CHAPTER FOUR

NATURE AND FUNCTION OF INSURANCE

As stated earlier there are a number of ways of dealing with risk. Insurance is one of the basic
tools of risk management and it is also the most important illustration of the transfer technique
and the keystone of most risk management programs.
Insurance is complicated and difficult to define. However, in its simplest aspect it has two
fundamental characteristics:
Transferring or shifting risk from an individual to a group.
Sharing losses, on some equitable basis, by all members of the group.
To illustrate the way the insurance mechanism works, let us assume that there are 1,000
dwellings in a given community and, for simplicity, the value of each dwelling is birr 10,000.
Each owner faces the risk that his house may catch on fire. If a fire should break out, a financial
loss of up to birr 10,000 could result. Some houses will undoubtedly burn but the probability that
all will is remote. Now let us assume that the owners of these dwellings enter into an agreement
to share the cost of losses as they occur, so that no single individual will be forced to bear an
entire loss of birr 10,000 whenever a house burns each of the 1,000 owners contributes his
proportionate share of the amount of loss.
If the house is a total loss each of the 1,000 owners will pay birr 10 and the owner of the
destroyed house will be indemnified for the birr 10,000 loss. Those who suffer losses are
indemnified by those who do not. Most who escape loss are willing to pay those who do not
because by doing so they help to eliminate the possibility that they themselves might suffer a
10,000 birr loss. Through the agreement to share the losses, the economic burden these impose is
spread throughout the group. This is essentially the way insurance works, for what we have
described is a pure assessment of mutual insurance operation.
There are some potential difficulties with the operation of such a plan, the most obvious being
the possibility that some members of the group might refuse to pay their assessment at the time
of a loss. This problem can be overcome by requiring payment in advance. To require payment
in advance for the loss that may take place, it will be necessary to have some idea as to the
amount of those losses. This may be calculated on the basis of past experience.
Let us now assume that on the basis of past experience we are able to predict with reasonable
accuracy that two of the 1,000 houses will burn. We could charge each member of the group birr
20, making a total of birr 20, 000. In addition to the cost of the losses, there would no doubt be
some expenses in the operation of the program. Also there is a possibility that our predictions
might not be entirely accurate. We might therefore, charge each member of the group birr 40
instead of birr 20, thereby providing for the payment of expenses and also providing a cushion
against deviations from our expectations.
Each of the 1,000 house owners will incur a small cost of birr 40 in exchange for a promise of
indemnification of the amount of birr 10,000 if his house burns down. This birr 40 premium is in
effect the individual’s share of the total losses and expenses of the group.
Insurance Defined
Insurance can be defined from two points of view.
First, insurance is the protection against financial loss provided by an insurer. It is an economic
device whereby an individual substitutes a small certain cost (the premium) for a large uncertain
financial loss which would exist if it were not for the insurance.
The primary function of insurance is the creation of the counterpart of risk, which is security.
Insurance does not decrease the uncertainty for the individual as to whether or not the event will
occur, nor does it alter the probability of financial loss connected with the event. From the
individual’s point of view, the purchase of an adequate amount of insurance on a house
eliminates the uncertainty regarding a financial loss in the event that the house should burn
down.

Many persons consider an insurance contract to be a waste of money unless a loss occurs and
indemnity is received. Some even feel that if they have not had a loss during the policy term,
their premium should be returned. Both view pints constitute the essence of ignorance. Relative
to the first, we already know that the insurance contract provides a valuable feature in the
freedom from the burden of uncertainty. Even if a loss is not sustained during the policy term,
the insured has received something for the premium: the promise of indemnification in the event
of a loss. With respect to the second, one must appreciate the fact that the operation of the
insurance principle is based upon the contribution of the many paying the losses of the
unfortunate few. If the premiums were returned to the many who did not have losses, there
would be no funds available to pay for the losses of the few who did. Basically then, the
insurance device is a method of loss distribution. What would be a devastating loss to an
individual is spread in an equitable manner to all members of the group, and it is on this basis
that insurance can exist.

