HISTORY OF INSURANCE
Origins in China
As important as insurance is to modern society, it is not a new idea. The insurance industry enjoys a long and sometimes colorful history dating back many centuries. The earliest form of insurance occurred when wealthy Chinese merchants along the Yangtze River decided that it was too risky to place all their merchandise on a single vessel and sail it down the river. To reduce their risks, they split the shipment into smaller portions and placed them on several boats. They knew that it was unlikely all the vessels would sink or suffer damage and that if one did sink, the majority of the cargo would reach its destination safely. Although this arrangement was not formally called insurance, it was the forerunner of the modern insurance company, which also recognizes the importance of spreading risk.
Lloyd's of London
The more formalized insurance arrangements we are familiar with today actually began at a coffeehouse owned by Edward Lloyd near London. In the late 1600s, wealthy merchants gathered at the coffeehouse to discuss their latest ventures, which often involved overseas shipments, increasingly to the new world. Concerned that they could be devastated financially if an entire shipment was lost, merchants began to make arrangements with each other to share their risks of loss. When a shipment was scheduled to depart, the owner posted a notice with a complete description of the cargo and vessel at the coffeehouse. Other merchants looked at the description and signed their names beneath with a percentage of the cargo they were willing to pay for if the vessel were lost. When 100 percent of the cargo was insured in this manner, the vessel sailed. These early merchants became known as underwriters. If the voyage was successful, each underwriter received a bonus, or premium. If, however, the vessel did not reach its destination, the underwriters made good the loss to the shipper. This, of course, was the beginning of Lloyd's of London, an institution that has continued to operate in much the same way for more than 400 years and after which many of our United States insurance customs and practices are patterned. Lloyd's remains a major participant in the worldwide insurance industry. Lloyd's of London is not an insurance company that sells policies. It is a group of private insurers that underwrite risks they feel are good business proposals submitted to them from customer groups.
Fire Insurance Origins
The U.S. insurance industry owes a great deal of its current structure to Benjamin Franklin, who is less known for instituting U.S. insurance practices than for inventing things. In the late 1700s, as cities grew, citizens were highly concerned about fire damage to homes and other buildings. Franklin convinced worried citizens to contribute to a fund that would pay for a fire brigade to extinguish fires. Each contributor received a fire mark plaque to be placed on the front of his or her house.
In the event of a fire, brigades came by looking for the fire mark. When they saw one, they stopped and put out the fire. If, however, a home didn't have one or it named another brigade, they kept going. Although this may not appear to be insurance by today's standards, this kind of arrangement involves many fundamental concepts still used in the modern insurance industry.
Overview of insurance sector in Nigeria
The British colonial government introduced insurance business into Nigeria in 1910. Before this time some forms of traditional social insurance had been in existence in every part of Nigeria. This was in the form of mutual and social scheme, which evolved through the extended family system, age grades and clan union of African cultures (Osoka, 1992 ).
Out of twenty-five insurance companies that existed in 1960, only seven were indigenous and their total market share was far below 10% (Osoka, 1992).The fallout from this was the drain on Nigeria foreign exchange earnings. As a result of this, a parliamentary committee was therefore set up in 1964, under the chairmanship of Honorable Obadan, to look into foreign domination of insurance. In the end, Obadan committee’s recommendation could not go beyond sensitization of Government over the danger inherent in the foreign domination of insurance industry (Usman, 2009 ).There was a phenomenal increase in the number of insurance companies in Nigerian financial market following the introduction of Structural Adjustment Programme (SAP) in mid 1986.
The need for intervention and control of the government led to the formation of National Insurance Corporation of Nigeria (NICON), in 1989 which was latter christened NICON Plc.
