Notes on Over and Under Insurance

This article provides notes on over and under insurance.

Notes on Over Insurance:

In case of over insurance a situation arises where insurance cover has been taken for the value which exceeds the actual cash value of the insured risks. It can be also known as the replacement value. In case of over insurance the insurer companies have to be very careful at the time of selling the insurance policy.

The insurance company in case of over insurance can bear much losses as the insured may be tempted to make false claim with a view to gain profit from the loss insured at over value. Over Insurance results into compensation to be paid by the insurance company in excess of the actual loss incurred by the insurer either by false claims or due to over valuation of the insured assets.

Many insurance companies have lately devised methods to prevent over insurance particularly in group health insurance or medi claim insurance. Recently in India it was observed that certain hospital in connivance with TPAs of respective insurance companies are staking claims for medical treatment of insured persons at much higher rates because of which many insurance companies are facing loss.

With the result many insurance companies have stopped cashless facilities because of this reason. These companies are bent upon to decide some basic modalities to provide cashless medical insurances. Inspite of taking many steps to control the problem of over insurance there remains many type of insurance products subjected to over insurance abuse.

In fact it is duty of insured to purchase an insurance policy for the correct amount. For example if some get insurance of a factory valued at Rs. 100000/-(one lac only) for Rs. 150000/-(one lac fifty thousand). It is over ensured. But in case of any miss happening the insured must be under the impression that he would be compensated for the amount insured i.e., Rs. 150000/-. and shall gain the profit of Rs. 50000/-.

But coming down on the actual grounds it is found that the insurance company has it own methods to gauge the loss actually incurred and shall be liable to pay the market value of the loss only which is Rs. 100000/- only. In such cases the insured forgets that he had been paying insurance premium at the more higher rates instead of actual rate of premium per month.

In case any loan has been raised from any bank or financial institution it shall create more problems because due to the inflated inventory submitted to the bank the loan amount might have increased, whereas the actual value of the insured stock is less than the amount of loan.

In such cases the insurance company shall first pay to the bank or financing company and the remaining amount shall be born by the insured for obtaining insurance cover over and above the actual or market value.

Notes on Under Insurance:

Under Insurance is to purchase an insurance policy for the value less than the actual or market value. Most of people are tempted to save on tine part of paying monthly premium.

Higher the insurance amount and higher the amount of premium keeping this fact in view and without going into the details of agreement of insurance (Insurance policy) people mostly on the advise of the insurance broker opt for the under insurance without keeping in mind the final consequences of such under insurance.

Under insurance is when the amount of insurance cover is less than the actual value of the insured items. It may also be less than the replacement value of the insured items. For example if a property of the actual and market value for Rs. 100000/- is insured for Rs. 50000/- only it is a case of under insurance.

In such a case the insured shall be required to pay the premium for sum assured of Rs. 50000/- only in place of Rs. 100000/-. Naturally the amount of premium shall less than what was required to be paid had the property been insured for full value of Rs. 100000/-.

Sometimes under insurance is done voluntary and willingly, but in many cases it can be ignorance or inability of insured to estimate the true and market value for replacement of insured property in case any loss or damage caused to the property.

Under insurance is neither beneficial to the insured nor to the insurance company. Both are at loosing feet. In case of any major disaster to the insured property because of any reason the insured person shall not be compensated with full value and only the sum amount insured shall be paid by the insurance company which shall not enough to replace the lost property or items.

On the other hand the insurance company remains at loss for being unable to receive the required amount of premium. Most important factor for insurance companies is the fact that they find it difficult to settle the claim for under insurance cases which adversely may affect their reputation. In matter of settlement of an insurance claim of any under insured property the insurance company applies principle of ‘average’

The principle of average formula is applied to ascertain the real amount for settlement of a claim in case of under insurance matter. According to this formula if any item or property is under insured, the person who has purchased the under insured policy must bear retainable proportion of each and every loss.

The principle is applied for three main reasons (every insurance company as per its actuary or adviser has devised their own methods to calculate the value of under insurance).

These reasons may differ from company to company but broadly can be seen as follows:

1. The methods to prevent underinsurance,

2. To obtain full premium for the risk the insurance company shall bear, and 

3. To insure that each party bears a fair share of each loss.

The simple method to arrive at the average cost is:

Sum Insured divided by value of risk and multiplied by amount of loss

For example the sum insured is Rs. 50000/- and the value of risk insured is Rs. 100000/- but the amount of loss is Rs. 90000/- the average shall be calculated as follows:

Sum Insured Rs. 50000/- divided by value of risk (i.e., actual value of property) Rs. 100000/- = 0.5 multiplied by amount of loss i.e., 90000/- = Rs. 45000/-

As the principle average the insurance company shall be liable to pay Rs. 45000/- only against the loss of Rs. 90000/- irrespective of the fact that the actual value of the property was Rs. 100000/- . This happened only because of under insurance.

View another example if a machine is insured for Rs. 100000/-.

The actual value for purchasing the new machine is Rs. 200000/- and the machine is damaged due to an accident and requires repair cost of Rs. 35000/- the claim settlement shall be settled as follows:

Rs. 100000/-Rs. 200000 x 35000/- =17500/-

Likewise in case of Over Insurance also the insurance companies go by the actual or market value of the insured item and compensate not at the over insurance but at the rate of actual value or market value.

It is therefore necessary that the insurance be purchased always at the true and correct value of the items insured. It must always be insured that the insurance of any kind must not be either under insured or over insured. No one should fall prey on the advise of insurance brokers.