Second, insurance is a device by means of which the risks of two or more persons or firms are
combined through actual or promised contributions to a fund out of which claimants are paid.
From the viewpoint of the insured insurance is a transfer device. From the viewpoint of the
insurer, insurance is a retention and combination device. The distinctive feature of insurance as a
transfer device is that it involves some pooling of risks; i.e., the insurer combines the risks of
many insureds. Through this combination the insurer improves its ability to predict its expected
losses. Although most insurers collect in advance premiums that will be sufficient to pay all their
expected losses, some rely at least in part on assessments levied on all insureds after losses
occur.

Insurance does not prevent losses, nor does it reduce the cost of losses to the economy as a
whole. As a matter of fact, it may very well have the opposite effect of causing losses and
increasing the cost of losses for the economy as a whole. The existence of insurance encourages
some losses for the purpose of defrauding the insurer, and in addition people are less careful and
may exert less effort to prevent losses then they might if it were not for the existence of
insurance contracts. Also, the economy incurs certain additional costs in the operation of the
insurance mechanism. Not only must the cost of the losses be borne, but the expense of
distributing the losses on some equitable basis adds to this cost.

Insurance Not Gambling or Speculation

The purchase of insurance is sometimes confused with gambling. Both acts do share one
characteristic. Both the insured and the gambler may collect more dollars than they pay out, the
outcome being determined by some chance event. However, through the purchase of insurance,
the insured transfers an existing pure risk. A gambler creates a new risk where none existed
before. Insurance is a method of eliminating or greatly reducing (to one party anyway) an already
existing risk.
Speculation is a transaction under which one party, for a consideration, agrees to assume certain
risks, usually in connection with a business venture. Every business accepts the possibility of
losing money in order to make money.

Requisites of Insurable Risks

Unfortunately, not all risks are insurable. For practical reasons, insurers are not willing to accept
all the risks that others may wish to transfer to them. To be considered a proper subject for
insurance, there are certain characteristics that should be present.

These requirements should not be considered absolute, as iron rules, but rather as guides. They
should be viewed as ideal standards, and not necessarily as standards actually attained in
practice. The prerequisites listed below represent the “ideal” standards of an insurable risk.

There must be a sufficiently large number of homogeneous exposure units to make the losses
reasonably predictable. Insurance, as we have seen, is based on the operation of the law of large
numbers. Unless we are able to calculate the probability of loss, we cannot have a financially
sound program.

The loss produced by the risk must be definite and measurable. The loss must have financial
measurement. In other words, we must be able to tell when a loss has taken place, and we must
be able to set some value to it. Before the burden of risk can be safely assumed, the insurer must
set up procedures to determine if loss has actually occurred and, if so, its size.

The loss must be fortuitous or accidental. The loss must be the result of a contingency, that is, it
must be something that may or may not happen. It must not be something that is certain to
happen. If the insurance company knows that an event in the future is inevitable, it also knows
that it must collect a premium equal to the certain loss that it must pay, plus an additional amount
for the expenses of administering the operation. Wear and tear or depreciation which is a
certainty should not be insured. The law of large numbers is useful in making predictions only if
we can reasonably assume that future occurrences will approximate past experience. Since we
assume that past experience was a result of chance happenings, the predictions concerning the
future will be valid only if future happenings are also a result of chance.

4. The loss must not be catastrophic. All or most of the objects in the group should not
suffer loss at the same time. The insurance principle is based on a notion of sharing losses, and
inherent in this idea is the assumption that only a small percentages of the group will suffer loss
at any one time. Damage which results from war would be catastrophic in nature. Simultaneous
disaster to insured objects can be illustrated by reference to large fires, floods, and hurricanes
that have swept major geographical areas in the past. If an insurer is unlucky enough to have on
its books a great deal of property situated in such an area, it obviously suffers a loss that was not
contemplated when the rates were formulated. Most insurers reduce this possibility by ample
dispersion of insured objects.

