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CHAPTER RISK AND RISK MANAGEMENT Risk, objective risk, subjective risk, pure risk, speculative risk (definition and example) - Risk: is uncertainty concerning the occurrence of a loss Ex: risk of being killed in an auto accident is present because uncertainty is present In economic terms: Risk = probability density/possible consequence In insurance economic, the probability of occurrence and severity of consequence are distinguished in definition of risk Note: loss happens after risk: whenever risk happens loss occurs - Subjective risk: is an uncertainty based on a person’s mental condition or state of mind Ex: drunk driver is uncertain whether he will arrive home safely without being arrested by the police for drunk driving - Objective risk: relative variation of actual loss from expected loss Calculated by statistical techniques like standard deviation, coefficient of deviation Ex: Among 10,000 houses insured, insurers expect 1% (100 houses) to burn each year But some years, 90 houses burn, some years 110 houses burn a variation of 10 houses from expected number of 100 (a variation of 10%) is objective risk - Pure risk: a situation in which there are only the possibilities of loss or no loss Nothing gain can come from an exposure of pure risk Ex: Factory exposure to loss by fire A factory either burns or it does not burn Ex: premature death or job related accidents - Speculative risk: situation in which either profit or loss is possible Ex: risk of price change of investment in stock market or investment in real estate Note: Possible outcomes of pure risk and speculative risk • Usually pure risk are insured Speculative risk is not insured (with certain exceptions: some insurers insure institutional portfolio investment and municipal bonds) • Law of large number can be applied more easily to pure risks than to speculative risks (Law of large number: exposure units increase the more closely the actual loss experience will approach the expected loss experience for predicting future loss experience) • Pure risk always cause harm to the society (ex: earthquake floods) on the other hand speculative risk may benefit society (ex: new technology is developed some company go bankrupt but society still gains) Fundamental risk and particular risk, enterprise risk (definition and example) - Fundamental risk: is a risk that affects entire economy or large number of persons or groups within the economy is called fundamental risk Ex: the risk of natural disaster, risk of high inflation, risk of terrorist attack… Note: Fundamental risk is always insured by social insurance and government insurance program Ex: the risk of unemployment is insured by state unemployment compensation programs, flood insurance is subsidized by federal government in USA - Particular risk: a risk that affects only individuals and not the entire economy Ex: bank robbers, car accidents, car theft - Enterprise risk: encompasses all major risk faced by a business firm, such as pure risk, speculative risk, strategic risk strategic risk, operational risk and financial risk used in commercial risk management Note: Commercial risk management is process that organizations use to identify and treat major and minor risks Enterprise risk management combines into single unified treatment program all major risk faced by the firm firm can offset one risk against another Strategic risk, operational risk and financial risk (definition and example) - Strategic risk: refers to uncertainty regarding the firm’s financial goals and objective Ex: a firm enters a new line of business, the line may be unprofitable - Operational risk: results from firm’s business operations Ex: bank offering online banking service face the risk of being hacked - Financial risk: refers to uncertainty of loss because of adverse changes in commodity prices, interest rate, foreign exchange rates or the value of money Ex: food company sells cereal at the fixed price to supermarket in months may lose money if grain price rise Three types of pure risk - Personal risk: directly affect the individual in the form either complete loss or reduction of earned money or extra expenses and the depletion of financial assets Note: major personal risk are: • Risk of premature death: death of a family head with unfulfilled financial obligations the human life value is lost, additional expenses, family has trouble making ends meet, certain non economic costs Note: Financial obligations: dependents to support, children to educate Human life value: the present value of the family’s share of the deceased future earnings breadwinner’s Additional expenses: funeral expense, uninsured medical bills, inheritance tax Noneconomic costs: emotional grief, counseling and guidance for children • - - Risk of insufficient income during retirement: majority of the workers experience substantial reduction in their money incomes after they retire a reduced standard of living unless they have sufficient financial assets or have access to other sources of retirement income such as social security or a private pension Especially for retired workers having substantial additional expenses such as high uninsured medical bills or high property taxes or both spouses paying for the cost of long term care in nursing facility most workers are not paying enough for comfortable retirement, these amounts are small • Risk of poor health: includes both payment if the catastrophic medical bills and loss of earned income unless workers have adequate health insurance, private savings, financial assets or other sources of income to meet these expenditure, the may be financially insecure Note: Cost of major medical bills has increased sharply in recent years (surgery, transplant, rehabilitation) Loss of earned income: the likelihood that man aged 22 will become disabled for 90 days or longer before age 65 is 21%, for female is 33% • Risk of unemployment: unemployment can result from business cycle downswing, technological and structural changes in the economy, the seasonal factors, and imperfections in the labor market The cause of unemployment are that corporations have downsized to save labor costs, millions of jobs have been lost to foreign nations bcs of outsourcing, the world economic crisis Effect: workers lose their earned income and employment benefits, may change to part-time jobs insufficient income if extended over long period past savings and unemployment benefits may be exhausted Property risk: risk of having one’s property damaged or lost from numerous causes Ex: any real estate and personal property can be damaged by or cause loss from fire, lightening cyclone, theft numerous causes Note: • Direct loss: a financial loss resulting from the physical damage, destruction or theft of property Ex: restaurant is damaged by fire, the physical damage is direct loss • Indirect loss: a financial loss resulting indirectly from the occurrence of a direct physical damage or theft loss Ex: in addition to the physical damage the restaurant will lose profit for several moths while is being rebuilt Consequential loss: loss of profit, loss of rents, loss of the use of the building, loss of local market, continuing expense Extra expense: when loss occurs bank owner must continue to operate regardless of the cost, even if he has to set up temporary operation at other location with extra expense, otherwise he will lose customers to his competitors Liability risk: risk of being legally liable for any bodily injury or property damage to someone else A court law