ChapterFiveInspectionandInsurance 5.1Inspection5.2Insurance

5.1Inspection

5.1.1Pre-shipmentInspection

Apre-shipmentinspectionisrecommendedwhengoodsarebeingmadeforthebuyerandthebuyerwishestoensurethatthegoodshavebeenmanufacturedcorrectlyandarenotdefective.Suchaninspectionhelpsavoidafuturedisputeoncethegoodshavearrived.Often,animportlicensewillnotbeissuedinadevelopingcountryunlessapre-shipmentinspectionreportisprovided.

Thebuyercaninsistuponaninspectionofthegoodsuponloadingorearlier,eitherbyitsownagentorbyaqualifiedinternationalinspectioncompany.However,pre-shipmentinspectionscanbeperformedatavarietyofdifferentlevels(andatcorrespondinglyvaryingfeerates).Manycompaniesthatspecializeinperformingsuchinspections,suchasSociétéGénéraledeSurveillance(SGS),willissueaninspectioncertificatewhichthencanberequiredasadocumentnecessarytoobtainpayment.

Oncethebuyerdoesnottakesufficientcareinensuringthatthepropertypeofinspectioniscarriedout,itwillfacedisasterwhenthegoodsarefoundtobedefectiveuponarrival,iftheinspectiondidnotrevealanydefectsnotcausedbydelivery.Inmanyinstances,anot-so-savvybuyerwillsimplyengageanotherwiseunknownlocalagenttoinspectthegoods.Theagentmayperformonlyalimitedvisualinspectionthatmaybeinsufficienttodeterminewhetherthegoodsaredefective.Thereafter,thebuyermayhavetheunpleasanttaskofhavingtoarguethatitsowninspectioncertificatewasdefective.Thebuyerthushasastronginterestinensuringthatthecompanyperformingtheinspectionisreliable.

Ensuringthatapre-shipmentinspectionisperformedisalsoimportanttothesellerasitcanlimititsriskofshippingthegoodsonlytohavethemrejecteduponarrival.Forthisreason,thesellermayhaveaninterestinchoosingtheinspectingagency.

Pre-shipmentinspectionscantakeonamuchmoresignificantrolewiththemanufactureandsaleofcomplexequipment.Inthesetypesoftransactions,inspectionsrequireamoreelaborateprocesstoensurethatbothparties’interestsareprotected.Forexample,thelastthingthesellerofheavycustomequipmentwantsisthebuyertobeabletocanceldeliverybaseduponaninspectionthatdoesnotpermitthesellertherighttorectify.

Ifthegoodsarebeingmanufacturedwithsub-componentsprovidedbyathirdpartymanufacturers,thebuyershouldconsidernegotiatingtheobligationofthesellertoobtainsimilarinspectionrightsofthemanufacturersofthesub-components.

Ifthebuyerdoesnotattendtheinspection,thesellershouldbeabletoperformtheinspection.Intheeventthatthebuyer’sinspectorsfindthatthegoodsaredefective,thesellershouldnegotiatetherighttoremovethedefects,atitsownexpense.Afterthisisdone,thebuyershouldensurethatitisentitledtoasubsequentinspection.

5.1.2Post-shipmentInspection

If,asisthecasethemajorityofthetime,thesellerdoesnotagreetoapre-shipmentinspection,thebuyermustinspectthegoodswhendelivered.Ifthegoodsarenon-conforming,thebuyercanrejectthem.Thisright,however,canbemodifiedbytradecustomorbyagreement.

Ininternationalsales,post-shipmentinspectionsareprudentlytobeavoidedbytheseller,asitmayfindthatithasshippedthegoodstotherequireddestination,withoutpaymentandwithoutpracticalrecoursetothebuyer.Occasionally,apost-deliveryinspectioncertificateisfoundtobearequirementforpaymentunderaletterofcredit.Forthebuyer,evenifpaymenthasbeenmade,thepost-shipmentinspectionmaystillpermitittoavoiddelivery.Thismaybevitallyimportantifthebuyerwouldotherwisehaveliabilityforthedisposalofthegoods,ortoobtainarefund,ortoquicklytriggertheseller’swarrantyobligations.Itistheseller’serrortoassumethatthebuyer’spaymentsignifiesacceptanceofthegoods.

