Insurance Concepts (Grade 12 NSC Matric Business Studies): Revision Notes

Insurance Concepts

What is insurance?

Insurance is a financial agreement between two parties: the insurer (insurance company) and the insured (person or business seeking protection). The insured person takes out an insurance contract and makes regular payments called premiums to the insurer. In return, the insurer promises to provide financial protection against specific losses or damages that are covered in the insurance contract.

Types of insurance coverage

Non-compulsory insurance

This type of insurance gives the insured person the choice of whether to take out cover against certain risks that might or might not happen. The key features include:

• The insured has complete freedom to decide whether to purchase this insurance
• The decision to insure an asset or risk lies entirely with the insurer and is not influenced by government requirements
• Examples include home contents insurance or extended warranty cover for appliances

Over-insurance

Over-insurance happens when someone insures their assets or possessions for more money than their actual market value. This situation has several important characteristics:

• The insurer may choose to reinstate (replace or repair) the insured item rather than pay out cash
• The insured will never receive more compensation than the actual market value of the item
• This prevents people from making a profit from insurance claims, which goes against the principle of indemnity

Under-insurance

Under-insurance occurs when items or assets are insured for less than their true market value. This creates specific consequences:

• The insured will only receive partial compensation for losses or damages
• The average clause will be applied to determine the payout amount
• This situation often happens when people want to pay lower premiums but don't realise the risks involved

Average clause

The average clause is a important stipulation that insurance companies use when property or goods are under-insured (insured for less than their market value). This clause ensures fair treatment in claims processing.

How the average clause works

When the average clause applies, the insurer calculates payments proportionally based on how much coverage the insured person actually purchased compared to the full value. The insured becomes personally responsible for the portion of risk that wasn't covered by adequate insurance.

Average clause formula

The calculation for determining payment under the average clause is:

$\text{Amount insured} \div \text{Market value of item} \times \text{Amount of damages} = \text{Payout}$

Reinstatement

Reinstatement is an alternative method of settling insurance claims that involves replacing or repairing damaged items rather than making cash payments. Key aspects include:

• The insurer may choose to repair or replace lost or damaged property instead of paying money
• This option is typically used when property or goods are over-insured
• The cash payment will never exceed the market value of the insured assets
• The insured must be returned to a similar financial position as before the loss occurred
• This prevents the insured from profiting from a risk they were insured against

Excess

An excess is a specific amount that the insured person must pay towards any claim before the insurance company pays out. Understanding excess helps explain how insurance premiums are kept manageable:

• The excess amount is not paid by the insurer when settling a claim
• Excess payments help keep insurance premiums lower for everyone
• They discourage fraudulent claims because the insured must contribute financially
• Excess payments prevent claims for very small amounts of damage
• The size of the excess is agreed upon and stated in the insurance policy

Comparing over-insurance and under-insurance

Over-insurance	Under-insurance
Assets insured for more than market value	Assets insured for less than market value
Insurer applies reinstatement clause	Insurer applies average clause
Compensation limited to market value	Insured compensated proportionally
Insurer may repair/replace damaged items	Insurer pays cash for proportional amount

Insurance versus assurance

While these terms are often used interchangeably, there are important distinctions between insurance and assurance that affect how policies work:

Insurance	Assurance
Based on the principle of indemnity	Based on the principle of security/certainty
Covers events that may occur	Covers events that will definitely occur
Transfers potential loss costs through premiums	Insurer pays agreed sum after specified period or death
Applicable to short-term agreements	Applicable to long-term agreements
Examples: Property, theft, fire, burglary	Examples: Life insurance, endowment policies, retirement annuities

Short-term and long-term insurance

Insurance can be classified based on the time period it covers, and this affects both the risks covered and how policies are structured:

Short-term insurance protects against events that may or may not happen within a shorter timeframe. The insured chooses whether to take out this type of cover.

Long-term insurance covers events that will definitely occur at some point, such as death, or provides financial security over extended periods.

Examples comparison

Short-term insurance	Long-term insurance
Property insurance	Endowment policies
Money in transit	Life insurance
Theft coverage	Retirement annuities/Pension funds
Burglary protection	Provident funds
Fire insurance	Funeral insurance
	Health/Medical insurance

The choice between short-term and long-term insurance depends on the nature of the risk, the time period involved, and the financial goals of the insured person.