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1.1 What is life insurance?

Life insurance is an agreement between you (the insured) and an

insurer. Under the terms of a life insurance contract, the insurer
promises to pay a certain sum to someone (a beneficiary) when you
die, in exchange for your premium payments.

1.2 Why would you need life insurance?

The most common reason for buying life insurance is to replace the
income lost when you die. For example, say that you work, and that
your income is used to support yourself and your family. When you die,
and your paychecks stop, the life insurance proceeds can be used to
continue to support the family members you've left behind.

Another common use of life insurance proceeds is to pay off any debts
you leave behind. For example, mortgages, car loans, medical bills,
and credit card debts are often left unpaid when someone dies. These
obligations must be paid from the assets left behind. This can deplete
the resources that your family needs. Life insurance can be used to
pay off these debts, leaving your other assets intact for your family to

Life insurance provides liquidity to your estate. When you die, you may
leave some liquid assets (such as cash, CDs, and savings bonds), and
some illiquid assets (such as real estate, an automobile, and stocks).
Your liquid assets may not be enough to pay all the debts that you
leave behind, plus all the expenses that arise because of your death
(such as funeral expenses and estate taxes). Your illiquid assets may

have to be sold in order to meet these obligations when they come
due. This may cause a financial loss if the assets must be sold cheaply
in order to get the money on time. Life insurance can avert this
situation, because the proceeds are available almost immediately upon
your death.

Life insurance creates an estate for your heirs. After your debts and
expenses are paid, there may not be much left over for your family.
Life insurance can automatically provide assets for them after your

Life insurance is a great way to give to charity when you die. You may
have always had a great philanthropic desire, but not the means to
make it a reality. Life insurance can do that for you.

Life insurance can be a critical component for specialized business

applications, such as funding a buy-sell agreement. Under a buy-sell
agreement, life insurance can be used to provide cash for the
purchase of a deceased owner's interest in the business.

Finally, life insurance can be an investment vehicle. Some types of life

insurance policies may actually make money for you, as well as
provide the benefits described above. This can help you with long-term
financial goals.

1.3 What do you need to know about life insurance?

You need to know that there are several kinds of policies that may be
available to you, if you are healthy enough.

Term life insurance policies provide life insurance protection for a

specific period of time or term. If you die during the coverage period,
the beneficiary named in your policy receives the policy death benefit.
If you don't die during the term, your beneficiary receives nothing.

Permanent insurance policies provide insurance protection for your
entire life as long as the policy remains in force. In addition to the
insurance protection provided, this type of policy also builds internal
cash values, often described as a savings account within the policy.

A life insurance contract is made up of provisions, options, and riders.

Provisions describe or explain features, benefits, conditions, or
requirements of the contract. Options are features of the agreement
that require you to make a choice regarding some aspect of coverage.
Riders are additional coverage (or endorsements) offered by the
insurer at the time of application and added to the standard agreement
in return for an additional premium.

Finally, you need to know the tax consequences of owning life


• Life insurance premium payments are not tax-deductible


• In general, the death benefit paid to the beneficiary is not

included in gross income for federal income tax purposes,
because it is paid with after-tax dollars.

• You must be very careful about who owns the policy and who
the beneficiaries are, in order to avoid estate taxes on the
proceeds when you die.


Your need for life insurance changes as your life changes. When
you're young, you typically have no need for life insurance, but this
changes as you take on more responsibility, and as your family grows.
Then, as your responsibilities once again begin to diminish, your need
for life insurance drops off. Let's look at how your life insurance needs
change throughout your lifetime.

1.4.1 School days

Childhood is typically a time of no worries, no cares, and no

responsibilities. A child depends on others to take care of them, not the
other way around. Although it would be tragic, a child's death would
likely have little financial impact on the child's family. Thus, there is
generally no need for life insurance at this point in an individual's life.

A child's death does create one short-term financial problem: funeral

expenses. But buying a life insurance policy just for that purpose
doesn't really make sense. Instead, think about saving the money you
would spend on insurance premiums and open a savings account, or
put the money in some type of investment vehicle. That way, the
money can be used for college expenses or a first home, but it will also
be available in case of a tragedy. Alternatively, a burial policy provides
enough money for funeral expenses, at a much lower cost than a
typical life insurance policy.

1.4.2 Footloose and fancy-free

As a young adult, you become more independent and self-sufficient.
You no longer depend on others for your financial well being. But in
most cases, your death would still not create a financial hardship for
others. For most young singles, life insurance is still not a priority.

Some would argue that you should buy life insurance now, while you're
healthy and the rates are low. This may be a valid argument if you are
at a high risk for developing a medical condition (such as diabetes)
later in life. But you should also consider the earnings you could
realize by investing the money now instead of spending it on insurance

If you have a mortgage or other loans that are jointly held with a
cosigner, your death would leave the cosigner responsible for the
entire debt. You might consider purchasing enough life insurance to
cover these debts in the event of your death. Funeral expenses are
also a concern for young singles, but it is typically not advisable to
purchase a life insurance policy just for this purpose. Instead, consider
investing the money you would spend on life insurance premiums, or
purchasing a small burial policy.

Your life insurance needs increase significantly if you are supporting a

parent or grandparent, or if you have a child before marriage. In this
case, life insurance could provide continued support for your
dependent(s) if you were to die.

1.4.3 Your growing family

When you have young children, your life insurance needs reach a
climax. In most any situation, life insurance for both parents is

Single-income families are completely dependent on the income of the

breadwinner. If he or she dies without life insurance, the consequences
could be disastrous. The death of the stay-at-home spouse would
necessitate costly daycare expenses. Both spouses should carry
enough life insurance to cover the expenses that would result from
their death.

Dual-income families need life insurance, too. If one spouse dies, it is

unlikely that the surviving spouse will be able to keep up with the
household expenses and pay for childcare with the remaining income.

1.4.4 Moving up the ladder

For many people, career advancement means starting a new job with
a new company. At some point, you might even decide to be your own
boss and start your own business. It might not be your top priority, but
it is important to review your life insurance coverage any time you
leave an employer.

Keep in mind, you probably won't be able to keep any life insurance
that was provided by your employer. If you're going to work for a new
company, you might receive a comparable life insurance benefit. But if
you're going into business for yourself, you'll need to purchase an
individual life insurance policy.

Make sure the amount of your coverage is up-to-date, as well. The

policy you purchased right after you got married might not be adequate
anymore, especially if you have kids, a mortgage, and college
expenses to consider. Business owners may also have business debt

to consider. If you were not incorporated, your family would have to
pay those bills if you die.

1.4.4 Single again

Unfortunately, divorce has become a fact of life in our society. You'll

have to make many financial decisions during this stressful time,
including the decision of what to do about your life insurance. Divorce
raises both beneficiary issues and coverage issues. And if you have
children, these issues become even more complex.

If you and your spouse have no children, it may be as simple as

changing the beneficiary on your policy and adjusting your coverage to
reflect your newly single status. However, if you have kids, you'll want
to make sure that they are provided for in the event of your death. This
may involve purchasing a new policy and naming them as
beneficiaries. The custodial and non-custodial parent will need to work
out the details of this complicated situation. If you can't come to terms,
the court may make the decisions for you.

1.4.6 The golden years

Once your children are grown, your life insurance needs decrease.
You'll live off your retirement savings, and hopefully you have
accumulated assets that can be passed on to your heirs when you die.
Not only is life insurance expensive at this point, but it's probably

One exception: if you will be leaving a large estate when you die, your
heirs may be stuck paying a hefty estate tax bill. Consider obtaining
cash value life insurance policy, because you don't actually know when
you're going to die. Your heirs can then use the death benefit to pay

the IRS. If the policy is held by a trust, the proceeds won't be included
in your estate


A. Life Insurance

Life insurance in its existing form came in India from United Kingdom (UK)
with the establishment of a British firm, Oriental Life Insurance Company in
1818 followed by Bombay Life Assurance Company in 1823, the Madras
Equitable Life Insurance Society in 1829 and Oriental Life Assurance
Company in 1874. Prior to 1871, Indian lives were treated as sub-standard
and charged an extra premium of 15% to 20%. Bombay Mutual Life
Assurance Society, an Indian insurer that came into existence in 1871,
was the first to cover Indian lives at normal rates. The Indian Life

Assurance Companies Act, 1912 was the first statutory measure to
regulate life insurance business. Later, in 1928 the Indian Insurance
Companies Act was enacted, inter alia, to enable the government to collect
statistical information about life and non-life insurance business transacted
in India by Indian and foreign insurers, including the provident insurance

In 1938, with a view to protecting the interest of insuring public, earlier

legislation was consolidated and amended by Insurance Act, 1938 with
comprehensive provisions for detailed and effective control over the
activities of insurers. In order to administer the aforesaid legislation, an
insurance wing was established and attached first with the Ministry of
Commerce and then Ministry of Finance. This ministry was
administratively responsible for policy matters pertaining to insurance. The
actuarial and operational matters relating to the insurance industry were
looked after by an attached office in Shimla, headed first by Actuary to the
Government of India, then by Superintendent of Insurance and finally by
the Controller of Insurance. The act was amended in 1950, making far-
reaching changes such as requirement of equity capital for companies,
carrying on life insurance business, ceilings on shareholdings I such
companies, stricter control on investment of life insurance companies,
submission of periodical returns relating to investments and such other
information to the Controller as he may call for, appointments of
administrators for mismanaged companies, ceilings on expenses of
management and agency commission, incorporation of the Insurance
Association of India and formation of councils and committees thereof.

