Insurable interest bases
A. Contribution methods
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E. All policies must have coverage for the same loss.
F. All insurance policies covering the risk must be in force when the loss occurs.
• The company secretary and financial manager both believing it is their responsibility to deal with the company’s insurance.
• The owner of goods and the owner of the warehouse both insure goods stored in the warehouse.
• Cover under two overlapping policies e.g. holiday insurance and a house policy.
If an insured takes out two insurance policies covering the same risk, he would have dual or double insurance. To allow recovery from both insurance companies would breach the principle of indemnity. Contribution is similar to subrogation; it exists to support the Principle of Indemnity and like subrogation, applies only to contracts of indemnity.
Dual insurance is usually unintentional but may happen through a misunderstanding.
Examples include:
Insurers allow for dual insurance by a contribution condition in their policies, which states that in the event of more than one policy they will only pay their share. This is the contribution or other insurance condition.
The share that each insurer agrees to pay is their rateable proportion of any loss. There are two methods of calculating an insurers’ rateable proportion, based on either sums insured or independent liability.
The goal of contribution method is to prevent the insured from claiming the full sum of indemnity from one insurer, as this will force insurer to go back to other insurers to pay their share of the sum of claim.
There are two ways to explain the meaning of “rateable proportion”:
In this method, the contribution to be paid by each insurer is calculated by apportioning it according to the sums insured.
Saud ensured his house with SR10,000 at Riyadh Insurance Company, with SR20,000 at Jeddah Insurance Company, and with SR30,000 at Dammam Insurance Company. If the house suffered a loss of SR6,000, how much will the Riyadh Company pay of this loss?
This method has an obvious negative side, there are several policies subject to different conditions.
Some policies include some but not all conditions or a different way to assess and settle claims. Thus, we can accurately identify the method used in each policy to deal with a claim, instead of just focusing on calculations regardless of policy condition. For instance, if one or all policies were subject to average condition and there was an underinsurance, then is it fair for an insurer, who has the right to Riyadh Company will pay = 6,000 x (10,000 ÷ (30,000 + 20,000 + 10,000) ) = SR1,000
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The alternative method is suitable for policies that are not identical; they may include deductibles, loss limits, or when average applies. They are also suitable for non-property policies e.g. liability insurances.
The great majority of contribution principle calculations apply to property insurance, especially fire insurance. Insurers tend to use standard methods for contribution principle calculations, which have been included in official agreements among large groups of insurers.
As for property insurance policies not subject to average condition and cover the same subject matter of insurance, the loss is settled according to each policy sum insured relative to total sum insured of all policies. This is done in the previous example. However, when applying contribution principle on policies not subject to average condition (property insured are not the same in all policies), the sum insured will be used for calculations also, but in a different complicated way called
“Arithmetic Mean”.
For the policies subject to average condition or indemnity limits to sum insured for single losses even if it is not subject to rateable proportion condition, the “Independent Liability Method” will be used to apply the contribution principle. “Independent liability” can be defined as the sum payable by each insurer as if the insurer was only responsible for the loss.
Second Method: Independent Liability Method:
Independent liability of each policy
Total Independent liabilities X Actual Loss = Policy Indemnity
Riyadh Insurance Company’s Sum Insured
The House’s Actual Value at the Day of Loss X Loss SR 20,000
SR45,000 = SR 2,000
SR 10,000
SR45,000 = SR 1,000
To calculate Jeddah Insurance Company’s liability, the follow average condition is applied:
The total of what the two companies paid = SR3,000
The average condition prescribes that insured must insure himself with the difference between the value of subject matter of insurance and sum insured.
Example:
Abdulaziz insured his house with SR20,000 at Riyadh Insurance Company and SR10,000 at Jeddah Insurance Company. If his house suffered a loss of SR4,500 and the house’s actual value at the day of loss was SR45,000, then there are three steps to solve this:
First Step:
Finding the sum payable by each insurance company in case it was the only insurer.
To calculate Riyadh Insurance Company’s liability, the following average condition is applied:
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In the example above, 10,000 + 20,000) – 45,000) = SR15,000
= SR 15,000
SR45,000 X 4,500 = SR1,500 Second Step:
If the total of insurance companies’ liabilities was SR3,000 as in the previous example, less than or equal to the loss value, then each insurance company payment equals its independent liabilities.
Third Step:
If the total of insurance companies’ independent liabilities was bigger than the loss, then a contribution will be made to pay for the loss with a percentage of what the independent liabilities of each insurance company represents out of the total independent liabilities.
Example:
Faisal insured his house with SR30,000 at Riyadh Insurance Company and SR50,000 at Jeddah Insurance Company. If the house burned and suffered a loss of SR1,000, and its value before the fire was SR70,000, how much will each company pay if each policy included average condition?
First Step:
since the two policies included average condition, independent liability method must be followed.
SR 30,000
SR 60,000 X 1,000 = SR 500 Riyadh Company =
500
1,333.33 X 1,000 = SR 375 Riyadh Company =
SR 50,000
SR 60,000 X 1,000 = SR 833.33 Jeddah Company =
833.33
1,333.33 X 1,000 = SR 625 Jeddah Company =
Now that the total of insurance companies’ independent liabilities equals SR1,333.33, which exceeds the loss, then each insurance company will contribute in paying loss value according to the percentage of what its liability represent out of the total independent liabilities as follows:
Independent liability
Total Independent liabilities X Loss = Riyadh Company
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Example:
If Bandar had two insurance policies on personal liability, one with SR30,000 at Riyadh Insurance Company and another with SR60,000 at Jeddah Insurance Company. How much will each company pay if Bandar was subject to a legal responsibility to a third party to pay SR50,000?
First Step:
Since the two policies are for liability insurance, then the independent liability method will be followed.
If Riyadh Company’s policy was the only policy, then it will pay SR30,000 and will take its ultimate liability even though the loss is SR50,000. As for Jeddah Company, it will take liability for the full loss SR50,000, since the indemnity in its policy is SR60,000.
Independent liability
Total Independent liabilities X Loss = Riyadh Company
Independent liability
Total Independent liabilities X Loss = Jeddah Company Second Step:
Riyadh Insurance Company =
Jeddah Insurance Company =
= 50,000 × ( 30,000 ÷ (30,000 + 50,000) ) = SR 18,750
= 50,000 × ( 50,000 ÷ (30,000 + 50,000) ) = SR 31,250
Which means that each insurance company will pay its share of the total of independent liabilities.
The correct method is the one that is most appropriate for the circumstances.
Similar to subrogation, larger insurance markets have agreements on contribution. When contribution is appropriate (if it is less than a certain amount, only one insurer will pay) which policy should take preference? A policy that is more specific would pay first. For example, if one policy covers jewelry and another a diamond ring. If the policies are contributory, then diamond ring is more specific than jewelry. The diamond ring policy will pay and the insurance company will not seek contribution when the loss occur. It is important to determine the cause of loss before making a decision regarding settlement. In most cases, there is only one cause of loss, but in other, there could be more than one.
In such circumstances, Proximate Cause Principle rule will help in determining the cause of loss.
After identifying the cause, it is essential to interpret the policy wording to see if the loss is covered under the insurance policy or not.
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Some policies include what is called non-contribution clause and its wording may be as follows:
“This policy would not pay any claim if the insured has the right to receive indemnity for any other policy”.
This means that the policy would not contribute to a covered loss whenever there is another policy available to cover the loss. An addition to the clause wording might be done by stating: With an exception of any additional amount to the sum payable by the other policy as if this policy did not exist (Alajmi, 2-27).