may order to pay substantial damages to the injured person Ex: business firm can be held legally liable for defective products that harm and injure customers Note: important because • • • There is no max upper limit with respect to the amount of the loss A person can be sued for any amount Unlike property risk if a person cause serous bodily injury to the other driver , he can be sued for $1mil by the person he injured A lien can be placed on income and financial assets to satisfy legal judgment Ex: if a person can not pay damages to the injured according to court judgment, a lien may be placed on his income, if he declare bankruptcy to avoid payment, his credit will be impaired Legal defense cost can be enormous the cost of hiring attorney to defend is high, especially if the suit goes to trial, attorney fees and other expenses can be great Analyze the burdens of risks on society - The size of emergency fund must be increased: In the absence of insurance individuals and business firms have to increase size of their emergency fund to pay for unexpected losses Sometimes the fund may be insufficient to pay the loss The higher the amount that must be saved, the more current consumption spending must be reduced, resulting in lower standard of living - Loss of certain goods and services: Only a small number of firms manufacture childhood vaccines, silicone-gel breast implants, certain birth-control devices because of fear of legal suit - Worry and fear are present: Mental unrest and fear caused by risks are present Ex: parents are fearful if their son depart on skiing trip during a blinding snowstorm because the risk of being killed on an ice road is present Analyze five major methods of handling risks - Avoidance: Ex: avoid the risk of divorce by not getting married Not all risk can be avoided Ex: avoid risk of being killed by staying at home and not taking part in traffic may die because of electric shock - Loss control: certain activities reducing both frequency and severity of losses Note: major objectives • Loss prevention: aims at reducing the probability of loss so that the frequency is reduced prevent the loss from occurring Ex: the number of heart attack can be reduced if individuals can control their weight, stop smoking, eat healthy diets… • Loss reduction: reduce the severity of a loss after it occurs Ex: plant can be constructed with fire-resistant materials to minimize fire damage Note: Loss control is desirable because: • - - Indirect cost of losses can be large, sometimes exceed direct costs Ex: a worker is injured on the job Direct cost = medical expense, certain % of earnings Indirect cost = cost of training a new worker to replace the injured one or a contract may be cancelled because goods are not shipped on time • The social costs of losses are reduced Ex: worker dies from the accident society is deprived of the goods and services the worker could produce Retention: An individual or business firm can retain all or a part of a given risk appropriate for high frequency, low severity where potential losses are quite small • Active retention: individual is consciously aware of risk and deliberately plans to retain all or part of it Two reasons: Save money Commercial insurance is either unavailable or unaffordable Ex: home owner may retain a small part of the risk of damage to the home by purchasing a homeowners policy with a substantial deductibles • Passive retention: certain risks are unknowingly retained because of ignorance, indifference or laziness Dangerous if the risk retained has the potential to destroy financially Non-insurance transfers: the risks are transferred to a party other than an insurance company Note: Three methods • - By contracts: unwanted risks can be transferred by contract (risk of rent increase can be transferred to landlord by a long-term lease) or hold-harmless clause (manufacturer of elevators insert a hold harmless clause in the contract with retailer, the retailer agrees to hold the manufacturer harmless in case of elevator fall • Hedging price risks: technique for transferring the risk of unfavorable price fluctuation to a speculator by purchasing and selling future contracts on an organized exchange (stock exchange) Ex: manager hold US Treasury bonds If interest rate rise, the value of bonds will decline To hedge this risk, he can sell US Treasury bonds futures Assume the interest rate rise, bond price decline The value of futures contract will decline, which helps the manager to make offsetting purchase at a lower price The profit obtained from the closing out futures position will partly offset the decline in the market value of US Treasury bonds Interest rates not usually move as expected, so the hedge may not be perfect • Incorporation of business firm: If a firm is sole proprietorship, owners personal assets can be attached by creditors for satisfaction of debts If a firm incorporates, personal assets can not be attached by creditors for payment of firm’s debts By incorporation the liability if stockholder is limited and the risk of the firm having insufficient assets to pay business debts is shifted to creditors Insurance: most practical method for handling a major risk • Pure risk is transferred to insurer • Pooling technique: used to spread the losses of the few over the entire group so that average loss is substituted for actual loss • The risk may be reduced by application law of large numbers by which an insurer can predict future loss experience with greater accuracy Risk management and steps in the risk management process (definition, example) - Risk management: is systematic process if identifying loss exposures faced by an org and selecting the most appropriate techniques for treating such exposures • Step 1: Identification of loss exposure: indentify sources of possible exposures Note: Loss exposures are related to following issues: Property loss exposures: building, plants, equipments… Liability loss exposures: defective products, environment pollution, liability arising from company decisions or equipments Business income loss exposures: continuing loss after a loss, extra expense Human resource loss exposures: death or disability or retirement of key employees, job related or diseases experienced by workers Crime loss exposures: fraud and embezzlement, Internet crime, theft… Employee benefit loss exposures Foreign loss exposures Reputation and public image of the company Note: Tools • Risk analysis questionnaires Physical inspection Flowchart Financial statements Historical loss data Step 2: Analyzing loss exposures: estimation of the frequency and severity of loss so that Loss exposures could be ranked according to their relative importance The risk manager can select the most appropriate technique, or combinations of techniques for handling these exposures The risk manager could estimate max possible loss and max probable loss Risk severity is more important than risk frequency as a single catastrophic loss could wipe out the firm • Step 3: Selecting appropriate techniques: include two broad categories: Risk control: techniques that reduce the frequency and severity of loss Risk avoidance: certain loss exposure is never acquired or an existing loss exposure is abandoned That means the chance of loss has been eliminated May reduce the chance of certain loss to zero but all loss exposure can not be avoided Ex: not investing in a risky country, withdrawing drug from market that has significant side effect Loss prevention: measures that reduce the frequency of particular loss Ex: Use of temper-resistant