By 1956, 154 Indian insurers, 16 non-Indian insurers and 75 provident

societies were carrying on life insurance business in India. Life insurance

business was confirmed mainly to cities and better off segments of the

On 19th January 1956 the management of life insurance business of 245

Indian and foreign insurers and provident societies, then operating in India,
was taken over by the Central Government and then nationalized on 1st
September 1956. LIC was formed in September 1956 by an Act of
Parliament, viz. LIC Act, 1956, with capital contribution of Rs. 5 crore from
the Government of India.

The then Finance Minister, Shri S.D.Deshmukh, while piloting the bill for
nationalization, outlined the objectives of LIC thus: to conduct the business
with utmost economy, in a spirit of trusteeship; to charge premium no
higher than warranted by strict actuarial considerations; to invest the funds
for obtaining maximum yield for the policy holders consistent with safety of
the capital; to render prompt and efficient service to policy-holders.

The recommendations of the Administrative Reforms Commission are as


a.To spread life insurance much more widely and in particular to the
rural areas and to the socially and economically backward classes

b.To making mobilization of people’s savings by making insurance

linked savings adequately attractive.

c.To bear in mind, in the investment of funds, the primary obligation to

its policyholders, whose money it holds in trust without losing sight of
the interest of the community as a whole

d.To conduct business with utmost economy and with the full
realisation that money belongs to the policy- holders.

e.To act as trustees of the insured public in their individual and

collective capacities.

f.To meet various life insurance needs of the community that would
arise in the changing social and economic environment.

g.To promote amongst all agents and employees of the Corporation a

sense of participation, pride and job satisfaction through discharge of
their duties with dedication towards achievement of corporate

B. General Insurance

General Insurance developed in India with industrial revolution in the West

and consequent growth of seafaring trade and commerce in the
seventeenth century. It came to India from UK. The first general insurance
company, Triton Insurance Company Ltd. was established in Calcutta in
1850 whose shares were mainly headed by Britishers. The first general
insurance company established by an Indian was Indian Mercantile
Insurance Company Ltd. in Bombay in 1907.

In 1957,the General Insurance Council, a wing of the Insurance

Association of India framed a code of conduct for ensuring fair conduct
and sound business practices in the general insurance industry. An
administrative set-up headed by the Controller of Insurance was set up at
Delhi in 1957 with a branch office at Bombay, Calcutta, and Madras for
administrating code of conduct. Further in order to retain the business of
general insurance in India, the insurers started a reinsurance company,
viz. India Reinsurance Corporation Ltd. In 1956 to which they voluntarily
ceded 10% of their gross direct business. In 1961, by arrangement to

Insurance Act, this voluntary arrangement was formalised by notifying the
Indian Guaranty and General Insurance Company Ltd., a government
company, along with the Indian Reinsurance Corporation as ‘Indian
Reinsures’. In 1968, the Insurance Act was amended to provide for
extension of social control over insurers transacting general insurance.
The amendments provided, inter alia for regulation of assets, setting up of
the Tariff Advisory Committee (TAC) under the chairmanship of Controller
of Insurance. Before the amendments of the act could be implemented,
management of non-life insurers was taken over by the Central
Government in 1971 as a prelude to nationalisation. General insurance
business was nationalised with effect from 1.1.73. , by the General
Insurance Business Act, 1972.

Prior to 1973, general insurance was more cities oriented, catering to the
needs of trade and industry. One hundred and seven insurers including
branches of foreign companies operating here were amalgamated and
grouped into four companies, viz. the National Insurance Company Ltd.,
the New India Assurance Company Ltd., the Oriental Insurance Company
Ltd., and the United India Assurance Company Ltd. GIC was incorporated
as a company in November, 1972 and it commenced business on January
1, 1973.

Government of India and that of four companies subscribe the capital of

GIC by GIC. All the five entities are Government companies, registered
under the Companies Act.

The purpose of establishment of GIC as a holding company of the four

operating companies as stated in General Insurance Business Act is
superintending, controlling, and carrying on the business of general

World Insurance Environment

In 1999 global premium income in the insurance industry, adjusted for

inflation, recorded strong growth of 4.5%. Booming life insurance and an
increase in non-life insurance business were the drivers of the growth.

Life insurance benefited as a result of shift from public to private pension

provision whereas non-insurance was adversely affected by low prices.

Some Highlights of World Insurance:

• 60% of all premiums are from life insurance.

Worldwide premium volume amounted to USD 2324 billion, with life

insurance accounted for 61% and non-life insurance accounted for

Japan and Switzerland spent the most per capita on life and non-
insurance respectively.

• Boom in Life Insurance –apart from Asia

Life Insurance Companies benefited in 1999 from low interest rates

and the increasing significance of private pension provision .At 6.9%,
growth was two percentage points higher than the average over the
previous ten years and considerably than the global economic growth
over the same period.

• Waiting for the turnaround in non-life insurance sector

Non-life growth of +1.2% in 1999 was below the long-term average,

although it did improve slightly over the previous year. Since 1994 non-
life premium growth has been lower than overall GDP.

Growth in U.S.A. (+1.3%) remained significantly below economic
growth. Japan registered a decline in premium for the third consecutive
year (-3.0%). South East Asian countries, which had to contend with
sharp falls in premiums last year as a result of the Asian crises,
recovered to a certain extent.

Introduction to Funds Flow and Cash Flow

4.1 Meaning of Fund

In a narrow sense, the fund is synonymous with cash. In this sense, the
funds flow statement is simply a statement of cash receipts and payments.
Such a statement is called cash flow statement; it portrays the inflow and
outflow of cash during a period.

The term “ Funds”, however, is broader than cash; it means working

capital, i.e., the difference between current assets and current liabilities or
the excess of current assets over current liabilities.

4.2 Meaning of Flow

The term flow means change. Therefore, the term “Flow of Funds” refers
to the movement of funds as a flow in and out of the working capital area.
All the flow of funds pass through working capital. In other words any
increase or decrease in working capital means, “ flow of Funds”.

4.3 Meaning of Funds Flow Statement

The balance sheet at the end of the period is generally different from the
balance sheet at the beginning of the year. The analysis method, which
discloses these changes, clearly is called “Funds Flow Statement”. In
short, funds flow statement is a statement, which is prepared to disclose
the changes in financial assets of balance sheets of two periods. Thus the
flow of funds could be studied with the help of funds flow statement.

4.4 Objectives of funds flow statement

The basic objectives of funds flow statement is to indicate whether funds

came from and where they are used between two balance sheet dates.
Funds flow statements a useful tool in the financial manager’s analytical

kit. Financial managers, financial analysts and credit granting institutions
use it.

Funds Flow Statement is prepared to know the periodic increase or

decrease of working capital of a business concern. It also enables the
management to know with reasons the basic causes of the changes in net
working capital.

Funds Flow Statement highlights the sources and applications of funds

and reveals changes in the financial structure of the firm between the two
Balance sheet dates.

4.5 Funds flow statement throws some light materially on the financial
aspects of the answers to the questions such as:

1) How much funds have been generated from recurring and non-
recurring activities?

2) How much funds have been raised from external sources?

3) Where did the profits go?

4) How was it possible to distribute dividends in excess of current

earnings, or in the presence of net loss for the period?

5) Why are the net current assets up even though there was a net loss for
the period?

6) How was the expansion of the plant and equipment financed?

7) How was the increase in working capital financed?

Thus Funds Flow Statement is able to present that information which

either is not available or not readily apparent from an analysis of other
financial statements.

