CHAPTER EIGHT
INSURANCE
Insurance is an undertaking or contract between an individual or business and an insurance on occurrence of risk(s)
(i.e. against events whose occurrences are unforeseen but causes financial losses or suffering to the affected parties.
Risks are also referred to as contingencies, hazards or perils and include:
Fire outbreak
Accidents
Thefts
Deaths
Disabilities
Risks are real and unforeseen. Methods to eliminate such risks has achieved very little and thus has necessitated the
need for insurance.
Importance of insurance
1. Continuity of business
Every business enterprise is exposed to a variety of risks e.g. fire, theft etc. The occurrence of such risks often result
in financial losses to the business. Insurance provides adequate protection against such risks in that, if a trader
suffers losses as a result of insured risk, she/he is compensated, thus he/she is able to continue with business
operations.
2. Investment projects
Insurance enables investors to invest in profitable yet risky business projects that would otherwise avoided.
Not all the money received as premiums (by the insurance companies) is used up for compensation to those who
have been exposed to risk and suffered losses. The rest of the money is invested in other businesses to earn profits.
3. Creation of employment
Insurance does provide employment opportunities to members of the public.
4. Government policy
The profits earned are a source of revenue for the government i.e. insurance companies are profit-making
organizations which generate revenue to the government through payments of taxes
5. Credit facilities
The insurance industry have also established credit or lending facilities which the business community uses by
borrowing. Loans are made available to the public for different investment projects in different sectors of the
economy and also for personal requirements.
6. Development of infrastructures
The insurance industry plays a crucial role in the development of urban facilities in major towns. Both residential
and office buildings have been developed by insurance firms. The firms also participate in development projects in
the areas where they operate. They contribute to development of a region by constructing and infrastructural
facilities
1. Life policies can be used as security for loans from either the insurance company or other financial
institutions.
2. Provision of life and general insurance policies encourages Kenyans to plan ahead for their dependents
thereby reducing the number of needy future students.
3. Loss prevention-The insurance companies encourage the insured not to cause accidents thus channeling the
unclaimed resources into the economy.
The Theory of Insurance
The insurance business relies on the law of large numbers in its operations. According to this law, there should be a
large group of people faced with similar risks and these risks spread over a certain given geographical area.
COMMERCE COURSE NOTES CHAPTER 8 – INSURANCE PREPARED BY MR. ANTONY AMBIA Page 1
, Every person in the group contributes at regular intervals, small amounts of money called premium into a “common
pool”. The pool is administered and controlled by the insurance company.
1. The fact that risks are geographically spread ensures that insurance does not have a concentration of risks in
one particular area.
2. The law of large numbers enables the insurance to accurately estimate the future probably losses and the
number of people who are likely to apply for insurance. This is done in order to determine the appropriate
premiums to be paid by the person taking out insurance.
Pooling of risks
The insurance operation is based on the theory that just a few people out of a given lot may suffer a loss. There is
therefore a “pooling of risks” i.e. the loss of the unfortunate few is spread over all the contributors of the group, each
bearing a small portion of the total loss. This is why the burden of loss is not felt by the individuals because it is
“shared” by a large group.
Benefits of the “pooling of Risks” to insurance company
1. Pooling of risks enables an insurance company to create a common pool of funds from the regular
premiums from different risks.
2. It enables the insurance company to compensate those who suffer loss when the risks occur
3. The insurance company is able to spread risks over a large number of insured people
4. Surplus funds can be invested in for example, giving out loans or buying shares in real estates
5. It enables the insurance company to meet its operating costs by using the pool funds
6. It enables the insurance company to calculate to be paid by each client
7. It enables the company to re-insure itself with another insurance company.
Terms used in Insurance
Insurance
This is a written contract that transfers to an insurer the financial responsibility for losses arising from insured risk.
Premium
This is the specified amount of money paid at regular intervals by the insured to the insurer for coverage against
losses arising from a particular risk.
Risk
These are perils or events against which an insurance cover is taken. It is the calamity or problem a person or
business faces and results into losses.
Note: The calculation of premiums depends upon the type of risk insured against. The higher the probability of the
risk occurring, the higher the premium. The more the risks the business or person is exposed to the more the
premiums payable.
Pure risk
This is a risk which results in a loss if it occurs and results in no gains if it does not occur. For example, if a car is
involved in an accident, there will be a loss and if the accident does not occur there will be no gain or loss
Speculative risk
This is a risk which when it occurs, may result in a loss or a profit. For example, a person may buy shares at ksh.50
each, one year later the shares may be valued at ksh40 each meaning a loss of ksh.10
Alternatively, their value might not have changed or might have increased to ksh.45 each. Speculative risk lures
people to venture into business in the first place.
Insured
This is the individual or the business that takes out the insurance cover and therefore becomes the policy holder
The insured pays premiums to the insurance company to be compensated should the risk insured against occur or
cause loss.
Insurer
This is the business company that undertakes to provide cover or protection to the people who suffer loss as a result
of occurrence of risks
Actuaries
These are people employed by an insurance company to complete expected losses and calculate the value of
premiums.
Claim
This is a demand by the insured for payment from the insurer due to some loss arising from an insured risk.
