Insurance
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Study Material for Insurance
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INSURANCE Risk in the context of insurance There are uncertainties in an average life which is exposed to many types of dangers or risks which may damage or destroy an asset, property or human life. The need for insurance arises out of the existence of these risks. However, risk in this sense is not the investment risk discussed earlier, but encompasses other types of financial risk, such as the loss of property, loss of income-earning capacity through illness or disability, or liability for damages. We therefore need to distinguish between these two major categories of risk. For the purposes of risk management, one of the important considerations in a financial plan, we will use the following classification. Meaning of risk Risk in insurance only means that there is a possibility of loss or damage which may or may not happen. The peril may sometimes be avoided through better safety and damage control management. Thus insurance is relevant only if there are uncertainties about the happening of events which may bring about loss or damage. The occurrence of the events insured against has to be random, accidental and not a deliberate act or creation of the insured person. Mechanism of insurance: People facing common risks come together or they are brought together by insurers and make their small contributions to the common fund. When risk occurs, the loss is made good out of this common fund. Thus the risks are pooled and losses are shared. Types of risks: 1. Pure risk refers to those situations where the consequences of the risk will be either a loss or no loss. It involves situations such as a house burning down, a car being damaged in an accident or loss of a limb due to an accident. These are instances where there is either a loss or no loss; a house may burn down or it may not. Insurance relates to this form of risk. 2. Speculative risk refers to those situations where the consequences of the risk can result in either a loss or a gain. Investing money as described earlier is a form of speculative risk. Managing risk Risk management is a new managerial discipline which has become a part of business management in many corporate firms. Risk management may be defined as a managerial function concerned with the protection of the firm's assets, earning or profits, legal liabilities and personnel against financial loss that may result from fortuitous events or accidental happenings. The process involves the following steps: 1.
Risk identification
2.
Risk evaluation
3. Selection of risk management techniques - these are risk avoidance and loss prevention and reduction 4.
Risk retention
5.
Risk transfer
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Pure risk can be managed in a number of ways, and we can categorise these means in the following manner: 1 Risk control: here, steps are taken to minimise risk (for example, putting locks on the windows partly controls burglary risk); 2 Risk avoidance: risk is eliminated by avoiding the risk altogether; for example, deciding not build a house on a flood plain; 3 Risk retention: a person decides simply to accept and pay for any loss himself. Examples include window replacement, where one agrees to pay an excess on a car insurance policy, or accept a certain waiting period on an income protection policy -all for a reduced premium. Many people accept the risk associated with medical and dental expenses. Effectively, risk retention is self insurance. Decisions to self insure are based on a cost-benefit analysis - the cost of the premiums against the value of the possible loss. In situations where the premium is disproportionately high relative to the risk for possible transfer,risk retention is the more appropriate risk strategy. 4 Risk transfer: where through contract, the risk is transferred to another party. For example, if property is leased, it may contractually transfer the risk of fire insurance to the lessee.
The most common form of risk transfer is through insurance, where through payment of a premium the risk is effectively transferred to the insurance company.(Technically, some would argue that the risk is not transferred per se, but rather shifted to, or shared among all the insures in the insurance pool. But the effect is the same -the insured is protected from the loss.) We are concerned primarily with risk transfer through insurance. To be insurable, there is one very important attribute of pure risk that we need to keep in mind: the occurrence of that risk needs to be mathematically predictable, using the law of probability. For example, we can investigate the occurrence of a type of pure risk in the past and use that to predict the occurrence of this type of risk in the future.
Pure risks that people face Any analysis of insurance needs is predicted upon an understanding of the risks with which people may be confronted. These risks include: Personal risks Risk of early death; (premature natural death or accidental death) Risk of injury or debilitating illness (short-or long-term); and Risk of loss of income through incapacity to work for some extended period. Other risks related to insurance include the risk of leaving an inadequate estate for dependants or other beneficiaries, or the risk of outliving retirement benefits.
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Property risks
Risk of loss or damage to one's own property (house, car).
Loss of use of property
Liability risks
Risk of causing injury to other persons or the damage or loss of others ' property through one's actions or inactions. For example, failure of any person in performing one's duty
For professionals in the financial services field: risk of causing financial loss as a result of inadequate, inappropriate, or otherwise negligent advice.
Loss/damage arising from negligence of third party
From recognition of these risks we can then establish the various needs that people have, needs that can be met by insurance. However, it is important to recognise that personal insurance is not the only mechanism available to handle aspects of risk. Depending on personal circumstances, there may be alternatives such as employer-provided benefits (like accumulated sick leave, superannuation and others). Similarly, both central and state governments make insurance compulsory in, transport (compulsory third party motor vehicle insurance). It is the task of the financial planner to ascertain which risk-related needs are not at present covered or not sufficiently covered, and to make recommendations to fill these gaps.
