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Risk Management in General Insurance


Risk management as a subject and as a function function of businss management and
therefore the purpose of unit is to explore some of the basic concept of risk and
management of it.
• The Entrance Arch into Lords where the World Cup 1999 culminated, carries the
following inscription, excerpted from the Poem "IF" of Rudyard Kipling, "If you
can cope equally well with triumph and disaster, JOU Will probably do all right
for yourself. Apparently, Kipling was writing about large and enduring things but
his sentiments very emphatically can be applied to any modern commercial enterprise
(including that Great Commercial Enterprise of International Cricket). In a real sense,
Business process is as much about coping with problems as it is do with Sales
Performance and Bottom line. This continuous process of problem solving, like any
other Faculty of Management, is an Art as well as a Science. This presentation aims
to identify a few critical areas of the "Risk Management Function". For the purpose
of ease in comprehension, this write up would use the word "Risk" as interchangeable
with "Hazard" (though essentially, Hazard is the cause and Risk is the resultant).
The term Risk Management first appeared in print in the Harward Business Review in an
article by Russel Galigar in 1956, although this term has been in conversational use some
years before. Ever since insurance was transacted as a separate discipline, the term Risk
Management has been interchangeably used with insurance. The word risk has shades of
uncertainty. In common parlance the word risk has been used more to indicate the chances
of failure. Life in this planet has evolved around a lot of uncertainty. Ever since life on this
planet evolved from the amoeba stage to the current level of human race, there have
always been uncertainties in the environment for billions of years. It was through a process
of mutation one species evolved into another, thereby overcoming the risks of uncertain
destinies. As we will see in the later chapters, Risk and Uncertainty have a direct relationship.
But then both are still different.

We all are familiar with resources that have many forms - Men, Materials, Finance, and
Intellectual Property etc. All of us are also aware that the human life involves a large level
of dynamism. Whether one chooses to call it as progress or deterioration, human life has
moved from one phase to another.
In the 20th century we have seen Industrial Revolution emerge into Technological Revolution
and in the 21 st century we are seeing even Basic Sciences undergoing tremendous amount

Unit 1

Basic Concept of Risk Management

of change in their approach and focus. But the problem with resources is that they are
limited in quality and quantity, e.g., Fossil fuels like Petrol, Diesel. Though reserves of
these types of fuels are being discovered from time to time, the fact remains that they are
all depletable. So, we have a situation, where there are several opportunities, these
opportunities require resources, but there are limitations in terms of the quantity and quality
of resources. So, we are forced to choose between the various opportunities and allocate
the limited resources in such a way that the optimum benefit from such an opportunity can
be derived.
Risk Management is all about efficient allocation of resources to various risks so that an
optimum utilization of these resources takes place.
When we talk of optimum utilization of resources, this process is not confined only to
Business Organizations. Even in individual life we come across several opportunities and
we similarly face the resource crunch which organizations face. We are therefore forced to
allocate priorities and use our personal limited resources in the best possible manner. Not
only commercial organizations but also Non-Profit entities like hospitals, charitable institutions
and even Government Departments will have to undertake the process of Risk Management
for efficient use of resources. So long as there is a limitation on resources and so long as
there is a variety of options available for using these resources then there has to be a
process of Risk Management.
JJ&Activity A:
Comment on "Risk Management is necessary for efficient use of resources."

Risk creates anxieties and anxieties result in lesser than efficient utilization of resources.
Risk Management enables a business to handle its ordinary businesses in a better manner.
Freed of concern about both accidental losses as well as usual business risks, a business
can more aggressively and intelligently organise its regular activities. Whether it is introduction
of new product or extending the operation into a new territory or making investments to
expand the level of operations, all will hinge upon the perceptions of risk both of accidental

Risk Management in General Insurance

and regular nature. The increasing complexity of both business and personal life Risk
Management is no longer an option.
Think of the number of Non-Banking Financial Institutions that suffered a collapse in our
own country. Many of them had a fundamental deficiency in that; they did not manage their
risks of their investments properly, with a result many investments floundered. Similarly,
think of several Fortune 500 companies in the United States of America collapsing one
after another in recent weeks. These companies again had a fundamental flaw that the
Corporate Management was less efficient in the management of risks related to Corporate
^Activity B :
You are a Director of a drug manufacturing factory and want to appoint a risk manager.
Write down your views on "Responsibility of a risk manager" in your factory.