4.6 Distinction between Funds Flow Statement and Balance Sheet.

1) Funds Flow Statement is based in flow concept as it reveals reasons for

changers in working capital that have taken place over a period of time,
whereas Balance Sheet is based on stock concept as it shows assets and
liabilities of the business firm at a point of time.

2) Funds Flow Statement is prepared to know the sources and

applications of the working capital, whereas Balance Sheet is prepared to
show the financial position of the concern at a point of time.

3) Balance Sheet is to be prepared in a prescribed form, whereas no such

form is prescribed for presentation of Funds Flow Statement.

4) Preparation and presentation of the Funds Flow Statement at the

annual general meeting is discretionary, whereas preparation of the
Balance Sheet and its presentation at there annual general meeting is

5) Funds Flow Statement is prepared with their help of the consecutive

Balance Sheet, Profit & Loss account and other schedules, etc.

4.7 Meaning of Cash Flow Statement

A Cash Flow Statement is not much very different from a ‘Funds Flow
Statement’. In preparation of Funds Flow Statement, the sources and
uses of the funds raised are taken into account while in preparation of
Cash Flow Statement, the sources and used of cash and cash equivalents
alone are taken into account. Thus the focus is on movement of casual
cash equivalents rather than on ‘net working capital’. The term ‘cash and
cash equivalents’ here stands for cash and bank balances. Cash is part of
working capital but working capital does not necessarily mean change in
cash. Therefore, Cash Flow Statement is prepared to show the impact of

various transactions on the cash position of the firm. It takes into account
the transactions resulting in cash inflows and cash outflows only. It
provides the details in respect of cash generated and applied during the
accounting period. Thus, a Cash Flow Statement may be defined as
summary of receipts and disbursements (or payment), reconciling the
opening cash (and bank) balance with the closing balances of the
concerned period with information about the various items appearing in the
Balance Sheet and the profit and loss account. Thus, a Cash Flow
Statement explains reasons for the changes in the cash position of the
firm. Transactions, which increase the cash position of the entity, are
labeled as ‘ inflow’ of cash and those, which decrease the cash position as
‘ outflow’ of cash. Cash Flow Statement traces the various fixed assets,
redemption f debentures and preference shares and other long-term debts
for cash. In short, a Cash Flow Statement shows the cash receipts and
disbursements during the period.


1. Funds Management

In narrow sense fund the word fund is synonymous with cash. However in
broader sense funds means working capital. They are used in same sense
so Funds management is same as working capital management current
asset management.

In any business working capital is one of the most important areas of

management. Interaction forms current assets and current liabilities in
such a way that a satisfactory level of working capital is maintained and
this is the main theme of working capital management.

The basic ingredients of theory of working capital management


1. Optimum level of current assets.

2. The trade off between profitability and risk, which is

associated with level of current assets and current liabilities.

3. Financing mix strategies.

For our purpose first two are important since 3rd is largely determined by
legal provisions. There is always conflict between profitability and liquidity
(risk). If a form does not have adequate working capital, i.e. it does not
invest sufficient funds in current assets it may become illegal and
consequently may not have ability to its current obligations and thus risk of
bankruptcy. If current assets are too large profitability is adversely affected.
The key strategies and considerations in enduring a trade off between
profitability and liquidity is one major dimension of working capital. In
addition to this current assets should be efficiently managed so those
neither inadequate nor unnecessary funds are locked up.

The management of working capital has two basic ingredients:

1. An overview of working capital as a whole

2. Efficient management of the current such as cash,

receivable and inventories.

Moreover in developing countries like India, importance of basic

infrastructure could not be underestimated. LIC are the backbone if funds
mobilization institutions in the country. Any asset management mismatch
could bring the whole financial system to a halt.

In the past it has been found that mismanagement of funds is the major
reason for liquidation of the company.

The companies which turned insolvent due to the mismanagement of

funds in the year 1999

Total Assets
Family Guaranty Life Insurance Co.
$28.9 million
Farmers & Ranchers Life Insurance Co.
$13.7 million
First National Life Insurance Co. of America
$126.2 million
Franklin American Life Insurance Co.
$76.1 million
Franklin Protective Life Insurance Co.

$30.1 million
General American Life Insurance Co.1
$14.1 billion
Integrity Life Insurance Co.
$7.4 billion
International Financial Services Life Insurance Co.
$206.9 million
Life Insurance Co. of Alaska
Not available
National Affiliated Investors Life Insurance Co.
$4.6 million
Settlers Life Insurance Co.2
$205.9 million
Universal Life Insurance Co.

2. Objectives of Funds Management or Liquidity


• Maintaining adequate funds for routine business activities like:

settlement of claims, payment of commission to agents, general

expenses for management of business.

• Maintain liquidity at operating units.

• Effective deployment and profit maximization.

• Ensure liquefying assets.

• Flexibility for re-mix and composition.

3. Liquidity Flow Cycle


• Premium minus Reinsurance

• Income from Investments

• Commission on Reinsurance ceded
• Other Income like Rent etc.

• Settlement of Claims.
• Commission on Reinsurance Accepted.
• Expenses on Management.
• Payment of Ex-Gratia /Arrears for Salary.
• Staff Loans, Housing, and Vehicles etc.
• Payment for purchase of capital items.
• Other Miscellaneous Disbursements.
• Investments.
• Money Market Lending (Loans)


As clear from the above cycle, the sources of cash flow can be divided
into three groupings.

1. New Money arising from the net savings of policy holders in life
insurance companies; This portion is made up of the inflow from

premiums, investment income, consideration for annuities, and other
types of income, less the outflow of funds for death claims and other
benefits, commissions, expenses, taxes and other disbursements. In
simplified terms new money is roughly equivalent to net savings of
policyholders in life insurance. More technically, the new money portion
of cash flow is made up of net investment income plus net income from
insurance operations, less the net increase in policy loans. The later
are investment assets but don’t represent investments under the
control of financial officers. Hence a rise in policy loans means a
decline in cash flow available for long-term investments in the capital

2. Return flow from invested arising from amortization, maturities and

other repayments of bonds and mortgages. They constitute an
important source of funds available for new investments. In the case of
mortgage loans, the bulk of this flow is rarely stable since it is derived
from contractual amortization payments which are typically on a
monthly basis for residential mortgage loans but often on an annual or
semi annual basis for commercial, industrial and farm mortgages.

The above listed forms of cash flow may be considered as the basic
cash flow against which investment officers may design their future
investment programs and issue forward investment commitments.
These forms of cash flow are beyond the direct control of investment
officers since they depend upon the decisions of policyholders to save
through life insurance, or upon scheduled repayments of bonds and
mortgages, or upon certain repayment options made available to the

3. The third major form of cash flow constitutes outright sales and
advancement of cash position. The sale of Government securities may
often involve taking if capital loses. A switch from Governments bonds
into private bonds or mortgages, therefore, requires a significantly
higher rate of return to recoup the loss incurred on sales below par.
Decisions to liquidate these securities, however, are likely to additional
factors such as the desire to broaden the diversification of bond
portfolio or to move out of securities in which the borrower’s credit
standing has deteriorated. For example, if it were considered desirable
to purchase a new bond being offered on the market, the only source
of available funds might be the liquidation present holdings, which are
relatively less attractive for a variety of reasons.

4. Few companies prefer to hold their cash position to a minimum level

and meet seasonal or temporary needs for cash through borrowing at
commercial banks for short periods.

4. Basic Steps In Funds Management

4.1 Basic funds management steps can be summarized under following


1. Receiving cheques for collections or cash payments.

2. Encashing the cheques as soon as possible by reducing the

transaction time to the minimum or depositing the cash in the central
pool account.

3. Estimating the liquidity requirements.

4. Investing the funds appropriately.

5. Prolonging the payments without forgiving the social objectives.

4.2On basis of above steps the basic strategies are:

1. Speedy collection of accounts receivable (covering first and second


2. Proper estimation and efficient investment management (covering third

and fourth step).

3. Stretching Accounts payable (covering fifth step).

4.2.1 Strategy 1 and Strategy 3 the companies could either set up their
own networks or could take the help of established bank networks of
various commercial banks providing cash management services package.
The broad Business situations, which arises in normal coarse of
business of Insurance

Companies and their probable solutions could be as follows:

Business Situation: one

Insurance Companies with many locations will have to keep separate
bank account for each location and must separately reconcile each

Managing accounts from numerous banks can be a hard task. Managing

treasury activities across the city with many different bank accounts can be

Example: A co ‘X’ is selling products BC in north India covering Delhi,

Lucknow, Meerut, Allahabad, Dehradun, Shimla and many other areas in
Punjab and UP. It is selling the product FG in west and east if x has a
separate band account for each of these 60 locations and may be with
different banks all together the head will receive 60 or more statements in
different banks all together the head office will receive 60 or more
statements in different formats to reconcile. It is hard task. Managing
treasury activities may be more frustrating when in spite of having money
in one bank account Co borrows at a higher rate.

