Insurance & Risk

Management
 Basic Queries
• What will be the contribution of this paper
in my carrier as finance professional?
• Why do we need to study Insurance?
• What are insurance services?
 WHAT IS RISK?
• Risk is defined as uncertainty concerning the
occurrence of a loss.
• Objective Risk: the relative variation of actual
loss from expected loss. Objective risk declines
as the number of exposures increases. More
specifically, objective risk varies inversely with
the square root of the number of cases under
observation.
• Subjective Risk :uncertainty based on a
person’s mental condition or state of mind.
 Categories of Risk
• Pure and Speculative risks
• Types of Pure Risk
– Personal risk
• Risk of premature death or disability
• Risk of insufficient income on retirement
• Risk of unemployment
– Property risk
• Direct Loss
• Indirect or consequential loss
– Liability risk
• Fundamental and Particular Risks
 Chance of loss
• Chance of loss is defined as the probability that an event will
occur.
• Objective Probability
– deductive reasoning
– inductive reasoning
• Subjective Probability
• Chance of Loss distinguished from Risk: For example,
assume that a fire insurer has 10,000 homes insured in
Mumbai and 10,000 houses insured in Delhi. Also assume
that the chance of loss in each city is 1 percent. Thus, on an
average, 100 homes should burn annually in each city.
However, if the annual variation in losses ranges from 75 to
125 in Mumbai, but only from 90 to 110 in Delhi, objective risk
is greater in Mumbai even though the chance of loss in both
cities is the same.
 Insurance and society
• Risk to society
– Larger emergency fund
– Loss of certain goods and services
– Worry and fear
• Costs to society
– Cost of doing business
– Fraudulent claims
– Inflated claims
• Benefits to society
– Indemnification for loss
– Less worry and fear
– Source of investment funds
– Loss prevention
– Enhancement of credit
 METHODS OF HANDLING RISK
• Risk avoidance;
• Risk retention;
– Active retention
– Passive retention
• Risk transfer;
– Transfer of risk by contracts
– Hedging
– Incorporation of a business firm
• Loss control;
– Loss prevention
– Loss reduction
• Insurance
• Choice of methods depends on the frequency and severity of loss.
 Peril and Hazard
• Peril is the cause of loss.
• Hazard is a condition that creates or
increases the chance of loss.
– Physical Hazard
– Moral Hazard
– Morale Hazard
 Definition of Insurance
• “Insurance is the pooling of fortuitous
losses by transfer of such risks to insurers,
who agree to indemnify insured for such
losses, to provide other pecuniary benefits
on their occurrence or to render services
connected with the risk”
Commission on Insurance Terminology
of the American Risk and Insurance
Association
 Basic characteristics of
insurance
• Pooling of losses
• Payment of fortuitous losses
• Risk transfer
• indemnification
 Insurable risk
• Large number of exposure units.
• Loss must be accidental and
unintentional.
• Loss must be determinable and
measurable.
• Loss must not be catastrophic.
• Chance of loss must be calculable.
• Premium must be economically feasible.
 MEANING OF INSURANCE
• The business of insurance is related to the protection of the
economic value of assets.
• LIFE ASSURANCE
• NON-LIFE INSURANCE OR GENERAL INSURANCE
• Conventional classification of General Insurance has been in
three branches-
— Fire Insurance.
— Marine Insurance.
— Miscellaneous (Accident) Insurance.
• In modern times it is classified as follows:
– Insurance of Person;
– Insurance of Property;
– Insurance of Interest; and
– Insurance of Liability.
 General Insurance Products
• Policies for cottage industries, tiny and small sector.
• Fire policy specifically rated for tiny sector.
• Burglary policy.
• Motor policy.
• Traders
• Shopkeeper policy.
• Traders policy.
• Dukan mitra policy.
• Office umbrella policy.
• Marine cargo policy.
• Burglary policy.
• Cash insurance.
• Fidelity guarantee.
• Plate glass and neon sign insurance.