Theprimaryissueishowquicklythebuyermustcompletetheinspectionsoastolawfullyrejectthegoods?Thisisimportanttothesellerbecause,ifithasnotyetbeenpaid,itwillwanttobepaid.Itisalsoimportanttothesellerbecause,whileliabilitycoveragemaybelimitedifthegoodsweredamagedintransit,therearetimelimitationperiodsthatmustbeobservedundertheWarsawConvention(asshortasfourteendays),theHagueRules(asshortasthreedays)andothertransportationrulesinordertopreservearightoflegalactionagainstcarriers.

Typically,thesellerwillnegotiatethemaximumperiodoftime(e.g.,tendays)followingdelivery,duringwhichthebuyercancomplainofdefectsastodiscrepanciesinquantitiesorqualityofthegoods.Therighttorejectdefectivegoodsfollowingapost-deliveryinspectionisusuallylimitedtoashortperiod,whereastheseller’swarrantyobligationtothebuyermaylastforseveralyears.Thereisoftenmisunderstandingoverwhentherighttorejectthegoodsceasesandtheissueofdefectivegoodsbecomesawarrantyissue.Thisconfusioncanbeavoidedbyensuringthattherighttorejectisclearlylimitedtoonlyseveraldays,orbyhavingnorighttorejectbutonlyrelianceontheseller’swarranty.

Wherecomplexorheavyequipmentisbeingsold,thesellerwillhaveapracticalinterestinattendingthepost-shipmentinspection,knownasan“open-packageinspection”.Thispermitsthesellertosatisfyitselfthattheinspectionwasproperlycarriedout.Thereisoftenaholdbackoffundspendingasatisfactorypost-deliveryinspection.Wheretheselleragreestoapost-shipmentopen-packageinspection,itshouldensurethattheconsequencesofsuchaninspectionareclearlydefined,andthattheinspectionconclusivelysatisfiesitsquantityobligations,ifnotitswarrantyobligationsastoquality.

Wherethereisnospecificwarrantyprovidedforthegoods,intheeventthattheCISGapplies,itspost-deliveryinspectionprovisionsbecomeofgreatimportance.Thebuyerisrequiredto“examinethegoods,orcausethemtobeexamined,withinasshortaperiodasispracticableinthecircumstances.”Ifthegoodsareredirectedandthesellerknowsthatit’sthebuyer’sintention,theexaminationcanbedeferreduntilthegoodshavearrivedattheirdestination.Thebuyermustgivenoticetothesellerwithinareasonabletimeafterithasdiscoveredthedefectoroughttohavediscoveredit.

Thequestionbecomes“whatisareasonabletime?”Manycaseshaveaddressedthisquestion,withlittleguidanceotherthantosuggestthatthebuyershouldactfast.

Whenthepost-shipmentinspectionrevealsthatthegoodsaredefective,thetwosideshaveverydifferingpositions.Theseller,atbest,wantsthepost-deliveryinspectiontobesimplyatriggeringeventforitswarrantyobligations(ifany),toreplaceorrepairthegoods.Particularlyifthegoodsarecomplexorrequiresignificantshippingexpense,orcanspoil,itisnotintheseller’sinteresttopermitthebuyertorejectthegoods.Ontheotherhand,thebuyerneedstobeabletorejectdefectivegoodsandsendthembackorgetapricereduction,atthebuyer’soption.

