Insurance as part of risk management
14 July 2023 7:48 PM
Introduction:
The difference between short-term and long-term (life insurance):
Short-term insurance: insurance
• Short term insurance is INCASE something happens
• e.g. Fire, theft, floods, etc.
• These things could or may not happen, but to manage the risk in case they happen, the insured ones to be indemnified (placed in the same financial position as
was the case before the incident)
Long-term insurance: assurance
• As sure as we are alive, we will all retire and it is possible that death may occur before it
• We can manage the risk of our loved ones if we die or the risk of being unable to maintain a decent standard of living after retirement through assurance
• Most people, will surely retire after they had worked (unless death happens first)
• We could, of course, die before retirement, but we cannot take the risk that our loved ones might be without any income when we die, or that we could not
maintain an acceptable standard of living after retirement
• e.g. Retirement or death
• Assurance covers against risks that will happen such as retirement, death, and perhaps disability or illness
• Although the time is not known, death remains an unavoidable risk
• Person who takes out the policy-policyholder
• Beneficiary-person the policy will pay out too
→ Types of assurance: (Investment chapter)
○ Life assurance: cover for loss of life. Exists as long as you are alive and pay premium
○ Term assurance: life cover valid for specific period/term. During debt period:house
○ Endowment: investment policy, pays after specific time period (e.g. 10 years)
○ Retirement annuity: policy taken out to provide income (pension) on reaching retirement age (55-65)
○ Disability cover: pay out predetermined amount if disabled/lose limb covered by policy
○ Trauma cover/dread diseases: cover lists of serious illnesses. Pay predetermined amount of cover
○ Funeral cover: pay for funeral costs
• By taking out short term insurance or long term insurance (individual or business) a monthly premium is paid by the insured (individual or business) to pass the
risk on to the insurer
• Premium is based on the value of insurable interest and risk involved
Non insurable risk:
• Some risks are insurable, others that are not insurable and some are so expensive to insure that it is not affordable to insure against risks
Some of these so called "non-insurable risks" include the following:
→ War is not insurable. Insurance firms regard it as a risk which has to be prevented by a government. As insurance firms are also hesitant to ensure other political
risks, the government, together with the South African insurance association found in 1979 the South African special risk insurance association to ensure risks like
political unrest and terrorism, if it is specified as such on the policy
→ Bad debts. Bad debt is usually regarded as non-insurable. There is, however, insurance against it available, but it is a risk group where insurance is almost
unaffordable expensive
→ Business risks like price changes due to the time lapse between the time goods were ordered and were delivered, are not covered by traditional insurance
policies. The business may decide to guard against such risks, but this is not in our syllabus
→ Trading stock which becomes out of date due to fashion changes, is a business risk which is not insurable
→ Technology changes rapidly and there are regular improvements in machines and production processes. A business cannot take insurance out against machines
that age or become out moded. Leasing is, however, a possibility to prevent the business being saddled with out of date machines, but once again it does not
form part of traditional insurance
→ No one can take out insurance against unlawful/illegal acts. For example, I cannot take out a policy against a fine for a traffic offence
→ It is interesting to note that climate changes in some parts of the world are so huge at present that some insurers do not want to cover these areas. During 2010
Santom declared that areas in South Africa we're too risky to ensure against some natural disasters
General concepts regarding insurance
Insurer:
• The business or company that provides insurance cover
The insured:
• The person, or business that is insured
Clause:
• A provision in an insurance contract
Premiums:
• The specified amount of payment required periodically by an insurer to provide cover under a given insurance plan for a defined period of time
• The premium is paid by the insured party to the insurer, and primarily compensates the insurer for bearing the risk of a payout (should the insurance
agreement's cover be required)
• The higher the risk= higher amount of premiums paid
Indemnity:
Insurnace as part of risk management Page 1
, Indemnity:
• Financial position of insured will be the same as before the loss
• Insurer undertakes to indemnify the insured in the event of a specific loss
• Indemnity gives the insured the Peace of Mind to know that, if the insured experiences a lot of damages or is destroyed, then showed will be sufficiently
compensated for any losses
• Sufficient in this case means that the insured will be put in the same financial position as before the event
• The insured will not suffer any losses (except for the possible excess), but will also not gain any profits from the insurance
• Only actual loss will be compensated, cannot claim more than what was lost (no loss= no compensation)