packaging, driver training and safety program Loss reduction: measurers that reduce the severity of a loss after it occurs Ex: installation of an automatic fire sprinkler system, maintaining limited amount of cash in the premises Risk financing: techniques that provide for the funding of losses Risk retention/Assumption: firm retains/ assumes part or all of the losses that can result from given loss If loss occurs the concerned person or firm will pay it out what ever the funds are available at that time It may be planned retention or unplanned retention Used when: There’s no other method of treatment or losses are highly predictable and that can be budgeted out of the firm’s income when used: risk manager must determine the retention level No insurance transfers: risk transfers other than insurance by which pure risk and its potential financial consequences are transferred to another party Note: include hedging, hold-harmless agreements and contracts Note: Advantages: cost less than insurance, some potential risk can be transferred that are not insurable, sometimes loss exposures are transferred to the parties who are in better position to exercise loss control Insurance: especially appropriate risk management tool when the chance of loss is low and severity of loss is high represents contractual transfer of risk Note: areas that must be decided - Selecting of insurance coverage - Selection of an insurer - Negotiation of terms - Dissemination of information abt insurance coverage - Periodic review of the program Note: Advantages: - Firm will be indemnified after loss occurs - Firm’s uncertainty is reduced - Insurance premiums are tax deductibles Disadvantages - Premium payment is major cost - Negotiating the insurance coverage take considerable time and effort Note: Frequency of loss Low High Severity of loss Low Retention Loss prevention and retention High Insurance Avoidance • Step 4: Implement and monitor the program: risk management program must be properly implemented and administered Including Preparation of a risk management police Close cooperation with other people and departments Periodic review of the entire risk management program CHAPTER INSURANCE Insurance, insurer, the insured, premium (definition, example) - Insurance: • Contractual agreement where one party agrees to compensate another party in exchange of premium for any future loss • The pooling of fortuitous losses by transfer of such risk to insurers, who agree to indemnify insured’s for such losses, to provide other pecuniary benefits on their occurrence, or to render services connected with the risks - Insurer: the party agreeing to pay for the losses - Insured: The party whose risk is transferred to the insurer - Premium: the payment the insurer receives from the insured Ex: Mr A buys a retirement insurance for himself from Dai-ichi Life Vietnam and pays 10 000.000VND per year So Mr A is the insured, Dai-ichi life Vietnam is insurer, 10.000.000VND is annual premium, retirement insurance is insurance basic characteristics of insurance (analyze) - Pooling of loss or the sharing of losses: spreading of losses incurred by the few over the entire group, so that in the process, average loss is substituted for actual loss large number of similar but not necessarily identical exposure units that are subject to same perils so a substantially accurate prediction of future losses • Involves: Sharing of losses by the entire group Prediction of future losses with accuracy based on the law of the large number • Insurers can predict future losses with greater accuracy reduce objective loss Objective risk varies inversely with the square root of the number if exposure units: No of exposure unit increases, the relative variation of actual loss from expected loss decline Objective loss is low actual premium will be enough for all claims, expenses and profit Ex: 1000 farmers, if one’s home is damaged by fire, the other members will indemnify the actual costs of the unlucky farmer Each home value is 200,000$ and on average home burns a year No insurance: the max loss of each farmer us 200,000$ if his house burns By pooling the loss, each farmer must only pay 200$ substitutions of an average loss of 200$ for the actual 200,000$ Note: Law of the large number: the greater the no of exposures the more closely will the actual results approach the probable result that are expected from an infinite number of exposures - Payment of fortuitous losses: one that is unforeseen and unexpected and occurs as a result of chance lost must be accidental Intentional losses not covered by insurance policy Ex: a person may have a plane accident and can not return home Risk transfer: pure risk is transferred from the insured to the insurer, who typically is in stronger financial position to pay the loss Ex: premature death, poor health, disability, destruction and theft of property Indemnification for losses: insured is restored to his or her approximate financial position prior to the occurrence of the loss Ex: a person crushes into a third party using his motorbike, his motorbike liability insurance policy will pay the sum which he is legally obliged to pay for the injury or death and property damage of the third party 10 ideal requirements of an insurable risk? - Large number of exposure units: there should be a large group of roughly similar but not necessarily identical exposure units that are subject to the same peril or group of perils enable insurers to predict loss based on the law of the large number with more accuracy Ex: A large no of motorbikes in a city can be grouped together for insurers to provide property insurance - - - - - Accidental and Unintentional • If intentional loss were paid, increase in moral hazard would increase premium would rise fewer people would buy insurance insurers have not enough exposure units to predict future losses • The loss should be accidental bcs the law of large numbers is based on the random occurrence of events If not prediction of future experience would be highly inaccurate Loss should be fortuitous and outside the insured’s control If an individual deliberately causes a loss he will not be indemnified Determinable and measurable loss: • The loss must be definite as to cause, time, place and amount Ex: Life insurance • Some losses are difficult to determine and measure Ex: Sickness and disability To enable insurer to determine if the loss is covered under policy and how much should be paid No catastrophic loss • Large portion of exposure units should incur losses at the same time Otherwise, premium must be increased to unplayable levels the pooling technique is not applicable as the losses of the few can not spread over the entire group • Catastrophic losses (hurricane, tornadoes, floods, earthquake…) are impossible to void some approaches are available: Reinsurance: arrangement by which the primary insurer initially writing the insurance contract transfers to another insurer part or all potential losses associated with such insurance contract Reinsurer is then responsible for paying its share of catastrophic loss Insurer avoids concentration of risks by dispersing their coverage over a large geographical area Financial instruments are used are used to deal with catastrophic losses such as catastrophe bonds which are designed to pay for a catastrophic loss Calculable chance of loss: • The insurer muss be able to calculate both the average frequency and average severity of future losses accurately insurers can charge a proper premium to cover all claims, expenses, and profit