Policy
COMMERCE COURSE NOTES CHAPTER 8 – INSURANCE PREPARED BY MR. ANTONY AMBIA Page 2
INSURANCE
Insurance is an undertaking or contract between an individual or business and an insurance on occurrence of risk(s)
(i.e. against events whose occurrences are unforeseen but causes financial losses or suffering to the affected parties.
Risks are also referred to as contingencies, hazards or perils and include:
Fire outbreak
Accidents
Thefts
Deaths
Disabilities
Risks are real and unforeseen. Methods to eliminate such risks has achieved very little and thus has necessitated the
need for insurance.
Importance of insurance
1. Continuity of business
Every business enterprise is exposed to a variety of risks e.g. fire, theft etc. The occurrence of such risks often result
in financial losses to the business. Insurance provides adequate protection against such risks in that, if a trader
suffers losses as a result of insured risk, she/he is compensated, thus he/she is able to continue with business
operations.
2. Investment projects
Insurance enables investors to invest in profitable yet risky business projects that would otherwise avoided.
Not all the money received as premiums (by the insurance companies) is used up for compensation to those who
have been exposed to risk and suffered losses. The rest of the money is invested in other businesses to earn profits.
3. Creation of employment
Insurance does provide employment opportunities to members of the public.
4. Government policy
The profits earned are a source of revenue for the government i.e. insurance companies are profit-making
organizations which generate revenue to the government through payments of taxes
5. Credit facilities
The insurance industry have also established credit or lending facilities which the business community uses by
borrowing. Loans are made available to the public for different investment projects in different sectors of the
economy and also for personal requirements.
6. Development of infrastructures
The insurance industry plays a crucial role in the development of urban facilities in major towns. Both residential
and office buildings have been developed by insurance firms. The firms also participate in development projects in
the areas where they operate. They contribute to development of a region by constructing and infrastructural
facilities
1. Life policies can be used as security for loans from either the insurance company or other financial
institutions.
2. Provision of life and general insurance policies encourages Kenyans to plan ahead for their dependents
thereby reducing the number of needy future students.
3. Loss prevention-The insurance companies encourage the insured not to cause accidents thus channeling the
unclaimed resources into the economy.
The Theory of Insurance
The insurance business relies on the law of large numbers in its operations. According to this law, there should be a
large group of people faced with similar risks and these risks spread over a certain given geographical area.
COMMERCE COURSE NOTES CHAPTER 8 – INSURANCE PREPARED BY MR. ANTONY AMBIA Page 1
, Every person in the group contributes at regular intervals, small amounts of money called premium into a “common
pool”. The pool is administered and controlled by the insurance company.
1. The fact that risks are geographically spread ensures that insurance does not have a concentration of risks in
one particular area.
2. The law of large numbers enables the insurance to accurately estimate the future probably losses and the
number of people who are likely to apply for insurance. This is done in order to determine the appropriate
premiums to be paid by the person taking out insurance.
Pooling of risks
The insurance operation is based on the theory that just a few people out of a given lot may suffer a loss. There is
therefore a “pooling of risks” i.e. the loss of the unfortunate few is spread over all the contributors of the group, each
bearing a small portion of the total loss. This is why the burden of loss is not felt by the individuals because it is
“shared” by a large group.
Benefits of the “pooling of Risks” to insurance company
1. Pooling of risks enables an insurance company to create a common pool of funds from the regular
premiums from different risks.
2. It enables the insurance company to compensate those who suffer loss when the risks occur
3. The insurance company is able to spread risks over a large number of insured people
4. Surplus funds can be invested in for example, giving out loans or buying shares in real estates
5. It enables the insurance company to meet its operating costs by using the pool funds
6. It enables the insurance company to calculate to be paid by each client
7. It enables the company to re-insure itself with another insurance company.
Terms used in Insurance
Insurance
This is a written contract that transfers to an insurer the financial responsibility for losses arising from insured risk.
Premium
This is the specified amount of money paid at regular intervals by the insured to the insurer for coverage against
losses arising from a particular risk.
Risk
These are perils or events against which an insurance cover is taken. It is the calamity or problem a person or
business faces and results into losses.
Note: The calculation of premiums depends upon the type of risk insured against. The higher the probability of the
risk occurring, the higher the premium. The more the risks the business or person is exposed to the more the
premiums payable.
Pure risk
This is a risk which results in a loss if it occurs and results in no gains if it does not occur. For example, if a car is
involved in an accident, there will be a loss and if the accident does not occur there will be no gain or loss
Speculative risk
This is a risk which when it occurs, may result in a loss or a profit. For example, a person may buy shares at ksh.50
each, one year later the shares may be valued at ksh40 each meaning a loss of ksh.10
Alternatively, their value might not have changed or might have increased to ksh.45 each. Speculative risk lures
people to venture into business in the first place.
Insured
This is the individual or the business that takes out the insurance cover and therefore becomes the policy holder
The insured pays premiums to the insurance company to be compensated should the risk insured against occur or
cause loss.
Insurer
This is the business company that undertakes to provide cover or protection to the people who suffer loss as a result
of occurrence of risks
Actuaries
These are people employed by an insurance company to complete expected losses and calculate the value of
premiums.
Claim
This is a demand by the insured for payment from the insurer due to some loss arising from an insured risk.
Policy
COMMERCE COURSE NOTES CHAPTER 8 – INSURANCE PREPARED BY MR. ANTONY AMBIA Page 2