Risk-related needs Having identified the risks to which people are exposed, we can now turn to a consideration of needs. Using the categories of pure risk cited above, the more common needs include: Personal protection
To provide a lump sum and/or income for any dependants in case of premature death;
To provide for oneself and any dependants in the case of total and permanent disability (including the cost of care);
To provide for oneself and any dependants in the case of serious injury, accident or illness (i.e. trauma) and a lump sum to cover major medical/hospital costs, or an income stream whilst unable to work; to provide a lump sum upon death to meet all liabilities and debts (like mortgage, personal loans, etc.). Property protection To provide sufficient funds to replace that which has been lost or damaged through fire, flood, theft, accident etc. including loss or damage to house, home contents, motor vehicles, boats, caravans and other vehicles. Liability protection To meet any liabilities associated with damage to another's property (like motor vehicle),or with injury to another to somebody you employ as a part-time gardener),or with other 'damage ' like a financial loss.
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The client life cycle While the needs listed in Figure 4.5 on the next page are common for most clients, client's specific needs will vary according to individual personal circumstances. Of particular relevance in this regard is the client's stage of life, as illustrated in the following Figure 4.5. Of course, this is very much a traditional, stereotyped life cycle and you may find that many of your clients will not conform to this pattern. However, Figure does illustrate the principle that clients ' needs change over time, and that it is important to clearly identify all aspects of the clients ' circumstances in the analysis of insurance needs.
Costing needs The financial planner needs to ascertain the costs associated with any of the identified risks materializing as an event. For example, in the case of early death, costs might include:
The cost of meeting commitments: repayment of loans, mortgages and the provision for any dependants lump sum (cash reserve) and/or ongoing income required to support the spouse/family in the lifestyle desired; coverage of future expenses such as children 's education. In the case of total and permanent disability or short-term critical illness, costs include immediate healthcare costs, as well as the amount needed in ongoing income to support the client and his/her family. In the case of property damage or loss, how much, in money terms, would this represent to the client? What would be the replacement value?
Matching needs against insurance in place A whole raft of insurance products have evolved to meet the many risk-related needs identified in the previous section. As a planner, you need to identify the types of insurance policies that the client already has in place, the premium costs, the rupee-value coverage, and any significant conditions attached to those policies before you can develop a set of insurance recommendations that will meet the client 's overall insurance needs.
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Insurance products can be simplistically classified into two main areas, life insurance and general insurance, and it is these two areas of insurance that are normally differentiated on a data collection form.
Life insurance This type of insurance relates to insurances that can be taken out over a human lifetime, whether it be insurance for death, disability or serious illness. In addition to insurance against premature death, illness or disability, life insurance may also have a savings or investment component. There are two key elements to a life insurance policy:
A life insurance policy requires an owner of the policy. This is the person, company or trustee who receives the benefit if one of the specified events of the policy occurs.
Secondly, a policy must have a life insured. This is the individual to which the life insurance policy relates.
Types of life insurance There are various types of life insurance, but they generally fall under the following categories:
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Figure 4.6: Forms of life insurance
Description
Owner
Comments
Term life insurance component.
Individual, company or trustee (superannuation fund)
4Life insurance with no investment component 4Contract cover the event of death within a specified period (hence, often referred to as temporary insurance) 4Pays on agreed lumpsum on death. No Surrender Valu
Total and permanent
As for term insurance above
Usually attached to life insurance cover and pays a lumpsum on specified total and permanent disability
disabil(TPD)*ty
conditions. There is some variation in definition between companies and policy owners need to read contracts carefully Trauma insurance* (with life cover)
Individual
Stand-alone trauma insurance
Pays out a lump sum on satisfying a covered life threatening medical condition
Terminal illness*
As for term insurance
Pays out a percentage of death benefit when terminal illness diagnosed.
Accidental death benefits
As for term insurance
Pays out on death accident only.
Income Protection*
Life Insured Individual
Pays out a percentage of life insured's regular income for illness or injury for a specified period after a set waiting period
Whole of life and endowment
As for term insurance
Collectively called permanent life insurance policies: pays out when the insured dies (see further below) Has surrender value
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*Usually extensions or 'riders' to life insurance contracts, but may be 'stand alone'; hence, not strictly life insurance (death protection) policies as such. However all of the above could be considered 'personal protection' policies. A life insurance policy may specify certain events where cover is not provided. For example, cover may not be provided when a person injures him-or herself intentionally or commits suicide. These events are known as exclusions and the nature and type of exclusions will vary from company to company. The amount paid by the policy owner to provide the cover is referred to as the insurance premium .The level of premium for a given risk is determined by a number of factors including: 4
Age of the life insured;
4
Health;
4
Habits
4
Family medical history;
4
Exclusions (HIV being a major exclusion);
4
The sum or amount being insured;
4
Any existing insurance in place or being applied for;and
4
Profitability and marketing objectives of the insurer.
Whole of life and endowment policies Many life insurance policies may deal not only with the pure risks described, but may also provide some form of investment or savings component. These types of policies are sometimes referred to as life assurance policies. Historically, these types of life insurance policies fall into two main types: 4 Endowment policies generally have a specified maturity date where the cover ceases and the accrued investment is repaid.(The sum insured is also usually paid out on the earlier death of the insured.)These policies can thus be used as a means of saving for retirement while protecting dependants from the financial effects of the insured person 's premature death; and 4 Whole life policies generally mature when the life insured is very old (100 years),and thus the maturity date of a whole of life policy is the same for each person insured. In practice, most policies therefore never mature before the death of the insured life. These types of policies generally have a low level of investment component and, as such, the investment value, relative to an endowment policy is less. Conversely, the sum insured or life insurance value is greater. Convertible whole life policies: Some companies permit the whole life policy to be converted to an endowment policy by the policy owner and specify an earlier maturity date. This ability to convert is a feature exploited by players in the secondary insurance policy market. As the premiums are paid, funds are gradually built up to pay the claim when it inevitably occurs. This accumulation in funds generates an equity in the policy - otherwise known as the surrender (or cash) value. This equity or surrender value is not the value of the premiums paid, but the residue, after taking expenses and other costs into account.
