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The Insured and the Insurance Contract: Bridging the Gap.

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The growing need for insurance in our everyday life cannot be overemphasized. Insurance is an essential financial component that need to be considered when making sound financial decisions. Insurance in its real sense is a means of protection from financial loss and as such must be critically assessed when engaging in any policy (contract).

Generally, when insurers give the policy document (insurance contract) to the insured, all he does is glance through the policy and pile it up with the other bunch of financial papers forgetting he is bound by every single word in the policy. A lot of people fail to take their time to read their contracts and when issues arise, they get caught up by surprises in the contract document.

This is an issue that bothers on the relationship between the insured and the insurer. To avoid this, the insured is expected to understand the nitty-gritties of every detail in the contract.

Essentials of a Valid Insurance Contract

  • Offer and Acceptance
    When applying for insurance, the first thing you do is get the proposal form of the particular insurance company. After filling in the requested details, you send the form to the company (sometimes with a premium check). This is your offer. If the insurance company agrees to insure you, this is called an acceptance. In some cases, your insurer may agree or accept your offer after making some changes to your proposed terms.
  • Consideration
    This is the premium or the future premiums that you have to pay to your insurance company. For insurers, consideration also refers to the money paid out to you should you file an insurance claim. This means that each party to the contract must provide some value to the relationship.
  • Legal Capacity
    You need to be legally competent to enter into an agreement with your insurer. If you are a minor or mentally ill, for example, then you may not be qualified to make contracts. Similarly, insurers are considered to be competent if they are licensed under the prevailing regulations that govern them.
  • Legal Purpose If the purpose of your contract is to encourage illegal activities, it is invalid.

Contract Values

Most insurance contracts are indemnity contracts. Indemnity contracts apply to insurances where the loss suffered can be measured in terms of money.

  • Principle of Indemnity
    This states that insurers pay no more than the actual loss suffered. The purpose of an insurance contract is to leave you in the same financial position you were in immediately prior to the incident leading to an insurance claim. In other words, you will be remunerated according to the total sum you have assured.
  • Premium or Full Insurance

This requires paying the full value of an insured asset so that when it comes to its claims you get the full value as a remuneration.

  • Under-Insurance
    Often, in order to save on premiums, you may insure a percentage of the total value of the asset and when there is a partial loss, your insurer also pays that proportion while you have to dig into your savings to cover the remaining portion of the loss. This should be tried to be avoid as much as possible.

Not all insurance contracts are indemnity contracts. Life insurance contracts and most personal accident insurance contracts are non-indemnity contracts. When you purchase a life insurance policy at a certain amount that does not imply that your life’s value is equal to that amount. Because you can’t calculate your life’s net worth and fix a price on it, an indemnity contract does not apply.

Insurable Interest

The legal right to insure any type of property or any event that may cause financial loss or create a legal liability is called insurable interest. When it comes to insurance, it is not the house, car or machinery that is insured. Rather, it is the monetary interest in that house, car or machinery to which your policy applies.

It is also the principle of insurable interest that allows married couples to take out insurance policies on each other’s lives, on the principle that one may suffer financially if the spouse dies. Insurable interest also exists in some business arrangements, as seen between a creditor and debtor, between business partners or between employers and employees.

Principle of Subrogation

Subrogation allows an insurer to sue a third party that has caused a loss to the insured and pursue all methods of getting back some of the money that it has paid to the insured as a result of the loss.

For example, if you are injured in a road accident that is caused by the reckless driving of another party, you will be compensated by your insurer. However, your insurance company may also sue the reckless driver in an attempt to recover that money.

Good Faith

Doctrine of Utmost Good Faith
All insurance contracts are based on the concept of “uberrima fidei”, or the doctrine of utmost good faith. This doctrine emphasizes the presence of mutual faith between the insured and the insurer. In simple terms, while applying for insurance, it becomes your duty to disclose your relevant facts and information truthfully to the insurer. Likewise, the insurer cannot hide information about the insurance coverage that is being sold.

  • Duty of Disclosure: You are legally obliged to reveal all information that would influence the insurer’s decision to enter into the insurance contract. Factors that increase the risks – previous losses and claims under other policies, insurance coverage that has been declined to you in the past, the existence of other insurance contracts, full facts and descriptions regarding the property or the event to be insured – must be disclosed. These facts are called material facts. Depending on these material facts, your insurer will decide whether to insure you as well as what premium to charge. For instance, in life insurance, your smoking habit is an important material fact for the insurer. As a result, your insurance company may decide to charge a significantly higher premium as a result of your smoking habits.
  • Representations and Warranty: In most kinds of insurances, you have to sign a declaration at the end of the application form, which states that the given answers to the questions in the application form and other personal statements and questionnaires are true and complete. Therefore, when applying for fire insurance, for example, you should make sure that the information that you provide regarding the type of construction of your building or the nature of its use is technically correct.

Representations: These are the written statements made by you on your application form, which represent the proposed risk to the insurance company.

Warranties: They are imposed by the insurer to ensure that the risk remains the same throughout the policy and does not increase.