Risk is defined in various ways, in various contexts. This write-up will define Risk as
Williams & Heins chose to define: "the variation in the outcomes that could occur
over a specified period in the given situation."
If only one outcome is possible, the risk is Zero. The greater the variation, the greater the
A risk may be defined as follows:

Risk is the possibility of an unfortunate occurrence.

Risk is a combination of hazard.

Risk is unpredictability _ the tendency that actual results may differ from predicted

Risk is uncertainty of loss.

Risk is the possibility of loss.

There are two possible outcomes . The closer the probability is to one the more likely it will occur. it could be a clean-bowled etc. as you will see in the one of the later chapters. If the probability is zero. a particular outcome will not occur at all. it is simple that either the individual person or his family organises the process of Risk Management either in a deliberate or a routine manner. The probability associated with a certain outcome is the relative likelihood that the outcome will occur.Head or Tail and therefore the possibility that one of the outcomes will occur during the toss of a coin is one by two. Since Risk pervades throughout the organisation. Contrast this with the possibilities. 1.Unit 1 Basic Concept of Risk Management Risk and probability are closely linked. If the probability is One that outcome will occur. Management of risk In the case of an individual. Therefore the probability that out of a ball being bowled the result will be run out is certainly not one by two or one by six but it is far less than that. But in the case of Corporate. it could be a stumping. Since we have defined risk as a function of outcome. The probability associated with a certain outcome is the relative likelihood that the outcome will occur. it could be a hit wicket. Probability varies between Zero and One. PROBABILITY AND UNCERTAINTY Since Risk Management is about managing risks. This would again require clarity on meaning of associated terms like Probability and Uncertainty.It could be a run out. Probability varies between zero and one. we need to know clearly. . Before the start of a Cricket match we have all seen the rival captains marching out to the centre of the field and one of them tossing the coin and the other calling either Head or Tail.5 RISK. If the probability is Zero. If one starts plotting the probability of various outcomes out of a particular event along a graph. There are a variety of possibilities for such a ball being bowled . Risk Management need not be isolated or become insular. then one gets what is called as the Probability Distribution. If the probability is one then that outcome will certainly occur. mathematically risk can be visualized as the characteristics of the probability distribution of certain outcome. the outcome will not occur. We will first start with the definition of the concept of Probability. which emerge out of a single ball being bowled. the meaning of the term Risk. Risk Management also has to pervade equally well. But. the recent trend has been that an exclusive Risk Management position is created and the Risk Manager handles the process of Risk Management.

1 are more when compared to the possibilities given in the Figure 1.Risk Management in General Insurance Please see the illustration Figure 1.1 and 1. 1 Probability 0 100 200 300 400 500 (Rs.2 wherein two probability distributions are given. Crores) Fig 1 : Total Losses in a financial year Probability 0 100 200 300 400 500 (Rs. These illustrations will be useful in understanding the concept of risk which we will define subsequently.2. Crores) Fig 2 : Total Losses in a financial year . You will find that the possibilities in the probability distribution 1.

