In a normal insurance policy for physical assets there is a standard condition called Condition of Average/ Condition of Underinsurance. This condition essentially balances the interests of the Insurers (Insurance Companies) with that of the Insured ( person/ organisation taking an Insurance policy).
It requires an Insured to declare the total value of his property/ goods & pay applicable premium on that. If a person declares a value less than the correct total value, he is considered as “self-insured” for the difference in values.
Let us understand this with an example- An insurance policy for a godown with goods worth 50 crores is taken for only 40 crores. In case of a total loss- the Insurer shall only pay 40 crores & the insured has to himself bear the loss of 10 crores ( Self Insured). Similarly if there is a loss of say 20 crores, the loss payable by Insurer shall be payable in same proportion (40/50) i.e.. (20 x 40/50)= 16 crores.
From the above examples, we can appreciate the financial need of opting for a value for insurance (Sum Insured) which covers the total value of goods/property & pay premium on it for a full coverage. It can also be easily understood that what one may “save” in premium payment on a lower value can have disastrous effect on the individual/ organisation in event of a claim.
Having understood the need for opting for the correct Total Value for insurance, let us look at the issue from a different perspective. What if the goods are of such nature that it is almost impossible for them to be stolen at the same time. Can an insurance policy be designed that does not require declaring the full value of goods for insurance and paying premium only on that selected percentage of Total property value?
First loss insurance precisely meets the above expectation. For example- if you have a godown storing 1,000 tons of wheat, It can be reasonably expected that there is almost Nil chance of the total wheat being stolen in one attempt. One may expect - say 20% of the total quantity as the maximum value which may be prone to theft/burglary in one incident.
The specific First loss insurance policy designed to cover the above offers a graded scale of premium for opting for different percentages of the total value, thus permitting coverage at a reasonable cost for the customers.
In 2003, the Insurance regulator (IRDAI) advised a set of standard terms for - say a Householders’ policy:
"It is hereby declared and agreed that this policy is issued as the First Loss Insurance up to _____% of the contents of the insured's household (100%) as limits in the schedule attached to and forming part of the policy. It is further declared and agreed that in the event of the total value of contents at risk at the time of loss being greater than the total value declared for purpose of this insurance and incorporated in the schedule, the insured shall be considered as being his own insurer, for the difference, and shall bear a rateable share of the loss accordingly."
It can be easily understood that the Average/ Underinsurance condition remains in the policy as a whole but the Insured can opt for a cover of a specified percentage of it.
The Regulator also indicated the scale of premium for different percentages. These can be used as a guide for policies issued for other insurance products covering theft/ burglary.
| Selected percentage of full value cover | Charging percentage of full value premium |
|---|---|
| Up to 25% | 50% of 0.50 per mille |
| Up to 50% | 70% of 0.50 per mille |
| Up to 65% | 85% of 0.50 per mille |
| Up to 75% | 90% of 0.50 per mille |
| Beyond 75% | 0.50 per mille |
Keeping in mind the specific nature of business & the kind of goods stored, two basic factors that need to be considered are: