KENYATTA UNIVERSITY

INSTITUTE OF OPEN LEARNING

CMS101:INTRODUCTION TO INSURANCE

DR. MARK O. OGUTU

 OVERVIEW
The study of introduction to insurance has a vital role in explaining and conveying the
underlying principles of conducting insurance business. Insurance is a way of reducing
uncertainty of occurrence of an event. It is in itself an investment. The study will help students
who wish to understand, invest or major in insurance as a career option.

This module consists of nine lessons. The subject matter is quite sufficient and complete and
tailored to suite the students need. There are a number of questions and activities for self-
testing at the end of every lesson, to boost the learning process.

Lesson one discusses Risk Management and insurance, concept of risk, risk management and a
few terms used in insurance. Lesson two covers the functions of insurance. Lesson three
discusses the nature of insurance and the basic principles of insurance. Lesson four entails the
practice of general insurance including the demand and supply of insurance in the market.
Lesson five is on life insurance and the types of life insurance policies available. Lesson six
covers five insurance and policy drafting. Lesson seven discusses marine insurance, marine
underwriting and the general contract under marine insurance. Lesson eight is on motor
insurance, including the policies covered. Lesson nine discusses the general and miscellaneous
insurance contracts.

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Table Of Contents

LESSON 1 ................................................................................................................................. 1
Risk Management And Insurance................................................................................................ 1
1.0 Introduction........................................................................................................................... 1
1.3 The Concept Of Risk ............................................................................................................. 2
1.3.2 Insurance: Nature And Sources Of Risks .......................................................................... 3
1.3.3 The Concept Or Risk .......................................................................................................... 4
1.3.4 Classification Of Risk ......................................................................................................... 5
Pure Risk Is Loss ......................................................................................................................... 6
1.3.8 Risk And Economic Burden ............................................................................................... 7
1.4 Types Of Preventive And Protective Efforts ......................................................................... 9
1.5 Insurer And Prevention Of Risk .......................................................................................... 11
1.6 Risk Management ................................................................................................................ 12
1.7 Principles Of Risk Management. ........................................................................................ 15
1.8 Future Of Risk Management............................................................................................... 19
LESSON 2................................................................................................................................. 29
Functions Of Insurance .............................................................................................................. 29
2.0 Introduction.......................................................................................................................... 29
2.2 Definitions Of Insurance...................................................................................................... 29
2.3 Functions Of Insurance ........................................................................................................ 31
2.3.0 Individual .......................................................................................................................... 31
2.3.1. Society.............................................................................................................................. 37
LESSON 3................................................................................................................................. 41
Nature Of Insurance................................................................................................................... 41
3.0 Introduction.......................................................................................................................... 41
3.2 Special Features Of A Valid Insurance Contract................................................................ 41
3.3 Basic Principles Of Law Governing General Insurance ..................................................... 42
3.3.0 Utmost Good Faith........................................................................................................... 42
3.1.2 Insurable Interest............................................................................................................... 44
3.1.3 Indemnity .......................................................................................................................... 47
3.1.4 Doctrine Of Subrogation................................................................................................... 49
3.1.5 Proximate Cause ............................................................................................................... 53
LESSON 4................................................................................................................................. 60
Practice Of General Insurance ................................................................................................... 60
4.0 Introduction.......................................................................................................................... 60
4.1 Objectives ............................................................................................................................ 60
4.2 The Insurance Market Structure........................................................................................... 60
4.3 Price Elasticity Of Demand For Insruance. ......................................................................... 63
4.4 Income Elasticity Of Demand For Insurance...................................................................... 64
5.0 Introduction.......................................................................................................................... 70
5.2 Fire Policy Drafting ............................................................................................................. 70

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5.5 Types Of Life Insurance Offered In Kenya ......................................................................... 71
Term Insurance .......................................................................................................................... 71
5.6 Health Plan........................................................................................................................... 72
5.7 Health Care Issues................................................................................................................ 73
Common Diseases...................................................................................................................... 73
LESSON 6................................................................................................................................. 75
Fire Insurance............................................................................................................................. 75
6.1 Introduction.......................................................................................................................... 75
6.2 Objectives ............................................................................................................................ 75
6.3 Fire Policy Drafting ............................................................................................................. 75
6.5 Standard Contract Or Policy ............................................................................................... 79
Basic Definitions In Use In Policy............................................................................................. 80
LESSON 7............................................................................................................................... 108
Marine Insurance ..................................................................................................................... 108
7.0 Introduction........................................................................................................................ 108
7.1 Objectives .......................................................................................................................... 108
7.2 Marine Underwriting ......................................................................................................... 108
7.2.2 Special Characteristics Of Marine Insurance Contract.................................................. 109
7.3.1 Insurable Interest............................................................................................................. 110
7.4 Meaning And Object Of Marine Insurance And Terms Used .......................................... 114
7.5 Subject Matter Of Marine Insurance................................................................................. 115
8.3 History Of Motor Insurance.............................................................................................. 120
8.4.2 Insurable Interest............................................................................................................. 121
8.4.4 Subrogation And Contribution........................................................................................ 122
8.4.5 Proximate Cause ............................................................................................................. 122
8.5 Types Of Motor Vehicles................................................................................................... 123
8.5.1 Types Of Policies............................................................................................................ 123
8.5.2 Classification Of Vehicles .............................................................................................. 124
8.6 Extent Of Cover ................................................................................................................ 127
8.8 Discounts............................................................................................................................ 130
8.10 Motor Claims .................................................................................................................. 132
LESSON 9............................................................................................................................... 135
General Insurance Miscellaneous Insurance............................................................................ 135
9.0 Introduction....................................................................................................................... 135
9.2 Miscellaneous Insurance.................................................................................................... 136
(A) Business Insurance ............................................................................................................ 136
(B) Product Insurance .............................................................................................................. 136
( C) Professional Insurance...................................................................................................... 137
(D) Public Insurance ................................................................................................................ 137
9.3 Development Of Miscellaneous Insurance ........................................................................ 137
9.6 Insurances Of Property ..................................................................................................... 141
9.7 Insurances Of Interest ...................................................................................................... 142
9.9 Burglary ................................................................................................................... 143

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 LESSON 1
RISK MANAGEMENT AND INSURANCE

1.0 Introduction
This lesson is intended to help the student in understanding the meaning of insurance and
the concept risk in any going concern. It covers the broad spectrum of risk management.
The lesson also highlights the major functional organization chart indicating the possible
scope of the risk management department in an organization.

1.1 Objectives

At the end of this lesson the learner should be able to:

(i) Conceptualize risk management and insurance.
(ii) Differentiate risk management, loss prevention and insurance management.
(iii) Understand the scope and functions of the risk management department in
an organization.
(iv) Identify the different forms of risks, nature and sources.

1.2 INSURANCE

Insurance is quite well known. Everyday, some news or other issues on insurance are
published in daily papers. Insurance is a way of reducing uncertainty of occurrence of an
event. Insurance is an investment. Since its birth, it has assumed many functions. Its
basic purpose is to derive plans to counteract the financial consequences of unfavorable
events. It formulates a financial mechanism, which provides a pool to which the persons
exposed to risk may contribute. The unfortunate few of this group who encounter the risk
get compensation out of this pool. Hence, insurance is based on the principle that a group
of persons facing a particular risk join together and co-operate to form a pool. A few of

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them maybe unfortunate (majority safe) and face the loss. The persons who are fortunate
and dont meet the loss share the burden of the unfortunate sufferers. Thus, it is a
cooperative device to share the sufferings of fellow persons. This is a part of human
nature. Therefore, we find human beings always live not in isolation, but in a
community.

The modern day insurance also applies this basic principle. The sophisticated calculation
and application of cooperate principle is done behind the screen kin a business form. The
insurance company creates a group and an agreement (each with the other) among all
members of the group to share the loss of any member due to an uncertain event-taking
place. Insurance is a social device for eliminating or reducing the cost to society of
certain types of risks. Since the World War II the people in general and the governments
of all countries have shown great interest in insurance. One example will be sufficient to
show how important insurance is; Sir Winston Churchill as Prime Minister won the war
of England. But Sir Atlee defeated him in the polls on the issue of National Insurance
Scheme. People thought Sir Atlee more suitable for the job than Sir Churchill. At
present the scheme has become costly. So, Mrs. Margaret Thatcher, the Prime Minister
of UK who followed, wanted to cut the budget on National Health Scheme (NHS). The
scheme was popular in spite of its defects. People wanted its continuance. A leak of
government's thinking aroused a lot of criticism. Mrs. Margaret Thatcher realized that
the end of NHS meant the end of her governance, so she promptly declared; NHS is
safe with us. Thus, risk reduction is part of our life and style of living.

1.3 THE CONCEPT OF RISK

1.3.1 Loss prevention and risk management
Risks have several meanings. The meanings differ according to their field of use. In
general, risk refers to the possibility or chance of meeting danger, suffering loss or injury
or exposure to adversity or danger (Mehr: Principles of Insurance). In a broader sense,
risk is uncertainty. Uncertainty refers to unknown result of an event. The result maybe
helpful or harmful to human interest. Uncertainty about the future is a basic fact of
human life on earth. It is a blessing because it gives rise to discussion, hope, planning,

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accomplishment and progress. It is a curse so far as it gives rise to discipline, fear,
defensive tactics, failure and retrogression. There is maximum feeling of uncertainty
when we believe that an event may either harm or help us; each one being equally likely.

Human powers have always prevailed, like comfort, power, wealth and what not. It is
here that the concept of risk and the possibility of gain or loss enter. A person never
knows what is going to happen, but he or she has a belief that possibilities are in his
favor. All the forces that work are not known, so, the outcome is not foreknown. If the
exact outcome of an event is foreknown, whether it involves loss or does not, then there
is certainty. It cannot be called a risk. Complete certainty of loss or gain is impossible.
So we plan to reduce uncertainty. Our past experiences help us to increase our
knowledge about events. That in turn increases the factor of certainty and reduces risks
or uncertainty. Insurance deals with uncertainty that involves a chance of economic gain
or loss. Let us first understand the nature and sources of uncertainty, to understand the
working principles of insurance.

1.3.2 Insurance: Nature and Sources of Risks

If the future events occur exactly or very close to our belief, there is certainty or no risk.
For example, if we can foretell the possibility of an earthquake, storm or rain, then there
is no risk. But this is difficult. Therefore, there is always a gap between our belief about
the event, occurrence and its actual occurrence. Scientific observation, past experience of
events may bring in some certainty or reduction in risk. Our judgment about the future is
based on our past experience. If we observe that an event, which happened in the past,
repeats, under similar circumstances in the same manner, then this pattern of recurrence
gives us a feeling of coming certainty. If we can recognize or identify many events and
observe that their pattern of happening is constant (repetitive), then we go towards
certainty.

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There are a few sources of uncertainty or risks that must be watched:
(i) Uncertain pattern
We feel certain that events will occur but are uncertain about the pattern. For
example there will be sufficient rainfall in a particular year but its distribution
over different months or days is uncertain. So there is risk of crop failure by a
change in pattern of distribution of rain.

(ii) Inaccuracy of Observation

Our experiences of past events are modified by our personal feelings and
prejudice. It is called bias or self-interest. As for example, we all place great
importance and become serious about loss due to accident. But facts show
that victims of diseases are more in number and they suffer greater disability
than those who meet accidents.

(iii) Facts and Future Planning

Our belief of certainty or uncertainty about events is influenced by facts
already available and future plans. As for example, in laying a road, we face
uncertainty about traffic. But we may plan for our present need with provision
for future increase. The facts about past traffic in volume and value reduce
uncertainty to a great extent.

1.3.3 The Concept or Risk

The concept of risk in insurance refers only to uncertainty on economic matters. Non-
economic risk of respect, insult, prestige or love is not dealt with in this subject. We shall
study he different types of risk, the nature of risk, the degree of risk, and the value of risk.
There are two types of risk:
(i) Pure or static, and
(ii) Dynamic or speculative.

According to source from which it comes, it can be: -

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 (a) Managerial
(b) Political
(c) Innovational

1.3.4 Classification of Risk

(i) Pure or Static
- Theft - Death, and
- Accident
- Disability
- Fire
- Ship wreck
(ii) Speculative and Dynamic
Management i.e.
(a) Market (change of fashion, bad or good trading conditions).
(b) Finance (class of interest or profit duet to selling conditions).
(c) Production (strikes by workers, lockout by owners and stop
production).

Political
(a) War
(b) Bad foreign relations
(c) Stop trade

Innovation (new business ventures initially lose).

Note

Insurance is only concerned with pure risks. This is so because it is pure

risks that are insurable, other risks are not.

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Pure Risk is Loss
Here, the outcome of an event is certain. Pure risk provides only one outcome i.e. loss.
There is no question of earning profit. For example, an enterprise starts manufacturing,
there is uncertainty whether it will succeed or fail. Success is profitable, failure means
loss. Another example is in tossing a coin or throwing a dice. The result of tossing or
throwing is uncertain, but gives either party a chance to gain or lose. Processing a
destructible property is an example of pure risk. Its destruction is always possible but not
certain. Its destruction result in sure loss but preservation does not itself yield any
increase in value or profit.

1.3.5 Degree of Risk

The degree refers to severity of loss (smaller or bigger). The degree of risk changes. The
changes depend upon the uncertainty of loss or gain. If loss is foreknown and there is no
uncertainty about time, then there is no risk, though the amount of loss maybe very great.
Such losses are rare, except where one property is destroyed to promote other gains, for
example when coal is burnt to product steam. On the other hand, if there is no possibility
of loss, there is no risk. There is no risk of fires to a masonry dam, for example.

There is a different between risk and probability of loss. The probability is a chance of loss,
which varies in degree with two extreme events. It moves between no chance and
certainty of loss. The greatest uncertainty in degree exists where chances of loss and gain
are equal if probability is one, then chances of loss or gain are each half.

Businesspersons assume speculative risks. They believe in certain gain by selling goods at
higher prices, which cover their expenses. They rely on high degree of probability of the
increase in prices (certainty is no risk). They may earn a profit for assuming losses. They
ignore losses in the hope of large profits.

In most pure risks, the probability of loss is small. The degree of risk and the probability of
loss are almost equal. The insurers cannot deal with risks bearing maximum uncertainty
where the probability of loss is 50 in 100. Let us take an example for consideration;

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 There is a property worth kshs. 200,000/=. It is probable that Kshs.
100,000/= maybe lost if a fire breaks out. The insurance company may
spend Kshs. 100,000/= to handle the risk (equal to fire loss). The insurance
must be for full value, i.e. kshs. 200,000/=. This is highly impractical. So
the maximum degree of uncertainty is not insurable. Therefore the degree
of risk must be calculated.

1.3.6 Value or Risk

Risk depends on value upon the possibility of loss. It is applicable to individuals and also
to society. The financial and economic strength or weaknesses of a person in relation to
loss suffered is more important here than the amount of actual loss. The economic strength
can be roughly measured. It is equal to margin or surplus of property available beyond his
needs of sustenance or living. The loss will cause more hardship for a person with a small
margin more hardship for a person with a small margin than for a person with a large
margin. A sudden immediate need of small value may put great pressure on even an
economically strong person. Spreading of loss over a long period may reduce this
incidence or pressure. As for example, none of us minds to lose a pen or pencil worth
Kshs. 10/=, but a student staying in a hostel may really suffer from such a loss.

1.3.7 Expectation of Loss

This is the foundation of insurance. This is roughly the product of the amount at stake and
the probability of loss. If Kshs. 10/= is the stake, (one party baiting on head and another
for tail of one coin), the expectation of loss is Kshs. 5. Probability of loss refers to the
proportion of total ventures, which according to statistical calculation or a prior reasoning
must result in loss. In amount it will be equal to expenditure that puts a sufferer in his
position, before loss. Various other calculations are made to provide for service rendered
and profit by modern insurance companies.

1.3.8 Risk and Economic Burden

Loss affects individuals who are poor and also who are rich under different situations. The
society as a whole is also affected. If one has not covered his property against risk of loss
by fire, wreck or accident, such a loss will ruin him or reduce his economic status. Some

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persons argue that personal savings may meet such losses, but, the savings maybe
inadequate for the loss. If they are in surplus over the actual loss then the society losses the
benefit of that amount which is locked up for a loss of a lower value. Another danger is
that, the savings grow gradually, what would happen if the loss occur before we have
sufficient savings? If risks are high, persons will keep aloof from profitable but uncertain
ventures. The loss is therefore, an unproductive use of capital, and failure to secure
advantages of trade and business.

1.3.9 Risk and Credit

We have seen the burden of society due to risk of loss. In modern society credit plays a
large part. In such an economy risk plays a greater role than otherwise. The lender lends a
greater role than otherwise. The lender lends money for earning interest. If the risk of loss
occurs, then he/she losses interest and capital. It is worse than putting money in a box.
The lender would like to avoid such risk. The banks insist on insurance of property to
accept as security.

1.3.10 Prevention of Loss

We already know something about uncertainty and probable loss. On that basis, let us
estimate the total cost of an event cost of risk and probability of loss (which maybe
eliminated by purchasing insurance) plus cost of insurance is the burden of an individual.
The society bears both the insurance cost and the total cost of loss. The total cost and
insurance cost increase directly with the increase in risk. Therefore, it is a social gain if
loss can be prevented wholly or partly.

Though loss prevention is desirable, individuals become selfish and complacent by

purchasing insurance prevention and develop indifferences towards prevention.
Indifference to prevention is marked in all societies. But it is quite wrong. We gain a lot
by preventing loss.

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Gains of Prevention
There are two types of losses. Natural loss or loss of natural resources and loss due to
negligence or carelessness resources like when ore, coal and trees are destroyed to convert
their form of use. But to keep a house without paint or repair is a real loss.

The gain of prevention = the average aggregate = the aggregate annual cost
Loss prevented to all individuals of prevention.
Each type of prevention has its own principles. We hereby, discuss some general matters
about prevention related to insurance.

1.4 Types of Preventive and Protective Efforts

They fall into 4 classes:
(i) Preventive The purpose is to eliminate the causes of loss. In physical property it
must be applied in planning and construction of a house, machine, ship or other
property.
(ii) Protective or Quasi Preventive - The purpose is to save things and persons subject to
damage.
(iii) Minimizing It is meant to keep the loss to a limit or as small as possible, when it
occurs.
(iv) Salvaging The aim is to preserve as much as possible of the value of damaged
property, or ability of injured persons.

The first two relate to situations before occurrence of loss. The second two are situations
arising after the occurrence of loss. We examine below the effectiveness, the agencies, and
the promotion of each type of measures of prevention.

(i) Pure Prevention - Preventive measures that are introduced at the structure or
construction are the best. For example, fire resistant buildings, non-removable
guards of machine. Probably, a few of the most striking examples of preventive
steps are elimination of yellow fever in Canal Zone and Gold states of USA and
small pox in India. Its success depends upon the feelings and sentiments of the
community or people. Demand for a safety code or safety law is a positive sign

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 for preventive steps. The codes must be revised with change in hazards.
Development of good preventive practices depends upon knowledge of hazards.
The insurance plays a major role in this regard. This step reduces loss cost,
insurance cost. The rates of premium are reduced to improved conditions. The
people are encouraged to take up more insurance at chapter cost.

(ii) Protection It is less than pure prevention. It should not cost more than what
is protects (the value of property). Some costs of protection are quite high. It is
not possible by an individual. It has to be undertaken by the government or
community as a whole. One such example is maintaining police department,
factory or boiler inspectors.

Another common effort is campaign of education to demonstrate safety first.

A suitable reduction for individuals, who are protecting property, in their
premium rates is a good incentive. It is equitable because one should pay
according to his share of contribution to risk. He should pay less if his risk is
low. In some European countries punishment is prescribed for failure to
protect. If the person could not prove that the fire in his house was not
preventable, then he has to pay for cost of fire brigade and also for damages to
his neighbors.

(iii) Minimizing Loss Most money for prevention is spent on this item. On his
heading falls expenditure of fire departments, of water supplies, and emergency
equipment. The need of such expenses will be reduced if prevention and
protection measures are good and working well. In military, emphasis is more
on inoculation against typhoid than to rely on hospital facility.

(iv) Salvage Salvage is recovery of materials of damaged things. If salvaged

goods in value exceed the cost of salvage then it is profitable. Insurer gains by
salvaging. As for example, insurance company pays Kshs. 7,000 to insured and
gets Kshs. 2,000 out of selling salvaged goods. Then it gains Kshs. 2,000 by
way of reducing the actual cost of compensation to it.

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1.5 INSURER AND PREVENTION OF RISK
Insurers fix the rates of premiums for each type of risk they are presented. They study
hazards. They also look to reduce them. They are experts. In 1764 the underwriters at
Lloyds London complied and issued guidelines called books - the parallel of modern
shipping registers. The first joint stock and mutual fire insurance companies in London
made the first recorded effort at prevention or protection in 1766. Since premium were
fixed, whatever salvage was made out of damaged property was a profit. So insurance
company managers took active interest in preventive efforts. In early 19th century the
insurers were not concerned with prevention. It was owners duty to prevent loss. Now
things have changed. Insurance companies are busy in researching ways and means of
prevention of loss and also putting them to action.

Insurance; -The Intensifier of Loss. In one respect, insurance works against prevention
and safety. Full or nearly full insurance may lead to recklessness, or over insurance may
give birth to moral hazard. Over insurance leads to fraud, full insurance to carelessness and
even partial insurance to some diminution of watchfulness (Allan H. Willett: The
Economic Treaties of Risk and Insurance, p. 114). The insured try to get more money as
compensation than their loss. It is true that the losses from most hazards (to insurer paying
compensation) are greater than they should be. A part of the so is due to fraud by insured.
This is true mostly of accident and fire covers.

It is also true that most stimulation or encouragement to adopt safety or preventive

measures came from insurers to employers and owners of property. Government units
conform to statutory and administrative preventive requirements. Still there is scope for
improvements. Prevention often obstructs or interferes with immediate convenience. It
requires considerable amount of investment. Therefore, the pact of progress is gradual and
slow. In Kenya it is slower and lagging behind other countries. We may cite an example.
In Kenya, matatu drivers are prohibited to use blaring music. But most of them ignore the
directive and only comply if they meet a police person. Most drivers always break speed
limits.

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1.6 RISK MANAGEMENT
Until 1930s risk was not considered as important as it is to day. It was limited to having
insurance. There was little analysis of the risk problem and little planning to meet it in
detail. What was done can only be described as generally haphazard? Inattention or small
attention was the result of neglecting risk. It is known only when we suffer a big loss.
Risk management responsibilities in all organizations have increased enormously in the last
decade.

1.6.1 Insurance Manager vs. Risk Manager. The Risk manager is always wrongly called
the insurance manager or manger of insurance department. The appropriate title should
have been insurance buyer (who buys a policy for the employer). Risk manager should be
the title of the person who is responsible for management of risk. The manager deals with
risk problems. Insurance may be the principal means of meeting it, but it is not the only
means.

H. P. Liveridge, in his What Management Expects from an Insurance Department in

Operating Guides for he Corporate Insurance Buyers, (p. 4) says, "To-day, we thus have
the full-time insurance executive heading a separate department in corporate structure a
specialist to whom management can look for the analysis of risks to which its company's
physical plant is exposed, the selection of methods through which these risk may be
reduced or eliminated, and the procurement of such insurance contracts as will provide
indemnification in the event of these risks result in financial loss." Risk management is
really what is described above. Risk management should not be confused with insurance
management. Historically, risk management has had strong links with insurance and loss
prevention measures. However, risk management is a much broader concept.

