Restoration, not profit making

Iran into a couple of guys recently. Once they realized I was an insurance professional, they said many beautiful things about the insurance industry. I was in dreamland until I was stung and brought back to reality. Both of them had claims – one, motor and the other, fire – which were promptly paid by their insurance companies. “We even made profit on the claim,” they happily announced to me. Whaaat! Who slapped me? You made a profit on a claim? How? By the time they finished fixing the various subjects matter of insurance, they had money left. It is the leftover money they were referring to as profit.

But how could this have happened? They could have inflated the figures for items needed for the repairs and the adjuster was not diligent enough to spot the inflation. The policy holder with the motor claim could have brought estimates for new parts and bought fairly-used parts after collecting his claim. The fire policy holder could have used cheaper items in his repairs. For instance, the damaged marbles cost N40,000 per square meter. Then he goes to replace them with marbles of N20,000 per square. In both examples, the policy holders only cheated and stole from themselves, they did not make any profit.

It could also have been cases of fraud and dishonesty, which were not noticed by the insurance company. Also, what the insurance company adjusts are estimates, which might be under or over the actual costs. When it is under, it is inevitable for the policy holder to be left with some cash after repairs and I have never heard that any policy holder returned such cash.

There are basically four methods insurance companies provide compensation to policy holders who suffer losses, and the insurance company is at liberty to opt for any of the methods. They are cash payment, replacement, repair and reinstatement. In most cases, companies opt for cash payment, which is more convenient. The other options have booby traps. Some difficult policy holders might make issues out of a repaired vehicle, reinstated building or a replaced item, if handled by the insurance company, even when there are no issues. This can lead to avoidable bickering and even litigations. It is to avoid such hassles that insurance companies usually prefer the cash option. But companies do go for the other options if they feel it will be more advantageous or where they cannot agree with the policy holders on the amount of cash to pay as compensation.

Whatever be the case, insurance is not meant for policy holders to make profit. The job of insurance is to place policy holders, who suffer losses, in the financial position they were before the loss occurred. This is one of the six principles and pillars of insurance and it is called INDEMNITY.

Indemnity in insurance simply means that if an incident leading to a loss occurs, the amount the policy holder will be entitled to will be determined by his actual financial loss. For instance, if a policy holder’s vehicle is involved in an accident, and it will take N500,000 to put the vehicle in the state it was before the accident, his financial interest is N500,000 and that is all he is entitled, as far as this incident is concerned, even if the sum insured of the vehicle is N4,000,000. He can only be placed in the exact financial position he was before the loss, no more, but it can be less due to some factors we shall come to later.

It is against public policy to make profit on your insurance contract of indemnity. Remember insurance fund is a financial pool where all policy holders contribute by way of premium and from where those who suffer losses are compensated. When a policy holder who suffered a loss attempts to make a profit, it is against the public policy because it is at the expense of other policy holders who contributed to the pool of funds from where the claims are paid. Moreover, it is illegal because often you have to engage in fraudulent acts like inflating cost of materials or repairs or other fraudulent activities.

Except for life and personal accidents, virtually all other insurances are contracts of indemnity. Life and personal accident policies are not strictly contracts of indemnity because you cannot really put financial value on health, life or limb. In specific terms, how much does a human life cost? What is the cost of a leg or arm? It is impossible to cost them in naira and kobo; that is why they cannot be contracts of indemnity, strictly speaking. Life and personal accident insurances are benefit policies, and compensation is usually determined by the sum insured/assured at the occurrence of the event insured against.

We stated earlier that there are certain factors that prevent policy holders from getting full indemnity. They are: One, excess. Excess is the proportion of each and every claim borne by the policy holder. Virtually all non-life policies carry the excess clause. It is usually inserted as a deterrent to ensure that the policy holder treats the insured property as if it were not insured, knowing he will participate in the claims payment. It is usually expressed in percentage or figures and whichever is higher devolves to the policy holder in the event of a claim. However, in motor insurance, there is provision for excess buy back, where the policy holder can pay an extra amount, usually one per cent of the sum insured, and have the excess clause deleted from his policy. The implication is that in the event of a loss, he does not participate in the claims payment and gets full payment.

Two, sum insured. This is the value the policyholder insured the property for. It should normally represent the full value, replacement value or value at risk. If not, in the event of a loss, the claim paid will not be able to replace/repair the property, thereby denying the policy holder full indemnity, which unfortunately, is self-inflicted.

The third is average. If a policy holder insures the subject matter for less than the actual value, the insurance company penalises the policy holder for underinsurance in the event of a claim. For instance, if the sum insured is N20 million and the value at risk is N30 million and there is a claim of N5 million, the insurance company will pay only N3.3 million, while the policy holder bears N1.7 million as a punishment for underinsurance.

The third way a policy holder can get less than indemnity is through deductible. Deductible is a large excess the policy holder voluntarily accepts, which makes him his own insurer for small claims he has determined and agreed to accommodate. In return, he gets either a lower premium rate or substantial discount on his premium. The implication is that if the deductible is N100, 000, for instance, he is solely responsible for any loss within the deductible. He can only have recourse to the insurance company when the loss is above the deductible.

We also have franchise. Franchise is like excess. An amount is fixed and if the loss is within the amount, the policy holder bears it alone, but once the claim is above the franchise, the insurance company pays the full claim, unlike excess, where the policy holder still participates.