The number of insurance companies increased from 70 in 1976 to 110 in 1990.However, to streamline insurance business activities and stem the upsurge of the “mushroom” insurance companies, insurance capital base was raised from N1 million to N2 million. Fall-out from this event was that only fifty-seven out of one hundred and fifty-two insurance companies qualified for registration. This was coupled with the tighter control over the industry that requested for provision for the licensing and control of insurance intermediary. In an attempt to fortify insurance sector in Nigeria, the sub-sector has undergone two round of recapitalization over the past 8 years. The first of the two round of recapitalization occurred in 2003 in line with passing of the 2003 insurance act where insurance companies were required to increase their capital bases from N20 million to N150 million for life businesses, N70 million to N300 million for non-life businesses, and N150 million to N350 million for reinsurance businesses. There were 117 insurance companies before the recapitalization in December 2002, 14 of them did not make it and were liquidated. In September 2005, a new capitalization Yinusa and Akinlo 219 requirement was announced, increasing the capital base to N2 billion for life businesses, N3 billion for non-life businesses and N10 billion for reinsurance. Following the completion of the 2005/6 recapitalization exercise, which also involved quite a number of consolidations, the number of insurance companies dropped from 103 to 49. In 2008 the total asset of insurance companies was N573, 152.48 billion (National Insurance commission, 2010).In Nigeria, insurance carriers accounted for 61% of jobs, while insurance agencies, brokerages and providers of other related-insurance services accounted for 39% of jobs in the industry. The majority of establishments in insurance industry were small. However, a few large establishments accounted for many of the jobs in the industry (National Bureau of Statistics, 2009). Insurance carrier tends to large establishments, often employ 250 or more workers, and whereas agencies and brokerages tend to be much smaller frequently employ fewer than 20 workers. Many insurance carriers’ home and regional offices are situated near large urban centre. Insurance companies which deal directly with the public are located throughout the country. Most of the workers are working in local insurance company offices. Many others in the industry work for independent firms in small towns and cities throughout the country (Mia de Vos et al, 2011). According to Akanro (2008), Government legislation has also supported the prospect of growth for the industry. Regulations that have been propagated by the Government in recent times in support of growth in the industry include the following: Compulsory insurance for all public buildings as well as those under construction; compulsion for all private sector organizations operating in the country to enrolls their employees in National
Health Insurance scheme to boost the resources base of the scheme; National Insurance Commission must ensure that any inhibitions to local insurers participating in the oil and Gas business are removed. It has also worked to ensure that “consortium bidding” is strongly considered by the Oil and Gas companies in selecting insurers for participation in the Oil and Gas business. This is to achieve a wider spread in participation by local insurance companies; an upward review of interest rates by the Central Bank that are currently earned on the Statutory Deposits of insurance companies which are placed with the CBN and the plan by the regulatory authority to address the tax law, which places separate tax on gross premium.
HOW INSURANCE WORKS
Insurance is an agreement where, for a stipulated payment called the premium, one party (the insurer) agrees to pay to the other (the policyholder or his designated beneficiary) a defined amount (the claim payment or benefit) upon the occurrence of a specific loss. This defined claim payment amount can be a fixed amount or can reimburse all or a part of the loss that occurred.
The insurer considers the losses expected for the insurance pool and the potential for variation in order to charge premiums that, in total, will be sufficient to cover all of the projected claim payments for the insurance pool. The premium charged to each of the pool participants is that participant’s share of the total premium for the pool. Each premium may be adjusted to reflect any 3 special characteristics of the particular policy. As will be seen in the next section, the larger the policy pool, the more predictable its results.
Normally, only a small percentage of policyholders suffer losses. Their losses are paid out of the premiums collected from the pool of policyholders. Thus, the entire pool compensates the unfortunate few. Each policyholder exchanges an unknown loss for the payment of a known premium.
Under the formal arrangement, the party agreeing to make the claim payments is the insurance company or the insurer. The pool participant is the policyholder. The payments that the policyholder makes to the insurer are premiums. The insurance contract is the policy. The risk of any unanticipated losses is transferred from the policyholder to the insurer who has the right to specify the rules and conditions for participating in the insurance pool.