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Basic difference between Insurance management and Risk management is as follows:

Insurance Management Risk Management

1. It confines itself solely to the use of the 1.
insurance transaction as the means of
treating risk.
2. The skills and experience required of an
insurance manager primarily is
technical knowledge of the insurance
policies and a familiarity with insurance
market.
3. Its major objective is the efficient
negotiation and placement of insurance
coverage on behalf of the insured firm.
It requires the quantitative consideration
of all aspects of uncertainty including: -
(a) Identification of risk to locate and
define the different sources of possible
a loss.
(b) Measurement of Risk: the amount that
can be lost from a single incident or
from a series of incidents.
(c) Treatment of Risk: to find out the
available alternatives either to
avoid/eliminate the uncertainty as to
mitigate the effect of potential loss.
2. Determination and valuation of risk is the
number one function of risk management.
3. The risk manager and his staff must take a
very professional approach to risk
management. He must step outside the
operation from time to time. He must make
a complete analysis of risk. He has to gather
several data to avoid disaster.

1.6.2 what is risk management?

Many unexpected disasters, such as property destruction, the death of senior executives,
adverse legal judgments, or embezzlement can seriously sidetrack a companys operation.
All companies must be prepared for a possible disaster.

Risk management is a plan to prevent earnings from becoming intolerably impaired by an

event that destroys company owned assets or contributing resources. It represents

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continuous effort to be aware of operational uncertainties and to minimize the loss
potential. If unplanned incidents or losses should occur, the adverse effect upon the firms
fiscal integrity and current operations will be minimized. Risk management provides a
precise plan for such contingencies (Oliver, J. Hocker and Dorothy M. Watson; Risk
Management: More than Insurance, Management accounting, August 1984, p. 22).

1.6.3 Reasons for Rise of Risk of Management.

We find there is great increase in risk. Increase and its different aspects of development
have taken place due to industrial changes. The reasons are:
(i) Insurance in size, diversification, and spread of activities of business has grown.
(ii) Complication of evaluating risk of each and every aspects has increased
(iii) Multiplicity of relation of business with suppliers, consumers, employees and
government has become complex.
(iv) Physical hazards have increased and changed in shape due to raw materials,
process, products, machines etc. coming into production.
(v) National laws are allowing liberal claims and public has learnt now of asserting
more rights or imaginary.
(vi) Increased and large investment increased the importance of protection and
preservation and compensation in case of loss.
(vii) Business operates now on small margin of profit and faces many contingencies
due to severe competition between enterprises. The heavy cost of replacing
physical assets and the limited availability of funds for development need
increasing attention to risk and its consequences.
(viii) Preventive methods are proper and they need planning.
(ix) Insurers, insurance contracts, and rating methods all have responded or
changed to adjust with new developments. What was a simple matter of choice
has become highly technical now.

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1.7 PRINCIPLES OF RISK MANAGEMENT.
There is great need for preparing a set of principles to serve as guide to the conduct of risk
management. These principles ought to serve as a guide/ideal towards which to work. In
this we always know that many limitations will remain i.e., all principles may not be
possible to follow.

1. The point of view of the loss. All risks are considered from the point of view of the
possible loss (tangible and intangible). The results of loss, the degree of loss, the
guarding against and minimizing the loss when it occurred are the possibilities. So
prevention and minimization of loss is the first principle.
2. Possibility vs. Probability. How much attention should be given to loss depends
upon possibilities of loss. A loss might be highly probable but of little consequence
(probability). On the other hand, the probability of another loss might be slight but if
it happens (possibility) the consequences would be disastrous. The main attention is
given to possible consequences. Whatever maybe the probability, we give the
following examples:
(a) Probability high Possibility is of little consequence.
(b) Probability low Possibility is of high consequence

Electricity supply through But (in failure) there is possibility of loss

underground cables has low degree of of highly valuable production, so demands
probability of failure (slight attention.
probability).

Industrial accidents have a high The possible consequences may also be

degree of probability. serious e.g. accidents in coal mines.

So the basic duty of a risk manger is to conserve (protect) the assets, actual and potential,
of the business.

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3. Prevention. Loss should be prevented or totally avoided. Loss prevention eliminates
risk problem. This is always the best because indemnity (compensation of loss) is
bound to be less than actual amount of loss. The loss prevention is measured by
comparing the cost of prevention. What measures of prevention are practical depends
upon judgment. This function is imposed on company from outside i.e., companies
dont favor prevention cost willingly or voluntarily.

1.7.1 Self-insurance and Non-insurance. Those risks that may be financially too much
(below capacity) should be transferred to an insurer. Losses which are correctly estimated,
and business can bear it (through self-insurance or as an operating cost) should be provided
for and not to be given to insurer. Sometimes companies insure to get advice and other
services of insurer though they have the loss bearing capacity. Some companies follow a
policy to prefer transfer of settlement of claims to an insurer. Some companies bear part of
loss and transfer the balance. In all these situations a company has to decide the amount of
insurance.

How much insurance? Full insurance of loss is the answer. For an insured full insurance is
the amount that would indemnify the insurer's real loss. Insured may get more or less
amount from insurance contract. We have two examples to show this: (Real loss is the
value of loss after loss. Insurance for loss is the possible amount of loss estimated before
loss).
(i) A timber contractor has erected a building on the tract of woodland to
accommodate his workmen. The building is abandoned and not replaced later.
Its destruction involves no real loss, so it need not be insured.
(ii) A firm raises a warehouse, which is essential to its operation. No fund for
depreciation is created. If this building is destroyed a new building will be
immediately required (replaced). Full insurance against real loss would equal cost
of replacement plus expenses for substituting of a warehouse.

Insurance other than real loss is not a good bargain. If premium rates are accurate, the
insured is always at a disadvantage. Insurers will always collect more in premiums than

16
they expect to pay out in losses. This is applicable to physical insurance relating to
property.

Personal insurance refers to insurance used in personal affairs. Insurance here deals with
person rather than with property. Life and disability insurance are examples of personal
insurance. It involves matters of human personality like taste, sentiment and necessities.
They differ from person to person. They are not governed by concept of indemnity.
Therefore, decision on insurance will be based on the desire of insured, his duty and his
willingness and ability to pay for insurance.

One must remember certain points regarding insurance, such as:

(i) Insurance is a plan for protection. Insurance is not something good by itself
but it is a financial tool useful for purposes that one wants to use and adopt.
(ii) Insurance plans are all the same. No particular type of insurance contract
(there are many) is in itself better than the other but the best contract is that
fulfills ones desires the best possible.
(iii) Insurance protection is limited to the value and purchase. No insurance
grants ability to meet losses, but it is limited to ones ability to pay for cover
offered by insurers. Therefore, complete satisfaction by insurance of ones all
reasonable desires is also beyond ones means or capacity.

In planning insurance the steps to be taken are:

1. It is necessary to set down first the desires of the buyer,
2. Then learn how they might be covered by insurance and
3. What would it cost?
4. Items of desires are to be selected and adjusted according to money available. As for
example, one person desires to have protection like:
(i) his widow would maintain the style as she does now, after his death also;
(ii) his three children would go to college as normal;
(iii) his mortgage on house will be paid off;
(iv) his funeral expenses will be paid for; and
(v) expenses to provide for reorientation of the family are covered.

17
The premiums for such insurance may go far beyond his means to pay. The selection has
to be limited to a few. It is a matter of personal taste and capacity. This is a part of risk
management.

1.7.2 Difficulties of Application of Principles

The principles are criticized. The main criticisms are:
1. The principles are theoretical, impractical and unrealistic.
2. The principles dont say about the immediate work of the risk manager.
3. They are not suitable for individual cases for application.

The principles are guidelines towards ends, which are not covered at present. The general
statements are to be modified suitably to apply to individual cases. So difficulties will be
solved by application.

1.7.3 Qualifications of a Risk Manager

A person with common sense, imagination, persuasiveness with certain specific
qualification as engineer, lawyer, statistician, accountant mathematician and insurance
expert can perform as risk manager.

Problems of a Risk Manager.

Certain problems are found in the job. They are:
1. Executives do not yet properly recognize the work.
2. It lacks high-grade persons, adequate organization for its conduct. The work is
limited to laying insurance or managing policies.
3. Manager often lacks authority to carry on work and he should be responsible to top
management for work results.
4. He needs the co-operation of the personnel of all departments for getting information,
carrying out regulations and for discussing risk aspects of work. All contracts, plans,
process and use of materials should pass through him. He should know plant details
and layout. Accidents should be reported to him.

18
The success of risk management depends upon mutual understanding and the ready
cooperation between his department and other departments. Other departments should
realize the importance of the risk problem and the usefulness of the risk management.

1.8 FUTURE OF RISK MANAGEMENT

Development of the knowledge and the principle essential to bring improvement is most
urgently necessary. The management should hold a positive and helpful view of risk
management. This can be done in following manner:
(a) Encourage insurance administrator to work in insurance groups,
committees or departments;
(b) To collect information on all serious fire and explosion accident occurring
throughout the country.
(c) To have personal visits to the scene of such an occurrence.
(d) To have thorough examination of the cause of disaster and the resulting
damage.
(e) To allow application of the conditions to our own company, to devise
preventive devices, or corrections.

Risk managers develop new ideas and applications for dealing with risk. They seek a
market. Leading managers try and succeed to adjust insurance to fit into their needs. The
persons to follow take advantages of the idea already developed in some company.

The importance of risk is growing. It is an element of business to day. The emphasis is on

security. The development of prevention and the widening use or risk bearing device all
suggest that risk management will become a major department of business activity in
future. The functional organization chart indicates the possible scope of risk management
department.

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Figure 1.1 Functional Organizational Chart
- Indicates the possible scope of Risk Management Department

RISK MANAGEMENT
Employee plans
management

Employee plans
Pure risks management

- Medical
- Meetings losses expense plans.
Loss - Non-insurance Retirement
prevention plan - Life plan.
- Self- insurance - Disability
plan

Property
loss Administration Administration

Records Records
Personal
injury
Claims
Loss adjustment

Endowment
Accounting

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1.8.1 Steps in Risk Management Plan

The different steps that risk manager must take are:

(i) Identifying risk. The risk manager is to determine where the risks for the company
lie. This includes fixed assets and property, other areas of potential loss are like
property borrowed or got under lease, business interruption. Unusual risks like flood,
earthquake, extra expenses; research activities, and third party liability.
(ii) Measurement of risk. Once the analysis of the possible loss of exposure is complete
the manager should calculate the need for insurance coverage. He should calculate
premiums for risks and what deductions are available. He should make a loss study
using historical data to eliminate future losses. Some losses of small values may be
ignored and retained by the company. Losses beyond certain values should be
covered by insurance. A stop loss technique may be used. Information about assets
must be gathered by inspection or from internal reports. Replacement costs should be
calculated. The aggregate loss must be found.
(iii) Treatment of risk. Upon completion of the risk analysis the problem is to decide
what risks may be retained and what risks will be transferred. Some risks are there
which cannot be insured, and some others are compulsory by law. Except these two,
all other risks may be wholly or partially self-insured. The consideration is not to
assume risk too much so as to expose the company to casual loss. Self-insurance is to
be decided under the three consideration:
(a) Some risk/also can be borne by company. Except destitute all can bear
some loss, the larger the company the smaller is transfer of risk.
(b) Self-insurance becomes cheaper than cost of purchasing insurance. One
has to compare cost of self-insurance with cost of insurance with others
and choose the cheaper of the two.
(c) There are risks for which insurance is not available or insurance companies
dont deal with. These losses have unfavorable characteristics. The
principle is that insurance should be the last line of defense against risk of
loss not the first. But complete determination of all risks of casual loss is
impossible. Sometimes the cost of elimination may be too high. The Risk
manager has the job of determining these matters.

21
Risk management may be defined as a managerial function dealing with:
- Identification (locating) sources of hazard to which the firm is exposed.
- Estimation of the probability of the number and size of the potential losses.
- Consideration of various techniques and methods available to cope with
these risks.
- Implementation of the selected techniques and methods.
- Periodical examination of the results achieved through these techniques and
methods.

The steps and process of risk management can be seen form the following examples. The
firm X maintains a fleet of motor vehicles and does the risk management as follows:
1. Identification of sources of hazard. From past experience it is found that hazards
common to motor vehicles are: accident, riot, theft, and earthquake. The injury to
third party and liability of the owner is another risk.
2. Estimation of the probability of potential risk. What proportion of total ventures may
result in loss, this is calculated by statistical formulas. This helps the management to
decide upon the amount of insurance they would levy.
3. Various techniques to be adopted. The company must adopt all techniques: loss
prevention, loss reduction, retention and insurance. In our example the following
preparation fall in categories mentioned against them.

Drivers training, better maintenance Prevention

Periodical check up, bonus and
Awards to safe drivers etc Reduction

Minor losses of theft of accessories Retention

Or depreciation to be met by management
Without insurance repairs.
Minor Injury to Third party Insurance

22
4. Implementation. Proper record of each measures and technique actually used and
costs are recorded. Losses recovered and premiums paid, own retentions. Compare
cost of insurance with losses saved or covered.
5. Review. If retention cost go on increasing all risks should be given over to insurers
for getting covers.

To sum up the above discussion we know that one cannot be free form risk. The risk of
probable loss must be reduced. Risk management refers to reduction of risk. Out of past
experience, businessmen, individuals or society and insurers have devised certain methods.
They fall into six categories.
(i) Avoiding
(ii) Assuming
(iii) Reducing hazard
(iv) Reducing loss
(v) Shifting loss and
(vi) Risk reduction.

(i) Avoiding risk

Some human activities are risky. They may give rise to possibility of loss. The
best way to avoid risk may be as follows; a house may catch fire, an aero plane
may have an accident, and so on. One may avoid an air travel but cannot avoid
staying in the said house. Life has to be lived, though at every moment we
expect death. We can avoid risks, but not always. Risk that offers us an
alternative way to avoid or reduce loss should be chosen. For example, the risk
that goes with a thatched house, we can accept an air travel in a company, which
has maximum safety record. This is how we can avoid some risks.

(ii) Assuming risk. Since risk is unavoidable to the full extent, we must assume
some risk. This is a way of living with least resistance. There are three ways of
accepting risk:
(a) by ignorance
(b) by inadvertence,

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 (c) by choice (willingly)

(a) Ignorance is very common. We dont know all the aspects of law related to our
work. In that case we assume the risk coming through our ignorance. As for
example, one purchases a house, insures against fire but forgets to insure against
theft he has to pay for that loss (theft).
(b) Inadvertent assuming of risk is also common. Rarely a person insures his life
voluntarily. He does so only when an agent persuades him to be insured. In this
way his family members accepts a risk, which they could have transferred to
insurance company.
(c) Deliberate acceptance of risk is found in business and through speculation. Some
vocations like auto racing and circus acrobats are not insurable. No insurance
company accepts such risks. In adventures of speculative business the speculator
becomes his own insurer, similarly a ticketless traveler, a cyclist at night without
light takes deliberate risk. Another example of deliberate risk-taking concerns the
petty losses of small value. One may lose a pencil or pen or a ten shillings. One
can replace this financial loss out of his own income.

(iii) Reducing hazard. Peril means an accident, which is not foreseen. Hazard is
the cause of risk. It refers to any condition, which may decrease or increase the
occurrence of risk. The accident is the hazard. The hazard refers to materials
used and safety measures. Even if fire takes place the magnitude will be more
or less due to nature of materials used.
(iv) Reducing loss. Loss is the certainty of risk. If fire actually breaks out, the loss
caused by fire should be reduced by hiring fire brigade. The preventive steps
and steps for reducing loss are complementary. They are found together.
(v) Shifting risk. Some common forms of shifting part of risk are.
(a) Hedging
(b) Sub-contracting
(c) Surety bonds and
(d) Limited Liability Company.

24
 Shifting means transferring a part of or the whole burden or risk to somebody
else.

(a) Hedging in common usage means putting a fence or defending your self against
attacks. In business it refers to reducing chances of loss in future if events are
unfavorable. One example of this is contracting to sell in future (hoping a rise in
price). If prices fall it will cause losses, so it is hedged by future purchases. So
some loss in sale is made up by purchases.

(b) Sub-contracting. One contractor of a building may take up building, electrification

and public health fittings. The work may take a long time to complete. If prices of
materials go up he suffers losses on sections. But if he gives away different works
to different persons his loss is shared by sub-contractors.

(c) Surety bonds. This is an arrangement by which one third person stands by the
executor to step in incase he fails to pay. The person who offers the work thus is
saved of possible loss. As for example, X allows credit to Y on condition that Z
will pay the debt if Y fails. Y is called the principal debtor and Z the surety. X
may recover money from Z if Y fails.

(vi) Limited company. Company has a pool of capital. Capital is divided into
several parts and distributed among large number of persons if there is total
loss; also, individual shareholders loss is limited to money he paid as share-
capital.
(vii) Risk reducing by insurance. Insurance eliminates risk. Out of past experience,
observations and mathematical calculations this is possible. In the past it
happened like this: There are 20 house owners. They learnt out of past
experience that one house is burnt every year. One house may be any one of the
20. So they each contribute one-twentieth part of the value of the house and pay
the value of house. This is a certainty. This same technique is now used by
insurance companies for risk of death, fire, marine and accident losses. This is
the best form of management of risk.

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1.9 SUMMARY

Terms used in insurance

There are certain common terms, which are used very often in insurance. These terms are:

i. Insurers The party who agrees to pay money on the happening of a contingency
is known as the insurer. Usually the insurers are insurance companies. Insurer
gives protection against loss according to his promise. E.g. Alico, Madison
insurance Co, etc.
ii. Insured This person faces a particular risk. He is part of insurance agreement.
He seeks protection against risk by paying premium. The insured claims and
receives money as compensation in the event of the happenings. The insured is
sometimes termed as assured.
iii. Premium This is the amount, which is paid by the insured to the insurer. It is the
consideration for which the insurer gives protection to the insured. It is the price
of the insurance cover.
iv. Policy This is the stamped document which contains the terms and conditions of
the insurance contract. Usually it is issued by the insurer (insurance company).
This is an acknowledgement of liability.
v. Insured amount it is the money value of the risk. This is also the maximum
amount he insured might get. This is also called the insured amount or policy
money or face value of policy.
vi. Peril This is an event that causes a personal or property loss.
vii. Insurance and Assurance - In insurance literature one finds these two words.
There is no difference in meaning of the terms. However, there are some who say
that assurance be used in cases where the contingencies like death is sure to occur.
This means that assurance applies to contract of life. The word insurance should
be used in those cases where the happening of an event is uncertain. The event of
contingency may or may not take place. This is possible in cases of marine and
the fire insurance. Both the terms are being used as having the same meaning.
Insurance - It is a contract in which there are two parties at least. One party transfers
some of his risks to the other. The man who takes over the risk insurers,
26
 viii. pay a certain sum to the insured if the risk really takes place, and the insured
suffers a loss.
ix. Risk It refers to uncertainty about loss. Let us suppose that one house out of
1000 houses will catch fire. One house out of 1000 belongs to X. Xs house maybe
burnt or may not be. X faces an uncertainty of loss.
x. Contingency This is the actual happening of an event or not happening of an
event on which the loss depends. In the example above, catching fire of the house
of X is the contingency on which the payment of insured money depends.
xi. Loss Loss is an unintentional fall in value or disappearance of value in property.
It arises out of contingency.
xii. Double Insurance When subject matter (life/property) is insured twice either
with two different companies or with the same company under two policies; it is a
case of double insurance. In case of life insurance the person can take as many
policies as he wishes. On the maturity of the policies, he can realize the whole
amount from the insurer.

1.10 Activity

(i) Explain the basic differences between insurance management and risk
management.
(ii) Briefly explain the different steps that a risk manager must undertake in

developing a risk management plan.

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1.11 Questions

1. Define the following: -

a) Insured.
b) Insurance.
c) Insurer.
d) Contingency.
2. In which cases can double insurance arise? Given an example.
3. Differentiate between
a) Insurance and Assurance.
b) Pure and Speculative risks.
c) Risk and loss.
d) Insurance manager and risk manager.
4. Give reasons for the rise of risk management.
5. What are the steps in a risk management plan.

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 LESSON 2
FUNCTIONS OF INSURANCE

2.0 Introduction
Insurance plays a vital role in the society and it is wise to understand its functions, both to

individuals and the society at large. This lesson will try to highlight some of these functions

of insurance.

2.1 Objectives

By the end of this lesson the learner should be able to:

(i) Describe the functions of insurance, both to an individual and the society.

(ii) Explain the role of insurance in increasing business efficiency.

2.2 DEFINITIONS OF INSURANCE

(i) Insurance is defined as: a co-operative device to spread the loss caused by a particular
risk over a number of persons who are exposed to it and who agree to insure themselves
against that risk. Insurance is a social device for eliminating or reducing the cost to
society of certain types of risk (Mowbray and Blanchard).

(ii) Insurance has been well defined as: that social device for making accumulations to
meet uncertain losses which is carried out through the transfer of the risks of many
individuals to one person or to a group of persons (Allan H. Willett).
What is uncertain with regard to an individual, however, may be closely calculated when a
group is involved.

(iii) In other words, insurance is a co-operative form of distributing a certain risk over a
group of persons who are exposed to it.

29
(iv) Dictionary of Business and Finance defines insurance as: a form of contract or
agreement under which one party agrees in return for a consideration to pay an agreed
amount of money to another party to make good for a loss, damage or injury to something
of value in which the insured has pecuniary interest as a result of some uncertain event.

(v) Insurance may also be defined as: a contract between two parties whereby one party
(the insurer) agrees to protect the other party (the insured) against a loss (which may
arise or may not) when it takes place through the risk insured (in case of property) or pay a
fixed amount on the happening of a certain event (death or expiry of the term) in exchange
of a fixed sum (premium).
The element of certainty of assurance is vital to every business and individual, and
insurance provides a way in which such certainty can be introduced.

(vi) From the functional standpoint: insurance is a social device whereby the uncertain of
individuals may be combined in a group and this is made more certain, small periodic
contributions by the individuals providing a fund out of which those who suffer losses may
be re-imbursed.

In this legal aspects it is a contract, the insurer agreeing to make good any financial loss the
insured may suffer within the scope of the contract, and the insured agreeing to pay a
consideration (Riegel and Miller).

Every plan of insurance is in its simplest terms, is merely a method of spreading over a
large number of persons a possible financial loss too serious to be conveniently borne by an
individual. (Joseph B. MacLean).

Insurance is a device for transfer of risk of individuals entities to an insurer, who agrees
for a consideration (called the premium), to assume to a specified extent loss suffered by
the insured. (Dr. W. A. Dinsdale).

Students should note that all the definitions discussed above highlight the following
characteristics of insurance: -

30
 - Insurance is a social device. It tries to reduce the cost of loss to society by
reducing risk.
- It accumulates funds to meet individual losses. The fund is the way of
transferring individual loss to a group. The loss was uncertain from
individuals side. But for a group the loss becomes certain. It is a
mechanism of spreading risk falling on one over many facing the risk. In
legal sense one promise to make good the loss of another for a small but
regular fixed payment. This is business insurance.
- Insurance cannot stop an event from happening. Even if we insure property,
loss of fire or storm or accident will take place. But the loss to the
individual will be reduced. Society will get a replacement of the asset,
which was lost.

2.3 FUNCTIONS OF INSURANCE

We have already known that insurance is very important for modern age. Functions and
services rendered by insurance will show us its importance. Everybody knows insurance,
as a business is very big in size. As an institution it has a very wide scope and various
types of transactions. It handles a very large investment of funds. But we must know what
insurance does? Insurance is now a social institution.

