Alternative Bases of Insurance
Some of the alternative basis of arriving at at the sum insured include:
Agreed Value Basis
An agreed value policy or valued policy is one which the maximum payable in the event of total loss is the sum insured which was agreed in between the insurer and the insured at the time of effecting the policy.
No account is taken for depreciation and appreciation which may have affected the value of the insured since inception of the contract. Where the loss is partial, the agreed value must be taken into account when calculating the amount of compensation just as in the case of total loss.
Valued policies are issued on items such as paintings, sculptures, works of crafts and jewellary. They are also widely issued in marine and aviation insurances. It is common for a valuation to be prepared by a qualified valuer or expert before the inception of the policy.
The arrangement is consistent with the principle of indemnity because both parties agree on the the value of the insureds interest at the commencement of the contract instead of waiting for it to be proved to be proved at the time of loss. the principle of indemnity is preserved, so long as the valuation is fair and reasonable.
However, the policy may be avoided by the insurer in the event of a gross over- valuation which is known to the insured and this may be an indication of fraudulent intentions., similarly, the policy would be avoided if valuation was so excessive as to render the policy a wagering. Valued policies may result in inadequate insurance which is an advantage to the insurers as they are able to receive an equitable premium.
Disadvantages of valued policies
- Preparation of an inventory and valuation can be expensive
- Appreciation in value which can be high at the time of a high rate of inflation is not provided for.
- Partial losses are difficult to settle
- Violation of the principle of indemnity may occur where depreciation in value due to wear and tear or change of fashion, the insurer will still have to settle a claim on this basis.
- Continual review of sum insured is needed if proper provision is to be made for new articles and this can be expensive and unnecessarily time wasting.
First Loss Insurance
First loss policies are treated as deliberate underinsurance where sum is accepted to less than the full value of the property. for example, the total value of stock may be KES 50 million but insurance is based on on a first loan basis of 20 million. It may be suitable for an insured who convinced that no one can exceed a given level which is less than the full value of asset at risk.
At the time of effecting insurance, the insured declares the full value of property at risk so that the insurer knows what proportion of risk is represented by the sum insured, this being a factor upon which the premium will be charged. A declaration of full value is contained in the policy. The application of normal average is not possible because of the agreed underinsurance but still, a form of average is employed which is based on the declared value of property at risk. Average is applied if the amount of the declared value is less than the actual value at time of loss or destruction or damage to such property.
Insurers issue first loss policies in respect of theft insurance because in many cases it can reasonably be urged that particular goods are too bulky or too heavy for thieves to take away or destroy more than a small proportion of the total at risk.
While first loss policies are common in burglary insurance, they are occasionally issued by fire and special peril insurers where they are generally restricted to insurances covering loss or damage resulting to;
- Storm and tempest
- Bursting or overflowing of water tanks, pipes, or other water apparatus
- Sprinkler leakage
With these perils, one can argue that total loss is unlikely in many instances.
Rating is difficult because no two proposals are alike and there is no scientific basis upon which the correct premium can be calculated.
To illustrate the difficulty, consider two risks where stock is of identical type of goods but the total value values are KES 50,000,000 and KES 10,000,000 respectively. The underwriters may think that the maximum possible loss in each is KES 5,000,000. They will not be content to receive the same premium at for each risk, however, since the bigger risk is likely to be greater for thieves as compared to the smaller risk.
On the other hand, some compensating reduction in the rate for the larger risk may be justified, but the extent depends largely on the subjective view of the underwriter. These factors will be considered;
The total value of stock
The sum insured selected by the proposer and its relationship to total value.
The underwriter’s opinion based on the surveyor’s report of the maximum probable loss
A higher rate of premium is charged to cater the fact that, sum insured is not the full value. In reality, insurers will charge a premium which reflects the risk, whatever the method or basis of insurance.
Bearing in mind a practical and widely used method of arriving at the premium is to charge a percentage of the full premium according to the proportion insured. For example
- 75 percent of the full value insured, charge 90 percent of the full premium
- 50 percent of the full value, charge 75 per cent of the full premium
- 25 per cent of the full value, charge 50 percent of the full premium
Some companies, however charge a mean of premium generated by applying the rate of premium to both the full value at risk and declared value.
Seasonal Stock Insurance
Many types of businesses are subject to seasonal fluctuations in the level of stock in their possession. it is common for example for retail or wholesale shops to carry additional stocks at certain times for the year when their goods are in high demand.
To cater for this, it would be necessary, to maintain the sum insured throughout the year at the highest anticipated amount. However, this is likely to result in excessive premium payment. The alternative is to advise the underwriters as and when the amount of stocks have gone up and hence an increase in cover is required. This may not always be possible or practical.
To overcome the difficult, most insurers incorporate an automatic seasonal increase clause for stock in their policies and include a pro rata additional premium to provide for the sum insured on stock is automatically seasonal increased by 20 per cent for certain months such as November and December. The insured chooses the seasonal increase as well as the best suited on their needs.