The insurer may restrict the particular kinds of losses covered. For example, a peril is a potential cause of a loss. Perils may include fires, hurricanes, theft, and heart attack. The insurance policy may define specific perils that are covered, or it may cover all perils with certain named exclusions (for example, loss as a result of war or loss of life due to suicide).
Hazards are conditions that increase the probability or expected magnitude of a loss. Examples include smoking when considering potential healthcare losses, poor wiring in a house when considering losses due to fires, or a California residence when considering earthquake damage.
In summary, an insurance contract covers a policyholder for economic loss caused by a peril named in the policy. The policyholder pays a known premium to have the insurer guarantee payment for the unknown loss. In this manner, the policyholder transfers the economic risk to the insurance company. Risk, as discussed in Section I, is the variation in potential economic outcomes. It is measured by the variation between possible outcomes and the expected outcome: the greater the standard deviation, the greater the risk.
CHARACTERISTICS OF INSURABLE RISK
We have stated previously that individuals see the purchase of insurance as economically advantageous. The insurer will agree to the arrangement if the risks can be pooled, but will need some safeguards. With these principles in mind, what makes a risk insurable? What kinds of risk would an insurer be willing to insure? The potential loss must be significant and important enough that substituting a known insurance premium for an unknown economic outcome (given no insurance) is desirable. The loss and its economic value must be well-defined and out of the policyholder’s control. The policyholder should not be allowed to cause or encourage a loss that will lead to a benefit or claim payment. After the loss occurs, the policyholder should not be able to unfairly adjust the value of the loss (for example, by lying) in order to increase the amount of the benefit or claim payment. Covered losses should be reasonably independent. The fact that one policyholder experiences a loss should not have a major effect on whether other policyholders do. For example, an insurer would not insure all the stores in one area against fire, because a fire in one store could spread to the others, resulting in many large claim payments to be made by the insurer.
These criteria, if fully satisfied, mean that the risk is insurable. The fact that a potential loss does not fully satisfy the criteria does not necessarily mean that insurance will not be issued, but some special care or additional risk sharing with other insurers may be necessary.
FUNDAMENTAL OF INSURANCE CONCEPTS
PERILS AND CAUSES OF LOSS
Many people use the term loss, peril and hazard synonymously. However, the meanings of these words as used in insurance are quite different and should be carefully distinguished. As we discussed in the last chapter, in insurance, a loss is defined as an unintended, unforeseen reduction or destruction of financial or economic value to an individual, organization or object caused by an accidental event. For example, the market value of an automobile decreases as it ages. Although depreciation represents a decline in the auto's economic value, it is not unforeseen, and, therefore, it does not represent a loss in an insurance sense. On the other hand, the destruction of an auto by a tornado is unintended and unforeseen and is, therefore, considered a loss.
Common Loss Exposures
The probability that an event will occur is called a chance of loss or an exposure to loss. Listed below are the most common exposures to loss are
Illness, injury and premature death are all examples of personal loss exposures.
Car accidents, house fires and storm damage to businesses are examples of property loss. Property loss involves the destruction of personal or commercial property.
Liability loss exposure means the potential to become legally responsible for injuries of others or damages to someone else's property. For example, if your dog bites a small child, you may be liable for the child's injuries. Likewise, if you have a car accident and are held at fault, you may be required to pay for any injuries or damages that result.
Direct and Indirect Losses
Losses can be classified as either direct or indirect, with insurance policies designed to cover either or both types of loss.
Direct loss refers to actual physical loss, destruction or damage to property—for instance, the loss caused by a fire as well as other damage for which the fire was the proximate cause, such as water damage from putting out the fire.