Large Loss. The risk to be insured against must be capable of producing a large loss which the
insured could not pay without economic distress. The potential loss must be severe enough to
cause financial hardship. The large loss principle states that people should insure potentially
serious losses before relatively minor losses. To do otherwise is uneconomical, since small losses
tend to occur frequently and are very costly to recover through insurance. Insurance against
breakage of shoestrings is unknown. If the loss involved is so small that it is not worth the time,
effort, and expense to enter into an insurance contract to indemnify the loss.

Reasonable cost of Transfer. One of the insured’s requirements is not to insure against a highly
probable loss, because the cost of transfer tends to be excessive. To be insurable the chance of
loss must be small. The more probable the loss, the more certain it is to occur. The more certain
it is, the greater the premium will be. A time is ultimately reached when the loss becomes so
certain that either the insurer withdraws the protection or the cost of the premium becomes
prohibitive.

The cost of insurance policy consists of the pure premium, or amount actually needed to make
loss payments, and the expense portion. If the chance of loss approaches 100%, the cost of the
policy will exceed the amount that the insurance company is obliged to pay under the contract.
For example, it would be possible for a life insurance company to issue a birr 1000 policy on a
man aged 99. The net premium, however, would be about birr 980, to which would have to be
added an amount for expenses which would bring the premium total to more than the amount of
insurance. To make insurance attractive, the premium has to be far less than the face of the
policy.

Benefits and Costs of Insurance

Insurance has peculiar advantages as a device to handle risk and so ought to be extended as far as
possible, in order to bring about the greatest economic advantage to a given society. Insurance,
like most institutions, presents society with both benefits and costs.

Benefits
Indemnification. The direct advantage of insurance is indemnification for those who suffer
unexpected losses. These unfortunate businesses and families are restored or at least moved
closer to their former economic position. The advantage to these individuals is obvious. Society
also gains because these persons are restored to production, and tax revenues are increased.
Reduced Reserve Requirements. If there is an insurance protection the amount of accumulated
funds needed to meet possible losses is reduced. One of the chief economic burdens of risk is the
necessity for accumulating funds to meet possible losses. One of the great advantages of the
insurance mechanism is that it greatly reduces the total of such reserves necessary for a given
economy. Since the insurer can predict losses in advance, it needs to keep readily available only
enough funds to meet those losses and to cover expenses. If each individual has to set aside such
funds, there would be a need for a far greater amount because the individual, not knowing
precisely how much would be required, would tend to be conservative.

For Example a birr 60,000 residence can be insured against fire and other physical perils for
about birr 200 a year. If insurance were not available, the individual would probably feel a need
to set aside funds at a much higher rate than birr 200 a year.

Capital Freed for Investment. Cash reserves that insurers accumulate are freed for investment
purposes, thus bringing about a better allocation of economic resources and increasing
production. Insurers as a group and life insurance firms in particular, have become among the
largest and most important institutions to collect and distribute a nation’s savings. A substantial
part of the contributions of insurance companies is derived from regular savings by individuals
through life insurance contracts. The provision of the life insurance mechanism, which
encourages individual savings, is a most important contribution of insurance to the savings
supply.

The insurance mechanism encourages new investment. For example, if an individual knows that
his family will be protected by life insurance in the event of premature death, the insured may be
more willing to invest savings in a long-desired project, such as a business venture, without
feeling that the family is being robbed of its basic income security. In this way a better allocation
of economic resources is achieved.

Reduced Cost of Capital. Since the supply of investable funds is greater than it would be without
insurance, capital is available at lower cost than would otherwise be true. Other things being
equal, this brings about a higher standard of living because increased investment itself will raise
production and cause lower prices than would otherwise be the case. Also because insurance is
an efficient device to reduce risk, investors may be willing to enter fields they would otherwise
reject as too risky. Thus, society benefits by increased services and new products, the hallmarks
of increased living standards.

