(A full ‘Study & Training Guide’ will accompany the
Study or Training Manual(s) you will receive soon by airmail post).
This Study Guide - like all our Training Materials - has been written by professionals; experts in the
Training of well over three million ambitious men and women in countries all over the world. It is
therefore essential that you:-
�� Read this Study Guide carefully and thoroughly BEFORE you start to read and study Module
One, which is the first ‘Study Section’ of a CIC Study or Training Manual you will receive for the
Program for which you have been enrolled.
�� Follow the Study Guide exactly, stage by stage and step by step - if you fail to do so, you might
not succeed in your Training or pass the Examination for the CIC Diploma.
�� STAGE ONE
Learning how to really STUDY the College’s Study or Training Manual(s) provided - including
THOROUGHLY READING this Study Guide, and the full ‘Study & Training Guide’ which you will
soon receive by airmail post.
�� STAGE TWO
Studying in accordance with the professional advice and instructions given.
�� STAGE THREE
Answering Self-Assessment Test Questions/Exercises.
�� STAGE FOUR
Assessing - or having someone assess for you - the standard of your answers to the Self-
Assessment Test/Exercises.
�� STAGE FIVE
Preparing for your Final Examination.
�� STAGE SIX
Sitting the Final Examination.
Remember: your CIC Program has been planned by experts. To be certain of gaining the greatest
benefit from the Program, it is essential that you follow precisely each one of the SIX stages in the
Program, as described above.
STAGE ONE is your thorough reading of this ‘Study Guide’
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ABOUT CIC STUDY and TRAINING MANUALS
A CIC Study or Training Manual (which comprises 4 or 6 Modules - the first Module of which follows)
supplied by the College as part of your Course or Program is NOT simply a text book. It must therefore
not be read simply from cover to cover like a text book or another publication. It MUST be studied,
Module by Module, exactly as explained in the following pages. Each CIC Study or Training Manual
has been designed and written by specialists, with wide experience of teaching people in countries
all over the world to become managers, administrators, supervisors, sales and accounting personnel,
business-people, and professionals in many other fields.
Therefore, it is in your own best interests that you use the Study or Training Manuals in the way
CIC’s experts recommend. By doing so, you should be able to learn easily and enjoyably, and master
the contents of the Manuals in a relatively short period of time - and then sit the Final Examination
with confidence. Every Study Manual and Training Manual is written in clear and easy to understand
English, and the meanings of any “uncommon” words, with which you might not be familiar, are fully
explained; so you should not encounter any problems in your Studies and Training.
But should you fail to fully grasp anything - after making a thorough and genuine attempt to understand
the text - you will be welcome to write to the College for assistance. You must state the exact page
number(s) in the Study or Training Manual, the paragraph(s) and line(s) which you do not understand.
If you do not give full details of a problem, our Tutors will be unable to assist you, and your Training
will be delayed unnecessarily.
Start now by reading carefully the following pages about Stages Two, Three and Four. Do NOT,
however, start studying the first Study or Training Manual until you are certain you understand how
you are to do so.
STAGE TWO - STUDYING A CIC MODULE
STEP 1
Once you have read page 1 of this document fully and carefully, turn to the first study section - called
Module One - of Study or Training Manual One. (Note: In some Manuals the term “Chapter” is
used instead of “Module”).
Read the whole of Module One at your normal reading pace, without trying to memorise every topic
covered or fact stated, but trying to get “the feel” of what is dealt with in the Module as a whole.
STEP 2
Start reading the Module again from the beginning, this time reading more slowly, paragraph by
paragraph and section by section. Make brief notes of any points, sentences, paragraphs or sections
which you feel need your further study, consideration or thought. Try to absorb and memorise all the
important topics covered in the Module.
STEP 3
Start reading the Module again from its start, this time paying particular attention to - and if necessary
studying more thoroughly - those parts which were the subject of your earlier notes. It is best that
you do not pass on to other parts or topics until you are certain you fully understand and remember
those parts you earlier noted as requiring your special attention. Try to fix everything taught firmly
in your mind.
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Note: You may not wish to, or be able to, carry out Steps 1, 2 and 3 one after the other. You could,
for instance, carry out Steps 1 and 2 and then take Step 3 after a break.
STAGE THREE - ANSWERING SELF-ASSESSMENT TESTS
STEP 4
When you feel that you have fully understood and learned everything taught in the whole Module
(and if necessary after a further careful read through it) turn to the Self-Assessment Test set at the
end of it, and read the Questions/Exercises in it carefully. You do not have to attempt to answer any
or all of the Questions/Exercises in the Test, but it is best that you do so, to the best of your abilities.
The reasons for this are:-
�� By comparing your answers with the Recommended Answers printed in the Appendix at the end
of the Module, you will be able to assess whether you really have mastered everything taught in
the Module, or whether you need to study again any part or parts of it.
�� By answering Questions/Exercises and then comparing your attempts with the Recommended
Answers, you will gain experience - and confidence - in attempting Test and Final Examination
Questions/Exercises in the future. Treat the Self-Assessment Tests as being “Past Examination
Papers”.
Professional Advice on Answering Self-Assessment Test
(and Examination) Questions and Exercises
1. You may answer the Questions/Exercises in a Self-Assessment Test in any order you like, but it
is best that you attempt all of them.
2. Read very carefully the first Question/Exercise you select, to be quite certain
that you really understand it and what it requires you to do, because:
�� some Questions/Exercises might require you to give full “written” answers;
�� some Questions/Exercises (e.g. in English) might require you to fill in blank spaces in sentences;
�� some Questions/Exercises (e.g. in bookkeeping) might require you to provide “worked” solutions;
�� some Questions/Exercises (called “multiple-choice questions”) might require you only to place
ticks in boxes ��against correct/incorrect statements.
In your Final Examination you could lose marks if you attempt a Question/Exercise in the wrong
way, or if you misread and/or misunderstand a Question/Exercise and write about something which
is not relevant or required.
3. Try to answer the Question/Exercise under ‘true Test or Examination conditions’, that is,
WITHOUT referring back to the relevant section or pages of the Module or to any notes you have
made - and certainly WITHOUT referring to the Recommended Answers. Try to limit to about two
hours the time you spend on answering a set of Questions/Exercises; in your Final Examination
you will have only two hours.
4. Although you are going to check your Self-Assessment Test answers yourself (or have a friend,
relative or colleague assess them for you) practise writing “written” answers:-
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�� in clear, easy-to-read handwriting;
and
�� in good, grammatical language.
The Examiner who assesses your Final Examination answers will take into account that English
might not be your national or main language. Nevertheless, to be able to assess whether you really
have learned what we have taught you, he or she will need to be able to read and understand what
you have written. You could lose marks if the Examiner cannot read or understand easily what
you have written.
5. Pay particular attention to neatness and to layout, to spelling and to punctuation.
6. When “written” answers are required, make sure what you write is relevant to the Question/
Exercise, and concentrate on quality - demonstrating your knowledge and understanding of facts,
techniques, theories, etc. - rather than on quantity alone. Write fully and clearly, but to the point.
If you write long, rambling Final Examination answers, you will waste time, and the Examiner will
deduct marks; so practise the right way!
7. When you have finished writing your answer, read through what you have written to see whether
you have left out anything, and whether you can spot - and correct - any errors or omissions you
might have made.
Warning: some Questions/Exercises comprise two or more parts; make certain you have
answered all parts.
8. Attempt the next Question/Exercise in the Self-Assessment Test in the same manner as we have
explained in 1 to 7 above, and so on until all the Questions/Exercises in the Test have been
attempted.
Note: There is no limit on how much time you spend on studying a Module before answering the Self-
Assessment Test set on it, and some Modules are, of course, longer than others. You will, however,
normally need to spend between twelve and fifteen hours on the thorough study of each Module -
and that time may be spread over a number of days if necessary - plus approximately two hours on
answering the Self-Assessment Test on each Module.
STAGE FOUR - ASSESSING YOUR ANSWERS
STEP 5
When you have answered all the Questions/Exercises set in Self-Assessment Test One to the best
of your ability, compare them (or ask a friend, relative or a colleague/senior at work to compare them)
with the Recommended Answers to that Test, printed in the Appendix at the end of the Module. In
any case, you should thoroughly study the Recommended Answers because:-
�� As already explained, they will help you to assess whether you have really understood everything
taught in the Module;
and
�� They will teach you how the Questions/Exercises in subsequent Self-Assessment Tests and in
your Final Examination should be answered: clearly, accurately and factually (with suitable
examples when necessary), and how they should be laid out for maximum effect and marks.
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MARKS AND AWARDS
To assist in the assessment and grading of your answers, the maximum number of marks which
can be earned for each answer to a Self-Assessment Test Question/Exercise is stated, either in
brackets at the end of each one.
The maximum number of marks for any one Test is 100.
Your answers should be assessed fairly and critically. Marks should be awarded for facts included
in your answer to a Question/Exercise, for presentation and for neatness. It is not, of course, to be
expected that your answers will be identical to all those in the Appendix. However, your answers
should contain the same facts, although they might be given in a different order or sequence - and
any examples you give should be as appropriate to the Questions/Exercises as those given in the
relevant “Recommended” Answers.