• Professionals and Specific Professions
• Accident Insurance
• Health Insurance
• Liability Insurance Policies
• Rural Industries and Rural Prospects
 SPREADING OF RISK
• Risks cannot only be spread over a larger capital or a
wider area; they can also be spread over a period of
time.
– By writing different classes of insurance business and even
within a single class, by catering to various types of risks;
– By writing business in different geographical locations, states
within a country or different countries;
– By incorporating as public limited company so that with the help
of larger capital resources, it is in a position to write larger
volumes of business in order to achiever a larger spread of risks;
– By means of reinsurance, i.e. by placing reinsurance business
with other companies and accepting reinsurances from other
companies;
– By entering into risk pools for certain risks, particularly, of difficult
or more hazardous nature.
 ROLE OF INSURANCE IN
ECONOMIC DEVELOPMENT
• Providing relief to the insured from any mishap;
• Reducing burden of Government in providing relief to the old
citizens; and
• Providing funds to Govt. for nation building activities.
• As on 31.3.2000, the total investments of the LIC exceeded
Rs.1,47,000 crore, of which more than Rs. 84000 crores were
directly in Government (both State and Centre) related
securities, nearly Rs.12,000 crores in the State Electricity
Boards, Rs.16,000 crores in housing loans and Rs.3,000
crores in water supply and sewerage systems. Other
investments included road transport, setting up .of industrial
estates and directly financing industry. Investments in the
corporate sector (shares, debentures and term loans)
exceeded Rs. 28,000 crores.
An Insurance Company’s Profile
•The IRDA Act, 1999 amending the Insurance Act, 1938 in
Section 2 Sub-section 7(a) states:
“ Indian Insurance Company means any Insurer being a
company -
(a) which is formed and registered under Companies Act, 1956;
(b) in which aggregate holding of equity shares by a foreign
company either by itself or through its subsidiary companies or
its nominees do not exceed twenty six percent paid up equity
capital of such Indian Insurance Company;
whose sole purpose is to carry on life insurance business
or general insurance business or re-insurance business.”
 PRODUCT PRICING -
ACTUARIAL ASPECTS
• Expected future experience and
• Extent of margins against adverse future
experience
• The assumptions needed in pricing a Product
are:-
– Demographic Assumption (Mortality)
– Investment return (interest rates)
– Expenses
– Commission
– Inflation of Expenses
– Withdrawals
 REINSURANCE
• This insurance of Insurers, involves transfer of some part
of risk assumed by a direct Insurer to a single or a group
of re-insurers in a pre agreed manner.
• The law of averages ensures that an adverse experience
in one part of the world is offset by favourable
experience in another part.
• Techniques of reinsurance
• Proportional treaty method
• Quota share
• Surplus
• Facultative obligatory
• Non proportional method
 NATIONALIZATION OF GENERAL
INSURANCE BUSINESS IN INDIA
• General Insurance Business was nationalized in the year
1972 through GIC Act of 1972 through which the general
insurance Business of private insurers was transferred to
GIC having its headquarter at Mumbai.
• The Govt. of India, through regulation framed 4 subsidies
to GIC, which were entrusted to control, regulate and
develop general insurance business of the country. The
subsidiaries headquarters are:
• The Oriental Insurance Co. — New Delhi
• The New India Assurance Co. — Mumbai
• The United India Insurance Co. — Chennai
• The National Insurance Co. — Kolkata
 REGULATION OF INSURANCE
BUSINESS
• Indian Life Insurance Companies Act, 1912 and the
Provident Fund Insurance Societies Act, 1912
• The Insurance Act, 1938
• Nationalization of the insurance business in 1956
• Opening up of the Insurance Sector
– Insurance business is measured in terms of penetration
(premium collection as a fraction of GDP) and density (premium
collected per capita). On both these counts India lagged far
behind peer countries.
• Following the Malhotra Committee recommendations, an
interim Insurance Regulatory Authority (IRA) was set up
by the Government and the Insurance Regulatory
Authority Bill providing for comprehensive legislative
changes was moved in the Parliament on 8.12.1998.
 THE INSURANCE ACT, 1938, AS
AMENDED BY THE IRDA ACT, 1999
• Provisions Relating to Insurance Business
• Regulatory Authority to register insurers and suspend/renew their
registration. This registration is to be renewed annually.
