts areDepending upon the manner of premium payments, whole life insurance contracts are

classified as: straight life, limited pay and single pay policies.classified as: straight life, limited pay and single pay policies.

A. Straight life insuranceA. Straight life insurance

It is also called ordinary life insurance. Under this policy, premiums are to be paid at regularIt is also called ordinary life insurance. Under this policy, premiums are to be paid at regular

interval until the death of the insured or until the achievement of a specified age limit, say 100interval until the death of the insured or until the achievement of a specified age limit, say 100

years. Such policy gives permanent protection at the lower costyears. Such policy gives permanent protection at the lower cost

B. Limited pay life insuranceB. Limited pay life insurance

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Under this insurance scheme, premiums are paid for a definite period of time which isUnder this insurance scheme, premiums are paid for a definite period of time which is

determined in advance. That is for 10, 15, 20, 25, and 30, years or up to age 85. After thedetermined in advance. That is for 10, 15, 20, 25, and 30, years or up to age 85. After the

expiration of the specified time, the policy is said to be paid-up, which means that no moreexpiration of the specified time, the policy is said to be paid-up, which means that no more

premiums are to be paid to keep the policy in force until the time of death of the insured atpremiums are to be paid to keep the policy in force until the time of death of the insured at

which time compensation amounting the face value of the initial policy is to be made to thewhich time compensation amounting the face value of the initial policy is to be made to the

insured’s beneficiary. This policy is desirable when one intends to stop payment of premiumsinsured’s beneficiary. This policy is desirable when one intends to stop payment of premiums

after reaching a given age level, usually upon retirement, but wants to continue with theafter reaching a given age level, usually upon retirement, but wants to continue with the

insurance protection till the end of his life. Since premiums are to be paid for a limited period,insurance protection till the end of his life. Since premiums are to be paid for a limited period,

they are usually higher than those under the straight life policy. Similarly, the cash valuesthey are usually higher than those under the straight life policy. Similarly, the cash values

under the limited whole life insurance are higher than the straight-line policy.under the limited whole life insurance are higher than the straight-line policy.

C. Single payment life insuranceC. Single payment life insurance

Here, premium payment is made in one lump sum at the time of purchase of the whole life Here, premium payment is made in one lump sum at the time of purchase of the whole life

insurance. In most cases, insurance buyers do not prefer this type of arrangement (mode of insurance. In most cases, insurance buyers do not prefer this type of arrangement (mode of

payment).payment).

2. Term life insurance2. Term life insurance

This insurance scheme provides compensation to the beneficiary if the insured dies within theThis insurance scheme provides compensation to the beneficiary if the insured dies within the

stated period mentioned in the policy. If the insured survives beyond the specified time limitstated period mentioned in the policy. If the insured survives beyond the specified time limit

in the policy, the policy will expire and there will be no payment made by the insurer. Termin the policy, the policy will expire and there will be no payment made by the insurer. Term

life policy gives temporary protection and there is no saving element involved. Since thelife policy gives temporary protection and there is no saving element involved. Since the

policy is taken for a specified period to deal with premature death, the cost of this policy ispolicy is taken for a specified period to deal with premature death, the cost of this policy is

relatively low. It is a form of temporary life insurance. relatively low. It is a form of temporary life insurance.

This is the simplest and oldest form of assurance and provides for payment of the sum assuredThis is the simplest and oldest form of assurance and provides for payment of the sum assured

on death, provided death occurs within a specified term. Should the life assured survive to theon death, provided death occurs within a specified term. Should the life assured survive to the

end of the term then the cover ceases and no money is payable. Depending on the age of theend of the term then the cover ceases and no money is payable. Depending on the age of the

life assured, this is a very cheap form of cover and would be suitable, for example, in the caselife assured, this is a very cheap form of cover and would be suitable, for example, in the case

of a young married man with medium to low income who wants to provide a reasonable sumof a young married man with medium to low income who wants to provide a reasonable sum

for his wife in the event of his death.for his wife in the event of his death.

101

Term policies do not provide the insured with loans, cash surrender or non-forfeiture options.Term policies do not provide the insured with loans, cash surrender or non-forfeiture options.

Insurance coverage terminates at the end of the period unless it provides an option forInsurance coverage terminates at the end of the period unless it provides an option for

conversion into other insurance schemes.conversion into other insurance schemes.

Term life policies can be single or level premium policy. Single premium policy requires theTerm life policies can be single or level premium policy. Single premium policy requires the

insured to pay premiums at the time the policy is purchased at lump sum while level premiuminsured to pay premiums at the time the policy is purchased at lump sum while level premium

requires the payment of equal amount of premiums at definite intervals. Most of the termrequires the payment of equal amount of premiums at definite intervals. Most of the term

policies are level premium. More appropriately, term contracts can be classified as: levelpolicies are level premium. More appropriately, term contracts can be classified as: level

term, renewable term or decreasing term.term, renewable term or decreasing term.

A. Level term policyA. Level term policy

Level term policy provides a constant sum assured throughout the term of the policy. ForLevel term policy provides a constant sum assured throughout the term of the policy. For

example, under a 15-year term policy of birr 30,000, the amount of payment to the insuredexample, under a 15-year term policy of birr 30,000, the amount of payment to the insured

will be birr 30,000 if the insured dies at any time during the policy period. Level term policieswill be birr 30,000 if the insured dies at any time during the policy period. Level term policies

can be convertible or nonconvertible.can be convertible or nonconvertible.

I. Convertible term policyI. Convertible term policy

Convertible term policy is a term policy that gives the policyholder the option to convert hisConvertible term policy is a term policy that gives the policyholder the option to convert his

term policy into the other types during the tenure of the term policy. No new evidence ofterm policy into the other types during the tenure of the term policy. No new evidence of

insurability is required upon conversion. If conversion is not made, the policy lapses at theinsurability is required upon conversion. If conversion is not made, the policy lapses at the

end of the term. The term contract can be converted into whole life or endowment insurance.end of the term. The term contract can be converted into whole life or endowment insurance.

Conversion may be effected using either the attained age at the time of conversion of the termConversion may be effected using either the attained age at the time of conversion of the term

policy or using the date of the initial term policy issued. In the case of the latter, premiums arepolicy or using the date of the initial term policy issued. In the case of the latter, premiums are

calculated retroactively, and the insured would be required to make up the difference incalculated retroactively, and the insured would be required to make up the difference in

premiums including interest, through lump-sum payment at the time of conversion. This ispremiums including interest, through lump-sum payment at the time of conversion. This is

similar to term assurance but includes a clause in the contract which allows the life assured tosimilar to term assurance but includes a clause in the contract which allows the life assured to

convert the policy into an endowment or whole life contract at normal rates, without medicalconvert the policy into an endowment or whole life contract at normal rates, without medical

evidence. A young person can therefore purchase low-cost life cover and convert it into theevidence. A young person can therefore purchase low-cost life cover and convert it into the

more expensive types as his career progresses and he can afford more suitable contracts.more expensive types as his career progresses and he can afford more suitable contracts.

To eliminate anti-selection problem, the following requirements are expected uponTo eliminate anti-selection problem, the following requirements are expected upon

conversion.conversion.

102

a.a. There will not be an increase in the sum assured.There will not be an increase in the sum assured.

b.b. The option will have to be exercised within a specified period.The option will have to be exercised within a specified period.

II. Nonconvertible term policyII. Nonconvertible term policy

Under this scheme, the term policy cannot be converted into other forms of life insuranceUnder this scheme, the term policy cannot be converted into other forms of life insurance

contracts. The policy terminates upon maturity. However, it could be renewable.contracts. The policy terminates upon maturity. However, it could be renewable.

B. Renewable term policy B. Renewable term policy

This is a term life insurance which can be renewed upon expiration. No new evidence ofThis is a term life insurance which can be renewed upon expiration. No new evidence of

insurability is required, but the premium charges are adjusted to reflect the standard premiuminsurability is required, but the premium charges are adjusted to reflect the standard premium

at the attained age. Accordingly, yearly renewable term policies require renewal every year.at the attained age. Accordingly, yearly renewable term policies require renewal every year.

Similarly, a 5-year term policy may be renewed upon its maturity. In most cases, groupSimilarly, a 5-year term policy may be renewed upon its maturity. In most cases, group

policies fail under this category. policies fail under this category.

C. Decreasing term insuranceC. Decreasing term insurance

In a decreasing term insurance, the sum assured decreases periodically. These policies areIn a decreasing term insurance, the sum assured decreases periodically. These policies are

usually issued to cover the outstanding claims (debts) of a creditor (debtor) in the event ofusually issued to cover the outstanding claims (debts) of a creditor (debtor) in the event of

accidental death of the debtor. The outstanding claims (debts) diminish periodically asaccidental death of the debtor. The outstanding claims (debts) diminish periodically as

installment payments are made by the debtor at regular intervals. In its basic form this is ainstallment payments are made by the debtor at regular intervals. In its basic form this is a

type of decreasing term assurance, with the benefit on death paid out by installments everytype of decreasing term assurance, with the benefit on death paid out by installments every

month or quarter. It is intended to replace the income which the life assured would havemonth or quarter. It is intended to replace the income which the life assured would have

produced for his family if he or she were still alive.produced for his family if he or she were still alive.