Social institutions impart two types of benefits. One becomes visible and everybody
knows, but the other one may give benefits indirectly. So some benefits are enjoyed by
every member of society without knowing that insurance has given this. Different types of
insurance give some common benefits. This is available to the buyer of policy. These two
classes of people belong to society. We shall see these two aspects of insurance benefits
and the important part played by insurance in business enterprise. The different benefits
will be discussed under several headings.

2.3.0 Individual
(a) Financial security to an individual. Insurance guarantees protection against
large and uncertain losses in return of small but certain payment. This service is

31
 common to all forms of insurance. Each insurance gives protection against a
particular risk. The insured (may be businessman) contracts to pay a small
premium at fixed interval. The insurance company assumes on his behalf the risk
of large but uncertain loss. One example of how uncertainty to an individual can
be converted to a certainty within a group is given below:
One individual knows from experience that fires are destroying business properties
and stock of goods; he cannot tell when his own property will suffer. If he can
know the future loss accurately he may make provision without depending upon
insurance. Insurance calculates and finds that certain houses per hundred-catch
fire every year. Then it makes provision for those owners through some
calculation. This element of certainty or assurance is vital to every business and
individual. Insurance provides one way of such certainty. All other forms of
insurance like life, marine, accident or liability do the same service. They assume
different risks but on the same accident and sickness insurance gives financial
protection when individual is unable to earn. Fire insurance protects loss due to
fire. Marine insurance provides protection against loss of ship, and cargo. Thus
relevant policies provide the necessary financial protection.
(b) Insurance provides assistance to business enterprise. There is heavy capital
investment in modern industry especially in building, machinery, and plant
equipments. This investment is exposed to loss or damage by fire, theft, accident
and other perils. The provision for these losses may be very costly. Business
enterprises may have to block large amount of capital as insurance fund if they
themselves have to meet the risk. But insurance gives protection to these
properties in return for a small payment called premium. This gives many
advantages to businessmen.
1. They need to have self-insurance provision
2. They save cost and blocking capital or capital is released.
3. Properties got security. We can examine the following and find how
insurance assists business.

Shipping business involves heavy capital investment. The ship owner cannot
venture to expand its fleet due to his worry and anxiety of the owner. Insurance of

32
 hull takes away much of these worries of the owner. Insurance eliminates harmful
consequences of risk and encourages business to assume more risk. Uncertainty
about future is a handicap to economic progress. Insurance removes the fear, worry
and anxiety associated with this future uncertainty and encourages free investment
of capital. So insurance encourages industrial and commercial development and
contributes to a vigorous economy and national productivity.
(c) Financial stability to commerce, and industry. A serious loss will not only
cause material damage to buildings, plant and machinery, but production will be
disturbed with other consequences like loss of profit, unemployment or loss of
trade. So a loss affects the owners of properties and others also. Insurance in fire
and engineering protect against consequential losses. It covers net profits wages,
taxes and other standing charges and increase in cost of working during stoppage
of production. These classes of insurance lend stability to industry. This helps
society to maintain economic equilibrium.
(d) Basis of credit. Modern business prospers on credit. We may say credit is the
mainstay of business expansion. This has become possible due to insurance. We
can examine certain examples and derive the conclusion easily.

(e) Mortgage upon real estate. No mortgage is willing to lend money unless he
knows that the property is protected against fire.

(f) Retailer and wholesaler. No manufacturer advances money or gives goods on

credit to wholesaler, or a wholesale to his retailer unless he knows that goods are
insured against fire. The banks these days are giving credit in large scale. They
allow loans against goods if they know that they are insured in addition to other
conditions. Again a dealer can use his grain as security for a bank loan if that is
insured. In international financial transactions three documents are most common;
a draft, bill of lading and a marine insurance certificate. A bill of lading gives
security to a draft. That means goods are loaded for which draft is made. The
marine insurance lends protection to the goods mentioned in the bill.
Businesspersons may take loan on the basis of these documents from banks.

33
So far fire and marine insurance are well known as bases of credit. But we find
that other forms of insurance may also become basis of credit. Two such instances
are life insurance and credit guarantee insurance. Life of the businessperson is the
spirit behind the properties of the business. That needs protection another
important asset is accounts owing to other concerns the debtors. These debts
fluctuate in value depending upon the business conditions and the character of
debtors. These debts must be covered by a credit insurance policy before they are
accepted for advancing credit. Still another case is that of the character and
integrity of servants. A business may be ruined by the dishonesty of an employer.
That needs to be insured by fidelity guarantee insurance. So it seems every form
of insurance is a basis of extending credit to a firm.

(g) Insurance plays a vital part in the reduction of losses. Insurance

encourages reducing loss in many ways.
(i) Through rating methods. Rating or premium charged to undertake
insurance itself is helpful for reducing loss. It gives incentives for
reducing loss by lowering premium and negatively by charging higher
premium for undesirable features of risk. In fire insurance for example,
extra rates are charged for inferior construction and discounts are
allowed for improvement in risk e.g. fire extinguishing appliances. In
motor insurance the provision of excess and offer of no claim discount
are such loss reduction provisions. Marine insurers allow lower rates
for good packing to encourage loss reduction.
(ii) Insurers may join different agencies engaged in loss prevention works
(fire, cargo loss prevention and industrial and road safety). A few of
such agencies started by insurers in India, for example are:
(a) Loss Prevention Association of India. It works for increasing
awareness among people for loss prevention and implementing
various measures for loss prevention.
(b) The Salvage Corps of Loss Prevention Association of India. It works
with the fire brigades when fire occurs. Fire brigade subsides the fire,

34
 the salvage corps save further damage by water, smoke and heat. It
saves goods from deterioration further.
(c) Survey and inspection of risks. Insurers arrange survey and
inspection of risks before acceptance in fire, engineering and accident.
The surveys suggest risk for rating and also recommend
improvements. This reduces potentiality of loss.
(d) Specialized Knowledge and Experience on Risks. Insurers out of
long years in business acquire special knowledge on different classes
of risks. It includes special knowledge on process of manufacture of
an article the physical and chemical properties of materials, methods
of fire extinction, packing, trade routes, pork conditions, etc.
Thorough knowledge renders vital service to the community in
minimizing economic waste.
(h) Insurance provides funds for investments. Some forms of insurance combine
with insurance feature an investment element. It is incidental only. But it serves
very useful purpose. Life insurance usually collects more money in the early period
from an insured under level premium palms. The insurance company can invest
these funds in bonds and securities. In other forms of insurance also insurers may
utilize a part of fund the excess of funds received over current expenses liabilities,
and reserves in government securities, municipal bonds, loans, mortgages and
equities. This capital is provided to the government and the industry.

It helps pubic in two ways:

1. They contribute to the wealth of the nation by financing economic
development and
2. By reducing the cost of insurance. Because investment income is adjusted
in the value of future premiums. That means by the amount of investment
income premiums are reduced.
(i) Insurance earns foreign exchange. Insurance is as good a source of foreign
exchange earning as export trade, shipping and banking services. Indiana
insurance is transferred in overseas countries particularly in the Middle East,
Africa and South East Asia through branches.

35
(j) Insurance tries to distribute cost equitably. Modern method of insurance is based
on correct distribution of cost. It is based on large number of risks. It must
have a systematic method of determining premiums. Customers are interested
in correct cost. Insurance companies employ expert mathematicians, actuaries
to find insurance premiums, surrender values, reserves and loans. In fire and
marine insurance large number of factors are considered for, fixing premiums.
Only under an organized system of insurance these things can be done. The
systematic cooperation of many to share the loss of a few cannot be done
without insurance plan.
(k) Capitalization of earning powers. This is a way of expression. It tells certain
incomes in terms of capital value. Suppose a machine is producing income of
Kshs. 2000 after repairs, depreciation and interest on its value. Its life is 25
years. Its capital value is 2000 x 25 = Kshs. 50,000. The same method may be
applied to human life. The points to be considered are probable lifetime of the
earner, percent of employment at different age, and loss in earning of that
person and present value of future incomes. This is calculated by actuaries.
This capital is a loss to the family if the person dies. In business it is a capital
loss if the machine is destroyed by fire or by accident. The insurance premium
is of the same nature as that of allowances for depreciation. It provides for
unpredictable depreciation whereas depreciation is a natural foreseen
contingency. Insurance protects this valuable human capital and adds
importance to its value.
(l) Insurance makes saving possible. It is a hedge a cover for wrong decision
very much familiar in business transactions. Savings plans are beneficial to
them who:
1. Are fortunate to survive till the full planned amount is achieved, and
2. Are determined and able to continue the savings till the end without
difficulty or outside help. Insurance assures a saving and guarantees the
amount.
Some firms prefer self-insurance. They set apart a part of income every year in a
separate fund. It is a protection fund against loss. If has certain risk. If a fire or a
large compensation damage suit is to be faced sooner than expected the self-

36
 insurance fund may be insufficient to meet the loss. Insurance provides a hedge for
such a risk. The business persons can assume self-insurance slowly until they are
fully equipped wit the required accumulation e.g. 1/10 self insurance plus 9/10
insurance, then 5/10 self-insurance and 5/10 insurance. Insurance thus is
complement to saving against uncertain loss. Insurance premiums are free of tax
expenditure. So it is a saving.
(e) Insurance promotes thrift. This is more clearly found in Life Insurance.
Because in life insurance there is provision for advance notice short period before
due date of premium due, and provision against withdrawal. In non-life insurance
the money paid to insurance company leaves certain margin of excess of income
i.e., premium over the actual expenditure over the actual expenditure. The excess
is kept as a reserve. This would otherwise have not been available. This is a by-
product of insurance. This would be wasted had it not been given to insurance.
The individual small saving may be consumed in expenditure but insurance
company changes its character to a community saving.

2.3.1. SOCIETY
(f) Community benefits of insurance. Insurance gives many benefits. Some
of these are direct and quite apparent. Others are indirect and remote. We enjoy
these benefits but cannot appreciate. Direct benefits go to insurer and insured.
When many such person enter into agreements they create other indirect benefits.
We discuss some of these. So far the benefits described are individual in character.
Benefits accrued to individual policy holder who paid the premium. Insurance
also performs certain services which are not meant to benefit any particular
individual. The benefits have the effect of community benefit. Among these
services the following may be mentioned:
(i) Fire and other property insurance provide for the present and also for
future events that may be anticipated. Adequate future provision is the
sign of a civilized society, and marks the difference between different
between stability and instability in business. It increases sense
responsibility and strengthens community connections. Property and

37
 casualty insurance are attempts to stabilize business conditions and
property rights.
(ii) Insurance fulfils certain needs for which state might have to provide. The
provision for old age, sickness and disability of persons in general. Some
who have their insurance dont become a burden on state insurance plan.
In case of fire, defalcations, failures, explosions, tornadoes an other
calamities that would tend to impoverish (render poor) families would
have been relieved of the financial shock if adequate insurance had been
maintained.
(iii) All forms of insurance lessen the number of person who are rendered
destitute through misfortune. They are able to maintain the standard of
living. They reduce the destitution and misery. These could lower the
ideals and standards of conduct of entire communities.
(iv) A well organized system of insurance tends to distribute equitably the cost
of accidental events. In the absence of insurance this would have been
paid in a haphazard manner. For example the cost of fire insurance is
reflected in house rent. In the absence of insurance some tenants would
pay higher rents than others.
(v) All forms of insurance, tend to reduce the extent of evils they are meant to
alleviate. The most effective argument for reducing of fire losses, is that
smaller losses will make smaller premiums possible.
(vi) Insurance accumulates from the small deposits of many persons, a large
fund that may be invested and used in the development of Indian
enterprises. In other words, vast funds are made available as capital which
otherwise would never be brought together in one place. The reserves of
life, fire, compensation and casualty insurance companies represent the
contribution of millions. Each of these contributions is significant, but in
total they amount to a gigantic amount. This vast sum is distributed
among the securities of government and non-government enterprises.
Between the time of insurance contract and the time of the event of loss
the insurance carrier works as a bank or an investment trust.

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2.3.2 INCREASES BUSINESS EFFICIENCY
It is common knowledge that if risk and uncertainty is reduced efficiency will rise.
Efficiency is measured by the price of goods. The prices go down if risk is reduced. On
the other hand, the most uncertain is the most inefficient business. The proprietor of such
enterprises remain busy and bother much over large financial risks such as protection of
premises against fire or riot, stock against theft etc. if these risks are transferred to
insurance underwriters then owner will look to details of production and increase
efficiency. Now he is able to face his competitors. The ways to increase efficiency are
many. Some of them are:-
(i) Increase in export trade. Young entrepreneurs fully trained and ready do not
take up trade due to transportation risk, fire and dishonesty. Insurance relieves
them of such uncertainties.
(ii) Delegation of work. Employers will not entrust large sums of money and
important duties to subordinates unless they make sure that such losses can be
re-imbursed. If they dont delegate their energy will be wasted on small matters
which servants may do.
(iii) Partnership dissolution. If one partner dies his heirs must get back the deceased
partners share. But immediately money is not available so business will run
short of money. Insurance may solve the problem and remaining partners will
not worry about funds.
(iv) Employees cooperation. Employers can have good relations with employees by
insuring employees against life, accident, and sickness etc. Satisfied persons
are best workers.

Insurance helps small business to compete successfully with the large enterprises. Element
of risk is very high in business. A small business cannot afford to take much risk. A large
business is able enough and its risks are sufficiently diversified and distributed to make
such a fund effective. But for a small business such fund is a pure gamble. Insurance is
therefore special benefit to small manufacturer, merchant and property owner.

39
2.4 Activity

(i) Name and explain the agencies that are started by insurers.
(ii) What role does insurance play in reduction of loss?

2.5 Questions

1) Outline the major functions of insurance to

a) An individual.
b) The society.
c) The business fraternity.
2) How does insurance benefit the public?
3) Insurance plays a vital role in reduction of losses Explain.

40
 LESSON 3
NATURE OF INSURANCE
3.0 Introduction
Insurance is governed by law. This is in form of certain basic principles that govern the

general insurance. This lesson will try to explain these principles and their application in

real life situations.

3.1 Objectives

At the end of this lesson the learner should be able to:

(i) Explain the basic principles of law governing general insurance

(ii) Outline the special features of a valid insurance contract.

3.2 Special Features of a Valid Insurance Contract

1. Valid agreement. One party must have given a proposal. Other party should have
accepted this.
2. Legal relationship. Agreement should create legal relationship. A friend promises to
come to your house for tea. If he does not come he does not break a legal
relationship. He breaks a social relationship. Legal relationship is there only when
each one of the two wishes to go to court if any of them breaks his/her promise.
3. Lawful consideration. Agreement in which each of one of the parties gains
something, and also gives something is legal. This mutual give and get is called
consideration.
4. Capacity of parties. Some persons cannot make agreements. If they make an
agreement law does not help them to enforce it. That means agreement by such
persons is invalid. Mad, disqualified person and minor are some examples of
incompetent persons.
5. Free consent. Nobody in the agreement should force the other to enter an agreement.
Some actions like coercion, undue influence, fraud and misrepresentation by any part
makes the contract invalid.
41
6. Lawful object. The purpose of agreement must be lawful. If the purpose of the
agreement goes against public good it becomes illegal.
7. Agreement should not be void. This happens when some law which is present now
and declares that your agreement is illegal. One example is the trade agreement
between two partners living in two countries. The countries went to war. The
partnership automatically dies.
8. Agreement should be possible. To sell tickets for a journey to Mars is such an
agreement of impossibility.
9. Formalities of law. The agreement should be registered, attested and properly
stamped (court fees).

Besides, these, the parties must fulfill the following conditions to complete an insurance
contract:
1. Utmost good faith;
2. Insurable interest;
3. Indemnity;
4. Causa proxima;
5. Subrogation;
6. Warranties;
7. Assignment and nomination and
8. Return of premium.

3.3 BASIC PRINCIPLES OF LAW GOVERNING GENERAL INSURANCE

3.3.0 Utmost Good Faith

Definition: Uberrimae fides means utmost good faith. The law compels the parties to the
contract (insurer and insured) to make full disclosure of all material facts. What is a
material fact? Material facts are that information, which affect the decision of parties to
enter or not to enter into an agreement. The insurer calculates the risk of the insurance and
fixes the price. The insured knows the nature of risk he is transferring. Full or partial
concealment of fact by any one of the parties makes the contract void.

42
This is something special and different from ordinary agreements of sale. In sale of goods
the principle is to let the buyer beware of what he buys. That means buyer examines the
goods and decides to buy or not to buy. But in insurance it is facts about the subject matter
to the insured. At times insurer also knows privately, about subject matter. These facts
known to one but not known to the other party must be disclosed. As for example, how
many times a person has suffered from asthma or tuberculosis is not known to the insurer.
Though both the parties have a duty of disclosure, the insured has more responsibility.

Who decides?
What is a material fact? The parties are not the best judges of the materiality. The law
courts decide what is material fact. From past judgments we find that those facts, which
influence are:
1. Nature of risk i.e., make the risk more dangerous or less; and
2. The character of the insured i.e., who suppresses the actual degree of risk by
concealing facts are material. Some examples of material facts may be given in life
insurance history of past diseases, in marine insurance repair and maintenance of
ship, in fire insurance, the surrounding and the materials stored, in motor insurance
the model and make of the car are material facts.

Effect of Concealment
The general rule for disclosure is the same for all types of insurance contracts. But the
responsibility of parties differs from one type to other. As for example, in UK the insured
in marine contract is supposed to know everything about the ship. If he does not disclose
some matters innocently or because of ignorance, then also in law it becomes concealment.
The contract is cancelled. In USA also the rule does not excuse innocent concealment. But
in Kenya rules are lenient. The insured is not punished for his non-disclosure in some
cases:
1. Facts which he does not know, and
2. Facts, which he cannot know with reasonable effort.

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Exceptional cases of non-disclosure
When concealment does not affect a contract? There are material facts which even if
concealed will not make a contract void. Some of these material facts are given below.
(a) Facts which are public knowledge or very common as the facts of
breaking out of war.
(b) Facts which reduce the degree of risk, as the fire extinguishing
arrangements.
(c) Facts, which are quite apparent from information already supplied.
(d) Facts which are mentioned in the Policy as a condition like a specific
looking measures.
(e) Facts mentioned in other laws but affecting insurance like Workmens
Compensation or Factory Act.
(f) Facts, which were surveyed or inspected by insurer.

Time of disclosure
The material facts must be disclosed at the time of giving a proposal for insurance by the
insured. He should also inform the insurer of about facts, which he knew later on, but
before completing the contract. Insured needs to inform other changes after the contract is
made. The insured has a major responsibility under insurance contract. If its proved that
he has intentionally concealed facts about subject matter then the contract can be declared
void. The insurer has no liability under such a contract.

3.1.2 INSURABLE INTEREST

We have discussed the essentials of a valid contract. Insurance contract requires some
other conditions also. The insured may enter into a contract but if he has no insurable
interest in the subject matter then the contract is invalid. Insurable interest is a necessity
for insurance contract. What is insurable interest? Interest means a relationship between
policyholder and the subject matter of insurance. It refers to monetary loss or gain. An
insurable interest is an interest of such a nature that the event insured against might cause
loss to the insured (Mowbray and Blanchard). If the insured does not suffer a loss out of

44
the destruction of the subject matter of insurance he has no interest. He cannot make a
contract. Interest means financial involvement. Prof. Mehr says, If the happening of the
event insured against cannot cost the insured money, then there is not insurable interest.
Insurance does not insure a property or life but it insures your monetary interest in that. As
for example, one house is worth Kshs. 1,00,000 in the market. If you are not the owner of
the house your interest in the hose is zero. Another case may be seen. A scooter is stolen
by A which belongs to B. A has no insurable interest. Some examples of insurable
interest are:
1. every person has an insurable interest on his or her life, or on life of the person
on whom he/she depends;
2. Owner of a dwelling house on the house;
3. Businessmen on the debtor up to the amount of a loan.

Insurance underwriters examine the presence or absence of insurable interest for two
reasons:
1. For them this is the maximum amount of compensation the insured may get and
2. The gamblers are not allowed to benefit out of insurance contract. In our example
of stolen scooter the thief has no interest but if he gets money for destruction of the
scooter it is pure wager.

The following are the conditions for valid insurable interest:

1. There must be a physical object like life or property as the subject matter of
insurance, which is likely to be destroyed.
2. The person desiring to insure (insured) must lose or gain money if the subject matter
is lost or saved from future events (like death or fire etc).
3. The monetary relationship between subject matter and the insured is recognized in
law.
4. There must be possibility or chance of a loss due to uncertain future event.

Who are the persons having insurable interest? We can make a list of persons and their
insurable interest as follows:

45
 Persons Insurable Interest
1. Whole undisputed owner House or property
2. Agent On property of his master
3. Trustee On trust property
4. Bailees (temporary possessors) On the property in which he has
worked and not yet paid (on ornament)
5. Mortgage (who has lent money On the security
against security of property)
6. Husband/wife On wife/husbands life
Father depending on son/daughter On son/daughter
7. Creditor On Debtors life
8. Partners On the partners lives
9. Employer On skilled and trained employees
10. Surety (who stands guarantee
to a debtor)
11. Owner of ship On ship
12. Crew of ship On ship (up to salaries)
13. Cargo owners on cargos.

When should insurable interest exist? Insurable interest must be proved at the time of
payment of insurance money. The practice differs from one form of insurance to other. In
life insurance it is sufficient if the insured has an insurable interest in the life insured at the
time of contract. It does not matter if the interest is absent at the time of paying insured
amount. In fire insurance the insurable interest in the subject matter must be present at the
time of entering into contract and also when the event takes place. This is done to prevent
moral hazard setting fire to property. This is very easy if the insured has no interest in
the property. Suppose A takes an insurance against fire on a go down. After sometimes
sells it to B. A cannot get insured amount or compensation for loss and he has no suffer.
In all other insurance contracts like marine and accident insurable interest must exist in the
subject matter at the time of event causing the loss.

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3.1.3 INDEMNITY
Scope
This principle is applicable to all insurance contracts except personal insurance contracts
(life, personal accident and sickness). This is regulating principle. This principle is
observed more strictly in property insurance than in life insurance. Ordinarily a property
owner may not recover more than the actual cash value of the property destroyed, whereas
a person may insure his own life for any sum within reason. (Regel and Miller). The
principle states that payment of loss under an insurance contract is enforceable only to the
extent of the actual loss to the insured resulting from a peril insured against. (Mowbray
and Blanchard). It as a contract by which one promises to save the other party from loss
caused to him by the conduct of the promiser himself or by the conduct of any other
person. This includes also a promise to save a person for loss caused, by events or
accidents, which may not be caused by the conduct of any person.
Meaning
Indemnity means security against loss or damage or compensation for loss. It is equal to an
exact financial compensation. The loss must be estimated in money value. The
compensation will be equal but never more than the value of loss to give a margin of profit.
The insured is restored with property loss or he is reinstated in his position before loss.
There may be some exceptions:
1. in fire and marine insurance amount of loss plus a certain amount of profit that the
insured might have earned if there was no loss is taken as amount of compensation;
2. in some lines of insurance valued policies are written. The value fixed by agreement
becomes a part of contract. Such cases arise where correct amount of loss is difficult
to calculate. Insurance of antiques and works of arts come in this line.

Purpose
The principle sets a limit to compensation. It says that even if an insurer promises to pay a
sum of money in the event of a loss it cannot be enforced above the actual values of loss.
The compensation over and above the actual loss is a profit of gamble or wager.
2. It is against public interest. Because the temptation to destroy ones own property
will increase and also the risk. It is against ethics of insurance. It will encourage
anti-social acts.

