INSURANCE

 SS2 Commerce Class Note

Week: 5

Topic: Fundamentals of Insurance

 

 1. Definition of Insurance

Insurance is a legal contract between an individual or business (the insured) and an insurance company (the insurer). In this arrangement, the insurer promises to compensate the insured for specific future losses in exchange for regular payments known as premiums. Essentially, it is a mechanism for transferring and sharing risk. 

 

 2. Importance of Insurance to Individuals and Businesses

Insurance plays a crucial role in the economy by providing financial security and stability.

1.    Risk Transfer and Peace of Mind: It relieves individuals and business owners of the anxiety of potential heavy financial losses.
2.    Business Continuity: If a business suffers a disaster (like a fire or theft), insurance compensation helps the business rebuild and continue operations rather than going bankrupt.
3.    Stimulates Business Enterprise: Entrepreneurs are more willing to invest and take calculated business risks knowing that their major assets are protected.
4.    Encourages Savings (for Individuals): Certain types of insurance, such as life assurance, act as a compulsory savings mechanism for individuals, providing for their families in the future.
5.    Provides Investment Funds: Insurance companies pool the premiums collected and invest them in the economy, which helps fund national development and infrastructure.
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 3. Basic Principles of Insurance

For an insurance contract to be valid, it must adhere to several fundamental legal principles:

1.    Insurable Interest: The person seeking insurance must suffer a direct financial loss if the insured item is damaged or destroyed. You can insure your own car, but you cannot insure a stranger's car.
2.    Utmost Good Faith (Uberrimae Fidei): Both parties must completely disclose all material facts related to the insurance contract. If the insured hides a vital piece of information (e.g., a pre-existing medical condition), the contract can be voided.
3.    Indemnity: Insurance is designed to restore the insured to the exact financial position they were in just before the loss occurred. It is not meant to be a way to make a profit.
4.    Subrogation: Once an insurance company has paid out a claim for a loss, they acquire the right to step into the shoes of the insured to sue any third party who caused the damage, in order to recover their money.
5.    Contribution: If an item is insured against the same risk with multiple companies, the insured cannot claim the full amount from all of them. The insurers will share the cost of the loss proportionally.
6.    Proximate Cause: The loss must be a direct result of the specific peril that was insured against. 

 

 4. Types of Risk

Risk in commerce refers to the uncertainty concerning the occurrence of a loss. They are generally categorized as follows:

1.    Insurable Risk: These are risks where the likelihood of loss can be mathematically calculated based on past data, allowing the insurer to set a sensible premium. Examples include the risk of fire, theft, or motor accidents. 
2.    Non-Insurable Risk: These are risks where the chance of loss cannot be accurately calculated, usually because it depends on unpredictable human behavior, economic changes, or changing trends. Examples include loss of profit due to a change in consumer fashion or bad management. Insurance companies do not cover these.
3.    Speculative Risk: This is a situation where there is a chance of either financial loss or financial gain. A prime example is gambling, buying shares, or starting a new business venture. Speculative risks are generally non-insurable.
4.    Pure Risk: This is a situation where there is only a chance of loss or no loss (no chance of profit). Examples include premature death or a factory burning down. Insurance primarily deals with pure risks.