Add together the marks awarded for all your answers to the Questions/Exercises in a Self-Assessment
Test, and enter the total (out of 100) in the “Award” column in the Progress Chart in the middle of
the full ‘Study & Training Guide’ when you receive it. Also enter in the “Matters Requiring Further
Study” column the number(s) of any Question(s)/Exercise(s) for which you did not achieve high marks.
GRADES
Here is a guide to the grade your Self-Assessment Test Work has achieved, based on the number
of marks awarded for it:
50% to 59% PASS 60% to 64% HIGH PASS
65% to 74% MERIT 75% to 84% HIGH MERIT
85% to 94% DISTINCTION 95% to 100% HIGH DISTINCTION
STEP 6
Study again thoroughly the section(s) of the Module relating to the Question(s)/Exercise(s) to which
your answers did not merit high marks. It is important that you understand where or why you went
wrong, so that you will not make the same mistake(s) again.
STEP 7
When you receive the complete Study or Training Manual One** from the College by airmail post,
‘revise’ - study again - Module One printed in it, and then turn to Module Two and proceed to study
it thoroughly in exactly the same way as explained in Steps 1, 2 and 3 in this ‘Study Guide’.
When you have completed your thorough study, follow steps 4, 5 and 6 for the Self-Assessment
Test on Module 2.
Continue in the same way with each of Modules 3, 4, 5 and 6 until you have attempted and
assessed your work to Self-Assessment Test 6, and have completed the study of Study or Training
Manual One. But - and this is important - study the Modules one by one; complete Steps 1 to 6 on
each Module before you proceed to the next one (unless during the course of your reading you are
referred to another Module).
**Note: When you receive Study or Training Manual One by airmail post, it will be accompanied by
a 20-page ‘Study & Training Guide’ (containing a ‘Progress Chart’) which you MUST read very
carefully before starting your study of Module Two.
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TRAINING ON
INSURANCE -
PRINCIPLES & PRACTICE
Module One
CONTENTS
Foreword page 8
Nature and Purpose of Insurance page 10
Risk:
what risk might involve
losses from risks
increased risks
what insurance seeks to achieve
the mathematical law of average
the nature of risk
types of risks:
fundamental risks
particular risks
pure risks
speculative risks
risk and insurance:
controlling the financial aspects of the unknown
reducing risks
problems with moral hazard
The main function of insurance:
compensation or indemnity:
forms which indemnity may take
How insurance differs from wagers:
the legal position
insurable interest
utmost good faith
indemnity
likelihood of the event occurring
Insurable risks:
examples
tests of insurability
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Uninsured risks:
risks which cannot be insured, examples
why some risks are not insured
Means of reducing risks:
risk control methods
Subsidiary benefits of insurance:
reducing fear of the future
encouraging confidence to undertake new ventures
assisting people to save
investments
reducing demands on social services
Insurance and the law:
practical example
Contracts:
definition of a contract
agreements which are not contracts
the six essentials for a genuine contract:
intention that it is to be legally binding
unrevoked offer
unqualified acceptance
consideration
legality
capacity of the parties
Insurance contracts
Self-Assessment Test One page 26
Recommended Answers to Self-Assessment Test One page 28
Contents of Modules 2 to 12 - What you will Learn page 29
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FOREWORD
Everything which exists, whether it is a human being, an animal, a building, a piece of machinery
or equipment or furniture, or any other “material” item, including money, is constantly exposed to
danger of some kind. A person or animal might suddenly die or be injured in an accident. A piece
of equipment or furniture might be broken, damaged or destroyed by fire or by water. Money, stocks
of goods or other valuable items might be lost or stolen.
The very large number of dangers which can do harm to humans, to animals and to non-living
things - and which can result in ‘losses’ - are called ‘risks’. Insurance is concerned with risk, and
its primary purpose is to eliminate or to reduce the harmful ‘effects of risk’, or the ‘fears’ which
arise from the existence of risk.
In every kind of society, most people and most organizations need some sort of protection - or
‘cover’ - against losses or the harmful effects or consequences of losses. There might be exceptions,
such as devoutly religious people who take vows of poverty and chastity, and who as a result have
no property and no dependants. But all other people and all organizations have possessions or
potential losses and liabilities which need to be protected.
Contracts of insurance, which we consider in Module 1, are only one way in which people can guard
against misfortune. Some tribal societies, for instance, developed systems of ‘mutual’ aid or help
to their respective “members”. If one member suffered a setback - such as the loss of a hut by fire
or the loss of cattle - the other members would act together to repair the damage, restore or rebuild
the hut, or to search for or even replace the lost animals. Such mutual aid does not work well unless
all members of a community are exposed to roughly the same risks, and will be unfair if some
members have the potential for greater and more frequent losses than do other members. The need
will then arise for a more equitable or fairer system, such as is provided by insurance.
Insurance developed in the distant past when societies found themselves unable to support trading
and manufacturing activities which involved risks of significantly increased size and/or frequency of
losses. Just as the ancient civilizations of the past: the Sumerians, Egyptians, Greeks, Romans,
Chineses and others, could not gain empires and “greatness” without what we would recognise as
bankers and banking services, so too did they need what we would today recognise as insurers and
insurance cover. For example, what we today call “marine insurance” was developed some 3,000
years ago by a race of people called the Phoenicians, who were great seafaring traders, around the
Mediterranean Sea in particular.
Many other types of property insurance date back to the “Industrial Revolution” in Britain, with its
growth of manufacturing enterprises using comparatively expensive buildings and machinery and
employing mass-production techniques. For example, private property insurance (initially to protect
against damage by fire) did not appear in England until after the “Great Fire of London” in 1666 AD,
which destroyed a large number of buildings.
The “roots” of modern-day insurance principles and practice extend back over thousands of years.
They have been developed, modified, codified and honed over many years, both in the light of
experience and also to meet prevailing circumstances from time to time in different countries or regions
of the world. Some countries have developed their own principles and practice of insurance
independently, without “outside” influences. In other countries the principles and practice of insurance
reflect past influences from other countries, although those might have subsequently been modified
in the light of national needs or circumstances.
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But the world of the 21st Century is “shrinking”; international trade and “globalization” are the order
of the day. More and more the need arises to “standardise” insurance practice, if not even some longheld
principles, between different countries. Similarly, computerisation, rapid communications, the
Internet, and new marketing methods have enormous impact on insurance practice in many countries.
It must also be borne in mind that new Statutes or Laws are enacted by the parliaments or other
legislatures of various countries from time to time, whilst older Statutes are amended or abolished.
Rules and regulations relating to insurance business in different countries also change over time.
In no way can insurance in practice be seen as being “static”; it is constantly adapting and evolving
to meet changing circumstances and customer demands. And it is customers who pay for insurance
cover, so their attitudes towards and requirements from insurance are very important.
It is therefore essential that any insurance practitioner:
�� Adapts as necessary what is taught in this Program to the conditions prevailing in his or her country
from time to time.
and
�� Keeps constantly abreast of any changes which occur from time to time which might affect
insurance practice in his or her country.
Of necessity, the major Case References and Case Studies and Acts of Parliament mentioned
in these Manuals, on which many of the recognised principles of insurance are based - are from British
- and frequently English - Law, or are as extended by European Community (EC) Directives. Similarly,
for the reasons already explained, there might be small or significant differences between insurance
practice as described in these Manuals between different countries.
Some of the “precedents” which still hold good today were set in Legal Cases and Acts of
Parliament as long ago as 200 years; and the language (English) in which they were written appears
to us today to be very old-fashioned. In the interests of accuracy, we have reproduced sections of
judgements and Acts as they were written at the time, and have explained in modern-day English
any difficult to understand wording.
Many principles or maxims used in insurance were originally set down in a language called Latin;
when we have quoted them (and many are still used in Latin to this day, although the language is not
widely spoken) we have translated them for you into English.
Finally, do not hesitate to refer to the Glossary at the end of Manual One when necessary; that
special Alphabetical Section is designed as a “quick reference check" to help your further
understanding of many: “technical” words and terms used in insurance; words and terms which have
“specialised” meanings when used in insurance; words and terms whose meanings in insurance differ
from their “everyday” meanings; which are introduced and explained in the twelve Modules comprising
this Program.
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RISK AND THE NATURE
AND PURPOSE OF INSURANCE
Introduction
Every human being, every business or other organization, every nation, and every item (whether
living or not) on which a ‘monetary value’ can be placed, is “exposed to” or “faces” dangers, which
we collectively refer to as ‘risks’. Amongst very many, risks which might be faced include:-
�� The risk of a person being injured in or by a motor vehicle, aeroplane, railway train, ship or boat.
�� The risk of the premises of a business or any of its “contents” (money, furniture, machines,
equipment, stocks of materials or goods for sale) being damaged or destroyed by fire or water.
�� The risk of farm or domestic animals falling sick, being injured or killed or stolen.
�� The risk of money, machines, equipment, motor vehicles, stocks of raw materials or goods for
sale, or some other valuable item(s) being stolen.