let us say. hundred bulbs will be defective will also have a certain number attachable.because there was lack of any statistical history. All the examples given the probability can be estimated by computing the proportion of times the outcome in question occurs in a long series of repeated observations. There is a theorem called as the Law of Large Numbers which may be proved mathematically and which goes as follows "As the number of independent observations increases the proportion of times as certain outcome occurs tends to approach the underlying probability". Likewise.Unit 1 ire en Basic Concept of Risk Management Take the case of a factory manufacturing electric bulbs. For every thousand bulbs. What is to be remembered however is that if you go on (Mgpp«Bi^)fccv»7X under essentially the same CQMitiQ^^a\^Q\vw&feiw Osss&vo^t /ing objective probability. You have seen it happen in the film making industry. Perhaps if it is a good elevator system. That this statement is subject to the assumption that if the underlying conditions undergo a change then still statistical evidence may be available that would indicate the trends. e. even a very . The reason being the former type of examples like the manufacture of electric bulbs or lift reaching a particular floor has what is called as an underlying probability to it and this underlying probability is more often than not an objective probability. cycles or seasonal fluctuations that will affect the outcome. On the other hand the probability that your boss is going to be good to you in office on any particular day cannot have a clear number attached to it. the probability that there will be zero defects will have a number attached to it. almost close to one. Similarly the probability that the stock market index will reach a particular level on a particular day cannot also have a clear number attached to it. the probability the elevator in a high rise building consisting of 40 storeys will always reach the desired floor or any particular floor also will have a certain number attachable to it. the probability that for every thousand bulbs. The chances that a particular film starring. By objective we mean that there is statistical evidence which may be available or which can be established through which this objective probability can be figured out. The probability that the 'Hole in One' situation will happen in a golf course may undergo a change if the landscape of the golf course is drastically altered. there is also a possibility of probability being estimated subjectively . for computing the probability of a certain number of bulbs being defective we can repeat the observations for a period of lets say 100 days or so and then whatever probability emerges out of that or whatever proportion emerges out of that these series of observations can be close to the underlying objective probability. As there exists objective probability. For e.g. Similarly.g.

in every ball. Think of Leonardo da Vinci who was trying to simulate the flight path of birds .Risk Management in General Insurance popular hero like Shah Rukh Khan. injury. which can arise out of a single ball being bowled. There have been other definitions of risk. we will get to define the crucial concept namely Risk. We will see more of this later. and naturally any commonly accepted yardsticks cannot measure uncertainty. The same dictionary defines Risk as a verb as "exposed to risk. cannot be very statistically established and therefore it has to be a highly subjective estimate . subjective probabilities have always had lent inner strength to creative talents of mankind. You can readily understand the concept of risk if you go back to the example given earlier of the coin tossing before the cricket match and the possibilities. actually to bring this concept into reality. We have to be clear that risk does not necessarily have a negative implication. in a given situation. venture on. will be a box office hit. the Risk for batsman or even bowler is more. loss". Subjective probability has always been utilized gainfully in human endeavors. But. The Risk in coin tossing is less as variations are only two.Though academicians will dismiss subjective probability as more of a belief. The Oxford English Dictionary defines Risk as "Chance of danger. Therefore the concept of uncertainty is close to what one can say as the subjective estimation of the risk. the greater the risk. Risk will be defined as the variation in outcomes that could occur over a specific period of time. s Now. uncertainty concerning the outcome" etc. as variations are more. But it took several centuries for the Wright Brothers.all he was doing was to estimate probabilistic the chances of successful flying so long as the flight mechanism of birds was copied. etc. We could say that the concept of uncertainty implies doubt about the future based on a lack of knowledge. takes chances of". If many outcomes are possible the variation is greater and therefore the risk is greater. in this belief. It depends upon the person's estimation of the risk that is what the person believes to be the state of the world and the confidence he or she has. Risk has been defined as "subject of insurance. . or imperfect knowledge. but for the current purpose. Uncertainty is a person's conscious awareness of the risk in a given situation. Therefore. If only one outcome is possible the variation is zero and therefore the risk is zero. The greater the variation. Since we call these graphics as probability distributions it is to be understood that Risk is a characteristic of the probability distribution.

The outcome which can happen out of this travel is a possible capsizing or safe landing on the other shore. One thing is certain that almost all human activities involve some risk and some uncertainty. there can be only loss of life or loss of property. Compare this with the film making. Pure Verses Speculative Risks Pure Risk is where there is a chance of a loss but there is no chance of a gain. even leaving the home and returning home safely is an activity which carries a sizeable amount of risk. as Organizations. We will first look at a broad categorization of risks. As individuals. we face as [variety of risks. which will make the boat capsize. which carries the risk. Think of a travel in a boat across the river . The third possibility is that there is a weather storm or high currents in the river.If the boat capsizes. Here the event. is the boat travel. there is only a chance that there will be a financial or personal or social or economic loss and no gain whatsoever. This means that if the event associated with the risk does happen.6 CLASSIFICATION OF RISKS There are various ways to categories risk. One possibility is that you will reach the other shore safely. To get this clear. In a Metropolitan city like Mumbai. A film well made with the right script and right cast can succeed or can flop. let us once again examine the variations which can arise out of traveling in a boat across the river. .Unit 1 Basic Concept of Risk Management ^Activity C : What is a difference between risk and uncertainty? 1. Speculative risk is a type of risk where there is a possibility of either gain or a loss occurring out of an event. Other possibility is that the boat may drift and take you to another location. then there is obviously no gain. So the contingency called the capsizing of the boat really comes about.

