Chara Charalambous CDA COLLEGE
FINANCIAL SERVICES
LECTURE 4
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Outcomes
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Types of business: what risks are insurance and what is
the purpose of insurance?
What is pure risk and what is speculative risk?
Conditions that must be met in order to arrange
insurance.
Contracts of insurance
Principle of ‘utmost good faith’
What is the insurable interest?
The UK insurance market
Bancassurance
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Definitions
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 Insurer or underwriter
A person or company that insures: offering insurance
policies in return for premiums (fees). It contracts to cover
another in the event of loss or damage. Also named the
underwriter.
 Policyholder or insured
A person or organization covered by insurance.
 Insurance
Cover against events which might occur e.g. fire, theft e.t.c
 Assurance
Cover against events which are certain to occur e.g. death
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Definitions
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 Industrial life insurance
Refers to an insurance which provides insurance coverage to
industrial workers or people who are unable to afford
insurance for bigger amounts. Here a fixed amount is given in
case of accident or death. They are also known as burial
policies, small death benefits and street insurance. It is paid
weekly or monthly and the amount is small. The roots of this
insurance are in the industrial revolution.
 Ordinary life insurance
insurance on the life of the insured for a fixed amount, at a
specific premium that is paid each year in the same amount
during the entire lifetime of the insured. The amounts of cover
and the premiums paid are considerably higher for ordinary
life than for industrial life.
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Insurance Business
Types of Business
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It is possible to arrange insurance for virtually any eventuality
(possible event). The more normal types of insurance business are
many and varied and include life and annuity (income), accident,
sickness, fire, damage to property, motor vehicle, aviation,
general liability and legal expenses.
The purpose of insurance is to spread the risk or losses that
threaten everyone but which will actually happen to a few of
the potential sufferers. Because the costs are shared by many,
each individual has to pay less than would otherwise have been
the case. A premium will be paid by the person or body that
wishes to arrange insurance at a level which is usually far less
than that of the potential loss that might be incurred. The
insurance company which is providing the cover and has
accepted the risk, will have done so on the basis of statistical
evidence which suggests that only a proportion of those insured
will make a claim.
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example
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As an example an insurance company may provide one
hundred car-owners with £5000 insurance cover for
damage to the vehicles. Each of these car owners pays
an annual premium of £100. if ten of the car-owners
during the year each makes a claim for £500 then both
the car owners and the insurance company will have
found that insurance was a sensible financial move. In
this very simplified example the car-owners who have
made a claim will have been relieved of considerable
expense, those car-owners who have not made a claim
will have had the benefit of insurance protection and
the insurance company will have made a profit. In real
life the targeted profit margin would not be so high.
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Insurance companies generally are only interested
in insuring pure risk – that is a situation in which, if
the even which is insured against happens, then loss
or damage of one sort or another occurs. This is the
case when a car is stolen or stock destroyed.
Speculative risk refers to the fact that there is a
chance of gain as well as of loss. This risk is
uninsurable. For example in setting up a new
business profits might occur if the business is
successful but losses might occur if it is not.
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Only pure risks are insurable because they involve only the
chance of loss. They are pure in the sense that they do not mix
both profits and losses. Insurance is concerned with the
economic problems created by pure risks. Speculative risks
are not insurable. Both speculative risk and pure risk involve
the possibility of loss. However the speculative risk also
involves the possibility of gain as well even of there is no loss.
In order to understand the difference between the two:
Investing in the stock market is an example of the speculative
risk. One can only speculate on whether the investment will
produce a profit or loss. Insuring an automobile is an example
of pure risk. If the insured auto is involved in an auto accident,
there is most definitely going to be some sort of damage
(loss). On the other hand if no accident occurs there is no
possibility of gain. And that’s the difference.
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Speculative risks involves the possibility of loss and gain.
Pure risks involve the possibility of loss only.
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In order for a risk to be insurable a number of
conditions need to be met. These are:
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I.
That the insurer (insurance company) must be able
to calculate the probability and the severity of the
loss
II. That the loss must be measurable in monetary
terms
III. That the risk is not speculative risk
IV. That the possible loss must be sufficiently large to
justify the cost of arranging the insurance.
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Contracts of insurance
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An insurance contract is setting out the terms of the
insurance and the premium payable and is
undertaken by two parties: the underwriter or
insurer and the policyholder or insured.