Business Situation: two

Insurance Companies have sales office, regional office at various


Managing separate bank accounts for each of these locations means

locking funds with many different Banks.

Example: suppose ‘A’ opens 60 or more accounts at all locations. Each

account having a minimum balance of Rs 1000(on an average), the co will
block Rs. 60000 or more of its funds with no returns.

Moreover if these are current accounts then minimum balance requirement

would be in the range of Rs. 5000 to Rs. 10000 each and with no interest.

Business Situation: three

Insurance Companies with many locations or distribution / sales network
or franchise network will have collection from these locations.

Often companies are deprived of access to the funds of their own for
profitable deployment.

Whatever efforts are made to streamline the process of collection and to

get the funds as early as possible with the given constraints there ate
always problems due to improper information systems or strategic
manpower which defeats the very purpose.

Example: ’ A’ Collects cheques and drafts from 60 or more centers. Funds

are kept at various Bank accounts across the country. The company does
not have the access to its own funds for profitable deployment. If ‘A’ make
bulk investments from Head Quarters then it could negotiate on the
interest rates as against separate deposits.

Business Situation: Four

Insurance Companies have multi location distribution and sales. Collecting

outstation instruments received in the course of business is an important
banking service needed by a company. Proceeds of cheques sent for
collection to the banks on any given day would normally be credited to the
account as and when such instruments are realized.

Companies will not normally know when the cheques tendered for
collection will be realized and relative proceeds will be credited to its
account. Sometimes such realizations take considerable time.

At times although cheques are paid by the drawee bank at the destination
& there is considerable delay in ultimate credit into the companies

Estimate the cash flow based on the outstation cheques tendered for
collection is difficult.

Example: ‘A’ has accounts in major cities but it sells the product in
countryside areas also. It receives outstation cheques in the due course of
business. The company normally does not know when it will get credit for
outstation cheques. It could not plan its investment. Even it could not
match its payoff schedules.

Business Situation: Five

Insurance Company wants to transfer salaries to its employees at various

locations at it wants to give dividends to its agents and distributors. How
will it do these transactions? Traditional method is to keep the funds
engaged in until they reach the other end. However the companies loose a
lot of interest.

These cash management services also helps in stretching of accounts

payable. All the cheques are issued from central pool account. The firm
can play with the Float (cheque kiting) In between the time when they are
issued and actually paid.

At present the major providers of Cash MANAGEMENT SERVICES are:

• Vysya Bank: with following services

Cash concentration account

Zero balance account

Rapid collection service

Vyswift collection service

Telegraphic transfer service

• Citibank: with following services

Citibanking online

Citicheck anywhere

• Bank Of Tokyo –Mitsubishi

Camslink service

And various other banks like ABN- AMRO Bank, Standard Chartered
Grindlays Bank, Hong Kong Bank, Corporation Bank.

4.2.2 The second strategy i.e. Proper estimation and efficient investment
management, has two parts. Proper estimation of funds requirement on
daily, monthly, quarterly and yearly bases needs accurate Assets Liability
Management. And efficient investment of funds requires answers to
various questions mentioned in next section.


The liabilities of an insurance company do not pertain to the year in which

the policy is purchased. It runs through out the life of the policy. Hence the
chances of asset liability miss match in an insurance company are very
high. Moreover the investments, which are made by the life insurance
Company, are also made for a long term so if a contingency arises in the
middle of a year care has to be taken to provide for such contingencies.
Thus proper asset liability management in an insurance company is very

The goal of asset-liability management (ALM) is to measure and manage

the investment and liability risks of life insurance companies so that they
can meet their solvency and profitability objectives. The purpose of this
section is to look at factors affecting successful asset-liability management
practices and suggests how to achieve companies’ objectives.

. A life insurance company offers a variety of product lines, which include
life insurance, disability income, and annuities. Selling these products
involves collecting premiums from customers on a one-time or periodic
payment basis in return for future promises, also called liabilities, which
provide protection or benefits in case of death, disability, or retirement.

. A life insurance company’s success is greatly influenced by a variety of

risk factors because of the nature of its business; therefore, it should
emphasize implementing adequate risk management practices that
identify, measure, and control risks.

Why Take Risks?

Why do companies take risks? There are two basic reasons. First,
because they can make money at it. Second, because they have no
choice — it is just part of being in business. Let's look at the four different
types of risk from this perspective.

• C1 — Companies can earn extra investment return for taking on C1

risk. Higher risk means higher return. This is a risk that insurers are
willing to take because they can make money at it, though some are
more willing to take this risk than others.

• C2 — Companies earn profit margins for taking on C2 risk. For

example, the risk of dying too early is very high for an individual
person, but adding one person to a large group of insured people
doesn't add much risk to the insurer. Therefore, the insurer can
charge a price, which is higher than the break-even cost to itself,

but lower than the benefit, is worth to the person. That's a win-win

• C3 — Some people believe that they can make money by

predicting how interest rates will move and setting themselves up to
profit when rates move in the direction predicted. Others think that
interest rate movements are inherently unpredictable and don't try
to speculate for profit on interest rate movements.

• C4 — General management risk exists in every company in every

industry. It's not a risk that you can make money at. Its just risk that
you inevitably become exposed to in the process of doing business.

Risks Affecting Management

Risk can be defined as the cause for change in an expected outcome.

Risk is difficult to measure and should be well integrated with a company’s
overall business and financial strategy. It is essential for management of
life insurance companies to understand the risks on both sides of the
balance sheet in order to mitigate the threat of insolvency. There are
various kinds of actuarial and financial risks that life insurers identify in
developing strategic asset-liability management (ALM) processes.

Financial Risks

Six general types of financial risks face the insurance industry. These

• Actuarial

• Systematic

• Credit

• Liquidity

• Operational, and

• Legal risks

As these risks vary with the type of services provided, management of life
insurance companies work very hard to define the inherent financial risks
that can alter their course of success.

Actuarial risks arise from raising funds by means of issuing policies and
other liabilities. The two risks that affect companies are (1) paying too
much for the funds received and (2) receiving too little for the risks taken.

Systematic risk, also called the market risk, deals with changes in value of
assets and liabilities. These include interest rates and basis risk. Life

insurers measure and manage their vulnerability to interest rate
movements. Companies with common stock holdings, large corporate
bonds, and mortgages watch closely swings in the basis rate. Any
movement in the rates affects the yields on those instruments. Life
insurers invest in assets that vary in credit quality, liquidity, and maturity,
which subject them to market value variations independent of fluctuating
liability values.

Credit risk takes considers that borrowers will not fulfill their obligations
and is affected by borrowers’ financial condition and the value of their
collateral. Life insurers need to be concerned with this type of risk,
because investments in bonds form part of their asset portfolios

Liquidity risk may present potential funding crises connected with

unexpected events in the market. Because of the long-term nature of risk
associated with this type of business, life insurers undertake long-term
investments to fulfill their contractual obligations as they fall due.
Unexpected situations such as disinter mediation can arise when
policyholders make increased withdrawals and surrenders due to high
interest rates offered in the market. Such actions taken by policyholders
could force companies to sell off long-term assets at losses to pay for
these unexpected events.

Operational risk not only looks at management and employees but also at
management information systems used for processing data and record
keeping. Inefficiency in this area can produce costly outcomes for life
insurance companies.

Legal risk should be of great concern to the life insurance industry. New
legal trends can be observed in litigation outcomes, especially in the U.S.,
and globalization adds new meaning to the legal environment. Other

reasons such as fraud, violation of regulations, and misinterpretation of
contracts by policyholders add to the complexity of this kind of risk. This
legal risk can result in catastrophic losses to life insurance companies.

Actuarial Risk

Actuaries have developed a system of classifying the different types of

risks to which insurance companies are exposed which divides risk into
four categories:

• C1 — asset default risk, or credit risk. C1 risk is the risk that the
company's investments go bad. Junk bonds in the 1980s and
commercial real estate in the 1990s were sources of huge losses
for many insurers and several U.S. insolvencies.