Indirect loss is a financial loss incurred as a result of direct damage to property. For a business, this includes loss of profits, rent and continuing or extra expenses necessary to keep the business operating after a direct loss. In the case of a personal dwelling, indirect loss involves the possible loss of rent from a rental unit in the dwelling or the extra expenses the homeowner incurs from living in a motel while his or her home is being repaired after a direct loss.
Proximate cause is the uninterrupted sequence of events that produces a loss due to negligence, injury or damage. In other words, there is an unbroken chain of cause and effect between the occurrence of an insurance peril and the damage to property.
Suppose a fire in one part of a building caused damage to wiring that in turn caused a short circuit. The short circuit then caused damage to machinery in another part of the building. In this example, fire was the proximate cause of damage to the machinery. The old story of Mrs. O'Leary and her famous cow that caused the Great Chicago Fire is still a classic example of proximate cause. The cause (cow kicking over the lantern) that sets in motion an unbroken chain of events leading to a loss (fire damage) is considered the proximate cause of the loss.
Peril is the insurance term for the actual cause of a loss. Perils are identified or referred to in the policy. Perils include such events as fire, wind, hail, collision with another car and the like. A named peril policy provides coverage only if a loss is caused by one of the perils specifically named or identified in the policy, such as fire, wind or hail. If a peril is not listed, it is not covered. Policies also can exclude perils only under certain conditions or cover them only under certain conditions.
For example, vandalism is a covered cause of loss in most property insurance policies.
However, coverage for vandalism often is excluded when a building has been vacant for more than 60 days preceding the loss.
The insuring agreement of an open perils policy is stated in very broad terms—the policy provides coverage for risks of direct physical loss or damage except from those causes of loss specifically excluded, such as intentional losses, earthquake and the like. In other words, open perils policies define coverage in part by the policy exclusions.
The term all risk should not be used in any written or oral communication with a Key^olnt insured. This has become insurance industry shorthand for an open perils or a special form policy, but the term can be misleading to a policyholder who might expect his or her policy to cover every type of loss situation.
Four types of hazards promote loss:
· •physical hazard;
· •moral hazard;
· •legal hazard
· •moral hazard.
This is a characteristic of a loss exposure or physical object that increases the chance or degree of loss. Examples of physical hazards include
•a broken step;
•a wooden building located far from a fire department; or
•a sports car driven by a reckless young driver.
This factor relates to the honesty of the individual who is insured and to conditions that encourage an insured to cause losses for his or her own benefit. The existence of moral hazard increases both the chance and degree of loss because it is often difficult
For the insurer to see and correct in advance. Examples of moral hazard include
•arson for profit
An attitude of carelessness or lack of concern on the part of the insured that increases the chance that a loss will occur is also a moral hazard. Examples of this type hazard morale include
• leaving doors unlocked;
• carelessly handling smoking materials; or
• storing oily rags near a fire source.
The legislation created and enforced by legislative, judicial and administrative agencies creates legal obligations and potential liability for an individual or entity. A legal hazard exists when an individual or entity is susceptible to legal action resulting from the enforcement of such legislation. The courts, for example, apply the doctrine of absolute or strict liability to a party engaged in an extra-hazardous pursuit, even if the person involved in the activity has not performed negligently. Anyone who possesses, stores, maintains or transports a dangerous instrumentality or device is absolutely liable for any injury or damage caused by that instrument, regardless of the presence of due care.
For example, assume a person keeps an undomesticated animal, such as a mountain lion, as a pet. The owner installs a 20-foot fence around the backyard and posts signs warning trespassers that a wild animal is present. The courts will likely find the owner absolutely liable for any injury or damage that the animal may cause, even though the owner took precautions to prevent such occurrences. The owner of the mountain lion has subjected his or her neighbors to abnormal risk by bringing a wild animal into the neighborhood.
REQUIREMENTS OF AN INSURABLE RISK
Not all risks and loss exposures are insurable. Insurance companies generally are unwilling to insure unusual risks or those that represent a potential for catastrophic loss. Certain requirements must be met for a risk to be insurable from a company's point of view. To be insurable, a risk must meet the following general requirements:
•large enough to cause economic hardship yet feasible to insure;
•not excessively catastrophic; and
• unintentional and accidental.