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Policy loans: Lastly, these 'traditional ' types of life insurance policies generally allow the policy owner to borrow against the policy, at interest rates generally lower than prevailing market rates. This can be one source of cash in the event that a client needs to access funds in an emergency situation but does not wish to cash out his or her life insurance policy.
General insurance General insurance is insurance that relates to risk financing of property. Property can take many forms and it need not specifically relate to tangible goods or items; it may relate to loss suffered by another party because of a person 's action or inaction. Loss can thus be tangible (as in damage to property)or intangible (such as the loss of future earnings due to receiving negligent advice).Note the distinction between this form of insurance and the 'personal protection ' insurance discussed previously, which relates purely to coverage of risk to the individual person who is the subject of the policy. Once again, the policy owner enters into a contract of insurance with a product provider that provides coverage for specific events in exchange for a premium.
Underlying principles and features As with life insurance, the purpose of general insurance is to indemnify the insured against loss, or to ensure they are no worse off after the specified event(s)occurs. This is an important concept, as an insurer will not better the insured 's position after the event. This reduces the 'moral risk ' on the part of the insurer and prevents the insured causing the event to effectively enhance their position. This underlying principle of indemnification lies at the heart of all general insurance contracts. Generally speaking, an insurer will not reimburse for a value greater than that, which was lost. Whilst you may insure your home for Rs 1,000,000, if is subsequently destroyed and was valued at Rs. 80,000,this is the amount which will be paid out (if covered under a normal indemnity value policy -see below). However, insurance companies have recognized that the indemnity value of, for example a home or its contents may not be sufficient to cover the replacement of those items should they be lost/stolen or destroyed. Hence two types of policies have evolved: 4 An indemnity value policy, where the insurer simply pays the value of the property or contents at the time of the loss; 4 A replacement value policy, where the sum provided is more in keeping with what is needed in the event of a loss. While the insured has only lost an amount equal to the indemnity value, it may well cost more to replace the property/contents with something equivalent i.e there is often a gap between the indemnity and replacement values. A replacement value policy leaves the insured in the same financial position after the loss as before. Of course, as the replacement value is normally higher than the indemnity value, the insurance premium is correspondingly higher. In your general insurance needs analysis, you should consider the type of policy that is in place, or to be recommended.
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The insured is required, to fully disclose all matters which might materially affect the risk on the part of the insurer. This is normally dealt with in the application for insurance, which provides a number of questions relating to the items to be insured and the individual or company applying for insurance. In your data collection process, you need to discuss the real value of particular assets and their insured values. One common error is to include the land value in determining house insurance cover levels, rather than the building itself and valuable items of furniture or equipment. Another error is to use the current value of the property instead of the replacement value of the home and contents.
Terms of the contract In some cases, an insurer may be prepared to specify the value of cover if sufficient in-depth information is provided at the time the contract is prepared. Similarly, the term of the general contract specifies dates and times at which cover will cease. Prior to the expiry of the contract, the insurer may decide to offer a new contract to renew the policy. There is no compulsion on the part of a general insurer to renew the policy and the insurer may decide to alter the terms offered to the insured. This is quite different from life insurance, where the insurer is required to provide ongoing cover, provided the premiums are paid. This allows companies to increase premiums and alter the terms of the contract based on general or specific claims experience of the insured. Insurers may also offer payment terms for annual premiums. Usually, the price includes a financing component and with a higher number of installments, the finance component can be relatively high. For example, Company XYZ charges Rs. 550 per annum for a contract paid annually, but charges Rs. 49.28 if paid monthly.
12 x 49.28 =Rs.591.36 This shows the annual finance cost is Rs.41.36 per annum or 7.52%p.a. General insurance contracts usually provide for a degree of self insurance by including a deductible amount or excess on any claim. Whilst in the fiercely competitive domestic insurance market these can be reduced or waived, they are a means to prevent petty claims clogging up a claims department. Similarly, excesses are sometimes used to limit 'risky ' activities on the part of the insured. For example, your client 's motor vehicle excess may be Rs.100 on a claim. Yet, if their 18-year-old son is driving, the excess increases to Rs.1,000.This 'penalty ' acts as a deterrent to having the 18-year-old use the car. Insurance contracts usually specify those events, or perils, which are covered in what is known as the 'operative clause ' of the contract. In addition, the contract will specify perils that are not covered as exclusions to the policy. Exclusions are often the source of dispute between insurers and the insured. One of your responsibilities as a financial planner is to identify these problems before they occur and highlight these to you client so that action may be taken.