• C2 — pricing risk, or insurance risk. C2 risk is the risk that mortality,

morbidity, persistency or expense experience will be worse than the
company charged for in its prices. This is the type of risk that
people normally associate with insurance.

• C3 — interest rate risk. C3 risk is the risk that the company will lose
money because of an unfavourable change in interest rates. The
example in the
introduction provides a
sense for how this risk
could occur.

• C4 — general
management risk. C4 risk
is the risk that
management will make
an error or that systems will fail or any similar incident that causes
the company to lose money.

Asset-Liability Management (Alm) Strategies

Life insurers operate either as mutual or stock companies and their overall
financial objectives generally involve a target return on capital and the
ability to provide prompt payments to their customers arising out of
contractual obligations. Thus, management’s role in a life insurance
company is to be proactive in scanning the environment. As shown in this
chart, this helps management to understand the trends that are happening
so that they can incorporate that understanding in planning and design of
asset-liability portfolios.

After management has developed comprehensive and understandable

asset-liability portfolios, it is necessary that these be communicated to all
levels in an organization. To accomplish the objectives, it is also important
that life insurance companies provide adequate technology and develop
organizational structures to

Assist management in performing its task. Organizational structures,

however, vary with life insurers and no one structure will work equally well
for all of them. Thus, in planning effective organizations "structure follows
strategy" (LOMA, 41). This implies that organizational structure should be
a result of asset-liability management’s objectives based on each insurer’s
strategies and levels of risk tolerance to reduce ineffectiveness in realizing
a company’s target. To achieve the determined objectives several
suggestions are made which include appointing a high-level asset-liability
committee and appropriating segmentation of investments and financial

Strategy Second: Part Two

Effects of investment on funds management

Since working capital management mainly deals with the management of
trade off between risk and liquidity, the investment decisions plays an
important role together with the fact that roughly 35% in 1999-2000 and
36% in 1998-1999 of the total income of LIC is earned from returns from
investments. The investment manager should take the following important

a) What type of securities to invest in

Whether to invest in equities, debt, bonds, gilt, municipal bonds, and

infrastructure bonds largely depends on legal framework and companies
policies. In USA the law relating to investment is less stringent so the
company are investing 10% of their funds in US govt. securities in 1960 as
compared to more than 54.78% of total funds in case of LIC in the year
1999-2000. It shows in 1960 US insurance companies were so liberal that
we are not even today.

A 54.78 Govt. of India, State Govt. and other securities

B 0.2 Loans to state road transport corporations.

C 4.4 Loans to state electricity Boards

D 0.46 House property and land

E 1.24 Loans for water supply & Sewerage

F 6.98 Loans for housing development

G 0.97 Other social Sector Investments

H 18.43 Investments in corporate sector

I 3.12 Loans to insure policies

J 0.3 Other investments

K 9.09 Other assets

Assets of LIC

b) Which specific of the selected type to invest in

The specific securities in the type depends upon past records, and return
of these securities

c) How much of our proportion of our fund to invest in each type of


The percentage of funds to invest in each depends upon the risk return
continuum and the expected % of return by the policyholders.

d) What is the approximate level of funds needed on each day, week, and
month, quarter, year?

It depends upon the past trends of outstanding claims on account of

maturity death and surrender and estimates about level of working capital


5.1 Introduction

It is axiomatic that as a life company grows over a period of time the level
of premium income also grows, adding additional amounts to the life funds
every year. Besides the receipts of investments from the previous year
would provide additional source of finance for additional purposes. As the
funds placed at the disposal of the life company are long term in nature
there is a assumption that on an average claims against the addition to the
policy reserves will not materialize for many years hence, i.e., usually upon
the death of the insured or at the maturity of the endowment policy. As
such, it is considered that investment of these reserves must be in long-
term obligations, such as govt. securities, real estates and mortgages.

Before life insurance contracts are entered into by life company, premium
rates are fixed making the requisite assumption regarding the rate of
interest at which earnings and policy holder reserves can be compounded
over the period of a life contract. Such an assumption regarding the rate of
interest allows the life company in placing its funds in those investment
outlets, which yield a fixed rate of return, a fairly regular payment of
interest over the life of the investment and assured repayment of a fixed
sum of rupees at the end of the investment period. Investment sin long-
term obligation satisfies these essential requirements. The advantages of
investing in long-term securities are

1) Higher rate of return

2) Elimination of transaction cost involved in frequent switching of a


3) Fairly stable rate of return

Maximizing investment earnings is dependent not only on the gross yield

on a particular of investments but also on the level of expenses connected
with the investment outlet.


The theory of portfolio selection, which is relevant for financial institutions

like a life insurance company, has to be somewhat different from that
which is applicable to the individual investors.


Traditional theories of portfolio selection under conditions of uncertainty

postulated that the individual investors choose the assets to be included in
the portfolio, taking into account the [probability distribution of returns
attach to each security or asset. The investor is expected to opt for a
portfolio, which maximizes the expected value of his utility function.


Harry Markowitz has rejected this traditional thinking on portfolio selection

under conditions of uncertainty. According to him investors are assumed to
choose among alternative portfolio of assets on the basis of two criteria.
Expected yield or return and risk. Asset or portfolio risk is measured under
this theory, by the variance of standard deviation of returns of the assets or
the portfolio. Once the investor has the information on the values of the
first two moments of the probability distribution of returns associated with
each security or asset how will e in a position to isolate from among the

set of available portfolios that set of portfolios which represent an efficient
combination of expected return and standard deviation of return when
these efficient combinations are plotted hey will yield an what is called an “
opportunity locus”.

There is however a number of practical difficulties in applying Markowitz

portfolio theory for an empirical study into an investment behavior,
particularly of financial institutions such as life insurance companies. There
is question whether variance of standard deviation completely reflects
what is called as default risk. Similarly the problems of marketability and
maturity of the financial assets, which are largely ignored in the portfolio
theory, are some of the attributes, which have a bearing on the portfolio

5.3 Yield Risk

It can be sub divided into two heads: capital value risk and income risk.

Capital Value Risk arises when the liquidity position of the company
becomes of bad as to necessitate a sale of security in the market before
maturity date, which results in a capital loss. The income risk arises when
there is possibility that the market rate of interest will change either during
the period life insurance contract is in force or at the time of deployment of
funds consequent on the maturity of securities. The first type of income
risk is peculiar to life insurance contract as premium are received at
different points in time while the rate of interest to be earned on those
funds has to be stipulated at the time the insurance contact is entered into.

5.4 Precautionary motive and speculative motive

For Precautionary motive life insurance companies maintain various kinds

of funds. It is not possible for the investment managers for life companies
to delay investment of funds at their disposal beyond a short period of

time, when there are significant excratios to these funds. Consequently the
companies cannot normally postpone investment purposes out of current
income, so they have weak speculative motive.

5.5 Income risk

It is axiomatic that a life insurance company must earn at least the rate of
return assumed in fixing the premium rates the question that need to be
discussed here related to the risk that arises as a result of uncertainty
about future variations in interest rates. This type of risk is particularly
relevant, as substantial portion of funds required to meet obligations
emanating from the existing life insurance contracts will only be received
at future dates. The funds that will become available for investments in
future arise mainly from two sources. First, premium payable in future on
existing life insurance contracts. Second, realization of previously invested
funds. The second source namely the turnover of the funds invested in the
past is n important problem. Suggestion offered for tackling this problem is
in the nature of matching and those, which are based on the basis on the
consideration of the expected yield. According to Clark, the investment
policy of Life Company must aim at maximizing the expected yield, with
minimum deviation of such yield from the realized yield.

Some other factors, which have an overbearing influence on funds

management of life insurance companies, are as follows:

1. Effect of Guidelines as issued by Insurance Regulatory Authority, India.

These guidelines govern the overall pattern of investments, reinvestments,

premium repatriation, creation of funds etc.

2. Effect of premature withdrawal: Pre-maturities could be of two kinds: by

death and by surrender. Life insurance companies calculate to a high
degree death pre-maturities on the basis of mortality tables. It is
surrender of policies that makes a problem. Proper consideration
should be given to them.


Case Study-


The LIC has a network of 7 zones, 100 divisions and over 2,000 branches.
LIC personnel exceed 700,000, with approximately 125,000 employees
and over 550,000 agents.

The Life Fund of the LIC, which was established in 1956 to conduct life
insurance transactions, has grown to approximately USD 25 billion from a
mere USD 94 million in its inaugural year. Over 100 million lives are
covered. The annual premium income, which was USD 21 million in 1956,
was estimated at USD 4.5 billion in 1997-98. Presently, business
investments of the LIC total over USD 23 billion.

