Insurance & Risk Management (2)

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

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Risk transfer; – Transfer of risk by contracts – Hedging – Incorporation of a business firm

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Loss control; – Loss prevention – Loss reduction

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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.

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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 • • •

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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: – – – –

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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.

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Types of Term Insurance Policies: Mortgage Redemption Policies Increasing term insurance plans

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