�� The risk of injury to a person due to an accident in the work-place. That person might be an
employee, a customer, or some other person permitted access to the premises or other area, or
even a person who was not authorised to enter a work-place, such as a building site.
�� The risk of ill health necessitating medical expenses, the loss of life or limb, the loss of a family’s
“bread winner”.
�� The risk of “malicious” damage to property due to vandalism or for some other reason.
Losses from Risks becoming ‘Reality’
The variety of possible risks is very wide indeed. However, as you can see from the examples we
have given above, they all have one feature in common. If a risk becomes ‘reality’, that is, a harmful
incident actually occurs, something on which a monetary value can be placed is lost which it is not
intended should be lost. That which is lost might be money or other property, life, limb or health.
In insurance that which is lost is called a ‘loss’ - plural ‘losses’. Those words used in an insurance
context differ from when they are used in a normal business context, in which a “loss” is the opposite
of a “profit”, and is made when the total expenditure (payments) of a business exceeds the total income
(receipts) generated by its commercial activities. An insurance “organization” (business, company
or corporation) can, as we discuss in Module 10, also make a “business loss” for various reasons,
but here we are concerned with losses arising from harmful happenings - risks.
Common Features of Risks
Because there are so many different risks which might be faced - and we have already described
a wide variety of risks - what exactly constitutes a ‘risk’ is not easy to define; and for that reason there
is no one universally accepted definition. However, we shall base our study in this Program on this
definition:
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‘Risk is the inability to accurately predict the effects
of future events which might result in losses.’
Despite the great diversity of risks - some of which we have already described - apart from the
inevitability of a loss if an undesirable event occurs, we can identify certain other common features:
.
�� There is the possibility - not a certainty - of an undesirable event occurring.
�� There is unpredicability; that is, it is not known when the undesirable event will occur, or indeed
whether it will occur at all.
�� There is uncertainty as to or the extent (or value) of the loss which will arise should the undesirable
event actually occur.
We consider these features of risks further later in this Module. We also consider how different
people have differing attitudes towards risks, and why some risks which could be insured against are
not insured.
Increased Risks
Not all people or organizations or animals or items are necessarily exposed to the same risks.
Furthermore, some people or organizations or animals or items might be exposed to greater risk
than are others. To put it another way, in their particular cases, the chances of risks becoming ‘reality’
are greater.
For example, a racing driver clearly faces greater risk of being seriously injured in a motoring
accident than does the average motorist. Similarly, a business selling paints and other inflammable
materials faces greater risk of fire than do businesses selling, say, machines or metal filing cabinets.
Cash is more “exposed” to risk by theft - because it is so much more portable (easily carried) and is
“negotiable” or easy to exchange - than is, say, a large and heavy piece of machinery.
Fortunately, not every person or business actually has to face the consequences of the risks to
which they are exposed. For example, most businesses ‘insure’ their business premises and stocks
of goods, etc, against the losses which they would incur if the premises or stocks were destroyed by
fire. However, relatively few businesses do actually experience such a disaster. The problem is that
it is impossible to state in advance which businesses will be caused financial loss by fire - and which
will not suffer loss from that particular risk.
Insurers
If we stay with the example of the risk of fire, we can explain very simply for you at this early stage,
that organizations (which we shall refer to as ‘insurers’ or ‘underwriters’) offering insurance cover
against fire:-
�� Collect sums of money - called ‘premiums’ - from those businesses which (and people who)
require protection against the consequences of fire.
�� They ‘pool’ the premiums they collect to create a ‘fund’.
�� Out of the monies in a fund, they ‘compensate’ or ‘reimburse’ - that is, “make good” the losses
of - those businesses which (or people who) DO experience the disaster of fire.
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The above - simplified - example illustrates to you that insurance spreads the risk over as large
a body of people and/or organizations as it is possible to obtain. In that way, the premium paid by
any one ‘insured party’ - often called an ‘insured’ or a ‘policyholder’ - is relatively small compared
to the financial loss which that “party” might suffer in the event of the risk becoming ‘reality’, that is,
loss actually occurring. (Certain factors might make insurers vary the amount of the premiums which
some insured parties must pay; the reasons for this variation are discussed in Module 6.)
In order to achieve their aims adequately, insurers make use of a mathematical principle called
the ‘law of average’ or the ‘law of large numbers’. Under this mathematical principle, if a sufficiently
large number of cases is considered, the more likely will the result be equal to the average of all
possible cases. All insurers must maintain accurate statistics and study them, so that the premiums
charged (the “selling price”) can be just that little ahead of the amounts paid to policyholders who do
incur loss, plus selling expenses (the “cost price”) so that a reasonable overall gain - or “profit” - is
made by an insurance organization.
Computers greatly assist the compilation and maintenance and analysis of statistics in all classes
of insurance, because they can store vast quantities of data, can rapidly sort and retrieve it, they are
accurate and, what is most important, they produce results and “reports” literally at the “touch of a
key”. Accurate risk assessment is therefore that much quicker and more complete today than ever
before.
Nevertheless, even in its most modern form, insurance really involves:
(1) Gathering together into a “group” many people and/or organizations who are exposed to the same
risk.
(2) Collecting a prearranged sum of money - a premium - from each of them, thereby creating a
fund.
(3) Using monies in the fund to compensate or reimburse those in the group who meet with the
misfortune insured against. This process is called paying or settling ‘claims’ because
policyholders who suffer loss must ‘claim’ the amounts due to them from the insurers.
Contemporary insurance not only “shares” the values of losses amongst groups of individuals and
organizations, it also spreads them over ‘time’. This is possible because in years when the total value
of losses are lighter than expected, insurers can build up ‘reserves’ out of the funds created from
premiums collected, and also “earnings” from interest on their investments. Those reserves can be
used later in years in which the value of outgoings to compensate for losses is as great as or greater
than income received.
All these various matters and the words and terms used will be explored, considered and explained
further in the Modules in this Program; remember to refer to the Glossary for the meanings of words
or terms with which you are not familiar, or whose meaning (in insurance) is not entirely clear to you.
In this Module we look further at risk.
The Nature of Risk
Risk or danger is present whenever human beings are unable to control or foresee the future with
certainty. For example, the risks to a homeowner arise because neither he nor she - nor anyone else
- can know for certain whether or not his or her particular house will be flooded, burned down, struck
by lightning, burgled or vandalised. No matter how “safety conscious” the owner might be, the house
cannot be completely protected from all those risks. In the same way, there is risk in running a
business, because no business person can guarantee that he or she will make profits rather than lose
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money from the activities of the business.
Although no-one can foresee the future, it can to some extent be measured. For example, if we
“toss a coin” we don’t know what will happen; whether it will land on its “head” or its “tail”, but we can
make a very good guess as to which it will be. In this case we have an equal chance: 50 percent or
50% or “50-50”, of the result being either a “head” or a “tail”.
In relation to insurance, we use the term ‘risk’ when:
�� Although the precise future outcome is unknown, the possible alternatives can be listed; such as
“heads” or “tails”.
and
�� The chances associated with those possible alternatives are also known; such as a 50% (50
percent) chance of either “heads” or “tails”.
The term ‘uncertainty’ is used in insurance when future alternatives and chances are not known,
such as in ‘speculative ventures’. Examples include the outcome of medical or space research or
the impact and possible sales volumes of new inventions or technological advances.
Types of Risk
There are several different ways of looking at risk, and different kinds of risks can be categorised
by considering their effects.
Fundamental Risks
These tend to affect large numbers of people, perhaps areas of countries, or whole countries, or
even a number of countries or a geographical region. Their affects are either on the community in
general or on groups of people, and they cannot be controlled - even partially - by any one person.
Such a risk is present in the “forces of nature”; the weather, for example, cannot be controlled or
influenced by individual action. Incidences of volcanic eruption, tidal waves and tsunami, floods,
earthquakes, and similar “natural” phenomena cannot be controlled, and the extent of damage or
devastation which they might - or might not - cause, cannot be predicted.
Another example of fundamental risk is the economy of a country. That is because the effects
of, say, “inflation” (increases in costs, prices, etc - see Module 8) or mass unemployment, are beyond
the influence of individuals.
In many countries today fundamental risks are regarded as being the domain of society and
government, and the State undertakes to deal with the consequences of events such as
unemployment, retirement, or riot. Such risks as war, earthquakes, famines, etc, are generally dealt
with by the governments of the country or countries concerned, or by international organizations.
Particular Risks
In contrast, these refer to risks whose future outcomes or effects can be partially controlled
(although not predictably) by individuals or groups of people . They arise, for example, from an
individual’s decision to drive a motor vehicle, or to own property, or even to cross a road. Much
depends on the individual’s action and level of care (or lack of care and attention). Because particular
risks are the responsibility of individuals, each person must live with their consequences, although
in many cases the effects can be alleviated by insurance; we say that such risks are ‘insurable’.
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Fig.1/1. types of risk
Pure Risks and Speculative Risks
Not all risks to which people or organizations or items are exposed are insurable, or are insured.
The majority of insurable risks are what are called ‘pure risks’ which include fire, accidents, theft,
etc, which offer no prospect of gain, but only of loss if the risk becomes a reality. If it does not, then
there is no change to the situation - what is called the “status quo” is maintained.