47
3. In the absence of this principle of indemnity overpayment for loss i.e., larger than
actual loss will be made. So premium rates will go up. Honest persons will leave
insurance for dishonest to come in. Insurance companies may fail and ultimately it
will be a great social loss.

We give two examples of over and under insurance. As for example, suppose A insures his
house for Kshs. 30,000 with an insurer. The loss comes to Kshs. 40,000. It is a case of
under insurance. If the actual loss is Kshs. 20,000, then it is over insurance. In the first
case A can get only Kshs. 30,000 and in the second case only Kshs. 20,000 as
compensation. The insured suffers both due to over and under insurance. In over
insurance he pays higher premiums. He does not recover the entire value of loss in case of
under insurance.

Application of the principle.

The conditions for application of the principle of Indemnity are given below:
1. Insured has to prove that he actually suffers monetary loss in the event of loss
taking place.
2. Compensation must be measured by comparing the value of loss or insured value.
It is either equal to or less than insured amount, but never more than loss. It
punishes over or under insurance.
3. The insurer takes over all rights and duties of the insured after paying
compensation. It includes any extra money earned as profit on sale of property
destroyed and so on.
4. The insurer has a right to claim against third party if the insured has a right after it
pays compensation. For example, As house is burnt. The loss is valued at Kshs.
30,000. The cause of fire was known. It was due to carelessness of X, As
neighbor. The insurance company can recover money for negligence from X after
paying for As loss.

Value of Compensation and Measure of Loss.

Loss always refers to estimates on an objective standard i.e., in terms of money. For
example, a family table now has a big emotional value of Kshs.10, 000 but actual money

48
value in the market is Kshs. 2,500. This value is less than that emotional value. In case
like loss of property cost of replacement of repair is the measure of loss:
1. Replacement means putting a new asset in place of an old one equal in all
respects to the old. The value is equal to the value of new one in the market.
Since the insured is to be placed in a position as he was before loss, the repair is
limited to the sound value at the time of loss. Sound value is calculated after
deducting depreciation adding appreciation in original value.
2. The original value of a machine was kshs. 10,000. Its depreciation loss is kshs.
1,000. So the present value is Kshs. 9,000. If the market value is kshs. 30,000.
Then the value will be kshs. 30,000 less depreciation i.e. kshs. 29,000.

3.1.4 DOCTRINE OF SUBROGATION

This principle of insurance is applicable to property insurance only. Life insurance and
third party liability in accident insurance dont come under this principle. Subrogation is a
combination of two Latin words: sub and rogare meaning under and asking respectively.
This means stepping into the shoes of other person. By this principle one party to a
contract gets the power to exercise all the rights of another party against a third party. This
is very clear if we look to a fire insurance contract. A suffers a loss of kshs. 10,000 by fire,
B the insurer indemnifies A upto Kshs. 10,000. A has another alternative to seek
compensation. He may claim damage from the person for whose negligence the fire
occurred. If A prefers to take compensation from the insurer, he cannot ask third party for
compensation. But the insurance company can recover damage from the third party
because he gets the rights of A after paying him compensation. But insurance company
cannot sue in its own name. It is a settled principle of law. It has also been incorporated in
all policies. That the insurance company, upon payment of the loss to the insured, is
entitled to his insureds legal, equitable, and (perhaps) contractual rights against third
parties. (Riegel and Miller). But insureds right does not include or allow insurer to sue
the offender.

Purpose
The principle supplements or helps to apply the principle of indemnity. Indemnity means
recovery of actual value of loss. Insured is not allowed to make a profit out of misery.

49
This is explained by L. J. Bratt (in Castellain Vs. Preston) that if a person wants to recover
compensation for loss he can do so by insurance. The insurance company may pay for the
total loss. The insured cannot take it with both hands. If he has a means of diminishing the
loss, the result of the use of these means belongs to the insurers. There are two purposes
behind the principle. They are:
1. Insured may recover his loss but not more than that;
2. The insurer, after paying for loss should avail ways and means open to insured to
reduce his liability. Lord Blackburn says that it becomes an equity that the person
who has already paid the full indemnity is entitled to the recouped by having that
amount back (Burnard Vs. Rodacanachi). The insurer is allowed to recover as
much as possible from third party by taking actions, which insured might have
taken.

Essentials of the Doctrine

1. It arises out of indemnity compensation should be upto the value of loss. The value if
any in the damaged property and any right of the insured against third party will
belong to insurer.
2. Insurer automatically displaces insured after paying for latters loss. Thereafter
insurer becomes the proxy or substitute for the insured. He will exercise all the rights
of insured.
3. Subrogation is limited in value. The insurer who steps into the insureds position can
get benefits upto his payment. As for example, A, a ship owner gets compensation of
Kshs. 80,000 from insurer. The insurer by exercising subrogation rights recovers
Kshs. 120,000 from another ship owner for his negligence. The insurer will pay
Kshs. 40,000 minus his expenses to A.
4. Subrogation may be applied before paying compensation. This happens, if the
assured gets compensation from third party. The insurer will pay the balance of loss.
For example, A sustains a loss of Kshs. 20,000. He recovers from the party
responsible for loss Kshs. 10,000. The insurance who agreed to compensate upto
Ksh. 20,000 will not pay only kshs. 10,000. That is total loss minus compensation fro
third party.

50
5. Subrogation does not apply to life contract. The person (insured) will get policy
money, and also the compensation from third party, in the event of an incident
insured against.

The doctrine of subrogation is based upon two principles:

1. The insured is not entitled to profit from the loss, but should be reimbursed (paid the
exact amount of loss) only for the amount of loss sustained.
2. The wrong-doer (for whom the loss occurred) should suffer the loss, which is
applicable only to cases involving fault. Wrongdoing are mainly civil wrongs the
common forms are negligence and nuisance. The insured gets compensation and
insurer proceeds to recover damage from wrongdoer to insured. This is settled
principle in insurance. So much so that the insured forfeits the right of claim under
the insurance contract, if eh settles the claim against the third party and so cuts the
rights of the insurer. It means that the insurer has certain rights in an insurance
contract. To reduce his liability is such a right. If insured does something by which
insurer is not able to recover anything from a wrongdoer then the insured is punished.
He cannot claim any compensation for his loss.

Contribution
This refers to sharing of loss between co-insurers. Sometimes one insured takes more than
one policies, against one loss, and one interest in a property. This is quite legal. There are
more than one insurer for a particular property or the insured has insured the same property
with many insurers. If one of them pays for the loss will he bear the expense alone? Can
he invite others to share his burden of payment?

The insurer paying the claim has a right upon other insurers to pass or transfer part of his
burden. This is called principle of contribution. How is the share of insurer fixed? The
shares are equal or are equitable (determined on some fair basis). The total loss will be
shared by insurers rate ably (according to the proportion one insurers promise bears to
aggregate of all insurers promise). The first claim payer can compel all others to
contribute. This right arises only after paying the insured for his loss.

51
Essential requirements of the doctrine of contribution
1. The insured should be the same for all contracts.
2. The policies should cover the same peril, which censed the loss.
3. They all try to protect the same interest of the one insured.
4. Policies must be in force when loss arose.

Calculation
Generally there are two ways to fixing the insurers shares.
(i) Independent liability:
(a) The money payable by each insurer is found out;
(b) The sums are added together;
(c) If the loss is smaller than amount payable, the individual share of each is
reduced rate ably.
(ii) Sum insured: The insures pay according to the proportion their shares bear to
total sum insured respectively.

Individual sum insured x loss

____________________________
Total sum insured by all insurers

Example
An insurer A, covers Kshs. 10,000; and B another insurer covers Kshs. 20,000 of a
property. The actual loss is Kshs. 9,000. A paid the sum of Kshs. 9,000. What would be
the loss, A can recover from B?

Total Insurance = A Kshs. 10,000 + B. Kshs. 20,000 = Kshs. 30,000

A = 10,000 x 9,000 = 3,000
30,000

B = 20,000 X 9,000 = 6,000

30,000

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A Kshs. 9,000 Kshs. 3,000 (As share) = Kshs. 6,000

A can get back Kshs. 6,000 from B, so B has to contribute Kshs 6,000 towards the loss
which A has already paid on his behalf.

3.1.5 PROXIMATE CAUSE

CAUSA PROXIMA
This principle is the most fundamental for deciding payment of compensation to be
insured. Insurance is taken against risk of happening one or more events. The insurer pays
compensation to insured only if the insured shows that the cause of loss was insured. This
is an additional principle besides insurable interest and subrogation.

If loss is caused by one event then it is easy to say whether it is insured or not.
Compensation is paid if the cause is insured against. But when loss is produced by more
than one cause it is difficult to say which one of them produced the loss:
1. The events may be complimentary or dependent upon one another and come one after
other.
2. The events may be quite independent of one another but some must happen first and
others next. All or only some of these events may be insured. In these situations the
cause of loss is found out by applying the principle of causa proxima.

The principle of determination of the cause of loss in latter case is: causa proxima non-
remota spectatur. It directs the parties to look at the most proximate (the nearest) but not at
the remote (distant or indirect) cause of loss. That means first pick up the proximate
cause and then verify if it is included in the insurance. If the two conditions are fulfilled
compensation must be paid.

What is causa proxima? What factors make a cause proximate to loss? Does it refer to the
time of the event, which occurred just before loss? Does it refer to the efficiency (power to
produce loss) of the cause?

53
Causa proxima is the cause which is the nearest in efficiency (the power) to produce the
loss. The cause need not be the nearest to loss in time of occurrence. The principle says
that the time of occurrence is unimportant. It looks at the result producing capacity of the
cause, which may come early or late in time. Lord Shaw (Leyland Shipping C. vs.
Norwich Union Fire Insurance) defines efficiency. He says that efficiency may have been
preserved, although other causes may mean time have sprang up, which have yet not
destroyed it, or truly impaired it, and it may culminate in a result of which it still remains
the real and efficient cause to which the events can be ascribed. This says that he cause
may appear some or long time in past. Some time may elapse from the first appearance.
Some other events may happen in a way to increase the efficiency or decrease it. The
cause exists and continues till it produces the loss. The points, which we should remember,
are:
1. Presence and existence of the case with force;
2. And its relation with the effect (loss) is cause and effect and that
3. The cause is insured against.

The latest incident of series of incidents may not be the nearest. The direct dominant,
operative and efficient incident producing loss is the proxima cause. Let us see two
examples. One marine insurer excluded loss by rats, but included sea perils in the
insurance. The rats made holes in the bottom of ship. It resulted in entry of water and
sinking the ship. It was held that rats were the remote, but sea perils were the proximate
cause.

In a fire policy ignition was insured against. The store was covered by fire insurance. The
radiators of the store had heating arrangements by steam. They became too hot and spoilt
the candy in the store. There is no fire so any compensation. Fire means ignition that
spoils the subject matter. Fire here is the remote (not direct contact with fire) reason or
cause.

We find from the list of cause and consequence that the circumstances of the occurrence
determine the nearness of the cause. The amount of damage depends upon the terms of

54
insurance and sequence of events. Some examples of circumstances and consequences are
given below.
1. A cruiser chased a ship. The ship ran to the shore to avoid capture. Being unable to
get out, was driven to shore and lost. Here proximate cause is hostilities.
2. In the example given above if the ship goes away from its normal course to avoid the
chase its journey is delayed and for the delay met a storm, then what is the proximate
cause? Argument is that if there was no storm ship would have escaped chase
harmlessly. So the proximate cause of loss is perils of sea.
3. In another example a port had two entries. A torpedo lay hidden in one of those to
destroy ships entering the port. The master of a ship may do two things under these
circumstances:
(a) Master may not know of torpedo. He enters the port by the way where
torpedo is hidden. The ship is destroyed. The cause of loss is act of
hostilities.
(b) Master knows of the torpedo and goes around the other entry channel. The
ship while navigating the channel ran around and was lost. Argument is
that had the ship navigated well it might have passed off safely. So the
cause is perils of sea here.
4. In one case, oranges and lemons were insured as cargo against collision of ship.
Actually the ship collided and was put into the port for repairs. For convenience of
repairs the cargo was unloaded on to lighters and reloaded on the ship after repairs.
The fruits when reached destination was destroyed. Find out which is the nearest
cause of loss? (Collision or loading and unloading? The perishables nature and
unloading loading of cargoes were the proximate causes. This is not insured so any
damage paid.

In the cases discussed we find two causes of loss: they are independent of each other. The
proximate cause is also proximate in time. It is easy to pick up the cause insured against
from the cause not insured. We may find cases where two correlated (one connected with
the other) incidents may arise out of one cause. The incidents may be separated but quite
linked with others and products a loss. That cause will be proximate which has not

55
unbroken connection between it an the loss without intervention of some new and
independent cause. In these cases time of occurrence of the event is not considered.

One tug, for example, was insured against collision but excluded of perils of sea. The tug
met an unexpected obstacle. Its engine room and machinery were damaged and condensers
were broken. To prevent entry of water through ejection for repairs. One of the plugs fell
out. The ship was filled with water and sank. The question was which is the proximate
cause the rest at port or the collision. The repairs were nearest in time to the loss, but the
nearest to loss was collision. The collision broke the condenser; the cause of danger never
disappeared though steps were taken to reduce them. The broken down condenser
remained the dominant, operative and decisive cause of loss.

The chain of incidents may be broken by the appearance of a new and independent cause.
This is a case of broken chain. If the new and independent incident is insured against, the
insurer has to pay compensation for that only, suppose A takes a personal accident policy.
It does not include cover for sickness. He met an accident. He was injured. He fell sick
due to pneumonia and lost his life. The insurers will pay cost of hospitalization only
nothing else.

If an independent incident appears in the midst of a chain of events which started from a
cause excluded from policy then the insurer must pay damage because the new incident is
not the result of the chain. A fire occurred. The public thronged and to disperse them
police charged. The public replied by stone throwing. One car, insured against mob
action, was lost. The insurer is bound to pay compensation. But no compensation can be
claimed if the insured event cannot be separated from the chain of incidents which started
with an excluded event (excepted).

In cases where incidents were started from the misconduct of the assured the proximate
cause is deliberate action. The crew of a ship scuttled the ship ( by making holes). Sea
water rushed in and ship was lost. There may be series of events arising out of the
original event but the cause causing ( the real and operative cause) is deliberate action of
the insured.

56
Lastly the claim of compensation is valid, only when the perils insured have operated
directly and not circuitously on the subject matter f the insurance. Fear of a peril and
actions taken against that and in the process of avoiding loss, meeting loss due to an
insured event cannot be a proximate cause. For example, one ship was sailing on high seas.
War broke out. It was sure that the ship would have been captured had it continued the
journey. The master of the ship steered it to a port of safety and waited there. The goods
were sold. The loss is accountable to the masters decision rather than to the direct
operation of hostilities. So no claim is allowed.

Clause and Basis of classification and Effect on Compensation

Cause(s) Basis of decision of proximate Compensation Amount
1 2 3
A. Single Insured Full
Uninsured Nil
B. Chain Difficult to pick up the immediate Available if proximate
cause cause is insured.
(i) Unbroken One event is the result of previous
chain of events event and produces the next event.

Full 1. All insured

2. Some Uninsured: the point of
occurrence of the uninsured Full
event has to be found.
(i) If it comes before insured
event in the chain.
(ii) If the insured event comes Nil
first and then uninsured
events. If it is possible to
separate the effects.
(iii) If effects are not Upto the happening of
separate. uninsured event the amount
of loss will be
compensated.

Nil

57
(ii) Broken chain 1. No succession of events. No
of events connection of events with one
another. One event arises then
others arise independent of the
risk. Loss is caused by any or
al independent events which
may be insured For the loss caused by the
OR insured event only
(See insured event comes first
or the uninsured comes first)
2. The insured event occurred
first and later on the uninsured
one Upto the happening of
3. If uninsured event comes first uninsured event
and insured events follow.
Full

C. Excepted or uninsured perils; Nil

perils born of misconduct or fault
of the assured causing a loss
directly or indirectly.

3.2 Activity

(i) Outline the conditions for a valid insurance interest.

(ii) Match the following persons with their insurable interest:

(a) Bailees (temporary possessors).

(b) Mortgage.

(c) Husband/wife.

(d) Partners.

(e) Employer.

(f) Surety.

58
 (g) Trustee.

(h) Agent.

(i) Whole undisputed owner.

(j) Crew of ship.

(k) Cargo owners.

(l) Creditor.

(iii) An insurer covers Kshs. 10,000 and B another insurer covers Kshs. 20,000 of a

property. The actual loss is Ksh. 9,000.00. A paid the sum of Kshs. 9,000.00 What

would be he loss, A can recover from B?.

3.3 Questions

1) What are the basic principles of General Insurance? State.

2) Describe how the principle of indemnity applies to insurance.
3) What are the essentials of the doctrine of subrogation?
4) An insurer (Madison) covers Kshs. 20,000 and Alico Incurrence covers Kshs. 40,000
of a property. The actual loss is Kshs. 10,000. Madison paid the sum of Kshs. 10,000.
What would be the loss that Madison Insurance Company can recover from Alico?
Under which principle does this fall?

59
 LESSON 4
PRACTICE OF GENERAL INSURANCE

4.0 Introduction
This lesson covers the general market structure of insurance, that is, the demand and supply
of insurance in relation to price and income elasticity. The content of this lesson will try to
explain how these forces affect the provision of insurance to the society.

4.1 Objectives

At the end of this lesson the learner should be able to:

(i) Explain the market structure of insurance.
(ii) Understand the forces of demand and supply in relation to price and income
elasticity.

4.2 The Insurance Market Structure

The Central economic problem is that (a) (i) the needs and desires for goods and services of
mankind, and (ii) demand for leisure together continuously outstrip (exceed) the (b)
productive capacity of factors of production at nay time. So the factors are to be allocated
over needs. There are two ways: (i) to leave it to a central body i.e. Government, to
produce and distribute the goods and (ii) distribution is determined by market forces of
demand and supply at a price.

4.2.1The Demand for Insurance

(a) Pure Risk. The demand for insurance arises from the existence of pure risks,
which affect human activity. If the savings element of many life assurance
contracts is ignored, then different classes of insurance offer the individual
financial security for income and capital against the losses caused by the
occurrence of pure risk. By purchasing insurance the individual can safeguard his
own, and his dependants financial interests.

60
(b) Certainty of Income and Capital. For the firm, insurance again provides greater
income and capital certainty. This is in the direct interest of a wider range of
individuals owners, employees, creditors and customers.
(c) Economic Institutions. Other economic institutions too may demand insurance,
such as local authorities, public corporations, charitable institutions, and so forth
where the effect of a loss could fall on limited body of individuals, e.g. local
ratepayers, as opposed to society as a whole. The one normal major exception is
the government, partly because it often controls a sufficiently large number of
exposure units to enable it closely to predict its actual loses. In any event its
powers of taxation are such that possible insolvency is not a cause of concern.
Government cannot be insolvent.
(d) Other Sectors. Thus, the demand for insurance arises from many sectors of
society. Like other commodities such demand must be seen as demand at a price.
Other things remaining equal, an increase in price will bring about a reduction in
demand. Moreover, the demand for insurance will be influenced by the other
determinants of demand, so that, for example, a fall in the price of cars leading to
an increase in the quantity purchase will bring about an increase in the demand for
motor insurance.
(e) Compulsory insurance. An important factor is that in many countries certain
classes of insurance have been made compulsory by legislation. So for example,
in most countries it is now a criminal offence to drive a motor vehicle on the
public highway without effecting insurance against level liability to other road
users.

In each country the tendency is for compulsory insurance requirements to be

extended. Sometimes this is accompanied by the creation of a state monopoly for
that class of insurance, in other cases only specially authorized insurers are
permitted to transact such business, and in other cases insurance can be effected
with any insurer willing to underwrite the risk.
(i) Quasi-compulsory. In addition to the above there are many other
insurance that may be termed as of a quasi-compulsory nature. The

61
 following are a few examples arising from different types of
contract:

(i) Property Insurance. (i) Under a mortgage or debenture deed a

requirement that the borrower shall insure the building against fire and
other perils; (ii) a requirement in a lease, that the tenant shall maintain and
insure the premises; (iii) the condition in a building contract that the
builder shall accept responsibility for and insure the building in course of
erection until completion.
(ii) Liability insurance. (i) In a contract for the supply of components the
supplier may be required to effect products liability insurance against
liabilities arising from accidents caused by the failure of the component;
(ii) a repair contract allowing the repairer access to the clients premises
may require the repairer to have an adequate liability insurance in force.

Sometimes such compulsory insurance conditions in contracts also specify

that the insurance shall be arranged with a named or approved insurer,
and perhaps through the agency of one of the parties to the contract, e.g.,
as in the case of mortgages effected through a building society.

Clearly such compulsory insurance requirements affect both the extent and the
nature of demand for insurance. The failure to insure legally debars the individual
or firm from engaging in the associated form of activity.

(ii) Market demand for Insurance Undoubtedly if there is only one

insurance industry dealing in the transference of pure risks and with
all suppliers confronted by common problems of rating, defining
capacity limits, marketing and so forth. Nevertheless, if a market is
defined as a body of buyers and sellers dealing together in close
substitutes, then it may be seen that the insurance industry operates
in a number of related markets. In identifying insurance markets the
following factors need to be considered.

62
 (i) Type of buyer; (ii) type of seller; (iii) the nature of the different classes of
insurance, including the technical and marketing problems associated therewith;
and (iv) geographical area. Several alternative classifications are possible and
over a period of time. At present, however, one which offers a satisfactory basis
for further analysis of direct business (i.e., excluding reinsurance) distinguishes
life, general and marine business. It further subdivides life and general into
home and overseas business, and general b business into industrial/commercial
and personal is based on differences in the needs and bargaining powers of the
classes of buyers, and the different technical and marketing problems involved
in handling the two categories of business. It further subdivides life and general
into home and overseas business, and general business into
industrial/commercial and personal. The sub-division of general business into
industrial/commercial and personal is based on differences in the needs and
bargaining powers of the classes of buyers, and the different technical and
marketing problems involved in handling the two categories of business.

Therefore, in considering market demand for insurance, such demand must be considered
in relation to the individual markets. On the other hand such markets are sufficiently
closely related that factors influencing one may very well affect others too. In each market
total market demand will comprise the aggregate demand of individual consumers. At the
other extreme an insurer able to achieve a substantial degree of product differentiation
would be in the position of a monopolist with a unique demand curve.

4.3 PRICE ELASTICITY OF DEMAND FOR INSRUANCE.

As noted in economics the responsiveness of demand to changes in price is determined
primarily by the availability of substitutes e.g., tea and coffee. The same holds true of the
demand for insurance. The elasticity of market demand for insurance will vary between the
different insurance markets. In relation to those classes of insurance which are made
compulsory by law, market demand would tend to be highly inelastic. On the other hand,
where demand is not compulsory it would not be perfectly inelastic. Motor insurance for
example, forms part of the cost of running a car. If the price of third-party motor insurance
rose very substantially there by significantly increasing total motoring costs, some

63
motorists would consider switching to other forms of transport. Similarly, national
insurance contributions increase the cost of labor relative to capital so causing firms to seek
more capital-intensive methods of production. In other words, rather than pay the high
premium the insured avoids the risk.

Ignorance and inertia. Other factors influencing elasticity of demand for insurance may
be ignorance and inertia. Neither the need for insurance (the risk) nor the produce itself
is easy to easy to evaluate. This will tend to make demand relatively less elastic, but here
the distinction between the markets for industrial/commercial and personal insurances is of
importance. The former will include many buyers with expert knowledge of the product so
that their responsiveness to price changes may be expected to be more positive than that of
individuals. Therefore, it may be argued that demand will tend to be relatively more elastic
in the market for industrial/commercial insurances than in the market for personal
insurances, both in relation to total market demand and the demand for the products of
individual insurers. On the other hand ignorance may produce more reactions from
personal buyers based on an inaccurate subjective evaluation of situation; the larger
numbers of individuals who have transferred their motor insurances to cut-price companies
in UK Perhaps is evidence of this.