1.1 Growth Of The Life Insurance Corporation (LIC)

Today the Life Insurance Corporation Of India has 2046 branches. It is

made up of 100 divisions, which are divided, into 7 zones. There are
558,000 LIC agents in the country.

The table below shows the expanding business over the years of the LIC.

YEAR 1957 1974-75 1979-80 1996-97

Total new Business 3.37 17.73 72 569.9
Individual (Rs. in billion) - 13.4 52.62 775.59
Individual (Rs in billion) 14.7 118.52 192.43 344.62
Group (Rs in billion) .05 14.57 61.37 64.61
No. Of policies in force (million) 5.69 18.8 22.09 77.75
Year 1957 1974-75 1789-80 1996-97
Group business (million) n.a. 2.33 5.84 24.45
Life fund (Rs in billion) 4.10 30.34 58.18 877.59

1.2 Investments:

The Investment pattern of LIC has undergone a change with it today
parking a lot of funds in the infrastructure sector as compared to before.
The following table indicates the above.

Type of Investment Investments Up to

(Rs. in billion) 1957 1967 1977 1987 1996 1997 1998
Central Govt. Securities 1.85 3.35 9.81 46.75 293.9 373.30 458.76
State Govt. & Other 0.70 2.63 7.15 16.83 75.45 89.06 104.71
Govt. Guaranteed
Marketable Securities
Electricity - 0.61 7.33 26.03 75.80 82.14 91.53
Housing - 1.21 6.18 18.72 87.31 109.67 122.42
Water Supply & - 0.16 2.03 7.18 18.81 20.28 22.64
State Road Transport - - - 1.80 4.77 5.40 5.51
Loans to Industrial - 0 0.1 0.37 0.45 0.45 0.45
Loans to Sugar Co- - 0 0.22 0.37 0.37 0.37 0.37
Development Authority- -- - 0.01 0.01 0.01 0.01
Roadways - - - - - - 0.25
Power Generation - - - - - - 2.76
(Private Sector)
Municipality - - - - - - 0.04
Total 2.55 7.99 32.81 118.06 556.9 680.68 809.45
Note: Items (1 & 2) are shown at Book Value and Items (3 to 12) are
Gross Investments.

1.3 Life Fund:

The Life fund of LIC has crossed Rs. 1,200 billion at the end of fiscal 1999
as compared to Rs.1,05 8.3 billion recorded in the previous fiscal.

Position as on 31st March (Rs. in billion)

1993 409.98
1994 496.65
1995 599.79
1996 727.80
1997 877.60
1998 1,05 8.32
1.4 Claims Settlement:

Over 110 million lives have been covered by the LIC under the Individual,
Group and Social Security schemes as on March 1998.

Claims settlement as on 31.3.98

Number – 5.65 million

Amount – Rs.66.77 billion

LIC settles over nineteen thousand claims amounting to around Rs 230

million every working day.

Claims settled in Rs. billion

Year Death Maturity Total

1975-76 0.38 1.28 1.66
1984-85 1.10 5.29 6.39
1990-91 3.12 14.38 17.51
1994-95 6.88 33.88 40.
1995-96 7.98 37.34 45.32
1996-97 10.01 46.90 56.91

1997-98 11.63 55.14 66.77
1.5 Highlights of 1998-99:

The first premium income, which is really the indicator of growth in the
business of Life Insurance, has grown by 28% during 1998-99. The LIC
has collected Rs.26.91 billion during the year, up from Rs.20.99 billion in
1997-98. About 14,843,680 new policies were added in 1998-99 to the
existing 80 million policies. The total sum assured is pegged at Rs.753.16
billion during 1998-99 up from Rs.631.67 billion during 1997-98.This would
give a new business premium of Rs.26.91 billion. The individual

Pension business grew with the sale of 105,638 policies generating a first
premium income of Rs. 1.11 billion posting growth rates of 63% and 131%
respectively. Under the group Insurance scheme a total of 1.27 billion lives
were covered generating a new business premium of Rs. 4.43 billion
registering a growth of 195% and 295% respectively. The institutions total
fund size has crossed Rs.1,200 billion during the year.

The growth in policies, minimum sum assured and the premium incomes
during the last five years has been highlighted below

Growth In Percentage


1994-95 1.4 32.1 5.3
1995-96 1.3 -6.2 20.7
1996-97 11.3 9.5 21.5
1997-98 8.5 12.1 15.6
1998-99 11.5 18.4 28.2

1.6 LIC and the Five-year Plans

LIC has consistently supported the five-year plans of India

Contribution to 8th plan: Rs.561 billion

Contribution to 9th plan till date: Rs. 404 billion

Contribution upto31.3.98 in

• Housing: Rs.122.42 billion

• Electricity: Rs.94.29 billion

• Water supply and sewerage: Rs. 22.68 billion

• Road Transport: Rs. 5.51 billion

Assets of U.S. Life Insurance Companies

Year U.S. Govt. Sec. State and Rail-Road Public


Local Bonds Bonds

1940 5,767 2,392 2,830 4,273
(18.7%) (7.8%) (9.2%) (13.9%)

1945 20,583 1,047 2,948 5,212

(45.9%) (2.3%) (6.6%) (11.6%)

1950 13,549 1,547 3,187 10,587

(21.0%) (2.4%) (5.0%) (16.5%)

1955 8,756 2,696 3,912 13,968

(9.5%) (3.0%) (4.3%) (15.5%)

1970 6,427 4,576 3,668 16,719

(5.4%) (3.8%) (3.1%) (14.0%)

Some Trends

• Less than half of the finance is raised from internal sources and more

than half is raised externally.

• The growing substitution of private debt for govt. debt. Govt. Bonds

serve as residual sources and uses of funds, they are the primary
standard in terms of which the investment qualities of alternate
investments are judged. As a rule they turn to govt. securities, first,
when there is a lack of high yielding private obligations processing
sufficient safety features and, secondly when the structure of interest
rates changes in a way that narrows the spread between the yield on
govt. and that on private obligations.

• They have dominating position in corporate bonds market.


1. Government securities constituted by far the most important asset

in the portfolio of the L.I.C. throughout the period, they are increasing but
the importance of these securities in the portfolio registered a decline over
the period (from 50% to 54% during 1957 to 1963 to 36% by the end of
march 1975).

2. Loans to State Electricity Boards, statutory authorities, housing

loans and loans guaranteed by Central and State Govt. progressively
because an important outlet for investment funds of the corporation.

3. Minimum operation in short terms market. Generally relying on long-

term investments and thus losing opportunities for earning.

4. L.I.C. gross yield performance has increased over time.

Year gross yield

Prior to 1963-64 less than 5%

1969-70 6%

1974.75 6.93

But it is less impressive than the rise in yield earned by the leading
British and U.S. life companies (their yield is approx. more than

5. There is a rise in the amount of policy loans advanced by the L.I.C.
as well corporate investment in land and house property

On the whole it has been observed that frequent govt. intervention and
handicap autonomy in taking investment decisions is affecting the
performance of L.I.C.

Increasingly it has been used as an instrument to bring back the stock

markets in line. Whenever there is a sharp decline in stock markets it is
asked to invest large amounts of funds in the stock markets.

Lack of Professionalism is also possible for its poor performance.

Under the Insurance Regulatory Development Act (IRDA) banks, private

sectors bank, public limited company have been allowed to enter into
insurance services whether its is life insurance of non-life insurance sector.
In the year 2001 three private sector banks/public sector companies have
applied to Reserve Bank of India/ IRDA to procure licenses for setting up
the insurance business. Only one public sector bank that is State Bank of
India has entered joint venture with Cardiff, PLC of France with 26% equity
participation to set up Life Insurance Business which is supplied to its
customer under the umbrella of Banc Assurance means to provide
Insurance services to the P segment customers. Mr. R. Krishna Murthy as
CEO of SBI Life Insurance Subsidiary has started functioning from its
corporate center at Mumbai.


With the opening of insurance sector to private players, large-scale

reforms are needed in its functioning. There should be change in the
mindset of the govt. that L.I.C. is the largest funds mobilizer in the country
should its financial performance along with satisfying the social
considerations. The broad changes necessary in its functioning could be

• Political intervention should be reduced and greater autonomy should

be given to L.I.C. in its operations. It will also help in taking quick

decisions in fast changing economic scenario.

• It should be much more professional in its approach. Initiatives should

be taken to launch alternative competitive policies.

• Greater transparency should be brought in functioning. Its investment

portfolio should be declared open.

