CIN 311

PRINCIPLES OF INSURANCE
1 INTRODUCTION

1.1 Concept of Risk

There have been many attempts to define „risk‟. Probably, to most of us,
„risk‟ contains a suggestion of loss or danger.
The word risk is certainly used frequently in everyday conversation and seems
to be well understood. Risk implies some form of uncertainty about an
outcome in a given situation. An event might occur and if it does, the outcome
is not favourable to us. Risk can be contrasted with the word chance which
implies some doubt about the outcome in a given situation; the difference is
that the outcome may also be favourable e.g. risk of an accident, chance of
winning a bet etc

However in common business conversations the word risk is used to mean

different things:
i) Risk as cause e.g. fire as a risk, Personal injury as a risk etc.
ii) Risk as likelihood e.g. the risk of something happening, leaving keys in
a car results in high risk etc.
iii) Risk as the object – e.g. factory, plane, machine or ship might be
referred to as the risk.
vi) Risk as verb – It is not only used as a noun but also as a verb e.g. risk
of crossing the road.

All the above illustrate how the use of the word goes far beyond its technical
meaning.

1.2 Meaning of risk

Various scholars have advanced different definitions of risk as follows:-

i) Risk is the possibility of an unfortunate occurrence.
ii) Risk is a combination of hazards.
iii) Risk is unpredictability – the tendency that actual results may differ from
predicted results.
iv) Risk is uncertainty of loss.
v) Risk is the possibility of loss.

Rather than try to ascertain the best definition of risk, the underlying commonality in
all the definitions should be of interest. From the above definitions some common
thread runs through each of them namely:

i) Uncertainty – It suffices because we have imperfect knowledge which leads

to doubt and hence the uncertainty which we express e.g. a child playing in the
middle of a busy road. Uncertainty implies doubt about the future based on a
lack of knowledge or imperfection in knowledge. If we always knew what was
going to happen, there would be no risk. Risk exists outside the individual, it

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 might be recognized as existing but this is not a pre-requisite. Risk is thus
objective and not dependent on any one individual.
ii) Levels of Risk – there are different levels of risk, some will be more or less
risky than others. This can be illustrated by looking at a house constructed by
the river side (River Nzoia in Budalangi, Busia), the river being known for its
potential to overflow its banks. The word risky may describe this situation.
There is uncertainty as to whether the river will flood or not. The fact that the
river is known for flooding has heightened the prospect that damage will
occur, that is, the frequency of damage is high. The term risky may be used to
denote this heightened possibility. If another house is constructed further from
the river bank and on a slight hill, it is in a less risky situation, not because the
prospect of the river flooding has changed but because the possibility of
damage being caused to the house is much lower. However, judgment may
change if the value at risk is considered. If the first house is valued at Ksh
50,000 and the second at Ksh 5,000,000, the higher risk in view of higher
potential of severity of loss may be the second house. Risk is thus a
combination of the likelihood of an event and the severity of damage should
the event occur. If an event occurs a great deal, then our knowledge about the
future begins to increase and an element of certainty begins to creep in e.g.
shoplifting. Combining frequency and severity we find two relationships

a) High frequency and low severity e.g. industrial injuries.

b) Low frequency and high severity e.g. Major earthquakes.

iii) Peril and Hazard (Cause(s))

We often use risk to mean both the event which will give rise to some loss and
the factors which may influence the outcome of a loss. In our house example,
flood is the cause of the loss and the fact that one of the houses is near the
river bank influences the outcome. Flood is the peril and the proximity of the
house to the river is the hazard. Peril is the prime cause, it is what will give
rise to the loss e.g. storm, fire etc. Factors which may influence the outcome
are referred to as hazards. Hazards are not themselves the cause of the loss but
they can increase the effect should a peril operate. Hazard can be physical or
moral. Physical hazard relates to the physical characteristics of risk e.g. grass
thatched house while moral hazard concerns human aspects which may
influence the out come. It usually relates to the attitude of the person e.g.
conman.

1.3 Classification of Risk

Risks could be classified as follows:

(i) Financial and non-financial risks- a financial risk is one where the
outcome can be measured in monetary terms and where it is possible to
place some value on the outcome. Measurement in personal injury may be
done by a court when damages are awarded or negotiation among lawyers
and insurers. There are cases where measurement is not possible e.g.
choice of a new car, selection from a restaurant menu, selection of a
career, choice of a marriage partner etc all these are non-financial risks.
Generally in business we are concerned with financial risks.

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 (ii) Pure and speculative risks- pure risks involve a loss or at best a break even
situation. The outcome can only be unfavourable to us of leave us in the
same position as we enjoyed before the event occurred e.g. motor accident,
fire, theft etc. speculative risk is where there is a chance of gain e.g.
investing money in shares ( the investment may result in a loss or possibly
a break even but the reason it was made was the prospect of gain), pricing
of products, marketing decisions, decisions on diversification, expansion
or acquisition, providing credit to customers among others. Generally pure
risks are normally insurable while speculative risks are generally not
insurable though the trend is changing and hence dynamic.

(iii) Fundamental and particular risks- fundamental risks are those which arise
from causes outside the control of any one individual or even a group of
individuals. In addition the effect of fundamental risks is felt by large
numbers of people e.g. earthquakes, floods, famine, volcanos, war etc.
Particular risks are much more personal both in their cause and effect e.g.
fire, theft etc. All these risks arise from individual causes and affect
individuals in their consequences. Risks however change classification,
mostly from particular to fundamental e.g. unemployment. In the main,
particular risks are insurable while fundamental risks are not.

1.4 Response to Risk

Conventionally insurance was always assumed to be the answer to risk. In a soft

market, where the premium levels are generally low, all that is considered is the cost
of premium and not alternatives. But in a hardening market, where premium levels are
generally high, alternatives to insurance are considered. For a long time, general
management suffered from „it won‟t happen to me syndrome‟ and many would go
through the school system without sensitization on risk. The trend has been changing
however with more positive attitude to risk developing and today companies have
individuals designated as risk managers. At personal level individuals could be-:
(a) Risk takers - jumping on any bandwagon,
(b) Risk neutral - fence sitters
© Risk averse - those avoiding it at all costs.
In measuring attitudes towards risk, we could use the standard gamble:-
(i) Standard gamble- is concerned with measuring attitude to risk in a
financial setting. If one was offered a gamble to win Ksh 4,000 on the toss
of a coin. If it is a head one wins ksh 4,000 and if a tail nothing. This is a
50/50 bet. If one is offered a sum of money instead of the gamble, what is
the least amount one would expect for sure than gamble?. The amount Ksh
Z is equivalent, in certain money, to the gamble. It is referred to as the
certainty equivalent. A person may decide to be indifferent between
accepting ksh 1,000 for sure and the gamble of ksh 4,000. With a large
number of people answering we could rank them according to how much
or how little their certainty equivalents are. We can measure the extent to
which a person deviated from the mathematically rational answer. The
mathematical or objectively rational answer is based on the fact that the
expected value of the gamble is ksh 2,000. If a person accepts less than the
expected value then he has preference for certainty while more than
expected value would be classified as a risk taker.

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1.5 The cost of Risk

The cost of risk can be looked at from the following perspectives:

(a) Frequency of risk
(b) Monetary cost or financial severity
(c) Human cost in terms of pain and suffering
On the Kenyan scene, the 1982 coup and the1998 bomb blast all give an indication on
the cost of risk. Work related injuries have cost a lot, increased insecurity has meant
high number of crime losses, road accidents resulting in death and serious injuries
have increased and fire losses have also increased with huge amounts paid out by
insurers.

In conclusion, it is impossible to remove risk entirely, but steps can be taken to ensure
that it is properly managed and hence need for risk management.

2: RISK MANAGEMENT

We have throughout portrayed risk as having a negative effect, this is not always the
case e.g. great steps in medical fields have been achieved at the personal risk of those
researchers prepared to test drugs and treatment; risk is also at the very heart of any
free market economy i.e. it enables wealth to be created. In summary therefore risk
can be negative or positive and the challenge to us is to manage the risk to which a
business is exposed. This has led to the evolution of the discipline of risk
management – which is the identification analysis and economic control of those risks
which threaten the assets or earning capacity of an enterprise. From the foregoing
definition, the following stand out:-
-Risks must be identified before they can be measured
-The eventual control mechanism must be economic i.e. you spend less to forestall
bigger losses
-Risks can affect assets or earning capacity and the assets can be both physical and
human
-The principles of risk management are applicable to service, manufacturing, public
or private sectors of the economy and hence the use of the word enterprise.