4.4 INCOME ELASTICITY OF DEMAND FOR INSURANCE.

It would be expected that insurance would have an income elasticity of demand greater
than 1,i.e, an increase in income would result in a more than proportionate increase in
demand for insurance. There are a number of reasons for this proposition, as follows:
(i) There is considerable evidence that savings are a function of income.
Therefore, as national income per capita increase, so it is reasonable to assume
that the demand for life assurance and pensions contracts will be rising even
faster. (ii) Increasing income is usually accompanied by an increase in
consumer durable goods (i.e. better houses, more cars, televisions, washing
machines, etc.) and a greater demand for leisure activities. This in turn, will
increase the demand for personal insurances. (iii) In an economy where
productive resources are fully employed, an increase in income per capital can
only come about by greater efficiency or by increasing capital employed. The

64
 latter will increase the demand for property insurances. Greater efficiency can
be achieved through increasing specialization, (export and import trade) perhaps
on an international scale, so increasing the demand for marine and other transit
insurances. (iv) In an underdeveloped country where incomes are low insurance
will rank as a luxury for the majority of the population. Then a rise in incomes
will create an effective demand for insurance.

Empirical evidence that insurance does have a positive income elasticity of demand
which often measures greater than 1,is provided by statistics published by the Swiss
Reinsurance Co., in its monthly publications Sigma the October 1968 issue was
devoted entirely to an investigation into the long term growth of insurance and the
national economy. The statistics taken from that paper, over the previous five or so
years show that the tariff companies had lost a considerable amount of business to
cheaper non-tariff competitors. Demand for insurance will rise at a higher rate than the
rise in rate of increase in income per head.

4.5 THE SUPPLY OF INSURANCE.

The nature of an insurers costs. As noted the price/output behaviours of firms is
determined to a considerable degree by their costs. Here, the position of insurers is
somewhat usual in that at the time of sale there remains an element of uncertainty in
the final cost. The business of insurance is not so risky. As the last sentence would
suggest, the insurer by combining similar exposure units reduces the level of risk in his
account. Although the potential claims costs of individual policies is uncertain the
actual result of a large account can be predicted with a substantial degree of accuracy.
The degree of risk remaining, and thus the level of fluctuations in an insurers results,
depends on: (i) the extent to which past results provide a guide for the future, i.e., the
degree to which risk factors have changed; (ii) the number of exposure units combined
in the insurers account; and (ii) variations in the sizes of the exposure units, i.e.,
whether the account is composed of small and large risks. The student should consider
different classes of business and the stability of underwriting results in the light of
these points. An insurer can reduce the degree of risk in his account by means of
reinsurances, the reinsurer practicing a second stage of risk combination. Like an

65
 original insured, the direct insurer then substitutes the certainty of the reinsurance
premium for some of the uncertainty of claims costs.

Small Fixed Cost. The second feature of an insurers expenses is that fixed costs form
only a small part of total costs. The major element of total costs comprises claims which
largely vary in proportion to business transacted. Likewise, a large proportion of
management and sales expenses comprise variable costs for the reason that insurance is a
labor intensive business and most companies obtain their business through intermediaries
who are remunerated by way of commission only on business transacted.

All insurers enjoy the benefits of low fixed costs but some methods of operation are even
less capital intensive than others. An insurer that relies on brokers for its business can
avoid the fixed costs associated with branch offices. Conversely, the changeover of manual
accounting, etc, to a computer increases fixed costs, unless computer time can be bought
from a bureau under a fairly flexible contract.

The organization of the insurance market. The second factor having a bearing on market
behavior is the market organization , as noted later in this lesson. The supply side of
insurance markets ranges from monopolistic competition to monopoly. At the one
extreme are the markets for personal insurance with supply in many countries in the hands
of a large number of insurers, while at the other extreme are countries where insurance
has been nationalized or the supply of certain classes of insurance is in the hands of the
stage, e.g., the national insurance scheme in Britain and entire business in India. In
addition a common feature of most insurance markets is the presence of intermediaries, i.e.,
part-time agents and brokers, which may exert various influences over the behaviour of the
market.

Entry and Exit from the Market. In the 10 years preceding 1956 less than a handful of
new companies entered the market each year then the pace went on decreasing until in
1956 (life) and 1972 (others) it was nationalized in India. In UK since 1963 about 20
companies were born per year. This was followed by the failure of several new cut-price
motor insurance companies. The most notable being the Fire Auto and Marine in 1966. it

66
led to demands for legislation to control new and existing companies culminating in Part
11 of the Companies Act 1967. The barriers to the entry of new insurance companies
anywhere to the market fall under the following headings. (i) The economics of large-
scale; (ii) advantages of product differentiation by established firms; (iii) insurance market
organization; (iv) the absolute cost advantages of established insurers; (v) minimum capital
requirements; (vi) legal barriers; (vii) the availability and cost of reinsurance.
(i) The Economics of large-scale. If costs fall substantially up to a large level of
output then this would place anew company at a serious cost disadvantage. So,
for example in an output of the minimal optimal scale, i.e., the point of lowest
long-run average cost, the unit costs of a firm producing at low output would be
twice as high as the optimal scale firm.
(ii) Advantages of product Differentiation by Established Firms
These may arise fro preferences by the public for established insurers based on
their reputations; membership of market associations such as the British
Insurance Association or the three associations of life offices; local connections
and branch networks; advertising and so forth.
iii) Insurance market organization. One of the advantages which an establish
branch network provides a company has been noted above.
iv) The absolute cost advantages of established insurers. For number of reasons
an established insurer may be able to operate more cheaply at any scale than a
new company. It may be necessary, for example; for a new company to offer
higher salaries in order to attract staff. Likewise, difficulty may be experienced
in finding suitable accommodation except at higher rents, which established one
can only provide.
v) Legal barriers. The 1967 Act in UK, and Insurance Nationalization Acts in
India also empowered the Board of Trade/Government (now the Department of
trade and Industry) to refuse authorization to a potential new entrant to the
insurance market in UK on grounds that it has failed to make adequate
reinsurance arrangement so that any officer of the company or its parent
company is an unfit person.
vi) The availability and cost or reinsurance. In order to operate safely an
insurance company must be able to secure reinsurance Research by Dr. Carter

67
 has shown that new non-life companies are at a limited disadvantage compared
with established companies due to:

a) Their inability to obtain certain types of reinsurance cover; and

b) The reinsurance cover available will tend to cost them relatively
more than established companies.
Therefore, it may be concluded that a new insurer is at disadvantage compared
with established insurers. For the new insurer will suffer higher costs per unit,
and may be forced to offer lower premiums in order to compete business from
established companies.
vii) The effect of mergers on the supply of Insurance. The direct effect of
mergers is to reduce the number of independent companies, so leading to an
increase in market concentration. The relationship of mergers to this problem is
what happens to the total retention of a new group when previously independent
companies are integrated. AT the moment no reliable empirical evidence is
available: possibly some will be provided by the Monopolies Commission of
England report in due course. The integration of two similar underwriting
portfolios (policies) would increase the numbers of exposure units combined
together in the one account, thereby further reducing residual risk. As reserves
would also be combined, it could be argued that integration should permit
retention limits to be raised above the aggregate of the previous individual
limits.

In practice this does not appear to have happened and from time to time it has been stated
that aggregate limits have been reduced. Why this should happen is not certain. Possibly
the explanation may be psychological, reflecting underwriters attitudes to risk, i.e. an
unwillingness to raise limits substantially beyond the amounts they had been prepared
individually to accept in the past. On the other hand, if it occurs at a time when companies
are incurring underwriting losses it may be because the group has taken the opportunity
afforded by the integration process to reconsider its overall underwriting policy. Again the
re-adjustments of group underwriting and reinsurance arrangements following several
major mergers of direct offices may have an adverse effect on the amount of reinsurance

68
supplied to the market, thereby reducing the acceptance limits of the direct offices. All of
this is no more than conjecture, and in relation to total market supply of insurance far more
research is required into the effects of mergers.

4.5Activity

(i) Explain the following in relation to demand for insurance.

(a) Economic institutions.
(b) Pure risks.
(c) Certainty of income and capital.
(d) Compulsory insurance.
(e) Quasi-compulsory.

4.6 Questions

1. What factors create demand for insurance?

2. How does price elasticity of demand affect insurance?

3. What are the barriers to entry of a new insurance company in the market?

69
 LESSON 5

LIFE INSURANCE

5.0 Introduction

This lesson covers the life insurance, briefly explaining how the life insurance cover is

taken and the diseases that can be insured. It also explains how a health plan works.

5.1 Objectives

At the end of this lesson the learner should be able to:

(i) Explain the types of life insurance available.

(ii) Explain how a health plan works.

5.2 FIRE POLICY DRAFTING

During the 16th century people contributed money to a common pool out of which
payments were made on the death of a member. The first real evidence of life insurance
dates back to 1583. The type of assurance offered those days was for a short term for a
period of 12 months. In 1757 Amicable society took a daring step of guaranteeing a
minimum sum to be payable on death. In 1762 the equitable life assurance society was
formed and transacted business dependent upon the age of the person when he took out
the policy. They also offered whole life policy that paid the sum assured on the death of
the assured person.

In 1774 Life assurance act was passed, its title was An act for regulating insurance upon
lives and prohibiting all such insurances except in cases where persons insuring shall have
interest on the life or death of the person insured

70
5.3 What is life insurance?
This is a cover that provides for payment of sum insured on death, provided death occurs
within a specified period. However if the insured survives until the end of this period
(maturity date) the sum insured is paid to the person. In the signed agreement the insured
takes a policy of so much money i.e. 200,000/- and agrees to pay 1500/= monthly for
period of about 15 years. In case the person dies after contributing for 5 years the
dependents are paid 200,000/= which is the money insured. The contract guarantees to
pay a certain amount of money to the dependents in the event of an injury , accident or
death.

5.4 Why life insurance

Life insurance is an essential part of financial planning. The money provided by life
insurance meets several urgent expenses like:
Funeral and medical expenses.
Pay debts owed.
Education expenses.
Needs during the adjustment period
The family therefore does not to need to sell assets to pay outstanding bills and
debts.

Factors that determine amount of life insurance taken.

Monthly income.
Needs at the time of death.
Funds for readjustment period.
Ongoing financial need i.e. Rent, education etc.
5.5 TYPES OF LIFE INSURANCE OFFERED IN KENYA
Term insurance
This is life insurance that provides protection for a specific period of time. The sum
insured is payable t the dependants in the event of death of the insured within a specific
period. Upon maturity of the policy, the insured is give the sum insured.

71
Permanent insurance
The cover provides life long protection. The policy is designed and priced for one to keep
over a long period of time. There are different types but the one offered locally is whole
life or ordinary life. Whereby a premium is paid periodically in the amount indicated in
the policy. The premium amounts remain constant and is paid by the life assured till
death or a predetermined age. The benefits under the policies are not paid before the
death of the life assured.
Calculations of premiums is similar to all policies. The net premium differs from
polices depending on the benefits requires by the proposer.
The primary information required i.e. Date of birth, sum assured, term, se, full
names and addresses.
Benefits applicable to the policy.
Cover commences on receipt of the first premium.
Cover ceases on demise of the life insured.
Premiums can be paid monthly, quarterly, or half yearly installments.
Common claims namely death claim, maturity claim surrender claim, paid up value
claim.
Terminology used e.g. in force, lased, paid up, matured, death, surrendered and
cancelled ( for definition check the glossary section).

5.6 Health Plan

Health plans are companies that negotiates and contracts with individuals or institutions to
provide medical care for active members. Health plans offer variety of health care
products form medical treatment health care.

Plans differ from one company to another and are available to individuals or groups. An
individual or employer pays an annual fee which is used t cover the member or employees
incase of illness. Some plans give members unlimited choice and access to doctors while
others provide their list of doctors from contracted medical service providers.

72
Along with payment of bills for members some health plans provide advice of health
related issues, medical check us, counseling services and preventive health care. All this
is to provide wellness and educate members in making wise health care decision.

5.6.1 Factors to consider when choosing a health plan

Just like making any other major purchase it is important that one selects a health plan
wisely by using the following factors:
i. Cost
You should gather information on what you will pay for your health plan option
ii. Coverage
Coverage of health care services differ from one company to another. Some health
plans offer.
(a) Medical check ups, follow up care, counseling services and preventive
care.
(b) Screening .
(c) Information on child immunization, cancer screenings, medical
examination and caring of your health.
(d) Accessibility of care: the health plan ensures that there are health centers
easily accessibility by its member.
iii. Quality
(a) While cost is a big concern for most people, quality should always be an
important consideration hen choosing a health plan. What do members of
specific health plan say about that company? From friends one can
determine how satisfactory a specific health plan is.

5.7 Health Care Issues

Common diseases
There are several disease that are currently diagnosed in Kenya and are such a threat to the
people of this country. The most common of these are:
Malaria
Typhoid
Diabetes

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 Hypertension
HIV Aids
Tuberculosis
Stress and Depression

5.8 Activity

(i) Give a brief summary of the life insurance policy and state how the health plan
works.

5.9 Questions

1. What is life insurance?

2. What are the types of life insurance offered in Kenya?
3. What factors should you consider when choosing a health plan?

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 LESSON 6

FIRE INSURANCE
6.1 Introduction
Fire is a peril that causes great loss of property. In this lesson we are going to discuss this
peril and the fire insurance cover that is taken against it. We are going to understand the
different causes of fire and how they are treated. This lesson highlights the structure of a
standard fire policy, among other issues.

6.2 Objectives

At the end of this lesson, the learner should be able to:

(i) Discuss the general laws/principles that govern fire insurance.

(ii) Explain the structure of a standard fire policy and conditions.

6.3 Fire Policy Drafting

Insurance protection is an (abstract invisible) intangible service. The service or functions
can be put in two groups: under writing and settlement of claims. When the event of risk
occurs insurance becomes a claim (tangible thing). Giving and asking for insurance
protection is the relation between insurer and the public. Settlement of claims should be
the promptist so that there is appreciation for insurance. Settlement of claims should be
fair and just. As far as possible claims should be settled. Rejection should be minimized.
The claims are to be settled within the framework of insurance contract. That means the
terms and conditions, limitations and extensions will determine the compensation. The loss
must be carefully investigated. Insurance business is a trust. The premiums received from
many should be kept as a trust fund, which is to be managed on business principles to pay
for the losses of the few.
So, fire insurance management is governed by several laws:

1. The general law of contract

2. The special law of contract

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 3. The terms and conditions of

4. The standard fire policy

5. The extensions to the standard policy

6. The special policies

7. Loss assessment procedure

In the following section we mention in brief the different items of legal aspects of fire

insurance.

6.3.1 Law of contract. The agreement binds insurer and insured for consideration by both

sides premium and indemnity. Essential features are: offer and acceptance,

consideration, capability of parties to enter into contract, common intention legal object of

agreement.

6.4.1 Special Principles: Utmost good faith insurable interest, indemnity obligation and

contribution. Some or all of three are mentioned in policy. But even if they are not

specifically mentioned they are applicable to fire contract i.e. implied conditions.

6.4.1 Utmost good faith: All commercial contracts are based on good faith i.e. absence of

cheating or fraud by parties. Insurance is based on utmost good faith i.e., disclosure by

insured. Therefore, there is provision in policy for intimation to insurer by insured of any

change in policy conditions. Good faith is a part of agreement. The utmost good faith is

applicable to insurer when insurer himself surveys the property and examines the interest of

insured. It extends over preservation of property. It extends over the whole term of policy.

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This put a duty on insured to inform all changes to insurer. Only when changes reduce loss

may not be informed by the insured.

6.4.2 Insurable interest: Capacity of person means more than what is found in the Indian

contract. Under contract Act if he is above 18 years, sane (not mad) may enter into

agreement. But in insurance he must have also an interest in the insurance property. If he

has no interest he has nothing to lose and no compensation to receive. Besides the owner,

the trustees, executors, administrators, mortgagor and mortgagee (up to part of loan amount

unpaid in loan granted against the property), the bank (Agreed Bank clause) have insurable

interest. Others who may have interest are partners, creditor and reinsure for his reward.

When insurable interest be present? Insurable interest must be present at the inception of

the contract and when the loss takes place. Exception is there. A businessperson expects a

consignment of goods; the time of arrival is not known. If the goods on arrival will be

under his risk he can insure the goods. He can arrange insurance in advance. If the goods

are lost before arrival there is no liability of insurer at all because the insured has no

insurable interest in the goods. Insurable interest is a personal right of insured so does not

pass automatically with the property. That means the buyer of insured goods does not get

cover secured by the original owner. But the legal heirs of insured get the insured right

automatically.

Subject matter. The property the subject matter must be present physically at the time

of contract. Locality or situation of property also comes under description of subject

matter.

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6.4.3 Indemnity. This is a condition of common law. It has two other aspects:

subrogation and contribution. Indemnity means payment of compensation for actual

amount of loss up to insured amount. Subrogation gives insurer all the rights of insured

against the third parties. So insurer recovers part or whole of the damages from the

defaulting third party. Contribution refers to the sharing of compensation with other

insurers of the property. Only when these are done the principle of indemnity works. The

measurement is done by the market value of property, upper limit being sum assured, but

value agreed in value policy. An example may clarify the concepts. A insured his factory

building for Ksh.30, 000 with X and ksh 30,000 with Y. It is lost by fire caused due to

negligence of Z. The court awards damage of ksh 5,000 on Z. X pays the loss in full to A.

X can recover 5,000 from Z by exercising rights of A (Subrogation) and ask Y to pay half

share of loss (contribution) balance after Kshs.5, 000.

6.4.4 Doctrine of Proximate cause: This principle looks at the origin of loss.

Compensation is payable only when the loss takes place by insured peril. Sometimes

insured peril comes a long with several uninsured perils. Some perils before and some

perils after the insured perils. There is a series of events attached to the perils causing the

loss. In such complicated situation previous legal decisions guide the insurers action we

mention a few points taken from such decisions. First what is proximate cause? It is (i) the

active efficient cause, (ii) this active cause sets in motion a chain of other events, (ii) then

the events cause the loss, (iv) in the chain there is no intervention of any other outside

force. Every event is the result of a cause. The criteria to pick up the direct cause of a loss

is to find out the dominant, effective and proximate cause (not the remote or distant one).

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But losses, which are indirect or consequential, may be covered by special agreement with

insurance company.

Insured Peril: Peril causes the loss must be insured against. One must prove that the loss

is connected with the peril by a chain of events leading naturally and in the ordinary cause

of events, from one to another. We must give two examples: (1) in the Gerald vs. Law

union case the facts were: that a wall was damaged by fire and remained standing for many

days. While standing so it was blown down during a storm. It damaged the neighboring

property. The loss was held to be result of remote cause of fire. It was held that fire did

not cause the loss so no compensation paid. (2) In Johnston vs. West of Scotland case the

facts were: that a fire left a wall of the building in a very dangerous condition. Local

authorities ordered to pull it down. The wall fell upon the neighboring building and

damaged that. The loss was payable as a result of fire. The connection between the loss

and fire must be direct and close to be called proximate cause. There are other causes of

loss like theft during carrying goods from firer to safety. The loss is also compensated.

Excepted Perils: The loss caused by an excepted peril however proximate to fire is not

payable at all. Such perils are war, forest, fire, earthquake etc. These are specifically

excluded from policy.

6.5 STANDARD CONTRACT OR POLICY

Insurance contract usually takes the form of a standard Fire Policy. It embodies all the

terms and conditions which are specific and applicable especially to relationship under the

contract. In the section to follow we discuss these matters. However, these points were

discussed in the lessons of general principles of insurance in details.

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Why standard Fire Policy? Unlike other forms of insurance, fire insurance is carried by

means of a standard contract all over the world. Not other form of contract can be used.

The standard policy may be modified to suit the desire of the insured. This can be done by

endorsements to meet the conditions of the particular case.

What is a policy? A policy is the written evidence of the contract of insurance between the

insured and the insurer or the insurance carrier. Oral contract is possible but not advisable

at all.

What we have learnt are as follows: contract is embodied in policy. It has two parties the

carrier of insurance-insurer and the insured. One of the party offers or request i.e. proposal

and the other may accept. Usually the insured offers or requests for insurance. The

acceptance comes from the carrier, or requests for insurance. The acceptance comes from

the carrier, or through an agent who is willing to accept the risk. There must be a valuable

consideration for the contract. Consideration from the carrier is his promise to pay

compensation and from insured side it is his payment of premium. If the contract is to be

valid and get the support of the courts it must have a legal object. Lastly, the insureds

relation with subject matter must be such that loss or damage of the property would harm

him. This is called insureds insurable interest. Without the interest contract becomes

gambling. Risk commences on payment of first premium.

Basic Definitions in use in Policy

1. Fire The policy insures against all direct loss by fire, lightning and by removal from

premises endangered by the perils insured against in the policy except as here provided.

Loss means damage and destruction. Direct loss means property insured must be actually

damaged, excludes indirect losses (inability to operate, loss or sales, profit) and the like.

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 (a) Loss by fire means a sufficiently combustion to produce ignition and

probably requires presence of flame. Hostile fire is that which is found

in a place not intended to be present. Friendly fire is one, which

confines to the respectable intended for it. Example, silk goods may be

damaged by soot escaping from store pipe is not loss by fire because fire

did not come out of store pipe. One proof is that fire must be the most

proximate cause of damage.

(b) Loss by lightning. It is covered by endorsements. If property is struck

by lightning and damaged (fire ensures or not) is covered.

(c) Other perils extended cover. They relate to hail, storm, tornado

earthquake, riot, and strike etc

(d) Removal of goods. Damage due to removal of goods from endangered

peril is also covered. Fire insurance is available to cover any agreement

on movable and immovable property having monetary value. Examples

are property like buildings, furniture, fixtures and fittings. Electrical

installations, household contents, plant, equipment, machinery, and

stock etc. fire means accidental ignition. We give below the meaning

of certain terms commonly used in fire insurance practice

2. Insured. The insured is the person or body who seeks protection against a particular

risk and is entitled to receive money from the insurer (insurance company) in the event of

happening of the stated risk. In return the person pays an agreed consideration (premium).

That person is known as Insured. Generally an insured is a policyholder.

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The insured must have an insurable interest in the property insured, as an essential

condition as regards fire insurance.

3. Insurer. The insurer is the person or body who, in return for the premium,

undertakes to indemnify the insured. The agreement sets forth the legal rights of

parties. That document is known as policy. Mostly the insurers are insurance

companies. But in India it is General Insurance Corporation. Unlike many other

forms of insurance, fire insurance is carried on by means of a standard contact

prescribed by law. But standard policy may be modified by endorsement to meet

the conditions of the particular case. Additional perils are added to the policy by

way of endorsements. The cover relates to loss or a=damage to insured property by

specified perils. This is called material damage. Cover for loss of profit by way of

stoppage of production is consequential loss.

4. Policy. The policy is a legal document which contains the terms and conditions of

insurance contract agreed between the insurer and insured. It describes, inter alia,

the property and peril covered.

5. Proposal form. It is the standard form of an offer or insureds request for

insurance. Insurer may accept this. The proposal form is a form frequently used in

insurance terms. It is neither general nor compulsory in use. The insurer supplies

the form. The proposer (the person who wants to take insurance policy) furnishes

the following particulars in relation to the policy in that form.

