Over-insurance

Insurance has a job: put the insured back where they were before a loss, no better and no worse. That is the Principle of Indemnity, insurance should restore the financial position, not create a profit.

Over-insurance breaks that balance from the other side. Instead of leaving risk with the insured, which is under-insurance, it pushes cover beyond what is genuinely needed. The workbook's own contrast: under-insurance means the person likely to suffer a loss is retaining part of the risk themselves, while over-insurance imposes unnecessary costs in the form of higher premiums, for cover that adds nothing at claim time.

For an indemnity policy, health, motor, property, over-insurance is largely wasted money. Because indemnity pays the actual, ascertained loss and never more, buying a sum insured far above the asset's real value does not increase what gets paid on a claim. It only increases the premium charged every year for a limit that will never be used.

The workbook's process for estimating insurance coverage is the direct antidote: consider the future value of the cost being replaced, the period protection is needed for, and the ability to bear the cost of insurance, sizing cover to the actual exposure rather than rounding up out of caution. The same section notes that a genuinely small extra cost can sometimes buy meaningfully more cover, its own example being that Rs 2,400 a year extra buys 10 more years of a term plan, the opposite problem from over-insurance, where extra premium buys nothing at all.

Ms Pillai's flat and its contents are worth Rs 40,00,000. She insures it for Rs 70,00,000, believing more cover means more safety.

If a fire destroys the flat, the indemnity principle pays her the actual loss, around Rs 40,00,000, regardless of the higher sum insured. The extra Rs 30,00,000 of cover has bought her nothing at claim time; it has only meant a higher annual premium for years, on a limit she could never legitimately claim against.

Compare under-insurance: had she insured the same flat for only Rs 20,00,000, an average clause, a common non-life provision, would reduce even a full-loss payout proportionately, and she would then be bearing part of the risk herself. Correct sizing sits between these two errors, at roughly the asset's real value.

Chapter 1 (Basics of Insurance), in the section on estimating the amount of insurance required, defines under-insurance and over-insurance as the two ways a sum insured can be wrongly set, immediately after stating the Principle of Indemnity. Expect a question pairing the two terms and asking which cost each one imposes, retained risk for under-insurance, wasted premium for over-insurance.

• Over-insurance does not increase the claim payout on an indemnity policy. The insurer still pays only the actual, ascertained loss.
• The cost of over-insurance is the premium, not a claims loss. It is a slow, ongoing cost, not a one-time risk.
• Under-insurance and over-insurance are opposite errors, not two names for the same problem. One retains risk, the other wastes money.
• A defined-benefit policy, such as life insurance or personal accident, behaves differently. Because it pays a pre-fixed sum regardless of actual loss, over-insurance in that context is really a question of adequate need-based sizing, not indemnity waste.