Loss Control. Another benefit of insurance lies in its loss control or loss- prevention activities.
Insurers are actively engaged in loss-prevention activities. While it is not the main function of
insurance to reduce loss, but merely to spread losses among members of the insured group,
nevertheless, insurers are vitally interested in keeping losses at a minimum.

Insurers know that if no effort is made in this regard, losses and premiums would have a
tendency to rise, since it is human nature to relax vigilance when it is known that the loss will be
fully paid by the insurer. Furthermore, in any given year, a rise in loss payments reduces the
profit to the insurer, and so loss prevention provides a direct avenue of increased profit.
By charging extra for bad features and less for good, insurers can induce the insured to make
improvements, which have beneficial effect on losses. This can clearly be seen, for example, in
fire insurance, where the installation of good-fighting equipment, such as a sprinkler system,
receives considerable reward by way of reduced premiums.

Business and Social Stability. Insurance contributes to business and social stability and to peace
of mind by protecting business firms and the family breadwinner. Adequately protected, a
business need not face the grim prospect of liquidation following a loss. A family need not break
up following the death or permanent disability of the breadwinner. A business venture can be
continued without interruption even though a key person or the sole proprietor dies. A family
need not lose its life savings following a bank failure. Old-age dependency can be avoided. Loss
of a firm’s assets by theft can be reimbursed. Whole cities ruined by a hurricane can be rebuilt
from the proceeds of insurance.

Aid to Small Business. Insurance encourages competition because without an insurance industry,
small business would be a less effective competitor against big business. Big business may safely
retain some of the risks that, if they resulted in loss, would destroy most small businesses.
Without insurance, small business would involve more risks and would be a less attractive outlet
for funds and energies.

Invisible Export. A valuable contribution towards Ethiopia’s balance of payments is made by

invisible exports. These include banking, shipping and other services, as well as insurance
transacted abroad by the Ethiopian Insurance Corporation. Overseas insurance as an export is
enhanced when the insurer is selling a commodity, namely security, to an overseas buyer.
Although this commodity is invisible it is an export in the same way as any material goods.

Costs of Insurance
Operating Expenses. Insurers incur expenses such as loss control costs, loss adjustment
expenses, expenses involved in acquiring insureds, state premium taxes and general
administrative expenses. These expenses, plus a reasonable amount for profit and contingencies,
must be covered by the premium charged. In real terms, workers and other resources that might
have been committed to other uses are required by the insurance industry. The advantages of
insurance are not obtained for nothing. They should be weighed against the cost of obtaining the
services.
Moral Hazard. A second cost of the insurance industry is the creation of moral hazards. A moral
hazard is a condition that increases the chance that some person will intentionally (1) cause a loss
or (2) increase its severity. Some unscrupulous persons can make, or believe that they can make,
a profit by bringing about a loss. For example, arson, inspired by the possibility of an insurance
recovery, is a major cause of fires. Others abuse the insurance protection by:
Making claims that are not warranted, thus spreading through the insurance system losses that
they should bear themselves (eg. claiming automobile liability when there is no negligence on
the part of the defendant).
Over utilizing the services (eg. staying in a hospital beyond the period required for treatment).
Charging excessive fees for services rendered to insured’s, as is done by some doctors and
garages, and
Granting larger awards in liability cases merely because the defendant is insured. Some of these
abuses are fraudulent; others indicate a different (and indefensible) code of ethics where
insurance is involved.

3. Morale Hazard. Another related cost is the creation of morale hazards. A morale hazard
is a condition that causes persons to be less careful than they would otherwise be. Some persons
do not consciously seek to bring about a loss, but the fact that they have insurance causes them to
take more chances than they would if they had no insurance.

Opinions differ on the degree to which moral and morale hazards are created by
insurance, but all agree that some persons are affected in each way and that morale hazards are
more common than moral hazards.