Some policies provide for a ‘cooling off’ period –
this is a set number of days during which the
policyholder can cancel the policy.
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Once the contract is in force , both parties have
specified rights and obligations:
I. The policyholder must pay premiums in
accordance with the terms of the contract. In
addition he must also be obliged to disclose any
material events – an example is driving assurance
and alterations to a vehicle.
II. The insurance company in turn is obliged to make
future payments to the policyholder on the
occurrence of specified risks.
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In arranging insurance the principle of utmost good faith
applies: minimum standard that requires both the buyer and
seller in a transaction to act honestly toward each other and
to not mislead or withhold critical information from one
another. The principle of utmost good faith applies to many
common financial transactions.
.
In the insurance market, the principle of utmost good faith
requires that the party seeking insurance discloses all
relevant personal information. For example, if you are
applying for life insurance, you are required to disclose any
previous health problems you may have had. Likewise, the
insurance agent selling you the coverage must disclose the
critical information you need to know about your contract
and its terms.
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Insurable Interest
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A right, benefit, or advantage arising out of property that
is of such nature that it may properly be compensate.
In the law of insurance, the insured must have an interest in
the subject matter (property which is valuable and thus
insured and protected) of his/ her policy or otherwise such
policy will be void and unenforceable since it will be
regarded as a form of gambling. An individual normally
has an insurable interest when he or she will obtain some
type of financial benefit or other kind of benefit from the
continuous existence of the insured object - subject matter
(or in the situation of living persons, their continued
survival) or will sustain economic loss from its damage or
harm when the risk insured against occurs.
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Insurable interest is not dependent upon who pays the
premiums of the policy. In addition, different people can have
separate insurable interests in the same subject matter, thing or
property.
For example, when a ship is mortgaged, and the mortgage has
become absolute, the owner of the legal estate has an
insurable interest, and the mortgagor, on account of his equity,
has also an insurable interest.
Typically, insurable interest is established by ownership,
possession, or direct relationship. For example, people have
insurable interests in their own homes and vehicles, but not in
their neighbours' homes and vehicles, and certainly not those
of strangers.
In certain fields, the innocent purchaser of a stolen car, who has
a right of possession superior to all with the exception of the
true owner, has an insurable interest in the automobile. This is not
the case, however, where an individual knowingly purchases a
stolen automobile.
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During 1700s people took out life assurance policies on the
lives of famous people such as the king or Queen, politicians
and others. On the death of these people the policyholders,
who had not suffer any financial loss, were able to collect
from the underwriters the insured sum.
The development of the concept of insurable interest as a
prerequisite for the purchase of insurance distanced the
insurance business from gambling, thereby enhancing the
industry's reputation and leading to greater acceptance of
the insurance industry. The United Kingdom was a leader in
that trend by passing legislation that prohibited insurance
contracts if no insurable interest could be proven, notably the
Life Assurance Act 1774 which makes such contracts illegal,
and the Marine Insurance Act 1906, which make such
contracts void.
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Finally in respect of liabilities it is possible to insure
one’s liability to others. Examples of this are motorists
being required by law to insure their liability for injury
to third parties and dentists who insure their liability
for injury caused to patients from their actions.
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The UK insurance market
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The British insurance market is big business. Not only
do insurance companies arrange insurance in the UK
but they also account for a significant amount of
world business and earn substantial sums by
exporting services.
The segments of the Insurance Market
INSURERS
Proprietary
Companies
Mutuals
INTERMEDIARIES
Brokers
Consultants
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Lloyd’s Chara Charalambous
Agents
INSUREDS
Personal
Commercial
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The previous table shows the segments into which the insurance
market can be divided and the components of each of those
segments.
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Lloyd’s is UK insurance company providing services in over 200
countries and territories
What is mutual insurance?
A mutual insurer is an insurance undertaking which is
collectively owned by its members who are at the same
time its clients (policyholders). Traditionally, all clients
(policyholders) of a mutual insurer are members. In some
fields, however, mutual insurers also have policyholders
who are not members. Typically, every member of the
mutual has an equal vote in members’ meetings
.
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mutual insurance continue….
Since mutuals are not established through the provision of capital by their
members and do not have any shareholders, they do not have to reward equity
investors by paying dividends. Proprietary companies have shareholders.