Categories of general insurance General insurance is usually separated into commercial and personal type contracts. Whilst there are many similarities, there are differences in the types of cover offered.
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One other difference is the nature of obtaining cover. Whilst in the personal market there are a number of players all vying for similar types of business, commercial insurance can sometimes present specific insurance needs which are difficult to 'place ' or find takers for. This need is often served by a general insurance broker who specialises in obtaining cover for these specific needs and, indeed, is able to obtain the 'best deal ' for their clients. The following list identifies some of the more common forms of insurance contract. The list is by no means exhaustive and many insurers may provide features and options not listed. Many insurance policies are 'bundled ' into packages. In some cases, insurers may be reluctant to offer one type of policy if others are not included. For example, public liability may only be offered if other policies are included. Similarly, many insurers provide for minimum sums insured or minimum premiums. This ensures that insurance contracts accepted are commercially viable.
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Forms of general insurance Name Home building
the only
Type
Description
Personal
Provides cover for a number of Listed
ones.
perils. Fire, storm, water, burglary, impact are the principal ones but not the only ones
Home contents
Personal
Provides cover for a number of listed perils, plus theft and, sometimes, accidental damage.
Public liability (home)
Personal
Covers the owner's legal liability to those who may sustain bodily injury or damage to property whilst on the insured's property.
Domestic workers' tcompensation
Personal
Covers the legal liability in relation those employed at the house for injury they sustain
Building
Commercial
As for home building
Contents
Commercial
Provides cover similar to home contents against a similar range of perils
Public liability
Commercial
Provides cover for the legal liability of the insured in relation to bodily injury or property damage to others arising out of the business.
Product liability
Commercial
Similar to public liability except it applies in relation to liability arising out of products
Professional indemnity
Commercial
Covers legal liability for wrongful advice on the part of a professional to a client
Crop insurance
Commercial
Provide cover for damage to crops as a result of fire or hail.
Comprehensive motor vehicle
Commercial/ Private
Provides cover for collision, fire, theft and third party accident (see below).
Third party Accident
Commercial/ Private
Covers legal liability for damages to third party property arising from the use of the motor vehicle.
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Health insurance In India, most people who have healthy insurance are covered under the mediclaim policy for individuals. There are certain other health insurance policies also.
Mediclaim policy (individual) This policy provides for reimbursement of hospitalisation/domiciliary hospitalisation expenses for illness/disease or acccidental injury sustained during the policy period. The liability in respect of all claims for expenses incurred in hospital/nursing home - boarding, nursing, doctors fees, operation charges, diagnostics and anaesthesia, blood, oxygen, medicines and so on shall not exceed the sum assured for the person during the period of insurance. Domiciliary treatment means medical treatment for a pperiod exceeding three days for such illness/injury which in the normal course woiuld require treatment at the hospital at actually taken whilst confined at home in India under any of the following circumstances namely: 1)
Condition of the patient is such that he/she cannot be removed to the hospital
2)
The patient cannot be moved to the hospital for lack of accommodation therein.
But expenses incurred for pre and post hospital treatment are not covered and certain ailments are also excluded. The insured is entitled to cost of health check-up not exceeding 1% of sum assured once in every four years subject to no-claim preferred during this period.
Group mediclaim policy: It is available to any group/association/institution/corporate body subject to a minimum number of persons to be covered. The coverage under this policy is same as under individual mediclaim policy but health check-up expenses are not payable and there are some other minor differences.
Jan Arogya Bima policy This is also similar to individual mediclaim policy and is available to individuals and family members with age limit (5 to 70 years). However, children between age of three months and five years can be covered provided one or both parents are covered concurrently. The sum assured per person is restricted to RS. 5,000/- only.
Cancer policy for members of
1. Indian cancer society - The insured member and his/her spouse are covered and if any of them contracts cancer, the cost of diagnosis , biopsy, surgery, chempotherapy, radiotherapy, hospitalisation and rehabilitation to the extent of Rs. 50,000/- only for each claim. Two dependent children can also be covered for nominal premium of Rs. 50 per child.
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1. Cancer Patients Aid Association (CPAA) - In 1994, CPAA introduced the Cancer Insurance Policy in colaboration with New India Assurance Company. The polici is available to healthy individuals who have not suffered from cancer in the past. There is a 20-year comprehensive scheme and a full life scheme for various sums assured. Under these schemes, the policyholder has the benefit of a fresh limit every year to take care of his treatment expenses. The policy also covers free annual check-up at CPAA facilities. There is also a corporate policy in which 6,500 individual members are participating.
Bhavishya Arogya policy This is adeferred mediclaim policy for persons aged between 25 to 55 years. The retirement age to be selected may be between 55 to 60 years.
Overseas medical policy Overseas medical schemes are available under different plans (A to H)
Videsh Yatra Mitra policy This policy is another overseas mediclaim scheme with benefits comparable with those offered by foreign insurance companies like personal accident, illness, accident, loss of checked baggage or delay in its arrival, loss of passport and so on. Managed health care This is a new and innovative concept in health insurance. The services made available include wide network of hospitals/nursing homes where a policy holder can avail of cashless services i.e. admission to these hospitals without payment of admission fees or deposits and other expenses which are reimbursed to the hospital concerned by the insurer.
