Banking Secrets: Why Pay More? Part III

Banking Secrets: Why Pay More? Part III

What is indemnity?

Indemnity means compensation for loss, damage, or injury. It’s a contract where one party agrees to pay for the losses or damages incurred by another. Usually, this stems from a contractual obligation to protect against liability, loss, or damage. Simply put, insurers pay to reinstate or replace damaged property, typically in cash.

What is Reinstatement?

Reinstatement means the insurer rebuilds the damaged property to its original state before it was destroyed. From an insurer’s perspective, rebuilding is often tedious and time-consuming. Therefore, insurers prefer to indemnify in cash.

Example 1: Home Insurance

Mr. and Mrs. Tan bought a house with a 90% loan margin and insured it for RM630,000. They paid the premium diligently. Ten years later, a fire destroyed their house. The insurer paid the bank first, leaving them with a small balance. They were left with no house and an outstanding loan. This highlights the importance of understanding indemnity and whose interest is truly protected.

Example 2: Car Insurance

Mr. Lee insured his car for RM100,000, even though its market value was only RM60,000. After an accident, the insurer compensated him based on the car’s market value, not the insured amount. The extra premium he paid was essentially wasted. This emphasizes the need to insure assets for their true value to avoid unnecessary expenses.

Car Loan Example

Let’s say you buy a new car worth RM 100,000 with a 90% loan. The bank offers a hire-purchase agreement at a 4% interest rate. You need to insure the car for the loan amount plus interest, so:

Loan Amount: RM90,000 (90% of RM100,000) Interest (5%): RM4,500 (90,000 x 0.05) Total Insured Amount: RM94,500

If the premium rate is RM0.17 per hundred, the total premium will be:

Total Premium: RM160.65 (94,500 x 0.17/100)

You end up paying a premium based on a higher value than the market value of the car, which is RM100,000. This leads to paying extra on your premium unnecessarily.

Example 3: Commercial Property Insurance

Mrs. Lim owned a commercial property insured for RM2 million. The property was originally used as office space. She later leased it to a manufacturing company without informing the insurer. A fire broke out, causing significant damage. The insurer denied the claim due to the change in the building’s use, which increased the risk. Mrs. Lim had to cover the losses herself. This underscores the need for clear communication with insurers.

Problems of Over-Insurance and Under-Insurance

Over-Insurance

Mr. Tan: “Why does over-insurance matter?”

Agent: “When you’re over-insured, you pay for coverage you don’t need. If your property is worth RM500,000 but you insure it for RM1,000,000, you’re paying extra premiums unnecessarily. In case of a loss, the insurer will only pay up to the actual value, not the insured amount.”

Under-Insurance and the Average Clause

Mr. Tan: “What about under-insurance?”

Agent: “If you’re underinsured, you’re at risk of not being fully covered. For instance, if your property is worth RM1,000,000, but you only insure it for RM500,000, you face significant out-of-pocket costs if there’s a loss. Let me explain the average clause in simple terms.”

The average clause applies when you are underinsured. It means that the insurer will only pay a proportionate amount of the claim based on the ratio of the insured value to the actual value. For example, if you suffer a loss of RM600,000 and the insured value is RM500,000 for a property worth RM1,000,000, the insurer will pay:

Insurance payout = (Insured Amount / Actual Value) x Loss = (RM500,000 / RM1,000,000) x RM600,000 = 0.5 x RM600,000 = RM300,000

So, you would receive RM300,000 from the insurer, and you would have to cover the remaining RM300,000 yourself.

Market Value and Agreed Value

Market Value: This is the current value of the car in the market, considering depreciation. It’s the price you would get if you sold the car today.

Agreed Value: This is the amount agreed upon by both the insurer and the insured at the start of the policy. It’s typically higher than the market value to cover the full cost of replacement or repairs.

Who’s interest is protected?

Mr Tan: “Why does the bank get paid first?”

Agent: “The bank’s interest is protected first because they hold the mortgage.”

Mr. Tan: “Is that fair to the insured?”

Agent: “It can seem unfair, but the insured must disclose all changes to ensure proper coverage.”

Living Example: Business Insurance

Imagine a small business owner, Ms. Cheng, who insures her bakery for RM200,000 even though it’s valued at RM400,000. A fire causes RM100,000 worth of damage. Due to underinsurance and the average clause, the insurer pays only half of the claim:

Insurance payout = (Insured Amount / Actual Value) x Loss = (RM200,000 / RM400,000) x RM100,000 = 0.5 x RM100,000 = RM50,000

Ms Cheng receives RM50,000 and must cover the remaining RM50,000 herself, highlighting the risks of underinsurance.

Conclusion

Understanding indemnity and the average clause ensures that you are adequately protected. Overinsurance leads to unnecessary premiums, while underinsurance exposes you to significant losses. Both the insured and the bank must maintain and disclose accurate information to ensure fair dealings. Educational campaigns, public awareness, and clear policy communication can help prevent misunderstandings and protect all parties involved.

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