Insurance is a risk management tool that provides financial protection to both individuals and businesses against any potential future losses or damages. It is a contractual agreement between the insured and the insurance company. The insured agrees to pay premium in exchange for a promise by the insurance company to pay claims in the event of a loss. The main purpose of any insurance contract is to provide financial security and peace of mind to both individuals and businesses.

A key requirement for issuing any insurance policy is the sum insured or limit of liability. The sum insured represents the financial cap or the highest amount the insurance company will pay in the event of a claim. This amount differs from one policy to another, making it crucial for individuals and businesses to select an appropriate sum insured that aligns with their specific needs and operations when purchasing an insurance policy.

In an insurance contract, the adequacy of the sum insured is determined by the insured or policyholder. It is the policyholder’s responsibility to assess their needs, evaluate the specific risks they face, and estimate the potential financial impact of future losses in order to determine the appropriate level of coverage. While insurance companies and intermediaries can provide advice, guidance, and recommendations based on their industry expertise, they are not responsible for setting the sum insured on behalf of the client. Ultimately, the decision rests with the insured, who must ensure that the sum insured adequately reflects the value at risk.

While it is the insured or policyholder who ultimately determines the sum insured, insurers may establish certain parameters or provide advice to ensure:

1.      The sum insured does not exceed the actual value of the asset or interest, in order to prevent over-insurance and discourage moral hazard.

2.      The sum insured is adequate to provide full coverage, thereby avoiding under-insurance, which could result in the application of the average clause at the time of a claim.