Such risks as trading risks are called ‘speculative risks’ because they offer the possibility of loss
or gain, and in general they are not insurable. Indeed, some business ventures positively encourage
uncertainty.
The distinction between the two categories - pure and speculative - depends on whether the
“unknown” future holds out prospects of both good and bad, or only the possibility of damage or hurt.
In other words, we consider the outcomes or effects of risks as follows:-
�� Speculative risk is present if either beneficial or adverse outcomes could arise from a specific
event.
�� If possible harm is the only alternative to the present “status quo”, the situation is one of pure risk.
. For example, the possibilities of damage by fire or of accidental injury are pure risks, because the
property-owner or the injured person concerned must not gain from such calamities (a principle of
insurance which we discuss in detail in Module 3.) In contrast, the outcome of a business venture
might be either profit or loss and, therefore, that is an example of speculative risk.
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Risk and Insurance
Buying insurance - or taking out ‘insurance cover’ as it is called - is one method of controlling
the financial aspects of the unknown future. A person who takes out an insurance policy exchanges:
�� A situation of risk - where different financial outcomes are possible.
for
�� A situation of financial certainty, that is, with only one definite financial result.
That is because the insurers guarantee the insured, subject to certain provisos, that his or her financial
position will not be affected by the occurrence or non-occurrence - as the case may be - of certain
specified events. In effect, the risk is transferred from the insured to the insurer.
For example, an uninsured person’s house burns down. In the first place he will have lost an asset
possibly worth a considerable sum of money. In the second place, even if he was sufficiently wealthy,
he might have difficulty in raising the cash, at short notice, to pay for the rebuilding of the house -
because he did not know when (or if) the fire would occur. But had he been insured against the loss
of his house by fire, his insurers would have provided the money necessary to rebuild the house as
and when the cash was required to do that.
In some respects the risks faced by insurers are the same as those faced by everybody else;
insurers are unable to foresee the future any more clearly than can their clients. Insurers must
therefore consider the possibility that the values of their policyholders’ losses - resulting in claims
being made - will exceed the total value of claims that they have anticipated.
The risk for an insurer is much less than that for an individual policyholder, however, because the
insurer knows far more about possible losses through having collected together a group of similar
“exposure units”, and as well as through data collection, analysis, and experience.
Whilst insurance controls risk mainly by transferring the responsibility for paying for losses from
one person or group to another, it might also affect the risk directly, by influencing the chance of a
loss occurring. This might happen in two opposing ways:
�� By insurers encouraging policyholders to take more care, and by offering advice on how to reduce
risks and prevent losses, as well as by “rewarding” (for example with “no claim-bonuses” - see
Module 6) those policyholders who do not make “claims” for compensation, or whose losses are
negligible.
�� By policyholders either deliberately causing losses in order to obtain money from insurers, or by
being less careful because of the insurance protection; for example by having the attitude of “don’t
worry, it’s insured”. This behaviour is termed ‘moral hazard’.
Moral hazard arises when the existence of insurance cover changes the behaviour of the insured
such that either the size of any loss or the chance that a loss will occur is increased.
The problem with moral hazard is that insurers cannot know whether or not the insured is affected
by the existence of the insurance cover. Past ‘claims history’ might give valuable insight to insurers
and, say, an insured who requires excessively large sums of life cover, would probably be treated
with some initial suspicion. We discuss moral hazard further in Module 4.
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The standard response to the potential existence of moral hazard is for insurers to require the
insured himself to “carry” some of the potential loss, by imposing an ‘excess’ (which we explain more
about in Module 6).
The Main Function of Insurance
The main function of insurance is to compensate the ‘insured’ (the person or organization who
“effected” or “took out” and paid for the insurance) for loss or damage caused by the risk insured
against.
In many cases the ‘compensation’ by the insurers takes the form of ‘indemnity’, which involves:
‘Placing the insured in the same position financially as he or she
or it was in immediately before the loss or damage took place.’
The insured should be no better and no worse off than he or she or it was before the loss or damage
occurred.
We consider indemnity more fully later in Module 3, but you should note at this stage that the
‘indemnity’ might take the form of one or more of the following:-
�� A payment of money (equal to the value of the item lost or damaged).
�� The replacement of the lost or damaged item.
�� The repair of a damaged item.
�� Restoration, for example, rebuilding a house destroyed by fire.
It is obvious that indemnity cannot apply to personal accident insurance or to life insurance, as
a lost limb cannot be replaced (expect perhaps partially by an artificial limb) any more than a dead
husband or wife or child can be replaced. In such cases the insurance (or what is sometimes still
called “assurance” in the case of life) seeks to alleviate (to reduce) the suffering or hardships caused
by the injury or death.
For example, the insurance will provide for the payment of medical bills, special equipment (a
wheelchair for example) required by an injured person, and possibly provide an “income” if the injured
person is no longer capable of undertaking employment and earning a salary or wage for any length
of time, or permanently.
In cases of death, the payment made will seek to reduce hardship. For example, the payment
made to a wife on the death of her husband might be intended to ensure that she can still maintain
a reasonable standard of living despite having lost the “wage earner” or “bread winner” of the family,
and that any children will still be properly fed, housed, clothed and educated, etc.
It is important to remember that the function of insurance is to compensate or reimburse an
insured for loss or damage; but not to allow the insured the opportunity of gaining more than the value
of the loss or damage. That is, he must not “profit” from his insurance.
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How Insurance Differs from Wagers
In view of our previous statement, we must make clear to you the essential - and important -
difference between insurance and “wagering” or “betting”. Far too many members of the general
public or “laymen”, who know little or nothing about insurance, think that there is no difference between
insurance and wagering. You must understand from the outset that there are many - and very
important - differences, which include:-
The Legal Position
A properly executed insurance contract is legally binding on both or all the parties to it. This
means that such insurance contracts can be enforced by Courts of Law if necessary. Wagers are
not enforceable at law and, in fact, in some countries certain types of wagers are against the law
(illegal).
We look further at insurance contracts later in this Module.
Insurable Interest
This means that an insured must suffer loss if the item insured is lost or damaged; he cannot
legally insure anything in which he has no insurable interest. This is not required in a wager.
Insurable interest is dealt with in greater detail in Module 2.
Utmost Good Faith
Both or all parties to an insurance contract must exercise ‘utmost good faith’, which means that
the insured must disclose all material facts about the item or risk to be insured to the insurers, whilst
the insurers must disclose to the insured the full details and terms of the insurance to be provided.
With a wager, there is no obligation on either party to disclose any information which might be
possessed.
Utmost good faith is also dealt with in greater detail in Module 2.
Indemnity
As we have already explained, many types of insurance cover are designed to compensate the
insured for loss or damage sustained, but do not permit him to make a profit. In the case of a wager,
the winner of it will almost certainly profit in one way or another!
Indemnity is considered in greater detail in Module 3.
Likelihood of the Event Occurring
With the exception of many types of life insurance, insurance contracts are designed to protect
against events that might or might not occur; that is, the events are “possibilities” and not
“certainties”. On the other hand, wagers usually concern a definite future event, such as a horse race
for example, which is bound to be won by one horse or another. Another example is a football match,
in which one team or the other will win or lose, or both teams might “draw”.
There are other differences too between insurance and wagers, which will become clear to you
as you proceed with the study of this Program. However, we have given you sufficient information
and examples so far to show you that there are important differences.
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We shall be looking more closely at the matters outlined above in later Modules, particularly at
good faith, insurable interest and indemnity, which are three of the main principles of insurance.
We also consider the precautions taken by insurers to try to prevent those who take out insurance
- called ‘policyholders’ or ‘insureds’, remember - from making profits, that is, gaining more than
they should, from their insurance.
Uninsured Risks
It is important for any person involved in insurance - as a buyer or as a seller or provider or
intermediary - to know which risks can normally be insured against (are “insurable”) and which cannot
be, and why; and also why many risks which could be insured against are not insured. He or she also
needs to learn what action can be taken to reduce the likelihood of risks becoming reality, or to reduce
the possible effects of risks.
Some action is taken automatically by people, like locking the doors and windows of their homes
at night and when they go out, like looking both ways before they cross a busy road, like putting out
fires and switching off electrical appliances at night, like using seat belts in motor vehicles, and so
on.
Risks Which Cannot be Insured
Not all risks are insurable, that is, can be insured against. Let us look at the main reasons why
risks might not be insurable, and at some examples which will make clear to you the various reasons,
which might differ between different types - or “classes” - of insurance.
�� No ‘Monetary Value’
Anything which does not have a ‘monetary value’ - which cannot be quantified in terms of money
(with the exception of life) cannot usually be insured.
Example: Photographs of dead relatives might have great “sentimental” value, but they have little
or no monetary value, and so cannot usually be insured against loss or damage.
�� Rare or Unusual Risks
Most “rare” or unusual risks cannot be insured. This is because, as we explained earlier, insurance
is based on the mathematical “law of large numbers”, which requires risks to be “spread” or “shared”
as widely as possible.