Alternatively,ifthebuyerispreparedtoacceptthegoods,thebuyershouldbecompensatedforallofthedamagesthatflowfromtheseller’sfailuretosupplythegoodsaspromised.Ifthesellerispreparedtoagreetothis,itshouldlimitthebuyer’sdamagestodirectdamagesonly,andshouldexcludedamageswhichareincidentalorconsequential,asthesecanbemuchhigher.Ifthebuyerisinaparticularlystrongbargainingposition,itcaninsistthatthesellerberesponsibleforalldamages,evenifitrejectsthegoodscompletely.Tomakeapropernotice,asmuchdetailaspossibleshouldbegiventothesellertoidentifythenon-conformity.

5.1.3Pre-shipmentInspectionvs.Post-shipmentInspection

Somecontroversyhasarisenastowhetherpre-shipmentinspectionismoresuitedtotheneedsofgovernmentsthanpost-shipment,ordestinationinspection.Intheend,mostargumentsaboutPSIversusdestinationinspectionreducetothequestionofwhetherPSIoratraditionalcustomsserviceispreferred.Destinationinspectionsarethesamethingasnormalcustomswork,theonlyquestionbeingwhoactuallyperformsthetask.AssumingthealternativestochoosefromareanormalPSIserviceandanequivalentservicebasedondestinationinspectionscarriedoutbyaPSIcompanyorsimilarentity,thereappeartobefourbasicargumentswhyPSImightbepreferred.

First,PSIoccursbeforetheownershipofgoodshaspassedfromthesellertothebuyerandbeforeshipment,makinganynecessarycorrectiveactionsonbehalfofthesellerortheauthoritieseasierthantheywouldbeinthecontextofdestinationinspections.Thisconsiderationwouldbeparticularlyrelevantincasesofover-invoicing,bothfromthepointofviewoftheauthorities,andthebuyerifheisnotinvolvedinacollusivearrangement.Asimilarargumentwouldapplyinthecaseoffraudperpetratedagainstabuyerviaquantityorqualitymanipulation.

Second,afargreaterdegreeofphysicalinspectionispossibleunderPSIthaninthecaseofdestinationinspections.Becausetheformeriscarriedoutwhengoodsarebeingpackedorpreparedforshipment,whilethelatterusuallynecessitatestheunloadingandreloadingofcontainers—atime-consumingprocedurelikelytocongesttheportsunlessundertakenonaveryselectivebasis.

Third,performingPSIinthemarketoftheexportergivespriceverifiersbetteraccesstopriceinformationwhenassessinginvoicevalues,andalsopermitstherealizationofeconomiesofscaleintermsofthespecializedskillsofPSIpersonnel.

Fourth,PSIgeneratesparallelandindependentinformationontradeflowsandtaxesowedinamannerthatdestinationinspectionscannot.AllthereasonsadducedaboveforpreferringPSItodestinationinspectionslosetheirvaliditywhenthecaseforPSIlosesitsvalidity—thatis,whencustomsisperformingtoacceptablestandards,whenbuyersarebetterequippedtolookaftertheirowninterests,andwhenover-invoicingbecomeslessprevalent.

Whataretheadvantagesofdestinationinspection?Theserelatetosuchmattersastraining,andskillsandtechnologytransfer.Aprogramofdestinationinspection,jointlyperformedbythenationalcustomsserviceandaprivateentitymaywellproveusefulinthatcontext.Butdestinationinspectionisnotasubstituteforpre-shipmentinspection,forthereasonslistedabove.Anotherargumentrelatestocost,andthepossibilitythatadestinationinspectionservicecouldbeperformedatlesscostthanpre-shipmentinspection.NogovernmentshaveoptedfordestinationinspectionasasubstituteforPSI,althougharolefordestinationinspectioninthecontextofreducedrelianceonPSIshouldnotberuledout.

FornormalPSIoperations,aproblemarisesiftheauthoritiesoftheimportingcountrypermitimporterstooptfordestinationinspectionratherthanPSI,asthisunderminesthesecurityandefficiencyoftheprogram.Ifgiventheopportunity,someimportersarelikelytooptfordestinationinspectioninthehopeofevadingtaxes.ButanotherobviousmotivationfordoingsoistoavoidtransactioncostsanddelaysassociatedwiththePSIprocess.EfficientdeliveryofPSIserviceswillweakenthelattermotive.

