Principles of Business

Form 4

Legal aspects of business: Insurance

Watch the video and answer the questions.

1. Who came out of the flood financially better, Paul or Dave?

2. Why?
3. What is insurance
4. State ONE benefit of insurance

[Link]
What is Insurance

A promise of financial compensation in the possible event of specific future losses, in

exchange for a periodic payment (premium).

Assurance- a promise of financial compensation following an inevitable event e.g. death

OR reaching old age.
Insurance is provided by insurance companies
such as
Benefits of insurance

1. Facilitates Trade
2. Provides a means of savings
3. Tax benefits
4. Provides collateral security for loans
5. Provides employment
6. A means of investment
7. Provides compensation in the event of a loss
Risks

A chance of something bad happening e.g. fire.

Some risks are insurable because:

1. A large group of persons face a similar risk but only few it happens to.
2. It may happen.
3. There is past data so that premiums can be calculated.
4. The person buying the insurance will be affected financially if the risk occurs.
Uninsurable risks

Are risks that you cannot purchase insurance for.

Can you buy insurance for contracting covid19? Why or why not?

Name some uninsurable risks?

How insurance works- The pooling of risks

Those at risk pay premiums into a pool, managed by an insurance company, to

compensate for losses suffered by themselves or others. Out of this pool the insurance
company pays expenses such as wages.

If nothing happens to the insured the insurance company wins!

Principles of Insurance

1. Indemnity
2. Insurable Interest
3. Utmost good faith
Utmost Good faith

The means that all vital/relevant facts that might affect the risk and thus the premium
charged by the insurance company must be disclosed. For example when purchasing life
insurance any health conditions likely to affect the insurance company accepting the risk
must be disclosed e.g. is the person being insured a heavy smoker.

This principle also applies to the insurance company.

Information is recorded on a form known as a PROPOSAL, which becomes a legal

contract between the insurer and the insured. Failure to give relevant information could
mean the insurance company may refuse to pay on the claim.
Insurable interest

To prevent persons from profiting from insurance the insurance company will insure
against a risk only is the insured would suffer if the risk insured against happens.

If an individual could just collect insurance because something bad happened to someone
else then the likelihood of that person causing the accident would be very real.

Therefore one can never purchase insurance for e.g. their neighbors house.
Insurable Interest- Exception

The exception is this that one can purchase insurance for their spouse’s life. The
reasoning behind this is that if your spouse dies one stands to lose financially.

However there are countless instances of the crime of murder, where persons cause the
death of their spouse in order to collect life insurance.
Indemnity- Compensation

This means that the policy holder will be compensated for the insured loss by the
insurance company to restore them to their former position.
What is the exception to this?

The point is the insured must never profit from insurance.

Clauses of indemnity

1. Contribution
2. Over insurance
3. Underinsurance/average clause
4. Subrogation
5. Proximate cause
Contribution

If an accident occurs and the insured had insured against this risk with two insurance
companies, the policy holder will not receive double the compensation. Instead the
insurance company will agree between them on how much each will contribute towards
the total compensation to be paid to the policy holder.
Overinsurance

Persons will only be compensated for the true value of an item. So if a person takes out
an insurance policy for a diamond ring and puts a value of $10 000 on it but is aware that
the real value is less, then the insurance company will only pay out the true lesser value.

One cannot insure an item for more than it is worth.

Underinsurance/
Average Clause

This is when an asset is insured for less than its true value. This is done in order to reduce
the premiums paid. However the insurance will calculate the percentage of the asset
insured and pay out less than is expected.
Example:
If a policy holder intentionally insures their $100 000 property for $80 000 and there is
damage of $10 000, the insurance company will only pay out $8000. Since only 80% of
the property was insured then only 80% of the claim will be honored.
80 000 × 100 = 80% Value insured × 100% = percentage of insurance
100 000 True value
So 80% of 10 000 = $8000
It is a calculated Issue!

1. If Princess Blac insures her $250 000 for $200 000 and a fire damages a part of the
property for $30 000 calculate:
a) What percentage of the house is insured?
b) How much will Princess Blac receive?
2. A factory claimed damages of $500 000 from their insurance company. However the
company would only meet 90% of the claim because the firm was underinsured.
c) Briefly describe how the insurance company decided on the 90%.
d) How much money will the factory receive?
e) Suggest TWO possible means of getting the rest of the money .
Feedback

 1. a) Percentage insured = 200 000 × 100

250 000
Answer 80%
b) 80% of $30 000 = $24 000
2 a) Once a property has been underinsured the insurance will use the formula ( value
insured ÷ true value) × 100
B) 500 000 × 90 = $450 000
100
C) Bank Loan, sell shares in the company
How insurance facilitate trade

 Taking on many of the risks of firms.

 Traders would not send goods if they were not assured of compensation for losses
incurred while the goods were in transit
 Insurance companies provide a source of capital as they are investors
 Insurance companies are also involved in the construction industry as they also
purchase/procure real estate.
Proximate cause

This principle states that a claim will only be honored if the loss suffered is a direct result
of the risk occurring.
If a person when travelling on a plane insures against death or injury from a plane crash,
but then dies of a heart attack on the plane. No compensation will be paid out.
If a factory is insured against fire but the fire started from an oil tanker parked nearby,
the factory owner would need to seek compensation from the owners of the oil tanker.
If in order to get to a fire that started in the bathroom, firemen had to break down the
door of a house then the insurance would honor the claim for the door as well as the
bathroom.
Subrogation

This means ‘to take the place of’.