In each case, under the basic term, decreasing term, convertible term, or family incomeIn each case, under the basic term, decreasing term, convertible term, or family income

policy, the benefit is only paid if the life assured dies within the term of the policy. It shouldpolicy, the benefit is only paid if the life assured dies within the term of the policy. It should

be noted that all these types of policy can also be coupled with an endowment assurance. Thisbe noted that all these types of policy can also be coupled with an endowment assurance. This

is particularly true of decreasing term assurance, where the combination can be used inis particularly true of decreasing term assurance, where the combination can be used in

conjunction with a standing mortgage. In this case, the benefit will be paid on death within theconjunction with a standing mortgage. In this case, the benefit will be paid on death within the

policy period, or the endowment part only on survival to the end of the period.policy period, or the endowment part only on survival to the end of the period.

This type of policies provides financial protection to the policyholder (creditor) and the familyThis type of policies provides financial protection to the policyholder (creditor) and the family

(dependants) of the debtor. The dependants of the insured are saved from raising funds or(dependants) of the debtor. The dependants of the insured are saved from raising funds or

selling certain property in order to pay the outstanding loans.selling certain property in order to pay the outstanding loans.

103

Premiums for a decreasing term insurance are made in a lump-sum payment at the beginningPremiums for a decreasing term insurance are made in a lump-sum payment at the beginning

(single payment).(single payment).

3. Endowment insurance3. Endowment insurance

This policy provides payment if the insured manages to live till the end of the endowmentThis policy provides payment if the insured manages to live till the end of the endowment

period specified in the policy, or upon the death at the time during the term of the policy orperiod specified in the policy, or upon the death at the time during the term of the policy or

whichever occurs first. The period of this policy is shorter than that for whole life insurance,whichever occurs first. The period of this policy is shorter than that for whole life insurance,

and hence the premiums are higher than for the same age level. The shorter the endowmentand hence the premiums are higher than for the same age level. The shorter the endowment

period the higher the premium. The sum assured is payable in the event of death within aperiod the higher the premium. The sum assured is payable in the event of death within a

specified period of, say 15, 20, 25 or 30 years. However, if the life assured survives until thespecified period of, say 15, 20, 25 or 30 years. However, if the life assured survives until the

end of this period (until the 'maturity date') the sum assured will also be paid. For a givenend of this period (until the 'maturity date') the sum assured will also be paid. For a given

level of cover, the endowment has the highest premium because the life assurance company islevel of cover, the endowment has the highest premium because the life assurance company is

guaranteeing to pay out the sum assured at a given date, or before it if the person dies. Theguaranteeing to pay out the sum assured at a given date, or before it if the person dies. The

maturity date is usually no later than the date when the life assured will reach age 65. maturity date is usually no later than the date when the life assured will reach age 65.

The whole life assurance, mentioned earlier, will be slightly cheaper than a long-termThe whole life assurance, mentioned earlier, will be slightly cheaper than a long-term

endowment because the average policy will not become a claim by death until a person is inendowment because the average policy will not become a claim by death until a person is in

his or her seventies. The company has the premiums to invest for a longer period and canhis or her seventies. The company has the premiums to invest for a longer period and can

charge lower premiums. The shorter the term of an endowment policy, the more expensivecharge lower premiums. The shorter the term of an endowment policy, the more expensive

per sum assured it becomes, since the company has fewer years in which to collect premiums.per sum assured it becomes, since the company has fewer years in which to collect premiums.

Those buying houses can use endowment assurance. The assurance policy is taken out for theThose buying houses can use endowment assurance. The assurance policy is taken out for the

amount of the loan, or mortgage if a building society is involved, and written in such a wayamount of the loan, or mortgage if a building society is involved, and written in such a way

that the sum assured is payable to the lender or society. The borrower then pays the interestthat the sum assured is payable to the lender or society. The borrower then pays the interest

and the premium. At the end of the term of the loan, the endowment policy matures andand the premium. At the end of the term of the loan, the endowment policy matures and

repays the amount borrowed (the capital sum) to the lender. In the event of the borrowerrepays the amount borrowed (the capital sum) to the lender. In the event of the borrower

dying prior to the end of the repayment period, the interest to date will have been paid and thedying prior to the end of the repayment period, the interest to date will have been paid and the

endowment policy will payout to repay the capital sum.endowment policy will payout to repay the capital sum.

This can be an expensive method of protecting a loan for house purchase, and therefore manyThis can be an expensive method of protecting a loan for house purchase, and therefore many

building societies accept modifications involving convertible or decreasing term andbuilding societies accept modifications involving convertible or decreasing term and

endowment combinations, which are considerably less expensive, but still provide the sameendowment combinations, which are considerably less expensive, but still provide the same

security.security.

104

In addition to the above-indicated types of life insurance contracts, the following can also beIn addition to the above-indicated types of life insurance contracts, the following can also be

considered.considered.

4. Group life assurances4. Group life assurances

Employers sometimes arrange special terms for life assurance for their employees, with theEmployers sometimes arrange special terms for life assurance for their employees, with the

sum assured being payable in the event of death of an employee during his term of servicesum assured being payable in the event of death of an employee during his term of service

with the employer. Membership of the scheme is open to all employees working on thewith the employer. Membership of the scheme is open to all employees working on the

inception date, or the anniversary date in future years.inception date, or the anniversary date in future years.

One policy is issued to the firm and each employee is given a certificate of membership.One policy is issued to the firm and each employee is given a certificate of membership.

Many people wish to make special arrangements for their children, and two common schemesMany people wish to make special arrangements for their children, and two common schemes

are the child's deferred assurance and the school fees policy.are the child's deferred assurance and the school fees policy.

Under a child's deferred assurance, a policy is effected on the life of a parent with an 'option'Under a child's deferred assurance, a policy is effected on the life of a parent with an 'option'

date normally coinciding with the child's eighteenth birthday. Should the parent survive untildate normally coinciding with the child's eighteenth birthday. Should the parent survive until

the option date, the child has the option of continuing the policy in his own name from thenthe option date, the child has the option of continuing the policy in his own name from then

on, as either an endowment or whole life. The policy can be continued without furtheron, as either an endowment or whole life. The policy can be continued without further

medical examination and this can be extremely important where a child has contracted anmedical examination and this can be extremely important where a child has contracted an

illness which would otherwise make effecting a policy difficult or extremely expensive.illness which would otherwise make effecting a policy difficult or extremely expensive.

Alternatively, a lump sum can be taken at the option date rather than continue cover. In theAlternatively, a lump sum can be taken at the option date rather than continue cover. In the

event of the parent dying before the option date the policy is continued, with out payment ofevent of the parent dying before the option date the policy is continued, with out payment of

premiums, until the option date. Should the child die before the stated age, the premiums canpremiums, until the option date. Should the child die before the stated age, the premiums can

be returned to the parent or the policy is continued.be returned to the parent or the policy is continued.

5. Insured pension schemes5. Insured pension schemes

These schemes provide a variety of benefits for members, but their main aim is to ensure thatThese schemes provide a variety of benefits for members, but their main aim is to ensure that

some form of pension is available on retirement. Life assurance companies perform a vitalsome form of pension is available on retirement. Life assurance companies perform a vital

role in running pension schemes. Those constructing a scheme may approach a company to:role in running pension schemes. Those constructing a scheme may approach a company to:

organize the whole scheme, receive premium contributions, invest the funds andorganize the whole scheme, receive premium contributions, invest the funds and

administer the pensions;administer the pensions;

manage the fund of a pension scheme; ormanage the fund of a pension scheme; or

105

provide life assurance benefits for widows of scheme members who die beforeprovide life assurance benefits for widows of scheme members who die before

retirement or widowers.retirement or widowers.

Many employers' pension schemes are insured by means of group or master policies issued toMany employers' pension schemes are insured by means of group or master policies issued to

the employer or to the trustees of the scheme. These provide retirement pensions and otherthe employer or to the trustees of the scheme. These provide retirement pensions and other

benefits in respect of the employees who are eligible for the scheme, usually related to theirbenefits in respect of the employees who are eligible for the scheme, usually related to their

service and salary.service and salary.

A record-keeping and administration service is usually provided in association with the issueA record-keeping and administration service is usually provided in association with the issue

of the policy. The contract may be based on one of the types of policy used in ordinary lifeof the policy. The contract may be based on one of the types of policy used in ordinary life

assurance, for example endowment assurances, or annuities (as described later), or it may beassurance, for example endowment assurances, or annuities (as described later), or it may be

specially devised for the purpose. The extent to which there is a transfer of risk variesspecially devised for the purpose. The extent to which there is a transfer of risk varies

considerably, and in some cases the main emphasis is on the provision of an investmentconsiderably, and in some cases the main emphasis is on the provision of an investment

service by the insurance company.service by the insurance company.

In association with the provision of retirement benefits, policies are usually issued insuringIn association with the provision of retirement benefits, policies are usually issued insuring

death in service benefits for those employees who do not reach retirement age. These may bedeath in service benefits for those employees who do not reach retirement age. These may be

in the form of group life assurance, as described earlier, or of widows' pensions.in the form of group life assurance, as described earlier, or of widows' pensions.

6. Annuities6. Annuities

Certain of the assurances mentioned above have had the aim of ensuring an income of oneCertain of the assurances mentioned above have had the aim of ensuring an income of one

form or another. An annuity is a method by which a person can receive a yearly sum in returnform or another. An annuity is a method by which a person can receive a yearly sum in return

for the payment to an insurance company of a sum of money. This is not life assurance as wefor the payment to an insurance company of a sum of money. This is not life assurance as we

have described it, but it is dealt with by life assurance companies and is based on actuarialhave described it, but it is dealt with by life assurance companies and is based on actuarial

principles.principles.