Breach of Utmost Good Faith

As already mentioned, insurance works on the principle of mutual trust. It is your responsibility to disclose all the relevant facts to your insurer. Normally, a breach of the principle of utmost good faith arises when you, whether deliberately or accidentally, fail to divulge these important facts. There are two kinds of non-disclosure:

  • Innocent non-disclosure relates to failing to supply the information you didn’t know about.
  • Deliberate non-disclosure means providing incorrect material information intentionally.

When you supply inaccurate information with the intention to deceive, your insurance contract becomes void.

  • Fraudulent non-disclosure means knowing about a material fact and purposely holding it back from the insurer.

If this deliberate breach was discovered at the time of the claim, your insurance company will not pay the claim.

If the insurer considers the breach as innocent but significant to the risk, it may choose to punish you by collecting additional premiums.

In case of an innocent breach that is irrelevant to the risk, the insurer may decide to ignore the breach as if it had never occurred.

Other Policy Aspects

Doctrine of Adhesion

The doctrine of adhesion states that you must accept the entire insurance contract and all of its terms and conditions without bargaining. Because the insured has no opportunity to change the terms, any ambiguities in the contract will be interpreted in his or her favor. 

Principle of Waiver and Estoppel

A waiver is voluntary surrender of a known right. Estoppel prevents a person from asserting those rights because he or she has acted in such a way as to deny interest in preserving those rights.

Presume that you fail to disclose some information in the insurance proposal form. Your insurer doesn’t request that information and issues the insurance policy. This is waiver. In the future, when a claim arises, your insurer cannot question the contract on the basis of non-disclosure. This is estoppel. For this reason, your insurer will have to pay the claim.

Endorsements

Endorsements are normally used when the terms of insurance contracts are to be altered. They could also be issued to add specific conditions to the policy. 

Co-insurance

Co-insurance refers to the sharing of insurance by two or more insurance companies in agreed proportion. For the insurance of a large shopping mall, for example, the risk is very high. Therefore, the insurance company may choose to involve two or more insurers to share the risk.

Coinsurance can also exist between you and your insurance company. This provision is quite popular in medical insurance, in which you and the insurance company decide to share the covered costs in the ratio of 20:80. Therefore, during the claim, your insurer will pay 80% of the covered loss while you shell out the remaining 20%.

Reinsurance

Reinsurance occurs when your insurer “sells” some of your coverage to another insurance company. Suppose you are a famous rock star and you want your voice to be insured for $50 million. Your offer is accepted by the Insurance Company A. However, Insurance Company A is unable to retain the entire risk, so it passes part of this risk – let’s say $40 million – to Insurance Company B. Should you lose your singing voice, you will receive $50 million from insurer A ($10 million + $40 million from insurer B). This practice is known as reinsurance.

Generally, reinsurance is practiced to a much greater extent by general insurers than life insurers.

So, when applying for insurance, ensure to understand the terminologies so you will not be found wanting.

 

 

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Insurance

Climbing the Power Curve: Winning in the Insurance Market

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Insurers can take concrete, evidence-backed actions to move them in the right direction and, cumulatively, improve their odds of long-term success. Purposeful, bold moves aimed at shifting resources, boosting underwriting margins and productivity, and delivering on a series of programmatic M&A deals can dramatically improve an insurer’s odds of reaching the top quintile of economic profit. While these moves may sound instinctive, many companies fail to pursue them rigorously. In fact, these moves are most powerful when undertaken in combination, at or beyond the thresholds of materiality described in this narration. The point isn’t that there’s a magic formula for achieving strategic differentiation. Rather, by taking a hard look at the potential of your key initiatives to achieve bold results in these areas, one can get a realistic forecast of the odds that one’s strategy will transform performance.

Understanding the power curve and how to apply it

Research identified a power curve—proof that economic profit is unevenly distributed among insurance companies (exhibit) across geographies from 2013 to 2017. The power curve illustrates the uneven distribution of insurance industry economic profit.

These findings may come as a wake-up call to insurers that find themselves outside the top quintile—but embarking on an effort to move up the power curve is difficult.

How to move up the power curve

Research shows that moving up the power curve requires a laser focus on the factors such as foundational factors and bold moves that have an outsized impact on success, measured as economic profit.

Pursuing the five bold moves by Insurers

While the five bold moves may seem intuitive, and many companies may already be doing them in some form, two factors set these actions apart. First, magnitude and intensity matter; these efforts force insurers to break free from their standard processes of investment and initiative prioritization. Even if a company is doing something in each of these dimensions, how much it is doing often makes a difference. In other words, strategy is not only about the directionality of moves but also their materiality.

Second, the impact of these moves is cumulative. Companies that employ three or more of these moves in concert are likely to be propelled up the curve. Findings show empirically that companies that focus on multiple moves over time can learn from and adapt to them, reaping even further benefits.