the risk is huge. Gold is subject to burglary or theft and Unit Basic Concept of Risk Management this represents the Pure Risk situation whereas gold is also subject to price fluctuations both upwards and downwards and this represents the Speculative Risk aspect. To illustrate. If the boat capsizes there is only a loss of life or loss of property and therefore a loss situation. and the probability that the boat might drift may be 5 in hundred and the balance 94 out of hundred is the probability that the boat will take you across safely. For e. It is not to be understood that just because the probability of capsizing is . Except in a game of chance wherein again due to repetition the Law of Large Numbers is still applicable and one can estimate e.g. Coming back to Pure Risk in the boat travel. In contrast to this investment in share markets represents a speculative risk situation. just because the variety is huge. for every 100 trips made across a particular river in a particular type of boat the probability that the boat may capsize may be one in hundred. Another interesting aspect about Pure and Speculative risk is that both may coexist.g. in how many throws one could get the number six in a dice. but speculative risks are generally uninsurable. Examples of pure risks are fire at a factory. A stock can appreciate or depreciate depending upon various factors and therefore an investor can either gain on its holdings or lose on its holdings. As you know. ^Activity D : . Another difference is that most pure risk situations result in loss and if an individual looses the society also loses. Pure risks also differ from Speculative risk situations in that they are generally repeatable and have essentially the same outcome under the same conditions and are therefore more amenable to the Law of Large Numbers.Risk Management in General Insurance If you look at only these three possibilities or possible outcome then there is associated probability of each of these events.01 or one in hundred the risk is low. Most pure risks can be dealt with by insurance. Though each of them might have a high or low probability associated with it. The various business risks cited are all speculative risks. Actually the risk is low in this travel scenario only because there are just 3 possible outcomes. storm. think of an individual's holdings in gold. the event that the boat could capsize represents a pure risk situation. As against this going back to the example of the outcome that can arise out of a cricket ball being bowled there are so many variations possible. accidental death or injury at work and theft of goods from a store. if there is a major catastrophe like in an Earthquake or Flood Storms. all individual loses sum up to huge loses for the society or country as a whole. The only exception perhaps is where an individual looses his possessions by the way of an act of theft or burglary and this mans loss results in gain to another individual who has taken possession of it.

The static risks are those that would exist in the absence of such changes. In static risks involves destructions of asset and hence loss to the individual and ultimately to the society.6. income and outgo. 1. Static risks are insurable where as Dynamic risks are not insurable. technological. environmental and political changes. that is. consumer tastes. social.2 Dynamic Versus Static Risks Dynamic risks arises from the changes that take place in every society. financial loss due to change in technology are some examples of Dynamic risks. . These risks are less predictable. ^Activity E: Write few words on "Dynamic risks may affect a large number of individuals ". economic. Generally these risks are predictable.Write down four examples each of pure and speculative risks. Dynamic risks are closely related to the speculative risks whereas most pure risks are also examples of static risks. Change in price level.

Larger losses which might bankrupt the firm. as follows: Class I . Unit Basic Concept of Risk Management Class III . theft.Those losses which would necessitate rising additional finance by borrowing or a share issue. They are both impersonal in cause and effect.Risk Management in General Insurance 1. Over time. For example.Those losses which do not disturb a firm's basic finances. 'Fundamental and speculative risks are usually uninsurable. but is now universally recognized as a responsibility of government. flood. such as uncertainties arising out of the economic or political system or natural catastrophes such as earthquake. views change as to the division between fundamental and particular risks. normally Class III losses can only be handled by transferring them. whereas individual should make their own arrangements for dealing with particular risks. work related injury robbery in bank and motor accidents. It may be argued that society collectively should accept responsibility for the losses incurred by individuals arising from fundamental risks.6.3 Fundamental Versus Particular Risks Fundamental risks are those which arise from causes outside the control of any one individual or even a group of individuals and affect the whole of society or a major part thereof. v £$ Activity F. 1. volcano and other natural disasters.' Explain whether this is a true statement. usuall y to an insurer .7 CLASSIFICATION BY SIZE OF LOSS A classification of risk can also be done according to potential loss severity for the individual or firm exposed to loss. in the past unemployment was regarded as a matter of individual responsibility. Particular risks are much more personal both in their cause and effect and affect mainly the individual or firm and arise from factors over which he may exert some control such as fire. famine. Where as it may be possible for a firm to handle internally Class I and even Class II risks. Class n .

