ROMA GIRLS SECONDARY SCHOOL

COMMERCE NOTES
INSURANCE
Def. Insurance is an aid to trade that provides cover to businesses against financial losses caused
by risks such as fire, theft, floods, accidents etc.

Insurance involves a written agreement between the Insurance Company (Insurer) and another
party (Insured) where the Insurer promises to compensate or pay a specified sum of money on the
happening of a particular event which results into a financial loss on the insured.

The Insured is expected to make a small payment regularly called a premium during the period of
cover.

PURPOSE/ IMPORTANCCE OF INSURANCE

 To a business
 Insurance enables the business to arrange for compensation or indemnification in case of a
loss resulting from the occurrence of a risk.
 Insurance provides businessmen and women with the confidence to continue trading and
to enter into large scale business investments that they might have avoided for fear of
incurring great financial losses.
 Some businesses, especially those involved in foreign trade would need relevant insurance
documents to obtain payment through documentary credits.
 Insurance helps businesses to settle claims against them from third parties through
employer liability insurance, third part fire and theft motor insurance and public liability
insurance.
 Insurance provides companies with the opportunity to pool up risks and for a fairly low
monthly or annual premium, reduce the risk of financial loss.

 To an individual
 Life assurance provides a savings plan and also benefits the dependants of the assured
through e.g. endowment policies, whole life policies and investment policies.
 Insurance helps individuals to overcome misfortunes like the theft or damage of property by
fire, floods or accidents.
 Insurance reduces the suffering and loss of earnings caused by disablement due to
accidents through compensation from companies with public, employer and third party fire
and theft insurance policies held by businesses.
 Insurance provides safety and security against the loss on a particular event. In case of life
insurance payment is made when death occurs or the term of insurance is expired. The
loss to the family at a premature death and payment in old age are adequately provided by
insurance. In other words, security against premature death and old age sufferings are
provided by life insurance. Similarly, the property of insured is secured against loss on a

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 fire in fire insurance. In other insurance, too, this security is provided against the loss at
fire, against the loss at damage, destruction or disappearance of property, goods, furniture
and machines, etc.
 Insurance affords peace of mind since much of the uncertainty that centres about the wish
for security and its attainment may be eliminated.
 Insurance protects mortgaged property. At the death of the owner of the mortgaged
property, the property is taken over by the lender of money and the family will be deprived
of the uses of the property. On the other hand, if the property was insured, the insurance
company will provide adequate amount to the dependents at the early death of the
property-owner to pay off the unpaid loans. Similarly, the mortgagee gets adequate amount
at the destruction of the property.
 Life insurance provides profitable investment. Individuals unwilling or unable to handle
their own funds are able to find an outlet for their investment in life assurance policies.
Endowment policies, multipurpose policies and deferred annuities which are a better form
of investment.

 To a nation
 Insurance is an invisible export that brings income to the country and helps to improve the
country’s balance of payment position.
 Insurance companies work as institutional investors. They lend money to businesses such
as banks, joint stock companies and in this way they make an important contribution to the
economic life of the country.
 Insurance helps the country’s economy to grow by giving confidence to businessmen and
women to enter into large scale business investments thus providing the much needed
goods and services and employment to the many citizens in the nation.
 Insurance creates jobs in nearly every area of the country. It also allows companies to
continue producing homes, cars, jewellery and other items that would represent substantial
financial losses if they were damaged or stolen. This allows people who work for these
companies to continue earning income.

HOW INSURANCE WORKS

 POOLING OF RISKS
 Insurance functions on the concept of pooling of risks or sharing risks. Because “a loss
lighteth rather easily upon many than heavily upon a few”.
 Pooling of risks means people or businesses faced with a risk make a small amount of
annual or monthly payment to the insurance company in return for insurance cover.
 The annual or monthly payments made in return for insurance cover are called premiums.
 In this way a common fund (collection of premium, pool) is created at the insurance
company.
 From this pool the insured who suffer financial losses are compensated. Thus, the pooling
of risks enables the fortunate to help the unfortunate.
 The pool of funds contributed is used in the following ways:

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  As compensation money to those who suffer losses.
 For administrative expenses of the insurance company such as salaries, rents,
equipment, tax, stationery, transport etc.
 Pay profits (dividends) to shareholders of the insurance company.
 Surplus funds are invested in property, businesses and some lent out to businesses
and the Government.

 THE STATISTICAL BASIS OF INSURANCE

a) Statistics is information shown in figures collected from the past, arranged for comparisons and
used to predict future events.
b) The importance of statistics to insurance companies include the following:
 Statistics enables insurance companies to assess risks and thus be able to decide whether
to accept these risks or not.
 Risks that have statistics (i.e. past records) are accepted by insurance companies while
those with no past records are not accepted.
 Statistics help insurance companies to work out the number of possible losses each year
(the frequency of losses)
 Statistics help to calculate the possible size of each of these losses.
 Statistics help insurance companies to value assets or property at risk (the maximum
possible loss).
 Statistics helps insurance companies to calculate a fair premium required to accumulate a
sufficient pool of funds out of which those who suffer losses are compensated.