2.1 Risk Identification

In risk identification we ask the question, how can the assets or earning capacity of
the enterprise be threatened? The objective being to identify all risks facing the
organization not limited to insurable or those experienced in the past. For risk
identification to be successful there must be two essentials;
(i) The task of risk identification must be someone‟s job. This is because
everybody‟s responsibility is nobody‟s responsibility e.g. having a risk
manager or someone‟s job description includes risk identification. Good
management on its own is not enough to identify risk, it must be
someone‟s job.
(ii) The tools of risk identification must be available to the person to identify
risk. The tools of risk identification include; Organization charts,

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 checklists, physical inspections, hazard indices, flow charts, hazard and
operability studies and fault trees.

2.2 Risk Analysis

Once a risk has been identified, then steps have to be taken o measure the potential
impact of the risk on the organization which entails statistical analysis e.g. data
gathering, analysis of past experience, frequency and severity etc. In carrying out the
analysis the following should be borne in mind:-
(i) Loss experience is important, this can yield information on trend and loss
patterns
(ii) Losses must be assessed in terms of their impact on the organization,
identifying the „layers‟ of losses. Bottom layer would be characterized by
high frequency and low severity (pound swapping layer); Middle layer by
moderate frequency and medium severity while top layer by low frequency
and high severity.
(iii) Express losses or potential losses in a way to be easily understood by the
users e.g. injury costs expressed as lost profit.

2.3 Risk Control

The emphasis is on economic control – unrealistic expenditure is not justifiable in risk

management. There are three main ways in which risk control can be exercised:-
(i) Reduction- these are the steps taken to ensure that the risk is as low as we
can possibly make it. Reduction can take place either before or after the
event has taken place. Pre-loss reduction involves those steps taken once a
risk has been identified but before the loss occurring e.g. instructions
issued with a product. Post loss reduction involves those steps taken to
reduce the impact of loss once the event has taken place e.g. fire sprinkler
systems
(ii) Retention- once a risk has been identified and reduced as far as possible,
for those within the pound swapping layer, they should be retained. But
care must be exercised not to expose the company to intolerable levels of
loss nor spend money on unjustifiable insurance. However in some cases
retention is involuntary e.g. where there is no cover or cost of premium is
prohibitive.
(iii) Transfer- this is transfer to some other party. This can be through an
ordinary contract e.g. tenancy agreement where the tenant meets any costs
of repair after loss. Transfer can also be by insurance which is a risk
transfer mechanism where one exchanges uncertainty for certainty.

The prime objective of any business entity is maximization of shareholders wealth yet
risk is a barrier to achieving this objective. Therefore risk management is a positive
help to operational managers in achieving their set objectives.

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3: INSURANCE

3.1 Historical Development

As early as 3000BC Chinese merchants utilized the techniques of sharing risks. About
500 years later, the famous Great Code of Hammurabi provided for the transfer of the
risk of loss from merchants to moneylenders. Under the provisions of the code, a
trader whose goods were lost to bandits was relieved off the debt to the moneylender
who had loaned the money to buy the goods. Babylonian moneylenders loaded their
interest charges to compensate for this transfer of risk. Loans were made to ship-
owners and merchants engaged in trade, with the ship or cargo pledged as collateral.
The borrower was offered an option, for somewhat higher interest charge, the lender
agreed to cancel the loan if the ship or cargo was lost at sea. The additional interest on
such loans was called a ‘premium’ and the term is still used even today. The contracts
were referred to as ‘bottomry contracts’ in cases where the ship was pledged and
‘respondentia contracts‟ when cargo was the security. Although these were insurance
of sorts, the modern insurance business did not begin until the commercial revolution
in Europe following the crusades.

Marine insurance the oldest of the modern branches of insurance was started in Italy
during the 13th Century. This early marine insurance was issued by individuals rather
than insurance companies. A ship-owner or merchant prepared a sheet with
information describing the ship, its cargo, its destination among others. Those who
agreed to accept a portion of the risk wrote their names under the description of the
risk and the terms of the agreement. This practice of ‘writing under’ the agreement
gave rise to the term ‘underwriter’.

Ship-owners seeking insurance found the coffeehouses of London convenient meeting

places. One of the coffeehouses owned by Edward Lloyd, soon became the leading
meeting place. Lloyds is known to have been in existence early in 1688.

3.1.1 Traditional African society

The concept of insurance is not new to Africa. The African communities have had
traditional forms of managing risks facing them. It is still common for the old or sick
to expect material support from members of their families or clan. The family was a
strong compact unit and family meant more than just husband, wife and children. The
cost (premium) was that any good fortune was shared by all. Relics of this practice
exist even today and the famous ‘Harambee’ is a spin off these traditional insurance
practices. These traditional forms of insurance are dying fast in most developing
countries as a result of economic and social developments.

3.1.2 Modern Insurance in Kenya

Following the scramble for Africa towards the end of the 19th Century, various
European powers established sovereignty on the African soil. This meant that trading
operations needed certain services among them insurance. The insurance industry in
Kenya owes its beginning to foreign nationals mainly of British and Asian origin.
Although the exact date of birth of the insurance industry in East Africa is not known,
there is evidence that the first marine agency was opened in the Island of Zanzibar in

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1879. It took another twelve years before an insurance office was opened in Kenya.
One British company was represented here in 1891. But the real birth of the industry
was within the first two decades of the 20th Century. The foreign companies in Kenya
operated through agents before establishing branches. Most of the agents were
individuals or firms that transacted other businesses and not specialized in insurance.
One of the early companies to open branches was Royal Exchange Assurance of
London which opened a branch in Kenya in 1922. It was in 1930 that the first locally
incorporated company was set up in the name of ‘Pioneer Assurance Society Limited’.
The others that followed are Jubilee Insurance in 1937 and Pan Africa Insurance in
1946. The insurance industry has grown since then to the current position. There are
about 200 registered insurance brokers, 193 loss assessors, 22 surveyors, 18 loss
adjusters, 3 risk managers, about 3,000 insurance agents, 45 insurance companies and
4 local reinsurance companies.

3.2 Requisites of Insurability

It is important to note that the world of businesses is not static and what may be
uninsurable risk today could very well be insurable tomorrow. A good example is
recent moves to ensure political risks through the African Trade Insurance Agency
(ATIA). However, the following would be the requisites for insurability:-

1) Fortuitous – the happenings of the event must be entirely fortuitous to the

insured. This rules out inevitable events such as wear, tear and depreciation.
Any damage inflicted on purpose by the insured would be ruled out.
However, purposeful events by other persons would be covered provided they
were fortuitous as far as the insured is concerned. In life assurance, although
death is certain, the timing of death is what is fortuitous and that is the concern
of life assurance.

2) Financial Value – Insurance does not remove the risk but it endeavours to
provide financial protection against the consequences. Therefore, the losses
must be capable of financial measurement. In some cases the court will decide
the level of compensation due to an injured person while in property insurance
it is possible to place a value on the loss or damage. In life assurance, the
level of financial compensation is agreed at the beginning of a contract.

3) Insurable Interest – The insured must have a legally recognized relationship

with the subject matter of insurance. (Refer to principles of insurance)
.
4) Homogenous Exposure – The law of large numbers entails that given a
sufficient number of exposure to similar risks, the insurance company can
forecast the expected extent of their loss and therefore move towards accuracy
in setting premium levels. There might be a few cases where heterogeneous
exposures are insurable but on the whole insurers prefer homogenous
exposures in order to benefit from the law of large numbers.

5) Pure Risks – Insurance is primarily concerned with pure risks. Speculative

risks are generally not covered because it may act as a disincentive to effort
e.g. insuring profit would mean no effort to achieve desired results. But the
pure risks consequences of speculative risks are insurable e.g. risks of a new

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 line of business selling or not – though in itself a speculative, the risk of the
factory being damaged by fire is pure and therefore insurable.

6) Particular risks – Fundamental risks are generally not insurable e.g. war,
inflation etc. However fundamental risks arising out of physical cause e.g.
earthquakes may be insurable.

7) Public Policy – Contracts must no be contrary to what society would consider

right and moral e.g. contracts to kill a person, no insurance for criminal
venture.

3.3 Functions of Insurance

1. Risk Transfer – The primary function of insurance is that it is a risk transfer

mechanism which exchanges uncertainty for certainty. It exchanges the
uncertain loss for a certain premium.

2. Creation of Common Pool – This enables the losses of a few to be met by the
contributions of many. An insurance company operates such a pool. It takes
contributions in form of premium and is able to pay the losses to a few. The
insurer benefits from the law of large number i.e. the actual number of events
occurring will tend towards the expected where there are large similar
situations.