Example: If the fund from which compensation is to be paid was made up of contributions (premiums)
from just a few people and/or organizations, the contribution from each would have to be very high;
probably unacceptably high for the few concerned. That is because the risk is not being shared widely
enough.
�� Insufficient Statistical Information
Another reason why a risk might not be insurable is that there is insufficient statistical information
available to enable a reasonably accurate prediction of the extent of loss.
Example: Risks due to losses from changes in fashion or from competition or from new inventions
or medical or technological advancements, cannot be insured because there is as yet no data on which
their likely effects can be predicted.
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�� Expected Losses
Usually, risks from which losses are expected cannot be insured. From the view point of the
insured, losses must be accidental or unintentional.
Example: It is unlikely that it insurers would be prepared to effect “new” or additional insurance on
the life of a person once it becomes known that he or she is suffering from an incurable disease.
Losses from risks must be reasonably unexpected. (Note, however, that in these circumstances,
any insurance taken out on that person’s life prior to the illness or disease being diagnosed is likely
to be unaffected.)
�� Catastrophic Risks
Many types of “catastrophic” risks cannot be insured against.
Examples include war, earthquake and volcanic eruption.
�� Cover Might Cause Harm
Some risks might be uninsurable in certain countries, because the “protection” afforded by the
insurance cover might be harmful to the general public, or to sections of the community.
Example: If motorists could insure against the risks of being fined or otherwise punished for traffic
offences, they might take less care to avoid committing those traffic offences, which could result in
an increase in motor accidents, injury and death.
Tests of Insurability
The answers to the following questions are often a useful guide as to whether or not a particular
risk is insurable. If the answers to these questions are in the positive, it is likely that the risk is
insurable:-
�� Is the occurrence of the event uncertain?
�� Would the only possible outcome of the event be unwanted?
�� Would the occurrence of the event be due to the action of a person or people?
�� Would the occurrence of the event result in a measurable financial loss?
�� Is there a legal relationship between the proposer and the potential financial loss? (See Module
2 on “Insurable Interest”.)
�� Does the event occur in sufficient numbers for an accurate premium to be calculated, using the
“law of large numbers”?
�� Would the event be legal and concur with public policy? Insurers must not cover risks which are
of a criminal nature, such as arson (deliberate fire razing) or deliberate damage to a person’s or
a business’ own property.
It is emphasised that the answers to the “test questions” should be looked upon as a “guide”. The
insurance market continues to develop to keep pace with requirements in the modern world, and the
boundaries of insurability do not, and cannot, remain constant.
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Why Some Risks are Not Insured
Now let us consider why some risks which could be insured against are not, in fact, insured against
by some people or organizations.
�� Lack of Awareness
People might be unaware of some risks which they face.
Example: A trader might be unaware that he is ‘liable’ (responsible) for injury sustained by customers
or employees whilst they are on the premises of his business; for instance, they might slip on a wet
floor or trip over something and might be hurt. He might not realise that legally he or his business
will be liable to pay any medical and other bills incurred as the result of the injury unless he has insured
against the risk.
�� Likely Loss Small
If the extent of a loss is likely to be very small, people might not find it worthwhile or cost-effective
to insure items of little value against loss by fire or theft. Insurance covering, say, “household contents”
might cover a wide range of “personal” items, clothing, furniture, domestic machines, etc, on an
“inclusive” basis, so that individual items - often of relatively minor value - do not have to be itemised.
(Any items of particular value, for instance a computer or a digital camera, might have to be declared
separately; see Module 8.) Statistics indicate that on average only about a third of people actually
insure their “household contents”.
�� Enjoyment of Risks
There are some people who enjoy and relish “taking” - or exposing themselves to - risks. Such
people might not take out insurance or, indeed, be able to obtain cover, for their “dangerous” sports
or pastimes.
Examples: Racing drivers, mountain climbers, parachutists, etc.
�� Cost
Some people might not be able to afford to pay the premiums necessary to insure against certain
risks to which they are exposed. People take out insurance because they are “averse to” or wish to
avoid taking risk; they are said to be ‘risk-averse’. A house-owner will buy home insurance because,
in effect, he prefers the certain “loss” or payment of the premium, as against the risk of either losing
nothing or losing all or part of the value of his property.
However, people’s dislike of risk has to be “balanced” against the price they are prepared to pay
to “remove” it or to “transfer” it to insurers.
Example: House-owner A might pay the premium required to insure his house against fire. Houseowner
B next-door might refuse to pay the same or similar sum of premium required for fire insurance
on his similar property. That does not necessarily mean that B prefers risk; it might simply be that
he feels the “asking” premium is too high a price to pay for certainty. He might well buy insurance
if it costs less: this simply means that he dislikes risk less than A does; that is, that he is less riskaverse
than is A.
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�� Lack of Understanding
There are some people who do not realise the value or the benefits of insurance . Some other
people do not bother to insure on the basis that “it will never happen to me!”. Yet others honestly
believe - wrongly - that it is “unlucky” or “tempting fate” to take out life insurance, in particular.
Risk Control
One of the “secondary functions” of insurance is to advise people and organizations on ways and
means of reducing the likelihood of risks becoming reality, and of reducing the effects of risks. In
other words, encouraging the development and use of appropriate and cost-effective means of “risk
control”.
There are many ways in which this can be done, depending on the particular risk. An example
is if insurers advise a ‘proposer’ - a person or organization wishing to take out insurance - or an
existing policyholder, that suitable fire extinguishers should be located in strategic positions in business
or other premises. Another example is the advice to motorists to wear seat belts.
In some cases, when the advice of insurers is heeded, reductions in premiums might be offered.
On the other hand, when steps are not taken by proposers or policyholders to reduce risks, higher
than usual premiums might be asked for. We deal with these matters in greater depth in Module 6.
Insurers frequently arrange for inspections and/or surveys of premises, complexes or compounds,
and/or machinery or plant housed in them, on which insurance is ‘proposed’, that is, required.
Furthermore, their specially trained staff often make recommendations for increasing safety, etc.
A major consideration in risk control is that the action taken by the insured should not cost more
than the value of the potential loss should the insured event occur. For example, there is no benefit
to an insured who spends, say, 30,000 units (of currency) on fire precautions, such as fire
extinguishers, sprinkler system, etc, to protect a storehouse which never holds goods valued at more
than 30,000 units. Similarly, the best way to prevent losses from pilfering - or “shoplifting” - would
be to stop potential customers entering the premises; but that would be very costly for “high street”
shops and stores.
The main ways of exercising risk control can be summarised as follows:-
�� Risk avoidance, which involves ceasing the activity causing the risk, or finding a way to “remove”
the ‘peril’ - the sources or causes of the risk (see Module 4).
�� Risk reduction, which involves reducing the frequency and/or sizes of losses through one or more
of:-
�� Education and training, such as holding regular “fire drills” for employees, or ensuring adequate
training of drivers, forklift operators, and so on.
�� Environmental changes, such as improving “physical” conditions, e.g. better locks on doors,
bars or shutters on windows, installing burglar or fire alarms.
�� Changes to dangerous or hazardous operations in using machinery and equipment and in the
performance of other tasks.
�� Risk retention, which involves paying for any losses as they occur.
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�� Risk transfer, which involves transferring the responsibility for losses to another party. Insurance
is one of the major forms of risk transfer, and it permits uncertainty to be replaced by certainty.
Other ‘Subsidiary Benefits’ of Insurance
What are often referred to as being ‘subsidiary’ or ‘secondary’ benefits arising from the availability
of insurance include the following:-
�� Reducing Fear of the Future
We can say that insurance contributes to ‘peace of mind’. For example, life insurance provides
a measure of relief to a husband or father in that he knows that in the event of his death, his wife and/
or family will be provided for. Without such comfort provided by life insurance, many people might
be “haunted” by what might happen to their wives and/or children in the event of their untimely death.
Although this benefit of insurance is “intangible” and cannot actually be seen or felt, it is nevertheless
very real.
The same applies to many other risks insured by individuals, and examples include fire, burglary,
motor accidents, etc.
�� Encouraging Confidence to Undertake New Ventures
Many businesses would not be started, and much research and development (R & D) would not
be embarked upon, unless the people concerned had confidence in the protection against losses from
risks provided by insurance. Of course, insurance cannot provide for losses arising from poor
management, competition, etc, but people would hardly risk time and money in new ventures unless
they had the protection provided by insurance against risks of losses by fire, water damage, theft,
accidents, injury, etc.
The alternative to insurance would be to maintain large “reserves” of money to meet any large
losses which might (or might not) occur. Another secondary function of insurance is therefore
“releasing” money which would otherwise be “tied up” in reserves; such money can instead be put
to more practical use in the purchase of machinery, or raw materials, or in modernisation, research
and development, etc.
�� Assisting People to Save
Certain types of life insurance - whilst insuring against the risk of death - also assist people to save
for the future. Such ‘endowment’ insurance’ (which is dealt with in Module 9) provides for the
payment of a sum of money if the person whose life is insured survives to a certain age agreed in
advance, whilst still providing payment to his dependants if he dies before reaching that agreed age.
This can be very useful for people who find it difficult to save money by other methods: with banks
or building societies, for example.