Study Material for Insurance
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INSURANCE Risk in the context of insurance There are uncertainties in an average life which is exposed to many types of dangers or risks which may damage or destroy an asset, property or human life. The need for insurance arises out of the existence of these risks. However, risk in this sense is not the investment risk discussed earlier, but encompasses other types of financial risk, such as the loss of property, loss of income-earning capacity through illness or disability, or liability for damages. We therefore need to distinguish between these two major categories of risk. For the purposes of risk management, one of the important considerations in a financial plan, we will use the following classification. Meaning of risk Risk in insurance only means that there is a possibility of loss or damage which may or may not happen. The peril may sometimes be avoided through better safety and damage control management. Thus insurance is relevant only if there are uncertainties about the happening of events which may bring about loss or damage. The occurrence of the events insured against has to be random, accidental and not a deliberate act or creation of the insured person. Mechanism of insurance: People facing common risks come together or they are brought together by insurers and make their small contributions to the common fund. When risk occurs, the loss is made good out of this common fund. Thus the risks are pooled and losses are shared. Types of risks: 1. Pure risk refers to those situations where the consequences of the risk will be either a loss or no loss. It involves situations such as a house burning down, a car being damaged in an accident or loss of a limb due to an accident. These are instances where there is either a loss or no loss; a house may burn down or it may not. Insurance relates to this form of risk. 2. Speculative risk refers to those situations where the consequences of the risk can result in either a loss or a gain. Investing money as described earlier is a form of speculative risk. Managing risk Risk management is a new managerial discipline which has become a part of business management in many corporate firms. Risk management may be defined as a managerial function concerned with the protection of the firm's assets, earning or profits, legal liabilities and personnel against financial loss that may result from fortuitous events or accidental happenings. The process involves the following steps: 1.
Risk identification
2.
Risk evaluation
3. Selection of risk management techniques - these are risk avoidance and loss prevention and reduction 4.
Risk retention
5.
Risk transfer
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Pure risk can be managed in a number of ways, and we can categorise these means in the following manner: 1 Risk control: here, steps are taken to minimise risk (for example, putting locks on the windows partly controls burglary risk); 2 Risk avoidance: risk is eliminated by avoiding the risk altogether; for example, deciding not build a house on a flood plain; 3 Risk retention: a person decides simply to accept and pay for any loss himself. Examples include window replacement, where one agrees to pay an excess on a car insurance policy, or accept a certain waiting period on an income protection policy -all for a reduced premium. Many people accept the risk associated with medical and dental expenses. Effectively, risk retention is self insurance. Decisions to self insure are based on a cost-benefit analysis - the cost of the premiums against the value of the possible loss. In situations where the premium is disproportionately high relative to the risk for possible transfer,risk retention is the more appropriate risk strategy. 4 Risk transfer: where through contract, the risk is transferred to another party. For example, if property is leased, it may contractually transfer the risk of fire insurance to the lessee.
The most common form of risk transfer is through insurance, where through payment of a premium the risk is effectively transferred to the insurance company.(Technically, some would argue that the risk is not transferred per se, but rather shifted to, or shared among all the insures in the insurance pool. But the effect is the same -the insured is protected from the loss.) We are concerned primarily with risk transfer through insurance. To be insurable, there is one very important attribute of pure risk that we need to keep in mind: the occurrence of that risk needs to be mathematically predictable, using the law of probability. For example, we can investigate the occurrence of a type of pure risk in the past and use that to predict the occurrence of this type of risk in the future.
Pure risks that people face Any analysis of insurance needs is predicted upon an understanding of the risks with which people may be confronted. These risks include: Personal risks Risk of early death; (premature natural death or accidental death) Risk of injury or debilitating illness (short-or long-term); and Risk of loss of income through incapacity to work for some extended period. Other risks related to insurance include the risk of leaving an inadequate estate for dependants or other beneficiaries, or the risk of outliving retirement benefits.
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Property risks
Risk of loss or damage to one's own property (house, car).
Loss of use of property
Liability risks
Risk of causing injury to other persons or the damage or loss of others ' property through one's actions or inactions. For example, failure of any person in performing one's duty
For professionals in the financial services field: risk of causing financial loss as a result of inadequate, inappropriate, or otherwise negligent advice.
Loss/damage arising from negligence of third party
From recognition of these risks we can then establish the various needs that people have, needs that can be met by insurance. However, it is important to recognise that personal insurance is not the only mechanism available to handle aspects of risk. Depending on personal circumstances, there may be alternatives such as employer-provided benefits (like accumulated sick leave, superannuation and others). Similarly, both central and state governments make insurance compulsory in, transport (compulsory third party motor vehicle insurance). It is the task of the financial planner to ascertain which risk-related needs are not at present covered or not sufficiently covered, and to make recommendations to fill these gaps.