3. Equitable Premiums - An insurance company maintains several pools for

each risk. This enables the insurer to tell the profitable from the unprofitable
ones. However, similar types of risks could be brought into a common pool
although they will represent different degrees of risk to the pool. This should
be reflected in the contributions to the pool. It wouldn‟t be equitable for
private car owners to subsidize commercial vehicle owners. The insurer has to
ensure that a fair premium is charged, which reflects the hazard and value of
risk brought to the pool. The competitive forces must also be taken into
consideration in premium rating.

3.4 Benefits of Insurance

1. Peace of Mind – The knowledge that insurance exists to indemnify

provides peace of mind for individuals, industry and commerce. Insurance
encourages entrepreneurship by way of transfer of risk. It also stimulates
the business in existence by releasing funds for investment. The recent
spate of robberies to banks in Kenya could have easily sent some closing,
but because of insurance these risks are catered for. The need of peace of
mind has led the government to make some forms of insurance
compulsory e.g. third party liability cover, workmen‟s compensation and
employer‟s liability.

2. Loss Control – Insurers play a great role in reduction of the frequency and
severity of losses. The surveyor plays the role of risk control specialist.

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 Advise could be given on pre-loss control (e.g. wearing safety belts) and
post –loss control (e.g. having fire extinguishers).

3. Social Benefits – The fact that insurance provides indemnity after loss
means jobs may not be lost and goods and services can still be sold.

4. Investment of Funds – Because of the time lapse between receipt of

premium and payment of claims, insurers are major investors of funds. By
having a spread of investments, insurance helps government in borrowing,
offers loans through mortgages, buying of shares on the stock exchange
etc. They form a part of institutional investors including banks, building
societies and pension funds. They also invest in property e.g. ICEA
Building, Jubilee Insurance House, etc. Most life funds are invested in
longer term ventures as apposed to general insurance. Insurance therefore
assists in mobilizing of savings.
5. Invisible Earnings – Insurance is one of the invisible earning forums
including such areas as tourism, banking etc. Risks outside the country can
be insured in Kenya and money earned on these transactions represents a
substantial volume of earnings. It contributes to a favourable balance of
trade i.e. exports exceed imports.
6. Employment – Insurance industry is one of the major providers of
employment in the country.

4: CLASSES OF INSURANCE

Insurance offices are split into departments or sections, which deal with types of risks
which have affiliation with each other. Generally insurance companies are categorized
into the following offering the specified products or policies:

4.1 Life and Health

Ordinary life assurance, industrial life and group life would all fall under the wider
caption of life and health insurance. Under life and health, there are various types of
(assurance) as follows:

a) Term Assurance – It provides for payment of the sum assured on death

occurring within a specified term. If the life assured survives to the end of the
term, cover ceases and nothing is payable by the life office.
b) Decreasing Term Assurance – It is designed to cover the outstanding balance
of a debt. It is common with mortgage institutions like HFCK and Saccos.
c) Convertible Term Assurance - This is synonymous with term assurance but
has a clause which allows the life assured to convert the policy into an
endowment or whole life contract at normal rates, without medical evidence.
d) Family Income benefits – The benefits on death within the term is paid out
by installments every month or quarter as opposed to lump sum.

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e) Whole Life Assurance – The sum assured is payable on the death of the
assured whenever it occurs. Premiums are payable throughout life or till
retirement but benefits are payable on death whenever it occurs.
f) Endowment Assurance – The sum assured is payable in the event of death
within a specified period but if the life assured survives up to the end of the
period, the sum assured will also be paid. For a given level of cover, it has the
highest premium because payment will be at a given date or before if the
assured dies, the end of the period is called the maturity date. The shorter the
term of an endowment, the more expensive it becomes.
g) Group Life Assurance – Employers sometimes arrange special terms for life
assurance for their employees, the sum assured is payable on death of an
employee during his term of service with the employer. The policy is issued to
the employer as sponsor.
h) Permanent Health Insurance – It was designed to overcome the limitations
of 104 weeks maximum benefit under personal accident and sickness cover.
Cover is provided to assureds‟ disabled for longer periods who due to accident
or illness may not engage in any occupation or change to a lower paid
occupation. The cover usually excludes say the first six or twelve months
since many employees under such circumstances may remain on payroll for
such period before being struck off. The maximum benefit is usually 75% of
previous earnings less any other disability benefits payable.

4.2 Liability Insurance

Cover is for loss suffered by the insured as to the amount he is liable to pay another as
compensation or some loss of his own money. There are types of liability insurance
namely:-

a) Employer’s Liability - This arises where an employee is injured by the fault

of the employer and the injured employee can claim compensation or
“damages” from the employer. In the past before introduction of this, an
industrial injury was very much a “particular” risk and not responsibility of the
employer. The principle was “volenti non fit injuria” i.e. the employee has
concerted to run the risk of injury by being employed. It was also extremely
difficult for an ordinary employee to succeed in any claim. When an employer
is held legally liable to pay damages to an injured employee he can claim
against his employer‟s liability policy which will provide him with the amount
paid out. The cover would include lawyer‟s and doctor‟s fees. The policy is in
respect of injury or death and not applicable where the property of an
employee is damaged. This insurance is compulsory at law.
b) Public Liability – Is designed to provide compensation for those who have to
pay damages and legal costs for injury or property damage in respect of
members of the public.
c) Products Liability – Where a person is injured by a product he has purchased
and can show that the seller or manufacturer was to blame he can claim for
damages.
d) Professional Indemnity Insurance - This is liability to other parties arising
out of professional negligence e.g. A lawyer may give advice carelessly that
results in a client losing money. Therefore, professional indemnity insurance

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 would be cover for various professional e.g. Lawyers, Accountants, Doctors,
Brokers etc.
e) Directors’ and Officers’ Liability – Shareholders, creditors, customers and
employees can take action against directors as individual for negligence in
operating a company. This recent development has been aided by legislation to
make individuals accountable. The policy therefore will cover defense costs
and compensation for which a director may be liable to pay.

4.3 Property Insurance

There are various covers for property depending with the cause or way in which it is
damaged:

a) Fire Insurance –The basic fire policy provides compensation to the insured
person if the property is damaged as a result of fire, lightning or explosions,
where the explosion is brought about by gas or boilers not used for any
industrial purpose.
b) Theft Insurance – This covers theft which within the meaning of the policy is
to include force and violence either in breaking into or out of the premises of
the insured.
c) All Risks Insurance – Uncertainly of loss may not only be due to fire or theft,
this led to the design of a wider cover known as all risks. The term all risks is
a misnomer as there are a number of risks that are excluded but it is an
improvement on the traditional scope of cover that was available on the
market. The policy can cover expensive items like jewellery, cameras etc. The
objective of the cover being to cover a whole range of accidental loss or
damage.
d) Goods in Transit – It provides compensation, if goods are damaged or lost
while in transit, this would cover modes of transport like road, railway etc.
The cover can be effected by the owner of the goods or the carrier if he is
responsible for them while in his custody.
e) Contractors All Risks – When new buildings or civil engineering projects are
being constructed, a great deal of money is invested before the work is
finished. There is a risk that the building or bridge may sustain severe damage
– prolonging construction time and delaying eventual completion date. This
may entail the contractor to start building again or repair the damages. The
extra cost cannot be added to the eventual charge the contractor will make to
the owner. The intention of the policy is to provide compensation to the
contractor for damage to construction works from a wide range of perils.
f) Money Insurance – The policy provides compensation to the insured in the
event of money being stolen either from the business, his home or while it is
being carried to or from bank.

4.4 Pensions

The prime objective is to ensure that pension is available on retirement. Most of the
pension schemes are arranged by employers for the benefit of their employees. In
association with pensions, policies are normally effected covering death in service for
those employees who do not live up to the retirement age. This is normally in the

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form of group life assurance. It is also possible for individuals to purchase personal
pension plans. The occupational pension plan may be on:
(i) Final Salary or defined benefit basis or
(ii) Money purchase or defined contributions

Annuity
Is a periodic payment made to the assured usually after retirement for a consideration.
The annuity can be;
 Immediate annuity – It starts to make the periodic payments
immediately after purchase.
 Deferred Annuity – The periodic payments commence sometimes
in future.
 Annuity Certain – The periodic payments are made for a certain
period irrespective of death.
 Guaranteed annuity - The annuity is made for a guaranteed
period or until death whichever is later.

