Insurance

Introduction
Running a business involves many risks.
Market risks, such as a change in
consumer tastes and buying habits, can
result in business failure. However, there
are many other risks that can also result in
significant financial losses unrelated to
market risks. For example, the business
premises may burn down, equipment
could be stolen, vehicles may be involved
in accidents or employees could injure
themselves at work. Although a business
may not be able to prevent some of these
events it may be able to insure itself
against some of the losses caused by
them.
Introduction

Insurance helps to reduce the risks

associated with operating a
business. Many probable events
can result in financial losses for a
business. Some of these probable
events include fire, theft and
accidents. The likely losses include
damage to property and injury to
persons. Insurance policies provide
compensation in the form of a sum
of money or payment of medical
or other expenses.
Introduction
Insurance involves an agreement between
an insured party or proposer and an
insurance provider, the insurer. The
agreement is called an insurance policy. In
the insurance policy, the insured party
agrees to pay an insurance premium to
the insurer in return for financial
compensation to be paid in the event a
particular loss occurs. Insurance therefore
increases the operating costs of the
business but eliminates the risk of an
unexpected financial loss. If insurance was
not available, there would be far fewer
businesses because of the substantial
financial risks involved.
 Principles upon which
insurance is based
An insurance contract or policy is a written agreement
between an insured party(policyholder) and the
Insurance provider.

A prospective policyholder first completes a proposal

form with details of the insurance cover they want,
for example life insurance in the event of death, car
insurance cover for theft, fire or accident or property
insurance cover in case of fire, flooding or another
catastrophic event. In the proposal form the
policyholder will specify or choose the maximum
value of insurance cover or financial compensation
they want according to the amount of premium they
will have to pay. The more cover they choose, the
more their premium will be. The proposal they
decide on forms their offer. If the insurance provider
agrees to cover the risk then the offer is accepted
and the insurance contract finalised.
 Principles upon which Principles upon which
insurance is based insurance is based:
• Pooling of risks
An agreement to provide insurance is • Subrogation
based on a number of principles. These • Proximate cause
are the legally binding guidelines for • Indemnity
entering into an insurance contract and • Utmost good faith
for preparing, filing and managing lawful
• Contribution
claims for compensation.
• Insurable interest
 Indemnity
The principle of indemnity means that in the event of a loss,
the insured person should not be better off or worse off than
before the loss. Indemnity restores you to the same financial
position before the loss occurred.

There should be no profit-making from the compensation. The

amount of compensation is limited to the value of the
insurance policy or the amount of the loss incurred (whichever
is less). If the item/asset has been overinsured, then you will
only be compensated for the actual value. If the item/ asset
has been underinsured, then the compensation will reflect the
proportion of the value.
For example, a garment factory located in Jamaica is valued at
$ 1 000 000. It has been insured for $ 900 000. This means that
nine-tenths of the factory has been insured. If a fire occurs
leading to damage of $ 500 000, then compensation will be
nine-tenths of $ 500 000, which is $ 450 000.
Pooling of risks
Insurance can be viewed as the pooling of risk, since many
individuals and businesses pay a relatively small sum of
money (premium) into a ‘pool of funds’ that will be used by
the insurance company to compensate the insured party in
the event a loss is incurred. The risk is therefore spread
over all those individuals or businesses that have
contributed to the pool of funds.
Insurance companies know most parties will not suffer any loss at all and
those that do suffer a loss don’t usually do so all at the same time. For
example, if 1 000 businesses pay an annual insurance premium of $ 1 000
each to insure their premises against fire or other damage, the pool will
be $ 1 million at the end of the year if there are no pay-outs. If one of the
businesses burns down and claims $ 50 000 to rebuild, the sum is drawn
from the pool $1 million). The risk of loss from fire to business premises is
thus spread among all the policyholders, allowing for indemnity of any
individual contributor when loss occurs.
 Subrogation