In weighing the social costs and the social values of insurance, the advantages far exceed
the disadvantages. Insurance is used because of the great economic services attained thereby.
These services cost something, of course; but like most expenses, insurance premiums are looked
upon as essential to the successful maintenance of a family or a business.
Functions and Organization of Insurers
As part of the study of the insurance mechanism and the way in which it works, it will be helpful
to examine some of the unique facets of insurance company operations. In general, insurers
operate in much the same manner as other firms, however, the nature of the insurance transaction
requires certain specialized functions which require a suitable organization structure. In this
section, we will examine some of the specialized activities of insurance companies and the
general forms of organization structure.

Functions of Insurers
Although there are definite operational differences between life insurance companies, and
property and liability insurers, the major activities of all insurers may be classified as follows:
Production (selling)
Underwriting (selection of risks)
Rate making
Managing claims
Investment

These functions are normally the responsibility of definite departments or divisions within the
firm. In addition to these functions there are various other activities common to most business
firms such as accounting, personnel management, market research and so on.
Production
One of the most vital functions of an insurance firm is securing a sufficient number of applicants
for insurance to enable the company to operate. This function, usually called production in an
insurance company, corresponds to the sales function in an industrial firm.
The term is a proper one for insurance because the act of selling is production in its true sense.
Insurance is an intangible item and does not exist until a policy is sold.

The production department of any insurer supervises the relationships with agents in the field. In
firms such as direct writers, where a high degree of control over field activities is maintained, the
production department recruits, trains and supervises the agents or salespersons.
Underwriting
Underwriting is the process of selecting risks offered to the insurer. It is an essential element in
the operation of any insurance program, for unless the company selects from among its
applicants, the inevitable result will be adverse to the company. Hence, the main responsibility of
the underwriter is to guard against adverse selection. Underwriting is performed by home office
personnel who scrutinize applications for coverage and make decisions as to whether they will be
accepted, and by agents who produce the applications initially in the field.

It is important to understand that underwriting does not have as its goal the selection of risks that
will not have losses, but merely to avoid a disproportionate number of bad risks, thereby
equalizing the actual losses with the expected ones. While attempting to avoid adverse selection
through rejection of undesirable risks, the underwriter must secure an adequate volume of
exposures in each class. In addition, he must guard against congestion or concentration of
exposures that might result in a catastrophe.

Process of Underwriting
The underwriter must obtain as much information about the subject of the insurance as possible
within the limitations imposed by time and the cost of obtaining additional data. The desk
underwriter must rule on the exposure submitted by the agents, accepting some and rejecting
others that do not meet the company’s underwriting requirements or policies. When a risk is
rejected, it is because the underwriter feels that the hazards connected with it are excessive in
relation to the rate.

There are four sources from which the underwriter obtains information regarding the hazards
inherent in an exposure:
The application containing the insured’s statements
Information from the agent or broker
Investigations
Physical examinations or inspections.

The application The basic source of underwriting information is the application, which varies
from each line of insurance and for each type of coverage. The broader and more liberal the
contract, usually the more detailed the information required in the application. The questions on
the application are designed to give the underwriter the information needed to decide if he would
accept the exposure, reject it, or seek additional information.

Information from Agent or Broker In many cases the underwriter places much weight on the
recommendations of the agent or broker. This varies, of course, with the experience the
underwriter has had with the particular agent in question. In certain cases the underwriter will
agree to accept an exposure that does not meet the underwriting requirements of the company.
Such exposures are referred to as “accommodation risk,” because they are accepted to
accommodate a valued client or agent.

Investigations In some cases the underwriter will request a report from an inspection
organization that specializes in the investigation of personal matters. This inspection report may
deal with a wide range of personal characteristics of the applicant, including financial status,
occupation, character, and the extent to which he uses alcoholic beverages (or to which
neighbors say he uses them.) All the information is pertinent in the decision to accept or reject
the application.

For example, the financial status of the applicant is important in both the property and liability
field, and in life insurance field, although for different reasons.

In the property and liability field, evidence of financial difficulty may be an indication of a
potential moral hazard. In life insurance, there is concern because an individual who purchases
more life insurance than he can afford is likely to let the policy lapse, a practice which is costly
to the company.