Dynamically shift resources between businesses

Some carriers offer customers too many legacy products that do not produce meaningful profit. These legacy products take attention away from distribution, product development, and policy administration. Instead, companies should reallocate capital to higher return-on-equity (ROE) activities and away from lower-ROE lines of business. Proactive measures are critical given the sector’s highly competitive pricing environment.

Resource allocation should also be employed across various strategic lines, not just products. Based on research, the threshold for outperformance is the reallocation of 60 percent of surplus generated over a decade. Insurers that optimize their business mix accordingly have a better chance of improving their odds of ascending the power curve. This threshold parallels our findings across industries that dynamic resource reallocators gain approximately three to four more percentage points of total return to shareholders each year compared with low reallocators.

Other companies have increased economic profit by divesting underperforming assets. In the wake of the financial crisis of 2007–08, a number of companies exited underperforming businesses through closed-block transactions through either legal entity sales or reinsurance transactions. These transactions were with organizations that were more natural owners of the distressed assets by virtue of their capital structures or business models. These back-book transactions, when thoughtfully structured, have freed up capital that helped move sellers up the curve.

Reinvest a substantial share of capital in organic growth opportunities

Reinvesting earnings in profitable and well-performing businesses is a reliable way to increase economic profit, but finding these opportunities has been challenging for many insurers over the past ten years. Companies meet the threshold in this area if they are in the top 20 percent of the industry by strategic reinvestment relative to new business premiums; typically, that means spending 1.7 times the industry median.

Often considered innovators in the industry, companies that achieve this high ratio of reinvestment to sales have a track record of introducing disruptive products and services, enabling them to grow faster than their peers. Indeed, these insurers are successful at finding accretive internal rates of return. And as they push the boundaries of new offerings, they are often able to achieve higher margins (and ROEs) thanks to the reduced competition at the vanguard.

Pursue thematic and programmatic M&A

The third move centers on the use of programmatic M&A, an important approach for insurers with financial flexibility and access to available targets. A programmatic approach to M&A focuses on executing a series of deals in which no individual deal is larger than 30 percent of market cap but in which the total over ten years is greater than 30 percent of market cap. This is often done in thematic areas of technology and capability building or in extensions to new product lines and geographic markets. Typically, programmatic M&A outperforms both pursuing very large transactions and avoiding M&A altogether. By using a series of small, thoughtfully curated transactions to advance innovation and growth, programmatic acquirers have several advantages: they can simplify integration, avoid competitive bidding, and facilitate the exploration of new opportunities without committing large amounts of capital up front. This approach to M&A also enables more effective acquisition of new capabilities, such as digital and analytics.

Enhance underwriting margins

The fourth bold move involves making ROE improvements through better underwriting and lower loss ratios—a particularly important objective given how, as a core competency of all insurers and particularly in the P&C segment, underwriting efficiency can serve as a differentiating factor that leads to higher economic profit. Insurers accomplish these results either through privileged access to particular customer segments or better use of customer or risk data through analytics. Benefits from productivity improvement are often reinvested to improve product margins. To maximize the odds of moving up the curve, companies need to be in the top 30 percent of the industry by gross underwriting margin.

Make game-changing function improvements in productivity

Insurers feel continued pressure to reduce costs because of increasing price transparency, the effects of digitization, and low interest rates. Indeed, new entrants are closing the gap on incumbents. It’s generally recognized that even though the loss ratio has the greatest leverage, insurers benefit significantly from improving efficiency, lowering expense ratios, and increasing revenues per employee. Many executives in the industry believe that a dramatic wave of efficiency and retooling will crest in the next three to five years, and many are embarking on these high-ambition, enterprise-wide efficiency journeys now. Research reveals that to maximize the odds of entering the top quintile, companies should aim for a cost improvement that is in the top 30 percent of the insurance industry.

The odds of moving up the curve become exponentially larger as insurers pull more levers, while a strategy that does not incorporate any of the moves will likely fail. Indeed, the CEO, CFO, other senior executives, and board members can often use these bold moves as a test of strategies brought to them by their teams. Strategies that neglect to engage these actions typically have a one in ten chance of succeeding, compared with one in two (or better) for those that do.

Rather than thinking about strategy as primarily a matter of frameworks and broad themes, leaders should ask themselves what they are doing to make bold moves along the five dimensions that matter and whether efforts already underway are truly significant. The extent of the moves matters a great deal—materiality matters, not just directionality. And CEOs are in a unique position to calibrate materiality; this, in fact, is one of the greatest aspects of their role and a productive means of challenging their teams. If proposed plans don’t meet the required threshold of activity to bend the odds of moving up the power curve, they are likely not aggressive enough. What often gets in the way is a resource allocation process hindered by social dynamics. Other common obstacles include a lack of objectivity on opportunities and an insufficient understanding of critical thresholds needed to move the needle. As a result, too many companies simply check the box on certain priorities while investing too little in the ones that truly matter.

Improved economic profit is within reach for insurers that can adjust their business models in the face of an efficient market and inject a newfound objectivity into their strategic processes. Indeed, insurers that have a favorable endowment, navigate industry and geographic trends, and make bold moves will be in a good position to climb the power curve.

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