 THEORIES OF PROBABILITY- This is a branch of mathematics and is concerned with

the analysis of the likelihood of events or risks occurring. Insurance experts known as
Actuaries use computations based on the likelihood of a risk occurring to help determine
how much premium can be paid for insuring against a particular risk.

 THE FREQUENCY OF RISKS –this means that the insurer would look at the number of
times a particular risk has occurred in the past and also the future likelihood. The
rationale is that the higher the frequency, the more likely that the premium would be
high.
Examples of insurance service providers in Zambia include: Zambia State Insurance Corporation
(ZSIC), Madison Insurance, Goldman Insurance, Professional Insurance, A-Plus Insurance etc.,
Guardian Insurance, etc.

INSURABLE AND NON INSURABLE RISKS

A risk is an event that causes financial loss. There are two types of risks namely insurable and non-
insurable risks. Their differences are as follows:

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 INSURABLE RISKS NON-INSURABLE RISKS

A These are risks that can be insured against These are risks that cannot be insured against

B They have past records They have no past records

C They are capable of being assessed and their They are not capable of being assessed and their
chances of occurring estimated. chances of occurring cannot be estimated.
D A fair premium can be calculated on them. A fair premium cannot be calculated on them. Not easy to
accurately calculate or ascertain the premium.
E A business undertaking or activity must be A risk is non-insurable if the act is illegal and is not in the
legal. For its risks to be covered by insurance public interest e.g. Stealing, drug trafficking.
Companies
F A person only has insurable interest in an A risk is also non-insurable if the person seeking
item if the item belongs to him/her. insurance cover has no insurable interest in the item to be
insured.
G The risk is preventable or its effects can be Most non insurance risks are un preventable
reduced through precautionary measures
H A large number of are interested in being Very few people are interested in insuring against such
insured. risks
I Occur regularly Do not occur regularly

J Examples of insurable risks include Examples of non-insurable risks include risk due to
Fire changes in fashion
Theft Bad Management
Accident Poor sales
Burglary Natural catastrophes like:
Aviation Earthquakes, Hurricanes
Marine
Public liability
Engineering

THE PRINCIPLES OF INSURANCE

The operations of insurance are governed by a set of principles which ensure that the insurance
pool of funds is not abused by gamblers on insurance. Failure to comply with the principles may
render a policy null and void, in which case the insurance company would not pay out any claim
arising from such a policy. The main principles are:

a) The principle of insurable interest

i. The principle of insurable interest states that the insured must possess an insurable interest
in the object insurance (in the property to be insured).
ii. Insurable interest may be defined as a financial interest in the subject matter of contract. This
means only the person who stands to lose financially if the risk insured against occurs has
the right to insure the property or life.

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 iii. So an insurance contract without the existence of insurable interest is not legally valid and
cannot be claimed in a Court.
iv. The importance of the principle of insurable interest is that it prevents people who are not
true owners of items from insuring them. This is because if people were allowed to insure
items or lives which do not belong to them, they might be tempted to deliberately destroy the
items in order to claim compensation and thus make profit out of the loss. It therefore
prevents insurance from becoming a gambling contract
v. For example, if Ms. Tembo owns a house, she is entitled to insure it because she stands to
lose financially (i.e. she will lose the money that she spent on building or buying the house) if
it is destroyed by floods or fire. Her neighbour Mr. Katyamba cannot insure Ms. Tembo’s
house because he has no insurable interest in the house. He would not lose anything if the
house is destroyed. Mr. Katyamba might also be tempted to destroy the house so as to
claim compensation and make profit out of Ms. Tembo’s loss.

b) The principle of Utmost good faith

(Also known as the Principle of disclosure or Uberrima fides).

The principle of Utmost Good Faith also known as Uberrima Fides demands that both the insurer
and the insured must act in good faith by telling the truth without leaving out any material facts
relating to the insurance contract whether asked for or not. The proposer (person seeking
insurance cover) should complete a proposal form giving full, accurate and detailed information
without omitting any material facts relating to the risk and property being covered.

i. The principle of Utmost good faith states that both parties (insurer and the insured) in the
insurance contract must disclose all material facts for the benefit of each other.
ii. This is important because correct information helps the insurance company to:
1) Assess the risk
2) Decide whether to accept the risk or not
3) Calculate a fair premium
iii. The information will also help the person seeking insurance cover to make a decision to
either accept or reject the conditions.
iv. False information or non-disclosure of any important fact from either party makes the
contract voidable or nullified.
v. The insurance company on its part must honour all its promises reflected in the insurance
contract.
vi. For example, a person insuring a house against fire must tell the insurance company the
truth if he or she keeps inflammable materials like petrol, paraffin, etc. in the house. The
presence of inflammable materials increases chances of the house catching fire, and
therefore a higher premium may be fixed. Where information on inflammable materials is
withheld and later the insurance company discovers this omission of facts, the insurance
contract would be void and compensation refused if the house is destroyed by fire.

c) The principle of indemnity.

i. The principle of indemnity states that the insured must be restored to the same financial
position as before the risk. This means replacing what one has lost.