^A ct ivi ty G : "Young drivers pay higher premiums than other drivers even if the car insured is a smaller one. general economic conditions. Financial Risks: If the earning falls due to increase in rate of interest of bank finance or change in exchange control regulations. managers and employers . Production Risk: A firm may fail to produce its planned output at a planned unit cost due to the operation of many types of uncertain events.8 OTHER TYPES OF RISKS Other than the above-mentioned categorization there are also many other ways in which risks are specified or categorized. Personnel Risks : The success or failure of any enterprises depends on the ability . change in credit facilities offered by financers. industrial firms may run the risks of heavy fines due to violation of pollution laws. introduce better product by competitors etc it may fail to do so." How would you explain this? 1. The Marketing and Distribution Risks : A firm must be able to sell all its products at a planned price deliver it to its customers.. But due to change in fashion. failure of debtors etc results in financial loss. Environmental Risks : Due to increase in awareness of pollution due to disposal of industrial wastage on land and into water courses or release of contamination into air. sickness or death may disturb the future planning of a company or poor industrial relations lead to frequent stoppages of work. integrity and enthusiasm of its directors. or a change in market conditions may adversely affect the availability and /or cost of materials and parts its purchases. 13 .Loss of a key man due to injury.

Similarly Suppliers Risk which used to involve only evaluation of the ability of the suppliers to ensure supplies on minimum standard is now even expanding beyond such considerations to concepts such as suppliers compliance's regarding Environmental considerations. An on-going organization encounters a continuous spectrum of risks. For e. interest rate risk. The risk of being left behind by competitors . which ultimately they try to balance by retaining and transferring such risks to various participants in the project situations. Contingent Risks: where events and circumstances beyond the control of an organisation dictate these type of risks for e. We have seen the effects of September 11 and we have also seen the build up of tensions along the Indo-Pakistan border and the consequent Travel Advisories issued by many developed countries. Organisations and individuals also carry what is called as Reputation Risk which may arise out of considerations like errors and omissions. "Problems are all brilliantly disguised opportunities".g. non-performing assets. the financial institutions carry the risk of lending. and this is what results in a number of project agreements. Political changes can bring more government intervention in employment. this risk could be one of those which are controllable by the organizations Management or those which are beyond. Similarly. In a project development situation. Risk need not always have a negative halo. The same way risk can also induce positive developments.. a manufacturing unit has a larger exposure to occurrences like Fire and explosion. We have also the Fiscal or Regulatory Risk. marketing.g.all these are contingent risks. defamation. professional malpractice etc. Another new and unsettling source of risk is political risk.Risk Management in General Insurance All organizations have an inherent risk but the types of inherent risk vary depending upon the type of organisation. Customer Risk: Dependency on a certain type of customers creates vulnerability because if the customer preference shifts. currency risk" etc. both the promoters and lenders of the^ project carry an enormous amount of and variety of risks. the customers profile getting affected . The famous American educationist John Gardner. then the supplying organisation suffers directly. investment and other policies may lead nationalization without compensation. This risk could be either internal or external to the organisation. On the other hand the latter is substantially exposed to a risk of speculative nature. swap risk. once said. whereas a financial institution has lesser exposures in respect of these kind of contingencies. the market forces.