• insurers not to invest the funds of the policy holders outside India either
directly or indirectly. (Section 27C). The controlled funds to be parked in
approved securities within the country. (Section 27A). 75 per cent of the
investible surplus to be invested in the development of rural infrastructure.
• The minimum paid-up equity capital of the insurer to be Rs. l00 crores for
life insurance or general insurance and Rs. 200 crores for re-insurance
business
• The registered insurer is required to deposit with the Reserve Bank of India,
in cash or approved securities, a sum equivalent to 1% (life insurance) or
3% (general insurance), of the total gross premium in any financial year,
subject to a maximum deposit of Rs. 10 crores. For re-insurance business,
the deposit amount is fixed at Rs. 20 crores.
• a minimum insurance business in the rural or social sector, as may be
specified by the Authority.
• Solvency Margin
Establishment of Regulatory and
Development Authority
• IRDA replaced the Controller of Insurance.
• Functions of IRDA
• To issue certificate of registration, renew, withdraw, suspend or cancel such
registration.
• To protect the interests of the policyholders/ insured in the matter of insurance
contract with the insurance company.
• To specify requisite qualifications, code of conduct and training for insurance
intermediaries and agents.
• To specify code of conduct for surveyors/ loss assessors.
• To promote efficiency in the conduct of insurance business.
• To promote and regulate professional organisations connected with the insurance
and reinsurance organisations connected with the insurance and reinsurance
business.
• To undertake inspection, conduct enquiries and investigations including audit of
insurers and insurance intermediaries.
• To control and regulate the rates, terms and conditions to be offered by insurer.
• To specify the form and manner for maintenance of books of accounts and the
statement of accounts.
• To regulate investment of funds by the insurance companies.
• To supervise the functioning of Tariff Advisory Committee.
• To specify the percentage of life and general insurance business to be undertaken in
the rural or social sector.
AGENTS / INTERMEDIARIES
• Chief agent & special agent
• Surveyors and Loss Assessors
 OMBUDSMAN
• The ombudsman may receive and consider complaints relating to
partial or total repudiation of claims relating to:
– Any dispute regarding premium paid or payable in terms of the policy;
– Any dispute on the legal construction of the policy relating to claims;
– Delay in settlement of claims; and
– Non- issue of any insurance document to customers after receipt of
premium.
• The ombudsman shall act as councilor and mediator in matters
within its terms of reference. His decision as to whether the
complaint is fit and proper for being considered by it or not shall be
final.
• A complaint can be made within one year after the insurer had
rejected the representation.
• The subject matter should not be already before any court or
consumers forum or arbitration.
 Life Insurance
• Documents Used in Life Insurance Transactions
• Document required as basis of contract:
— Proposal form including personal statement.
— Medical Reports.
— Special Questionnaires / Special Reports.
— Proof of Age.
— Agents Confidential Report and Moral Hazard Report.
• Document as an evidence of contract:
— First premium Receipt.
— Policy Bond.
• Documents required during servicing of policy:
— Renewal Premium Notices.
— R.R. Receipt.
— Bonus Notices.
— Endorsement.
• Document required at the time of claim:
— Maturity and survival Benefit claims.
— Death Claims.
— Miscellaneous Documents.
LIFE INSURANCE PRODUCTS
• A life insurance product has, essentially, two basic elements:
• Risk cover - i.e. benefit payable in the event of death. (TERM
INSURANCE)
• Savings - i.e. the benefit payable in the event of survival. (PURE
ENDOWMENT)

• All plans of life insurance are combinations of both term insurance

element and pure endowment element in different proportions. An
endowment plan stipulates that a specified Sum Assured (SA) would
be paid if the life assured dies within the term selected or survives
that term. The death benefit is paid by term assurance and the
survival benefit is paid by the pure endowment. An annuity plan is a
pure endowment plan with the condition that the SA is payable in
instalments over a specified period of time.
• Types of Term Insurance Policies: Mortgage Redemption Policies and
Increasing term insurance plans