Economic Hardship Losses
When an individual purchases an insurance policy, he or she transfers the risk of economic loss to an insurance company. Although people might wish to transfer all of their chances of loss to the insurer, insurance companies are not interested in assuming every risk inherent in a person's everyday life. The potential losses insurance covers must be large enough to warrant the insurer's time, effort and expense to provide insurance against the occurrence. Thus, the potential loss must be large enough to cause an economic hardship for the insured, yet the cost of insuring the risk must be economically feasible. Most insurance policies do not provide coverage for small losses, such as an injury
To a household pet, that insured can usually afford to pay themselves. To this end, many insurance policies include a deductible provision, which specifies that, in return for a reduced premium, the insured will assume losses below a specified amount, perhaps $100 or more.
Individually Random Losses
To be insurable, losses must be individually random. The risk is not likely to result in repeated catastrophic losses, either to the same insured or to a significant number of similar insured at the same time. Assume that several houses are built along the banks of a river that overflows its banks almost every year. When the floods begin, the homeowners must evacuate the homes and move to another location until the flood waters subside. Most of these homeowners have an average loss of $15,000 each time the river overflows.
Because there is a significant chance that the insurance company would lose a great deal of money insuring these house for flood damage, most home owners insurance policies exclude the peril of flood. Certain natural disasters that can cause widespread disaster may appear to be uninsurable. However, coverage can be purchased through certain specialty insurers or particular government programs.
Fortuitous or Accidental Losses
The loss must be fortuitous or accidental; meaning to be insurable, losses must be accidental and unintentional from the insurer's standpoint. Individuals covered by insurance contracts should not benefit financially from the occurrence of an event insured against. Neither can they intentionally cause a loss to recover from an insurance company.
INSURABLE INTEREST AND INDEMNITY
Once a company has determined that a risk is unintentional, significant in size to cause economic hardship, not excessively catastrophic and feasible to insure, it next must determine if the client has an insurable interest. Insurable interest means having a relationship to property such that a loss of or damage to the property results in a financial loss to an individual or organization. Such an interest generally comes about through
• owning property;
• having a relationship with the named insured;
• holding a mortgage or Men on property; or
• having care, custody or control of other people's property.
Insurable interest is a relationship between a person and a property such that, if a loss occurs, the person is harmed financially. An insurable interest must exist at the time of the loss for payment to be made.
Generally, state law requires that the insurance buyer, as well as other insured on the contract, have an insurable interest at the time of application for the insurance policy and at the time of a loss (claim). However, insurable interest need not be maintained throughout the life of the contract. For example, a loan can be paid off, extinguishing the lender's interest. The policy does not have to be cancelled nor the name of the lender removed, but it will not receive any benefits under the policy because its insurable interest has ended.
The Principle of Indemnity
One of the foundations upon which the property and casualty industry is built is the principle of indemnity. This is similar to insurable interest, but rather than defining under what circumstances a policyholder can collect on an insurance policy, the principle of indemnity determines how much he or she can collect.
Under this rule, insurance policies are considered to be contracts of indemnity, meaning they are designed to put someone back in the same general financial condition he or she was in before the loss. In other words, a person should not be able to profit by collecting on insurance. The elimination of gain also supports the idea that insurance is designed to insure only pure risk situations.