1. For instance. Whereas.9 TYPES OF RISKS REQUIRED TO BE MANAGED____________________ ons Any professional Risk Manager in a business organisation would be only .9 TYPES OF RISKS REQUIRED TO BE MANAGED Any professional Risk Manager in a business organisation would be concerned about Pure risks. ^Activity H: A food Manufacturer has a large factory with sophisticated machinery and production lines. The Speculative risk is created by the possibility that this investment may result in either financial gain or financial loss to the organisation.Unit 1 Basic Concept of Risk Management indeed compels many organisations to stretch themselves to the limits of creativity and be constantly innovative. rned about jg^Activity H: Pure A food Manufacturer has a large factory with sophisticated machinery and risks. He or she will be involved with Speculative risk situations only to the extent that the creation of Speculative risk. a typical Pure risk is represented in such newly acquired property by the possibility that it may undergo a loss due to fire or cyclone. He produces a range of foodstuffs for both home and export market. will be involv ed with Specul ative risk situati 1. forces them to face certain Pure risk. He produces a range of foodstuffs for both home and export He or she market. List out risks faced by this factory. List out risks faced by this factory. ^Activity I: "Nowaday it is felt that Fundamental risks are responsibilities of the society." How would you explain this? ts of conce constantly innovative. the acquisition of a new property by a business enterprise represents both Speculative and Pure risks. production lines.

a typical Pure risk is represented in such newly acquired property by the possibility that it may undergo a loss due to fire or cyclone." How would you explain this? 15 . forces them to face certain Pure risk. For instance. Whereas. "Nowaday it is felt that Fundamental risks are responsibilities of the society. the acquisition of a new property by a business enterprise represents both Speculative and Pure risks. The Speculative risk is created by the possibility that this investment may result in either financial gain or financial loss to the the extent that the creation of Speculative risk. ^Activity I.

political.Risk Management in General Insurance 1. Uncertainty It is the conscious awareness of the risk in a given situation. Fundamental risks are normally so uncontrollable. Particular Risks are much more personal both in cause and effect. Dynamic Risks arises due to. v Probability The probability associated with a certain outcome is the relative likelihood that the outcome will occur. Speculative Risk is where there is a chance of gain. social. The occurrence of some events may result in either gain or loss whereas others cause only loss. Static Risks are exists in the absence of such changes. Some events are the results of human behaviors.economic.10 SUMMARY In this unit we have introduced the concept of Risk and Uncertainty. We have also seen the impact of various risks on firms. Risk It is the variation in the outcome that could over a specific period of time in a given situation. Fundamental Risks are those which arise from causes outside the control of any individual or group.11 KEY WORDS Risk Management A scientific approach to the problem of dealing with the pure risks facing an individual or an organization in which insurance is viewed as simply one of several approaches for dealing with such risks. environmental and technological changes. industries and organizations. . Pure Risk Pure risk is where there is a chance of a loss but there is no gain. 1. widespread and indiscriminate that it is felt they should be the responsibility of society as a whole. others are beyond human control. In this unit we also discussed various types of risks which an individual or organization have to face in their day to day life and working.

The direct cost to a firm due to compensation of a injured person.1 INTRODUCTION Imagine for a moment. There is a compulsive characteristic present in the human race.. all have an economic cost.Risk Management in General Insurance 2. The reason is. loss of production due to accident. Insurance premium. Activities are inherent in all walks of human life. evaluate and handle risks. take the case of the disastrous floods. The cost of uncertainty itself. that risk and its associated levels of uncertainty. Tsumani taking more than 150000 lives and rendering few thousands homeless and injured. . charges for loss prevention devices are some examples. businesses and societies suffer losses on account of Pure risk situations. 2. Human curiosity about the world and environment about us has led to the development of various bodies of knowledge and various endeavors. The unexpected losses that do occur. individuals. 2001 in USA which devastated the entire world. all of us would still be cave men or women.3 THE COSTS OF UNEXPECTED (DIRECT) LOSSES Everyday. We see individuals losing their life or getting disabled in road accidents. As the great German thinker Nietsche once said "A heart full of courage and cheerfulness needs a little danger from time to time or the world gets unbearable".Gujrath and Rajsthan causes heavy losses to individual and society directly and indirectly. Loss producing events results in both direct and indirect losses. Similarly. 2. in his discussion of the Economics of insurance refers to the cost of uncertainty. the cost of uncertainty arises out of: 1. So. this takes us back to the question why should we try to manage risk. which hit parts of Germany and Czechoslovakia recently. time spent on risk handling by management cannot be devoted to other activities. hi addition there will be opportunity cost too. 2. The terrorist act of 11th September. According to him. Millions of small and medium business have been forced to close because the raw materials and finished goods which these businesses were storing were either washed away in the floods or made unfit for sale. Allan H. if the cave man did not step out of confines of the cave. We will now discuss it in detail.2 RISK HANDLING COST Some cost will be incurred to identify. which makes us venture out and explore. Willet. Suddenly heavy rains in Maharshtra.

