Insurance is an important risk management tool that provides financial protection to the insured in the event of a loss. Having an insurance policy in place is not enough to protect your financial interest. In this regard, individuals and corporate organisations should pay particular attention to the limit of liability or sum insured when buying insurance policy.
This article will give you more insight into sum insured, its significance and why it is important to ensure that it is adequate.
What is the difference between sum insured and sum assured?
Sum insured and sum assured sound the same in principle but have different meanings.
Sum insured
Sum insured refers to the financial limit or the maximum amount of money that an insurance company will pay out in the event of a loss. Sum insured varies from policy to policy. The concept of sum insured is only applicable to non-life insurance policies which are indemnity policy. When we say indemnity policy, we mean policies that compensate the insured up to a certain limit or the amount of loss when the insured event occurs. Examples of indemnity policies are fire insurance, home insurance, motor insurance, travel insurance and other liability insurance policies.
Sum assured
The concept of sum assured is applicable to life insurance policies which are referred to as benefit policies. Sum assured refers to a pre-agreed value or an amount that is payable to the assured or their nominees in the event of a loss or at the end of the insurance period. The value does not change throughout the policy period. These policies are opposed to general insurance policies which are indemnity policies.
Benefit policies do not follow the principle of indemnity, which requires that the insured be put in the same position as before the occurrence of a loss. Under a benefit policy, the assured can take as many number of policies as desired – and he is entitled to claim from all of them in the event of a loss. Premiums paid are calculated based on the future amount which the assured will be entitled to benefit. Examples of benefit policies are funeral policy, family protection plan, personal pension plan etc.
Underinsurance and average clauses
Underinsurance occurs if the sum insured of the policy is not enough to cover the loss sustained by the insured. In this case, the insured is his own insurer for the extra value of the loss. The basic principles of insurance require the insured to pay a premium into the ‘common pool’ that is in line with the size of risk which they introduce. This means that where there is underinsurance, as in our example above, the policyholder is not paying their fair share into the pool.
Logically, therefore, their entitlement to draw on the pool when they have a loss should be scaled down to take into account this under-contribution, whatever the size of the loss. This can be achieved by introducing an average clause into the policy. An average clause provides that where the sum insured is less than full value, the insured will be considered their own insurer for the uninsured part of the risk – and the claim payment for any loss will be scaled down proportionately.
Illustration
If goods worth GH¢30,000 were insured for GH¢20,000 under a fire insurance policy (average clause endorsed) and there is a fire that results in a loss of GH¢15,000, how much will the insurance company pay?
Solution
Excess
An excess is a policy condition applied to an insurance contract that requires the policyholder to pay a sum on their own before the cover under the insurance contract kicks-in or takes effect. It can be expressed as a sum or in percentage terms.
For example, if a fire policy has an excess of GH¢1,000 and a claim of GH¢3,000 is filled by the insured, the insured will be responsible for paying the first GH¢1,000 and the insurance company will cover the remaining GH¢2,000. Excess is important because it relieve insurers from having to deal with small losses and makes the insured also put in risk mitigation practices to prevent a loss from occurring, as he will also have to contribute.
Who determines the adequacy of sum insured in an insurance contract? Is it the insured or the insurance company?
In any insurance contract, the adequacy of sum insured is determined by the insured or policyholder. The policyholder or insured has the responsibility of evaluating their needs, the specific risk they face and the future financial impact of potential losses in determining the level of coverage they require with the help of an intermediary or an insurance company. Insurance companies are not tasked to determine sum insured for their insureds, but rather they provide guidance and recommendations based on their industrial knowledge and expertise.
When presented with an insurance risk, insurance companies have the right to review and assess the risk and also make some recommendations. They can make adjustments to the information provided or request additional information. After assessing the risk, insurance companies then have the right to either accept or reject the risk presented by the insured. Once the insurance company assesses, rates and accepts the risk (sum insured) with the insured paying premium, the insurance company is bound to pay any valid claim when a loss occurs without raising any queries with regard to sum insured.