Physical Examinations or Inspections In life insurance, the primary focus is on the health of the
applicant. The medical director of the company lays down principles to guide the agents and
desk writers in the selection of risks, and one of the most critical pieces of intelligence is the
report of the physician. Physicians selected by the insurance company or recognized medical
centers supply the insurer with medical reports after a physical examination; this report is a very
important source of underwriting information. In the field of property and liability insurance, the
equivalent of the physical examination in life insurance is the inspection of the premises.
Although such inspections are not always conducted, the practice is increasing. In some
instances this inspection is performed by the agent, who sends a report to the company with
photographs of the property. In other cases a company representative conducts the inspection.

Rate Making
An insurance rate is the price per unit of insurance. Like any other price, it is a function of the
cost of production. However, in insurance, unlike other industries the cost of production is not
known when the contract is sold, and will not be known until some time in the future, when the
policy has expired. One of the fundamental differences between insurance pricing and the pricing
function in other industries is that the price for insurance must be based on a prediction. The
process of predicting future losses and future expenses, and allocating these costs among the
various classes of insureds is called rate making.

A second important difference between the pricing of insurance and pricing in other industries
arises from the fact that insurance rates are subject to government regulation. Because insurance
is considered to be vested in the public interest all nations have enacted laws imposing statutory
restraints on insurance rates. These laws require that insurance rates must not be excessive, must
be adequate, and may not be unfairly discriminatory.

Other characteristics considered desirable are that rates should be relatively stable over time, so
that the public is not subjected to wide variations in cost from year to year. At the same time,
rates should be sufficiently responsive to changing conditions to avoid inadequacies in the event
of deteriorating loss experience.

Makeup of the Premium

A “rate” is the price charged for each unit of protection or exposure and should be distinguished
from a “premium”, which is determined by multiplying the rate by the number of units of
protection purchased. The unit of protection to which a rate applies differs for the various lines
of insurance. In life insurance, for example, rates are computed for each 1,000 birr in protection;
in fire insurance the rate applies to each of birr 100 coverage.

The insurance rate is the amount charged per unit of exposure. The premium is the product of the
insurance rate and the number of units of exposure. Thus, in life insurance, if the rate is 25 birr
per 1,000 birr of face amount of insurance, the premium for a 10,000 birr policy is 250 birr.
The premium is designed to cover two major costs:
The expected loss and
The cost of doing business.

These are known as the pure premium and the loading, respectively. The pure premium is
determined by dividing the total expected loss by the number of exposures. In automobile
insurance, for example, if an insurer expects to pay 100,000 birr of collision loss claims in a
given territory, and there are 1,000 autos in the insured group, the pure premium for collision
will be 100 birr per car, computed as follows.

Pure premium = Expected Loss = birr 100,000 = 1,000

Exposure units birr 100
The loading is made up of such items as agents’ commissions, general company expenses, taxes
and fees, and allowance for profit. The sum of the pure premium and loading is termed as the
gross premium. Usually the loading is expressed as a percentage of the expected gross premium.
In property – liability insurance, a typical loading might be 33 percent. The general formula for
the gross premium, the amount charged the consumer, is

Pure Premium
Gross Premium =
1-Loading percentage

In the above example, where the pure premium was birr 100 per car, the gross premium would
be calculated as
Birr 100
 = birr 150
1 - 0.333

Rate - Making Methods

Two basic approaches to rate making, class and individual rating are discussed below.

Manual or Class Rating The manual or class rating method sets rates that apply uniformly to
each exposure unit falling within some predetermined class or group. Everyone falling within a
given class is charged the same rate. For example a class rate might apply to all types of dwelling
of a given kind of construction in a specific city. Rates which apply to all individuals of a given
age and sex are also examples of class rates.

