Fundamental Principles of Insurance

• This edition incorporates web updates issued up to 31 May 2024
• This edition is based on the 2024 examination syllabus, and can be examined between 1 January 2024 until 31 December 2024

Fundamental Principles of Insurance

• Risk is used in different ways in the insurance marketplace
• There is no universally recognised definition for the term risk
• Risk management includes measurement and ways of dealing with the risks

Definition of Risk

• Owning a building brings multiple risks, such as:
• Fire and flood damage
• Injury to someone working or visiting
• Third-party damage from falling parts
• Each represents a risk that can be insured via risk transfer

Risk transfer mechanism

• Insurer's acceptance of future potential risk for an agreed premium
• The term 'risk' can also mean:
• Peril insured (fire, collision)
• Subject-matter of insurance (factory, ship, liability)
• Thing insured and scope of cover required

Attitude to Risk

• Individual attitude varies
• Risk-seeking: willing to carry risks,
• Risk-averse: minimizing risk

Risk Management

• Formal strategy for managing business risks
• Risk managers are commonly appointed in industry/commerce
• Members of the Association of Insurance Risk Managers (AIRMIC)
• Involves deciding to transfer risks through insurance

Function of Risk Management

• May be defined as the identification, analysis, and economic control of risks that threaten assets or earning capacity
• Should address methodically all risks surrounding the firm’s activities
• Involves identification, analysis, and control

Risk Identification

• Discovering existing and potential future threats
• Not all risks are insurable, but must be managed

Risk Analysis

• Risk managers examine past data to evaluate or analyse the risk

Risk Control

• Action put in place to control, reduce, or eliminate risk
• Elimination is most effective, but may be costly or impracticable
• The cost of doing so is reasonable compared to the cost of the feared event

Components of Risk

• Need a deeper understanding of the meaning of risk, and to take a closer look at the various components of risk

Uncertainty

• Implies doubt about the future because there is an incomplete ability to predict what is going to happen

Level of Risk

• Relates to the different levels of risk that exist.
• Risk is usually assessed on the basis of:
• Frequency – describes how often it will happen
• Severity – describes how serious it will be if it does happen

Significance of Frequency and Severity

• Frequency and severity profiles are important to insurers, they wish their businesses to be as free as possible from great peaks and troughs

Categories of Risk

• Not every type of risk or eventuality is insurable.
• Financial vs non-financial risks, pure vs speculative risks, particular vs fundamental risks

Peril and Hazard

• Peril - gives rise to a loss, e.g. fire or flood
• Hazard - influences the operation/effect of the peril
• Physical Hazard: relates to physical characteristics of the risk
• Moral Hazard: arises from attitude/behaviour of people, often the insured person

Financial and Non-Financial Risks

• Some risks cannot be fiscally measured
• Real risk stems from other considerations
• Insurable risks must be measurable financially, and general insurances are compensatory

Pure and Speculative Risks

• Pure risks involve a possibility of loss, where the goal is to break even
• Speculative risks involve activities to make a gain along with a possibility of failure

Particular and Fundamental Risks

• Particular risks: Localised/personal in cause and effect, like damage to specific properties in a storm
• Fundamental risks: Widespread with social, economic, political or natural causes, like famine or war which are uninsurable

Features of Insurable Risks

• Must be financial, pure, and particular and also be a fortuitous event, insurable interest, not against public policy, the risk must generally not be a one-off

Fortuitous Event

• Accidental/unexpected, not inevitable

Insurable Interest

• Legally recognised financial relationship between insured and insured object/liability

Public Policy

• Contracts must not be against public policy
• Insurers should not cover risks that are against public policy

Homogeneous Exposures

• Sufficient exposures to similar risks allow insurers to forecast future losses: "objective risks"
• Without homogeneous exposures, determining a pattern is harder
• Homogeneous exposures are an ideal, not absolute requirement for insurability

Pooling of Risk

• Concept: Losses of the few are met by contributions of the many exposed to similar loss
• Contributions (premiums) from many insureds create a pool
• Payments from pool compensate losses of the few
• Ensure premium relates to introduced risk