When a person has a reasonably large sum of money and wants to provide an income forWhen a person has a reasonably large sum of money and wants to provide an income for

himself after he retires, or at some other time, he can approach a life assurance company andhimself after he retires, or at some other time, he can approach a life assurance company and

purchase an annuity. The annuity may start at once, an immediate annuity, also sometimespurchase an annuity. The annuity may start at once, an immediate annuity, also sometimes

called annuity due, or may start at some date in the future, a deferred annuity. Regardless ofcalled annuity due, or may start at some date in the future, a deferred annuity. Regardless of

when it starts it can take various forms. It may provide an annuity for the life of the person,when it starts it can take various forms. It may provide an annuity for the life of the person,

the annuitant, or it may be payable irrespective of death for a certain period, as in the case ofthe annuitant, or it may be payable irrespective of death for a certain period, as in the case of

the annuity certain. The guaranteed annuity is similar in that it provides the annuity for athe annuity certain. The guaranteed annuity is similar in that it provides the annuity for a

guaranteed period or until the annuitant dies, whichever is later. The reversionary annuityguaranteed period or until the annuitant dies, whichever is later. The reversionary annuity

106

provides for payment to the annuitant, say the wife, on the death of another named person, sayprovides for payment to the annuitant, say the wife, on the death of another named person, say

the husband. The joint and last survivor annuity is payable while two people, husband andthe husband. The joint and last survivor annuity is payable while two people, husband and

wife, are alive and on the death of one will continue at the same or smaller rate on the life ofwife, are alive and on the death of one will continue at the same or smaller rate on the life of

the survivor.the survivor.

3.7.1.3 Life Insurance Premium Calculations3.7.1.3 Life Insurance Premium Calculations

Dear student, before any extended discussion on life insurance premium calculation, it seemsDear student, before any extended discussion on life insurance premium calculation, it seems

quite logical for you to know about the types of premiums available in life insurance. To thisquite logical for you to know about the types of premiums available in life insurance. To this

effect, we have mentioned two types of life insurance premiums. effect, we have mentioned two types of life insurance premiums.

1.1. Net premium.Net premium. The determination of net premium considers The determination of net premium considers

only the mortality rate and rate of interest. It ignores operating costs charged by theonly the mortality rate and rate of interest. It ignores operating costs charged by the

insurer. N.B. Net premium provides the insurer only with the amount of money requiredinsurer. N.B. Net premium provides the insurer only with the amount of money required

to pay death claims. The net premium to be paid could be single or level premium. to pay death claims. The net premium to be paid could be single or level premium. NetNet

single premiumsingle premium is the net premium to be paid as a single sum at the beginning of the is the net premium to be paid as a single sum at the beginning of the

contract while a contract while a net level premiumnet level premium is a premium charge that doesn't change from year to is a premium charge that doesn't change from year to

year throughout the term of the policy.year throughout the term of the policy.

2.2. Gross Premium.Gross Premium. The insurer's costs of operating the business The insurer's costs of operating the business

are added to the net premium, which is called loading. Loading is the act of adding costsare added to the net premium, which is called loading. Loading is the act of adding costs

of running business to the net premium costs including operating expenses, commissions,of running business to the net premium costs including operating expenses, commissions,

advertisement expenses, etc.advertisement expenses, etc.

3.7.1.3.1Computing Net Single Premium3.7.1.3.1Computing Net Single Premium

The information required to compute net single premium are the rate of interest and amount ofThe information required to compute net single premium are the rate of interest and amount of

insurance policy. For the purpose of illustration, the following assumptions are made.insurance policy. For the purpose of illustration, the following assumptions are made.

Population size =10,000Population size =10,000

Male people at age 40 =Male people at age 40 =

9,5809,580

Probability of death at age 40Probability of death at age 40

= 165/9580= 165/9580

Amount of insurance policyAmount of insurance policy

(Benefit)= 5000(Benefit)= 5000

107

Assume further that premium will be collected at the beginning of the policy issue. DeathAssume further that premium will be collected at the beginning of the policy issue. Death

benefits (policy amount) is to be paid at the end of the year. benefits (policy amount) is to be paid at the end of the year.

Interest rate is 10%.Interest rate is 10%.

Each policyholder brings the same level of risk to the group Each policyholder brings the same level of risk to the group

Expected number of death at age 40 is 165.Expected number of death at age 40 is 165.

Expected amount of death benefits would be = 165X5000= 825,000Expected amount of death benefits would be = 165X5000= 825,000

N.B.N.B. The insurer will not collect 825,000 from the insured but only its present The insurer will not collect 825,000 from the insured but only its present

value.value.

Present value of Br. 825,000 = 825,000 (1.10)Present value of Br. 825,000 = 825,000 (1.10)-1-1is the total net premium to beis the total net premium to be

collected.collected.

Net single premium = Total net premium/No of insured Net single premium = Total net premium/No of insured

= 750,000 /9580 = 750,000 /9580

= = 78.28878.288

The insurer collects 750,000 Birr and invests it at 10%. An amount of 750,000 birr collectedThe insurer collects 750,000 Birr and invests it at 10%. An amount of 750,000 birr collected

at the current period will just be enough to settle the expected death claims by the end of theat the current period will just be enough to settle the expected death claims by the end of the

year. year.

Premium computation for term life insurancePremium computation for term life insurance

Consider the following informationConsider the following information

3 Years term policy 3 Years term policy

Policy amount = 5,000 to be paid at the end of the year.Policy amount = 5,000 to be paid at the end of the year.

Number of policyholders at age 30 = 958,000. Number of policyholders at age 30 = 958,000.

Interest rate = 10%Interest rate = 10%

Premium = Single premium payment at the beginning of the year.Premium = Single premium payment at the beginning of the year.

Mortality rate, male, 1990.Mortality rate, male, 1990.

Year Age Year Age Number Number Number Probability of Number Probability of

of living of living of dying dyingof dying dying

1 30 1 30 958,000 958,000 1657 0.00173 1657 0.00173

2 31 2 31 956,343 956,343 1702 0.00178 1702 0.00178

108

3 32 3 32 954,641 954,641 1747 0.00183 1747 0.00183

Expected death claimsExpected death claims

Year Age Year Age

NumberNumber

of Dyingof Dying

Policy Expected death Policy Expected death

Amount claims Amount claims

1 30 1 30 16571657 5,000 8, 285,0005,000 8, 285,000

2 31 2 31 17021702 5,000 8,510,0005,000 8,510,000

3 32 3 32 17471747 5,000 5,000 8,735,0008,735,000

Total expected death claimsTotal expected death claims 25,530,00025,530,000

Discount each year's expected death claim at 10% interest rate to arrive at the present value ofDiscount each year's expected death claim at 10% interest rate to arrive at the present value of

total clams, (see below).total clams, (see below).

11 22 33 44

(2*3)(2*3)

55 66

(4/5)(4/5)

Year Year DeathDeath

ClaimsClaims

PV Factor atPV Factor at

10%10%

PV ofPV of

ClaimsClaims

No. ofNo. of

InsuredInsured

Annual netAnnual net

PremiumPremium

11 8,285,0008,285,000 0.90910.9091 7,531,893.57,531,893.5 958,000958,000 7.8627.862

22 8,510,0008,510,000 0.82640.8264 7,032,6647,032,664 958,000958,000 7.3417.341

33 8,735,0008,735,000 0.75130.7513 6,562,605.56,562,605.5 958,000958,000 6.8506.850

25,530,00025,530,000 21,127,16321,127,163 22.05322.053

Net single premium = Net single premium = PV of Claims PV of Claims

Number of insureds Number of insureds

= 21127163/958,000 = 21127163/958,000

= = 22.053 22.053

Each insured will be required to pay a net single premium of Birr 22.053 at theEach insured will be required to pay a net single premium of Birr 22.053 at the

beginning of the policy. This premium enables the insurer to meet the expected deathbeginning of the policy. This premium enables the insurer to meet the expected death

claims that occur in each year. See the amortization table below.claims that occur in each year. See the amortization table below.

109

YearYear BeginningBeginning

balancebalance

Interest at 10Interest at 10

%%

Beginning balanceBeginning balance

+ Interest+ Interest

DeathDeath

claimsclaims

EndingEnding

balancebalance

11 21,127,16321,127,163 2,112,716.32,112,716.3 23,239,879.323,239,879.3 8,285,0008,285,000 14,954,879.314,954,879.3

22 14,954,879.314,954,879.3 1,495,487.931,495,487.93 16,450,367.2316,450,367.23 8,510,0008,510,000 7,940,367.237,940,367.23

33 7,940,367.237,940,367.23 794,036.72794,036.72 8,734,403.958,734,403.95 8,735,0008,735,000 (596.05) *(596.05) *

* Difference due to rounding. The ending balance at year 3 should be equal to 0.* Difference due to rounding. The ending balance at year 3 should be equal to 0.

Actuarial NotationsActuarial Notations

Let: Let:

t t = time (years)= time (years)

x x = age= age

Lx Lx = number of people living during age x = number of people living during age x

dx (Lx-Lx+1) = the difference between the number of people living duringdx (Lx-Lx+1) = the difference between the number of people living during

age x and age ( x + 1) i.e. the number of people dying inage x and age ( x + 1) i.e. the number of people dying in

one year.one year.