5.1.4ThePre-shipmentInspectionIndustry

TherearefivefirmsactiveinthePSIindustry,althoughanumberofotherssometimesbidonPSIcontracts,andmayenterthemarketinthefuture.ThefiveareBIVACInternationalofParis,COTECNAofGeneva,InchcapeInspectionandTestingServicesInternational(ITSI)ofLondon,InspectorateAmericafromHouston,andSociétéGénéraledeSurveillance(SGS)ofGeneva.Thesecompaniesareeitherdirectlyinvolvedincommercialinspectionofonesortoranother,orareaffiliatedwithcommercialinspectionenterprises.

Thecommercialactivities,whichhavebeencarriedonformanyyears,providethebasisofexpertiseandtheinternationalinfrastructureforthegovernmentPSIcontracts.ThelargestofthePSIcompanies,SGS,hasover130affiliatedenterprises,withapresenceinmorethan140countries,andemploysapproximately30,000people.ThePSIcompaniesaremembersofthePre-shipmentInspectionCommitteeoftheInternationalFederationofInspectionAgencies(IFIA),throughwhichthemembersconsultandcoordinateoncertainissues.TheprerequisitesformembershipofthePSICommitteeareIFIAmembershipandpossessionofatleastonegovernmentPSIcontract.Amongitsactivities,theCommitteehasestablishedaCodeofPracticeforGovernmentMandatedPre-shipmentInspection.

Incontrasttocommercialinspection,comprehensivegovernment-mandatedPSIisnotaparticularlyoldindustry,andwaspioneeredbySGSinthe1960s.Theearliestgovernmentcontractwassignedin1963withtheGovernmentofZaire.TheindustrycontinuestobedominatedbySGS,andnewcompaniesonlybegantosecuregovernmentcontractsinthemid-1980s.Forthefirstfifteenyearsorsooftheindustry'sexistence,PSIserviceswereconcernedexclusivelywithcapitalflight.Exchangecontrolsandforeignexchangerationingwerepervasiveindevelopingcountriesatthistime,andgovernmentsbelievedthattheover-invoicingofimportswasamajorvehicleofcapitalflight.

ItwasnotuntiltheIndonesiancontractof1985thatcustomsworkenteredthepicture.Sincethen,theemphasisonPSIhasshifteddramatically,tothepointwhereconcernwithover-invoicinghasbecomealmostresidual,althoughmostcurrentPSIcontractsstillembodybothcustomsandcapitalflightwork.Thischangeisaclearreflectionofpolicydevelopment.Asmoreandmorecountrieshavedispensedwithcapitalcontrolsandliberalizedtheirtraderegimes,governmentshavebecomeincreasinglypreoccupiedwithtaxevasion.

5.1.5ChoiceoftheInspector

Ininspectingtheproductstoimport,animportereitherreliesontheexporter’sself-inspection,hasanimporter’sagentconductaninspectionpriortoshipment,orhiresanindependentthird-partyinspector.

Forproductsfromreliablemanufacturers,themanufacturer’sinspectioncertificatealoneissufficient.Reliablemanufacturershaveabuilt-inqualitycontrolandself-inspectionsystem.Reliablemanufacturersprovidebuyerswithafter-saleservicesandwarranties.

Forproductsfromdevelopingcountries,especiallyfromemergingmanufacturerswhoarenotyetwellestablished,theimportershouldhaveaninspectionpriortoshipmenteitherbyhisagentorbyanindependentthirdparty.Havingone’sowninspectorstationedattheoverseasfactoriescostsalot.Aninspectionisconductedonarandombasisinsteadof100percentinspection.Itwouldbeverydifficultforanimportertobecompensatedfordefectsofproductsthathavepassedtheimporter’sinspectionatthefactory.