Law of Large Numbers

• Insurers benefit, as the number of similar situations increases, the number of actual events will tend towards the expected number

Equitable Premiums

• Pool setup: one for each main risk group
• Joining pool: Each insured makes equitable contribution
• Deciding on contribution: Insurers use discrimination factors

Reasons For Buying Insurance

• Decision to purchase, or not to purchase insurance is based on:
• Attitude to risk
• Price for peace of mind
• Choice about insuring

Primary Functions of Insurance

• Spreading the risk, provide degree of certainty, transferring risk

Secondary Functions of Insurance

• Companies don't have to set aside large sums of money, companies can confidently look to expand their business, jobs are protected, losses are reduced in size and number, insurers are largely investors of funds, "invisible" exports

Compulsory Insurance

• Certain forms of insurance are compulsory

Motor Insurance

• Illegal to use vehicle on public road without insurance (Road Traffic Act 1988)

Employer's Liability Insurance

• Compulsory for GB employers to cover employee injury/disease (Employers' Liability (Compulsory Insurance) Act 1969)

Professional Indemnity Insurance

• Compulsory for certain professions

Claims personnel

• Efficient claims departments, staffed by competent personnel are vital to a use of insurance company's financial resources

Basic Insurance Legal Principles and Terminology

• English contract law governs deals/agreements between two parties
• Insurance contract: agreement enforceable by law between insured/insurer

Essentials of Valid Contract

• Two most important ones are offer and acceptance, and consideration Contract Essentials
• Intention to create a legal agreement: parties act deliberately
• Possibility of performance: agreement must be feasible
• Capacity to enter into legal relations: parties have legal capacity
• Consensus ad idem: both parties agree on the same thing
• Legality: contract must be legal
• Certainty: terms must be clear

Other Valid Contract Requirements

• Absence invalidates contract (void ab initio)
• All parties act in good faith

Offer and Acceptance

• Contract forms when one party provides an offer that is accepted unconditionally

Consideration

• Each person’s side of the bargain supports the contract
• Insured - payment of premium
• Insurer - promise to pay valid claims

Insurable Interest

• Legal right to insure from financial relationship between insured and subject-matter

Features of Insurable Interest

Subject-matter: What is being insured Subject-matter of contract: Relationship the insured has with the subject-matter of insurance Legal relationship: Must be recognised in law Financial value: Insured may face a downside financially

Creation of Insurable Interest

• Common law, contract, statute

Duties of Disclosure During Contract Negotiation

• Apply equally to proposer/insurer
• Openness and transparency in sharing risk info
• Fair presentation of the risk
• Consumer Insurance (Disclosure and Representations) Act 2012
• Insured duty to take care not to misrepresent

The Insurance Act

• The Act states the insured cannot data dump on the insurer
• the insurer has to consider whether the presentation invites to be asked further questions; the burden to ensure those questions is on the insurer, if needed

Examples of Information That Does Not Need to be Disclosed

• Matters of law, state of war exists etc, factors that lessen the risk

Remediation

• Under the Act, there are a number of remedies for breach of the duty of fair presentation
• First decision - was the breach deliberate or reckless?
• Second decision - did the breach took place as part of the original risk placement or in relation to any variation of the contract?

Remedial Placement

• Insurer can avoid policy ab initio and retain premium if breach was deliberate/reckless
• Insurer must return premium to prevent the insurer from entering into the contract at all if the correct information had been presented

Variation

• A variation or change to an insurance contract can occur at any point after the original placement is concluded.
• A variation can be anything from a simple change, such as the correction of a spelling mistake, or something more substantial, such as adding a new asset to an insurance policy.