Px (dx/Lx) Px (dx/Lx) = Probability of dying during age x = Probability of dying during age x

gx(Lx+l/Lx) gx(Lx+l/Lx) = probability that an individual at age x survives age x= probability that an individual at age x survives age x

Consider the example above (the 3-years term insurance) Consider the example above (the 3-years term insurance)

NotationsNotations

T T = policy term (3 years) = policy term (3 years)

S S = sum assumed (Birr 5000)= sum assumed (Birr 5000)

r r = interest rate (10%)= interest rate (10%)

Formula to determine net single premiumFormula to determine net single premium

NSP = NSP = S{dx/Lx}S{dx/Lx} + + S{dx/Lx}S{dx/Lx} +…+ +…+ S{dx+t-1/Lx}S{dx+t-1/Lx}

(1+r) (1+r) (1+r) (1+r)22 (l+r)(l+r)tt

Using the formula the net single premium is computed as follows:

110

YearYear

(t)(t)

AgeAge

(X)(X)

Number of LivingNumber of Living

LxLx

Number of DyingNumber of Dying

dxdx

11 3030 958,000958,000 16571657

22 3131 956,343956,343 17021702

33 3232 954,640954,640 17471747

NSP NSP = = 5000 (1657/958000) 5000 (1657/958000)

1.10 1.10

+ +

==5000 (17027 958000)5000 (17027 958000)

(1.10)2 (1.10)2

+ +

==5000 (1747/958,000)5000 (1747/958,000)

(1.10)3 (1.10)3

== BirrBirr 22.053 22.053

Dear student, did you notice how the two alternatives of computing net single premiumDear student, did you notice how the two alternatives of computing net single premium

reached us towards the same value of Birr 22.053.reached us towards the same value of Birr 22.053.

3.7.1.3.2 Net Level Premium 3.7.1.3.2 Net Level Premium

Instead of a single premium payment, in this case the policyholders will pay annual premiumsInstead of a single premium payment, in this case the policyholders will pay annual premiums

of equal size. Consider the following three points carefully.of equal size. Consider the following three points carefully.

i.i. Not all the policyholders will pay the annualNot all the policyholders will pay the annual

level premiums (Since some of them are expected to die before the end of the term). level premiums (Since some of them are expected to die before the end of the term).

ii.ii. The insurer will collect a limited amount ofThe insurer will collect a limited amount of

money to invest at the very beginning of the policy.money to invest at the very beginning of the policy.

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iii.iii. The total annual level premiums paid by aThe total annual level premiums paid by a

policyholder under the level scheme will be greater than the single net premium.policyholder under the level scheme will be greater than the single net premium.

Assuming all facts as in the previous illustration, calculate the net level premium?Assuming all facts as in the previous illustration, calculate the net level premium?

Example

YearYear AgeAge No. ofNo. of

InsuredInsured

11 3030 958,000958,000

22 3131 956,343956,343

33 3232 954,640954,640

Assume each insured pays level premium of Birr 1 throughout the term of the policy.Assume each insured pays level premium of Birr 1 throughout the term of the policy.

YearYear AgeAge No. ofNo. of

InsuredInsured

Present value ofPresent value of

Birr.1payable atBirr.1payable at

beginning of yearbeginning of year

Present value ofPresent value of

Birr.1 premiumBirr.1 premium

11 3030 958,000958,000 11 958,000958,000

22 3131 956,343956,343 0.90910.9091 869,411869,411

33 3232 954,641954,641 0.82640.8264 788,915788,915

TotalTotal 2,616,3262,616,326

Payment per insured Payment per insured = 2,616,326/958,000 = 2,616,326/958,000

= 2.731 = 2.731

Net level premium = Net level premium = Net Single Premium Net Single Premium

PV. Of Birr 1 premium PV. Of Birr 1 premium

Payment per insured Payment per insured

= 22.05/2.731 = 22.05/2.731

= = Birr 8.075Birr 8.075

The amount of net level premium to be collected and the expected death claims are shownThe amount of net level premium to be collected and the expected death claims are shown

below.below.

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YearYear AnnualAnnual

levellevel

premiumpremium

TotalTotal

premiumpremium

collectedcollected

BeginningBeginning

balancebalance

Beg. BalBeg. Bal

invested atinvested at

10 %10 %

DeathDeath

claimsclaims

EndingEnding

balancebalance

11 8.0758.075 7,735,8507,735,850 7,735,8507,735,850 8,509,4358,509,435 8,285,0008,285,000 224,435224,435

22 8.0758.075 7,722,4707,722,470 7,946,9057,946,905 8,741,5968,741,596 8,510,0008,510,000 231,596231,596

33 8.0758.075 7,708,7267,708,726 7,940,3227,940,322 8,734,3548,734,354 8,735,0008,735,000 (646)*(646)*

* Difference due to rounding. * Difference due to rounding.

Present value of Present value of

Birr 1 payment = (958,000/958,000) 1Birr 1 payment = (958,000/958,000) 1+ (956,343/958,000) 0.9091 + (956,343/958,000) 0.9091 + (954,640/958,000) 0.8264 + (954,640/958,000) 0.8264

= = 2.731 2.731

3.7.2.3.7.2. Non life InsuranceNon life Insurance

As insurance has developed, the various types of cover have been grouped into severalAs insurance has developed, the various types of cover have been grouped into several

classes, which have come about by practice within insurance company offices, and by theclasses, which have come about by practice within insurance company offices, and by the

influence of legislation controlling the financial aspects of transacting insurance. Insuranceinfluence of legislation controlling the financial aspects of transacting insurance. Insurance

offices are generally split up into departments or sections, each of which will deal with typesoffices are generally split up into departments or sections, each of which will deal with types

of risk, which have an affiliation with each other. There is a very wide variety in the way inof risk, which have an affiliation with each other. There is a very wide variety in the way in

which companies organize their business, but the following divisions are not unusual:which companies organize their business, but the following divisions are not unusual:

Fire, including business interruption; Fire, including business interruption;

Accident, including theft, all risks, goods in transit, glass, money, credit, fidelity Accident, including theft, all risks, goods in transit, glass, money, credit, fidelity

Liability, including employers' liability, public liability, products and professional Liability, including employers' liability, public liability, products and professional

indemnity;indemnity;

Motor; engineering; marine and aviation; life and pensions.Motor; engineering; marine and aviation; life and pensions.

A discussion on the above non life insurance will be made as follows;A discussion on the above non life insurance will be made as follows;

3.7.2.1. Personal Accident Insurance3.7.2.1. Personal Accident Insurance

This type of cover is devised to compensate the insured that is temporarily or totallyThis type of cover is devised to compensate the insured that is temporarily or totally

disabled from engaging in his usual occupation due to sickness. Personal accident anddisabled from engaging in his usual occupation due to sickness. Personal accident and

sickness policies are renewable annually and, if a claim has occurred, which could be of asickness policies are renewable annually and, if a claim has occurred, which could be of a

recurring nature, the cover may be restricted at renewal or in severe cases renewal mayrecurring nature, the cover may be restricted at renewal or in severe cases renewal may

not be offered.not be offered.

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3.7.2.2.Permanent Health Insurance3.7.2.2.Permanent Health Insurance

This type of cover has been devised to overcome the limitation of the personal accidentThis type of cover has been devised to overcome the limitation of the personal accident

and sickness policies. It provides benefits for those who are disabled for longer periods orand sickness policies. It provides benefits for those who are disabled for longer periods or

who, due to accident or illness, have to change to a lower paid occupation. It may also bewho, due to accident or illness, have to change to a lower paid occupation. It may also be

called long term disability insurance.called long term disability insurance.

It is usual to arrange cover to exclude the first month, six months or twelve months ofIt is usual to arrange cover to exclude the first month, six months or twelve months of

disablement with appropriate discounts in the premium rates, since many people willdisablement with appropriate discounts in the premium rates, since many people will

receive a substantial part of their salaries for a certain period when off-work. Coverreceive a substantial part of their salaries for a certain period when off-work. Cover

cannot continue beyond age 65 and in order to save premium some people elect for covercannot continue beyond age 65 and in order to save premium some people elect for cover

to cease at age 55 or 60. The maximum benefit payable is usually 66 per cent or 75 perto cease at age 55 or 60. The maximum benefit payable is usually 66 per cent or 75 per

cent of earnings, less any other disability benefits payable.cent of earnings, less any other disability benefits payable.

The intention of the basic policy is to provide compensation in the event of an accidentThe intention of the basic policy is to provide compensation in the event of an accident

causing death or injury. What are termed capital sums are paid in the event of death orcausing death or injury. What are termed capital sums are paid in the event of death or

certain specified injuries, such as the loss of limbs or sight as may be defined in thecertain specified injuries, such as the loss of limbs or sight as may be defined in the

policy.policy.

The policy is usually extended to include a weekly benefit for up to 104 weeks, orThe policy is usually extended to include a weekly benefit for up to 104 weeks, or

compensation if the insured is temporarily totally disabled due to an accident and acompensation if the insured is temporarily totally disabled due to an accident and a

reduced weekly benefit if he is temporarily only partially disabled from carrying out hisreduced weekly benefit if he is temporarily only partially disabled from carrying out his

normal duties. In the event of permanent total disablement (other than loss of eyes ornormal duties. In the event of permanent total disablement (other than loss of eyes or

limbs) an annuity is paid.limbs) an annuity is paid.

In addition to the purchase of personal accident insurance by individuals, it is alsoIn addition to the purchase of personal accident insurance by individuals, it is also

possible for companies to arrange coverage on behalf of their employees and manypossible for companies to arrange coverage on behalf of their employees and many

organizations arrange 'group schemes' to this end. organizations arrange 'group schemes' to this end.

3.7.2.3.Motor Insurance3.7.2.3.Motor Insurance

The minimum requirement by law is to provide insurance in respect of legal liability toThe minimum requirement by law is to provide insurance in respect of legal liability to

pay damages arising out of injury caused to any person. Policies with various levels ofpay damages arising out of injury caused to any person. Policies with various levels of

cover are available:cover are available:

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Third party only:Third party only: provides cover in respect of liability incurred through death or provides cover in respect of liability incurred through death or

injury to a third party, or damage to third party property. injury to a third party, or damage to third party property.