Risk-related needs Having identified the risks to which people are exposed, we can now turn to a consideration of needs. Using the categories of pure risk cited above, the more common needs include: Personal protection
To provide a lump sum and/or income for any dependants in case of premature death;
To provide for oneself and any dependants in the case of total and permanent disability (including the cost of care);
To provide for oneself and any dependants in the case of serious injury, accident or illness (i.e. trauma) and a lump sum to cover major medical/hospital costs, or an income stream whilst unable to work; to provide a lump sum upon death to meet all liabilities and debts (like mortgage, personal loans, etc.). Property protection To provide sufficient funds to replace that which has been lost or damaged through fire, flood, theft, accident etc. including loss or damage to house, home contents, motor vehicles, boats, caravans and other vehicles. Liability protection To meet any liabilities associated with damage to another's property (like motor vehicle),or with injury to another to somebody you employ as a part-time gardener),or with other 'damage ' like a financial loss.
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The client life cycle While the needs listed in Figure 4.5 on the next page are common for most clients, client's specific needs will vary according to individual personal circumstances. Of particular relevance in this regard is the client's stage of life, as illustrated in the following Figure 4.5. Of course, this is very much a traditional, stereotyped life cycle and you may find that many of your clients will not conform to this pattern. However, Figure does illustrate the principle that clients ' needs change over time, and that it is important to clearly identify all aspects of the clients ' circumstances in the analysis of insurance needs.
Costing needs The financial planner needs to ascertain the costs associated with any of the identified risks materializing as an event. For example, in the case of early death, costs might include:
The cost of meeting commitments: repayment of loans, mortgages and the provision for any dependants lump sum (cash reserve) and/or ongoing income required to support the spouse/family in the lifestyle desired; coverage of future expenses such as children 's education. In the case of total and permanent disability or short-term critical illness, costs include immediate healthcare costs, as well as the amount needed in ongoing income to support the client and his/her family. In the case of property damage or loss, how much, in money terms, would this represent to the client? What would be the replacement value?
Matching needs against insurance in place A whole raft of insurance products have evolved to meet the many risk-related needs identified in the previous section. As a planner, you need to identify the types of insurance policies that the client already has in place, the premium costs, the rupee-value coverage, and any significant conditions attached to those policies before you can develop a set of insurance recommendations that will meet the client 's overall insurance needs.
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Insurance products can be simplistically classified into two main areas, life insurance and general insurance, and it is these two areas of insurance that are normally differentiated on a data collection form.
Life insurance This type of insurance relates to insurances that can be taken out over a human lifetime, whether it be insurance for death, disability or serious illness. In addition to insurance against premature death, illness or disability, life insurance may also have a savings or investment component. There are two key elements to a life insurance policy:
A life insurance policy requires an owner of the policy. This is the person, company or trustee who receives the benefit if one of the specified events of the policy occurs.
Secondly, a policy must have a life insured. This is the individual to which the life insurance policy relates.
Types of life insurance There are various types of life insurance, but they generally fall under the following categories:
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Figure 4.6: Forms of life insurance
Description
Owner
Comments
Term life insurance component.
Individual, company or trustee (superannuation fund)
4Life insurance with no investment component 4Contract cover the event of death within a specified period (hence, often referred to as temporary insurance) 4Pays on agreed lumpsum on death. No Surrender Valu
Total and permanent
As for term insurance above
Usually attached to life insurance cover and pays a lumpsum on specified total and permanent disability
disabil(TPD)*ty
conditions. There is some variation in definition between companies and policy owners need to read contracts carefully Trauma insurance* (with life cover)
Individual
Stand-alone trauma insurance
Pays out a lump sum on satisfying a covered life threatening medical condition
Terminal illness*
As for term insurance
Pays out a percentage of death benefit when terminal illness diagnosed.
Accidental death benefits
As for term insurance
Pays out on death accident only.
Income Protection*
Life Insured Individual
Pays out a percentage of life insured's regular income for illness or injury for a specified period after a set waiting period
Whole of life and endowment
As for term insurance
Collectively called permanent life insurance policies: pays out when the insured dies (see further below) Has surrender value
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*Usually extensions or 'riders' to life insurance contracts, but may be 'stand alone'; hence, not strictly life insurance (death protection) policies as such. However all of the above could be considered 'personal protection' policies. A life insurance policy may specify certain events where cover is not provided. For example, cover may not be provided when a person injures him-or herself intentionally or commits suicide. These events are known as exclusions and the nature and type of exclusions will vary from company to company. The amount paid by the policy owner to provide the cover is referred to as the insurance premium .The level of premium for a given risk is determined by a number of factors including: 4
Age of the life insured;
4
Health;
4
Habits
4
Family medical history;
4
Exclusions (HIV being a major exclusion);
4
The sum or amount being insured;
4
Any existing insurance in place or being applied for;and
4
Profitability and marketing objectives of the insurer.
Whole of life and endowment policies Many life insurance policies may deal not only with the pure risks described, but may also provide some form of investment or savings component. These types of policies are sometimes referred to as life assurance policies. Historically, these types of life insurance policies fall into two main types: 4 Endowment policies generally have a specified maturity date where the cover ceases and the accrued investment is repaid.(The sum insured is also usually paid out on the earlier death of the insured.)These policies can thus be used as a means of saving for retirement while protecting dependants from the financial effects of the insured person 's premature death; and 4 Whole life policies generally mature when the life insured is very old (100 years),and thus the maturity date of a whole of life policy is the same for each person insured. In practice, most policies therefore never mature before the death of the insured life. These types of policies generally have a low level of investment component and, as such, the investment value, relative to an endowment policy is less. Conversely, the sum insured or life insurance value is greater. Convertible whole life policies: Some companies permit the whole life policy to be converted to an endowment policy by the policy owner and specify an earlier maturity date. This ability to convert is a feature exploited by players in the secondary insurance policy market. As the premiums are paid, funds are gradually built up to pay the claim when it inevitably occurs. This accumulation in funds generates an equity in the policy - otherwise known as the surrender (or cash) value. This equity or surrender value is not the value of the premiums paid, but the residue, after taking expenses and other costs into account.