• Yield risk may be sub-divided under two heads: (a) capital value risk:

and (b) income risk. L.I.C. during the 70`s and 80`s did not care about
its capital value risk. It cares only for income risk. It used to neglect it
because of high degree of accuracy with which actuaries can forecast
mortality rates.

However, the situations will not remain same in the open and
competitive market. They have to make suitable policies for it. The
need for its consideration will increase due to two reasons:

(a) The privilege that is granted to policy holders to receive surrender

values of their policies by premature termination

(b) The right to secure loans from life companies up to a ceiling of the
surrender values.

• With the permission to invest greater percentage in stock markets and

highly volatile markets, it should not generally postpone buying

decisions expecting higher rates of return nor do they “ over commit
themselves in anticipation of declined of returns.

L.I.C. should be careful while taking investment decisions.

Here are a six of the most important decisions it must take before making

1. Goals and objectives of the investment function

What is more important to your company? Yield, total returns, some

combination? If a combination, how is the importance of yield and total
return weighted in importance for your company? Are taxes important? To
what extent will review after tax total return be important to your company?
Finally, what are the overall financial objectives of your company?
Maximizing short-term earnings? Maximizing long-term economic value?
Maximizing shareholder value? Maximizing return on equity?

All of these questions must be answered to determine the overall direction

in which the investments should be made.

2. Investment policy

Does the current investment policy accurately reflect the purpose and
goals of the investment function you have just outlined? The policy should
not start with the basis of what other companies are doing? That is one of
the many problems to which all human decision-making is subject. It is
called farming, and it means we automatically use to comfortable frame of
references within which to make decisions. Setting forth even a draft of an
investment policy requires a complex set of decisions. Of course, that
does not mean that your company’s investment policy will not look like

many other insurer policies. After all, similar investors with similar goals
and constraints will tend to have similar policies. However, it does mean
that the investment manager will have considered asset classes and policy
issues that, perhaps, he might have not fully considered in the past. And
the result may indeed be investment results.

3. Liability characteristics

What does the manager know about the company’s liabilities, and what
more does he needs to know to fashion an appropriate investment policy?
Your company has funds to invest to satisfy two major constituencies:
policyholders and stockholders. For stock companies, that means
understanding the impact of your company’s capital structure on the
investment portfolio. For stock or mutual companies, that means
understanding more than just what duration of liabilities are, but it means
understanding how the liabilities will react in different economic, market
and underwriting environments.

Duration might be the most overly relied upon and ill-used financial. A
duration of 5 years on liabilities means assets must have the same
duration, more or less. For any single duration numbers there are literally
countless combinations of cash flows that will produce the same number.
Thus duration is only part of the story – amount, timing and variability of
the amount and timing to cash flows for both assets and liabilities must be

4. Asset allocation

A company’s asset allocation decision will decide 80-90% of the returns on

the portfolio. However, many times there is insufficient attention given to
this most important decision. So we should ask what standards the
investment manger would use to judge the usefulness of asset allocation

and other modeling done for us? Let’s face it there really isn’t all that much
difference in core fixed income manager performance – certainly nowhere
near the amount of variability found in the world of equities.

Thus, in an effort to differentiate what is largely similar core fixed income

performance, investment managers have resorted to a variation on the old
bromide. “Baffile them with b.s.” This has meant a proliferation of various
asset allocation models, some well, some bad, many ugly. In every case,
these models are really more to protect the manager legally (due diligence
has been done), and put the company’s senior management at ease (we
used a really more to protect the manager legally (due diligence has been
done), and put the company’s senior management at ease (we used a
really advanced process, right?), than to really add significant value to the
investment process.

Hence, a few words of caution: First, all of these models invariably assume
that we human beings are rational and always act that way. Thus, any
significant deviations are accounted for within bounds of confidence inside
the models. We trust these models implicitly, despite the fact that none of
us really know any 100% rational humans. And it is those times of
irrationality that can truly wreak havoc with our company’s financial
statements. Second, all of these models must be questioned on three
basic levels – assumptions, model structure (how the thing works), and
output (what all that stuff means).

In other words, look inside the black. If it is difficult to understand it may

be just as difficult to support the next time on the ‘unusual’ events occur
and you have to explain why your company did what it did to the board of
directors, rating agencies or regulators. The examples of not being able to
successfully do this before following the models’ recommendations are

myriad, but we’ll name there recent ones: General American, ARM
Financial and Long Term Capital Management. Go ahead and add a few
names of your own to the list.

Of Course, for many companies, simply following what other insurers are
doing seems to be the answer to the asset allocation question. This is an
answer that should, in itself, be questioned, for the reasons noted in
number 2 above. It will be inevitable spell investment under performance –
a recipe for problems in an increasingly competitive market.

5. Investment benchmarks

What types of benchmarks will we use to judge investment performance?

Notice this does not require the fund manager to choose a benchmark yet.
It does require that you decide what type of benchmarks he wants. What
will be the purpose of the benchmark? When will it be used to warm or fire
the manger? If the purpose of benchmark is simply to see how the
manager did against a generic universe of similar securities of similar
securities, one of the generic benchmarks (e.g. S&P 500, Lehman
Aggregate) will do. However, if the purpose is to see how the manager did
in meeting your company’s goals and objectives, then the company will
need to use a more customized benchmark.

A world of caution here: In their continuing effort to keep the business, the
manager will spend a lot of time fashioning a benchmark that should be
relatively easy to beat. If the company would like to maintain relationship
with the investment manager no matter his performance, this is an
excellent solution. However, if superior performance is a goal, setting the
bar as high as possible should be your company’s goal.

6. Manager monitoring

Under what circumstances will you consider replacing your manager? This
is important, even when hiring a brand new manager. The company must
ask itself the question that “value” investors ask every day. Based upon
what investment has been done for so far, would the company continue to
own it.

Annually, the company should carefully review if the existing manager is

meeting the needs of the company. If not, what should be done to get
them there and how? If this does not appear immediately feasible, you
have begun making the case for a manager search.

Here are the six key investment decisions, which should be made by a
company before investing. Not easy decisions by any means, but
important decisions that will set the tone for a successful, high
performance investment operation.

Model 1

In the following model, I tried to reshuffle the portfolio of the LIC, taking
into account the average of the opening and closing balances and tried to
suggest better allocation of funds available with the LIC.

In the first two tables, returns on the investments of the year 1998 and
1999 have been calculated. As either opening or closing balance cannot
give the actual picture of the funds invested over the year so that average
of the opening and closing balances has been taken in to consideration for
the calculation of the return.

In table 3, total investment funds inclusive of percentage investment in the

each category for the year 2000 has been shown. And return has been
calculated on that.

In next table, reshuffled portfolio has been shown and return on the new
portfolio has been calculated. All though the minimum limit for investing in
Government Securities is 50% but to play safe we have invested 53% of
the total funds in the government Securities. This is also done because
the proportion of investments has to be 50% minimum on any given date
so by investing 53% we provide a margin of 3%. All though the returns in
the non approved security are high but still we have invested 28.5% of the
funds and not the entire 30%, this is done because such securities carry
along with them a high risk factor also. So we have invested 28.5% only.

Here, we can see that after the reshuffling of the portfolio, percentage
return has just increased to 11.33% from 11.24%, but in the actual
monetary terms it results in increment of Rs. 132.68 crores.


Exposure/ Prudential Norms

Without prejudice to anything contained in Sections 27A and 27B of the

Act, every insurer shall limit his investments based on the following
exposure norms:

A) Exposure Norms
Type of Investment Limit for Investee Limit for the Limit for the
Company entire group to industry sector to
which the which the
investee investee company
company belongs
Not exceeding 15%
(a) Equity/ Preference (i) As on any date (i) As on any
of the total capital
Shares/ Convertible date
Not exceeding employed* in all
portion of Debentures 20% of the total Not exceeding such companies.
at face value. capital employed*. 15% of the total
(b) Debentures - (face capital employed*
value) including of the group
private placed NCD companies.
and Non-convertible
portion of Convertible (ii) During the (ii) During the
Debentures. year year
(c) Short/ Medium/ Long Not exceeding 5% Not exceeding
Term Loans and any of estimated 10% of estimated
other direct financial annual accretion of annual accretion
assistance. funds. of funds.

* Total capital employed means total of equity shares, preference shares,

debentures, long/ medium/ short term loans (excluding public deposits),
free reserves but excluding revaluation reserves, of the investee company
as shown in its last audited balance sheet.