• Indemnity refers to short term insurance
Security:
•Security is applicable when reference is made to long term insurance (assurance)
•The purpose is to give financial security to the insured at retirement or to their insured's dependants when they die or in the case of becoming disabled
•Group life cover: inform of life assurance
→ The group life policy to which the employee could belong at work (if applicable) give security to the family in the form of long term insurance (when the person
dies
→ Businesses insurers workers for the amount equal to annual salary multiplied by a factor
→ Premiums on group life cover is usually lower than life insurance policies, as a large number of employees take up the same cover (the same principle as 'bulk
discount'
→ Larger number of people insured, reduces risks and increases insurance company's monthly income
Average clause:
• The principle of the average clause is applied when the asset is not insured for the correct value:
► Under insurance: as it's not insured for the full value-insured doesn't pay a premium that covers the risk
→ If the asset is under-insured, the insured has not paid continuously a premium that is sufficient to cover the full risk
→ Remember, that the premium is calculated by the value of the asset and risk factors. If the monthly premium was too low, the full value of the loss will not be
indemnified
→ e.g. If the value of an asset is R10,000 , but the asset is insured for only R6000, it would mean that only 60% of the risk was insured. If this asset is now damaged
in a fire and the damages amount to R2000, only 60% of the damage will be paid out and not the full amount
► Over-insurance: when property or other assets aren't shared for more than their actual value
→ Refers to a situation where the asset is insured against more than its present value
→ This means that the insured will pay a higher premium than necessary
→ If damage is caused to the asset, only the value of the acid will be paid out by the insurer as the insurer does not allowed to make a profit from the insurance
(Principle of indemnity)
→ Nobody should profit from insurance and in case of over-insurance, the insurer may choose to reinstate the property or asset rather than paying out the amount
(insurer rebuilds or replaces the property or acid, as they are not under obligation to make cash settlements)
→ Motor vehicles are often being over insured, Because the value of a car on a yearly basis decreases due to wear and tear and people do not always adapt their
policies to ensure it at the lower value. If the car is stolen, the value of the car is paid out and not the value of the insurance contract
Excess:
• Excess is the amount or percentage of the loss/claim Stipulated by the policy that determines what the insured needs to pay
• Amount on each claim which is not covered by the policy
• Excess is specified in the insurance policy and they should will have to pay first the amount specified in the contract
• The excess could be lower, but then the monthly payments will be higher.
• if the insured is willing to accept a higher excess payment, the monthly payment could remain lower
Proximate cause:
• Insurer is only responsible for the losses as a direct result of the event that was insured
• If a person claims from an insurance company for a loss suffered, the company will ensure that the loss was due to the cause that was insured (the immediate or
real cause) and not some secondary event that is not insured
• e.g. If someone has household insurance and there are items stolen, the household insurance will pay for the loss of the items stolen if they were insured. But
suppose the person has no insurance on his car and the car is stolen at the police station while he reports the theft at his house, the person cannot claim for the
loss of his car from his household insurance, as this is a different incident that caused the second loss (his car)
• e.g. Fire insurance covers fire: if someone slips on a wet floor where there was water used to extinguish the fire and breaks watch-cannot claim watch from fire
insurance as was not damaged in the fire
Subrogation:
• Based on principle of indemnity
• If a person does suffer financial loss as a result of an event covered, he may only claim recovery from losses once
• No person is allowed to make profit after loss has been indemnified
• If the insured person had claimed from the insurance company for an incident that has happened, they cannot claim from the guilty party who caused the loss as
well
• The right to claim from the guilty party is given to the insurance company that could claim from the guilty party
• This applies mainly to car insurance
Cession/assignment or to cede the policy:
• When the rights of one person are transferred to another person
• An endowment policy builds up a cash worth over time (every month when the premium is paid).
• Should an immediate need arise by the insured for the money, the policy may be signed over to a creditor as collateral in order to get the loan
• For example, when someone transfers life insurance/endowment policy over to the bank as security for a mortgage bond/collateral to get a loan
Re-insurance:
• Form of insurance used by insurers
• Insurance company cannot bear the entire risk for a large policy, we'll place part of the risk with a reinsurance company which specializes in re-insuring
• Reassurance company might possibly spread risk even further to other companies
Insurnace as part of risk management Page 2