4.5 Transport Insurance

The policies here cover marine, aviation and road risks. Marine policies relate to three
areas of risk i.e. hull, cargo and freight. Freight is the sum paid for transporting goods
or for hire of a ship. When goods are lost or destroyed by marine perils then freight or
part of it is lost – thus need for cover. The risks covered in a marine policy are
generally referred to as “perils of the sea” and includes fire, theft, collision etc.

i) The main types of marine policies are:-

a) Time Policy – Which is for a fixed period e.g. 12 months.

b) Voyage Policy – which is operative for the period of the voyage - for
cargo it is from ware house to warehouse.
c) Mixed Policy – Which covers the subject matter for the voyage and a
period of time thereafter e.g. while in port.
d) Building Risk Policy – It covers construction of marine vessels.
e) Floating Policy - It provides the policy holder with a large reserve of
cargo. A large initial sum is granted and each time shipments are sent,
the insured declares the value which is deducted from the outstanding
sum insured.
f) Small Craft – It covers the leisure use small boats. It is
comprehensive in style covering liability insurance.

ii) Aviation Insurance – Most policies are issued on an “all risks basis”, subject
to certain restrictions. In most cases a comprehensive policy is issued covering
the aircraft itself (the hull), the liabilities to passengers and the liabilities to
others.

iii) Motor Insurance – The minimum requirement by law is to provide insurance

in respect of a legal liability to pay damages arising out of injury caused to any
person. Motor Insurance polices can either be:

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 a) Third party only – It provides cover in respect of liability incurred
through death or injury to a third party or damage to the third party
property. This is according to the Road Traffic Act.
b) Third party, fire and theft - It provides cover as above but in addition
cover damage or loss to the vehicle from fire or theft.
c) Comprehensive policy – It provides cover as above but in addition
cover accidental loss or damage to the vehicle itself.

Also motor insurance is categorized into;

a) Private Car Insurance - It covers private cars used for social, domestic and
business purposes. Some of the covers include personal accident benefits
for the insured and spouse, medical expenses and loss or damage to rugs,
clothing and personal effects.
b) Vehicles used for commercial purposes e.g. Lorries, taxis, vans, hire cars
are insured under commercial vehicle policies.
c) There is separate cover for motor cycles – the cover is fairly inexpensive
when contrasted with motor car insurance.

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5: PRINCIPLES OF INSURANCE

Insurance principles are the basic doctrines that guide the practice of insurance. They
include:

5.1 Insurable Interest

An insurable contract is one whereby the insurer agrees to indemnify the insured
should a particular event occur or pay him a specified amount on the happening of
some event. In return the insured pays a premium. The subject matter of insurance
under a fire policy can be buildings, under liability policy can be legal liability for
injury or damage, under life assurance policy the life assured, in marine is the ship
etc. It is important however to note that it is not the house, ship etc that is insured. It is
the financial or pecuniary interest of the insured in the subject matter that is insured.
The word „interest‟ can have a number of meanings. In the present context, it means a
financial relationship to something or someone.

The subject matter of the contract is the name given to the financial interest which a
person has in the subject matter of the insurance. This is the root of insurable interest
as in the case of Castellain V Preston (1883) “What is it that is insured in a fire
policy? Not the bricks and materials, but the financial interest of the insured in the
subject matter of insurance.”
Insurable interest is a person‟s legally recognised relationship to the subject matter of
insurance that gives them the right to effect insurance on it. Since the relationship
must be a legal one, a thief in possession of stolen goods does not have the right to
insure them.
An insurance agreement is void without insurable interest.

5.1.1 Historical Background

A contract of Life Assurance was enforceable at common law despite the absence of
any relationship between the assured and the life assured. Wagers in general were
legally enforceable and courts had no option but to enforce them like life assurance
contracts. This position led to an increase in murder cases and raised public concern.
Responding to this public concern, the Life Assurance Act 1774 was enacted. But this
only addressed the matter on the life assurance front but other forms were exposed
except Marine where the Marine Insurance Act 1745 had addressed this. But
successive legislation particularly the Gaming Act 1845 rendered all contracts by
way of gaming or wagering void. The following legislations are important:-

i) Marine policies are governed by the Marine Insurance Act 1906 which
renders all Marine policies without insurable interest void.
ii) Life assurance policies are governed by the Life Assurance Act 1774-
which renders all life assurance policies without insurable interest void.
iii) All other polices are governed by the Gaming Act 1845 – which also
renders the policies without insurable interest void.

The following are the differences between an insurance contract and wagering
contract

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Insurance Contract Wagering Contract

1. Insurable interest in the subject 1. The interests are limited to the

matter is essential. stake to be won or lost and not
2. The Insured is immune from loss recognized at law.
and his identity is known upfront. 2. Either party may win or lose and
3. Full disclosure (uberrimae fidei) the loser cannot be identified
is required of both parties. upfront.
4. In most cases an indemnity only is 3. Full disclosure is not required by
secured either party.
5. The contract is enforceable at law. 4. There is no indemnity. Payment is
made without suffering loss
before hand.
5. Neither party has any legal
remedy.

5.1.2 Essential Features of Insurable Interest

(a) There must be some person (i.e. life, limbs, etc.), property, liability or legal right
(e.g. the right to repayment by a debtor) capable of being insured;
(b) Such property, rights, interest etc must be the subject matter of insurance.
(c) The insured must stand in a relationship with the subject matter of insurance
whereby he benefits from its safety and would be prejudiced by its damage.
(d) The relationship must be recognized at law e.g. Macaura V. Northern Assurance
Company (1925). Mr. Macaura effected a fire policy on an amount of cut timber on
his estate. He later sold the timber to a one-man company of which he was the only
shareholder. A great deal of the timber was destroyed in a fire and the insurers refused
to pay the claim on the basis that Mr. Macaura had no insurable interest in the assets
of the company of which he was principal shareholder. A company is a separate legal
entity from its shareholders and the relationship between timber and Mr. Macaura,
whereby Macaura stood to loose by its destruction – had to be one recognized or
enforceable at law. In this case such a relationship did not exist as Macaura‟s financial
interest in the company as a shareholder was limited to value of his shares and he had
no insurable interest in any of the assets of the company.

5.1.3 Creation of Insurable Interest

Insurable interest may arise in the following circumstances:
i) At common law e.g. ownership of property or potential liability a
negligent car driver may be faced with it. Ownership of a building, car etc,
gives the owner the right to insure the property.
ii) By contract - Here a person agrees to be liable for something for which he
would not be liable in the absence of the contractual condition e.g. a
landlord passing damage responsibility to a tenant. Such contracts place
the tenant in a legally recognized relationship and hence insurable interest.
iii) By Statute – Some statutes place responsibilities on people similar to
contractual obligations e.g. married women‟s property Act (1882) and
married women‟s policies of assurance Act 1980. These Acts provided

15
 married women with insurable interest in their own lives and those of their
husbands for their own benefit.

5.1.4 Statutes Modifying Insurable Interest

The liability of some people was too onerous and statues were passed modifying this
liability. In most cases insurable interest was correspondingly reduced.
i) Carriers Act 1830 - A common carrier is exempted from liability for
certain valuable articles of greater value than a fixed amount, except where
the value is declared and an extra charge paid
ii) Hotel proprietors Act 1956 – Where people have booked sleeping
accommodation at a hotel, where a schedule of the Act is displayed
prominently, the liability for loss or damage to property of a guest is
limited to a fixed amount so long as he was not negligent.
iii) Trustee Act 1925 - Trustees can effect fire insurance on trust property,
paying premiums from the trust income.

5.1.5 Application of Insurable Interest to Main Forms of Insurance

1. Life Assurance
Everyone has un-limited insurable interest in their own life and is entitled to
effect a policy for any sum assured. Also a person has unlimited insurable
interest in the life of his or her spouse. However, a blood relationship does not
imply an automatic insurable interest. Further, one may insure the life of one's
child or ward (in guardianship) who is under 18 years of age, and a policy so
effected will not become invalid upon the life insured turning 18.
Also some people can assure the life of another to whom they bear a
relationship recognized at law, to the extent of a possible financial loss.
Therefore, partners can insure each others lives up to the limit of their
financial involvement. Also a creditor has insurable interest in the life of his
debtor.

2. Property Insurance
For Property, insurable interest mostly arises out of ownership. A person with
a partial interest in some property is entitled to insure the full value of that
property rather than his partial interest. But in the event of loss, he acts as a
trustee passing over other proceeds to the other partners. Mortgagees and
mortgagors have insurable interest; the purchaser as owner and seller as
creditor. A bailee is a person legally holding the goods of another either for
payment or gratuitously and is legally responsible for property under their care
and hence have insurable interest.

3. Liability Insurance
A person has insurable interest to the extent of potential legal liability he may
incur by way of damages and other costs. A person‟s extent of interest in
liability insurance is without limit.

5.1.6 When Insurable Interests Must Exist

1. In Marine Insurance, insurable interest need only exist at the time of any
loss. This is because of customs of maritime trading where cargo may

16
 change ownership while in transit and protects merchants who may assume
interest in cargo during a voyage.

