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Chapter 1 Risk and insurance 1/13 Chapter

H Benefits of insurance 1

Insurance brings many benefits to policyholders and to society as a whole. We have already mentioned
the peace of mind that it can provide, and how it enables the risk of financial loss to be transferred.
There are other benefits too, including:
• It releases capital within companies that can be used in the business. In the absence of insurance
large sums would need to be built up and set aside to cater for unforeseen contingencies, such as fire,
flood or liabilities.
• Enterprises are encouraged to start or expand. In their early years companies are particularly
vulnerable to loss, and this may inhibit an entrepreneurial approach in, say, opening up a factory or
launching a new product. Insurance provides security from which to develop such innovations.
• Employees are kept in work. This is a great social benefit of insurance. Whenever there is an insured
occurrence at a location there will be physical damage, but often it does not stop there; the company
will lose turnover until their trading position is restored. Insurance can cover, not only physical loss or
damage, but also wages, salaries and the loss of trading income for the period during which the
business is recovering. This in turn ensures that jobs are maintained.
• Losses are reduced in size and number. The overall cost to the community of all damage by fire in a
year is called ‘fire waste’ and insurers are keen to minimise this. Every fire prevented is a claim that
does not need to be paid and a business that can continue trading without disruption. For larger risks
insurers use the services of surveyors, who assess the risk for the underwriter, estimate the loss
potential and recommend improvements designed to reduce the incidence of fires or their effect.
• The nation benefits from the investments made by insurers. This arises in two main ways:
– There is a time delay between the receipt of premiums and the occurrence of claims. This creates a
premium reserve.
– Once claims have been made there is a further period (which can be very extensive for those
involving personal injury or illness) before the claims are actually paid. This element is a claims
reserve.
At any one time insurers will have substantial sums of money in these reserves to invest in a wide range Reference copy for CII Face to Face Training
of areas, including property and equities.

I Risk sharing

Part of an insurer’s job is to manage the pool of money valid claims are to be paid from. Each insurer
will, therefore, decide upon the maximum limits of acceptance for particular categories of risk. For
property insurances this will probably be a range of acceptance limits, depending upon the trade being
carried on in the premises and usually linked to different construction standards. For example, an
insurer will be comfortable accepting a higher sum insured for an office than for a plant where plastics
are manufactured.
So what happens when a risk is offered to an insurer but the amount at risk is greater than the insurer’s
retention limits for that category? The insurer has the option of declining to insure the risk, but it will not
wish to do this if the only reason is size and in all other respects the risk is of good quality.

The insurer must find a way of sharing the risk with others and there are two principal ways of doing this:
co-insurance and reinsurance. We will look at reinsurance in chapter 2. There is further risk sharing
method that insurers occasionally use: coming together to form a pool and agreeing to jointly underwrite
particular risks. These are usually designed to cover catastrophic risks such as terrorism or earthquakes.

I1 Co-insurance

The term co-insurance is used in two distinct ways by those in the insurance market. The first of these
An insurer may
relates to risk sharing between insurers; the second we will consider in section I1A. For property choose to share a risk
by means of co-
insurance in particular, an insurer may choose to share a risk by means of co-insurance. This involves an
insurance
insurer agreeing with other insurers the rating and terms to be applied and issuing a collective policy.
Each insurer receives a stated proportion of the premium and pays the same proportion of any losses
that occur. The leading office is the first named insurer in the policy and invariably carries the largest
share of the risk, and they are also responsible for issuing the documentation. Each time a change is
required the leading office issues closing instructions to each of the co-insurers advising them of the
proposed change and requesting their agreement.