The Contract of Conventional Insurance
As stated above that the purpose of all insurances is to seek protection against all kinds of risk to which man is exposed. The purpose of insured is to prepare himself against probable hazard and loss in his life and trade. He tries to shift the burden of the probable loss on to shoulders of others, who are prepared to take the risk for some financial gains to themselves.
All insurance contracts are based on the law of large numbers[1] and the mathematics of probability. In a large homogeneous population it is possible to estimate the normal frequency of common events, such as deaths and accidents. Losses can be predicted with reasonable accuracy, and this accuracy increases as the size of group expands[2].
All insurance contracts are made on the principle of uncertainty, uncertain events, which involve speculation as well as risk[3]. Both the insurer and the insured enter into contract of mutual risk, the former risking a loss and the latter risking his premiums.
The agreements between the insurer and the insured in insurance contract are embodied in a formal document, called a policy which, afterwards, the insurer is legally bound issue to the insured on the receipt of premium and the insured is legally obligated to pay the premium monthly or annually appropriate with previous agreement between the parties.
The insurance contract is not like the contract of other service companies. It has characteristics as below:
a. Future contract, because the benefits of this contract just appear when the loss is paid in next day,
b. Contingent contract, because the loss happens uncertainly and it undertakes based on probable perils,
c. Service contract, because the insurance provides the services, benefit understanding and suggestions.
d. Risk contract, the base of insurance contract is the uncertainty with the probable loss of perils. The insurance shifts the risks of this loss on to company’s shoulder as the professional risk bearer[4].
a. Policy[5]
Policy is a formal document contains the agreements between the insurer and the insured in insurance contract[6]. The policy can be the small sheet of paper contains the concise and simple agreement, or be the long and hard document. All of both documents state dues and obligations of both parties.
The policy plays an important part in the insurance contract, whether in the beginning step, during the contract or in the covering of insurance. For the insured, the policy is the basis evidence to propose the indemnity demand when the insured hazard causes the loss. And for the insurer, the policy is the basis to know the insured’s responsibility toward the hazard[7].
Except life insurance policy, every policies must contains of eight main points, they are:
1. The day of the insurance covering
2. The name of the insured who agrees the insurance covering
3. The clear explanation about the assured goods
4. The amount of money for how many times the insurance is held
5. The assured perils and hazards
6. The beginning time and the end of the insurance
7. The amount of premium
8. The matters that normally must be well known by insurer, and the certain promises and clauses between the insured and the insurer[8].
Globally, the eight main points above are divided into four parts, they are[9]:
1. Declaration.
The declaration is a statement made by insurance applicant, who basically furnishes all such information and documentary evidences about his identity, the value of the goods, and everything related to the covering of insurance contract as the insurer may requires. This information must be appropriated with the utmost good faith principle. The insurance applicant gives this information by filling up the application form or questionnaire, and then he signs it up.
2. Insurance clause.
The insurance clause is the main part of the policy. It contains of the provision of whatsoever risks determined in the policy, the requested requirements and the column for the insurer’s liabilities.
3. Exclusions.
In the sections of the exclusions, the policy determines whatever the excluded matters, whether disasters or hazards, subjects or losses. Hence, the insured must know and understand precisely whatever excluded in the recovering of the purposed policy.
4. Conditions.
In this part of the policy, be explained all about dues and duties of the parties, whether insurer or insured. These conditions normally contains of premium payment, risks alteration, insured’s duties toward the incidents, report of losses, indemnity, etc.
Thus, except the application form, the insurer is who makes the standardization policy. Then this policy offered to the insured in order to examine the requirements and clauses carefully. If the insured agrees all terms, the policy will be finished and signed up, and after 24 hours it will be returned back to the insured.
But, practically this short time hardly can be fulfilled, because the insurer must complete the mails and process the received data. So, before the policy can be returned to the insured, temporarily the insured will receive the “cover note” or “bider”, it is a temporary contract of insurance recovering before the policy can be returned[10].
b. Premium
The premium is the price at which the insurer is prepared to take risks and bear the burden of the probable loss involved in the contract of insurance. The premium is the obligation of the insured against the services of the insurer in an agreed period of time[11].
On the basis of law of averages, the insurer finds through experience an amount of premium with calculating the details as below:
1. The reasonable amount sufficient to cover the risks,
2. Other charges, including policy and administration expenses,
3. The tip for agents, if the insurance held through the agency,
4. The profits from the investment of accumulated funds[12].
The contract of insurance becomes effective only when the premium is paid by the insured and received by the insurer. If it is not so, the insurance is unavailable[13]. Thus, the premium must be paid completely during the contract. At the sort-range insurance such as travel insurance, the premium is paid on the beginning of contract. But, at the long-range insurance, the premium can be paid monthly on the previous agreed date, started on the first month periodically. The amount of premium and its payment date are clearly embodied in the policy.
Once the premium is paid by the insured and risk assumed by the insurer, there shall be no apportionment or return of premium afterwards, even though the subject-matter of the risk may vanish before the period of cover has elapsed.
The Operational Practice of Conventional Insurance.
Normally, the insurance company is operated as well as other companies. However, because the transaction of insurance needs special functions in its operational practice, so in this field there are some functions specified for the insurance company only.