Forsophisticatedproducts,importersrelyonathird-partyinspectiontomaintainthequalityoftheimportedgoodsbyhiringaprofessional,qualifiedinspectorwhocanbackuptheinspectionfinanciallyandlegally.Thethird-partyinspectorsshouldbefinanciallystrongenoughtoberesponsibleforanyinspectionmistakes.

Thethird-partyinspectorsconductthree-stageinspectionswhichare(1)aninitialproductioncheck,(2)aduringproductioncheck,and(3)afinalrandominspectionpriortoshipment.Theydolaboratorytestingtocheckconformancetospecificationsorstandardsrequiredbytheimporter,andon-siteinspectiontooverseeproduction.

5.1.6TheBasicMechanicsofPSI

TherearemanyvariantsontheprecisemodalitiesofPSI,dependingonthepracticesoftheprovider,establishedimportprocedures,andthecontractualrequirementsoftheclient.Itisuseful,however,toprovideabriefgeneralexplanationofthebasicsofthesystem.AlthoughPSImayapplytoimportsorexports,thediscussionherefocusesontheimportside.Pre-shipmentinspectionofimports,asthenamesuggests,isaserviceperformedinthecountryofexportpriortoshipmentofmerchandisetotheimportingcountry.

Certainaspectsofthedeliveryoftheservicedo,nevertheless,havetobeperformedintheclientcountry.Therearetwodiscreteaspectsoftheservice—physicalinspectionandpriceverification.Thephysicalinspectionisdesignedtoconfirmtheinformationprovidedbytheexporterinthesaleinvoice,thecontract,orintermsofanyotherpertinentdetailsordocumentation.Theinspectiontakesplaceatthesiteofproduction,warehousingand/orshipment.

Thepriceverificationexercisefocusesonthedeclaredinvoicepriceofthegoods,comparingthiswith“theprice(s)ofidenticalorsimilargoodsofferedforexportfromthesamecountryofexportationatoraboutthesametime,undercompetitiveandcomparableconditionsofsale,inconformitywithcustomarycommercialpracticesandnetofanyapplicablestandarddiscounts.”Thepriceverificationisundertakenseparatelyfromthephysicalinspection,butmayrelyinpartonconfirmationfromthephysicalinspectionthatthemerchandiseinquestioncorrespondstothedescriptiongivenintheproformainvoice.Insomecontracts,apreliminarypriceverificationexerciseisundertakenpriortothephysicalinspection,andsubsequentlyconfirmedinlightoftheinspection.

Pre-shipmentinspectionservicestypicallycoverallimports,exceptthoseexplicitlyexemptedinthecontract.Most,ifnotall,contractsspecifyathresholdvaluebelowwhichgoodsareexemptfrompre-shipmentinspection.Inaddition,certaincategoriesofgoods,suchasnewspapersandperiodicals,personaleffects,diplomaticgoods,defensesupplies,andfreshproduceareoftenexcludedfrominspectionrequirements.

ThefollowingisastylizeddescriptionofthedifferentstepsinthePSIprocess:

(1)Upondecidingtoimport,theimportercompletesthenecessarydocumentaryformalitiesoftheimportauthorities,arrangespaymentprocedureswithacommercialbank(usuallybyopeningaletterofcredit),andnotifiesthelocalofficeofthePSICompanyoftheintentiontoimport.TheimportermustprovideacopyofproformainvoicetothePSICompany(indicatingdetailsofthetransactionandoriginofthegoods)andanyotherinformationordocumentaryrequirementsspecifiedaspartofthePSICompany’sarrangementswiththegovernment.

(2)ThelocalofficeofthePSIcompanymakesapreliminarydeterminationregardingtheeligibilityoftheproposedtransactionandtransmitsaninspectionorder(usuallybyelectronicmeans--electronicdatatransfer,orEDT)toitsaffiliateinthecountryfromwhichthegoodsarebeingshipped.