�� Investment
Insurance organizations build up large “reserves” in funds created from premiums paid by those
for whom they provide insurance cover. A proportion of those reserves is invested by insurance
organizations with government or in private enterprises, often assisting greatly in the economic
development of a country.
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�� Reducing Demands on Social Services
An “indirect” benefit of insurance to society is the way in which it reduces “demands” on the social
services provided by a country. A good example of this is the large amounts of money paid as
compensation by insurers to victims of motor accidents. Very few motorists would themselves be
able to pay compensation to victims for injury or death caused as the result of their negligent driving,
and if it was not for insurance, heavy demands would be made on governments to compensate or
to assist road traffic accident victims. In fact it is for this very reason that certain motor insurance
is ‘compulsory’, that is, it must be paid for by every motorist in most countries.
In many countries, ‘private health insurance’ is taken out by both individuals and by organizations
on behalf of some or all of their employees. Such insurance not only provides for the payment of
medical bills arising from ill health and injury, but it also substantially reduces the “demands” made
on often overworked “national health or social services” provided by government (and funded by tax
payers).
Insurance and the Law
At this time we shall give you only a brief “introduction” to matters which we deal with more fully
at a later stage in the Program. To do so we shall use an example of a very common “practical”
situation.
Let us assume that Mr & Mrs Wise have bought a house and have sensibly decided that they need
to insure it against loss by fire. They contact an ‘insurance broker’ (whose range of duties we discuss
in Module 10) who after taking note of all the necessary particulars - of the house-owners and of their
property - recommends appropriate insurance organizations which were asked to quote their
premiums for the cover required. Having accepted one of the quotations - which constitutes an “offer”
- they buy what may be called a ‘householder’s policy’ or a ‘home insurance policy’ from the
insurer chosen, and jointly become the policyholder.
At a later date their house was damaged by fire. They submitted a ‘claim’ to the insurers for
compensation for their financial loss which had arisen as the result of the damage caused by the risk
insured against, which in this example is fire. The insurers paid the value of the claim for
compensation.
“The Law” appears in this simple example in several different ways:-
�� Firstly, Mr & Mrs Wise contacted an insurance broker to arrange their insurance. In doing that,
they formed a “legal relationship” with the broker, who in turn formed a “legal relationship” with the
insurer selected. The law governing such relationships is known as the ‘law of agency’ and is
discussed in a later Module.
�� Mr & Mrs Wise then formed an agreement with an insurer. That agreement was governed by the
normal ‘laws of contract’. But special additional rules applied, because the contract was one of
insurance, and we explain these matters in the next Section.
�� Before paying the claim made - or “submitted” - by Mr & Mrs Wise for fire damage, the insurer had
to decide whether the cause of the fire was covered by their policy. The decision reached was
governed by the ‘doctrine of proximate cause’, which we discuss in Module 4.
�� All the foregoing events took place within the laws enacted by the government of the country
concerned to ensure that both the broker and the insurer conduct their business properly, fairly
and ethically.
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At a later stage we examine the law governing agreements between the “sellers” and “buyers” of
insurance. Here we first look at the ‘law of contract’ which governs all agreements between buyers
and sellers. Then we examine the special rules applying to insurance contracts.
Contracts
For a risk to be insured, the person or organization wishing to take out the insurance - the
“proposer” - must enter into a ‘contract’ with an insurance organization. A contract is:
‘A legally binding agreement between two or more parties.’
In this context a ‘party’ refers to one of the “participants”, that is, one of the people or organizations
making the agreement. There might be only two parties to a contract, or there might be three or more.
Provided that a contract meets with certain basic essentials - which we describe below - the failure
of one “party” to fulfil or honour the obligations of that party under the contract, enables the other party
or parties to seek enforcement - or ‘redress’ - through the Courts of Law and/or to institute action
for ‘damages’, which term means:
‘The financial reparation or compensation due for loss or injury or
harm sustained by one ‘party’ (person or organization) through
the fault or negligence of another ‘party’ (person or organization.’
Not all “agreements” made between people and/or organizations are legal contracts. For example,
a person might agree to lend a friend his motor vehicle, on condition that the friend replaces the fuel
(petrol or gasoline or diesel) he uses. If the friend fails to replace the fuel, the owner of the vehicle
has no “legal redress”.
Let us return to Mr & Mrs Wise. They had looked through the “houses for sale” columns in their
local newspaper and found one which they liked. They made an ‘offer’ of a “certain sum” (of money)
to the owner of the house to buy it from him, with the curtains and carpets included in the price. The
owner agreed to the “deal” and the sale was duly completed.
Before the Wise’s purchase of the house could go ahead, it was important that they and the present
owner agreed the ‘terms’ of the offer. In this context, “terms” are those facts or conditions contained
in the contract - in this case the agreed price, and the inclusion of curtains and carpets. Clearly, a
contract cannot be completed if the parties disagree over the terms. In some cases the parties might
“negotiate” - to discuss or correspond - about the terms before agreement is reached between them.
The eventual agreement might be in the way of a “compromise” between the two “parties”. For
example, the “asking price” of the house might have been 70,000 units (of money) for the “empty”
house. The Wises might have offered to pay 65,000 units for the house, including the curtains and
carpets. The eventual “compromise” between the seller and buyer - on which the agreement was
based - might have been, say, 68,000 units including the curtains and carpets.
In contracts of insurance, the insurer and insured must agree “details” such as the premium (in
effect the “price” to be paid); the extent and nature of the cover to be provided; the period of the cover,
and so on. These “terms” are usually set out or “embodied” by the insurer in a document called the
‘policy’, which we discuss in detail in Module 5.
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Essentials of a ‘Genuine’ Simple Contract
There are six essentials for a genuine ”simple” contract:-
1. The intention that the agreement is legally binding must be present. In our example of the friends
and the motor vehicle, there was no intention or understanding that their agreement would be legally
binding in that the borrower had to replace the fuel, or else be “taken to Court”.
2. An unrevoked offer must be made, either in writing or orally. An “offer” is a communication of
the contract terms. “Unrevoked” means that it is not withdrawn. For example if Mr & Mrs Wise
had “second thoughts” about buying the house, and had withdrawn or cancelled the offer they had
earlier made, their offer will have been revoked.
3. The offer must be accepted in precisely the terms submitted - which is called an “unqualified
acceptance” - either in writing or orally. In this case “acceptance” means an agreement of the terms
of the offer.
As soon as these three essentials have been satisfied, the parties are said to be “of one mind”,
and this is the fundamental requirement of any agreement if it is to be enforceable legally.
4. A ‘consideration’ is required from both parties. A “consideration” refers to the gain or benefit
received by one party in return for a promise or the performance of an act of another party. In
insurance, the insured’s “consideration” is the premium which is paid to the insurer, whilst the
consideration from the insurer to the insured is the undertaking to compensate or to make payments
to the insured on the occurrence of a certain event or events within a specified period.
5. The contract must be legal, according to the laws of the country in which it is made. A contract
must not be illegal, that is, it will be invalid if it is forbidden by statute or is against public policy.
Examples of illegal contracts include contracts which impede justice; contracts with an enemy of
the State; contracts to commit a crime (such as tax evasion); contracts which involve sexual
immorality.
6. Both or all parties must have the legal ‘capacity’ to make the agreement. Minors (under, say, 18
or 21 years of age, depending on the Law of the country concerned), drunkards, drug adicts, and
insane people may not have this legal capacity, and contracts made by them might be “set aside”
by the Courts.
Insurance Contracts
Simple contracts do not need to be “in writing” (which term includes typing and printing, for example
by computer output) but it is very rare for an insurance contract not to be in writing. What are called
“speciality” contracts are comparatively rare in insurance, and we shall not consider them at this stage.
You should learn by heart this definition:-
A contract of insurance is one:
‘Whereby one person, called the insurer, undertakes, in return for the agreed
consideration, called the premium, to pay to another person, called the insured,
a sum of money or its equivalent on the happening of a specified event.’
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A contract of insurance is usually “embodied” or set down in a written (typed or printed) document
known as a ‘policy form’ or simply a ‘policy’. However, it is important for you to note that the policy
itself is not the contract; it is merely evidence of the contract, that is, it is written proof that the
contract has been made. The contract is actually the “invisible” agreement between the parties to
that contract.
A good definition of an insurance policy is:
‘A written or printed document formally setting out particulars of the concluded
contract which has been made between the insured and the insurers.’
We return to the consideration of contracts and insurance policies in Module 5.
SELF-ASSESSMENT TEST ONE
Recommended Answers to these Questions - against which you may compare your answers - will
be found on page 28. The maximum mark which may be awarded for each Question appears in
brackets at the end of the Question. Do NOT send your answers to these Questions to the College
for examination.
No.1. What is the main function of insurance? Describe briefly the “secondary” benefits which
individuals, organizations or the community as a whole gain from insurance.
(maximum 30 marks)
No.2. Describe in your own words what you consider to be the difference between insurance and
a wager or bet. (maximum 30 marks)
No.3. Describe the differences between (a) fundamental risk and particular risk; (b) pure risk and
speculative risk. (maximum 30 marks)
No.4. Place a tick in the box ��against the one correct statement in each set.