2. In Life assurance – Insurable interest needs to exist when the policy is

effected and not necessarily at the time of claim. With life insurance,
insurable interest is only needed at policy inception. Suppose a woman had
effected a whole life policy on the life of her husband, who died some
years later. When the woman presented a claim to the insurer, the latter
discovered that at the time of the man‟s death, they were no longer in the
relationship of husband and wife. That means the woman had no insurable
interest in the life of the deceased at the time of the death. Nevertheless,
this lack of insurable interest will not disqualify her for the death benefit.

3. For all other Insurances - Insurable interest must be present both at the
time of effecting the policy and when any claim is made.

5.1.7 How It Arises

Insurable interest arises in a variety of circumstances, which may be considered
under the following headings:
(a) Insurance of the Person: everyone has an insurable interest in his own life, limbs,
etc. One also has an insurable interest in the life of one's spouse. Further, one may
insure the life of one's child or ward (in guardianship) who is under 18 years of age,
and a policy so effected will not become invalid upon the life insured turning 18.
(b) Insurance of Property (physical things): the most obvious example arises in
absolute ownership. Executors, administrators, trustees and mortgagees, who have
less than absolute ownership, may respectively insure the estate, the trust property and
the mortgaged property. Bailees (i.e. persons taking possession of goods with the
consent of the owners or their agents, but without their intention to transfer
ownership) may insure the goods bailed.
(c) Insurance of Liability: everyone facing potential legal liability for their own acts
or omissions may effect insurance to cover this risk (sometimes insurance is
compulsory), such liability being termed „direct liability‟ or „primary liability‟.
Insurance against vicarious liability (see 2.2(c) above) is also possible, where, for
example, employers insure against their liability to members of the public arising
from negligence, etc. of their employees.
(d) Insurance of Legal Rights: anyone legally in a position of potential loss due to
infringement of rights or loss of future income has the right to insure against such a
risk. Examples include landlords insuring against loss of rent following a fire.
Note: Anyone (agent) who has authority from another (principal) to effect
insurance on the principal‟s behalf will have the same insurable interest to the same
extent as the principal. For instance, a property management company may have
obtained authority from the individual owners of a building under its management to
purchase fire insurance on the building. There is no question of a fire insurance
effected under such authority being void for lack of insurable interest, even if it is the
property management company (rather than the property owners) which is designated
in the policy as the insured.

3.1.8 When Is It Needed?

(a) With life insurance, insurable interest is only needed at policy inception.
Suppose a woman had effected a whole life policy on the life of her husband, who

17
died some years later. When the woman presented a claim to the insurer, the latter
discovered that at the time of the man‟s death, they were no longer in the relationship
of husband and wife. That means the woman had no insurable interest in the life of
the deceased at the time of the death. Nevertheless, this lack of insurable interest will
not disqualify her for the death benefit.

(b) However, with marine insurance, insurable interest is only needed at the time of
loss.
(c) The above marine insurance rule is probably applicable to other types of
indemnity contracts as well.

5.2 Utmost Good Faith

Most commercial contracts are subject to the doctrine of caveat emptor (let the buyer
beware). In most of these contracts each party can examine the item or service and as
long as one does not mislead the other party and answers questions truthfully, the
other party cannot avoid the contract. There is no need to disclose information not
asked for. However, when it comes to arranging insurance contracts, while the
proposer can examine a specimen of the policy document before accepting the terms,
the insurer is at a disadvantage as he cannot examine all aspects of the proposed risks
which are material to him. In order to make the situation more equitable, the law
imposes a duty of „uberrimae fidei‟ or utmost good faith on the parties to an insurance
contract. The contract is deemed to be one of the faith or trust. The duty of full
disclosure rests on the underwriters also and they must not withhold information from
the proposer which leads him into a less favorable contract e.g. not to accept an
insurance which they know is un-enforceable at law or they are not registered to
underwrite.

Utmost good Faith is a positive duty to voluntarily disclose, accurately and fully all
facts, material to the risk being proposed, whether asked for or not.

A material fact is every circumstance which would influence the judgment of a

prudent insurer in fixing the premium or determining whether he will take the risk.
However, a fact which was immaterial when the contract was made, but later became
material need not be disclosed in the absence of a policy condition requiring
continuous disclosure. The facts that must be disclosed are:-

i) Facts which show that the risk being proposed is greater because of
individual, internal factors than should be expected from its nature or
class. e.g., the fact that a part of the building is being used for storage of
inflammable materials.
ii) External factors that make the risk greater than that normally expected e.g.
the building is located next to a warehouse storing explosive material.
iii) Facts that would make amount of loss greater than normally expected e.g.
there is no segregation of hazardous goods from non-hazardous goods in
the storage facility.

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 iv) Previous losses and claims under other policies.
v) Previous declinature or adverse terms imposed on previous proposals by
other insurers.
vi) Facts restricting subrogation rights due to the insured relieving third
parties off liabilities which they would otherwise have.
vii) Existence of other non-indemnity policies like life and personal accident.
viii) Full facts relating to and descriptions of the subject matter of insurance

The following facts need NOT to be disclosed:-

i) Facts of law: Everyone is deemed to know the law. Overloading of goods

carrying vehicles is legally banned. The transporter cannot take excuse that
he was not aware of this provision.
ii) Facts which the insurer is deemed to know: The insurer is expected to
know the areas of strife and areas susceptible to riots and of the process
followed in a particular trade or Industry. (e.g. the problem of piracy in
Somalia)
iii) Facts which lessen the risk: (eg The existence of a good fire fighting
system in the building)
iv) Facts which could be reasonably discovered: For e.g. the previous history
of claims which the Insurer is supposed to have in his record.
v) Facts which the insurer‟s survey should have noted: In burglary and fire
insurance it is often the practice of Insurance companies to depute
surveyors to inspect the premises and in case the surveyor fails to notice
hazardous features and provided the details are not withheld by the Insured
or concealed by him them the Insured cannot be penalized.
vi) Facts covered by policy conditions. eg Warranties applied to Insurance
policies i.e. there is a warranty that a watchman be deployed during night
hours then this circumstance need not be disclosed.
vii) Facts which the proposer does not know.
ix) Facts (convictions) which are „spelt‟ under the Rehabilitation of Offenders
Act 1974.

Some examples of Material facts are

(a) In Fire Insurance: The construction of the building, the nature of its use i.e.
whether it is of concrete or having thatched roofing and whether it is being
used for residential purposes or as a godown, whether firefighting equipment
is available or not.
(b) In Motor Insurance: The type of vehicle, the purpose of its use, its age
(Model), Cubic capacity and the fact that the driver has a consistently bad
driving record.
(c) In Marine Insurance: Type of packing, mode of carriage, name of carrier,
nature of goods, the route.
(d) In Personal Accident Insurance: Age, height, weight, occupation, previous
medical history if it is likely to increase the choice of an accident, Bad habits
such as drinking etc.
(e) Burglary Insurance: Nature of stock, value of stock, type of security
precautions taken.

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5.2.1 Duration of the Duty of disclosure
At common law, it starts at commencement of negotiations and terminated when the
contract is formed. However, inmost cases the conditions of a policy extend the
common law position by requiring full disclosure during the currency of the contract
which the insurer is not obligated to underwrite.

The position at renewal is that for life and permanent health insurance contracts
disclosure lasts only until completion of the contract. This is because they are long
term contracts. But in the other classes of insurance the original duty of disclosure is
revived at renewal. However, for all classes if the terms of the contract are altered e.g.
increase of sum insured, then the duty of disclosure arises.

5.2.2 Representations and Warranties

Representations are written or oral statements made during negotiations for a contract.
Some of the statements will be material and others not. Warranties on the other hand
in ordinary commercial contracts are promises, subsidiary to the main contract, a
breach of which would have the aggrieved party with the right to sue for damages
only. However, warranties in insurance contracts are fundamental conditions to the
contract and a breach allows the aggrieved party to repudiate the contract. Warranties
are imposed to ensure “good housekeeping” and also ensure certain features of higher
risk are not introduced without the insurer‟s knowledge. Warranties can either be
express or implied. Express warranties are agreed on upfront e.g. I will not store
inflammable liquids in my premises. Implied warranties are assumed to be part of the
contract even though not expressly negotiated e.g. the vehicle is road worthy.

Breach of utmost good faith can either be innocent or accidental and deliberate or
fraudulent. There are several remedies for breach of utmost good faith and include:-

i) Avoid the contract by either repudiating the contract abinitio or

avoiding liability for an individual clam.
ii) The damages if it is by concealment or fraudulent
iii) Waive these rights and allow the contract to carry on.