during policy period • Certain losses, such as floods, wars, cyclical unemployment , which occur on an irregular basis, and prediction of average frequency and severity of loss is difficult not insured Economically feasible premium • Affordable premium: the premium paid must be substantially less than the face value of the policy to make the insurance more attractive • Low chance of loss: if chance of loss > 40%, the cost of policy will exceed the total value the insurer must pay under the contract Ex: premium for a 1000$ life insurance policy on 99 aged man is 980$ +additional amount for expenses Note: • • Most personal risks, property risks, liability risks can be privately insured as they meet requirements of insurable risk Most market risks, financial risks, production risks, political risks are not insured as they are speculative risks, possibility of catastrophic loss is great 11 Social insurance (definition, characteristics) - Social insurance: government insurance programs financed entirely or in large part by mandatory contributions from employers, employees, or both, and not primarily by the general revenues of government The contributions are usually earmarked for special trust funds The benefits are paid from these funds The right to receive benefits is ordinarily derived from or linked to the recipient’s past contributions or coverage under the program • Old age, survivors, disability insurance: known as Social security, massive income maintenance program providing benefits to eligible individuals and family • Medicare-part of total Social security program: covers medical expenses of most people aged 65 and older and certain disabled people younger than 65 • • • Unemployment insurance program: weekly cash benefits to eligible workers, experiencing short term involuntary unemployment Paid up to 26 weeks Worker compensation insurance: covers workers against a job-related accident and disease Compulsory temporary disability insurance: provides partial replacement of wages lost because of a temporary nonoccupational disability in the railroad industry 12 main benefits of insurance to society (analyze) - Indemnification of loss: • Allows individuals and families to be restored to their former financial position in part or in whole after loss occur can maintain their financial security less likely to apply for public assistance from relatives or friends • To business firms: allows to remain business and employees to keep job the community cost as tax base is not eroded - Reduction of worry and fear: reduced both before and after a loss Ex: Family heads have suitable amount of life insurance worry less abt financial security of dependents in the vent of premature death and have peace of mind bcs they know if loss occurs, they are covered - Source of investment fund: • Insurers have substantial source of funds for capital investment and accumulation Premiums are collected in advance of loss, funds not needed to pay immediate losses and expenses can be loaned to firms and invested in hospitals, shopping centers… increase economic growth and full employment • Cost of capital to firms borrowing from insurers is less than from banks and credit org as the capital of insurers comes from advance payment of insurance premiums with no interest - Loss prevention: • Insurers are actively involve in numerous loss prevention programs: Highway safety and reduction of automobile deaths Fire prevention Reduction of work-related injuries and diseases Prevention of auto thefts Prevention and defection of arson losses Prevention of defective products that could injure the user Prevention of boiler explosions Educational programs or loss prevention • Insurers employ lot of loss prevention personnel, occupational safety engineers and specialists in fire prevention, occupational safety and health, product liability Loss prevention activities reduce both direct and consequential losses society benefits - Enhancement of credit: guarantees the value of the borrower’s collateral or gives greater assurance that the loan will be repaid Ex: house is purchased, landing institution requires property insurance on the house before the mortge loan is granted bcs property insurance protect lender’s financial interest if the property is damaged or destroyed 13 main costs of insurance to society - Social costs of insurance can be viewed as the sacrifice that the society must make to obtain true benefits of insurance society - Cost of doing business: • Insurers consume scarce economic resources to provide insurance to society The premium must include expense loading - the amount needed to pay all expenses, state premium taxes, acquisition expense, allowance for contingencies and profit - to cover the expenses incurred in their daily operations • Cost of doing business can be justified because Uncertainty concerning the payment of a covered loss is reduce because of insurance The cost of doing business are not necessarily wasteful as insurers engage in a lot of loss prevention activities Insurance industry provides jobs to millions of people in each country - - Fraudulent claims: • Auto accidents are faked or staged to collect benefits • Dishonest claimants fake slip-and-fall accidents • Phony burglaries, thefts and acts of vandalism are reported to insurers • False health insurance claims are submitted to collect benefits • Dishonest policy owners take out life insurance policies on insured who are later reported as having died Payment of such claims results in higher premium to all insured Existence of insurance prompts some insured to deliberately cause a loss so as to profit from insurance Inflated claims: • The loss is not intentionally caused by the insured but the dollar amount of the claim may exceed the actual financial loss Ex: Disabled often malinger to collect disability income benefits for a longer duration Insureds inflate the amount of damage in auto collision claims so that the insurance payments will cover the collision deductibles • Inflated claims are social cost of insurance as premiums must be increased to pay for additional losses Note: Cost of fraudulent and inflated claims: • • • The cost of fraudulent and inflated claims is huge (80mil$ annually in USA) Lax public attitude toward insurance fraud 2/3 Americans tolerate insurance fraud to varying degree 2/5 Americans want little or no punishment for insurance cheats They blame the insurance industry for its fraud problems as they believe insurance is unfair Many ordinary Americans often engage in variety of actions linked with insurance fraud 14 Distinguish property insurance, liability insurance and person insurance - Property insurance: All types of property insurance that includes risk under marine, fire, motor, engineering… • Insurance value can be and must be calculated = value of goods at the time of buying insurance = the value of goods at the time of buying - depreciation Note: - • Insurance value (V) - gia tri bao hiem: actual value • Insurance amount (A) - so tien bao hiem: agreed amount of money btw insurance buyer and insurer A is smaller or equal to V Ex: buy insurance with A=1000 (V=2000) Loss of 500 compensate: 500*A/V=250 Liability insurance: All types of liability insurance like employer’s liability, public liability, product liability, liability portion of motor and hull insurance and professional liability Person insurance: Include life insurance and personal accident insurance • Life insurance • Personal accident insurance Insurance of person and liability only identify limit of liability = amount of