(i) Name, address and occupation of the proposer

(ii) The property to be covered, its occupational and the sum insured,

(iii) Risks to be covered or contingencies

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 (iv) Particular features in connection with the property, such as construction,

heating and lighting of the premises. Nature of adjacent (lying near)

property.

(v) Previous insurance history with special reference to declinature or

acceptance only upon special terms.

(vi) Agency

Fire insurance right from its birth in society is transacted by word of mouth. Unlike

other classes, it is not compulsory to obtain a proposal from duly signed by the proposer.

However, in order that there is no misunderstanding it is an accepted principle, that the

insurers confirm in writing by means of a letter what has been communicated orally.

6. Cover Note. It is issued temporarily. The request comes from the insured or, the

insurer if he anticipates any delay in the issue of policy document, usually issues a

cover note or a letter of cover for provisional protection to the assured. Cover note

promises protection between payment of premium and issue of policy. The cover

note briefly describes the property to be covered, perils against which it is insured,

the period of the cover, sum insured, agency and also mentions that the insurance

cover issued is subject to terms and conditions. Cover notes usually have a limited

validity period within which it must be replaced by a policy. It is effective till the

issue of fire policy.

7. Renewal Notice. This is issued 30 days in advance of the expiry date of the policy.

This is purely a reminder. It is not binding on the insurer to send a Renewal notice

and an insured cannot plead non-receipt of this notice, as an excuse to make the

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 insurer liable for the loss, should there be any loss between the period of expiry and

the date of request for renewal. Section 64 VB of the Insurance Act 1938 duly

amended provides that no insurer in India can assume cover unless the premium is

paid in advance/covered by a bank Guarantee/Cash deposit before assumption of

the cover. No insurer can grant any grace days.

8. Extent of Protection. There are two aspects of the extent of protection:-

(i) The events covered by the policy, such as damage by fire, water smoke

and like;

(ii) The amounts covered by the policy, i.e., the definition of the sums that

can be recovered by the insured in case of loss.

9. Inspection Report. Inspection is universal to all insurance. Its manner of

preparation is different in different insurance. The purpose is to indicate by some

means and to as much extent as possible to know about the insured and the subject

matter of insurance. In life the person is the subject matter but in fire and other

non-life contract the person and subject matter are different. Inspection determines

the acceptability of the proposal for insurance the price and the terms of the policy

contract. It may relate to classification of a house in a rural environment. There is

no standard form. It will depend upon each individual case of investigation.

6.6 POLICY DRAFTING

1. Quality of a good draft. The effectiveness of efficient drafting of a policy can be

tested only when a claim is processed for settlement. Good clear draft helps in

quick settlement of claims. It is a skill to draft well. Both knowledge of insurance

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 and clarity of writing are essential for this. The following qualities are considered

essential in efficient policy drafting.

(a) Sound knowledge of the principles and practice of Fire Insurance,

(b) Thorough knowledge for various Tariff provisions and Fire hazards,

(c) Accurate knowledge in premium computation,

(d) Accurate description of the subject matter of insurance to be covered,

(e) Avoidance of terms which are capable of wider interpretation or superfluous

thereby confusing the scope of cover granted.

Practice in policy drafting is of prime importance. The course in insurance will

offer every opportunity for this, but students should endeavour to supplement it by

private work, wherever possible. They should read policies and follow them.

2. Materials used for Drafting. This tells us about the paper and information that are

used in draft. From the following sources of information we can build up a policy.

(a) Proposal form and the related correspondence between insurer and insured;

(b) Cover notes if issued,

(c) Site plan and

(d) Inspection report.

Form (a). The insurer can obtain the name and address of the person and nature of property

to be covered, sums to be insured and various other attendant considerations, such as nature

of occupation of the premises, insurance history, and for small risks where a survey report

is dispensed with, from the proposal forms. It also gives information about heating,

lighting and construction the premises.

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Form (b). This is prepared by an official of the company to obtain:

(i) Full description of the construction, occupation, lighting, and heating of

the building concerned together with full details of trade processes,

particular hazards, and fire appliances installed.

(ii) Information for rating and for applying the relative warranties and

special conditions are available. Inspection report is prepared to know

facts about insured and property. Survey particulars are not necessary

for all insurance, whereas inspection is almost common. Generally

survey is done only for the larger insurances, property in congested or

conflagration prone areas, and for risks under which trade processes are

carried. These facts are considered to rate the risk and determine the

specific loadings.

(iii) Principles of Reading a Policy. A policy is a legal document. Dispute

may arise in future on the correct meaning of the terms used in policy.

On this, amount of compensation depends.

When intention of parties is clear no difficulty arises. When disputes arise, the meaning is

found as follows: (a) intention of parties, (b) handwritten or typed words are accepted as

intention. These are special writing added to printed form, (c) endorsement in writing

overrides typed, the typed words override printed ones in case of any duality in meaning,

(d) the meaning which goes against the drafter is accepted, benefit goes to insured.

Because the words used were chosen by insurer, (e) words will mean ordinary sense, e.g.

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stored and kept means heavy stocking, (f) ordinary rule of grammar and punctuation will

apply to draft.

Structure of a Standard Fire Policy and Conditions

The formal undertaking of the company to indemnify the insured in the event of destruction

of or damage to the property by certain contingencies is expressed in a document known as

the standard Fire Policy. The Standard Policy is divisible into two parts: (a) The printed

portion common to all contracts, (b) The written portion inserted by the policy drafter.

The standard fire policy form is issued by the offices of the subsidiaries of the General

Insurance Corporation and the terms and conditions are governed by the various provisions

of the Tariff. Uniform policy wording conditions have been given in the Tariff and are

binding on all the four insurers.

In the event of conflict between the written portion and the printed, the former over-rides

the latter. Ambiguity between the two should in all circumstances be avoided.

Before an attempt is made to draft policies, the Standard Fire Policy should be studied

thoroughly. The examination will indicate that the printed document is divisible into three

parts: (1) Preamble and Operative clause, (2) schedule, and (3) conditions.

1. Policy preamble indicates the following major features:

(i) Insurers liability would rise only after premium payment.

(ii) Liability is subject to the conditions that are printed and or endorsed,

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 (iii) Peril included are: (a) Fire, (including fire following explosion), (b)

Lighting, (c) Explosion of Boiler used for domestic lighting or heating in

a building not forming part of any Gas works.

(iv) Expiry of the contract,

(v) Indemnity afforded in the value of the property at the time of the

happening of its destruction or the amount of such damage or at

insurers option reinstate or replace such property or part thereof,

(vi) The total payment by each item or by the whole policy is relative to sum

insured.

6.7 FIRE
The term fire has to be understood in its ordinary popular meaning. The term simply

means actual ignition under accidental circumstances (as far as the insured is concerned).

Ignition means burning, the presence of flames is a condition pre-requisite. Thus,

damage by smoke, heating scorching or charring without actual burning, is not considered

as fire.

Secondly, the ignition has to be fortuitous or accidental. But this applies only to the

insured. If a third party deliberately sets fire to insured property, it is still accidental so far

as the insured is concerned, provided the third party is not acting with the direction

connivance of the insured. If the insured himself sets fire to the insured property, it is

certainly not accidental; in fact, it is fraud. However, a fire caused by the negligence of the

insured or of his employees will be payable, so long as there is no element of fraud.

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A fire lighted for a definite purpose and confined to its proper place limits, e.g. for cooking,

heating or manufacturing purposes is not a fire within the meaning of the policy. An

interesting English case clarifies this. Sugar, which was undergoing refining process

through the application of heat, was damaged due to excessive heating caused by the

negligence of an employee. The Judge said: There was no more fire than always exist

when the manufacturer is going on. Nothing was consumed by fire the sugars were

chiefly damaged by the heat; and what produced that heat? Not any fire against which the

company insures but the fire for heating the pans which continued to burn all the

time. Fire here is a regular work not accidental.

If the fire had broken its limits and caused ignition to take a place outside the pans, grate or

furnace, then the loss would be within the policy. To clarify this position beyond doubt a

condition is inserted in the policy [condition 5(i) (b)]. This is fire in improper place.

Another interesting English case (Harris vs. Poland 1941) throws light on the subject.

Fearing possible burglary a lady hid her jewellery for safety in an unlighted grate. The next

morning, the fire was lighted by mistake and the jewellery was damaged by fire. The

insurers repudiated liability. But the judge held them liable saying that it made no

difference whether the fire came to the insured property or the insured property came to the

fire.

Thus, in either case, where the fire breaks its limits or causes ignition of property or the

property breaks out of its proper limits and comes into contact with fire, there is accidental

loss by fire.

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The position may be summarized thus: (a) there should be actual ignition, (b) of property

which ought not to have been on fire, (c) under accidental circumstances, so far as the

insured is concerned it is fire.

Once there is fire within the meaning of the policy, then various other types of losses come

within the scope of the policy.

Examples are: -

(a) Damage during or immediately following a fire caused by: (i) smoke and heat; (ii)

scorching, (iii) falling walls.

(b) Damage caused by the fire brigades in the discharge of their duties e.g. (i) damage

caused by water or other extinguishers, e.g. chemicals, foam, etc., (ii) damage caused by

blowing up the property to prevent spreading of fire.

( c) Damage to property removed from a burning building caused by exposure to weather,

provided the removal was made in an endeavour to mitigate the loss.

6.7.1 Fire resulting from Explosion

The insurance does not cover any loss or damage occasioned by or through or in

consequence of explosion except as stated on the face of the policy, but it covers certain

types of explosion

Explosion. It is first necessary to understand the precise meaning of explosion and the

types of loss that follow explosion. A dictionary defines explosion as a sudden violent

burst with a loud report. Harriss Technological Dictionary of insurance Chemistry

defines explosion as anything, which causes a sudden increase in pressure in the

surrounding air, or gases, from sudden violent burst with a loud report. Harriss

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Technological Dictionary of insurance Chemistry pressure in the surrounding air, or gases,

from sudden and violent expansions of any substance in their neighbourhood. It is bursting

with a loud discharge.

Excluded.

(a) Damage caused by explosion is usually due to conclusion a blow. Concussion

damage

is to be excluded.

(b) According to the doctrine of proximate cause all damage proximately caused by

explosion is outside the purview of the policy.

(c) But insurers are prepared to include all fire damage resulting from explosion.

Explosion Included. Loss or damage (Both fire and concussion) caused by the explosion of

a boiler is covered provided the boiler is used for domestic purposes. The word domestic

is important. Two English cases provide guidance in the interpretation of the word

domestic.

(i) In smith vs. Muller, it was held that a boiler used for supplying hot water for

cleaning and heating the office operation of business premises was held to be

domestic.

(ii) In metropolitan Water Board vs. a very, it was held that if the water is used for

a purpose which is common to all domestic establishment, it is none the less

used for domestic purposes.

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Applying these tests, it is clear that what is important is the use made of the boiler and not

user thereof. Thus, explosion of a boiler in a canteen in a factory would be within the

scope of the policy.

6.7.2 Explosion of Gas.

Uses- for domestic purposes only, or lighting or heating a building not forming part of any

gas works.

Gas may be used for cooking purposes or for lighting or heating. These are domestic

purposes. But cover is not restricted only to explode the loss will be payable. However,

explosion of gas in a gas works causing damage to insured property is not covered.

Secondly, gas explosion must be in a building. Therefore, damage caused by an explosion

of gas in street is not covered.

Lighting. This peril is included so that all damage so caused, whether fire results or not, is

covered. In the absence of a specific mention damage by lighting involving no ignition

would be excluded.

Exclusions (nature of loss). Condition 5 of the policy excludes certain type of losses.

Condition 6 excludes certain n perils and conditions 7 certain types of property from the

scope of cover.

Condition 5 reads as follows:

This insurance does not cover:

Loss or damage to property occasioned by its own fermentation, natural heating or

spontaneous combustion or by its undergoing any heating or drying process;

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Loss or damage occasioned by or through or in consequence of

The burning of property by order of any public authority.

6.7.3 Subterranean Fire.

Loss or damage directly or indirectly caused by or arising from or in consequence of or

contributed to by nuclear weapons material.

Loss of or damage to any electrical machine, apparatus, fixture or fitting.

Loss by theft of insured property during or after the occurrence of a fire is excluded. This

exclusion is necessary to avoid doubt in the application of the legal doctrine of proximate

cause. If goods were stolen from burning premises there would be no liability under a fire

policy. The proximate cause of loss will be theft and fire the remote cause. Goods stolen

while removing them to a safe place is covered. This comes under loss covered by action

of mitigating damage. Other cases are damage by fire brigade.

Loss by fermentation, natural heating, and spontaneous combustion, heating or drying

process is regarded as an inevitable, natural loss. In many instances no actual ignition

would be involved. Most of these losses generally result from carelessness or defective

storage and the object of the exclusion is to penalize the insurer for his lack of care. It

applies to a particular property only.

An example will make this clear. If one haystack were to ignite through spontaneous

combustion and the fire spreads by natural causes to other haystacks, the exclusion would

apply to the first haystack only, subsequent losses being payable.

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Loss or damage to property occasioned by its under-going any heating or drying process is

excluded.

Spontaneous combustion may be covered on payment of extra premium.

Loss by burning under orders of public authority would occur when, for example, the

appropriate authority orders intentional destruction of property for sanitary reasons.

The term subterranean fire has not been satisfactorily defined. Literally, it means fire

occurring below the surface of the heated materials accumulated underground or to

artificial heat igniting a coal-bearing stratum.

Exclusion (d) refers to nuclear hazards. Exclusion (e) excludes loss or damage to

electrical machine, fixtures, fittings, etc, or to any portion of the electrical installation

caused by electrical risks such as short-circuiting, self-heating, over running, or whatever

cause including lighting. However, this exclusion applies only to the particular electrical

machine, etc. or portion of the electrical installation which is affected by any of the

electrical risk. Loss or damage to other machines, apparatus, fixtures, etc, is payable

provided it is damaged or destroyed by fire as a result of electrical risks.

Exclusions (Nature of Property). Thus natural perils like earthquake, cyclone, etc. and

social perils like riot and political perils like war, etc. are excluded from the scope of

the policy.

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Riot has been defined by the Indian Penal Code as follows: Whenever force or violence

is used by an unlawful assembly or by any member thereof in prosecution of the common

object of such assembly every member of such assembly is guilty of the offence of rioting.

6.7.4 Consequences of Excluded period

Two important features must be noted. Loss or damage directly or indirectly, proximately

or remotely caused by the excluded perils is outside the scope of the policy. The words

used establish that even loss or damage indirectly or remotely caused is excluded.

Secondly, the onus of proof that the loss is not caused by the excluded perils is placed upon

the insured.

In regard to (a) the proof of insurable interest is a must. It is to be established whether the

insured is legally liable for loss in trust or on commission. In practice, however, the fire

policies are worded to include cover in respect of these goods. The words for which the

insured is responsible are also inserted to make it clear that cover operates only where

there is clear insurable interest.

The expression goods held in trust extends to include all goods, which are in the

possession of the insured as bailee. The expression goods held on commission is used to

refer to goods, which are held by the insured as bailee for the purpose of sale.

There is an interesting case law on the insurance of goods held in trust or on commission.

There is an interesting agent, contracted to transport some bales of cloth and yarn from

Bombay to Shrivardha. Owing to certain circumstances, 181 bales out of these bales could

not be transported and had to be stored in a go down at Khondpole. Quazi Ali took out a

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policy of fire insurance from 26-11-1995. In February 1996 the goods were destroyed by

fire.

While observing that the words the property of the insured in such policies covered not

only goods belonging to the insured but also goods in respect of which he had a lien or a

charge for services rendered or for expenses incurred.

It followed from the above that the words held by him in trust or on commission

themselves cover both the lien of the insured as well as his liability to the extent of the lien

of the assured on those goods as well as to the whole extent of his legal liability to the true

owner of the goods.

Classes of property in bullion and valuable stones are of high value in small bulk; these

will present difficulties in assessment of loss, so excluded.

Cover is available as an extension for certain classes of property. Claims for documents,

manuscript and business books are settled on the basis of the value of the materials as

stationery together with the cost of clerical labor necessarily incurred in their production.

Losses on patterns, models, moulds, etc. are settled on the basis of the cost of labor and

material necessary for their reproduction, subject to the sum insured on each item.

6.8 SUMMARY
1. drafter is concerned. It is very much vital to the insured and the insurer and test

of its accuracy is the intention of the parties to the contract would come up only

when a loss is reported. The schedule indicates the following:

Insured and his address

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 Policy no. Issued in lieu of cover note

Place of issue and date of issue

Period of insurance

Total sum insured

Risk covered and the premium thereof

Total premium

Agency

Description of the property to be insured

Attestation

2. Policy condition. The standard fire policy form is prescribed by the tariff. The

conditions regulate the fire policy contract. If a policy does not contain these

conditions then it would be subject to implied conditions only. The implied

conditions are utmost good faith, insurable interest and indemnity. That means

policy is subject to both implied conditions and express conditions. We shall

deal with express conditions below. Conditions are printed on the standard fire

policy itself. There are twenty printed conditions present in a standard Fire

Policy.

They are enlisted in serial number of the standard policy:

Misdescription

Payment of premium

Other Insurance

Fall/displacement,

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 Excluded losses.

Excluded Perils

Alteration

Excluded perils

Marine Clause

Cancellation

Claims procedure

Right of entry

Fraud/Arson

Re-instatement

Subrogation

Contribution

Average

Arbitration

Limitation

Notice clause

The attention should be paid towards these conditions particularly by the policy drafter.

Good draft needs a mastering of conditions.

Misdescription (Condition 1). The result of misrepresentation is serious. The insurer has

no liability or his liability ends if he proves misrepresentation by insured.

Misrepresentation may be regarding property insured or material misdescription of

property.

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This emphasizes the duty of utmost good faith; in parties cover the exact property.

Therefore accuracy in translation of the property to be insured is of supreme importance.

The policy drafter should take particular care in avoiding terms, which are capable of being

interpreted wider than it was originally intended. Terms must be specific and have one

meaning.

Premium payment (Condition 2). No payment in respect of premium shall be deemed

unless a printed form of receipt for about the proof of premium payment (1) premium be

paid, (2) form of printed receipt be obtained (3) it should be signed by an official or agent

of the company. Unless premium is paid in advance no risk is covered. We have already

seen the calculation. It should be accurate. All sum insured at the same rate should be

grouped together. The rate of total sum should be the rate.

Other Insurances (Condition 3). The insured shall give notice to the company of any

insurance or insurances affected, or which may be subsequently be affected. The purpose

is to know about other insurances on the same subject matter. Because of applying

principles of contribution. Other insurances are declared while replying on the extent of

loss.

Collapse of Building (condition 4). This condition provides for automatic cancellation of

cover in the event of collapse of the building or of any important part of the building if it

goes to change the risk (original risk). The fall or displacement may subject the building or

its contents to an increased risk of fire. The cover is not cancelled if the collapse is caused

by fire. The responsibility to prove falls on the insured. Excluded losses, excluded losses,

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excluded perils and excluded properties are dealt in condition 5,6,and 7. We discuss the

conditions as a recapitulation as these have been already discussed earlier.

Excluded losses (condition 5). It deals with the excluded losses which ca be excluded from

standard fire policy. They are:

(a) Loss of theft during after occurrence of fire

(b) Loss of damage to property occasioned by its own fermentation, natural

heating or spontaneous combustion or by its under-going any heating or

drying process.

(c) Loss by burning of Public Authority or subterranean fire

(d) Loss or damage caused by Nuclear Weapons material.

(e) Loss or damage caused to any Electric Machine/Apparatus/ Fixture or

fitting arising or occasioned by over running, excessive pressure, short

circuiting or arcing, or self heating or whatever cause including lighting

and this applies only to the machine so destroyed but spread of fire will

fall under the standard fire policy.

(f) Damage caused by ionizing radiations or contamination of radio

activitive materials from any nuclear fuel or any self-sustaining process

of nuclear fission.

Excluded Perils (condition 6). It excludes fire damage caused by perils listed. They are:

(a) Earthquake, Volcanic eruption or convulsions of nature

(b) Typhoon, hurricane, tornado, cyclone atmospheric disturbance.

(c) War and civil war

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 (d) Mutiny, riot, military or other social perils

(e) Explosion except as given in the preamble

(f) Bush fire, praire, pampas or jungle fire.

Excluded articles Property (Condition 7). It deals with the articles, which are normally

excluded from the scope of the standard fire policy. These will have to be specially

included in the policy whilst drafting if the intention is to cover these articles also. They

are:

i. Goods held in truest or on commission

ii. Any curiosity or work of Art not exceeding an amount of Rs. 1,000.

iii. Bullion or precious stores

iv. Manuscripts, plans, drawings designs or models or Moulds

v. Securities, documents of any kind of stamps. Coins or paper money, chequebooks

or other business books, computer system records.

vi. Explosives

Termination of Liability Alteration (Condition 8). It deals with alteration in the risk

originally proposed. Should there be any change it will have to be recorded by the insurer

and unless this is done no liability attaches on the insurer. These are as follows:

If trade or process or nature of occupation or other circumstances affecting the building

insured or containing the insured property be changed in such a way as to increase the risk

of loss or damage by fire.

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If the building insured or containing insured property becomes unoccupied or so remains

for a period more than 30 days.

If the property insured be removed to any building or place other than that which it is

herein stated to be insured. If the interest in the property insured passes from the insurers

otherwise than by will or operation of law. The insurers liability will not end if the

following conditions are fulfilled: (a) the change was notified to insurer, (b) change was

endorsed in policy, (c) if the insured dies the policy is automatically transferred to his legal

heirs. Another point is to determine the increase in risk. It depends upon circumstances

and the insurers giving proof. Change of interest does not affect a banks interest.

It provides for stoppage of cover in case of material alteration in subject matter. No notice

was given and no acceptance insurer was got for these changes.

Marine Clause (Condition 9). The intention behind this condition is that fire policy would

not pay earlier than the Marine policy should the subject matter of insurance be covered

under a Marine Policy. If one property is insured under marine and fire policies than the

payment of compensation will be from marine first and any balance left of the loss will be

met by the fire policy.

Cancellation (condition 10). This condition provides for the cancellation of the policy by

either party (insurer or insured) by giving notice to the other party. If insurer cancels the

policy the insured may claim pro-rata refund of premium. If insured cancelled the policy

the refund of premium is made according to the short period scale.

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Example: Annual Premium ksh. 240.00

Insurance Period 1st January 1979 to 1st January 1980

Date of cancellation 1 April 1979

Pro-rata Refund ofksh.240 i.e. 180

Short period Premium for 3 months at 40% of the Annual Premium =ksh96: Refund (ksh

240 96) =ksh144.

Procedure of claim (condition 11). The insured must give (a) immediate notice of loss

(b) Written statement of particulars of property lost or damaged, and (c) proof of loss, at his

expense.

Rights of Insurer on Loss or Damage (condition 12). In the event of loss the insurer has the

following rights: (a) to enter the insured premises, (b) to take possession of the insured

property (c) salvage the insured property, and (d) sell the property on behalf of concerned

parties. The insured cannot abandon his property to insurer.

Fraudulent Claims (condition 13). If the claim put forward is fraudulent or the loss is

willfully caused by the insured the benefits are forfeited. The circumstances (i) the claim is

fraudulent (ii) the claim is based on a false declaration (iii) use of fraudulent means to

claim (iv) willful damage are fraudulent.

Insurers Opinion of Reinstatement of loss (Condition 14). The insurer may pay

compensation in cash or reinstate the insured. The expenses are to be limited to the cost of

reinstating to the condition just before damage putting insured in the position prior to loss.