(3)Theaffiliatecontactstheexporter(ifcontacthasnotalreadybeenmade),seeksrelevantinformationabouttheproposedshipment,andarrangesthetimeandplaceforaphysicalinspection.Suchinformationmayincludeproformainvoice,pricelist,transportcost,copiesoflettersofcredit,technicalliteraturepertainingtotheproduct,packinglists,informationaboutcommissionspayabletothirdparties,andshippingdetails.Theaffiliatealsoundertakespriceverification,tariffclassification,andanyothertaskscontractuallyspecified(suchascalculatingtaxesdueorensuringcompliancewithlocalregulations,althoughthismaybedoneinconjunctionwiththelocaloffice).

(4)UponsatisfactoryPSI,andproductionofthefinalinvoiceandproofofshipmentbythesupplier(thelatterisnotalwaysaprerequisite),theaffiliatetransmitsaReportofFindings(ROF)tothelocalPSIofficeintheimportingcountrybyEDT.TheaffiliatealsoissuesanROFtotheseller,whichisanegotiabledocumentrequiredinorderforthecommercialbankintheimportingcountrytoauthorizereleaseoffundsinpaymentforthegoods.Insomecases,acustomsdutyreportmaybeseparatelyfurnished.

IfPSIprovesunsatisfactory,thesuppliermaymakethenecessaryadjustments(forexample,totheinvoicepriceinthecaseofover-invoicing),orthePSIcompanywillissueanon-negotiableROF.Incasesofunder-invoicing,thereisnoreasontoadjusttheinvoiceprice,andthePSICompanywillsimplyindicateadutiablevaluedifferentfromtheinvoicepriceontheROF.

(5)ThelocalofficeofthePSICompanyissuestheROFtotheimporterfordutypaymentandcustomsclearancepurposes,andalsofurnishescopiestotheimporter'scommercialbank,andtherelevantgovernmentauthorities(customs,thecentralbank,etc.).

(6)Theimporter(orimporter’sagent)payscustomsdutiesandtaxesdue(sometimestoacommercialbankasapriorconditionofcustomsclearance)andclearsthegoodsthroughcustoms,withtheROF,proofofpaymentoftaxesdue,theimportentryform,andotherrequireddocuments.

5.1.7InspectionDocuments

Inspectiondocumentsmayberequiredbyexportandimportauthoritiesaswellasbytheimporter/buyerpriortoshipment.Someofthesedocumentsareintroducedbrieflybelow:

1.InspectionCertificate(generallyissuedbyathird-partyindependenttestingcompany)

Thisdocumentoffersindependentproofofproductquality,quantityoradherencetocertainspecifications.Itisoftenrequiredbytheimporterortheimportauthorities.Itmayalsoberequiredbycertainnationsasameansofcontrollingfraudulenttransactionsthatcircumventexchangecontrolregulations(e.g.,overstatedquantitiesorunder-declaredvaluations).

Animportlicensemayrequirea“CleanReportofFindings”byanauthorizedinspectionorganizationbeforethegoodscanclearcustomsorpaymentcanbemade.

2.QualityCertificate(generallyissuedbyathird-partyindependenttestingcompanyorgovernmentagency)

Thisdocumentcertifiesthattheproductscontainedintheshipmentmeetthestandardsoftheimportingcountry.Mostcountriesrequirethatthiscertificationbeprovidedbytheexporterandbeapprovedandfiledbytheappropriategovernmentalcontrolagency(e.g.,DepartmentofConsumerSafetyintheexportingcountry)priortoshipment.

3.PhytosanitaryCertificate(generallyissuedbyathird-partyindependenttestingcompanyoragovernmentauthority)

Thisdocumentcertifiesthatashipmentofplantsorplantproducts(i.e.,seeds,bulbs,flowers,fruits,vegetables,etc.)isfreefrompestsordisease.Thiscertificatemayrequireon-siteinspection(s)duringthegrowingseasonandisusuallyprovidedbytheAgriculturalMinistryofthecountryofexport.Insomeinstances,thecertificatemaybeprovidedbyanauthorizedprivatecompany.