money buyer of insurance negotiate and is agreed upon by the insurer 15 Time Policy, Voyage Policy and Mixed Policy in Maritime insurance - Time policy: covers the subject matter only for specific duration Normally the policy is made for year and whatever the number of voyage made within this time is covered under this policy For valid claim the loss must be happened within specified period Usually the ship/hull insured by this policy - Voyage policy covers the subject matter only for specific voyage not for time duration For valid claim the loss must be happened during the specified voyage Usually cargo is insured by the policy - Mixed policy: resolves drawbacks of time and voyage policies by covering a voyage and additional time after completion of the voyage Note: there’s also • • Floating policy: issued for a number of estimated shipments of cargo to avoid formalities for each individual shipment At the time each shipment, the insured just declares shipment and obtain a certificate of insurance Building risk policy 16 Analyze standard perils in standard fire insurance policy: fire, lightening, explosion of boilers or of gas - Fire: resulting from explosion or otherwise, but not happened by • Its own spontaneous fermentation of heating or its undergoing any process involving the application of heat • Earthquake, riot, civil war, rebellion, revolution, military power Lightning: whether or not there is any fire involved Explosion of boilers or of gas: used for domestic purpose only, even though there is no fire involved However, this policy does not cover: • Consequential loss • Goods held in trust or on commission, money, stamp, pictures, designs,… unless are specially insured • Loss caused by radioactive contamination or irradiated nuclear fuel CHAPTER ANALYSIS OF INSURANCE CONTRACTS 17 Insurance contract (definition) and basic parts of an insurance contract - Insurance contract is a contract (generally a standard form contract) between the insurer and insured, known as the policyholder, which determines the claims which the insurer is legally required to pay - basic parts: • Declarations: question 18 • Definitions: key words or phrases have quotation marks or are in boldface type clearly define meaning of key words or phrases Note: insurer usually referred to as we, our, us Insured usually referred to as you, your • • • • Insuring agreement: question 19 Exclusions: question 20+21 Conditions: question 22 Miscellaneous provisions: question 23 18 Declarations (definition) and Clarify declarations in property insurance contract and life insurance contract - Declarations: statements that provide information about the particular property or activity to be insured Information in the declarations section is used for underwriting and rating purposes and identification of the property or activity insured Declarations on the 1st page of the policy or policy insert - In property insurance: contains Identification of insurer Name of the insured Location of the property Period of protection Amount of insurance/premium Period of protection Size of the deductibles - In life insurance contains Insured’s name, age Premium amount Issue date however, now have a provision stating how a subrogation recovery is to be shared between the insured and insurer In the absence of any policy provision, the courts have used different rules in determining how a subrogation recovery is to be shared One view is that the insured must be reimbursed in full for the loss; the insurer is then entitled to any remaining balance up to the insurer’s interest, with any remainder going to the insured Ex: Andrew has a $200,000 home insured for only $160,000 under a homeowners policy Assume that the house is totally destroyed in a fire because of faulty wiring by an electrician The insurer would pay $160,000 to Andrew and then attempt to collect from the negligent electrician After exercising its subrogation rights against the negligent electrician, assume that the insurer has a net recovery of $100,000 (after deduction of legal expenses) Andrew would receive $40,000, the insurer can retain the balance of $60,000 After a loss, the insured cannot impair or interfere with the insurer’s subrogation rights to proceed against a negligent third party Ex: If the insured waives the right to sue the negligent party, the right to collect from the insurer for the loss is also waived This could happen if the insured admits fault in an auto accident or attempts to settle a collision loss with the negligent driver without the insurer’s consent If the insurer’s right to subrogate against the negligent motorist is adversely affected, the insured’s right to collect from the insurer is forfeited Subrogation does not apply to life insurance contracts and to most individual health insurance contract Life insurance is not a contract of indemnity and subrogation has relevance only for contracts of indemnity The insurer cannot subrogate against its own insureds If the insurer could recover a loss payment for a covered loss from an insured, the basic purpose of purchasing insurance would be defeated 28 principle of utmost good faith? An insurance contract is based on the principle of utmost good faith – that is, a higher degree of honesty is imposed on both parties to an insurance contract than is imposed on parties to other contracts This principle has its historical roots in marine insurance An marine underwriter had to place great faith in statements made by the applicant for insurance concerning the cargo to be shipped The property to be insured may not have been visually inspected and the contract may have been formed in a location far removed from the cargo and ship The principle of utmost good faith is supported by important legal doctrines: representations, concealment and warranty Representations: are statements made by the applicant for insurance Ex: If you apply for life insurance, your answer to the questions concerning your age, weight, height, occupation, state of health, family history, other relevant questions are called representations The legal significance of a representation is that the insurance contract is voidable at the insurer’s option if the representations is material, false, relied on by the insurer Material means that if the insurer knew the true facts, the policy would not have been issued, or it would have been issued on different terms False means that the statement is not true or is misleading Reliance means that the insurer relies on the misrepresentations in issuing the policy at a specified premium - If an applicant for insurance states an opinion or belief later turning out to be wrong, the insurer must prove that the applicant spoke fraudulently and intended to deceive the company before it can deny payment of a claim - An innocent misrepresentation of a material fact, if relied on by the insurer, also makes the contract voidable An innocent misrepresentation is one, that is unintentional - The doctrine of material misrepresentations also applies to statement made by the insured after a loss occurs If the insured submits a fraudulent proof of loss or misrepresents the value of the items damaged, the insurer has the right to void the coverage Concealment: is intentional failure of the applicant for insurance to reveal a material fact to the insurer Concealment is the same thing as nondisclosure; that is, the applicant for insurance deliberately withholds material information from the insurer The legal effect of a material concealment is the same as aa misrepresentation - the contract is voidable