PRINCIPLES OF UTMOST GOOD FAITH
Both the parties to a commercial contract are by law required to observe good faith. Let us say that you go to a shop to buy an electrical appliance. You simply will not enter, pay and pick up any sample piece but will check two, three or even more pieces. You may be even ask the shopkeeper to give a demonstration to ensure that it is in working condition and also ask several questions to satisfy yourself about what you are buying. Then when you go home you find it does not work or is not what you were looking for exactly so you decide to return the item but the shopkeeper may well refuse to take it back saying that before purchasing you had satisfied yourself; and he is possibly right. The common law principle “Caveat Emptor” or let the buyer beware is applicable to commercial contracts and the buyer must satisfy himself that the contract is good because he has no legal redress later on if he has made a bad bargain. The seller cannot misrepresent the item he has sold or deceive the buyer by giving wrong or misleading information but he is under no obligation to disclose all the information to the buyer and only selective information in reply to the buyers queries is required to be given. But in Insurance contracts the principles of “Uberrima fides” i.e. of
Utmost Good Faith is observed and simple good faith is not enough. Why this difference in Insurance contracts?
Firstly, in Insurance contracts the seller is the insurer and he has no knowledge about the property to be insured. The proposer on the other hand knows or is supposed to know everything about the property. The condition is reverse of ordinary commercial contracts and the seller is entirely dependent upon the buyer to provide the information about the property and hence the need for Utmost Good Faith on the part of the proposer. It may be said here that the insurer has the option of getting the subject matter of Insurance examined before covering the risk. This is true that he can conduct an examination in the case of a property being insured for fire risk or of getting a medical examination done in the case of a health policy. But even then there will be facts which only the insured can know e.g., the history of Insurance of the property whether it has been refused earlier for Insurance by another company or whether it is also already insured with another company and the previous claim experience. Similarly a medical examination may not reveal the previous history i.e. details of past illness, accidents etc. Therefore Insurance contracts insist on the practice of Utmost Good Faith on the part of the Insured.
Secondly, Insurance is an intangible product. It cannot be seen or felt. It is simply a promise on the part of Insurer to make good the loss incurred by the Insured if and when it occurs.
Thus the Insurer is also obliged to practice Utmost Good Faith in his dealings with the Insured. He cannot and should not make false promises during negotiations.
He should not withhold information from the Insured such as the discounts available for good features e.g., fire extinguishing Appliances discount in fire policies or that Earthquake risk is not covered under the standard fire policy but can be covered on payment of additional premium.
In the recent Earthquake disaster in Gujarat a number of Insured failed to get any relief from Insurance Companies as Earthquake risk was not covered. Utmost Good Faith can be defined as “A positive duty to voluntarily disclose, accurately and fully all facts material to the risk being proposed whether requested for or not”. In Insurance contracts Utmost Good Faith means that “each party to the proposed contract is legally obliged to disclose to the other all information which can influence the others decision to enter the contract”.
The following can be inferred from the above two definitions:
(1) Each party is required to tell the other, the truth, the whole truth and nothing but the truth.
(2) Unlike normal contract such an obligation is not limited to any questions asked and
(3) Failure to reveal information even if not asked for gives the aggrieved party the right to regard the contract as void.
How is this duty of Utmost Good Faith to be practiced? And what are the facts that the proposer has to disclose? The answer to both the question is simply the proposer must disclose to the insurer all material facts in respect of the subject matter of Insurance.
WHAT IS A MATERIAL FACT?
Material fact is every circumstance or information, which would influence the judgments of a prudent insurer in assessing the risk. Those circumstances which influence the insurer decision to accept or refuse the risk or which effect the fixing of the premium or the terms and conditions of the contract must be disclosed.
FACTS, WHICH MUST BE DISCLOSED
I. Facts, which show that a risk represents a greater exposure than would be expected from its nature 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 normal e.g. the building is located next to a warehouse storing explosive material.
iii. Facts, which would make the amount of loss greater than that normally expected e.g. there is no segregation of hazardous goods from non-hazardous goods in the storage facility.
iv. History of Insurance (a) Details of previous losses and claims (b) if any other Insurance Company has earlier declined to insure the property and the special condition imposed by the other insurers; if any.
v. The existence of other insurances
vi. Full facts relating to the description of the subject matter of Insurance