(a) An insurance organization collects premiums in a “fund”:
1�� to ensure that the maximum profits will be made by their endeavours.
2�� so that a policyholder will be able to profit from his or her loss.
3�� to reduce the chances of risks becoming reality.
4�� so there will be sufficient money to compensate or to reimburse insureds who experience
an insured disaster.
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(b) In insurance, the term “uncertainty” is used when:
1�� a person cannot decide whether or not to insure a particular risk.
2�� the insurers have not been able to calculate the premium to charge.
3�� future alternatives and chances are not known.
4�� any loss will be unintentional or accidental.
(c) The two parties to an insurance contract are “of one mind” when:
1�� all six essentials for a genuine simple contract have been met.
2�� they agree that it is legal according to the country in which it is made.
3�� they intend the contract will be legally binding, an unrevoked offer has been made and has
been accepted without qualification.
4�� a consideration, in the form of a premium, has been paid.
(d) Insurers will not normally offer to insure a risk if:
1�� a person cannot afford to pay the premiums required.
2�� the loss to be insured is expected.
3�� a large number of policyholders is already exposed to that risk.
4�� to do so encourages too many people to embark on new ventures.
(e) “Utmost good faith” in insurance means that:
1�� an insured will trust the insurers implicitly to compensate him in the event of a loss occurring.
2�� both parties have agreed that a contract will be legally binding.
3�� the insurers trust the policyholder to pay the required premium at some time after the
insurance cover commences.
4�� the insured must disclose to the insurers all facts about the risk to be insured, and the
insurers must disclose to the insured full details and terms of the cover to be provided.
(2 marks for a statement correctly ticked - maximum 10 marks)
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RECOMMENDED ANSWERS TO
SELF-ASSESSMENT TEST ONE
No.1. The main function of insurance is to eliminate or to reduce the effects of risk, or the fears which
arise from the existence of risk. One of the secondary benefits gained from insurance is the advice
given by insurers to people and organizations on ways in which they can reduce the likelihood of risks
becoming reality, and also reduce the effects of risks. Another benefit is the “peace of mind” given
by the existence of insurance cover; for instance, a husband or father knows that in the event of his
untimely death, his wife and/or family will be provided for from the proceeds of his life insurance. Also,
endowment insurance helps people to save for the future.
Instead of businesses having to keep money “tied up” in reserves against contingencies, the
insurance cover they take out in effect “releases” money for those businesses to use in the purchase
of machinery, or raw materials, or in modernisation, in research and development, and so on.
Insurance organizations invest heavily in government and/or in private enterprises, which assists in
the economic development of a country. Furthermore, insurance benefits the country as a whole by
reducing demands on its social services, and national health service.
No.2.(a) Wagers are not enforceable at law and in some countries certain types of wagers are against
the law, that is, are illegal. But a properly executed insurance contract is legally binding on both or
all the parties to it, which means that insurance contracts can be enforced by the Courts.
(b) An insured must actually suffer loss if the item insured is lost or damaged, and he cannot
legally insure anything in which he has no insurable interest, which is not the case with a wager.
(c) With a wager, there is no obligation on either party to disclose any information which might
be possessed. But both or all parties to an insurance contract must exercise “utmost good faith”; a
proposer must disclose all material facts about the item or risk to be insured to the insurers, whilst
the insurers must disclose to the insured the full details and terms of the insurance to be provided.
(d) The winner of a wager will almost certainly make a profit, whereas many insurances are
designed to compensate the insured for loss or damage, but do not permit him to make a profit.
(e) Whilst wagers usually relate to a definite future event, many insurance contracts are intended
to protect against events which might or might not occur.
No.3. (a) Fundamental risks usually affect groups of people or the community in general, and they
cannot be controlled even partially by any one person. Particular risks are those whose future
outcomes or effects can be partially controlled, although not predictably, by individuals or groups of
people.
(b) A speculative risk is one from which either beneficial or adverse outcomes could arise from
a specific event. A pure risk is one from which the only alternative to the continuation of the “status
quo” is possible harm.
No.4. The correct statement from each of the sets selected and ticked:
(a) 4�� (b) 3�� (c) 3�� (d) 2�� (e) 4��
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WHAT YOU WILL LEARN IN MODULES 2 TO 12
OF THE PRINCIPLES & PRACTICE OF INSURANCE PROGRAM
Module 2 - Insurable Interest and Utmost Good Faith
How insurance developed
Classes of insurance business
Categorisation by object or event
Subject-matter:
what it may be in insurance
examples in the classes of insurance
Insurable interest:
explanation and definition
the legal position
requirements for valid insurable interest
those who can have insurable interest
those with limited insurable interest
those who have no insurable interest
when insurable interest is necessary:
the Life Assurance Act, 1774
examples of insurable interest
insurable interest and life insurance:
insurable interests allowed in law
timing of insurable interest:
time of purchase
time of loss
assignment of insurable interest:
assignment of the proceeds of a policy
assignment of the policy itself
transfer and resale of life insurance
transfer and resale of non-life insurance:
Utmost good faith:
what is involved
legal obligations
onus placed on the insurers and the proposer
material facts:
definition
legal rulings
facts which are material:
examples in classes of insurance
facts which need not be disclosed
timing of utmost good faith
facts which must be disclosed
Void and voidable contracts:
nondisclosure
concealment
representations
fraudulent misrepresentation
innocent misrepresentation
warranties:
express warranties
implied warranties
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declarations
differences between representations and warranties
contemporary thinking on disclosure:
unfair contract terms
statements of practice
Module 3 - Indemnity
The contract of indemnity:
the purpose of indemnity
Forms of indemnity:
cash payments
replacement
repair
reinstatement
Value at the time of loss
Applications of the principal of indemnity:
variations between classes of insurance
total loss
partial loss:
examples
Agreed value or valued policies
Replacement or reinstatement policies
Indemnity for partial losses:
difficulties in assessing value
betterment
large partial losses
cover after partial losses
modifications of indemnity:
contract conditions
underinsurance:
example
excess
Subrogation:
definition and purpose
rights in damaged property:
practical example
effects of the doctrine of subrogation
subrogation in practice
timing of subrogation
two or more policies on the same subject-matter
intercompany agreements:
knock for knock
third party sharing
waiver of subrogation
Contribution:
the same risk insured under two or more policies:
practical examples
the doctrine of contribution
conditions for the application of contribution:
differences between subrogation and contribution
the need for common interest
timing of contribution
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avoidance of contribution rights:
non-contribution clause
more specific clauses
specific market agreements
Module 4 - Proximate Cause, Physical and Moral Hazard
Types of perils:
insured perils
excepted perils
uninsured perils
Proximate cause:
definition
a “train” or “chain” of related causes, factors, or events
concurrent causes
non-concurrent unrelated causes
meanings of:
proximate
remote
practical examples
general rules for applying proximate cause
conditions for proximate cause
application of proximate cause to claims
consequential loss:
damage caused by thieves
damaged cause by fire-fighting
legal costs
Moral hazard:
fraud
carelessness
circumstances
steps to be taken to reduce bad moral hazard
Physical hazard:
examples in different classes of business
steps which can be taken to reduce bad physical hazard
Module 5 - Proposal Forms and Policies
Buyers and sellers of insurance:
proposers and insurers
Methods of selling insurance
Stages in buying insurance
Proposal forms:
the questionnaire
their functions:
to obtain information
to make a legal offer
to elicit a quotation
to describe the cover available
advertising/publicity
to establish a warranty
the declaration:
specimen
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layout and contents:
information required:
name, address, occupation, age
insurance and claims history
sum insured
medical history
use of postal codes in claims analysis and statistics
When proposal forms are not used in different
classes of insurance
Offer and acceptance:
documents in which acceptance might be shown
The premium:
when premiums are paid
deposits
Proof of insurance cover:
cover notes:
when and why they may be issued
how they may be issued
claims whilst they are valid
certificates of insurance:
when and why they may be issued
how they differ from cover notes
employers liability insurance certificates:
information they contain
motor insurance certificates:
information they may contain
green cards and bail bonds
Policies:
what they are
their sections and what those contain:
the preamble
the operative clause
exceptions and provisos
the schedule
the policy conditions
the attestation clause
endorsements:
what they are
why they are used
legal interpretation of policies:
meanings of the words
typed or handwritten words
benefits of reasonable doubt
general and particular statements
Module 6 - Premiums, Renewals and Claims
Underwriting:
underwriting factors
average claims experience
effects of underwriting factors
proposer’s characteristics
premium versus claims value
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Premiums:
rating the risk
life insurance premiums:
why they can be rated accurately
non-life insurance premiums:
bases of ratings
Reserves:
why they need to be established and built up:
higher than anticipated losses
unearned income
unpaid claims
one class of business must not subsidise another
Renewals:
meaning and process
no obligation to renew, or on the same terms
considerations of the insured
considerations of the insurers
utmost good faith
reasons why terms may be varied
policies under which insurers may not come “off risk”
renewal procedure:
the renewal notice:
its purpose
its contents:
renewal premium required:
alternative values and premiums
days of grace:
when they may be allowed