at the insurer’s option To deny a claim based on concealment, a nonmarine insurer must prove two things: the concealed fact was known by the insured to be material & the insured intended to defraud the insurer Warranty: is a statement that becomes part of the insurance contract and is guaranteed by the maker to be true in all respects Ex: in exchange for a reduced premium, a liquor store owner may warrant that an approved burglar alarm system will be operational at all times A clause describing the warranty becomes part of the contract Based on the common law, in its strictest form, warranty is a harsh legal doctrine Any breach of the warranty, even if minor or not material, allowed the insurer to deny payment of a claim Some modifications of the warranty doctrine are summarized: - Statements made by applicants for insurance are considered to be representations and not warranties Thus, the insurer cannot deny liability for a claim if a misrepresentation is not material - Most courts will interpret a breach of warranty liberally in those cases where a minor breach affects the risk only temporarily or insignificantly - Statutes have been passed that allow the insured to recover for a loss unless the breach of warranty actually contributed to the loss CHAPTER MARINE INSURANCE 29 reinsurance Practice where an insurance company (the insurer) transfers a portion of its risks to another (the re-insurer) Legal right of the policyholders (insureds) are in no way affected by reinsurance, and the insurer remains liable to the insureds for insurance policy benefits and claims 30 double insurance Situation in which the same risk is insured by overlapping but independent insurance policy Is it possible to obtain double insurance and make claim to all insurers? YES! It is lawful to obtain double insurance, and the insured can make claim to both insurers in the event of a loss How much money that insured can received from all insurers? The insured, however, cannot profit (recover more than the loss suffered) from this arrangement because the insurers are law bound only to share the actual loss in the same proportion they share the total premium Ex: Mr A involves in insurance policies for his car at insurance companies X, Y and Z with insurance amounts are 300, 400 and 500 millions VND (insurance for physical value of car); assuming that the value of the car is 500 millions VND Define the compensation of each insurer in case the car is totally destroyed? Total insurance amounts = 300 + 400 + 500 = 12000 Compensation for X = × 500 Compensation for Y = × 500 Compensation for Z = × 500 A just can receive total compensation of 500 millions VND to avoid fraud 31 co-insurance Insurance held jointly by or more insurers Insurer/underwriter: the party to an insurance arrangement who undertakes to indemnity for losses Insured: an insured or policyholder is the person or entity buying the insurance and receiving indemnity on happening of unforeseen events Subject-matter insured: the person, group, or property for which an insurance policy is issued Insurance value – V (giá trị BH) The term “value” refers to the value of the property, on the same basis used in indemnifying losses; that basis is usually actual cash value or replacement cost The replacement value of property is equal to the amount it would cost to fully repair or replace the property if it must be reconstructed or purchased new Insurance amount – A (số tiền BH) Is a certain amount of insurance coverage that the insured requires in the insurance policy, it can be a part or an entire of insurance value Limitation of liability (hạn mức trách nhiệm): the largest total amount the insurance company will pay for covered losses Insurance rate: a factor used to determine the amount to be charged for a certain amount of insurance coverage, called the premium Insurance premium: payments to the insurance company to buy a policy and to keep it in force I = V(A) x R V=A => I = V(A) x R A I = A x R 32 double insurance and co-insurance (Q 30 + 31) 33 the relationship between insurance value and insurance amount? In property insurance, A ≤ V A = V => compensation = the value of loss and damage A < V => compensation = × the value of loss and damage A > V => not allow 34 the difference between insurance amount and limitation of liability? Insurance amount Is a certain amount of insurance coverage that the insured requires in the insurance policy, it can be a part or an entire of insurance value Limitation of liability the largest total amount the insurance company will pay for covered losses 35 marine insurance Marine insurance covers the loss and damage of ships, cargo, terminals and any transport or property by which cargo is transferred, acquired, or held between the points of origin and final destination 36 the needs for marine insurance? Exporters and importers face all the time uncertainties of loss of their goods Insurance is used to protect their financial interests against such risks and actual losses Without adequate insurance and protection of the interests of those with goods in transit, international trade would be negatively affected Liability of carriers to the goods is very limited 37 types of marine insurance? Marine cargo insurance: covers export – import goods carriage by sea and related – reasonable costs Hull insurance: covers material loss of or damage to hull and machinery in the hull, a portion (3/4) of costs for collision liability, and other reasonable costs Protection and indemnity insurance (P&I insurance): provide cover to ship owners against rd parties liabilities in connection with the operation of vessels & a portion (1/4) of costs for collision liability 38 risks in marine insurance? Definition Probability or threat of a damage, injury, liability, loss or other negative occurrence, caused by external or internal vulnerabilities, and which may be neutralized through premediated action Marine risks are the risks that occur on the sea/ the risks of the sea/ the risks related to an ocean voyage Risks are of many kinds Different risks mean different losses And different risks are covered by different clauses And the different insurance clauses mean different premiums So we need to have a good understanding of the different risks and losses before we know how to effect insurance 39 risks in marine insurance based on the causes Acts of God: vile weather, thunderstorm and lightening, tsunami, earthquake, flood, volcanic eruption, etc Perils of the sea: ship striking upon the rocks, ship sinking, ship collision, colliding with iceberg or other objects Risks caused by Social – political actions: war, SRCC (strikes, riots, civil, commotions) Risks caused by particular actions of people: thieve, robber Risks caused by other sources 40 risks in marine insurance based on the insurance technique Insured common perils: the risks that are normal insured in original insurance clauses: Main risks: - Stranding: a vessel is stranded when, in consequence of some accidental or unusual occurrence, she comes in contract with the ground or other obstruction, and remains hard and fast upon it The vessel needs an external force in order to getting off the stranding - Sinking - Fire or explosion - Collision - Jettison: to throw part of the cargo or gear of the vessel overboard to lighten the load and save the vessel The owner of the jettisoned goods is entitled to a “general average”, i.e., the loss is shared by the owners of the vessel and the owners of the cargo which was not thrown away - Missing: British law: times of ship’s itinerary in