INSURANCE BASICS PART 1

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A LOSS is insurable only if it is caused by an unexpected event, and not caused intentionally by the person covered by insurance. As an example, a property loss can be insured against the chance of fire, but the policy benefit is not payable if the fire is set deliberately. While death is certain, a person’s life is insurable because the time of death is a matter of chance.

An insurable loss must be definite in terms of time and amount. The insurer must be able to determine when the benefit would be payable and how much it should be. A contract of indemnity sets a limit or maximum amount payable regardless of the size of the loss, and, used for insuring a car that is stolen for example, would pay the depreciated value of the car on the day it was stolen.

A valued contract, used for a life insurance policy for say K50, 000 will pay that amount as the death benefit. The amount is called the face amount or face value because it is mentioned on the face or first page of the policy.

The loss must be significant. The loss of a story book or a school bag would not cause financial hardship to anyone. These types of losses are not normally insured. The cost of providing such a small amount of insurance would be too high to make the protection economical.

The rate of loss must be predictable. The rate, or the number and timing of losses expected in a group of insureds during the term of coverage, determines the premium.

The rate can be predicted by the use of:

A) probability, of the relative frequency with which an event has occurred or is likely to occur, and

B) the law of large numbers: the larger the sample, the more accurate the estimate or prediction.

The loss must not be catastrophic to the insurer. It should not be beyond the insurer’s ability to honour the claim. An insurer can avoid huge losses by means of reinsurance or a transfer of risk to other insurers.

There must be an insurable interest. The insured event must cause a genuine loss to the insured. A fire insurance policy on a particular building would not be sold to a person who does not own the building.

For life insurance there must be family or financial ties: a) Beneficiary’s interest. It is legally established that all persons have an insurable interest in their own lives; In the physical world, there is more to gain by living than by dying.

Although spiritually this statement may not be debatable, an applicant/insured also has the legal right to designate as beneficiary any person or party desired.

Family relationships create an insurable interest. b) Financial interest. An insurable interest is not presumed when the designated beneficiary is more distant than the insured’s family by blood or marriage. In such a case a financial interest in the continued life of a person or safety of property must be demonstrated.

There must not be anti-selection or selection against the insurer. Insurance is based on a risk pooling concept whereby funds from many policyholders are used to compensate the unfortunate few who are affected by a peril. For the risk pooling mechanism to work, a policy should be designed to attract applicants who are unlikely to present claims. To avoid adverse selection, the risk should be spread among a large number of policyholders, and steps need to be taken to prevent the pool from being dominated by high risk persons.

A number of reasons for an insurer’s failure also apply to other businesses, but are still worth highlighting. They include: inadequate expertise and know-how, use of proceeds for personal gain, extravagant expenses, unreasonable delays in producing audited results, and trying to grow too quickly.

Some failure factors are particular to the insurer’s sponsoring organisation. For cooperatives, these include seeing the insurance programme not as a service operated for the benefit of the customers, but as a source of revenue for the development of the sponsoring organisation itself.

Complex products will invariably encounter uncontrollable claims costs and erratic cycles. A new insurance programme should begin operations with a limited number of services that are easy to manage and control.

Insurance is a long term business and builds over time. It is also technical and capital intensive. For each line of insurance offered, adequate claims reserves need to be established and sufficient capital and surplus maintained in accordance with professional standards. As it expands, the insurance programme itself will require an increasing amount of capital. Before paying dividends, insurers should retain sufficient earnings to support future growth. If an opportunity looks too good to be true, it probably is a Pitfall. The corporate form chosen for the insurer – joint stock, mutual or other may stunt future growth. Plan into the future, when you put it together.

Heavy infrastructure and overheads are not supported by the income stream. Put functions in place, but not everything everywhere. Distribution channels do not suit customers. Deliver what customers want in a way that will reach them.

Policy holders service is provided without an eye on the total picture and there is no appeals process in place for claimants. One person’s gain could be at others’ expense. Premium collection is tentative and a high proportion of amounts due remains outstanding. Premiums must always precede or come before coverage.

At times the insurer may give in to the temptation of raking in high premiums for riskier lines of insurance. Employees are hired without proper background checks, and there are no checks and controls. Biggest asset, yes – but where has it been all along?

Basic operations of an insurer; A typical fully developed insurance operation might comprise the following departments: Marketing and Sales; This department normally conducts market research and works with other departments to develop new products and revise current ones to meet the customers’ needs. It prepares advertising campaigns, designs promotional materials, and establishes and maintains distribution systems.

It may be responsible for distribution and delivery of products and services to customers, or it may share that responsibility with a separate sales department.  Sales targets are set for each year and agencies and branches are consulted on how best to achieve them. Branches carry out the programmes by appointing and training agents to represent the insurer, keeping them informed of new products and services, and following up on policy renewals.

To underwrite is to accept or reject the risk of insuring. This department studies market trends, past experience and statistics, and then formulates underwriting guidelines, such as risk and class limits and other controls. At the branch level, policies are underwritten according to those guidelines. Look out for Part II.

*Note: In this column I offer general insurance information. Do not completely rely on this column in making insurance decisions. For specific guidelines email; insuculture@gmail.com

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