Sample Case Law in Ghana
There has been a decided case between Kwame Asamoah and SIC insurance company with regard to a motor insurance policy claim. In Kwame Asamoah V/S SIC Insurance, the insured (Asamoah) made a claim against the insurance company (SIC insurance company) to recover GH¢116,200 being the insured/claim/replacement cost for his Chevrolet vehicle that was stolen under a comprehensive insurance policy with the insurer. The insured had insured the vehicle for GH¢116,200 at an agreed premium of GH¢5,759. The insurance company sought to repudiate its liability on several grounds.
SIC Insurance contended that the insured had inflated the value of the vehicle far in excess of the value declared at the port when taking delivery of the vehicle – because of which he paid lower Customs duty thereby perpetrating fraud on the state, which required an annulment of the insurance contract.
The Supreme Court of Ghana by majority decision ruled on November 21, 2018 that an insurer is not entitled to avoid an insurance contract based on inflated sum insured. This is because the insurance company has an option to accept or decline a risk. When in doubt of the vehicle’s value, queries and probes should be made at the underwriting stage and not when a claim is being made. https://ghanalawhub.com/supreme-court-on-the-determination-of-the-value-of-a-car-under-a-comprehensive-insurance-policy/
Other types of sum insured / Insurance cover
Cover on reinstatement basis
This is normally applicable to property or building insurance. Under cover on reinstatement basis, there is no deduction and the insurance company agrees to pay for the full cost of the loss. This will include the cost of inflation from the date of damage and the completion date for the building.
Cover on New for Old
New for old is normally related to insurance for household goods and personal possessions including household contents. Under this type of cover, the insurance company agrees in advance to pay for full replacement cost ‘as new’ of any insured item that is lost or destroyed – with no deduction for wear and tear or depreciation. The cover may be a little more restrictive for items with a limited life, such as clothing and linen, and pays ‘new for old’ only when the items are less than, say, three years old at the date of loss.
Cover on Agreed Value basis
The principle of indemnity operates in a much modified form in the case of insurances written on an agreed value basis (often known simply as valued policies). We have seen that for a loss under a policy written on an ordinary indemnity basis, the insurers are liable to pay a sum equivalent to value of the property at the time and place of loss.
In the case of a valued policy, the parties agree that in the event of a loss, a particular sum fixed at the outset of the insurance will be paid – regardless of actual value of the property at the time. The object of a valued policy is to avoid disputes as to value of the property at the time of loss. This form of cover is therefore often employed when the property is unique or of a type for which there is a limited market. Here, the question of value is likely to be more subjective than is normal; and more likely to give rise to a dispute.
Importance of adequate sum insured in an insurance contract
- Adequate sum insured ensures effective risk transfer or mitigation from the insured to the insurance company.
- Having adequate sum insured provides peace of mind to the insured. This makes it possible for the insured to focus on other aspects of life and business without worrying about any out of pocket expense in the event of a loss.
- Adequate sum insured ensures that individuals and organisations are able to stand any economic or market changes – such as inflation, interest rate variations and appreciation of assets.
- Adequate sum insured enables the insured to have access to a full claim amount in the event of a loss without any deduction for underinsurance.
- Having adequate sum insured provides enough financial protection against any unforeseen future losses.
Conclusion
In conclusion, an insured should have a good knowledge of the type of cover and sum insured he is signing up for – as it will be the basis for claims settlement in the event of a loss. The insured is responsible for providing adequate sum insured based on his expected risk exposure. Once the insurance company accepts the risk at a particular sum insured and premium, it has no right to repudiate a claim on the basis of sum insured when a loss occurs.
Reference
Chris Parsons (2023), Insurance Law (M05), The Chartered Insurance Institute, London, UK https://ghanalawhub.com/supreme-court-on-the-determination-of-the-value-of-a-car-under-a-comprehensive-insurance-policy/
>>>The writer is a chartered insurance Practitioner (CII, UK) and holds a professional qualification in Risk Management (ARM) from the American Insurance Institute. He has over nine (9) years’ experience in insurance, reinsurance and risk management and is currently a Manager at Star Assurance Company Limited. He can be reached on +233249236939 and or [email protected] / [email protected]