normal conditions (no longer than months, no shorter than months) Auxiliary risks: theft, rain, leakage, breakage, dampness, heating, hooking, rusting Relatively Excluded Perils: risks that are not included in standard insurance clauses: War, SRCC Absolutely Excluded Perils: risks that are not insured in any circumstances - Loss damage or expense attributable to willful misconduct of the assured - Ordinary leakage, ordinary loss in weight or volume, or ordinary wear and tear of the subject-matter insured - Loss damage or expense caused by insufficiency or unsuitability of packing or preparation of the subject-matter insured - Loss damage or expense caused by inherent vice or nature of the subject-matter insured - Loss damage or expense proximately caused by delay, even though the delay be caused by a risk insured against - Loss damage or expense arising from insolvency or financial default of the owners managers, charterers or operators of the vessel - Loss damage or expense arising from the use of any weapon of war employing atomic or nuclear fission and/or fusion or other like reaction or radioactive force or matter 41 loss (definition) Distinguish actual total loss from constructive total loss Losses Losses sustained by the insured due to the risks listed above come from not only the loss of the goods or the damage dine to the goods, but also from the expenses the insured sustained in rescuing the goods in danger The losses and the damages done to the goods can fall into total loss and partial loss Total loss includes Actual Loss and Constructive Total Loss Partial Loss means that the loss or damage dine to the goods is only partial Partial loss can be either general average or particular average Distinguish actual total loss from constructive total loss Actual Total Loss Means the whole lot of the consignment has been lost or damaged or found valueless upon arrival at the port of destination 42 Notice of Abandonment (NOA)? Constructive Total Loss Is found in the case where the actual loss of the insured goods is unavoidable, or the ship or the consignment has to be abandoned because the cost of recovery would exceed the value of the ship and the consignment in sound condition upon thee arrival of the port of destination Is a notice in which the insured commits to give up all of his right related to the subject-matter insured to the insurer in order to be fully compensated Requirements: Where notice of abandonment is accepted the abandonment is irrevocable The acceptance of the notice conclusively admits liability for the loss and the sufficiency of the notice NOA is unnecessary when the consignments have already reached final destination and are in actual total loss 43 Particular Average and insurer’s liability? Particular Average: losses of each insured interest individually due to acts of God or Perils of the sea Insurer’s liability: compensate for both of the losses and reasonable costs caused by particular average Goods: reasonable costs are the cost used for saving cargo or reducing its damaged measurement 44 General Average? Example General Average: the losses/ damages caused by special expenses and sacrifices that intentionally and reasonably conducted to save the vessel, cargo and freight from a threat in the common ocean voyage There is a general average act when, and only when, any extraordinary sacrifice or expenditure is intentionally and reasonably made or incurred for the common safety for the purpose of preserving from peril the property involved in a common maritime adventure General Average are for the common safety of all of the interests (cargo, vessel, freight) A ship carrying goods in stranding status Order of master: a part of cargo is jettisoned, main engine is damaged (due to the act of forcing the ship off) Result: after repairs at the port of refuge, the ship is able to complete her voyage with the rest of her cargo Examples Cargo, freight - Jettison from underdeck - Jettison from on deck - Water or other means used to extinguish a fire on board ship - Discharge and re-shipment for the purpose of floating a stranded ship when in a position of peril Ship’s materials - Masts, spars, sails or rigging cut away for common safety - Chains and anchors slipped to avert a threatening peril - Damage to a vessel’s machinery, ropes, winches, windlass and other gear sustained in endeavours to float a stranded ship when in a position of peril - Damage done in the efforts to extinguish a fire on board or in the process of jettisoning cargo Expenditure - Expenses incurred in floating a stranded ship in peril - Inward expenses entering a port of refuge to repair damage to ship Cost of discharging cargo at a port of refuge for the purpose of repairing damage to ship - Cost of warehousing, re-shipment of cargo and outward expenses leaving the port of refuge 45 essential features of General Average - The loss must be voluntary - It must be properly made - It must be extraordinary in its nature - The object of the sacrifice or expenditure must be nothing other or less than the common safety of ship and cargo - There must be imminent danger, and the object must be the attainment of safety - The loss must be the direct result or reasonably the consequence of the act causing it 46 The content of General Average? GA sacrifices: to sacrifice properties for the rest ones GA expenditures: consequent costs of GA act or expenditures concerning GA acts: Salvage cost Temporary repairs cost Cost at port of refuge Wages and maintenance of master, officers and crew reasonably incurred and fuel and stores consumed during the prolongation of the voyage occasioned by a ship entering a port or place of refuge or returning to her port or place of loading Interest of 7% shall be allowed on expenditure, sacrifices and allowances in general average until three months after the date of issue of the general average adjustment 47 the Amendments of York- Antwerp Rules 2004 in comparison with previous versions? Rule VI: salvage remuneration is not included in GA Rule XX: a commission of 2% on GA disbursements, other than the wages and maintenance of masters, officers and crew and fuel and stores not replaced during the voyage is not included in GA Rule XXI: interest shall be allowed on expenditure, sacrifices and allowances in GA until months after the date of issue of the general average adjustment Each year the Assembly of the Committee Maritime International shall decide the rate of interest which shall apply This rate shall be used for calculating interest accruing during the following calendar year Rule XXIII: limitation of claims: year after the date upon which GA adjustment was issued or years from the date of termination of the common maritime adventure These periods may be extended if the parties so agree after the termination of the common maritime adventure 48 steps to calculate General Average? Step 1: determine GA value (L), which consists of GA sacrifices and expenditures If goods are sacrificed in GA act, value of the goods is calculated based on loading/unloading value or the one in commercial invoice It includes insurance premium and freight, except one case when cargo owner is not liable for paying the freight Step 2: determine total contributing value (CV) of contributing interests: consists of value of all interests in vessel that were saved by GA act, including properties sacrificed in GA act Those damages belong to particular average occurred before the GA act are not included in contributing value/ after the GA act are included in contributing value Step 3: