Slide 6.7.8 - Understanding Insurance: Concepts and Evolution

Concept of Insurance

• The modern world is full of risks and uncertainties that affect people, business, and assets.
• These risks include potential losses to life, health and property.
• Insurance products have been created in order to mitigate potential losses by offering financial compensation.
• Insurance minimizes the financial impact of risks to protect individuals from loss and uncertainty, compensating for potential losses.
• Insurance can be seen as a social tool that reduces the peril of loss to life and property, safeguarding the economic value of personal assets.
• Insurance helps to protect against unexpected events.
• Asset owners assign a value to insured property which provides benefits and protection against potential losses.

Evolution of Insurance

• Insurance started thousands of years ago with "pooling risks".
• Common funds were established at the village or community level where many people made contributions.
• The amount each person contributed was determined based on past experience, not individual prediction.
• Funds were used to compensate those who had losses.
• A village with 500 houses valued at AED 200,000 may have an average of 4 houses damaged annually by fire, for a loss of AED 800,000.
• If 500 homeowners contributed AED 1,600 each, the collective funds can cover this risk.
• The risk is spread across all homeowners.
• The first known written insurance policy was present on a Babylonian obelisk monument that contained the code of King Hammurabi.
• The Hammurabi Code was one of the initial forms of written laws.
• Cargo protection was given to Babylonian traders through basic insurance measures.
• The general average principle is a maritime law concept that requires all parties in a sea venture to proportionally share losses from a voluntary sacrifice of ship or cargo to preserve the entire vessel.
• A fire began at a bakery on Pudding Lane in London, 1666 which then spread rapidly.
• Residences primarily consisted of timber-framed buildings that were clustered closely together, making them vulnerable to fire.
• As the city was rebuilt after being contained, people were left without homes, highlighting the need for a professional fire service and insurance for homeowners and business owners.
• In response, insurance companies emerged, which offered coverage to property owners.
• It was recognized that preventing fires was a high priority and insurance companies, therefore, established their own fire services to minimize the risk of fires in the first place.

Principles of Insurance

• The business of insurance protects the economic value of assets or life.
• A contract between the insurer and insured agrees to make good any loss on the insured property or loss of life that may occur over a course of time as determined by the premium paid.
• The Principles of Insurance include:
  • Utmost good faith
  • Insurable interest
  • Indemnity
  • Subrogation
  • Contribution
  • Proximate cause
  • Loss Minimization

Principle of Utmost Good Faith

• Both the insured and insurer should maintain honesty and have good faith toward each other.
• The insurer must provide the insured complete, correct, and clear information regarding the terms and conditions of the contract.
• The person getting insured must willingly disclose and surrender all true information to the insurer regarding the subject matter of insurance.
• The insurer’s liability could become void if any facts about the subject matter of the insurance are omitted, hidden, falsified, or presented in a wrong manner.

Principle of Insurable Interest

• The insured must have insurable interest in the subject matter.
• In life insurance, it refers to insuring the life of a person.
• In marine insurance, the insurable interest has to exist only at the time a loss occurs.
• The person being insured must have insurable interest in the insured object.
• A person has an insurable interest when the physical existence of the insured object gives some gain but its non-existence will give a loss.
• The insured person must suffer some financial loss by the damage to the insured object.

Principle of Indemnity

• Indemnity restores the insured to the position they were in right before an unforeseen event.
• The insurer agrees to compensate for the loss incurred.
• Indemnity provides security, protection, and compensation to cover damage, loss, or injury.
• An insurance contract is designed to protect against unforeseen financial losses that may result from upcoming uncertainties, so its objective is not to generate profit, but to offer compensation when an event occurs.
• The amount of compensation paid in an insurance contract is proportional to incurred losses, and limited to the amount assured or the actual losses (whichever is less.)
• Compensation is not paid if the specified loss doesn't happen for a particular reason during a specific time period.
• Insurance is only for protection against losses and not for making profit.

Principle of Subrogation

• According to this principle, the ownership rights of property are transferred to the insurer, once the insured is compensated for the loss or damage to the insured property.
• The principle is applicable only when the damaged property holds any value following the event that caused the damage.
• The insurer can only benefit from the subrogation rights to what has been paid to the insured as compensation.
• Subrogation is an extension and corollary of the principle of indemnity or substituting one creditor for another

Principle of Contribution

• The principle of contribution is corollary to the principle of indemnity and it applies to all contracts of indemnity.
• The insured can only claim compensation to the extent of actual loss either from any one insurer or all the insurers.
• If a single insurer pays full compensation, that insurer can seek contribution from any other insurers.
• It applies when the insured has multiple policies covering the same subject matter.

Principle of Proximate Cause

• Principle of Causa Proxima or the principle of Proximate, is when a loss is caused by more than one cause.
• The nearest or closest cause is taken into consideration in order to determine the liability of the insurer. This is also known as the most dominant and direct cause of the loss.
• The loss of the insured property can be caused by more than one cause in succession to another.
• The property may be insured against some causes and not against all causes and the proximate should be found out.
• If it's the one that is insured against, the insurance company must pay the compensation.
• The insurer is only liable for the closest (proximate), not the most remote cause.

Principle of Loss Minimisation

• The insured person is obligated to take all reasonable steps to minimize the loss to the insured property, when an uncertain occurrence occurs.
• The insured must make every effort to reduce the loss of their insured property, when faced with unforeseen events (such as a fire, explosion, or similar incidents).
• The insured is expected to take all necessary actions to control and mitigate such losses.
• The insured must not act negligently or irresponsibly simply: it remains the insured's responsibility to protect the property and prevent any further damage or loss.