Insurance and Risk Management

1 INTRODUCTION

1.1 Concept of Risk

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 – If 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 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. 1998 Nairobi bomb blast.

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 or decrease 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. 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. Al 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 we have individuals designated as risk managers. At personal level individuals could be risk takers-jumping on any bandwagon, risk neutral- fence seaters and 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.

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 costed 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 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 every 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, 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.

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 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 3000 insurance agents, 43 insurance companies and 2 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 – Refer to principles of insurance to be discussed later
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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 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 completive 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. 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 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.

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.
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 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, lighting 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 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 period 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 mater 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 for 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:

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.

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 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.”

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

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

5.1.2 Essential Features of Insurable Interest

(a) There must be some property rights, interest, life, limbs or potential liability 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. 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 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. But 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 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. 3. For all other Insurances - Insurable interest must be present both at the time of effecting the policy and when any claim is made.

5.2 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. ii) External factors that make the risk greater than that normally expected. iii) Facts that would make amount of loss greater than normally expected 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. ii) Facts which the insurer is deemed to know. iii) Facts which lessen the risk. iv) Facts about which the insurer has been put on enquiry v) Facts which the insurer’s survey should have noted. vi) Fact s covered by policy conditions. vii) Facts which the proposer does not know. ix) Facts (convictions) which are ‘spent’ under the rehabilitation of offenders Act 1974.

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

In insurance contracts, there are two main types of perils that need consideration:-

i) Insured Peril – these are perils that covered by the policy. ii) Excluded Perils - these are the perils not covered by the policy.

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.

Proximate cause means the active, efficient cause that sets in motion a train of events which brings about a result, without the intervention of any force started and working actively from a new and independent source. It is not necessarily the first cause nor the last one but the dominant, efficient or operative cause.

5.3.1 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 due to attempts to minimize a loss already taking place is covered. iii) Intervention of a new act is outwith 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 gale caused the collapse of the wall onto another property. It was held that fire was not the proximate cause but the gale. 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 South Easthope 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 started but had to be stopped when a storm blew up. The harbour master ordered the ship out of port in case she sank and blocked the harbour. Outside the harbour 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 the moment it was damaged and as repairs had not been completed that danger was always present.

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 in a 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 thus indemnity is not possible.

5.4.1 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 repair 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.

5.4.2 Measurement of Indemnity
In property insurance the measure of indemnity is respect 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.

5.4.3 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.

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 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 a very large excess particularly in commercial insurance.

5.4.4 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 wear, tear 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 happening 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 Burnand V 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 entitled to recover more than he has paid out.

5.5.1 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 to an amount equal to that share of the risk out of any money recovered. Where the insurer makes ex-gratia payment to an 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.

5.5.2 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, lost 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 tortfeasor 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 proprietor. 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 an insurance policy and in the event of damage; if he recovers from the insurance policy, he is not entitled to compensation from the tenant and the insurers assume the rights to any money from the tenants. c) Right arising out of statute – 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 Rot Damage Act 1886. d) Rights arising out of subject Matter of insurance - where an insured has been indemnified for a total loss, he cannot claim the salvage as it would be more than indemnity.

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.

5.5.3 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, the property insurer would exercise subrogation against the driver who in turn passes it to motor insurer. This may mean insurers getting involved against each other often. This is particularly true for motor insurance and is handled in the following ways:-

i) Motor insurance – Some insurers waive their subrogation rights against each other by executing “knock for knock” agreements. 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 by way of contribution. Contribution ensures that the insurers will share the loss as they have all received a premium for the risk. Contribution applies only to contracts of indemnity. Contribution is the right of an insurer to call upon others 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 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 is 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 had a strict liability for the grain by custom of his trade and had insured it. The owner had 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 owner’s insurers. As interests were different, one as bailee and the other as owner, the court held that contributions should not apply.

5.6.1 When Contributions Operates 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 insurer 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 insurers if he wishes to be indemnified.

However, sometimes the equitable right 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 employer’s 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 there is no contribution with the motor insurers.

5.6.2 Basis of contributions

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

Sum insured by particular insurer x loss Total of sum insured of all insurers = Liability of particular insurer

e.g. Company A insures house contents for Ksh.10,000 while company B insures them for Ksh.5,000, the insured losses = Ksh. 2000 in afire Office A pays = 10,000 x 2000 = 1,333 15,000 Office B pays = 5,000× 2000 = 667 15,000 TOTAL 20000

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.

Insurer’s independent liability x loss Total of all insurers’ liabilities = liability of individual insurer

e.g. If property is 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

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

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.

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.

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:

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 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 – its 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.