Exposure Norms for Investment in Public Financial

Equity Share and Preference Shares (at Not exceeding 15% in general of the paid
their face value). up equity/ preference capital of the
institution or the existing holding % level, if

Investment in Equity Capital, Bonds, Not exceeding 10% of the capital employed
Debentures, Term Loans. by an institution as per the last audited
Balance Sheet.

Total Investment vis-à-vis Net Worth of Not exceeding 60% of Net Worth of the
the Company. institution.

Total Investment in a Financial Year. 7.5% of annual accretions.

Total Investments in all the Financial Annual aggregate financial assistance to all
Institutions. Development Financial Institutions put
together in a single year shall not exceed
20% of the estimated annual accretions for
the year.

Prudential Norms

The prudential norms for various instruments shall be as under:

i) Debentures:

Norms for Fully Convertible Debentures and Partly Convertible


Investment decisions are related to attractiveness of equity shares to be

received as a result of conversion. Due consideration is also given to the
factors, viz

a) Rate of interest at the time of subscription to said debentures,

b) Appreciation and

c) Dividend income likely to be received from the equity shares.

Similar considerations also apply for Non-Convertible (NC) Debentures

with detachable warrants attached to it.

Norms for Non-Convertible Debentures and Non-Convertible

Debentures with warrants attached:

1. Eligibility Amount

a) Working Capital 20% of the current assets, loans and advance minus
Debentures outstanding amount of existing working capital NC

b) Project Finance As appraised by the Investment Committee

c) Normal Capital As assessed by the Investment Committee


Asset Cover (as specified in Schedule III):

First pari passu charge on fixed assets of the company offered as

security with a minimum of 1.25 times including proposed borrowings
(excluding revaluation of assets).

Debt Equity Ratio (as specified in Schedule III):

Not to exceed 2:1 including the proposed NC Debenture issue. However,

in case of capital-intensive project debentures, higher ratio up to 4:1 may
be considered.

Interest Cover (as specified in Schedule III):

Not less than 2 times for the latest year or on the basis of the average of
the immediately preceding three years after including the interest on the
proposed debentures at the applicable rate.

Dividend Payout:

Minimum dividend of 10% in each of the two years out of the

immediately preceding three years including the latest year.

Term Deposits and Loans with Non Banking Companies:

The insurers need to place the deposits with a view to cater to working
capital needs of the corporate sector. The placement of the deposit is to
be decided after evaluating financial and non-financial aspects of the
performance parameters of the companies. The analysis need to include
study of financial position, track record and other features such as quality
of management, future prospects and market potential for the company's
products. Credit rating of borrower should be uniformly maintained at a
position which is indicative of a very strong financial position being not
less than AA of Standard and Poor or equivalent rating of any other
reputed and independent rating agency.

The maximum amount of Short Term Deposit that may be placed with any
company is restricted to Rs 2 crores or 10% of net worth whichever is

The various norms/ parameters for the placement of term loans are as

Particulars Limits
Unsecured borrowing as a % Not to exceed 25% of net worth including the proposed
of net worth. loan, subject to net worth of the borrowing company
being not less than Rs. 15 crores.
Interest Cover. At least 2.5 times including interest on proposed loans.
Debt/ Equity Ratio. Not to exceed 2:1.
Current Ratio. Not less than 1.33:1.
Dividend Record. At least 10% for the last 5 years or 15% and above for
3 out of 5 years.
Listing Equity shares of the Company shall be listed on any
recognised stock exchange and the price should
continuously been quoting above par at least for 12
months prior to the date of sanction of loan.
Collateral Security Cheques shall be obtained for principal and interest
amount. Personal guarantee of promoters and pledge
of shares may be taken.

iii) Infrastructure and Social Sector:

In the case of projects/ works in the infrastructure and social sector

undertaken by a person other than a company, the norms indicated in the
table above shall have to be met to the extent applicable.

Guidelines on subscription to Preference Shares:

a) Companies whose preference shares are selected for investment

should have sound financial position and steady income earning

b) The dividend payable on the preference shares should be cumulative.

c) The preference shares shall be redeemable.

d) Preference capital after proposed issue shall not exceed 100% of

equity capital.

e) Dividend should have been paid on equity shares for two years out of
immediately preceding three years.

f) Preference dividend should have been paid for 3 years or 3 out of 4 or

5 years including latest 2 years if the preference shares are issued

g) Non-dividend paying preference shares should not be considered for


h) Dividend cover on the basis of average profit of last 3 to5 years should
be 3 times.

Returns to be submitted by the Insurer:

Every insurer shall submit to the Authority the following returns

within such time, at such intervals and verified / certified in such manner
as indicated there against. These returns shall be in addition to those
prescribed in Insurance Rules, 1939.

S.No Form No as Short description Periodi Time limit for Verified/
annexed to city of submission Certified by
these returns

1 Form 1 Statement of Yearly Within 30 days Principal Officer/

investment and from the date Chief
income on of Board (Investment)
investment approval of

2 Form 2 Statement of down Quarterl Within 21 days Principal Officer/

graded investments. y of the end of Chief
each quarter. (Investment)

3 Form 3 A Statement of Quarterl Within 21 days Principal Officer/

Investment of y of the end of Chief
Controlled Fund each quarter. (Investment)
(Life) – Compliance

4 Form 3 B Statement of Quarterl Within 21 days Principal Officer/

Investment of Total y of the end of Chief
Assets (General) – each quarter. (Investment)
Compliance Report

5 Form 4 Prudential Yearly Within 30 days Principal Officer/

Investment Norms – from the date Chief
Compliance Report of Board (Investment)
approval of

The Authority may, by any general or special order, modify or relax any
requirement relating to the above.

Power to call for additional information

The Authority may, by general or special order, require from the insurers
such other information in such manner, intervals and time limit as may be
specified therein.

Duty to Report extraordinary events affecting the investment


Every insurer shall report to the Authority forthwith, the effect or the
probable effect of any event coming to his knowledge, which could have
an adverse impact on the investment portfolio held by him.

Constitution of Investment Committee

Every insurer shall constitute an Investment Committee which shall

consist of a minimum of two non-executive directors of the Insurer, the
Principal Officer, Chiefs of Finance and Investment divisions, and
wherever appointed actuary is present, the Appointed Actuary. The
decisions taken by the Investment Committee shall be properly recorded
and be open to inspection by the officers of the Authority.


(1) Valuation of Assets and Accounting of Investments shall be as

per the Insurance Regulatory and Development Authority
(Preparation of Financial Statements and Auditor’s Report of
Insurance Companies) Regulations, 2000.

(2) The Authority may, by any general or special order, modify or

relax requirement relating to regulation 5.


(See Regulation 3)


‘Approved Investments’ for the purposes of Section 27A of the Act shall be
as follows:

a. All approved investments specified in Section 27A of the Act except

i) Clause (b) of sub-section (1) of section 27A of the Act;

ii) First mortgages on immovable property situated in other country as

stated in clause (m) of subsection (1) of section 27A of the Act

iii) Immovable property situated in other country as stated in clause (n) of

subsection (1) of section 27A of the Act

In addition the Authority under powers given vide clause (s) of sub-section
(1) section 27A of the Act declares the following investments as approved

b. All secured loans, deposits, debentures, bonds, other debt instruments,

shares and preference shares rated as ‘very strong’ or more by a
reputed and independent rating agency (e.g. AA of Standard and Poor);

c. Deposits with banks (e.g. in current account, call deposits, notice

deposits, term deposits, certificates of deposits, etc) and with Primary
Dealers recognised by RBI included for the time being in the Second
Schedule to the Reserve Bank of India Act, 1934 (2 of 1934);

d. Commercial papers issued by a company having a ‘very strong’ or

more rating by a reputed and independent rating agency (e.g. AA of
Standard and Poor);

e. Investments in Venture Capital Funds of such companies/
organisations, which have a proven track record and have been, rated
‘very strong’ or more by a reputed and independent rating agency (e.g.
AA of Standard and Poor).

Explanation: For this purpose any investment in the shares or debentures

or short or medium or long-term loans or deposits with private limited
companies shall not be treated as ‘approved investments’.


 Introduction 2
 Indian Insurance Industry: A Perspective 10
 World Insurance Environment in 1999 15
 Introduction to Funds Flow and Cash Flow 17
 Funds Management 22
 Objectives of funds Management or Liquidity 25

 Liquidity Flow Cycle 26
 Basic Steps in Funds Management 29
 Investment policy of Life Insurance companies 43
 Life Insurance Corporation of India 48
 Conclusion 57
 Recommendations 59
 Annexure 66