Although there are some different functions between life insurance and lost insurance, but the main operational practice of all kinds of insurance company is divided as below[14]:
a. Underwriting
Underwriting is classifying the risks that will be assured. It is the essential element in the operational practice of insurance company, because the underwriting can maximize the profits through risks distribution.
The main duty of the underwriter in the risks classification is to ensure no risks can cause great difficulties for the company in next days. For this reason the underwriter must develop sharp consideration through understanding the hazards.
To execute the underwriting process effectively, the underwriter must collect the information as much as possible about the insurance subjects and the cost to get additional data. The underwriter may approve new costumer as long as he complies all underwriting requirements determined by the company. But if he does not so and the hazard risks are too big, the underwriter may reject him.
There are five essential information resources related to the risks, they are:
1) New costumer’s statement embodied in the questionnaire,
2) Information from the insurance broker,
3) Direct investigations toward new costumer’s personality related to the moral hazards such as financial status, occupation, characteristics, etc.
4) Information from the service bureau concerning to the objects or goods. For instance, health information bureau which stores the files of costumer’s physical checking up for life insurance.
5) Direct Inspection toward object’s physical condition.
b. Rating / Pricing
Rate is the price of each protection or exposure units. The rate is different from the premium; the premium is determined by multiplying the rate with the total of bought protection units.
To calculate an equitable rate of premium for an individual risk, the underwriter has recourse either to the pooled record of risks of the same class in his own portfolio, or in the wider record of a group of insurers. Having found the norm of the class concerned, he can adjust the rate upwards or downwards for favourable or unfavourable features in the individual risk to arrive at what he considers a fair rate[15].
By this rate, the income of insurance company from the premium must suffice all losses' covering and operational expenses. To get the income from this premium, insurance company must foretell the claim and distribute the anticipated expenses to every policyholder classes.
c. Investment
It is the liability of financial staff of company to invest the accumulated amount of money as the accumulated premiums paid by insured. The addition of investment interest purchasing is important variable in determining the rate of premium.
Principally, life insurance is long-range investment. Hence, Life Insurance Company entrusts its funds especially in the long-range investment amounted to 2/3 of asset total invested in the company stocks and the obligation letters, the common stocks amounted to less than 10% and the government’s stocks amounted to 5%.
And loss insurance, normally, is short-range investment. Hence, Loss Insurance Company invests half of its assets total in the government and private company’s stocks. The investment percentage composition of life insurance and loss insurance can be seen in the table below[16]:
Investment Capital
|
Life Insurance (%)
|
Loss Insurance (%)
|
Stock
|
9,7
|
32,4
|
Obligation
|
36,6
|
28,8
|
Government's Obligation
|
5,2
|
28,9
|
Mortgage
|
30,8
|
0,2
|
Real Estate
|
3,3
|
1,6
|
Policy Loan
|
8,5
|
-
|
Premium Balance
|
-
|
7,2
|
Other Investments
|
5,9
|
7,3
|
d. Loss Adjustment
Before the insurance company covers the losses, it must finish the process of loss adjustment. Loss adjustment is most difficult step for insurance company; therefore it needs a good adjuster in claim section.
It is important for insurance company to pay for the claim properly, speedy and satisfactory, because it is the effective promotion device. And it is important also for insurance company to refuse the unevaluated claim, and to prevent the payment more than full indemnity.
There are two basic actions for insurance company toward a claim, those are payment and rejection. There are two matters provided the basis for insurance company to refuse the claim:
1) No losses happen,
2) The involved policy does not cover the loss, because it's out of the insurance contract, whether the contract becomes invalid or the insured violates the clauses of the legal policy.
In determining which whether the insurance company must pay or refuse the claim, the adjuster must attend settlement procedures with four main steps as below[17]:
1) Loss information, the insured informs the insurance company that the loss was happening.
2) Loss investigation, the insurer ensures the loss fact by direct investigation which whether that loss assured by policy or not. Then the amount of losses will be countable.
3) Loss evidence, made by the insured after informing the loss.
Payment or rejection. If all steps run as well as the clauses of policy, the insurance company will draw the draft to indemnify the insured. But if they do not so, the insurance company will refuse that claim.
[1]The law of a mathematical concept states that the ability to predict losses improves with larger groups. Using calculations based on statistics and actuaries to accurately predict the losses of a large population, even without knowing when or how any one individual will experience loss. (See in Microsoft Encarta Encyclopedia 2004, loc. cit)
[4]Drs. Herman Darmawi, op. cit, p. 71.
[5]See the example of insurance policy at Appendix I.
[6]Supardjono, op. cit, p. 20.
[8]KUHD, section 256, quoted by Dr. Sri Rejeki Hartono, S.H., op. cit, p. 125
[9] Please see in Dr. Sri Rejeki Hartono, S.H., ibid, p. 129 – 131.
[10]Dr. Sri Rejeki Hartono, S.H., op. cit, p. 130.
[11]Afzalur Rahman, op. cit, p. 89
[12]Supardjono, op. cit, p. 40.
[13]Drs. Thomas Suyatno, MM. Et. All, Kelembagaan Perbankan, (Jakarta: PT. Gramedia Pustaka Umum, 1999), third edition, p. 92.
[14]See Drs. Herman Darmawi, op. cit, p. 31 - 52.
[15]Afzalur Rahman, op. cit, p. 150.
[16]Drs. Herman Darmawi, Op. cit, p. 50
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