Example:
If your car was involved in an accident and was totally damaged, the insurance company
will compensate you BUT the wrecked vehicle becomes the property of the insurance
company. Therefore the compensation takes the place of the car!

If this were not the case the insured would sell the parts of the wrecked vehicle and
collect the value of the car in compensation from the insurance company. This would
mean that the insured profited from insurance. And if you remember the principle of
indemnity states that one MUST NEVER PROFIT FROM INSURANCE!
Types of insurance

A. Life Insurance
B. Non-life insurance/Business insurance
Life Insurance

1. Whole life insurance

2. Endowment policies
Whole life policies

Designed so that when someone dies their beneficiaries usually the spouse or the
children is compensated.
This gives the insured peace of mind that if they die their family will receive financial
support.
There is also term life policies that provide insurance coverage for a fixed period of time
e.g. 10 years, if one does not die during this time no payment is made by the insurance
companies.
Endowment Policies

Provides life coverage in the same way as term policies however if at the end of the
term one does not die then a payment is made. This is a common way of saving.

When a with profits endowment policy is taken out the policy holder shares in the profits
of the insurance company.
Non-Life Policies

Common types of non-life policies:

 Fire insurance
 Accident insurance
 Marine insurance
 Fidelity insurance- covers loss to the business due to fraud by employees.
 Product liability insurance- covers loss to the business if a customer takes legal action
because of the product of the business.
 Credit insurance- covers loss to the business caused when customers do not pay their debts.
 Goods in transit insurance- covers loss or damage to goods while they are being transported.
 Personal accident insurance
Fire Insurance

Provide protection in the case of damages caused by a fire however they also include,
theft, flood, storm and so on.

A consequential loss insurance can be added so the business can be compensated for
loss of earnings during the days the business was unable to trade.
Accident Insurance

Covers:
1. Motor vehicle insurance
2. Employer’s liability insurance- covers the employer’s liability for the safety of their
employees.
3. Public liability insurance-covers the liability of businesses for accidents by visitors to
the premises of the business.
Motor vehicle insurance

Two common types

1. Comprehensive insurance- covers all risk to the insured e.g. personal injury to the
driver and passengers and third parties.
2. Third party, fire and theft- provides protection only for third parties, fire and theft.

Note:
There are two parties to the insurance contract the insurer (insurance company)and the
insured. Anyone else covered in the contract is considered a third party.
Marine insurance

Consist of:
 Hull insurance- covers the ship itself
 Cargo insurance- covers the goods carried by the ship
 Freight insurance- covers the cost of transporting the goods in case something
happens and the goods were not delivered.
 Shipowner’s liability insurance- covers the ship owner in case of accident e.g. collision,
pollution of beach
Personal Accident
Insurance

Insurance coverage for accidents to individuals or groups of people. Compensation is

provided for losses due to total or partial disability arising from accidental causes.

Celebrities usually take out this type of insurance in case they are injured and cannot
work for long periods of time.

Persons travelling on an aircraft can take out a short-term policy to cover them for the
period of flight.
The insurance contract

 The prospectus
 The proposal
 The premium
 The policy
 The claim
Prospectus

A leaflet with the services provided by the insurance company. Today this information
can be found on a company’s website.
The Proposal

The application form. It is important that the proposer (the person wanting to buy
insurance) gives every detail which applies to the risk. If a ‘material fact’ is concealed the
policy will be ineffective.
The premium

After the proposal the insurance company will determine the premiums to be charged.
The person who calculates premiums is called an ‘actuary’. In calculating the premiums
the points to be considered include:
 The value of the item being insured
 The risk involved
The Policy

The document sent to the insured that states what is insured. In other words it is the
insurance contract. The following documents may also be issued in association with the
policy:
1. Certificate of insurance- Evidence of insurance
2. Cover note: temporary document showing proof of insurance whilst the certificate of
insurance is being prepared.
3. Endorsement- notice of changes to the policy, usually by the insurer.
4. Renewal notice- issued by the insurer prior to the expiry date of the insurance.
The claim

Is made when the risk insured against happens.

Loss adjustors are then sent to ensure that claims are settled fairly.
Graded Activity-

Jane Steel has a small shop in the rural town of Mavis Hill. She buys and sells a wide
range of items. Some of these are imported. In recent time there has been an increased
level of crime in the community, with several businesses in the area being the target of
robberies and arson.
a) Distinguish between ‘insurance ‘ and ‘assurance’. (2 marks)
b) State THREE principles upon which insurance is based.
(3 marks)
c) Identify THREE types of insurance risks which businesses in Mavis Hill could insure
against and state how the business will benefit from EACH risk named. (6)
d) i) Identify THREE trade documents that Jane Steel may use when importing goods. (3 )
ii) State the purpose of EACH of the THREE trade documents you identified in d (i) above.
(6)