OVER AND UNDER INSURANCE: IMPACTS ON CLAIM SETTLEMENT AND FINANCIAL RISK

Over and Under Insurance: Impacts on Claim Settlement and Financial Risk in India

Introduction

In the context of insurance, over-insurance and under-insurance are crucial concepts that significantly impact claim settlements and financial risks. Both scenarios can lead to financial losses, either for the insurer or the insured, and understanding their implications is vital, particularly in the Indian insurance market.

Understanding Over-Insurance

Over-insurance occurs when the insured value of an asset exceeds its actual value. In India, this situation might arise due to a lack of awareness, improper assessment, or the belief that higher coverage will lead to a larger payout. However, insurance contracts typically contain clauses that limit payouts to the actual value of the loss, which means the policyholder cannot claim more than the actual damage.

Impacts of Over-Insurance

1. Financial Loss for the Insured: Since insurers only pay up to the actual value of the loss, the policyholder pays higher premiums without any corresponding benefit.
2. Increased Premiums: Over-insurance leads to unnecessarily high premiums, which could strain the financial resources of the policyholder.
3. Misleading Financial Security: The insured may falsely believe they are fully protected, leading to financial complacency.

Understanding Under-Insurance

Under-insurance occurs when the insured value of an asset is less than its actual value. This situation is more common in India due to cost-cutting measures, inadequate assessment, or lack of understanding. In the event of a claim, under-insurance can lead to significant financial distress.

Impacts of Under-Insurance

1. Proportional Loss Payment: In cases of under-insurance, claim payouts are often reduced proportionally. This is known as the “average clause” in insurance contracts, where the claim amount is adjusted based on the ratio of the insured value to the actual value.
2. Inadequate Compensation: The insured might receive compensation that is insufficient to cover the full extent of the loss, leading to financial strain.
3. Increased Financial Risk: Under-insurance exposes the policyholder to higher financial risks, as they might have to bear a significant portion of the loss out-of-pocket.

Claim Settlement Process

The claim settlement process is heavily influenced by whether the insured asset is over-insured or under-insured.

1. Assessment of Loss: The insurer assesses the loss and compares it with the insured value.
2. Application of Average Clause: In under-insurance, the average clause is applied, reducing the payout proportionally.
3. Payout Determination: The final payout is determined based on the actual value of the loss, irrespective of whether the asset was over-insured or under-insured.

Financial Risk Implications

Both over-insurance and under-insurance carry significant financial risks.

• For the Insured: Over-insurance leads to higher premiums with no additional benefit, while under-insurance results in inadequate claim settlements.
• For the Insurer: While over-insurance does not usually result in higher payouts, it could lead to a misallocation of resources. Under-insurance, on the other hand, might lead to disputes and dissatisfaction among policyholders, affecting the insurer’s reputation.

In India, understanding the balance between over-insurance and under-insurance is crucial for both policyholders and insurers. Proper valuation of assets and adequate insurance coverage can help mitigate financial risks and ensure fair claim settlements. Policyholders must be educated about the importance of accurate insurance to avoid the pitfalls of over-insurance and under-insurance.