Old school insurance 101

This past week I had the pleasure of addressing a group of young persons who wanted to have a better understanding how insurance works and its role in the economic system. It is not very often one gets the opportunity to deal with a technical matter which is wrapped in legal jargon and to reduce it into layman’s language. Consumers and the public at large are of the view that the insurance companies hold “all the trumps” and the dice is loaded against them because insurance is complicated and usually beyond the knowledge of the man in the street. There is some truth in this perception but on a wider scale it is no different from the other professions — perhaps insurance is not so bad after all when you compare it with law and medicine.

Lawyers now called attorneys would write or communicate with you in a way that often times you need to have them explain the issue in a language that you can understand. Even worse are the doctors who would tell you of your illness or medical condition in a language that only doctors understand and so it is refreshing when you find a doctor who has the ability to relate in simple English. In a general sense professionals can relate to one another but it takes a special skill to be able to transfer knowledge and information in a form that persons outside the profession or the ordinary layman can understand. This is the sign of a true professional when he has such a good grasp or command of the issue that he could reduce the technical information into simple layman’s language but sadly there are too few of these persons. The business of insurance is grounded on a few basic principles and for the sake of being technical — insurable interest, utmost good faith and indemnity. What do these words mean? Insurable interest simply means that the item that you want to insure must be owned by you or that you have a title or interest in it and if it is lost or destroyed you stand to lose financially. Insurance is not about speculation but rather seeking to protect your financial interest.

In the case of utmost good faith, some people have difficulty with this principle since insurance is unlike a commercial transaction where the principle involved is “let the buyer beware.” In insurance all the information about the item to be insured resides with the buyer and therefore he must truthfully disclose that information especially when it can influence the decision of the insurance company. In practice the proposal form is a questionnaire that seeks answers and the buyer is required to give truthful answers or run the risk of having his claim rejected. In commercial transactions, the opposite applies in the sense that the buyer must exercise care and a decision is usually made on price and value of money. The principle of indemnity is that the insured must be put back in the same financial position as if the loss did not take place and therefore he must not profit from a claim. While in theory the principle is simple enough, in practice it probably poses the greatest challenge and issues like depreciation, average for under insurance and market value when applied do not sit well with the insured.

The problem rears its head every day especially in motor insurance when the rate of depreciation is not spelt out in the policy and an opinion is provided by the loss adjuster on the market value taking into account the condition of the vehicle at the time of the accident and what a willing buyer and a willing seller will agree on as the value. The layman would usually view the application of this principle as arbitrary since there is no exact science. The opinion of the loss adjuster is based on experience and the knowledge of the market and he will indicate a range of values which will then leave room for negotiation. What should be appreciated is that most items depreciate in value through use or obsolescence and their useful life must be taken into consideration when establishing their value. One important term that is commonly used in insurance is “subrogation” and it simply means that the person who causes a loss can be pursued in the Courts or otherwise to make good. This happens often in motor insurance where under a full comprehensive policy an insurance company would settle the repair costs of its insured and then stand in his shoes and institute an action to recover its outlay against the other party that was responsible for the accident.

One must differentiate between life and non-life insurance policies. Life insurance and personal accident contracts are not contracts of indemnity but they are subject to the other principles of insurable interest and utmost good faith. Why is this so? It is said that one cannot put a price on a life and the only determinant is the insured’s ability to pay the premium. In practice, however, insurance companies have yardsticks where they correlate ability to pay the premium and one’s earnings and if they are out of line then further investigation is carried out since insurance companies do not want a mismatch as  an early lapse results in the loss of the front-end costs associated with the issue of a policy. Insurance accounts for approximately 6 percent of GDP. Its plays a most important role in the economic life of any country and is a key mobiliser of savings as a financial intermediary. Inspite of its contribution to national development the industry does get a bad ‘rap’ from time to time — some deserved — but often not deserved as it is often misunderstood and therefore it has to do a better job at communicating with its various publics.
E-mail: daquing@cablenett.net