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Generally therefore, mutuals:
 are able to construct their products in a very competitive way;
 are able to retain profits in the company to build up reserves for good risk
provision and future growth;
 have the possibility to re-distribute profits to membership, e.g. via refunds and
rebates;
 have the possibility to establish particular bonds with their employees, e.g. by
including them in result-related remuneration schemes;
 have no need to keep their eyes fixed on shareholder value, on maximising returns
to capital investors or on the development of the price of their own shares;
 are protected to takeover bids – this, together with other characteristics, fosters
long-term strategic planning and means the undertaking does not have to be
managed in line with short-term interests;
 engage strongly with their local communities.
Instead of focusing on short-term profitability, the management of a mutual can
look at broader aspects, such as ethics, democratic governance, and a wider social
responsibility, and can enter into intense interaction with member-policyholders
about their needs and expectations.
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Acting in the best interest of its members
 Enhanced
information
to
member-policyholders,
competitiveness and long-term vision allow mutual insurance
companies to offer member-policyholders high-quality services
at a low price.
.
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The basic characteristics of a mutual make it possible to avoid
certain conflicts of interest that can emerge institutionally in
other corporate structures and that usually require time and
energy to identify and address.
National farmers Union and Standard Life are mutual
companies. The Guardian Royal Exchange and Sun Alliance
are examples of proprietary companies.
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Proprietary companies
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Of the insurers the proprietary companies are the most important
sector , comprising some 800 or so registered insurance
companies licensed to trade in the UK. All are public companies.
Some are small specialist firms offering particulars types of
insurance only. At the other end are combined companies, so
called because they transact most classes of insurance business
including fire, theft, motor, liability, life and personal accident.
As Britain is the leading insurance market, many overseas-based
insurance companies have set up operations there. Names such as
Australian Mutual Life or Zurich life indicate the country of origin.
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A recent trend has been for large firms to form their own
insurance companies as part of a diversification plan. One
example is the Black horse insurance company which was
formed by Lloyds Bank initially for the transaction of
household insurance arranged for the bank’s customers. In
1985 the Royal Bank of Scotland set up its own insurance
company for the writing of motor insurance . Later in 1991 the
Abbey National, Halifax, Leeds and Woolwich have all
formed their own insurance companies.
Various Building societies have set up their own life companies:
for example Britannia Life for the Britannia Building Society.
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The term bancassurance is beginning to take hold. The concept
refers to banking and insurance products being provided by the
same organization. (integration-lecture 1)
The advantages of bancassurance include:
I. Increase in sales and the resulting income and profits
II. Enabling an independent arm as well as a tied life assurance
company to operate within the same group.
III. The ability to use the existing customer base for possible sales
IV. Greater opportunities to use branches for ‘one-stop’ financial
services shopping
V. Life companies generally having long term profitability
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The disadvantages include:
I. The capital needed to set up the company
II. Understanding the different sales process involved
in life sales
III. Having the structure to cope with the sales process
IV. Changing the culture of the organization away
from a deposit-based business.
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Lloyd’s of London is unique. It consists of underwriters who are technically
in the position of being sole traders. The underwriters are organized into
teams or syndicates which tend to specialize in particular areas of
insurance.
A syndicate may have just a few members or up to several hundred. To
become a member it is necessary to have significant disposable income
that is not tied up in a property. Syndicates operate as separate firms
but all share common facilities for the transaction of business in the Lloyd's
building where business is accepted from brokers.
Intermediaries are those who introduce insurers to policyholders . They
may be individuals, partnerships, small companies or large financial
institutions. Insurance brokers are the most important sector of the
intermediaries market.
A client using a broker should obtain a number of benefits by doing so.
Firstly brokers deal with a wide range of insurers from the company
markets and Lloyd’s. Secondly the broker will shop around to find the
best deal for the client , thereby saving the client time and effort. Thirdly
brokers have access to computers which enable quotations from several
companies to be obtained and compared very quickly.
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Commission: is the reward which insurance
companies pay to those who find the policyholders.
It can be paid as percentage of premium at each
renewal date or paid up front when the client signs
the direct debit to commence payments or a
combination of the two.
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THANK YOU
Chara Charalambous CDA COLLEGE