Third party, fire and theft:Third party, fire and theft: provides cover as above and in addition includes cover provides cover as above and in addition includes cover

for damage to the vehicle from fire or theft.for damage to the vehicle from fire or theft.

Comprehensive:Comprehensive: provides cover as above and in addition including cover for provides cover as above and in addition including cover for

accidental loss of, or damage to, the vehicle itself. This is the most common form ofaccidental loss of, or damage to, the vehicle itself. This is the most common form of

policy.policy.

Private car insurance applies to private cars used for social and domestic purposes and/orPrivate car insurance applies to private cars used for social and domestic purposes and/or

business purposes. Comprehensive policies issued to individuals also include personalbusiness purposes. Comprehensive policies issued to individuals also include personal

accident benefits for the insured and spouse, medical expenses and loss of, or damage to, rugs,accident benefits for the insured and spouse, medical expenses and loss of, or damage to, rugs,

clothing and personal effects.clothing and personal effects.

Vehicles used for commercial purposes (including lorries, taxis, vans, hire cars, milk floatsVehicles used for commercial purposes (including lorries, taxis, vans, hire cars, milk floats

and police cars) are not insured under private car policies, but under special contracts knownand police cars) are not insured under private car policies, but under special contracts known

as commercial vehicle policies.as commercial vehicle policies.

Separate cover is available for motorcycles. The type of policy depends upon the machine,Separate cover is available for motorcycles. The type of policy depends upon the machine,

whether it is a moped or a high-powered motorcycle, and on the age and experience of thewhether it is a moped or a high-powered motorcycle, and on the age and experience of the

cyclist. The cover is comparatively inexpensive relative to motorcar insurance.cyclist. The cover is comparatively inexpensive relative to motorcar insurance.

Special policies are offered to garages and other people within the motor trade, to ensure thatSpecial policies are offered to garages and other people within the motor trade, to ensure that

their liability is covered while using vehicles on the road. Damage to vehicles in garages andtheir liability is covered while using vehicles on the road. Damage to vehicles in garages and

showrooms can also be included under such policies.showrooms can also be included under such policies.

In addition to private cars, motorcycles and commercial vehicles, there are a number ofIn addition to private cars, motorcycles and commercial vehicles, there are a number of

vehicles which fall into a category known to insurers as 'special types'. These will includevehicles which fall into a category known to insurers as 'special types'. These will include

forklift trucks, mobile cranes, bulldozers and excavators. Such vehicles may travel on roads asforklift trucks, mobile cranes, bulldozers and excavators. Such vehicles may travel on roads as

well as building sites and other private ground. Where these vehicles are not used on roadswell as building sites and other private ground. Where these vehicles are not used on roads

and are transported from site to site, it is more appropriate to insure the liability under a publicand are transported from site to site, it is more appropriate to insure the liability under a public

liability policy, since the vehicle is really being used as a 'tool of trade' rather than a motorliability policy, since the vehicle is really being used as a 'tool of trade' rather than a motor

vehicle and include fire, theft, collision and a wide range of other perils.vehicle and include fire, theft, collision and a wide range of other perils.

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3.7.2.4. Marine and Transport Insurance3.7.2.4. Marine and Transport Insurance

I. Marine cargoI. Marine cargo

Marine policies relate to three areas of risk: the hull, cargo and freight. While hull and cargoMarine policies relate to three areas of risk: the hull, cargo and freight. While hull and cargo

are self explanatory, the word freight may not be: it is the sum paid for transporting goods, orare self explanatory, the word freight may not be: it is the sum paid for transporting goods, or

for the hire of a ship. When goods are lost by marine perils then freight, or part of it, is lost;for the hire of a ship. When goods are lost by marine perils then freight, or part of it, is lost;

hence the need for cover.hence the need for cover.

The risks against which these items are normally insured are collectively termed 'perils of theThe risks against which these items are normally insured are collectively termed 'perils of the

sea' Cargo is usually insured on a warehouse (of departure) to warehouse (of arrival) basis andsea' Cargo is usually insured on a warehouse (of departure) to warehouse (of arrival) basis and

frequently covering all risks. Terms of sale and conditions of carriage have importantfrequently covering all risks. Terms of sale and conditions of carriage have important

implications for cargo insurers where goods may change ownership and pass through theimplications for cargo insurers where goods may change ownership and pass through the

hands of more than one shipper or haulier. It is vitally important in cargo insurance tohands of more than one shipper or haulier. It is vitally important in cargo insurance to

establish who is responsible for the insurance cover and to work out when the risk passesestablish who is responsible for the insurance cover and to work out when the risk passes

from the consignor to the consignee.from the consignor to the consignee.

Insurers often rely on inadequate packing/loading to modify claims under cargo covers.Insurers often rely on inadequate packing/loading to modify claims under cargo covers.

Where appropriate insurers will pay claims and then seek recoveries from carriers.Where appropriate insurers will pay claims and then seek recoveries from carriers.

II. Marine liabilitiesII. Marine liabilities

The custom has been to provide insurance for three-quarters of the ship owner’s liability for The custom has been to provide insurance for three-quarters of the ship owner’s liability for

collisions at sea under a marine policy. The remaining quarter, and all other forms of liability, collisions at sea under a marine policy. The remaining quarter, and all other forms of liability,

are catered for by associations set up for the purpose by ship owners and known as Protecting are catered for by associations set up for the purpose by ship owners and known as Protecting

and Indemnity Clubs (P and I clubs). It should be noted that the P and I clubs can now insure and Indemnity Clubs (P and I clubs). It should be noted that the P and I clubs can now insure

hull and machinery as well as liabilities.hull and machinery as well as liabilities.

III. Aviation insuranceIII. Aviation insurance

The use of aircraft as a means of transport is increasing each year and because of the specialistThe use of aircraft as a means of transport is increasing each year and because of the specialist

and technical nature of the risks associated with it, plus the high potential cost of accidents, alland technical nature of the risks associated with it, plus the high potential cost of accidents, all

aviation risks, from component parts to complete jumbo jets, are insured in the aviationaviation risks, from component parts to complete jumbo jets, are insured in the aviation

insurance market.insurance market.

Most policies are issued on an 'all risks' basis, subject to certain restrictions. The buyers ofMost policies are issued on an 'all risks' basis, subject to certain restrictions. The buyers of

these policies include the large commercial airlines, corporate aircraft owners, private ownersthese policies include the large commercial airlines, corporate aircraft owners, private owners

116

and flying clubs. Usually a comprehensive policy is issued covering the aircraft itself (theand flying clubs. Usually a comprehensive policy is issued covering the aircraft itself (the

hull), the liabilities to passengers and the liabilities to others.hull), the liabilities to passengers and the liabilities to others.

Liability for accidents to passengers is governed by a maze of international agreements andLiability for accidents to passengers is governed by a maze of international agreements and

national laws around the world. The main ones are the Warsaw Convention 1929, which madenational laws around the world. The main ones are the Warsaw Convention 1929, which made

signatories liable to passengers without negligence, subject to certain maximum amounts, andsignatories liable to passengers without negligence, subject to certain maximum amounts, and

the Hague Protocol 1955, which raised some of these limits. The national laws may placethe Hague Protocol 1955, which raised some of these limits. The national laws may place

higher limits on domestic flights. For domestic flights within the UK the provisions of thehigher limits on domestic flights. For domestic flights within the UK the provisions of the

Carriage by Air Act 1961 apply together with Orders made under it. You will find referenceCarriage by Air Act 1961 apply together with Orders made under it. You will find reference

to limits of liability in the small print, which forms part of the standard airline ticket. to limits of liability in the small print, which forms part of the standard airline ticket.

The position has been made more complex by some governments imposing on their nationalThe position has been made more complex by some governments imposing on their national

airlines increased limits of liability, which do not have worldwide approval. Although theairlines increased limits of liability, which do not have worldwide approval. Although the

appropriate rules for calculation of legal liability are normally determined by reference to theappropriate rules for calculation of legal liability are normally determined by reference to the

country at point of departure and the country of destination recorded on the ticket, an airlinecountry at point of departure and the country of destination recorded on the ticket, an airline

disaster may produce claims from passengers of many nationalities.disaster may produce claims from passengers of many nationalities.

It is interesting to note that inIt is interesting to note that in Goldman v. Thai Airlines InternationalGoldman v. Thai Airlines International (1981), (1981), it was held that it was held that

the limits did not apply when the aircrews were 'reckless' in flying the aircraft. In thethe limits did not apply when the aircrews were 'reckless' in flying the aircraft. In the

aftermath of the Lockerbie disaster, there have been a number of attempts at securing muchaftermath of the Lockerbie disaster, there have been a number of attempts at securing much

higher compensation than the agreements laid down. Some claims have been settled forhigher compensation than the agreements laid down. Some claims have been settled for

higher amounts, especially when the limits have appeared low in relation to the earninghigher amounts, especially when the limits have appeared low in relation to the earning

capacity of the passenger.capacity of the passenger.

There have been unsuccessful efforts to increase the Warsaw/Hague limits. Change will onlyThere have been unsuccessful efforts to increase the Warsaw/Hague limits. Change will only

be piecemeal without the support of the major airline operating countries, notably the Unitedbe piecemeal without the support of the major airline operating countries, notably the United

States of America.States of America.