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Policy loans: Lastly, these 'traditional ' types of life insurance policies generally allow the policy owner to borrow against the policy, at interest rates generally lower than prevailing market rates. This can be one source of cash in the event that a client needs to access funds in an emergency situation but does not wish to cash out his or her life insurance policy.
General insurance General insurance is insurance that relates to risk financing of property. Property can take many forms and it need not specifically relate to tangible goods or items; it may relate to loss suffered by another party because of a person 's action or inaction. Loss can thus be tangible (as in damage to property)or intangible (such as the loss of future earnings due to receiving negligent advice).Note the distinction between this form of insurance and the 'personal protection ' insurance discussed previously, which relates purely to coverage of risk to the individual person who is the subject of the policy. Once again, the policy owner enters into a contract of insurance with a product provider that provides coverage for specific events in exchange for a premium.
Underlying principles and features As with life insurance, the purpose of general insurance is to indemnify the insured against loss, or to ensure they are no worse off after the specified event(s)occurs. This is an important concept, as an insurer will not better the insured 's position after the event. This reduces the 'moral risk ' on the part of the insurer and prevents the insured causing the event to effectively enhance their position. This underlying principle of indemnification lies at the heart of all general insurance contracts. Generally speaking, an insurer will not reimburse for a value greater than that, which was lost. Whilst you may insure your home for Rs 1,000,000, if is subsequently destroyed and was valued at Rs. 80,000,this is the amount which will be paid out (if covered under a normal indemnity value policy -see below). However, insurance companies have recognized that the indemnity value of, for example a home or its contents may not be sufficient to cover the replacement of those items should they be lost/stolen or destroyed. Hence two types of policies have evolved: 4 An indemnity value policy, where the insurer simply pays the value of the property or contents at the time of the loss; 4 A replacement value policy, where the sum provided is more in keeping with what is needed in the event of a loss. While the insured has only lost an amount equal to the indemnity value, it may well cost more to replace the property/contents with something equivalent i.e there is often a gap between the indemnity and replacement values. A replacement value policy leaves the insured in the same financial position after the loss as before. Of course, as the replacement value is normally higher than the indemnity value, the insurance premium is correspondingly higher. In your general insurance needs analysis, you should consider the type of policy that is in place, or to be recommended.
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The insured is required, to fully disclose all matters which might materially affect the risk on the part of the insurer. This is normally dealt with in the application for insurance, which provides a number of questions relating to the items to be insured and the individual or company applying for insurance. In your data collection process, you need to discuss the real value of particular assets and their insured values. One common error is to include the land value in determining house insurance cover levels, rather than the building itself and valuable items of furniture or equipment. Another error is to use the current value of the property instead of the replacement value of the home and contents.
Terms of the contract In some cases, an insurer may be prepared to specify the value of cover if sufficient in-depth information is provided at the time the contract is prepared. Similarly, the term of the general contract specifies dates and times at which cover will cease. Prior to the expiry of the contract, the insurer may decide to offer a new contract to renew the policy. There is no compulsion on the part of a general insurer to renew the policy and the insurer may decide to alter the terms offered to the insured. This is quite different from life insurance, where the insurer is required to provide ongoing cover, provided the premiums are paid. This allows companies to increase premiums and alter the terms of the contract based on general or specific claims experience of the insured. Insurers may also offer payment terms for annual premiums. Usually, the price includes a financing component and with a higher number of installments, the finance component can be relatively high. For example, Company XYZ charges Rs. 550 per annum for a contract paid annually, but charges Rs. 49.28 if paid monthly.
12 x 49.28 =Rs.591.36 This shows the annual finance cost is Rs.41.36 per annum or 7.52%p.a. General insurance contracts usually provide for a degree of self insurance by including a deductible amount or excess on any claim. Whilst in the fiercely competitive domestic insurance market these can be reduced or waived, they are a means to prevent petty claims clogging up a claims department. Similarly, excesses are sometimes used to limit 'risky ' activities on the part of the insured. For example, your client 's motor vehicle excess may be Rs.100 on a claim. Yet, if their 18-year-old son is driving, the excess increases to Rs.1,000.This 'penalty ' acts as a deterrent to having the 18-year-old use the car. Insurance contracts usually specify those events, or perils, which are covered in what is known as the 'operative clause ' of the contract. In addition, the contract will specify perils that are not covered as exclusions to the policy. Exclusions are often the source of dispute between insurers and the insured. One of your responsibilities as a financial planner is to identify these problems before they occur and highlight these to you client so that action may be taken.
Categories of general insurance General insurance is usually separated into commercial and personal type contracts. Whilst there are many similarities, there are differences in the types of cover offered.