4.FumigationCertificate(generallyissuedbyathird-partyindependenttestingcompanyoragovernmentauthority)

Thisdocumentoffersproofthatwood-basedpackingmaterials,usedclothingorpackaging(e.g.,coffeeorcocoabeanbags),andcertainothercommoditieshavebeenfumigatedorsterilizedtokillanypests.Thesecertificatesareissuedbyprivatecompaniesauthorizedtocarryouttheseproceduresandincludedetailsofthespecificprocess,temperaturerange,chemicalsandconcentrationsused.

5.VeterinaryCertificate(generallyissuedbyathird-partyindependenttestingcompanyoragovernmentauthority)

Thisdocumentcertifiesthatashipmentofliveanimalsorfresh,chilledorfrozenmeats(andsometimescannedmeats)hasbeeninspectedfordisease.

6.PublicHealthCertificate(generallyissuedbyathird-partyindependenttestingcompanyoragovernmentauthority)

Thisdocumentcertifiesthatashipmenthasbeeninspectedfordisease.

5.2Insurance5.2.1Definition

Thereisnosingledefinitionofinsurance.Insurancecanbedefinedfromtheviewpointsofsuchdisciplinesaslaw,economics,history,actuarialscience,risktheory,andsociology.Buteachpossibledefinitionwillnotbeexaminedatthispoint.Instead,wewillexaminethosecommonelementsthataretypicallypresentinanyinsuranceplan.Beforeproceeding,aworkingdefinitionofinsurance—onethatcapturestheessentialcharacteristicsofatrueinsuranceplan—mustbeestablished.

TheCommissiononInsuranceTerminologyoftheAmericanRiskandInsuranceAssociationhasdefinedinsuranceasfollows:

Insuranceisthepoolingoffortuitouslossesbytransferofsuchriskstoinsurers,whoagreetoindemnifyinsuredforsuchlosses,toprovideotherpecuniarybenefitsontheiroccurrence,ortorenderservicesconnectedwiththerisk.

Althoughthislengthydefinitionmaynotbeacceptabletoallinsurancescholars,itisusefulforanalyzingthecommonelementsofatrueinsuranceplan.

5.2.2BasicCharacteristicsofInsurance

Basedontheprecedingdefinition,aninsuranceplanorarrangementtypicallyincludesthefollowingcharacteristics:

1.PoolingofLoss

Poolingorthesharingoflossesistheheartofinsurance.Poolingisthespreadingoflossesincurredbythefewovertheentiregroup,sothatintheprocess,averagelossissubstitutedforactualloss.Inaddition,poolinginvolvesthegroupingofalargenumberofexposureunitssothatthelawoflargenumberscanoperatetoprovideasubstantiallyaccuratepredictionoffuturelosses.

Ideally,thereshouldbealargenumberofsimilar,butnotnecessarilyidentical,exposureunitsthataresubjecttothesameperils.Thus,poolingimplies(1)thesharingoflossesbytheentiregroup,and(2)predictionoffuturelosseswithsomeaccuracybasedonthelawoflargenumbers.

2.PaymentoffortuitousLoss

Asecondcharacteristicofprivateinsuranceisthepaymentoffortuitouslosses.Afortuitouslossisonethatisunforeseenandunexpectedandoccursasaresultofchance.Inotherwords,thelossmustbeaccidental.Thelawoflargenumbersisbasedontheassumptionthatlossesareaccidentalandoccurrandomly.Forexample,apersonmaysliponanicysidewalkandbreakaleg.Thelosswouldbefortuitous.Insurancepoliciesdonotcoverintentionallosses.

3.RiskTransfer

Risktransferisanotheressentialelementofinsurance.Withtheexceptionofself-insurance,atrueinsuranceplanalwaysinvolvesrisktransfer.Risktransfermeansthatapureriskistransferredfromtheinsuredtotheinsurer,whotypicallyisinastrongerfinancialposi