The two international agreements also place limits on liability for goods carried by air. UnlessThe two international agreements also place limits on liability for goods carried by air. Unless

of special risk or value, cargo is usually insured 'all risks' in the marine or general marketsof special risk or value, cargo is usually insured 'all risks' in the marine or general markets

rather than in the aviation market. Other groups of persons requiring aviation liability coverrather than in the aviation market. Other groups of persons requiring aviation liability cover

are aircraft and aircraft component manufacturers, and airport authorities.are aircraft and aircraft component manufacturers, and airport authorities.

3.7.2.5 Fire and Other Property Damage Insurance3.7.2.5 Fire and Other Property Damage Insurance

117

There are a number of different ways in which property can be damaged. One needs only to There are a number of different ways in which property can be damaged. One needs only to

think of a small factory unit to imagine all that can be damaged and all the ways in which think of a small factory unit to imagine all that can be damaged and all the ways in which

damage can be sustained. Fire and theft probably come to mind first, but then there are very damage can be sustained. Fire and theft probably come to mind first, but then there are very

many different forms of accidental damages. many different forms of accidental damages.

I. Fire Insurance I. Fire Insurance

In most commercial policies the insured will require cover for buildings, machinery and plant,In most commercial policies the insured will require cover for buildings, machinery and plant,

and stock. These are the three main headings under which property is insured and in someand stock. These are the three main headings under which property is insured and in some

cases a list of such items can run to many pages, depending upon the size of the insuredcases a list of such items can run to many pages, depending upon the size of the insured

company.company.

In addition to these areas it may be necessary to arrange cover for property while it is stillIn addition to these areas it may be necessary to arrange cover for property while it is still

being built, that is buildings in course of erection, but this form of cover is gradually givingbeing built, that is buildings in course of erection, but this form of cover is gradually giving

way to a policy known as 'contractors all risks' which will be discussed later.way to a policy known as 'contractors all risks' which will be discussed later.

A standard fire policy is used for almost all business insurances, with Lloyd's of London alsoA standard fire policy is used for almost all business insurances, with Lloyd's of London also

issuing a standard fire policy that is slightly different in its wording. The basic intention of theissuing a standard fire policy that is slightly different in its wording. The basic intention of the

fire policy is to provide compensation to the insured person in the event of there beingfire policy is to provide compensation to the insured person in the event of there being

damage to the property insured. It is not possible, in the commercial world, to issue a policydamage to the property insured. It is not possible, in the commercial world, to issue a policy

that will provide compensation regardless of how the damage occurs. The insurancethat will provide compensation regardless of how the damage occurs. The insurance

companies, the insurers, have to know which perils they are insuring against.companies, the insurers, have to know which perils they are insuring against.

The standard fire policy covers damage to property caused by fire, lightning or explosion,The standard fire policy covers damage to property caused by fire, lightning or explosion,

where this explosion is brought about by gas or boilers not used for any industrial purpose.where this explosion is brought about by gas or boilers not used for any industrial purpose.

This is limited in its scope because property can be damaged in other ways and, to meet thisThis is limited in its scope because property can be damaged in other ways and, to meet this

need, a number of extra perils (known as special perils) can be added on to the basic policy.need, a number of extra perils (known as special perils) can be added on to the basic policy.

These perils are:These perils are:

Storm, tempest or flood;Storm, tempest or flood;

Burst pipes;Burst pipes;

Earthquake;Earthquake;

Aircraft;Aircraft;

Riot, civil commotion;Riot, civil commotion;

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Malicious damage;Malicious damage;

Explosion;Explosion;

Impact.Impact.

It is important to remember that these additional perils must result in damage to the property,It is important to remember that these additional perils must result in damage to the property,

and it is as well to precede each by saying 'damage to the property caused by special periland it is as well to precede each by saying 'damage to the property caused by special peril

element'.element'.

II. Theft insuranceII. Theft insurance

Theft policies have the same aim as the standard fire policy, in that they intend to provideTheft policies have the same aim as the standard fire policy, in that they intend to provide

compensation to the insured in the event of loss of the property insured.compensation to the insured in the event of loss of the property insured.

The property to be insured, for a commercial venture, will be the same as under the fireThe property to be insured, for a commercial venture, will be the same as under the fire

policy, of course except for the buildings. The theft policy will, in addition, show a morepolicy, of course except for the buildings. The theft policy will, in addition, show a more

detailed definition of the stock. The reason for this is that fire is indiscriminate, whereas adetailed definition of the stock. The reason for this is that fire is indiscriminate, whereas a

thief is not, so the insurers charge more for stock which is attractive to thieves.thief is not, so the insurers charge more for stock which is attractive to thieves.

The law has its own definition for theft having an impact on insurance companies, as itThe law has its own definition for theft having an impact on insurance companies, as it

defined the term 'theft'. The legal definition was wider than that which the companies weredefined the term 'theft'. The legal definition was wider than that which the companies were

prepared to offer, especially for business premises, because the definition did not mention anyprepared to offer, especially for business premises, because the definition did not mention any

need for there to be force and violence in committing a theft. This meant that shoplifting, forneed for there to be force and violence in committing a theft. This meant that shoplifting, for

example, was 'theft' and this kind of risk had traditionally been uninsurable. To remedy theexample, was 'theft' and this kind of risk had traditionally been uninsurable. To remedy the

problem, insurance companies included in their policies a phrase to the effect that theft,problem, insurance companies included in their policies a phrase to the effect that theft,

within the meaning of the policy, was to include force and violence either in breaking into orwithin the meaning of the policy, was to include force and violence either in breaking into or

out of the premises of the insured.out of the premises of the insured.

3.3.7.2.5. Comprehensive Insurances7.2.5. Comprehensive Insurances

A step on from issuing combined policies, which is only the combination of separate policiesA step on from issuing combined policies, which is only the combination of separate policies

within the one folder, is the comprehensive policy. This form of insurance represents awithin the one folder, is the comprehensive policy. This form of insurance represents a

widening in the scope of cover. It is also sometimes called a 'package' policy and is an attemptwidening in the scope of cover. It is also sometimes called a 'package' policy and is an attempt

by insurers to have a single policy section detailing the policy cover, exclusions andby insurers to have a single policy section detailing the policy cover, exclusions and

conditions. For example, the household comprehensive policy covers the basic perilsconditions. For example, the household comprehensive policy covers the basic perils

mentioned above and also includes cover against damage caused by collapse of televisionmentioned above and also includes cover against damage caused by collapse of television

119

aerials, leakage of central heating oil, the breakage of underground water pipes, sanitaryaerials, leakage of central heating oil, the breakage of underground water pipes, sanitary

fittings and many more risks. fittings and many more risks.

This widening of scope of the perils insured has been accompanied by alterations in the basicThis widening of scope of the perils insured has been accompanied by alterations in the basic

method of providing cover, so that today it is possible to arrange a household comprehensivemethod of providing cover, so that today it is possible to arrange a household comprehensive

policy which provides cover against damage caused by almost any event and with the amountpolicy which provides cover against damage caused by almost any event and with the amount

being paid representing what it will actually cost to replace the damaged property.being paid representing what it will actually cost to replace the damaged property.

This widening in cover has not been without its problems and many insurers have experiencedThis widening in cover has not been without its problems and many insurers have experienced

large losses on their household insurance business, as a result of which substantial increases inlarge losses on their household insurance business, as a result of which substantial increases in

premiums have been introduced.premiums have been introduced.

Comprehensive policies are also available for offices and shops, where cover is provided as aComprehensive policies are also available for offices and shops, where cover is provided as a

package. This is an efficient and relatively inexpensive way of providing cover for smallpackage. This is an efficient and relatively inexpensive way of providing cover for small

offices and shops.offices and shops.

3.8 LIMITATION OF INSURANCE3.8 LIMITATION OF INSURANCE

In our daily lives, we all face problems that are risky. People know there is always a risk that In our daily lives, we all face problems that are risky. People know there is always a risk that

some times may include very dangerous results in a future period. To deal with various kinds some times may include very dangerous results in a future period. To deal with various kinds

of risks, people may purchase insurance policies. However, insurance is not a cure for all ills. of risks, people may purchase insurance policies. However, insurance is not a cure for all ills.

This is because the scope of insurance is limited due to the following points.This is because the scope of insurance is limited due to the following points.

General LimitationsGeneral Limitations

Every insurance policy is constrained by the following limitations.Every insurance policy is constrained by the following limitations.

Limitation By Pecuniary value.Limitation By Pecuniary value. Loss or damage covered by insurance must be capable of Loss or damage covered by insurance must be capable of

being expressed in the terms of pecuniary payment. An article may have little commercialbeing expressed in the terms of pecuniary payment. An article may have little commercial

value but may be highly priced by its owner for certain associations. Such peculiar personalvalue but may be highly priced by its owner for certain associations. Such peculiar personal

value is not capable of being expressed in pecuniary terms and compensation in money isn'tvalue is not capable of being expressed in pecuniary terms and compensation in money isn't

feasible.feasible.

Limitation by 1aw. Limitation by 1aw. A person cannot insure against the consequences accorded to him of hisA person cannot insure against the consequences accorded to him of his

own deliberate act. A Murderer who had effected an insurance on the life of his victim couldown deliberate act. A Murderer who had effected an insurance on the life of his victim could

not himself collect the money.not himself collect the money.

