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
•personal;
•property
•liability
Personal Losses
Illness, injury
and premature death are all examples of personal loss exposures.
Property Losses
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 Losses
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
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
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.
Hazards
Four types of
hazards promote loss:
·
•physical
hazard;
·
•moral
hazard;
·
•legal
hazard
·
•moral
hazard.
Physical
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.
Moral
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
•embezzlement.
Moral
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.
Legal
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