Sample Notes: Insurance

O Level and IGCSE Commerce
Chapter 11: Insurance – Full Detailed Notes

11.1 Purposes of Insurance

• Definition of Insurance:
  • A contract in which an individual or business pays premiums to an insurer in exchange for compensation in the event of specified loss.
  • It is based on the principle of risk transfer from the insured to the insurer.
• Main Purposes:
  • Risk Reduction:
    • Spreads the financial consequences of risk across many policyholders.
    • Makes unpredictable risks more manageable for individuals and businesses.
  • Compensation:
    • Provides financial reimbursement to the insured when losses occur.
    • Helps recover from events such as theft, fire, accident, or natural disaster.
  • Financial Protection:
    • Prevents financial ruin by covering unexpected expenses.
    • Ensures economic continuity in the face of loss.
  • Business Confidence:
    • Reduces anxiety about unforeseen losses, allowing businesses to operate more freely.
    • Enables firms to focus on core operations without fear of loss.
  • Investment:
    • Premiums collected by insurers are invested in government bonds, stocks, and projects.
    • Contributes to national economic growth.
• Importance of Pooling of Risk:
  • Insurance works on the principle of collective contribution.
  • Large numbers of people pay into a pool from which claims are paid.
  • Since not all will suffer losses at the same time, pooled resources are sufficient to cover claims.
  • Encourages fairness and sustainability in the system.

11.2 Business and Personal Risks

• Business Risks:
  • Fire: Destruction of assets or premises due to accidental fires.
  • Theft: Loss of stock or equipment through burglary or internal fraud.
  • Employer’s Liability: Legal responsibility for injuries to employees at the workplace.
  • Loss of Profits: Business interruption from disasters may halt operations.
  • Goods in Transit: Risk of loss or damage during transportation.
• Personal Risks:
  • Accident: Injuries from road accidents or workplace incidents.
  • Illness: Medical expenses and loss of income.
  • Theft: Burglary at home, car theft.
  • Death: Financial impact on dependents.
• Insurable Risks:
  • Quantifiable and meet certain conditions:
    • Must be accidental
    • Measurable in monetary terms
    • Not against public interest
  • Examples: fire, theft, vehicle damage, medical expenses
• Non-Insurable Risks:
  • Risks that are:
    • Unpredictable or unmeasurable
    • Result from poor decisions
    • Intentionally caused
  • Examples: falling demand, changes in fashion, war, political instability
• Why Some Risks Are Not Insurable:
  • Cannot be measured accurately
  • High likelihood of occurrence
  • Could lead to moral hazard
  • Lack of statistical data

11.3 Insurance Principles

• 1. Indemnity:
  • The insured is restored to the same financial position as before the loss.
  • Prevents profit from a loss.
  • Application: If a damaged car is worth ₨500,000, insurance pays ₨500,000—not more.
• 2. Contribution:
  • If the insured holds multiple policies for the same risk, insurers share the cost of the claim.
  • Formula:
    • Payment = (Sum insured with one company / Total sum insured with all companies) × Loss
• 3. Subrogation:
  • After compensation, the insurer acquires rights to claim from third parties or to take the salvage.
  • Prevents double benefit.
• 4. Insurable Interest:
  • The insured must stand to lose financially if the insured item is damaged.
  • Must exist at the time of the loss.
  • Example: You can insure your car, not your neighbour’s.
• 5. Utmost Good Faith:
  • All material facts must be disclosed honestly.
  • Non-disclosure or misrepresentation can void the policy.
• Importance of Principles in Practice:
  • Ensure fair, legal, and enforceable contracts.
  • Allow correct premium calculations and risk evaluation.
  • Prevent fraud and misuse.

11.4 Effecting Insurance Cover

• Steps to Take Out Insurance:
  1. Proposal Form:
     • Completed by applicant.
     • Includes personal details and information about the risk.
  2. Risk Assessment by Insurer:
     • Evaluates whether to accept the risk and determine the premium.
  3. Cover Note:
     • Temporary certificate proving coverage before the full policy is issued.
  4. Insurance Policy:
     • Legal document detailing:
       • What is insured
       • Premium
       • Period of insurance
       • Conditions and exclusions
• Premium Calculation Factors:
  • Value of item insured
  • Risk level (e.g., location, past claims)
  • Age and experience of the insured (e.g., driver’s age)
  • Usage (e.g., personal vs commercial)
• Documents in Insurance:
  • Proposal Form: Request for insurance with full risk information.
  • Cover Note: Temporary document showing proof of cover.
  • Policy Document: Contract of insurance.
  • Renewal Notice: Issued before the policy expires.
• Role of Insurance Broker:
  • Advises clients on insurance needs.
  • Searches the market for best policies.
  • Acts as intermediary between client and insurer.
  • Paid via commission by the insurer.

11.5 Statistical Basis of Insurance

• Factors Influencing Premium Level:
  • Probability of Occurrence: Higher risk = higher premium.
  • Value of Insured Item: More valuable = higher premium.
  • Policyholder Profile: Age, location, claims history.
  • Inflation and Market Conditions
• Use of Actuarial Data:
  • Insurance companies employ actuaries to analyse past data and predict future claims.
  • This statistical analysis allows:
    • Accurate risk assessment
    • Fair premium pricing
    • Long-term solvency of insurer
• Evaluating Quotations:
  • Key criteria:
    • Coverage scope (what’s included/excluded)
    • Premium cost
    • Excess (amount paid by insured before claim is paid)
    • Reputation and reliability of insurer
  • Businesses often compare multiple insurers to choose best value.

11.6 Effecting a Claim

• Claim Process:
  1. Incident Occurs: Loss/damage takes place.
  2. Claim Form Submitted: Details of incident + documents (photos, receipts, police report).
  3. Assessment: Insurer verifies and investigates the claim.
  4. Approval and Settlement: Compensation is calculated and paid.
• Claim Form Must Include:
  • Policy number
  • Date and time of loss
  • Description of event
  • Details of loss or damage
  • Supporting evidence
• Timeliness:
  • Claims should be made promptly.
  • Delays can lead to denial.

Application Examples