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a.a. Limitation by insurable interestLimitation by insurable interest. There must be an insurable interest to be. There must be an insurable interest to be

protected, where there is no insurable interest, the agreement between the parties isprotected, where there is no insurable interest, the agreement between the parties is

nothing more than a waiver. Although a waiver is legal, courts don't enforce it, and it isnothing more than a waiver. Although a waiver is legal, courts don't enforce it, and it is

illegal when it is done by cloak of insurance.illegal when it is done by cloak of insurance.

b.b. Limitation by insufficiency of knowledgeLimitation by insufficiency of knowledge. There are certain risks that insurance. There are certain risks that insurance

companies will not undertake. Perhaps the most important of these risks is the risk ofcompanies will not undertake. Perhaps the most important of these risks is the risk of

loss of profit through market fluctuations in prices and alterations in cost of production,loss of profit through market fluctuations in prices and alterations in cost of production,

i.e. trade risk. The loss of profit by reasons of market fluctuations is certainly capable ofi.e. trade risk. The loss of profit by reasons of market fluctuations is certainly capable of

being expressed in pecuniary terms.being expressed in pecuniary terms.

c.c. Limitations by public policy. Limitations by public policy. Certain risks can't be insured because to do soCertain risks can't be insured because to do so

would be against public policy. Public policy refers to those recognized by responsiblewould be against public policy. Public policy refers to those recognized by responsible

authorities as controlling the relationships between men and women in the country.authorities as controlling the relationships between men and women in the country.

These five considerations limit the scope of insurance whether it is life insurance, carThese five considerations limit the scope of insurance whether it is life insurance, car

insurance, marine insurance or any other insurance. In speaking of limitations, everyinsurance, marine insurance or any other insurance. In speaking of limitations, every

insurance policy has its own limitations. The limits of each type of insurance polices areinsurance policy has its own limitations. The limits of each type of insurance polices are

identified as follows.identified as follows.

II. Limitations By Policy II. Limitations By Policy

a.a. Personal Accident Policy. Personal Accident Policy. This insurance coverage is for a person who is insuredThis insurance coverage is for a person who is insured

from many perils like death, disability, chance of survival to a specified age, accidents etc.from many perils like death, disability, chance of survival to a specified age, accidents etc.

The part that this policy doesn't cover is death or disablement consequent up on:The part that this policy doesn't cover is death or disablement consequent up on:

War, civil war rebellion, revolution, insurrection, mutiny, martial law, invasionWar, civil war rebellion, revolution, insurrection, mutiny, martial law, invasion

act by foreignness hostilities. Naval, military or air force service operations.act by foreignness hostilities. Naval, military or air force service operations.

Hunting, race driving, winter sport Hunting, race driving, winter sport

Suicide, attempted suicide or intentional self injurySuicide, attempted suicide or intentional self injury

Child birth or pregnancy in womenChild birth or pregnancy in women

The insured suffering from any pre existing physical defect or infirmityThe insured suffering from any pre existing physical defect or infirmity

The insured being in / entering into / alighting of / falling from aircrafts thatThe insured being in / entering into / alighting of / falling from aircrafts that

aren't fully licensed.aren't fully licensed.

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The insurance company in order to take responsibility must see some conditions first. TheseThe insurance company in order to take responsibility must see some conditions first. These

conditions are: conditions are:

Notice in writing of any accident occurring to the insured during theNotice in writing of any accident occurring to the insured during the

occurrence with full particulars of the injuries must be given to the insurer asoccurrence with full particulars of the injuries must be given to the insurer as

soon as possible. In no condition will the insurer be liable to pay compensationsoon as possible. In no condition will the insurer be liable to pay compensation

to the insured or to his representatives unless the medical advisor appointed byto the insured or to his representatives unless the medical advisor appointed by

the insurer examine the insured or the event of death. the insurer examine the insured or the event of death.

Under no circumstances will the insurer be liable for any claims unless noticeUnder no circumstances will the insurer be liable for any claims unless notice

has been of be received with in a specified period of time after the occurrencehas been of be received with in a specified period of time after the occurrence

of the accident.of the accident.

b.b. Work Men's compensation policy. Work Men's compensation policy. This insurance is purchased by industrialistsThis insurance is purchased by industrialists

to secure their personnel. This insurance covers loss to workers while working in theto secure their personnel. This insurance covers loss to workers while working in the

factory, losses might be death, disability, sickness and diseases due to work areafactory, losses might be death, disability, sickness and diseases due to work area

conditions and from the work itself. The Ethiopian law forces employers to payconditions and from the work itself. The Ethiopian law forces employers to pay

compensation for losses incurred on their workers caused due to working conditions.compensation for losses incurred on their workers caused due to working conditions.

However, the insurer will not be liable to the following conditions.However, the insurer will not be liable to the following conditions.

Any accident or occupational disease resulting from any contravention ofAny accident or occupational disease resulting from any contravention of

regulation to which the workers attention has been specially drawn to inregulation to which the workers attention has been specially drawn to in

writing.writing.

Any sum which the insured would have been entitled to recover from any partyAny sum which the insured would have been entitled to recover from any party

but for an agreement between the insured and such party. but for an agreement between the insured and such party.

Any liability directly/indirectly caused by intentional self injury, suicide orAny liability directly/indirectly caused by intentional self injury, suicide or

attempted suicide, provoked assaultattempted suicide, provoked assault

While traveling in any air craft except a fair paying passenger over establishedWhile traveling in any air craft except a fair paying passenger over established

air lines routes in a fully standard type aircraft owned by recognized airair lines routes in a fully standard type aircraft owned by recognized air

transport. In this policy, permanent disabilities are first determined by theirtransport. In this policy, permanent disabilities are first determined by their

scale which shows their seriousness. The scale for permanent disablement isscale which shows their seriousness. The scale for permanent disablement is

shown as follows.shown as follows.

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c.c. Fire and lightening PolicyFire and lightening Policy

This insurance covers losses caused by fire and lightning. The losses are only property losses,This insurance covers losses caused by fire and lightning. The losses are only property losses,

this insurance doesn't cover items that can be covered by other insurance polices like lifethis insurance doesn't cover items that can be covered by other insurance polices like life

insurance for life. This policy doesn't cover the following aspects. Loss or damage to propertyinsurance for life. This policy doesn't cover the following aspects. Loss or damage to property

occasioned by its own fermentation, natural heating, spontaneous combustion, or by its underoccasioned by its own fermentation, natural heating, spontaneous combustion, or by its under

going any heating or drilling process.going any heating or drilling process.

Loss or damage in consequence of the burning of property by order of any public authority orLoss or damage in consequence of the burning of property by order of any public authority or

subterranean fire. Loss caused directly or indirectly by nuclear weapons’ material ionizingsubterranean fire. Loss caused directly or indirectly by nuclear weapons’ material ionizing

radiations, contamination by radio activity or waste from combustion of nuclear fuel. Lossradiations, contamination by radio activity or waste from combustion of nuclear fuel. Loss

caused by natural perils, invasion, war, mutiny, riots, strikes, martial law etc.caused by natural perils, invasion, war, mutiny, riots, strikes, martial law etc.

Loss occasioned by the burning of forests, bushes jungle, etc.Loss occasioned by the burning of forests, bushes jungle, etc.

Loss occurring due to goods held in trust.Loss occurring due to goods held in trust.

d.d. Commercial vehicle policyCommercial vehicle policy

This policy covers losses to vehicles. The losses that are not covered by this policy areThis policy covers losses to vehicles. The losses that are not covered by this policy are

losses arising out side the stated geographical area.losses arising out side the stated geographical area.

Wear and tear, depreciation of the vehicle, Mechanical or electrical breakWear and tear, depreciation of the vehicle, Mechanical or electrical break

down. down.

Loss due to over-loading or strainLoss due to over-loading or strain

Loss due to racing, pace making and speed testing.Loss due to racing, pace making and speed testing.

Loss caused due to driving under the influence of intoxicating liquor or drug.Loss caused due to driving under the influence of intoxicating liquor or drug.

Loss due to explosion.Loss due to explosion.

Loss due to damage on any bridge or road caused by load of vehicle.Loss due to damage on any bridge or road caused by load of vehicle.

Loss due to damage on any bridge or road caused by load of vehicle.Loss due to damage on any bridge or road caused by load of vehicle.

Loss due to natural perils, war, invasion, mutiny strikes martial law, riots etc.Loss due to natural perils, war, invasion, mutiny strikes martial law, riots etc.

e.e. Private Vehicle PolicyPrivate Vehicle Policy

This policy is the same as the commercial vehicle policy but only with additional perquisites. This policy is the same as the commercial vehicle policy but only with additional perquisites.

This policy in addition to the commercial vehicle polices doesn't cover:This policy in addition to the commercial vehicle polices doesn't cover:

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Loss occurring in connection with bodily injury if the number of Loss occurring in connection with bodily injury if the number of

persons exceeds the sitting capacity. persons exceeds the sitting capacity.

Loss directly occasioned by aircrafts or other aerial factors while Loss directly occasioned by aircrafts or other aerial factors while

traveling at sonic/supersonic speeds.traveling at sonic/supersonic speeds.

f.f. Burglary and house breaking PolicyBurglary and house breaking Policy

This policy covers losses from burglary and housebreaks. This policy doesn't cover the This policy covers losses from burglary and housebreaks. This policy doesn't cover the

following losses.following losses.

Losses due to war, invasion, mutiny, riots, strikes, civil commotions, military /Losses due to war, invasion, mutiny, riots, strikes, civil commotions, military /

popular rising, insurrection rebellion and martial law. popular rising, insurrection rebellion and martial law.

Loss arising from ionizing radiations /contamination by radioactivity from anyLoss arising from ionizing radiations /contamination by radioactivity from any

nuclear fuel / nuclear waste from combustion of nuclear fuel.nuclear fuel / nuclear waste from combustion of nuclear fuel.

Loss caused by nuclear weapon materialLoss caused by nuclear weapon material

Loss from material alteration with out consent from the firm.Loss from material alteration with out consent from the firm.