The major areas of insurance that emphasize use of the manual rate making method include life,
automobile, residential fire, etc. For example, in life insurance the central classifications are by
age and sex. In automobile insurance the loss data are broken down territorially by type of
automobile, by age of driver, and by major use of automobile. In each case it is necessary only to
find the appropriate page in a manual to find out what the insurance rate is to be, hence, the term
“manual rate making.”

The obvious advantage of the class rating system is that it permits the insurer to apply a single
rate to a large number of insureds, simplifying the process of determining their premiums. Class
rating is the most common approach in use by the insurance industry today, and is used in
various lines of insurance.

Individual Rating Under individual rating, each insured is charged a unique premium based
largely upon the judgement of the person setting the rate. This rating is supplemented by
whatever statistical data are available and by knowledge of the premiums charged similar
insureds. It takes into account all known factors affecting the exposure, including competition
from other insurers. If the characteristics of the units to be insured vary so widely it is desirable
to calculate rates for each unit depending on its loss producing characteristics.
Managing Claims / Loss Adjustment /
The basic purpose of insurance is to provide indemnity to the members of the group who suffer
losses. This is accomplished on the loss-settlement process, but it is sometimes more
complicated than just passing out money. The payment of losses that have occurred is the
function of the claims department. Life insurance companies refer to those employees who settle
losses as “claim representatives,” or “benefit representatives.” Employees of the claims
department in the field of property and liability insurance are called “adjusters.”

The Adjustment Process

In determining whether to pay or contest a claim, the adjuster follows a procedure with four main
steps: notice of loss, investigation, proof of loss, and payment or denial of the claim. The details
of these steps vary with the type of insurance.

Notice The first step in the claim process is the notice by the insured to the company that a loss
has occurred. The requirement differ from one policy to another, but in most cases the contract
requires that the notice be given “immediately” or “as soon as practicable.” The policy usually
requires that the notice be given in writing. Actually, however, oral notice to the insurer is
usually sufficient unless the insurer or its agent objects.

The insured may also be expected to notify someone other than the insurer. Under a theft
insurance, for example, the insured must tell the police, as well as the insurer, about the loss.

Investigation. The investigation is designed to determine if there was actually a loss covered by
the policy, and if so, the amount of loss. Following the loss the insured should assist the loss
adjuster in the investigation. The adjuster must determine:
Whether the loss actually occurred
Whether it is covered under the contract, and
The extent of the loss

Proof of Loss Within a specific time after giving notice, the insured is required to file a proof of
loss. This is a sworn statement that the loss has taken place, and states the amount of the claim
and the circumstance surrounding the loss. The adjuster normally assists the insured in the
preparation of this document.

Payment or Denial If all goes well the insurance company draws a draft reimbursing the insured
for the loss. If not, it denies the claim. The claim may be disallowed because there was no loss,
the policy did not cover the loss, or because the adjuster feels that the amount of the claim is
unreasonable.

Investment Function
When an insurance policy is written, the premium is generally paid in advance for periods
varying from six months to five or more years. This advance payment of premiums gives rise to
funds held for policyholders by the insurer, funds that must be invested in some manner. When
these are added to the funds of the companies themselves, the assets would add up to huge
amounts. These funds should not remain idle, and it is the responsibility of finance department or
a finance committee of the company to see that they are properly invested.

Not all the money collected by the insurer is to be invested. A certain proportion of it should be
kept aside to meet future claims. However, the need for liquidity may vary from one state to
another.

Organization of Insurers
The type of organization used by a given insurer and the types of departments created depend
upon the particular problems it faces. The most common basis is a centralized management with
departments organized on a functional basis. However, other bases, such as territorial, are
commonly used, often concurrently with the functional type. Thus, the form of organization
adopted depends on the scope of the line of business and the activities performed by the
insurance organization.

Based on the line of business, there are two basic forms of organization of insurers; single line or
product organization and all-line organization. Single line insurance organizations are those who
deal only with one type business, say fire insurance or life insurance only. All-line organization
refers to that type of arrangement by which an insurer may write literally all lines of insurance
under one administrative frame work of a single organization, example, the Ethiopian Insurance
Corporation.