First loss insurance

Last week, we talked about self-insurance. We also said First Loss Insurance, though partial, is a form of self-insurance. First Loss Insurance is a type of policy where the policy holder, with the full knowledge of the insurance company, insures for less than the full value of the property and stocks at risk. First Loss Insurance is predominantly used in property insurance, specifically theft and burglary insurance. For example, a supermarket is stocked with goods worth N20 million. The owner estimates that at any single occurrence, the maximum value of goods that can be stolen from his supermarket is N5 million. he goes on to take a First Loss Policy with a sum insured of N5 million. The premium is calculated proportionately, which means it is based on the N5 million sum insured, not the N20 million full value or value at risk

The implication is that if there is a case of burglary, the maximum amount he can claim is N5 million per occurrence. If the burglars steal goods worth N7 million, he can only get N5 million from the insurers, while he will be his own insurer for the balance of N2 million. That is why potential policy holders of this policy need to do their homework before arriving at their first loss sum insured.

In First Loss Insurance policies, average does not apply unlike in other insurances.  We had explained previously that average is a clause in insurance policies that becomes operative when there is a partial claim and the sum insured is lower than the actual value of the subject matter of insurance. The insurance company bears only a rateable proportion of the claim. For instance, if the actual value of your car is N10 million and you insure it for N8 million, if there is a partial loss of N1 million, the insured will only be paid N800,000 to reflect his underinsurance. He will now be his own insurer for the balance of N200,000. However, if there is a total loss, the insurance company need not apply average. The policy holder will be paid the full sum insured. Note that the actual value of the vehicle is N10 million, while the sum insured is N8 million. Automatically, the policy holder needs an additional N2 million to replace the vehicle.

Application of average in first Loss Insurance also helps to ensure indemnity. We treated indemnity earlier where we described it as one of the principles of insurance meant to put policy holders in their pre-loss positions immediately after they suffer a loss. Policy holders are not supposed to make a profit from insurance. The business of insurance is to restore policy holders to the financial position they were before suffering the loss. Applying it to First loss Insurance policies, indemnity means claims will be paid based on the first loss sum insured, not the value at risk. Applying it to the example of the supermarket above, it means claims payment will be paid based on the N5 million limit, not the full value of N20m of the stocks in the supermarket.

We said earlier that First Loss Insurance is used mainly in burglary policies. Please note that all the conditions of a burglary policy apply. There must be forcible and violent entry and/or exit before the insurance company can become liable. The insurance company will not be liable for losses as a result of shoplifting and other acts where force and violence were not applied in gaining entry and/or exit.

Also, luxury items like watches, jewelry, money, gold, precious stones, drawings and artefacts must be specifically insured before the insurance can be liable for their loss or theft. Thefts by employees or members of the insured’s household are also not covered. We explained some time ago that this risk is the subject of another insurance called Fidelity Guarantee.

The major benefit of First Loss Insurance is that it enables the policy holder to cut down on his premium and save much needed cash. The main drawback is that if the policy holder makes wrong projections, it faces the possibility of being saddled with making up for losses it cannot cope with.