The aggrieved party must exercise the option within a reasonable time of discovery of
the breach. However, for some insurances that are compulsory like third party cover
for motor vehicles, the Road Traffic Act prohibits the insurer from avoiding liability
on grounds of breach of utmost good faith. But the insurer may claim the amount paid
from the insured though this situation is faced with practical differences.

5.3 Proximate Cause

There are three types of perils related to a claim under an Insurance policy
(1) Insured Perils: These are the perils mentioned in the policy as being insured e.g.
Fire, lightening, storm etc. in the case of a fire policy

(2) Excepted Perils: These are the perils mentioned in the policy as being excepted
perils or excluded perils e.g. Riot strike, flood etc. which may have been excluded and
discount in premium availed.
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(3) Uninsured Perils: Those not mentioned in the policy at all either in Insured or
excepted perils e.g. snow, smoke or water as perils may not be mentioned in the
policy.

Insurers are liable to pay claims arising out of losses caused by Insured Perils and not
those losses caused by excepted or Uninsured perils.
Example: If stocks are burnt then the cause of loss is fire which is an Insured Peril
under a fire policy and claim is payable. If the stocks are stolen the loss would not be
payable as Burglary is not an Insured peril covered in fire policy Burglary policy is
needed to take care of „theft‟.
It is therefore important to identify the cause of loss and to see if it is an Insured peril
or not before admitting a claim.

It is because of the above that the principle of proximate cause is important. Every
loss is the effect of some cause. Sometimes there is a single cause of loss but
frequently there is a chain of causation or several causes may operate concurrently.
And in these circumstances it may require considerable thought to decide whether the
loss is within the scope of the policy or not. The doctrine covering such deliberations
is proximate cause.

Need to Identify Proximate Cause

If the loss is brought about by only one event then there is no problem in settlement of
liability but more often than not the loss is a result of two or more causes acting
together or in tandem i.e. one after another. In such cases it is necessary to choose the
most important, most effective and the most powerful cause which has brought about
the loss. This cause is termed the Proximate Cause and all other causes being
considered as “remote”. The proximate cause has to be an insured peril for the claim
to be payable.
The following illustration may help in distinguishing between the proximate cause
and the remote cause.
I. “A person was injured in an accident and was unable to walk and while lying on the
ground he contracted a cold which developed into pneumonia and died as result of
this. The court ruled that the proximate cause of death was the accident and
Pneumonia (which was not covered) was a remote cause and hence claim was payable
under the Personal Accident Policy.”
II. “A person injured in an accident was taken to a hospital where he contracted an
infection and died as a result of this infection. Here the court ruled that infection was
the proximate cause of death and the accident was a remote cause and hence no claim
was payable under the Personal Accident Policy.

The Meaning of Proximate Cause

The doctrine of proximate cause is based on the principle of cause and effect, which
states that having proved the effect and traced the cause it is not necessary to go any
further i.e. cause of cause. The law provided the rule “Cause Proxmia non Remote
spectator”. The immediate cause and not the remote one should be taken into
consideration.
Therefore the proximate cause should be the immediate cause. Immediate does not
mean the nearest to the loss in point of time but the one most effective or efficient.
Thus if there are a number of causes and the proximate cause has to be chosen the

21
choice should be of the most predominant and efficient cause i.e. the cause which
effectively caused the result.
Proximate cause has been defined as “The active efficient cause that sets in motion a
train of events which bring about a result without the intervention of any force started
and working actively from a new and independent source”. (This definition comes
from the ruling given in the case Pawsey v/s Scottish Union and National Insurance
Co. (1907).
It is important to note that in Insurance Proximate has got nothing to do with time
even though the Dictionary defines Proximity as „The state of being near in time or
space‟ (period or physical) and the Thesaurus given the alternate words as “adjacency
of” “closeness”, “nearness” “vicinity” etc. But in Insurance Proximate cause is that
which is Proximate in efficiency. It is not the latest but the direct, dominant, operative
and efficient cause.

Rules for the Application of Proximate Cause

i) The risk insured against must actually take place e.g. mere fear of insured
peril is not loss by that peril.
ii) Further damage to the subject matter sue to attempts to minimize a loss
already taking place is covered.
iii) Intervention of a new act is out with the doctrine e.g if during a fire
onlookers cause damage to surrounding property then fire is not the cause
of the loss.
iv) Last Straw Cases – where the original peril has meant that loss was more
or less inevitable, the original peril will be the proximate cause even
though the last straw comes from another source.

The following case law illustrates this.

a) Gaskarth V Law Union (1972) – a fire left a wall standing but in a

weakened condition. Several days later, a gate caused the collapse of the
wall onto another property. It was held that fire was not the proximate
cause but the gate. The crucial factor was the delay of several days during
which no steps were taken to shore up the weakened wall. The chain had
been broken.
b) Roth V Fouth Eastlope Farmers Mutual (1918) – Lightening damaged a
building and almost immediately afterwards a storm blew it down. It was
held that lightening was the proximate cause. There was no time to take
remedial action and the danger created by the fire was still operating.
c) Leyland Shipping V Norwich Union (1916) – Last Straw Cases. A
marine policy excluded war risks. In time of war a ship was badly
damaged. It managed to get to a port and repair work was stared but had
to be stopped. When a storm blew up. The harbor master ordered the ship
out of port in case she sank and blocked the harbor. Outside the harbor she
met bad weather which normally she would have survived, but in this case
she sank. It as held the proximate cause of loss was war risks, the ship was
in danger of sinking from it was damaged and as repairs had not been
completed that danger was always present.

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 5.4 Indemnity

Is the controlling principle in insurance law. It responds to the question “what is a

person to receive when the insured against event occurs? Indemnity is a mechanism
by which insurers provide financial compensation in an attempt to place the insured
pecuniary position after the loss as he enjoyed immediately before it.

Indemnity is related to insurable interest as it is the insured‟s interest in the subject

matter of insurance that is in fact insured. In the event of a claim, the payment made
to an insured cannot therefore exceed the extent of his interest. In life assurance and
personal accident insurance, there is unlimited interest and this indemnity is not
possible.

Methods of Providing Indemnity

i) Cash payment – It is the most common method of settlement where a

cash payment representing indemnity to the insured is made. In liability
insurance the money is paid directly to the third party rather than the
insured.
ii) Repairs – It is commonly used in motor insurance where garages are
authorized to carry out repairs work on damaged vehicles.
iii) Replacement - It is common in glass insurance where windows are
replaced on behalf of insurers by glazing firms. It is also used in motor
vehicle insurance where a nearly new car is destroyed and replaced by a
similar model.
iv) Reinstatement – Used in property insurance where an insurer undertakes
to restore or rebuild a building damaged by fire.

Measurement of Indemnity
In property insurance the measure of indemnity is reflect of loss of any property is
determined not by its cost but its value at the date of the loss and at the place of the
loss. If the value of the property has increased, the insured is entitled to this subject to
the sum insured or average being applied. For buildings it is the cost of repair or
reconstruction less an allowance for betterment which includes improvements or non
deductions of wear and tear. In liability insurance the measure of indemnity is the
amount of any court award or negotiated out of court settlement plus costs and
expenses thereon.

Factors Limiting the Payment of Indemnity

i) Sum Insured – The limit of an insurer‟s liability is the sum insured. The
insured cannot receive more that the sum insured even where indemnity is
a higher figure.
ii) Average – Where there is under-insurance the insurers are receiving a
premium only for a proportion of the entire value at risk and any
settlement will take this into account using the formula.

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 Liability of Insurer = Sum Insured x loss
Full value
When average operates to reduce the amount payable, the insured receives
less than indemnity.
iii) Excess – An excess is an amount of each and every claim which is not
covered by the policy. Where excess applies to reduce the amount paid,
the sum insured receives less than indemnity
iv) Franchise – A franchise is a fixed amount which is to be paid by the
insured in the event of a claim. But once the amount of franchise is
exceeded then insurers pay the whole of the loss.
v) Limits – Many policies limit the amount to be paid for certain events.
vi) Deductibles - Deductible is the name given to every large excess
particularly in commercial insurance.

Extension in the Operations of Indemnity

There are cases where the insured may receive more than indemnity.

i) Reinstatement – An insured can request that his policy be subject to the

reinstatement memorandum where settlement is without deductions of
wears, tears and depreciation. The sum insured is normally high with
consequent high premium.
ii) New for Old – Insurer agrees to pay for reinstatement of contents if
destroyed within a specified period without deduction of wear and tear.
iii) Agreed additional costs – Insurers may pay including additional costs
like architects and surveyors fees if agreed. This may mean receipt of
more than indemnity.