then there will be tremendous incentive for individuals in business to continue in their respective activities. The story of Dhirubhai Ambani is a revelation as to how a risk taking individual with limited resources could build up a huge industrial empire. If there is any way to either foresee these losses or if they are unforeseeable. we find quite a few enterprises going beyond their routine to explore new and unknown territories of business. all entrepreneurship is about risk taking. which are used for with lesser level of uncertainty and other with greater level of uncertainty. therefore such strain results in lesser creativity and lesser efficiency. We have to think of those early day Adventure Travelers like Vasco da Garna. various benefits of such space technology would not have been available to us at all. After all. manage the losses once they happen. Many studies have established that different people as also different organisations have different levels of sensitivity to risk. From out of the materials. any individual or enterprise would choose to invest their resources in the first opportunity rather than in the second. Between two options . Uncertainty itself has a cost. Sometimes this may result in lopsided use of resources. ^gTActivity A: Write down any incidence in which society and individual suffers direct and indirect losses. who ventured out against all odds into unknown territories. If only safe avenues of investment were to be chosen. . These types of individuals have a good appetite for risk and as we have seen in History subsequently. 2. Space Technology is a classic avenue which is full of unknowns. these adventures have indeed opened up new avenues. in the current day business environment. If the level of uncertainty could prevent exploring space.4 COST OF UNCERTAINTY ITSELF (INDIRECT LOSSES)________________ Uncertainty causes physical and mental strain resulting in fear and worry. today we have novel uses for such materials for even equipments for disabled persons and synthetic Cornea for people with disabled eyesight. were unexpected either to the individual or to the firm or to the society and these losses resulted in irretrievable loss of the assets to the society. Uncertainty results in distorted use of resources. the development as we see today would have never taken place. Likewise.Unit 2 The Process of Risk Management In most of these cases. the losses.

Therefore. Private costs are those costs necessarily incurred by the individual or firm engaging in a particular activity. it is all perceived and not objective and hence in this process of either holding back activities or diverting activities we would have never progressed the way we have today. Social cost is the cost flowing from these activities fall on the community at large. Because Pure risks present no offsetting benefits. Both private and social costs associated with many pure risks. untreated effluents into adjacent water courses or additional cleaning charges fall on the community. A serious fire may close down a factory with a loss of employment who worked there and also its suppliers and retailers. we lose the benefits accompanying it. people and firms will either avoid any activity in those areas or. . Whereas smoke into air. we can conclude that uncertainty has a cost and therefore it results in a reduction in well being because of fear and worry and also less than optimum production or price levels or price structures.5 PRIVATE AND SOCIAL COSTS ^.Risk Management in General Insurance So if there is uncertainty. It has to be remembered here that when we say uncertainty. families and businesses have strong reasons to manage these risks successfully." 2. are private cost of a manufacturing company. Cost of raw materials. labour etc. individuals. will divert their resources to activities with lesser levels of uncertainty. ^ Ac tiv it y B : Comment on "If we avoid the risk.

Without risks nobody can progress. Risk Management function includes • Planning • Implementation • Control for the protection of economic value of assets and earnings of any organization against adverse effects of risks. This process involves five steps. Give your suggestions to control pollutions and thus private as well social cost should be minimum.6 THE RISK MANAGEMENT PROCESS______________________________ Risks and uncertainty has its economical costs. Liability and Personal areas. . • Identify all significant risks • Evaluate potential frequency and severity of losses • Develop and select methods for managing risks • Implement risk management methods chosen • Control on the performance Stepl Risk Identification This is first and perhaps the most difficult function. Risk identification is as on-going process depending upon the nature of activities. Human life is full of risks. The loss exposures of either the business or family must be currently identified. the process or manner of execution. Risk Management is the identification measurement and treatment of Pure risk exposures in Property.Unit 2 The Process of Risk Management ^Activity C: Suppose there is a PAPER factory in your area. 2.