Loss of property that can be insured under another policy unless otherwiseLoss of property that can be insured under another policy unless otherwise

specifically provided.specifically provided.

g.g. Consequential loss policyConsequential loss policy

This insurance covers buildings or any other property used for the purpose of business that is This insurance covers buildings or any other property used for the purpose of business that is

destroyed or damaged by fire, lighting or explosion (in a building in which gas is not destroyed or damaged by fire, lighting or explosion (in a building in which gas is not

generated). This policy does not cover loss occasioned by:-generated). This policy does not cover loss occasioned by:-

burning of property by order of government authority subterranean burning of property by order of government authority subterranean

firefire

explosion except as stated explosion except as stated

due to burning of forests, bush, prairie, pampas, jungledue to burning of forests, bush, prairie, pampas, jungle

clearing of lands by fireclearing of lands by fire

nuclear weapons material ionizing radiationsnuclear weapons material ionizing radiations

natural perils, atmospheric disturbances natural perils, atmospheric disturbances

war, invasion, act of foreign enemy or war like operations.war, invasion, act of foreign enemy or war like operations.

Mutiny, riots, strikes, civil commotions, insurrection rebellion, Mutiny, riots, strikes, civil commotions, insurrection rebellion,

revolution, martial law, terrorism, the overthrow of government by revolution, martial law, terrorism, the overthrow of government by

force.force.

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h.h. Money PolicyMoney Policy

This policy covers the loss of money to the insured. Money means cash, bank notes, currencyThis policy covers the loss of money to the insured. Money means cash, bank notes, currency

notes, checks (except crossed checks, postal orders, money orders, current postage andnotes, checks (except crossed checks, postal orders, money orders, current postage and

revenue stamps). This policy doesn't cover loss.revenue stamps). This policy doesn't cover loss.

Direct or indirect war, invasion, hostilities, warlike operations, civilDirect or indirect war, invasion, hostilities, warlike operations, civil

war, mutiny, riots, strikes civil commotions, military rising, insurrection,war, mutiny, riots, strikes civil commotions, military rising, insurrection,

rebellion, martial law, terrorism, armed or unarmed robbery, overthrow ofrebellion, martial law, terrorism, armed or unarmed robbery, overthrow of

government by force.government by force.

Arising from dishonesty of any messenger.Arising from dishonesty of any messenger.

Shortage due to errors or omissions and loss due to depreciation in Shortage due to errors or omissions and loss due to depreciation in

value.value.

Contributed by nuclear weapon material, ionizing radiation, andContributed by nuclear weapon material, ionizing radiation, and

contamination by radioactivity from any nuclear fuel.contamination by radioactivity from any nuclear fuel.

From an attend vehicleFrom an attend vehicle

Loss insured by any policy except with respect to any excess beyondLoss insured by any policy except with respect to any excess beyond

the amount which would have been payable under such other policy, had thisthe amount which would have been payable under such other policy, had this

insurance not existed.insurance not existed.

i.i. All Risk PolicyAll Risk Policy

This policy covers any property or any part there of lost or damaged by accident orThis policy covers any property or any part there of lost or damaged by accident or

misfortune. This policy does not cover loss arising from moth, vermin, insects, wear and tearmisfortune. This policy does not cover loss arising from moth, vermin, insects, wear and tear

damp, mildew, light, atmospheric or climatic conditions or any other gradually operatingdamp, mildew, light, atmospheric or climatic conditions or any other gradually operating

cause. It also includes loss occasioned by cleaning, dyeing, alternation, repairing or restoring.cause. It also includes loss occasioned by cleaning, dyeing, alternation, repairing or restoring.

Damage to products due to their brittle or fragile nature unlessDamage to products due to their brittle or fragile nature unless

thieves or fire causes such damage. Damage caused by over winding,thieves or fire causes such damage. Damage caused by over winding,

mechanical or electrical breakdown.mechanical or electrical breakdown.

Loss caused by order of government officials.Loss caused by order of government officials.

Loss to property dispatched by air or ship other than in which theLoss to property dispatched by air or ship other than in which the

insured is traveling unless specially agreed up on by the corporation.insured is traveling unless specially agreed up on by the corporation.

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Loss due to theft or attempted theft by a relative of insured or by theLoss due to theft or attempted theft by a relative of insured or by the

willful act of the insured.willful act of the insured.

Loss due to warlike operations, civil war, strikes, mutiny, martialLoss due to warlike operations, civil war, strikes, mutiny, martial

law, revolution, rebellion.law, revolution, rebellion.

Loss not reported with in a specified period of time after occurrence. Loss not reported with in a specified period of time after occurrence.

Loss of plan specifications, blue prints, models, deeds, bonds, bills ofLoss of plan specifications, blue prints, models, deeds, bonds, bills of

exchange, promissory notes money securities and all legal documents.exchange, promissory notes money securities and all legal documents.

Loss to any photographic equipment insured while being used forLoss to any photographic equipment insured while being used for

professional purposes.professional purposes.

There can be also limitations on the insurer's liability. The sum insured stipulated limit of theThere can be also limitations on the insurer's liability. The sum insured stipulated limit of the

insures liability to the insured. There may also be a single article limit or limitation on theinsures liability to the insured. There may also be a single article limit or limitation on the

amount of revocable, in all, on items of special type. For example, the sum applicable toamount of revocable, in all, on items of special type. For example, the sum applicable to

valuable items may be limited to one- third of the total sum insured under a household policy.valuable items may be limited to one- third of the total sum insured under a household policy.

If an item is specifically insured with a separate sum allocated there to, then that sum is theIf an item is specifically insured with a separate sum allocated there to, then that sum is the

extent of the insured liability with respect to the item concerned. When the insurer instructsextent of the insured liability with respect to the item concerned. When the insurer instructs

adjusters to deal with a claim, their fees are payable in addition to any payment to the insured.adjusters to deal with a claim, their fees are payable in addition to any payment to the insured.

Under some type of polices there may be different limits to the insurers’ liability underUnder some type of polices there may be different limits to the insurers’ liability under

different section. Under most house hold policies on buildings, the sum insured is the limit ofdifferent section. Under most house hold policies on buildings, the sum insured is the limit of

the amount revocable but loss of rent is usually payable in addition up to a certain percentagethe amount revocable but loss of rent is usually payable in addition up to a certain percentage

of the sum insured similarly, there is a separate public liability section with a limit of aof the sum insured similarly, there is a separate public liability section with a limit of a

specific amount on any accidents.specific amount on any accidents.

Public liability policies as a rule contain a limit of liability for any one occurrence, but legalPublic liability policies as a rule contain a limit of liability for any one occurrence, but legal

costs and expenses are payable in addition to that limit. Occasionally, the indemnity iscosts and expenses are payable in addition to that limit. Occasionally, the indemnity is

unlimited in amount and this is always so under employers liability policies.unlimited in amount and this is always so under employers liability policies.

Another factor affecting the limitations of the insurers liability is the use of average. TheAnother factor affecting the limitations of the insurers liability is the use of average. The

application of average is a means where by insurers seek to defeat under insurance its effect toapplication of average is a means where by insurers seek to defeat under insurance its effect to

make the insured his own insurer to some extent when "under insurance " exists. The insurermake the insured his own insurer to some extent when "under insurance " exists. The insurer

will only pay the proportion of the loss that the sum insured bears to the total volume of thewill only pay the proportion of the loss that the sum insured bears to the total volume of the

property insured. property insured.

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From the point of the insurance supervision, the most critical challenge is how to preventFrom the point of the insurance supervision, the most critical challenge is how to prevent

insolvency of insurance companies. Insolvency in insurance business is not a suddeninsolvency of insurance companies. Insolvency in insurance business is not a sudden

phenomenon, rather, the impairment takes place gradually. The ultimate disaster ofphenomenon, rather, the impairment takes place gradually. The ultimate disaster of

insolvency can be averted through timely corrective actions.insolvency can be averted through timely corrective actions.

Check Your Progress ExerciseCheck Your Progress Exercise

1.1. Define insurance from legal and business point of view.Define insurance from legal and business point of view.

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2.2. Discuss the five legal principles of insurance.Discuss the five legal principles of insurance.

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3.3. List and explain the 3 major types of life insurance policies.List and explain the 3 major types of life insurance policies.

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4.4. Identify the general limitations of insurance.Identify the general limitations of insurance.

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5.5. Give two major benefits of insurance to the society.Give two major benefits of insurance to the society.

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3.9 SUMMARY3.9 SUMMARY

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A number of important features have been introduced in this unit. The functions of insurance,A number of important features have been introduced in this unit. The functions of insurance,

the benefits to the individual and the economy, a brief account of the historical developmentthe benefits to the individual and the economy, a brief account of the historical development

of insurance and a description of the main classes of insurance currently known have all beenof insurance and a description of the main classes of insurance currently known have all been

covered. This is a lot of material to cover, but it is an essential groundwork for anyone whocovered. This is a lot of material to cover, but it is an essential groundwork for anyone who

intends to make a serious study of insurance.intends to make a serious study of insurance.

3.10 ANSWER TO CHECK YOUR PROGRESS EXERCISE3.10 ANSWER TO CHECK YOUR PROGRESS EXERCISE

1.1. Refer to Section 3.2Refer to Section 3.2

2.2. Refer to Section 3.6Refer to Section 3.6

3.3. Refer to Part 3.7.1.2 of Section 3.7Refer to Part 3.7.1.2 of Section 3.7

4.4. Refer to Section 3.8Refer to Section 3.8

5.5. Refer to Section 3.4Refer to Section 3.4

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