5.5 Subrogation

Subrogation and contribution are corollaries of indemnity. A major effect of

indemnity is that a man cannot recover more than his loss, he cannot profit from the
happenings of an insured event. Subrogation is the right of one person to stand in the
place of another and avail himself all the rights and remedies of that other, whether
already enforced or not. In the case of a Burnand J Rodocanachi (1882) - It was held
that the insurer having indemnified a person was entitled to receive back from the
insured anything he may receive from any other source. Subrogation only applies
where the contract is one of indemnity. Therefore life and personal accident contracts
are not subject to subrogation. However, also an insurer is not entitles to recover
more that he has paid out.

Extent of Subrogation Rights

i) An insurer is not entitled to recover more than be has paid out. Insurers
must not make profit by exercising subrogation rights.
ii) Where the insured retains part of the risks e.g. by an excess or application
of average, he is entitled an amount equal to that share of the risk out of
any money recovered. Where the insurer makes ex-gratia payment to an

24
 insured then the insurer is not entitled to subrogation rights. This is
because ex-gratia payment is not indemnity and subrogation rights arise
only to support the concept of indemnity.

Ways in which Subrogation May Arise

a) Arising out of tort – A tort is a civil wrong and incorporates negligence,

nuisance, trespass, defamations and other legal wrongs. Where an insured
has sustained some damage, cost rights or incurred liability due to the
tortuous actions of some other person, then his insurer, having
indemnified him for loss, is entitled to take action to recover the outlay
from the tort feasor or the wrong doer.
b) Right arising out of contract – This can arise where a person has
contractual rights to compensation regardless of fault and where the
custom of trade to which the contract applies dictates that certain bailees
are responsible e.g. hotel promoter. The insurer then assumes the benefits
of these rights e.g. tenants agree to make good any damage to the property
they occupy. The owner may also maintain insurance policy and in the
event of damage; if he recovers from the insurance policy, he is not entitles
to compensation from the tenant and the insurers assume the rights to any
money from the tenants.
c) Right arising out of statute – Where the Act or Law permits, the insurer
can recover the damages from Government agencies like the where a
person sustain damage in a riot and is indemnified, his insurers have a
right to recover the outlay from the police authority as per Riot Damage
Act 1886 gives the right to insurers to recover damages from the Police
Authorities in respect of the property damaged in Riots which has been
indemnified by them.
d) Rights arising out of subject Matter of insurance - When the Insured
has been indemnified and the property treated as lost he cannot claim
salvage as this would give him more than indemnity. Therefore when
Insurers sell the salvage as in the case of damaged cars it can be said that
they are exercising their right of subrogation.

Subrogation – When?
At common law subrogation does not arise until the insurers have admitted the
insured claim and paid it. However, insurers place a condition in the policy giving
themselves subrogation rights before the claim is paid. Subrogation has the effect of
ensuring negligent persons are not „let off the hook‟ simply because there was
insurance.

Modification to the Operation of Subrogation

The exercising of subrogation rights by one insurer my involve claiming money from
another insurer for a motorist hitting property would exercise subrogation against the
driver who turn passes it to motor insurer. This may mean insurers getting involved
against each other often. This is particularly true.

i) Motor insurance – Some insurers waive their subrogation rights against

each other by executing “knock fro knock” agreements.

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 ii) Other insurers sign agreements whereby they contribute towards the losses
by pre-determined proportions.
iii) In employers liability, subrogation is waived where one employee causes
injury to another.

5.6 Contribution
In a case where someone has a right to recover his loss from two or more insurers
with whom he has effected policies, the principal of indemnity prevents the insured
from being more than fully indemnified by each way of contribution. Contributors
ensure that the insurers will share the loss as they have all received a premium for the
risk. Contribution applies only to contract of indemnity. Contribution is the right of
an insurer to call upon similarly but not necessarily equally liable to the sum insured
to share the cost of an indemnity payment.

At common law contribution will only apply where the following are met:-

i) Two or more policies of indemnity exist.

ii) The policies cover the same or a common interest
iii) The policies cover the same or common peril giving rise to loss.
iv) The policies cover the same or common subject matter
v) Each policy is liable for loss.

The policies do not require to cover identical interest, perils or subject matter so long
as there is an overlap shared by them.

The leading case in contribution in North British & Mercantile V Liverpool &
London Globe (1877). It is also known as the “king and Queen Granaries” case.
Merchants had deposited grain in the granary owned by Barnett. The latter has a strict
liability for the grain by custom of his trade and had insured it. The owner has
insured it to cover his interest as owner. When the grain was damaged by fire the
bailee‟s insurers paid and sought to recover from the owners insurers. As interests
were different, one as bailee and the other as owner, the court held that contributions
should not apply.

When Contributions Operate

i) At common law – When an insured has more than one insurer, he can
confine his claim to one of them if he so wishes and that insurers must
meet the loss to the limit of his liability and can only call for contribution
from the others after he has paid.
ii) To avoid the common law position, there is a contractual condition –
where most policies state that the insured is liable only for his “rateable
portion” of the loss and the insured is left to make a claim against the other
insurer if he wishes to be indemnified.

Rateable Proportion
The accepted way to interpret the term Rate-able Proportion is exhibited. First being
that the Insurers should pay in the proportion to the sum insured for example Sum
Insured Policy A = 10,000/- Sum Insured Policy B = 20,000/- Sum Insured Policy C =
30,000/- Total = 60,000/-

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In case of a claim of Rs.6000/- the three insurers would be liable to pay in the
proportion 1:2:3 i.e. „A‟ pays Rs.1000/- „B‟ pays Rs.2000/- and „C‟ pays Rs.3000/-.

However, sometimes the equitable rights to contributions is removed by non-

contributory clauses e.g. “this policy shall not apply in respect of any claim where the
insured is entitled to indemnity under any other insurance where a policy is issued
covering a wider range of property, a “more specific clause” is usually inserted to
prevent contribution between the wide range policy and any which might be more
specific in its cover. Also there are market agreements in relation to injuries suffered
by employees being carried in the employees vehicle in the course of their
employment. A claim could arise under the motor policy and employers liability
policy. The market agreement states that such claims will be dealt with as employers
liability claims and that here is no contribution with the motor insurers

Basis of contributions

a) Property policies (not subject to average) the following formula applies.

Sum insured by particular insurer x loss = Liability of particular insurer

Total of sum insured of all insurers

e.g. Company A insurers a house contents for Ksh.10,000

while company B insurers the for Ksh.5,000
the insured loses = Ksh. 2,000 in afire

Office A pays = 10,000 x 2,000

15,000

Office B pays = 5,000 x 2,000

15,000

TOTAL 2,000

b) Other Policies - In case of policies which are subject to average or where an

individual loss limit applies within a sum insured, the method used is
“independent liability”. The independent liability is the amount which an
insurer would be obliged to pay if it were the only or independent is insurer.

Insurers independent liability x loss

Total of all insurers‟ liabilities = liability of individual insurer

e.g. If property us insured with companies A and B for Ksh.4,500 and

Ksh.1,000 respectively and the value of the property is Ksh.4,500. In the
event of a loss of Ksh.450, with both polices subject to average, the
contributions is

A’s liability = 4500 x 450 = 450

4500

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 B’s liability = 1000 x 450 = 100
4500
TOTAL = 550

However, total independent liabilities are more than the loss hence:
A pays 450 x 450 = 368.20
550

B Pays 100 x 450 = 81.80

550
TOTAL = 450.00

6: INSURANCE PRACTICE

6.1 Proposal Forms

A proposal form is the mechanism by which the insurer receives information about
risks to be insured. It is completed by the proposer and submitted to the insurer for
most classes of insurance. However, there are classes of insurance where the proposal
form is not necessary. This is particularly so for corporate fire or marine insurance.
The details for fire are so complex to be confined to a proposal form. In these cases,
insurers use their own risk surveyors to visit the premises to discuss the risk with the
proposer. Brokers play an important part, preparing full details for an insurer. For
personal insurance, the form carries both general and specific questions. The forms
are simple to understand and easy to complete. For business insurances the
information required is greater and is supplemented by additional information
provided by the proposer or broker. Every proposal has a declaration that the proposer
confirms that the information which has been supplied is true to the best of the
proposer‟s knowledge and belief.

6.2 Policy Document

Once a proposer has completed a proposal, submitted it to an insurer and is accepted,

then there is a contract of insurance. A contract of insurance is subject to all laws of
contract and it exists whether policy is issued or not. The policy is only evidence of
the contract. Components of the policy document are:
i) Heading – It includes the name of the insurer, address and logo.
ii) Preamble – This is the wording at the beginning of each of the policies. It
covers the following aspects:-
a) The proposal is stated as being the basis of the contract and
incorporated in it.
b) It also states that premium has been paid or agreement that the
insured will pay
c) It states that the insurer will provide cover detailed in the policy
subject to the terms and conditions.