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Insurers right to obtain insureds assistance against third party (Condition 15). Insurer

must be assisted with information and proof available to insured to precede against the

third party. This arises when third party is liable for the damage under law.

Payment of pro-rata share of loss (Condition 16). This condition deals with multiple

insurance on the same subject mater. Suppose a person insured the same subject matter

with more than one insurer, then each insurer will pay only a rateable proportion of the

loss; e.g. one subject matter building is insured for ksh 40,000 with A, and for ksh60, 000

with B. There is a loss of ksh.20, 000.

A pays 40,000/100,000 x 20, 000 = ksh8, 000

B pays 60,000/100,000 x 20,000 = ksh12, 000

It is arrived at by finding the proportion the sum insured bears to the aggregate insured sum

and applying that to the amount of loss.

Under insurance (condition 17). If the sum insured is valued at a lower price than the

property on the date of loss, then the insurer will pay in the same proportion the insured

sum bears to the value of property. The insured is penalized for under insurance. As for

example, let us assume that value of property on the date of loss is ksh 75, 000 and the

actual loss is valued at ksh .30,000 and the insured value was ksh .50,000. What will be

loss payable?

Sum insured/Value of property x loss or 50,000/75,000 x 30,000 = ksh.20, 000

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Arbitration (condition 18). In case of a dispute under the policy on the amount of claim,

the condition provides to refer to the dispute to arbitrator to be appointed by both the

parties. But whether claim is insured or not has to be decided by the court of law.

Limitation on right of claim (Condition 19). The insured forfeits his claim if he does not

take the claim to court within 12 months from the date of refusal by the insurer. Notice and

communications (condition 20). All notices and communications to the insurers are to be

in writing only. A breach of these conditions mentioned above has different effect under

different conditions.

Condition 1. Insurer is not liable only in respect of property affected by material miss-

representation.

Condition 4 and 8 policy ceases when certain events occur. It relates to building or any

part thereof, property contained in any subject matter. Under condition 13 due to fraudulent

claim all benefits are forfeited.

6.9 Miscellaneous legal features

Burden of Proof. When the loss is caused by an insured peril e.g. Fire, the onus of proving

that the loss was so caused is upon the insured. He is not expected to further prove that the

cause of loss does not fall within any exception.

According to generally recognized rule, the onus of proof is on the insurers that the loss

was caused by an excepted peril. However, this onus of proof may be shifted back to the

insured by policy conditions. For example condition 6 (Excluded Perils) of the standard

Fire Policy provides, inter alia, as follows:

Any loss or damage happening during the existence of abnormal conditions (whether

physical or otherwise), of any of the said occurrence or in consequence, directly or

105
indirectly, of any of the said occurrences shall be deemed to be loss or damage which is not

covered by the insurance, except to the extent that the insured shall prove that such loss or

damage happened independently or the existence of such abnormal conditions.

In any action, suit or other proceeding, where the company alleges that by reason of the

provision of this condition any loss or damage is not covered by this insurance, the burden

of proving that such loss or damage is covered shall be upon the insured.

The onus of proving that the excepted peril was in operation at the time of fire is on the

insurers. But once the insurers prove this, the onus shifts to the insured who has to prove

that the loss was not caused by the excepted peril or that it arose independently of the

operation of the excepted perils.

The reference to abnormal conditions is to be constructed as reference only to the

abnormal conditions previously referred to in the condition e.g. Earthquake, cyclone, riot

etc. Where a breach of condition is alleged, the onus of proving it is on the insurers.

Waiver. Waiver defined as the voluntary relinquishment of a known right. It may arise

when a person knowing of a right, which has accrued to him, fails to take advantage of the

right within a reasonable time.

6.10 Activity

(i) what are the qualities of a good draft.

(ii) Explain the meaning a different types of the peril fire.
(iii) What is a schedule and what does it indicate?

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6.11Questions

1. State the laws that govern fire insurance management.

2. Explain the meaning of the following as used in fire insurance.

(a) Insured peril.

(b) Indemnity.

(c) Expected period.

(d) Fire.

(e) Extent of protection.

(f) Inspection report.

3. Describe the structure of a standard fire policy and its conditions.

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 LESSON 7

MARINE INSURANCE
7.0 Introduction
This lesson covers marine insurance and the characteristics of marine insurance contract. It
explains the general principles that govern the insurance policy.

7.1 Objectives

At the end of this lesson, the learner should be able to:

(i) Explain the concept of maritime interest.
(ii) Discuss the terms used and features of a marine insurance contract.

7.2 MARINE UNDERWRITING

A contract of Marine insurance is a contract whereby the insurer undertakes to indemnify

the assured, in a manner and to the extent thereby agreed, against marine losses. That is to

say, the losses incidental to marine adventure. It is a contract of indemnity. In fire the

indemnity is limited to actual loss, in marine insurance it is ordinary based on values

agreed upon in advance. The value may be more or less than the risk.

The risks are marinetime perils on insurable property. While afloat. But modern cover

extends up to inland waters or on land in conjunction with the sea voyage.

7.2.1 Maritime Interest

There are three principal interests in the usual marinetime venture: hull, cargo, and freight.

Ship is the hull including its equipments. The cargo interest is represented by cargo

carried; and the freight interest, by the earnings of the ship. Since fortuitous events event

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may cause loss to any of these interests, they are insurable interests. The relations of

persons or organizations to these basic interests are varied according to circumstances.

A ship may carry only cargo belonging to owner of the ship (he has three interests: hull,

cargo and freight). The owner may charter a ship, who has mortgaged the ship, to an

operator, who carried cargo belonging to others, who financed it through a bank. Each of

the parties has an insurable interest here. (Chatterer, Operator, Financier and cargo owner).

7.2.2 Special Characteristics of Marine Insurance Contract

There are three outstanding characteristics of the application of Marine Contract. First, it is

a contract uberrimaefide, of utmost good faith. Second, it is more strictly interpreted.

Third much is read into the contract by implications, both specific requirements of

stipulations and conformity to accepted business practice. However marine insurance has

the following essential features or fundamental principles:

Feature of general contract, insurable interest, utmost good faith, doctrine of Indemnity,

subrogation, warranties, proximate cause, assignment and nomination of the policy, return

of premium, non-deviation in voyage.

7.3 FEATURES OF GENERAL CONTRACT.

It comprises proposal, acceptance, considerations and issue of policy. Broker prepares the

slip after getting ship owners instructions, merchant or other proposers. The original slip

is presented to a Lloyds underwriters who initial the slip and it is accepted. The premium

is determined on assessment of the proposal. The premium is the consideration. The

broker then sends the cover note with the terms and conditions of insurance.

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7.3.1 Insurable interest

The subject matter of insurance may be sold or transferred during period of insurance. So

the insurable interest of the person must be present at the time of happening of the loss.

The subject matter changes hand from time to time during insurance. So the policy is

easily assignable. There are two exceptions:

Lost or not lost: there is no bar to purchase insurance even one does not know about the

existence of the subject matter. There is complete reliance on mutual good faith of parties.

If one of the parties knows about the subject matter and does not disclose then the contract

is void.

PPI policy: Insurance policy itself is the insurable interest in such a policy. (Policy Proof

of Interest). If loss takes place the insurer will not verify the insurable interest of the

holder. These are not legally enforceable though insurers keep their promises. Persons

having insurable interest are: (a) ship of ship-owner, (b) cargo-cargo owner, and price of

cargo plus freight; (c) Freight receiver-of freight; (d) Reinsurer for his insurance, Insurer

may reinsure, (e) Other cases-liability in respect of salaries (master and crew), (f) Lender of

money on battomry or respondentia in respect of loan. In case of cargo the insurable

interest is in the shipper or the consignee. This depends upon the terms of sale.

F.O.B (Free on board

F.O.B factory the buyer assumes responsibility when the goods leave the factory.

F.O.B railroad the buyer assumes responsibility after the goods have been placed on

railroad car.

F.O.B vessel the buyer assumes responsibility after the goods have been placed on

board the vessel.

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2. F.A.S (free along side) the buyer assumes responsibility after the goods have been

delivered at the steamer ready for loading.

3. C & F (Cost and Freight) at.. price is for the goods unloaded from steamer at

destination, but the buyer assumes responsibility for all insurance.

4. C.I.F. (Cost, Insurance and freight) the buyer assumes complete responsibility for

security for securing all necessary insurance.

3. Uberrimae fidei utmost good faith. This is a general characteristic of all insurance

contracts. It has some special importance in marine insurance. The insurer relies more on

insureds information and contact than in case of any other. He is dependent upon

cooperation of the incurred. The insurer has also some liability i.e., he cannot urge upon

proposer to effect an illegal insurance. Duty of discloser of material facts falls on the

insured and the broker. There are certain exceptions: good faith (disclosure) does not apply

to

(A)(i) Facts of common knowledge

(ii) Facts ought to be known to insurer

(iii) Facts not required by insurer;

(iv) Facts which insurer can infer,

(v) Facts of public knowledge

4. Doctrine of indemnity. Insurance compensates loss, but allows no profit out of it.
The money value of subject matter lost is determined. This can be the insured or
insurable value. If it is determined at the time of taking policy it is called Insured
value. In case of loss the payment is made in the proportion the sum assured bears
to insured value. Insured value includes cost of transportation and anticipated
profit. It is agreed upon earlier. Loss is determined at the time of happening only.
If the insurable value becomes higher than the sum for which it is insured then the
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 insured is treated as his own insurer for the difference or excess. On the underhand,
if the insurable value is lower than insured sum the underwriter would be liable for
a return of premium of the difference.

Exceptions. The following exceptions are found in principle applied to marine insurance.

Profit allowed. A certain margin of profit on subject matter insured is allowed to insured.

Insured value. Indemnity is based on insurable value but in marine insurance insured

value is paid which may be higher than insurable value of subject matter.

7.3.2 Doctrine of Subrogation. This is a right of insurer to all remedies, rights and

liabilities of the insured after payment of compensation. Insurer may reduce the sum

payable to insured by the amount insured receives from the third party as compensation.

Insurer gets all the insureds right against the third party but cannot sue in his own name

against third party. If insured gives up his right to claim from third party the insured is

liable to repay the amount he forgoes to the insurer.

Warranties. A warranty is that by which the assured undertakes that some particular thing

shall or shall not be done. That certain conditions shall be fulfilled. That assured affirms

or negatives the existence of certain state of facts. Warranty is strictly enforced because a

breach of warranty ends a contract. There are two classes of warranties.

(a) Express warranties;

(b) (b) Implied warranties.

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Express warranties are expressly mentioned in the contract of policy. Implied warranties

are not mentioned in the contract at all. But non-compliance with any one of them is fatal

to the contract.

There are two implied warranties: (i) in every voyage policy that the vessel shall be sea

worthy, when the risk commences. (ii) That there will be no deviation from the agreed

course of voyage.

Sea Worthiness. Sea worthiness means reasonable fitness ( in all respects) to survive the

normal course of its proposed use. It includes proper construction, (2) good repair, (3)

adequate equipments, (4) proper manning (5) furnishing, (6) provisioning and (7) proper

stowing of cargo and not too heavy to cause danger to ship. It relates to start of the voyage.

It is applicable to hull, cargo, freight, or other insurance. It is not applicable to hull insured

under time policy. Unless owner charters a ship it is waived by express term in cargo

policy. If voyage has several stages the ship must be sea worthy at the beginning of every

stage.

Legality. The conduct of the venture and its purpose must be legal under the laws of the

country of insurance and international laws. Smuggling or importing prohibited goods are

illegal. Violation of laws of foreign countries does constitute breach of warranty. This

cannot be waived under any conditions.

Non-deviation. Ship should not deviate from direct. Normal routes. If the ship deviates

from normal route without legal reason the insurer is free from responsibility. Deviation is

allowed in the following circumstances. (a) Deviation or delay allowed under a warranty,

(b) when it is beyond the control of master or crew, (c) when it is done for safety, (d) when

it is due to barratry.

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7. Proximate cause. The insurer is liable for any loss proximately caused by insured peril.

So insurer is not liable,

(i) For any loss due to willful misconduct of the insured, loss

due to delay

(ii) For loss, which is, normal and due to natural wear and tear.

Causa proxima is the cause proximate in efficiency, and not necessarily the cause nearest in

time. The cause which is truly proximate is that which is approximate in efficiency. (Land

shore and shipping Co Norwich Union Fire insurance Soc.)

8. Assignment. It may be assigned either before or after loss. It is done by

endorsement or other traditional manner.

7.4 Meaning and object of Marine Insurance and Terms used

Marine insurance is closely related to Import and Export trade over seas. It provides

protection for loss or damage to property in the course of shipment.

The marine Insurance Act 1963 defines Marine Insurance as a contract between insurer and

insured. The insurer as per the agreement undertakes to identify the insured in as agreed

manner and to the interest, against marine losses incident to marine adventure. The

insured has to pay a certain sum of money as premium in consideration of insurers

guarantee against sea perils

(Sea perils are an event, which causes personal/property loss at the time of shipment

through seas). The contract is incorporated in a document. This document is called as

marine policy. The insurer in this contract is also known as the Underwriter.

The term Maritime adventure includes:

(a) Any insurable property exposed to maritime perils

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 (b) The earnings or any freight, passage, money, commission of other financial

benefit, loans etc, are endangered by exposure of property to marine perils, (c)

any liability to a third party may be incurred by the owner of, or other person

interested in or responsible for insurable property by reason of maritime

perils.

Maritime perils refer to the perils consequent on or incidental to the navigation of the sea,

that is to say, perils of seas, fire, war perils, rivers, thieves and other perils of same kind.

According to Section 2(13) A of the Marine Insurance Act 1938, Marine insurance

business means the business of effecting contracts of insurance upon vessels of any

description including cargoes, freights and other interests which may be legally insured for

any transit by land or water or both.

7.5 Subject matter of Marine insurance

On the basis of subject matter of property we can divide marine insurance into Hull

insurance, cargo insurance and freight insurance.

(i) Hull Insurance

Hull refers to the frame or body of the ship or vessel and its machinery. As the

ship/vessel/hull moves from one part to another and it may be subject to marine perils,

hence insurance is affected against the risks. There are a number of classifications of

vessels. As for example, steamers, sailing vessels etc. It is generally issued for 12 months.

Hull policies are also issued to cover vessels in course of construction.

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(ii) Cargo insurance

Cargo means the goods or merchandise commodities carried in a ship in the course of

shipment. When the goods or cargo transported from the port of departure to the port of

destination, forms the subject matter of insurance, it is called as Cargo Insurance. This

policy may be arranged for the duration of a voyage or as time policies or open policies or

on other basis.

Freight Insurance. Freight means payment received for the transportation of goods. The

freight receiver to protect freight purchases the freight insurance policy. Generally the ship

owner and the freight receiver a re one and same person. Freight may be paid in two ways.

Such as it may either be paid in advance or on the arrival of goods at the port of

destination. In the first case there will be no problem for the freight receiver. But if freight

is to be paid on the port of destination, then as per the marine perils, the freight receiver

loses freight. Freight Insurance, therefore, is a device to protect against such loss of

freight.

Most marine countries have set up marine insurance facilities. But the nature, extent and

capacity of insurance varies from one country to another. The major international markets

exist in United Kingdom. Till to day it is considered to be having stronghold in Marine

Insurance Market.

The London Market is predominantly made up of the Lloyds the Principal British

insurance companies, the agencies and branches of some overseas companies and mutual

associations.

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7.6 The Lloyd Organization
The organization of Lloyds is a corporation. Lloyds provides all facilities enabling its

members to transact on their own account insurance business of all kinds. This

organization is governed by a committee consisting of 16 members. Out of these 16

members in each year 4 of them retire on rotation basis. The membership comprises both

underwriting and non-underwriting members. The insurance brokers are chosen as

underwriting members. The insurance brokers are chosen as underwriting members.

7.7 Activity

(i) What are the special characteristics of marine insurance contract?

(ii) What is the Lloyd organization?

(iii) Explain the meaning of;

(a) Hull insurance.

(b) Cargo insurance.

(c) Freight insurance

As used in marine insurance.

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7.8 Questions

1. What is maritime interest?

2. Explain the meaning of the following as used in the marine insurance.

(a) F.O.B. factory.

(b) F..B.O vessel

(c) F.A.S

(d) C.I.F

(e) Uberrimae Fidei.

3. What are the basic principles in fire underwriting?

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 LESSON 8

MOTOR INSURANCE

8.0 Introduction

This lesson is going to cover motor insurance, where different forms of motor insurance
policies are discussed. The principles that govern this insurance are also extensively
covered, including the policies that fall under this insurance.

8.1 Objectives

By the end of this lesson the learner should be able to

(i) Give a brief history of motor insurance.

(ii) Explain the different policies that can be taken under motor insurance.

8.2 Introduction

Motor insurance belongs to miscellaneous class of Insurance. But the business is so big

that insurance companies have to maintain a separate department. This is a tariff class of

business. So the cover, premium rates and policy forms are all standardized or uniform.

Every one who owns an automobile assumes certain risks. Because the property is exposed

to damage and law imposes upon owners some responsibility towards the public. Those

who drive cars are more responsible to public. The risks are of two types:-

Legal liability for damages for bodily injuries or damage to property caused to other.

Damage to or loss of ones own automobile. Everyone who owns an automobile assumes a

risk because the property is subject to damage and the law imposes upon owners
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responsibility to public. In the absence of any law also the owner or driver of an

automobile is required to use reasonable care with respect to such vehicle to safeguard

public from injury.

8.3 History of Motor Insurance

Motor insurance was first started in U.K the first car appeared in 1894 and the first policy

was issued in 1895. It covered liabilities to third party. In 1899 accidental damage to car

and in 1901 burglary and fire were added. Thus the progress made is found in

comprehensive policy of to day.

In 1903 the car and general insurance corporation limited was started and many others

followed. The victims could not get compensation so the third party insurance was made

compulsory (The Road Traffic Acts 1930 and 1934-1936).

8.4 Basic Principles

The basic principles applicable to motor insurance are the same as they are in property and

liability insurance. But the application of these principles to automobile insurance is

accepted as a specialized problem requiring a special contract. However, we recall the

principles below in brief.

8.4.1 Utmost good faith

The doctrine imposes a legal responsibility on the proposer to disclose material facts to the

insurer. The proposal form is compulsory. The declaration clause given there makes the

proposers responsibility a contractual duty of utmost good faith. The answers to questions

in form given by proposer become warranties or promises. So the answers must be true to

the language and must be correct. Any incorrect answer on any matter will make the
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contract voidable. Examples are the type of vehicle, the geographical area of use, the

physical health of driver, the driving history, traffic convictions, and past loss experience.

Many of these provisions are now regulated by Motor vehicle Act 1939.

8.4.2 Insurable Interest

This is the legal right to insure. The essentials are:

1. Existence of property exposed to damage or liability;

That must be subject matter of insurance;

1. The insured must be in such a position that he shall suffer by loss or damage or

benefit by the safety of the property. The parties who are expected to have

insurable interest are:

(a) Insured. He as owner of vehicle suffers a loss if car is damaged or

from a legal liability to third party who suffers a loss for his

negligence.

(b) Other than insured. the driver or person who drive may create a

liability for insured. In effect the insured becomes the agent for

these persons and insured indemnifies them.

(c) Financier. In hire purchase agreement the financiers interest is

insurable. In case of loss or damage the owner shall get

compensation (Owner is financier).

(d) Motor Trader. The garage proprietors as bailees have insurable

interest for customers loss or damage.

8.4.3 Indemnity

It means, the insured is placed after a loss, as far as possible, in the position as he was

before the loss. It ensures no profit to insured out of loss. So the insurer pays the actual

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value of loss or sum insured whichever is less in case of total loss to insured. If old parts

are replaced by new a suitable depreciation is charged on new parts. Insurer may repair or

replace or pay cash as it likes. Liability to third party, is limited to policy sum. Legal costs

are also indemnified. Indemnity is payment of actual loss.

8.4.4 Subrogation and contribution

Subrogation is transfer of right to insured to insurer. It arises only when the third party is

responsible for damage. Insurers may exercise the insureds right to cover damage.

Generally the right arises after payment of damage. But policy may contain transfer before

payment (knock and knock agreement). Contribution refers to sharing of damage between

co-insurers. It is done in the proportion the insurers share bears to total sum of all

insurers.

8.4.5 Proximate cause

The insurers shall pay damage only if loss is caused by a peril most proximate or the

nearest to damage and if tit is insured against. It is applicable to third party claims also.

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8.5 Types of motor vehicles

Three classifications are found in Act as follows;

Motor Vehicle

Private Cars Motor Cycles Commercial vehicles

1. Social, domestic & 1. Motor cycles 1. Goods carrying (private

pleasure purposes. with/without side
2. Professional or cars.
business purposes 2. Auto cycles or
by insured or his mechanically
employee. pedaled cycle.
3. Motor scooters
4. Three wheelers, in
valid carriage.
carriers permit).
2. Goods carrying (Public
carriers permit).
3. Trailers without means of
self-copropulsion.
4. Passenger carriers buses,
hotel omni buses, airline
buses
5. Passenger carrying vehicles
hire miscellaneous special
type.

8.5.1 Types of Policies

1. Act only policy

This provides the minimum cover for legal liability for injuries to third parties or
their property damage.

2. Third Party policy.

This provides all covers of Act only and allowed higher limits for third party
property damage.
3. Comprehensive Policy
After providing for damages as contained in above policies it also covers loss of or
damages to the vehicle. Two other different covers are available for private cars.
4. Fire and/half theft.
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 This covers the risks of fire and/or theft to car while in garage and out of use.
5. Third party and fire and/or theft risk.
This policy covers risks covered by Act only and third party policies and in addition
covers risks of fire and /or theft whilst the vehicle is running and /or in garage.

8.5.2 Classification of vehicles

The vehicles are generally divided in the following four categories for the purpose of
insurance.
(a) Private cars
(b) Commercial vehicles

It refers to any type of mechanically driven vehicle used for business or trade purposes

(i) Commercial passenger vehicle

(ii) Commercial goods vehicle or traders.

Motor Vehicles

Classification is necessary for fixing the rates of premium. For that vehicles are further

classified on the basis of their use or work. The Tariff defines and describes the vehicles in

the following ways: -

(a) Private Cars

Vehicles used solely for social, domestic and pleasure purposes.

Cars of private type (including station wagon) used for social, domestic and pleasure

purposes and for the business or professional purposes of the insured or insureds

employees.

Three wheeled cars (including cabin scooters) used for private purposes

(b) Motor Cycles

This class includes the following different types of vehicles:-

- Motor cycle with or without side car

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 - Auto cycles or mechanically assisted pedal cycles

- Motor scooters with or without side car

- Three wheeler invalid carrier

(a) (i) Commercial vehicles Owners goods. Vehicle carrying goods of the owner or

insured. These vehicles are used under a private carriers permit. The motor

vehicles act, 1939 defines a private carrier as an owner of a transport vehicle other

than a public carrier as an owner of a transport vehicle other than a public carrier

who uses the vehicles solely for the carriage of goods which area his property or the

carriage of which is necessary for the purpose of his business not being a business

of providing transport.

8.5.3 The following characteristics make a vehicle private commercial vehicle: -

1. It is owned by the insured

2. It is run under a private carriers permit

3. it is not a public carrier i.e. carries owners goods only for his business purpose

only.

4. It does not run for transporting goods for other than the owner.

(ii) Commercial Vehicles General Carriage.

These vehicles are used under public carriers permit. The Act defines a public carrier as

an owner of a transport vehicle who transports or undertakes to time or in any public place

for hire or reward, whether in pursuance of the terms of a contract or agreement or

otherwise.