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One other difference is the nature of obtaining cover. Whilst in the personal market there are a number of players all vying for similar types of business, commercial insurance can sometimes present specific insurance needs which are difficult to 'place ' or find takers for. This need is often served by a general insurance broker who specialises in obtaining cover for these specific needs and, indeed, is able to obtain the 'best deal ' for their clients. The following list identifies some of the more common forms of insurance contract. The list is by no means exhaustive and many insurers may provide features and options not listed. Many insurance policies are 'bundled ' into packages. In some cases, insurers may be reluctant to offer one type of policy if others are not included. For example, public liability may only be offered if other policies are included. Similarly, many insurers provide for minimum sums insured or minimum premiums. This ensures that insurance contracts accepted are commercially viable.
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Forms of general insurance Name Home building
the only
Type
Description
Personal
Provides cover for a number of Listed
ones.
perils. Fire, storm, water, burglary, impact are the principal ones but not the only ones
Home contents
Personal
Provides cover for a number of listed perils, plus theft and, sometimes, accidental damage.
Public liability (home)
Personal
Covers the owner's legal liability to those who may sustain bodily injury or damage to property whilst on the insured's property.
Domestic workers' tcompensation
Personal
Covers the legal liability in relation those employed at the house for injury they sustain
Building
Commercial
As for home building
Contents
Commercial
Provides cover similar to home contents against a similar range of perils
Public liability
Commercial
Provides cover for the legal liability of the insured in relation to bodily injury or property damage to others arising out of the business.
Product liability
Commercial
Similar to public liability except it applies in relation to liability arising out of products
Professional indemnity
Commercial
Covers legal liability for wrongful advice on the part of a professional to a client
Crop insurance
Commercial
Provide cover for damage to crops as a result of fire or hail.
Comprehensive motor vehicle
Commercial/ Private
Provides cover for collision, fire, theft and third party accident (see below).
Third party Accident
Commercial/ Private
Covers legal liability for damages to third party property arising from the use of the motor vehicle.
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Health insurance In India, most people who have healthy insurance are covered under the mediclaim policy for individuals. There are certain other health insurance policies also.
Mediclaim policy (individual) This policy provides for reimbursement of hospitalisation/domiciliary hospitalisation expenses for illness/disease or acccidental injury sustained during the policy period. The liability in respect of all claims for expenses incurred in hospital/nursing home - boarding, nursing, doctors fees, operation charges, diagnostics and anaesthesia, blood, oxygen, medicines and so on shall not exceed the sum assured for the person during the period of insurance. Domiciliary treatment means medical treatment for a pperiod exceeding three days for such illness/injury which in the normal course woiuld require treatment at the hospital at actually taken whilst confined at home in India under any of the following circumstances namely: 1)
Condition of the patient is such that he/she cannot be removed to the hospital
2)
The patient cannot be moved to the hospital for lack of accommodation therein.
But expenses incurred for pre and post hospital treatment are not covered and certain ailments are also excluded. The insured is entitled to cost of health check-up not exceeding 1% of sum assured once in every four years subject to no-claim preferred during this period.
Group mediclaim policy: It is available to any group/association/institution/corporate body subject to a minimum number of persons to be covered. The coverage under this policy is same as under individual mediclaim policy but health check-up expenses are not payable and there are some other minor differences.
Jan Arogya Bima policy This is also similar to individual mediclaim policy and is available to individuals and family members with age limit (5 to 70 years). However, children between age of three months and five years can be covered provided one or both parents are covered concurrently. The sum assured per person is restricted to RS. 5,000/- only.
Cancer policy for members of
1. Indian cancer society - The insured member and his/her spouse are covered and if any of them contracts cancer, the cost of diagnosis , biopsy, surgery, chempotherapy, radiotherapy, hospitalisation and rehabilitation to the extent of Rs. 50,000/- only for each claim. Two dependent children can also be covered for nominal premium of Rs. 50 per child.
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1. Cancer Patients Aid Association (CPAA) - In 1994, CPAA introduced the Cancer Insurance Policy in colaboration with New India Assurance Company. The polici is available to healthy individuals who have not suffered from cancer in the past. There is a 20-year comprehensive scheme and a full life scheme for various sums assured. Under these schemes, the policyholder has the benefit of a fresh limit every year to take care of his treatment expenses. The policy also covers free annual check-up at CPAA facilities. There is also a corporate policy in which 6,500 individual members are participating.
Bhavishya Arogya policy This is adeferred mediclaim policy for persons aged between 25 to 55 years. The retirement age to be selected may be between 55 to 60 years.
Overseas medical policy Overseas medical schemes are available under different plans (A to H)
Videsh Yatra Mitra policy This policy is another overseas mediclaim scheme with benefits comparable with those offered by foreign insurance companies like personal accident, illness, accident, loss of checked baggage or delay in its arrival, loss of passport and so on. Managed health care This is a new and innovative concept in health insurance. The services made available include wide network of hospitals/nursing homes where a policy holder can avail of cashless services i.e. admission to these hospitals without payment of admission fees or deposits and other expenses which are reimbursed to the hospital concerned by the insurer.
