Insurance Companies in Nigeria and around the world operate in the financial services sector. The business of insurance involves the insurance company guaranteeing replacement or repairs or a shorty for an asset or service that may have been damaged or impaired or defaulted under terms and conditions in exchange for a premium. This article is aimed at understanding how insurance works in Nigeria.
One of the financial services major players in Nigeria is the Insurance sector. Usually, insurance firms are the quietest in Nigeria. This is majorly because Nigerians do not see the inevitable need to ensure their assets.
The business of insurance is simply providing a comprehensive guarantee to replace or repair or shorty for an asset or service that may have been damaged or impaired or defaulted under terms and conditions in exchange for a periodic premium.
For instance, an insurance company insures your vehicle against theft or damage by accident by replacing it or repairing it at no additional cost to you in exchange for a premium you have paid upfront.
How insurance works
In the instance above, if the value of the asset insured is N10million, your premium (to be paid to the insurance firm) would have been about N500k. If your insured item gets stolen or damaged in an accident beyond your control, you are liable to get the fully insured N10million towards a possible repair or a replacement of the item depending on the insurance policy type.
A premium is a fee a client pays the insurance company and it has a validity of one year. This means one has to pay a “premium” yearly. If during a certain year, you have experienced neither mishaps nor accidents to trigger a claim, the insurance company does not return any part of the premium to you. This is what an insurance company does. However, processes might have marginal differences in different companies. This is key to understanding how insurance works in Nigeria.
Despite a huge possibility to make infinite profit from unclaimed premiums, the risk involved in this business model must also be monitored. Imagine if a surge of mishaps had happened and clients decide to lay claims to their full insured amounts.
Understanding components of an Insurance Policy
An insurance policy is a contract that defines the obligations of both the insured and the insurer. Most insurance policies contain terms that are hard to understand and policies are often written in a confusing manner. Taking the time to understand your policies is well worth the effort. Besides providing coverage, policies also assign certain responsibilities to the insured. Your failure to meet these obligations may impair the coverage your nonprofit relies on for protection. Every insurance policy has five parts: declarations, insuring agreements, definitions, exclusions and conditions.
In policy writing, contextual meanings are embedded in a different vocabulary.
This is meant to convey the exact meanings intended in the agreement. This is key to understanding how insurance works in Nigeria. Below are 15 of the most-used terms:
- Insured– The person(s) or asset(s) covered by the insurance policy.
- Premiums – The monthly or annual amount that you must pay in order to have the insurance coverage.
- Face Amount– The dollar amount that the insurance policy would payout upon the death of the Insured.
- Primary Beneficiary– The person(s) designated to receive the proceeds of the life insurance policy upon the death of the Insured.
- Contingent Beneficiary– The person(s) designated to receive the proceeds of the life insurance policy if the Primary Beneficiary is no longer living.
- Term Life Coverage– The type of coverage that lasts for only a specified period of time (the “term”) and has a defined ending date. The face amount would be paid to the designated beneficiary if the Insured dies while the policy is in force.
- Whole Life Coverage– The type of coverage that can last for as long as the Insured is alive, provided that all of the premiums are paid. This type of coverage usually keeps the same premium rate throughout the life of the policy.
- Co-payment– A flat fee that you must pay toward the cost of medical visits, your insurance provider pays the remaining balance. For example, you could be responsible for a N20k co-pay for each visit to the doctor.
- Coinsurance– The percentage that you must pay to share responsibility for your medical claims after you meet your annual deductible. For example, your insurance provider might
- Deductible– The amount of money that you must pay out of pocket for damages sustained, such as in a collision or a medical expense, before your insurance kicks in and starts to make payments.
- Collision Coverage– The type of coverage that pays for the damages to your vehicle sustained as a result of a collision with another vehicle or object.
- Comprehensive Coverage– The type of coverage that pays for damage to your vehicle sustained as a result of fire, theft, vandalism, or various other stated causes.
- Bodily Injury Coverage– The type of coverage that pays for medical expenses and/or funeral costs of other individuals injured, or killed, in an accident for which you are liable.
- Medical Payments Coverage– The type of coverage that pays for medical and funeral expenses for anyone covered under your insurance policy in the event of an accident, regardless of fault.
- Uninsured Motorist Coverage– The type of coverage that pays for injuries, including death, which you and/or other occupants of your vehicle sustain as a result of a collision with an uninsured driver who is at fault.
Underwriting Profit/Income Channels
Insurance Companies make net income in two major ways;
- Net Premium Income
Net Premium Income
Net premium income is the income the insurance company records after deducting claims, operating costs, and taxes against the gross premium in a particular year. This is called Underwriting Profit. This is key to understanding how insurance works in Nigeria.
This is how insurance companies make underwriting profits via net premium. For instance, the insurance company receives a premium of 5% for 100 cars worth N2million each. This means the insurance company is taking a promissory risk to refund all their clients’ insured N200million with a premium of mere N10million in case of mishaps! Usually though, less than half of clients usually come in for claims.
If during a given financial year, claims paid sum up to about N5million, the insurance company would have paid this from their N10million premium. Then their underwriting profit is N5million. View this on a much larger scale, because insurance companies actually usually have thousands of customers in their clientele running various policies. This is key to understanding how insurance works in Nigeria.
This is the other channel, possibly the more lucrative one. Remember that insurance company above received N10million, in exchange for a commitment to pay claims. These premiums are interest-free i.e they are not paying anybody to have these monies.
Rather than allow the premiums lay idle, they invest these premiums in several securities such as eurobonds, shares, treasury bills, private equity, real estate etc. Whatever income derived from these investments is also termed Underwriting Profits. This is similar to pension funds models – they invest with idle pension premiums which run into billions of dollars.
Premiums are purely cash backed and free of interest making them one of the most liquid armories required for investing.
Of course, insurance companies can also make underwriting losses. In fact, this sector is very volatile and easily susceptible to major mishaps.
In cases where an insurance company is restricted only a percentage of the entire customers in the sector due to rife competition, their pool funds and total premium will take the same lean shape! This affects their profit, investing power, the entire pool of funds, everything basically. Some competitors make this even harder by giving massive premium discounts to customers simply because they can afford to do it. This is key to understanding how insurance works in Nigeria.
Also, a surge of claims can push an insurance company to a loss position. Referring to the instance given earlier, if that insurance company pays huge claims from their earned premium of N10million, they will have very little money left. After deducting capital and operating expenses, salaries and taxes, they could be looking at a huge loss!
What should investors look out for?
An investor must look beyond the usual paparazzi of the market. These are basic ways to judge an insurance outfit:
- Inclining (not static) underwriting profits
- Sound risk assessment and management model
- Tactical claims investigations
- Increased investment incomes
- They must post increasing net profits