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8.5.4 The following characteristics in a vehicle make it a public commercial vehicle:-
1. It is run under public carriers permit

2. Its owner transports goods of all classes of others.

3. It transports any type of goods from any public place at any time.

4. It may carry goods under an agreement or without agreement.

(iii) Trailers. Any truck, cart carriage or other vehicle without means of self-

propulsion. It includes also agricultural implements drawn or hauled by self-

propelled vehicles.

(iv) Passenger carrying vehicles. The vehicles may be made like buses including

tourist buses; hotel or school omnibuses, and air-line buses. The passenger

carrying vehicles +may be used for hire:

(a) As taxis or private car type vehicles used for public hire;

(b) Private type taxis let out on private hire direct from the owner with or

without maters and driven by the owner.

Motor insurance belongs to miscellaneous class of insurance. But the business is so big

that insurance companies have to maintain a separate department. This is a tariff class of

business so the covers, premium rates and policy forms are all standardized or uniform.

Everyone who owns an automobile assumes certain risks, because the property is exposed

to damage and law imposes upon owner some responsibility towards the public.

Those who drive cars are more responsible to public. The risks are of two types : -
i. Legal ability for damages for body injuries or damage to property caused to others;
ii. Damage to loss of ones own automobile.

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Everyone who owns an automobile assumes a risk because the property is subject to
damage and the law imposes upon owners responsibility to public. In absence of any law,
also, the owner or driver of n automobile is required to use reasonable care with respect of
such vehicle safeguard public from injury.

8.6 EXTENT OF COVER

Comprehensive cover
Third party, fire and theft
TPO
Excess
Discounts
Renewals and lapse
Endorsement motor claims
Process functions of motor insurance

Motor insurance is divided into a number of classes:

1. Motor Private
(i) Motor private
(ii) Motor cycle
2. Motor Commercial
(i) Motor Commercial
(ii) Motor Tractors
(iii) Motor Trade
(iv) Motor (PSV) Self Drive
(v) Motor (PSV) Private Hire
(vi) Motor (PSV) Tanker/Trailer.
(vii) Motor (PSV) Articulated Tanker.
(viii) Motor (PSV) General Cartage.
(ix) Motor (PSV) General Cartage Articulated

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For each class there are 3 types of cover available these are:
1. Compressive
2. Third Party Fire an Theft (TPFT).
3. Third Party Only TPO).

1. Comprehensive cover
Covers the insured against losses that may be caused by all possible causes except
definitely stated exclusions such as Acts of god and Terrorism. This kind of
insurance covers the insured against the risk of losing his/her vehicle either by
theft, fire or accident. Within the same policy the insured will be covered against
the loss or damage of accessories in the vehicle such as alloy rims, radio cassette,
etc. There is also cover against third party liability. The basic premium is arrived
at by applying a percentage to the value of the vehicle or the.

2. Third party Fire and Theft (TPFT)

Covers the insured against losses caused specifically by Fire or Theft of the vehicle
i.e. other causes such as accidents are excluded from compensatory cover.
However in case of an accident and there was a third party involved, the third
would be compensated. The premium in most cases is a present amount depending
either on the cc or type of vehicle. Covers the insured against losses that may be
incurred by Third Parties involved in an accident with the insureds vehicle. The
insurance company undertakes to compensate the Third party on behalf of the
insured.
3. Third Party Only (TPO)
Covers the insured against losses that may be incurred by Third parties involved in
an accident wit the insureds vehicle. The insurance company undertakes to
compensate the third party on behalf of the insured.

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8.7 The Extent of Cover
Compressive cover and Third party, Fire & Theft
These cover:-
1. Value of the vehicle (basic)
2. Value of any accessories for which the insured wants cover.
3. Windscreen
4. Radio cassette
5. Anti-theft devices
6. Air-conditioners
7. Alloy rims
8. Any other stated accessories
9. Standard rates are applied to these values to come up with the premium.

Extensions are available to these covers. These include

1. Strike Riots And Civil Common (SRCC)
2. Increased Third party Property Damage Cover (TPPD).
3. Extra Medical Expenses cover.
4. Extra Towing Expenses Cover.
5. Personal accident to passengers in the vehicle (limited number of occupants).
6. Legal Liability to passengers in the vehicle (LLP).
7. Special Perils cover (SPC).

Standard rates are applied to these stated minimum values for these additional extensions to
come up with the premium. Additional rates may be applied for any amounts above the
stated minimums.

TPO
This only covers the insured against Third Party liability.

Excess
Excess can be defined as the share of the loss that the insured should bear. This can be in
form of a predetermined amount or percentage rte. Certain Excesses are also imposed on

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the insured depending on the cover taken. These Excesses govern the limits above which
the insured can make a claim. Claims with amounts below the excess limit are normally
paid by the insured. Also in the event of a claim the insurance company may require the
insured to pay the excess amount before they settle the claim. The excess prevents the
insured from making too many claims. Applicable Excesses for Motor covers include:
1. Fire Excess
2. Accident Excess
3. Theft Excess
4. Third Party Excess
5. Novice and young drives Excess

8.8 Discounts
Certain discounts are also applicable to a motor policy. These are applied after calculation
of the premium. They include:-

1. Fleet Discount
This is applied in situations where the insured has a fleet of vehicles insured wit the
company. The actual amount of discount depends on the size of the fleet and the
insureds relationship wit the insurance company.

2. Non-Claims Discount (NCD)

This is applied if the insured has not had a claim in the past insurance year. The
percentage increases by 10% every year to maximum of 60%. Should the insured
have a claim at any point the NCD automatically reduces to 0% for the next
insurance period. The NCD is transferable if the insured is moving from his
current insurance company to another.

N/B. The discounts are not all calculated on the net premium, but are applied one
after the other to the reducing premium. This gradually reduces the overall impact
of the discount on the total premium e.g. if NCD of 10% fleet Discount of 10% and
Special Discount of 10% were to be applied to a premium of 60,000 in the same
order, the resulting discounts would be as follows:

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 Net premium = 60,000/=
NCD 10% = 6,000/- New net = 54,000/=
Fleet discount 10% = 5400/= New net = 48,600/=
Special Discount 10% = 4,860/= New net = 4,740/=

Renewals and Lapses

Most motor polices cover a period of one year except for sort-term polices, which may go
for 14 days depending on the requirements of the insured.

Insurance companies normally process renewals for their clients every month.
Renewals/lapse processing involves:-
1. Recalculation of applicable premiums after any alterations in premiums rates and
discounts especially NCD. Printing and sending of renewal notices to he clients,
which require the clients to make any necessary amendments to the insured value
of their vehicle and to confirm instructions to he insurers to go ahead and renew
their policies.
2. Printing and sending of renewal reminders t those clients who have not sent any
confirmation that they wish to renew their policies.
3. Lapsing of polices whereby the insured has not sent instructions for renewal
Policies will normally be lapsed if they have not been renewed for some time
since the required renewal date. The grace period will normally vary per
company.

The calculation of premiums for renewals is done in the same way as it would be done for
new business wit the exceptions of training levy and stamp duty.

8.9 Endorsements
During the period of cover, it may be necessary to endorse a policy because of various
reasons. Endorsements will normally involve charging of additional premium or refunding
of some premium. This my happen if the client increases or reduces the value of what he
has insured e.g. by buying a new car or adding some accessories, which he wants covered.
When processing endorsements the period of cover has to be taken into consideration to

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ensure that the client is not overcharged. If the policy has already run over a period of half
a year, the calculated premium to be charged or refunded will be for the un-expired term of
cover, i.e. prorate premium.

8.10 Motor Claims

There are various types of motor claims. These are classified mainly by the cause/peril,
which resulted in the claim. They are:-
1. Own Damage
2. Third Party Property Damage.
3. Third Party personal Injury
4. Theft
5. Windscreen
6. Radio Cassette.

Other important considerations for motor claims are the prevailing circumstances at
the time of loss e.g.
1. Weather conditions
2. Road conditions
3. The speed
4. The number of victims injured or deceased
5. The extensions and exclusions to the vehicle.
6. The mechanical state of the vehicle.
7. Identify of the driver.
8. Period of cover.
9. Any excess that is applicable.
10. A reserve amount is set for the claim
11. Companies retention limit

When processing any claim, certain validations have to be taken into consideration.
1. The vehicle for which a claim is being booked has to exist in the companys
books/files already.

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 2. The vehicle has to have been on cover under one of the companys policies at the
time of loss/accident i.e.
The claim should not be before the date of inception of the policy.
The policy must show that a renewal debit had been raised which covers the
actual date of occurrence of the accident.
The claim did not occur after the policy had been canceled or after the
vehicle had been deleted from the schedule of vehicles covered under the
policy.

8.11 Process functions of motor insurance

1. Filling in proposal form.
2. Calculation of premium

There are rates for calculating premiums for comprehensive cover. These vary from client
to client
(a) Basic premium is calculated from the value of the vehicle for comprehensive
cover and preset amounts for the TPPD and TPO.
(b) An extension is insurance for additional items the insured would like covered and
additional premium is charged for the same.
(c) There are discounts applied to the premium above. These discounts are like,
NCD and special discounts. E discounts can be applied either before or after the
extensions.
(d) Stamp duty is applied to premium for new policies at a rate that is decided by the
government.
(e) Training levy is also applied to new premium, which is usually a percentage of
the basic premium.

3. The debit is note is printed and reinsurance is handled at this point.

4. The policy is printed and issued to the client after the premium is paid. The clauses
that are relevant to this policy are attached to the actual document.

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 5. Renewals are done after the policy insurance date closes expiry. The company
sends renewal advice notes to the insured indicating the premium that is due for
payment. Information required:-
Policy number
Expiry date status
6. Claims are processed for policies that are issued and are in force bearing the fact
that the claim occurred during the policy cover period.
8.12 Activity

(i) What are the basic principles of insurance that govern motor insurance?
(ii) Who is a third party in motor insurance.?

8.13 Questions

1. Give a brief history of motor insurance.

2. Explain the basic principles of motor insurance.
3. What are he types of policies under motor insurance. Explain the various covers
offered in this area.
4. What is a Non-Claim Discount? (NCD)
5. What does Third Party Only Cover entail?
6. What do these abbreviations stand for in motor insurance?
(a) TPO
(b) SRCC
(c) LLP
(d) SPC
(e) TPFT

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 LESSON 9
GENERAL INSURANCE MISCELLANEOUS INSURANCE

9.0 Introduction
General insurance or miscellaneous insurance is extensively discussed in this lesson where
different forms of burglary are discussed and the general principles to that apply to them.
This lesson will help the learner to clearly understand this important branch of insurance..
9.1 Objectives

By the end of the this lesson, the learner should be able to: -
(i) Understand the concept of general insurance and the main clauses that
govern this types of insurance.
(ii)
General insurance is the term used to refer to the insurance of property and other classes of
insurance apart from Life Insurance. The main modules of General Insurance would thus be
classified as follows:-
Motor insurance.
Fire Insurance
Marine insurance
Miscellaneous insurance

Each of the above classes of insurance is further subdivided into various sections as shown
here below:- motor insurance
(f) Commercial
(g) Private
(h) Motor cycle /pedal
(i) Tractors
(j) PSV

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 Fire insurance
(a) Fire domestic
(b) Fire industrial

Marine insurance
(a) Open cover
(b) Hull

9.2 Miscellaneous insurance

This is a consortium of different policies that are not very common e.g. cash in
transit, fidelity guarantee, engineering, bonds, contractors all risks, workmens
compensation etc. The above are the major subdivisions of these four classes of
insurance.

Also included in this area are:-

(a) Business Insurance

Business insurance is divided into different classes some of which are:

Product insurance
Professional insurance
Public insurance

(b) Product Insurance

This is a cover taken to protect a manufacturer against claims arising from loss caused by
his product. For example if one gets injured from any product that he purchased like
canned food and he can show that the manufacturer was to blame, he can succeed in a
claim for damages.

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( c) Professional Insurance
Lawyers, Doctors, Dentists etc take professional insurance to cover claims arising from
loss caused during their professional performance. A doctor who is sued for giving a
prescription that harmed a patient turns to the professional cover to pay the claims.

(d) Public Insurance

This is cover taken by Authors or Editors who in their professional undertaking writes
something that results in defamation. To pay claims arising from defamation the writers
turns to public insurance. This cover can also be useful for liability arising from your
actions to cause one injury or harm like your dog biting a neighbour, crossing the road
without looking and causing an accident etc.

It may be used generally that all principles of general insurance, vis., insurable interest,
utmost good faith , indemnity (including its corollaries subrogation and contribution) and
proximate cause, apply to the various classes of miscellaneous (accident) insurance dealt
with here. Special observation, if any, in the matter of application of any principles to a
specific class of business will be made while dealing with the relevant class of business.

9.3 Development of Miscellaneous Insurance

The development of miscellaneous (accident) insurance is inextricably linked with the
Industrial Revolution. The social and economic changes that the community in its wake
and the increased hazards to life and property gave rise to miscellaneous (accident)
insurance. The progress through the nineteenth century was rather tardy, largely because of
the absence of any insurance consciousness and the general lack of awareness that people
had of their right. But the turn of the century witnessed for reaching changes both in the
scope and the content of miscellaneous (accident) insurance coverage. The two world
wars, notably the second world war, gave a great emphasis to many of the miscellaneous
(accident) insurance covers which we witness today.

Burglary and fidelity guarantee insurances which had already gained currency became
increasingly popular with the introduction of the five year plans scarcity of goods and
inflation have had a significant say in the development of this class of business, as losses

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tend o increase during periods of acute scarcity and/or depression, and inflation contributes
to artificial jacking up of insured values.
The potential of miscellaneous (accident) insurance is very vast in this country. It would
be an understatement to say that we have touched just the fringe of it. With he
development further of the agricultural and industrial sectors, miscellaneous (accident)
insurance is bound to grow and is destined to reach new heights. There are many other
types of contracts besides fire and marine) which are no so much popular they may be
quite helpful to individual insured. In general, these contracts follows the fire insurance
contract. So it facilitates the insurer to cover any risk through extended cover by
endorsements. The main characteristic of these contracts is the high degree of
individuality. Any contingency which may result in financial loss can be included here.
They could be risk against liability, against dishonesty or failure of others.

9.4 Scope
The scope of miscellaneous (accident) insurance cannot be precisely defined. Any class
for which there is no provision in the fire or marine insurance is underwritten in the
accident department. This is so because the transacting of fire and marine business is
controlled respectively by the fire tariff and by the Marine Insurance Act and the Institute
Classes (Cargo and Hull), whereas accident department, excepting for the motor tariff,
workmens compensation tariff, bankers indemnity tariff and personal accident tariff, is
practically unfettered. Hence a wide range of risks and contingencies are insured in the
accident department, through strictly all the risks an contingences may not originate from
accident.

9.5 Main Classes

The main classes of business are as follows:
i. Personal accident and sickness insurance. The insurance provides for payment
of compensation against death or disability arising out of accidental bodily injuries,
or disability arising out of sickness.
ii. Motor insurance. The policies required to be taken compulsorily provide for act
liability cover, i.e. third party risks to cover the statutory liability of motor vehicle

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 owners under the Motor Vehicles Act, 1989. comprehensive policies insuring
risks of liability and risk of loss of or damage to the vehicles are also issued.
iii. Burglary insurance. This insurance indemnifies the insured against loss or damage
arising out of burglary and/or house breaking. All risk insurance policy affords a
wider cover inclusive of theft, fire and accidental losses. Money-in-transit
insurance covers lots of money whilst in transit. The principal types of re:-
a) Burglary (business premises) insurance.
b) Burglary (private dwellings) insurance.
c) Combined fire and burglary private dwellings) insurance.
d) Money-in-transit insurance.
e) Cash-ins-safe insurance.
f) Baggage insurance.
iv. Fidelity guarantee insurance. Under commercial guarantees, indemnity is
provided to an employer against direct losses arising out of any dishonest or
fraudulent act on the part of his employees. Courts and government bonds are wide
in scope. They guarantee the due and proper discharge of duties connected with
official appointments or with certain understandings given. The main types of
policies are:
a) Commercial guarantees individual, collective or floating.
b) Court bonds administration bonds, Liquidators and
c) Receivership bonds.
d) Government bonds Customs and excise bonds.

v. Workmens compensation (employers liability) insurance. The policy protects

the employers statutory liability under the Fata Accidents Act, 1882, the
Workmens Compensation Act, 192 and Common Law, for disability of workmen
arising out of employment injuries or occupational disease. The policy an also be
issued to cover employees other than workmen. The benefits are the same as
available to workmen.
vi. Public (third party) liability insurance. This insurance seeks to indemnify the
insured against legal liability devolving on him for injury to the person or damage
to the property of a third party by reason of any negligent act, error or omission

139
 committed by the insured. The same actions done by any person under the
insureds control or by any defect in the ways , works, machinery or premises of the
insured.
vii. Engineering insurance. This class of insurance is designed to indemnify the
insured against loss or damage arising out of boiler explosion, breakdown of
machinery or erection of plant and machinery. The boiler insurance policy and
the erection insurance policy can be extended to cover third party liability risk.
Loss of profits insurance in conjunction with machinery breakdown insurance can
also be granted.
viii. Aviation insurance. This class of business is one of the latest branches of
miscellaneous (accident) insurance. The indemnity afforded is against loss of or
damage to aircraft hulls and the liability associated with the operation of the
aircraft.
ix. Other classes. Some of the notable classes are indicated below:-
a) Contract guarantees (covering solvency risks).
b) Credit guarantees (covering credit risks).missing documents indemnity
(covering loss or damage airing by reason of issuing duplicate documents.
c) Missing documents indemnity (covering loss or damage arising by reason of
issuing documents).
d) Pedal cycle insurance covering the pedal cycle against own damage and
third party liability. Personal accident benefits to the rider can also be
granted.
e) Plate glass insurance covering plate glasses fixed to display windows or
showcases of commercial establishments against breakage).
f) Bankers indemnity insurance covering insurance (covering loss of money
and/or securities of banks).
g) Jewellers block of insurance covering the property of the jewellers whilst
on the premises in display windows, in ban lockers an also while in transit).
h) Television insurance (covering the television apparatus and the legal
liability to the public)
i) Crop insurance (covering standing crops).
j) Cattle insurance (covering cattle against death due to accident or sickness).

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For the sake of completeness, a brief description of the scope of all major classes of
miscellaneous (accident) insurance is given above. The course deals with the classes of
miscellaneous (accident) insurance other than motor, personal accident, liability,
engineering, aviation and agricultural insurances.

Conventionally, insurance is classified as life insurance, fire insurance, marine, insurance

and accident insurance. However, it can also be classified according to he subject matter of
insurance, i.e., insurances of person, insurances of property, insurances of liability and
insurances of interest. While it will be appreciated that the miscellaneous (accident)
insurance will embrace all the four classifications, the classes of business covered by this
course will embrace the classifications, the classes of business covered by this course will
embrace the classifications other than the insurances of person. The features of each of
these three classification are, therefore stated below:

9.6 Insurances of Property

Under this classification, the vast majority of miscellaneous (accident) insurance policies
are included, viz., burglary, money-in-transit, all risks, combined fire and burglary, pedal
cycle, plate glass, television and other classes of property insurance. All policies under this
classification have the following features in common:
i. All are contracts of indemnity. Hence after making good the loss, the insurers
are subrogated to the rights and remedies of the insured. They can also call into
contribution other policies covering the same risk. They can also take over the
salvage, after settlement of a claim.
ii. The indemnity can be by way of a cash payment repair, replacement or
reinstatement. The depreciation of value is an important factor to be
considered.
iii. The indemnity extends and covers the actual pecuniary loss suffered by the
insured. But it is restricted to a minimum of the sum insured by the policy.

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9.7 Insurances of Interest
The interest arises out of such relationship as employer and employees principal and agent,
principal and contractor, and creditor and debtor. The insurance policies which comprise
this group are fidelity guarantees, contract guarantees, credit guarantees and other similar
policies. Their common features are:
i. Three parties are involved in a contract instead of the customary two the
employer, the employee and the insurers, or the principal, the agent (the
contractor) and the insurers, or the creditor, the debtor and the insurers. The
insurance contract is only between two parties viz, the employer and the
insurers, or the principal and the insurers, or the creditor and the insurers.
ii. The insurers in every case become a surety and hence they automatically get
suretyship rights to proceed against the employee, agent, contract or debtor, as
the case may be , after paying the loss to the employer, principal or creditor.
iii. The duties of utmost good faith, disclosure, etc, are very onerous and even a
minor breach can render the contract invalid.
iv. On payment of a loss, the policy ceases immediately, and insurers have no
further obligation as to the risk, for the remaining part of the period.

9.8 Insurance of Liability

Although this course does not deal directly with liability insurance such, it deals with
certain policies, which certain policies, which grant liability insurance cover in conjunction
with property insurance. An example is television insurance. It is for this reason that the
features of this type of liability are given here. They are:
i. The liability arises at law out of a negligence act, error or omicron or any defect in
the insureds machinery or premises.
ii. The claimant is an employee or member of the public.
iii. The payment is made to a person other than insured.

iv. The insurers very often take over the conduct of the claim proceedings including
defending suits in courts.

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 v. In addition to the compensation or damages payable, insurers also reimburse the
legal costs or other expenses (for defending the claim) incurred by the insured with
the consent of the insurers.

9.9 Burglary

Principles of Covers, Extensions, Factors and Methods of Rating under Various

Types of Policies.

1) Burglary

It was attempted to sell cover for burglary in 1787 but until 1890 no substantial

amount was sold. Human dishonesty may take the shape of robbery, theft, forger.

One is burglary insurance. This is one of the major classes of business

underwritten in the accident department. It accounts for a sizeable portion of the

departments premium income. It falls under the classification Insurances of

property and is non-tariff. Apart form traders and manufacturers, he householders

frequently sought the insurance in respect of general household goods and personal

effects. For the businessmen, burglary insurance is as essential as fire insurance. It

enables them to recoup the losses suffered by them consequent on burglary or

housebreaking.

Whereas most classes of miscellaneous (accident) insurance business provide

indemnity against a fortuitous happening or mishap, burglary insurance seeks to

provide indemnity against a loss or damage occasioned by a breach of the criminal

law, which is a pre-mediated, deliberate and illegal and is committed by the human

agency. In addition to he burglary insurance policy, there are other types of policies

giving wider covers. His policy compensates loss suffered through criminal or
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 dishonest act of others. Burglary means forcible entry into premises for the purpose

of stealing. Robbery is the taking of property from a person by force or threat of

force. Theft includes misappropriate by servants having access to property.

The main polices are as follows:

i. Burglary (business premises) insurance policies.

ii. Burglary (private dwellings) insurance policies.

iii. Combined fire and burglary insurance policies, jewellery and valuables

insurance polices.

iv. All risk insurance policies.

v. Baggage insurance policies.

9.10 Activity

(i) What is burglary. What is full value and first loss basis

(ii) What are the contents of a burglary insurance

9.11 Questions

1. What are the main classes of miscellaneous insurance?

2. What is burglary and what covers are provided for in this area?
3. What are the divisions of business insurance?

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References

(i) Bennett C.,1992 Dictionary of Insurance . Prentice Hall, Edinburgh gate, England UK.
(ii) Clark, O. E. John,(2001) Dictionary of International Insurance and Finance Terms.
Revised edition, Financial World Publishing, Canterbury, United Kingdom.
(iii) Diacon, S. R. Carter R. L.,(1992) Success in Insurance, 3rd edition, John Murray
Publishers, London, Britain.
(iv) Panda G. S. (1992). Principles and Practice of Insurance, Kalyani publishers, 1st edition,
New Delhi, India.

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