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iii) Signature – Under the preamble or close to it is the signature of an authorized
official of the insurer.
iv) Operative Clause – It is the part that outlines the actual cover provided. It
begins with “The company will…….” And then states what the company
promises.
v) Exceptions or Exclusions – This is the inevitable consequence of having a
scheduled policy e.g. war and nuclear risks.
vi) Conditions – they include a condition that the insured will comply with all
terms of the policy and procedure in the event of a claim etc.
vii) Policy Schedule - This is where the policy is made personal to the insured.
The details specified include; name of the insured, address, nature of business,
period of insurance, premiums, sum insured and policy number among others.

6.3 Premiums

The premium which an insured pays represents his contribution to the common pool
and thus must reflect the value of risk and the degree of hazard brought to the pool.
The premium must be sufficient to:-
a) Cover expected claims – the law of large numbers does allow the
underwriter to make a reasonably accurate assessment of the likely loss
costs.
b) Create an estimate for outstanding claims – the premium must take into
account those claims still to be settled at the end of the year.
c) Provide a reserve – contingencies must be taken into account e.g.
provisions for IBNR reserve.
d) Meet all expenses – including salaries, office costs, advertising,
commission etc.
e) Provide for profit – underwriter must ensure provision for reasonable
profit.
In arriving at the premium figure a number of commercial considerations must be
taken into account.

a) Inflation – the cost of settling claims may rise due to the fall in the
value of money.
b) Interest rate – Since insurers are major investors, variability in interest
rates should be incorporated in premium calculation
c) Exchange rates – Because of movement of money across national
borders, there‟s a problem of exchange rate risk which must be taken
into account in premium computation.
d) Competition – Charging too high a premium may result in loss of
business but too little could result in a loss, so a balance is needed.
Life assurance premiums are made up of four components namely:-
i) Mortality – is the risk of death, mortality tables are used.
ii) Expenses – salaries, commission etc.
iii) Investment – Investments earn substantial income & are taken into account
iv) Contingencies – Unexpected level of loss.
The premium charged will mostly be a level premium though the risk increases each
year as person gets older but this is taken into consideration.

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6.4 Claims and Disputes
i) Claims notification is the responsibility of the insured- The insurer will
want speedy notification of the claim. This enables the insurer for
instance to take statements from witnesses immediately after the
accident. A claim is normally intimated by completing a claim form.
In life assurance, the insurer needs proper proof of death and wills or
assignments is taken into consideration.
ii) Claims handling – Small brokers may have authority to handle claims
although limits will be imposed. A majority of claims are handled in
the claims department of the insurer. The insured has to prove the
amount of loss e.g. purchase receipt, repair account or valuation. In
addition to claims staff of insurance companies, experts could be
retained like loss adjusters. The adjusters report covers basic facts
about the insured and the loss.
i) Claims Settlement – The final stage in the claims procedure is the
actual settlement. In life assurance, what is payable is a fixed sum.
However for general insurance the eventual costs of the claim will
depend on the extent of loss or damage and nature of cover afforded by
the policy.
ii) Disputes - when a dispute does a rise it could revolve around a number
of factors. The liability of an insurer to pay a claim, amount to be paid
or the speed with which claims are handled. Claims where liability has
been admitted must first be referred to arbitration, otherwise to court.

6.5 Reinsurance

Having accepted a risk the insurer is in much the same position as the insured as
pertains to uncertainty. Insurers are not immune to the possibility of larger than
expected losses or more looses than anticipated. Thus insurers also seek insurance; the
insurers insure the risk again, which is called reinsurance. The reasons why insurers
buy reinsurance are:-
a) Security – the insurer seeks security and peace of mind.
b) Stability – to avoid fluctuation in claim costs from year to year.
c) Capacity – the insurer can increase capacity to accept business
d) Catastrophes – which could cause financial problems are
transferred to reinsurers
e) Macro benefits – the cost of risk is spread at the market place and
the world, the impact of risk does not fall solely on one economy.

There are two main forms of reinsurance namely facultative and treaty. For
facultative, each risk is offered to the reinsurer by the direct office and the reinsurer
assesses it and decides whether to accept or not. Treaty is where there is an agreement
to the effect that all risks within certain parameters will be offered (ceded) to the
reinsurers. The reinsurer cannot decline the risk and the direct office cannot select
which risk to offer and which ones to retain.

The methods of provision of treaty reinsurance can either be by proportional treaties

or non-proportional treaties. The arrangements under proportional treaties include:

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 (a) Quota share treaty where a fixed proportion of every risk defined in the
treaty is reinsured e.g. reinsure 80% of each and every risk.
(b) Surplus treaty - The direct office decides how much to retain on each
risk (retention) e.g. Ksh.20,000. The direct office then arranges
reinsurance measured in lines. A line being equal to the retention.
Reinsurance will be multiples of this line e.g. a risk of Ksh.500, 000 is
placed with an insurer whose retention is Ksh.20,000. There are two
surplus treaties, a ten line first surplus and a ten line second surplus.
The reinsurance arrangement would be as follows:-
Retention - 20,000
First surplus treaty (10 x 20,000) - 200,000
Second surplus treaty (10 x 20,000) - 200,000
TOTAL 420,000
Facultative reinsurance 80,000
TOTAL RISK VALUE 500,000
The arrangement under non-proportional treaties include; Excess of loss and stop loss
reinsurance.

7: INSURANCE MARKETS

Like any other market, the insurance market comprises of sellers, buyers and
middlemen.

7.1 The Buyers of Insurance

Most people tend to think of insurance in terms of personal insurances e.g. private car
insurance, household insurance, life assurance etc. However, for most insurance
companies, it is commercial and group insurances that form a big volume of their
business. One single company could be spending millions per year on insurance
premium. Thus buyers of insurance are individuals and enterprises.

7.2 The Intermediaries

It is possible to buy insurance direct from the insurance company. It is also possible
for an individual to use services of an intermediary. The commercial buyer however
may be faced with complex risks. He needs expert advice to enable him assess the
risks he has and match then to the best seller of the insurance. In legal terms an
intermediary is an agent who is authorized by the principal to bring the principal into
a contractual relationship with another third party. There are different forms of
intermediaries in the market place:-
(a) Insurance Broker – A broker is an individual or firm whose full
time occupation is the placing of insurance with insurance
companies e.g. AON Minet Insurance Brokers Ltd. The broker

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 offers independent advice on a wide range of insurance matters
e.g. insurance needs, best type of cover, best market, claims
procedure etc. Most commercial insurance will be transacted
through a registered broker
(b) Lloyds Brokers – carries out the functions mentioned above but
only for placing business at Lloyd‟s. The council of Lloyd‟s
registers broking firms to act as Lloyds brokers.
(c) Insurance Consultants - Regulations exist for those who wish to
call themselves brokers. Many of the persons acting as
intermediaries without registering under the relevant legislation
(The insurance Act) may refer to themselves as consultants.
(d) Tied Agents – tied agents can only advise on products offered
by their host company.
(e) Home service representatives – industrial life offices employ
representatives to call at the homes of policy holders to collect
premium and pay claims.

7.3 The Sellers or Suppliers of Insurance

1. Lloyds - The Corporation does not transact insurance but provides

premises, services and assistance for the individual or corporate
underwriting members. The capital behind underwriting at Lloyds is
supplied by investors called “Names”. Until 1994 Names had to be
individuals investing in personal capacity but from January 1994,
corporate members have been admitted.
2. Insurance Companies - majority sellers are insurance companies which
can either be:
a) Proprietary companies – created by royal charter, or Act of
parliament –normally formed by registration under the
companies Act. These companies have an authorized and
issued share capital. The shareholders liability is limited to the
normal value of their shares.
b) Mutual Companies – They are owned by the policy holders,
who share any profits made. The shareholder in the proprietary
company receives his shares of profit by way of dividends but
in the mutual company the policy holder owner may enjoy
lower premiums or higher life assurance bonuses than would
otherwise be the case.
3. Captive Insurance companies – it‟s an arrangement where the parent
company forms a subsidiary company to underwrite certain of its
insurable risks. It benefits by the groups risk control techniques thus
paying premiums based on its own experience, avoidance of direct
insurers‟ overheads and purchasing reinsurance at lower costs.
4. Reinsurance Companies - Reinsurance furthers the principle of
spreading risk and offers the insurer stability and protection against
catastrophe and offers technical devises.

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