claims arising during them
when renewal premiums are not paid:
lapsing the policy
reviving policies
Return of premiums:
no general entitlement
when total refunds might be made
when partial refunds might be made
No-claim bonuses:
why they are offered
transfers between insurers
Excess:
what is involved
advantages to insurers
Surrender value
Paid-up policies
Delay of premium payments
Claims:
handling of claims by insurers
conditions for claims
notification to the insurers
proof of loss
claims forms:
their uses
information required
methods by which proof of loss may be provided
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claims settlement
ex gratia payments
reasons why claims may fail:
invalid contract
policy exclusions
proximate cause:
contract wording which overrules general application
the amount of the claim:
considerations
disputes over claims:
liability
quantum
negotiation and compromise, litigation
arbitration:
what is involved
why insurers prefer arbitration to litigation
Average
different meanings in classes of insurance
the pro rata condition
the special condition
two conditions
Who pays the claim:
underinsurance or partial insurance
more than one insurer involved:
possible complications
Recipients of claim payments:
the insured
other parties
Sympathetic treatment of claims
Module 7 - Transportation Insurance
Marine Insurance:
the background
hull insurance
cargo insurance
marine liability damage
modern developments and trends
time policies
voyage policies
building risk policies
floating policies
Aviation Insurance:
extent of cover
aviation liability insurance:
injured passengers
non-passenger third parties
aircraft manufacturers
airport owners and operators
comprehensive policies
personal accident policies
cargo policies
loss of service policies
airport liability policies
product liability policies
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Transit Insurance:
overland transport
liability of hired carriers
floating policies
Motor Insurance:
Road Traffic Acts:
types of vehicle used on the roads
types of policies:
third party only
third party, fire and theft
comprehensive
act only
motor cycle policies
commercial vehicles policies
fleet policies and premiums
increased premiums
excesses
no-claim bonuses
rebates
Module 8 - Property, Accident, Pecuniary and Liability Insurances
Property Insurance:
the Great Fire of London:
developments thereafter
definition of “fire”
the standard fire policy:
insured perils:
fire, lightning, explosion
exclusions
additional special perils which can be covered
combined or comprehensive policies
period of cover
inflation and property insurance:
indexing schemes
non-private property
household comprehensive policies:
definitions of “buildings” and “contents”
personal possessions
new for old policies
all-risks household policies:
scope of cover
commercial theft insurance:
commercial or business combined policies:
scope of cover
office combined policies:
scope of cover
stock or inventory policies:
valuing “stock at risk”
business loss of profits policies:
scope of cover available
rent policies:
who may insure
excesses
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Accident Insurance:
overlap of fire and accident policies
industrial all-risks policies:
scope of cover
contractors all-risk policies:
scope of cover
theft or burglary policies:
scope of cover
glass policies
money policies
goods in transit policies
contract policies
rainfall and hail policies
licence policies
caravan policies
small/pleasure boat policies
travel insurance:
scope of cover
single trip policies and annual policies
sports insurances:
scope of cover
livestock insurances
pet insurances
engineering insurance
inspections
scope of cover:
extraneous perils
computer insurances:
scope of cover
Pecuniary Insurances:
fidelity guarantee or suretyship:
commercial guarantees
court bonds
government bonds
legal expenses policies
credit policies
business interruption policies:
scope of cover
mortgage indemnity insurance:
scope of cover
Liability Insurances:
liabilities arising from:
negligence
nuisance
trespass
strict liabilities
statutory liabilities
contractual liabilities
employers liability insurance:
compulsory in many countries
scope of cover
public liability insurance:
scope of the wide variety of policies available
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Module 9 - Insurances of the Person
Income, expenditure, wealth and purchasing power
How the need for personal insurances can arise
Social security or national insurance:
common state benefits:
unemployment
sick pay and sickness/health care
disablement and disability
maternity leave
retirement pension
Personal accident and sickness insurance:
scope of cover:
the policy schedule
stand-alone policies
specified benefits:
how and when they might be paid
deferred periods
exclusions from policy cover
Permanent health insurance (PHI):
scope of cover
the long-term liability
level premiums
policy exclusions
specified benefits:
how and when they might be paid
deferred periods
Long-term care insurance:
scope of cover
Private medical/health care insurance:
scope of cover
policy exclusions
factors which influence premiums quoted
excesses
Group insurance schemes:
employees personal accident schemes
employees personal accident and sickness schemes
schemes for clubs and other organizations
How personal insurances may be affected by:
a person’s occupation:
hazards associated with different occupations
a person’s age:
risk exposures at different ages
a person’s family circumstances:
number and ages of dependants
a person’s sex:
reasons why women’s PHI premiums may be higher
a person’s health and medical history:
factors which influence insurers
Holiday travel insurance
Business travel insurance
Sports insurance
Debt repayment insurance
Mortgage protection payment insurance
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Life Insurance:
special features
types of life policies and scope of cover:
term policies
whole life policies
endowment policies
with profits policies
unit-linked endowment policies
flexible endowment policies
guaranteed insurability policies
unit-linked whole life policies
specialised life policies
industrial life insurance:
how it differs from ordinary life insurance
considerations in effecting life insurance:
family protection
educational fees protection
debt and mortgage protection
endowment house-purchase policies
sole business owner protection
key-personnel protection
providing an inheritance
savings for the future
Pensions:
providing an income on retirement
state retirement pensions
occupational pension schemes
personal pension plans
Annuities:
types of annuities
Tontines and capital redemption policies
Module 10 - The Insurance Market
Composition of the insurance market
Buyers of insurance:
personal and business buyers
Sellers of Insurance:
Lloyds underwriters:
the background
the Corporation of Lloyd’s
the Lloyd’s Acts
underwriting members
names
syndicates
Lloyd’s brokers
stages in placing a risk at Lloyd’s
shipping intelligence:
Lloyd’s agents and sub-agents
publications:
Lloyd’s list
Insurance companies:
limited liability companies:
the meaning of limited liability
mutual companies
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captive insurance companies
bankassurance
Mutual indemnity associations
Collecting friendly societies
Tariff and non-tariff insurers
Intermediaries - middlemen:
insurance agents:
Law of Agency
types of agents:
cash, credit, bulk business
commission
insurance brokers:
professional conduct and expertise
brokerage
differences between agents and brokers
tour operators and travel agents
bank building societies and other lenders
large retailers
Direct selling or writing:
increasing use of telesales and the Internet
standardised cover
reductions in insurers’ costs
savings on commission and brokerage
reductions in premiums
convenience for buyers
Third party administrators
Reinsurance:
the necessity for reinsurance
methods of reinsuring:
faculative reinsurance
treaty reinsurance:
fixed share/quota treaties
surplus treaties
excess of loss treaties
excess of loss ratio treaties
reinsurance pools
Module 11 - Organisation & Management of Insurance Companies
Centralised organisations:
advantages and disadvantages
Decentralised organisations:
advantages and disadvantages
Regional or zonal organisations
Semi-autonomous branches
Branches and claims
Executives of insurance companies:
the board of directors:
composition
duties and responsibilities
managing director
general manager
heads of departments
executive directors
non-executive directors
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the chairman
company secretary
agency manager
marketing manager
investment and estates manager
personnel and training:
the importance of training
underwriting executives
Organization charts:
what they show
organisation by function
organisation by division
Branch staff
Specialist staff
Insurance funds:
the meaning of “funds” in insurance
types of funds
Insurance reserves:
reasons why different reserves must be build up
Investment of insurance company funds:
aims of the investment policy:
considerations in non-life business
considerations in long-term business
Insurance and the economy:
how insurance funds can assist a country’s economy
ways in which insurance funds can aid a country’s development
insurance and the balance of payments:
visible and invisible imports and exports
possible positive and negative affects of insurance
Module 12 - Supervision and Regulation of Insurance
The “promissory” nature of insurance:
insurance as an intangible product
the effects of insolvency of insurers on:
policyholders
third parties
The need for regulation
consumer protection:
areas of concentration:
financial standing and stability of insurers
buyers’ understanding of what they are buying
availability of insurance when and where needed
national and economic interests
aleatory nature of insurance
Development of the regulation of insurance:
self-regulation
acts and statutes
EU Directives
authorisation of insurers:
requirements for authorisation
supervision of authorised insurers
solvency margins:
premium basis of calculation
claims basis of calculation
41
INSMOD1(2007)
Send for a FREE copy of our Prospectus book by airmail, telephone, fax or email, or via our website:
International Headquarters: College House, Leoville, Jersey JE3 2DB, Britain.
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minimum guarantee funds
examples of legislation enacted with regard to:
policyholders protection
insurance brokers
Lloyd’s insurance brokers
financial services
insurance standards
the financial services authority
insurance ombudsman schemes:
the role of ombudsmen
Conclusion:
the continuing evolution of regulation and supervision
Glossary of Words and Terms Used in Insurance
This Alphabetical Section (which is provided in the printed Manual One of the Program) is designed
as a “quick reference check" to help further understanding of many: “technical” words and terms used
in insurance; words and terms which have “specialised” meanings when used in insurance; words
and terms whose meanings in insurance differ from their “everyday” meanings; which are introduced
and explained in Modules 1 to 12
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