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 ii. The principle of indemnity is based on the idea that the assured in the case of loss shall
only be compensated against the actual total loss. The insured must not be allowed to
make profit out of the loss as he/she may be encouraged to cause losses deliberately.
iii. Indemnity is limited to the sum insured as insurance companies do not compensate at
more than the sum insured. It always pays out at either the sum insured or at the market
value of the loss whichever of the two is lower.
iv. The principle of indemnity is supported by two subsidiary principles, rules or corollaries of
contribution and subrogation.

Contribution
Contribution applies where one insures an item with more than one insurance company. If the
item is destroyed by the risk insured against, the insurance companies concerned would
contribute proportionately toward the amount of compensation required without allowing the
insured person to make profit out of the loss.

Subrogation
 To subrogate means to take over the right to the remaining or salvage value of the scrap. It
is derived from two Latin words “Sub” and “Rogare” which means to step into the place of
another person.
 Subrogation states that once the insured is compensated in full for the loss, the residue or
remains of the damaged item becomes the property of the insurance company.
 The insured must not be allowed to make profit out of the loss by receiving compensation
money and keeping the wreck or recovered item. It prevents the insured being indemnified
from two sources in respect of the same loss.
 Suppose Mr. Kaliye’s car stolen and the matter has been reported to the Insurance company
who after a professional assessment replaces Mr. Kaliye’s car with a car of the same value
and make. If after this compensation, Mr. Kaliye’s stolen car is found, subrogation demands
that the lost car be handed over to the insurance company as failure to do so would result into
Mr. Kaliye having two cars hence profiting from the bad incidence of losing his car.
 Another good example of how subrogation is applied is where one whose car has been
replaced after being involved in a road accident, is required by law to surrender the wreckage
to the insurer who becomes the owner of the wreckage once the insured has been
compensated.

Underinsurance

v. Underinsurance is when the insured value of an item is less than its actual value.
vi. In such cases the rule of Average Clause applies. This rule states that the insured is
his/her own insurer for the value of the item not covered by the insurance company. If a
person insures 60% of the total value of the item, the insurance company would also pay
out 60% of the total loss sustained in compensations.
vii. This prevents people who under insure from making profits out of their losses.
viii. For example, if you insure a car valued at K80 000.00 for only K60 000.00 and it is later
partially damaged in an accident such that it needs K40 000.00 to repair, the amount of
compensation will be calculated as follows:

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 Insurance claim = Sum Insured X Market value of loss sustained
True value

= K60 000.00 X K40 000.00

K80 000.00

= K30 000.00

Therefore, the insurance company will only pay out K30 000 .00 in compensation. The rest of
the expenses will be borne by the insured.

Cases where Indemnity does not apply

The principle of indemnity does not apply to some situations because not all types of losses
can be restored to the same financial position as before the risk occurred. The following are
examples:

 Death or loss of body parts. Once a person dies, life cannot be replaced or if a person
loses an eye it cannot be replaced.
 Offer of new for old insurance policies. Some insurance companies offer new for old
insurance policies where the old items lost are replaced with new ones. In this case the
principle of indemnity does not apply because the insured is restored in a better financial
position than he/she was in before the risk occurred.
The doctrine of Proximate cause or Causa proxima

The doctrine or principle of proximate cause states that the insurance company or insurer is only
liable for the insured peril and can only pay compensation if the loss was caused by the risk that
was covered by the policy and the cause of the risk is within the precise terms of the policy.

The cause need not be the first or last but must be the dominant cause or there must be a direct
link between the cause (insured risk) and the result (loss incurred).

a) The insurance company would only compensate a person who has suffered a loss if the risk
insured against is the immediate cause of the loss.
b) This principle is found very useful when the loss occurred due to series of events. It means
that in deciding whether the loss has arisen through any of the risks insured against, the
proximate or the nearest cause should be considered.
c) No compensation is payable if the loss is caused by a risk not insured against.
d) For example, if a farmer insures his store house against fire and not burglary, and the store
house is destroyed during a burglary, the farmer has no cause to claim for the loss suffered.
This is because the risk that was insured against was not the immediate cause of the loss.