Insurers Duty of Disclosure

• to the insured so they behave in good faith by explaining clearly the various products available and the options available to the insured and an insurer's ability to reduce premium if an insured fits sprinklers or superior locks to property

Peril

• Defined as cause of loss

Hazard

• Influences operation/effect of peril

Nature of Perils Classification

• Insured perils: Covered by a policy, named in the policy
• Excepted perils: Named in policy as specifically uncovered
• Uninsured perils: Not mentioned in policy

Indemnity

• Actual payment by insurer depends on:
• Cover's nature and extent
• Conditions
• Short-term contracts: Contracts to indemnify the insured

Definition of Indemnity

• Sufficient financial compensation to restore insured to pre-loss financial position

Option Available to Insurers

• Number of settlement options
• Cash payment
• Repair
• Replacement
• Reinstatement

Property Insurance Indemnity

• Indemnity is limited to the sum insured

Inner Limits

• Most policies contain inner limits with the overall sum insured

Average

• Understating Value: This is when the person understates the subject-matter of the insurance value

Excess

• A deductible is deducted last if there is underinsurance or any other policy term that limits or reduces a loss, and an excess or deductible applies to the same loss

Franchise

• Operates the same way, however it differs once the claim value exceeds the franchise value In general, policies that contain an excess will pay up to the policy limit over and above the excess building

Contribution Definition

• The insurers endeavor to makes a financial contribution to allow others to call upon

How Contribution Arises

• Common subject-matter of the insurance, there must be common insurable interest, both policies must be liable for the loss, insurance must be insured against common perils

Rateable Proportion

• Insurers contribute to a claim on a rateable proportion, two possible ways of determining the rateable proportion of a claim include: sum insured, and independent liability method

Subrogation

• Right of an insurer following payment of a claim, to take over the insured’s rights to recover payment from a third party responsible for loss

Contribution

• Contribution is the right of an insurer to call upon others similarly but not necessarily equally, liable to the same insured to share the cost of an indemnity payment.

No Rights

• The insurers right to subrogate relies on the insured having rights against a negligent party

Types of Insurance

Marine Insurance Hull and yacht/recreational vessel insurance includes ships, etc Commercial vessel insurance includes cargo vessels, cruise vessels The key element is damages to the insured ship = 1st party insurance Also covers maritime claims

Vessel construction Insurance

The construction of a vessel is a lengthy process for both the owner and builder, This provides a combined physical damage and liability cover The main aspects are the length of the process but also increasing values as the building processes through

Loss of Earning Insurance

If shipowners cannot use that ship and lose money from it

Marine Liability Vessel Insurances should address

Liability for crew death and injury, Visitors death and injury Liabilities from cargo escape which can cause pollution, liability for the good itself, liability for damage done with another property like docks lighthouse

Non-Marine Insurance

• Property/physical damage can be "1st party and short-tail"
• Liability can be "3rd party or long-tail"
• Property, Construction, Onshore energy

Property Insurance

• Physical damage insurance for buildings, offices, industrial buildings, public, retails

Stocks Insurance

• A physical damage covering stock
• Regular declaration of stock levels
• There is no danger of undrerinsurance

The Insurance Sector

• The Insurance sector includes pipelines, renewable energy and petrochemical processing

Construction Insurance

• Combo of physical damage and liability called contractors all risks CAR policies or Erection All risk EAR policies

Insurance Sector Includes

• Reputation cover, director and officers liability, business interruptions and potential cyber hacks

Insurance contracts that cause financial loss rather than physical loss Fidelity gaurantee insurance - which relies on fraduletn acts

Bloodstocks and livestock

• Are not pet insurances but are for animals instead which are used for race hoses or competition Also covers infertility

Personal accident or general liabilities

• The UK have public liability, professional liabilities, general liabilities and products liabilities

Maritime insurance in terms of terrorism

Includes cover for war and strikes

Satellites Insurance

• Includes satellite insurances in space, or at facility before it is sent into space

Kidnapping Insurance

• Involves capturing of a person and then demanding payment or a ransom for their release Payment for medical expenses for the captured ransom with the main provision given to negotiation

Intellectual property insurance

Is the technical term rights that companies and individuals have to adhere to , inventors are their legally patented This will cover legal costs or the potential you have interfered with some one intellectual property rights

Aviation Insurance

Includes both commercial and personal planes helicopter etc where we measure types of damage, for both personnel and general Including Loss of license for use of insurance

Reinsurance

• Where a company provides insurance to another insurance company to transfer the ri