Take cover

Insurance is an arrangement through which one party (the insurer) promises to pay another party (the insured) a sum of money if a defined future event happens that causes the second party to suffer financial loss. Therefore the burden of loss is moved from the insured to the insurer at a price that is called the premium. Insurance is therefore a financial decision, although it can be compulsory through law (third-party motor insurance or employer’s liability) or by trade requirements (professional indemnity). Each individual will have to decide for themselves just what they have to insure, want to insure and can afford to insure. Equally, they must decide what they are prepared not to insure.

Insurers calculate the likelihood of a certain event happening to the individual. Provided that it is a common event, many people will want to insure against it happening to them, creating a pool of people wishing to be insured. Assuming that the event is not going to happen to everyone simultaneously, it can be spread among all the members of the pool to produce a level of premium that most people would be prepared to pay to cover the risk of the event happening to them. That is why some types of insurance (especially if the risk is high and there are comparatively few people who might be affected by it) are extremely expensive, while others (with a relatively low financial penalty and a very large pool) are much cheaper.

Incidentally, insurance can only deal with risk – when a range of possible outcomes can be identified, and when their probability can be established and therefore quantified. It cannot cover uncertainty – when outcomes can be neither identified nor quantified. So it is possible to insure against weather disruption to a sporting event, but it is not possible to insure against the failure of a business venture.

The people who carry out the mathematical calculations on which insurance premium rates are calculated are called actuaries; the firms that offer the insurance are the underwriters; and the people that sell the policies are called brokers. Brokers may be tied to one or more particular underwriter(s) and sell only their policies, or they may be independent and offer products from a number of companies. They may be paid a salary and/or a commission on the value of the policies they sell. Internet and telephone brokers are increasingly popular but they are still intermediaries, and the insurance contract is between the insured and the insurer. Loss adjusters or claims investigators examine the circumstances of particular claims; they work for underwriters, and they may prevent or reduce a payment if they find some reason why the insured should not be reimbursed.

The size of the claim depends on the nature of the policy; it may be indemnity (putting the insured in the same position they were in before the loss), reinstatement (which could be ‘new for old’) or an agreed value written in the policy. The insured should never be better off as a result of an insurance claim. Insurance also differs from other types of contract in that all parties are required to disclose all material information – there is no ‘buyer beware’. The insured must also have an insurable interest in the property; it is not generally possible to insure someone else’s assets.

Reinsurance is huge business nowadays and involves an insurer accepting a risk, receiving the premium and then passing on some or all of the risk to another insurer by paying them a premium. It is essentially the same process as bookies ‘laying off’ at the racetrack.

There are essentially two categories of insurance: insurance of the person and general insurance.

All insurance of the person is based on agreed sums of payment rather than indemnity. The principle of contribution (whereby two insurers holding a policy with the same insured can share the claim value so that the insured does not receive two payouts for the same loss) does not apply – people can have as many life policies as the wish, to as much value as they wish, and the insurers must all pay in full. Most Service people are familiar with life insurance (or life assurance as it should more properly be known because it pays out on death and this, as the only certainty in life, is not a contingency). There are three basic types: term, whole life and endowment. Term covers a fixed period of years and will pay out only if the insured person dies during that period. Whole life pays out to the beneficiaries of the insured’s will, on the death of the insured. Pure endowment pays out to the insured only if they survive to the end of an agreed term; while endowment assurance pays an agreed sum on the death of the insured during the term or on their survival to the end of it.

Policies may be taken out with or without profits. With profits benefit from bonuses that come from the insurer investing part of the premium in ‘safe’ investments so that both they and the insured benefit from market gains. While popular in times of plenty (bull markets), the bonuses can reduce to very small sums when investment performance is poor (bear markets). As a young person with no dependants, life insurance may not be required. However, once a spouse and children come into the picture, most people try to protect their interests in terms of both an income for the future and their ability to inherit assets through life insurance cover.

Another insurance of the person is accident insurance (specific benefits for accidents caused by external and unexpected circumstances based on a scale of award depending on extent of injury). Sickness insurance may be linked or taken out separately, and replaces all or a proportion of income lost through temporary injury or incapacity. This insurance may often be arranged by a large organisation, but it is especially relevant for self-employed people who will receive very limited income for any period during which they may be unable to work.

Permanent health insurance (PHI) can be arranged (often by a large employer as a benefit for all staff) to provide a proportion of income for a long-term or permanent incapacity due to accident or sickness. There will typically be a 26-week waiting period before PHI starts. Finally, some people may be so valuable to an organisation that their loss may be a crippling blow to its operation – often senior managers or specialists. Key man insurance may be taken out by the organisation to cover its expenses in lost business and replacement costs, both of which can be hard to establish.

Strangely enough, private medical insurance is not strictly insurance of the person. However, busy people may wish to be able to arrange their own medical treatment as it suits them rather than relying on the NHS. It is also something that may be worth taking out at an early age when the chronic conditions that may strike later (diabetes, back and heart problems, to name but a few) have not yet come to light and so the policy will continue to cover the insured for these conditions into old age.

Finally, travel or holiday insurance is not only wise but is a requirement for many holiday organisations. It is usually possible to obtain cover for individuals or families, for a one-off trip or annually, for various parts of the world, and to engage in different activities. Provided that the correct cover is held, travellers do not have to pay for their travel company’s own insurance.

General insurance is mainly a concern of businesses, and private individuals are usually concerned only with three aspects: motor, buildings and contents insurance.

Everyone who owns a vehicle must make sure that it is insured. The legal minimum is third-party, fire and theft cover, so that anyone involved in an accident (except the owner and their vehicle) is protected, and the owner is protected if the vehicle catches fire or is stolen. Comprehensive vehicle insurance is usually more expensive and also covers the owner and their vehicle. Add-ons might include windscreen, courtesy car and a host of other options.

Building insurance applies to people who own their houses either outright or, more often, with the help of a bank or building society mortgage. All that is being purchased is the cost of clearing the site and rebuilding the property, so the sum assured should be a great deal less than the total cost of the building because the latter includes the cost of the land as well.

Property insurance is often linked with building cover. It covers the replacement value of the contents of the building. Usually there are various categories of contents – furniture, clothes, etc. – with very expensive items needing to be individually detailed and described. It may cover a certain amount of belongings if they leave the building (on holiday or business), and it may operate on a ‘new for old’ basis.

Almost all insurance policies have either a compulsory or voluntary excess, or both. An excess is the amount of money that the insured will pay if an insured event happens before invoking the policy and seeking payment from the insurer. A large voluntary excess can be a good way of reducing the premium. Many insurance companies will offer a no claims bonus or discount. This means that the insurer will reduce the premium by a certain amount or percentage for each consecutive year in which a claim has not been made. This is most common in motor insurance.

A good place to start to receive insurance advice tailored to your precise needs is from a local independent broker. A family member or friend may be able to recommend one. An initial consultation will usually cost you nothing but time, and you can always search the internet for the best deals once you are clear about what you need. It certainly pays to shop around, but remember that you must fully declare all your circumstances to the insurer otherwise the cover you are paying for may be lower than you think or may not exist at all.