determine contributing rate: Contributing rate = total GA value/ total contributing value = L/CV Step 4: determine contributing value of each interest C = contributing rate x contributing value Step 5: determine financial result (actual income/ expenditure of ship owner/ cargo owner after deducting value of the properties or expenditures spending in GA act Financial result > 0: the interest collects from GA Financial result < 0: the interest adds more to GA Step 6: examination Total contributing value of all interests = total GA value The amount of money one interest collects from GA = the amount of money one interest adds more to GA 49 marine cargo insurance and the needs for it? 50 ICC 1963 & ICC1982? ICC 1963: - FPA: Free from Particular Average - WA: With Particular Average - AR: All Risks (Điều kiện bảo hiểm rủi ro, có excluded provisions) - WR: War Risks - SRCC: Strike, Riot, and Civil Commotion → It is no longer used currently because the condition name does not clearly show the content of the condition, causing the users to misunderstand ICC 1982: - C clause - B clause - A clause - WR - SRCC 51 the insured risks in C clause, ICC1982 C clause: this insurance covers loss of or damage to the subject- matter insured reasonably attributable to: • Stranding, sinking, fire or explosion, collision • discharge of cargo at a port of distress • overturning or derailment of land conveyance • Sacrifice in and contribution to GA and reasonable expenditures (salvage) • Jettison • Missing The insurer compensate for damages and costs: • GA and salvage costs • Expenses for unloading, warehousing and forwarding at ports along the way as a result of a risk covered by the insurance policy • Private expenses (compensation in addition to general average and cost of complaints) • Expenses for inspection or determination of losses • Such proportion of losses sustained by ship owners as is to be reimbursed by the cargo owners under the contract of affreightment “Both to blame Collision” clause 52 the insured risks in B clause, ICC1982 C clause + Damages are caused by the following risks: • • • • Earthquake volcanic eruption or lightning Washing overboard Entry of sea, lake or river water into vessel craft hold conveyance container liftvan or place of storage Total loss of any package lost overboard or dropped whilst loading on to, or unloading from, vessel or craft 53 the insured risks in A clause, ICC1982 B clause + The auxiliary risks: theft, rain- water, leakage, breakage, dampness, heating, hooking, rusting, malicious damage (not by insured), piracy… 54 scope of cover in C clause ICC1982? C clause: this insurance covers loss of or damage to the subject- matter insured reasonably attributable to: • Stranding, sinking, fire or explosion, collision • discharge of cargo at a port of distress • overturning or derailment of land conveyance • Sacrifice in and contribution to GA and reasonable expenditures (salvage) • Jettison • Missing The insurer compensate for damages and costs: • GA and salvage costs • • • • Expenses for unloading, warehousing and forwarding at ports along the way as a result of a risk covered by the insurance policy Private expenses (compensation in addition to general average and cost of complaints) Expenses for inspection or determination of losses Such proportion of losses sustained by ship owners as is to be reimbursed by the cargo owners under the contract of affreightment “Both to blame Collision” clause Risk of exclusion: • Absolute exclusion: In all cases the insurance company is not responsible for - The bad thing, intentionally of the insured - Delay is a direct cause - Ships or barges that are not seaworthy or means of transportation or containers are unsuitable for the carriage of goods that the insured or their employees knew of that at the time of loading the ship - Ship owners lose financial ability - Inadequate packaging - Natural loss, normal leakage - Loading overloaded or unregulated • Relative exclusion: covered by two additional insurance conditions (No agreement is not covered, the agreement is insured) - War, civil war, revolution - Strikes, violence, labor disorders, - Capture, restrain (except piracy) - Use nuclear weapons of war - Political crackdown - Inherent defects or special properties of insured goods - Malicious action (except A clause) 55 scope of cover in B clause ICC1982? C clause + Damages are caused by the following risks: • • • • Earthquake volcanic eruption or lightning Washing overboard Entry of sea, lake or river water into vessel craft hold conveyance container liftvan or place of storage Total loss of any package lost overboard or dropped whilst loading on to, or unloading from, vessel or craft 56 scope of cover in A clause ICC1982? B clause + The auxiliary risks: theft, rain- water, leakage, breakage, dampness, heating, hooking, rusting, malicious damage (not by insured), piracy… For exclusion risks like B and C clause but excluding risks from malicious action 57 Transit Clause “from warehouse to warehouse” in marine cargo insurance? Clause: Stage from port of discharge to final warehouse: insurance policy terminates either - On safely delivery to the final warehouse, or - On the expiry of 60 days after completion of discharge Definition of “warehouse”: - Departure warehouse: place of storage at the place named herein for the commencement of the transit - Final warehouse: • Final warehouse owned or managed by the assured, or • Store other than in the ordinary course of transit, or • Store using for allocation or distribution, or • Store named in insurance policy Duration: 60 days During the insurance period, if there is a delay outside the control of the insured (deflective, binding unloading, transhipment or change the itinerary), the insured must notify the insurer and pay the premium according to the new path is longer and more risky 58 Voyage policy and Open cover policy in marine insurance cargo? Voyage policy: is an insurance policy for a shipment or a consignment shipped from one port to another port - Responsibilities of the insured: always follow the terms “from warehouse to warehouse” - Only valid for each shipment - Indicated by insurance policy or insurance certificate Open cover policy: - Large export/import oriented industry usually prefer open cover agreement as they have to make numerous regular shipment who would otherwise find it very inconvenient to to obtain insurance cover seperately for each and every shipment - A marine cargo open cover insurance policy is an agreement between a merchant and an insurance company to insure all goods in transit within the agreement, until either party cancel the agreement 59 Insurance value V, insurance amount A, insurance premium I? Insurance value (V): The term “value” refers to the vlue of the proprerty, on the same basis of used in indemnifying losses; that basis is usually actual cash value or replacement cost The replacement value of property is equal to the amount it would cost to fully repair or replace the property if it must be reconstructed or purchased new For ship: V = The ship value + premium For cargo: V = C + I + F, V is CIF or CIP In addition to the benefits, the insured can also cover the estimated interest (up to 10%) due to the import → Formula V: V= (a=0) or V= (a=10%) Insurance amount (A): A certain amount of insurance coverage that the insured requires in the insurance policy, it can be a part or an entire of insurance value In principle, A is always smaller than or equal to V - If A> V, the greater part will not be counted In contrast, if A