When you make an insurance claim for

compensation to replace damaged items (such as
machinery, computer equipment, a vehicle or any
other valuable asset), their ownership passes to the
insurance company once it has paid the
compensation. This is the principle of ‘subrogation’.
Subrogation means that the insurance party will be able to sell the
damaged assets for their scrap value; or, if it can be proved that
the damage was caused by another party, it can recover its costs
from them.
For example, Mr Avocado had fully comprehensive motor
insurance. There was an accident that caused his vehicle to be so
badly damaged that it was unfit for use. The insurance company
paid Mr. Avocado a sum of money equivalent to the value of the
motor vehicle before the accident. The insurance company then
took ownership of the damaged vehicle. Since Mr Avocado was
indemnified, or compensated, for the loss of the car, the
subrogation principle allows for the damaged asset to now be
owned by the insurance company.
Proximate cause
Several factors can contribute to damages or
injury in a financial loss, and some factors may
be insured, and others not. So, it is important
to establish the ‘proximate cause’ of a loss. This
identifies whether or not it is covered within an
insurance policy. Proximate cause is the main
or primary cause of an injury or damages that
give rise to a financial loss.
For example, a factory could burn down following a power
surge caused by an earthquake. If the property insurance
cover excludes earthquakes, then the owner may not be able
to claim.
 Utmost good faith
The principle of utmost good faith means that both
parties (the insurer and the insured) must enter into
the insurance contract with utmost good faith (in
other words, in belief, trust and honesty). Utmost
good faith means that both parties disclose all
relevant facts and issues related to the insurance
contract.
The insurer must give accurate information on terms
and conditions, as well as other information on the
issue. The person being insured must divulge all
related information as well. The insurer will not have
to pay compensation if it is discovered that important
information was withheld, distorted or misrepresented
by the policyholder.
EXERCISE
 Contribution
Sometimes you may take out more than one
insurance policy with different insurance companies
for the same risk. The ‘principle of contribution’
applies here, this means, each insurance company
will only pay part of the compensation.
For example, if a person is insured with different
insurance companies for the same risk and there is a
claim of $ 10 000, the different insurance companies
will contribute money towards the claim. Each
insurance company will pay only a portion of the $ 10
000. However, you will not get more than $ 10 000 in
total from the insurance companies, as then you will
have profited from the event.
 Any individual or company wanting an
insurance policy must have an ‘insurable
interest’. Insurable interest is monetary
Insurable interest in what is being insured. This means
that an insured person will lose money if the
interest event they have insured against occurs.
For example, a business owner has a
monetary interest in any buildings and
equipment owned by the business. This is
because they generate income. If they were
damaged by fire or some other event, the
owner would lose money. A film company
could insure a major actor, because they
would suffer financial losses if the actor was
injured and not able to do their part. This film
company has insurable interest. On the other
hand, you cannot insure your neighbour’s
house ,this is because you do not have an
insurable interest in your neighbour’s house.
Difference • Insurance allows your risk of
loss from known events (such
between as a car accident, fire and theft)
to be transferred from one
Insurance and party to another in exchange
Assurance for a payment (premium).
• Life assurance or life insurance
policies are based on the
certain event of death. The
terms life assurance and life
insurance are sometimes used
interchangeably.
Types of
Insurance
Policies in
business
 How insurance
facilitates business
activity and trade

• Commercial insurance protects business

owners from specific events which can cause
financial problems. Without it, many would
be unwilling and unable to accept the
financial risks, and fewer businesses would
exist. In turn, far fewer goods and services
would be produced, and costs of production
and prices would be much higher.
• Insurance reduces the risk of operating a
business, because it protects business
owners from financial losses that will reduce
profits. For example, catastrophic fires or
major personal injury claims could halt
production and result in bankruptcy
 How insurance
facilitates business
activity and trade
Insurance is crucial to financial and
organisational stability. This is because
liability can quickly lead a business and its
owners into bankruptcy. Without
insurance, businesses would have to draw
down their financial reserves or sell off
assets. Insurance may be needed to repair
or replace damaged property, or pay
compensation to settle lawsuits (such as for
injuries suffered on the business premises
or due to faulty equipment or products).
Sole traders and partners with unlimited
liability may have to draw on their personal
savings or sell their possessions.
 How insurance
facilitates business
activity and trade

A business can offer to provide private

medical and car insurance cover for its
employees. This can be in order to attract,
retain and motivate skilled employees to
achieve business goals. The principle of
indemnity applies here too, and insurance
compensation will seek to put a
policyholder back in the same position as
before the loss. As a result of the
insurance, business operations will be
able to continue in most cases.