D : Corporation has given permission to a CRACKER factory in a residential area .Risk Management in General Insurance Failure to identify all the exposures of the firm or family means that the Risk Manager will have no opportunity to deal with these unknown exposures intelligently. Example : Risk is depends on type of construction of a building. c) The ability to predict the losses that will actually occur over a particular period of time. Nature. Location of the property. a) The probability or chance that the losses will occur. if at all they occur. Risk Measurement would include a determination of. process of the activity performed 2. The measurement process helps in grading of exposures from the most serious to the most irrelevant as well as from the most urgent to the least urgent. Physical. For identification following aspects must be considered: 1 .Identify risk involved in this situation. Study of past records etc. surrounding environment production method employed. b) The impact. the losses would have upon the financial status of the firm or the family. Step 2 Evaluate Potential Frequency and Severity of Losses The next important step is a proper measurement of the losses associated with the exposures identified. place. . social and legal environment 4. Political background 3.

Unit 2 The Process of Risk Management ^Activity E. the cost and other consequences of using such tools or combination'of tools will be evaluated. "Insurance is the best remedy to transfer a risk. . b) Reducing the chance that the loss will occur or reducing the magnitude of the loss if it does occur. This stage of Risk Management involves use of tools which primarily aim at a) Avoiding the risk. d) Retaining or bearing the risk internally. In selecting an appropriate tool. How would you evaluate exposures of a gas dealer and a retailer of a sugar. The alternative (c) includes but is not limited to the use of insurance. c) Transferring the risk to a Third Party. the various tools of Risk Management should be considered and the decision made with respect to the best combination of tools to be used for treating the exposures. ^Activity F. Step 3 Develop and Select Methods for Managing Risks Treatment of the Risk Once the exposures have been identified and measured." Write down your views.

By transferring I the cost of such losses to an insurance company for a competitive rate of premium. 2. a major catastrophic loss like floods can lead to a total halt of business processes. and the business may run into a Bankruptcy situation. By managing such risks properly the business can ensure continuity even in the case of such a loss. the implementation status and then the results. So that. Risk Management may make a difference between survival and failure. StepS Control on the Performance All Management decisions do have a critical element of monitoring. It has to be remembered that individuals as well as organizations do not work in isolation they are ultimately elements in an environment and therefore there has to be a continuous process of monitoring how they are related to the environment and change any objectives or action plans depending upon the changes in the environment. j the firm is able to price its product appropriately.7 THE BENEFITS OF RISK MANAGEMENT Risk Management makes five types of contribution to the betterment of a business. reviewing the decisions made. during the process of implementation if there is a need to correct the course then it can be done at the appropriate time. a.Risk Management in General Insurance Step 4 Implementation Risk Management Methods Chosen Once a decision on treatment of risk is made then comes the question of implementation of such decision. Risk Management can contribute dkectly to business profits by helping an organization to lower expenses through preventing or reducing accidental losses or transferring serious losses to others at lower transfer fees and through electing to retain risk and thereby saving a transfer fee. 1 . Risk Management helps to improve the bottom line \ imagine if a serious loss is uninsured and there is no recovery possible from an insurance \ firm. As you have seen earlier. This may be happening in the form of either purchase of insurance or transferring the risk to capital market etc. then the business enterprise has to carry this loss in its own books and therefore ] it may become uncompetitive as far as its product pricing is concerned. b.

Risk Management also transforms the Management into a valuable non economic asset. iv. By ensuring the peace of mind and well-being of the management. then by a proper Risk Management procedure. Therefore by ensuring business continuity.Unit 2 itationof trance or decisions rocess of jpropriate it work in lastobea (langeany ness. It also brings in benefits to individual and family units. Even customers. e. if an existing firm has to tap new markets in an area of the country which is Earthquake prone. since Risk Management plans also take care of continuation of employment as also work situation. without a proper Risk Management measure. Risk Management helps you to retain your customers. But if the Management has a proper Risk Management for earthquake losses then they are free to venture into even such areas and they will be able therefore to enhance their market share here. then they may migrate to other suppliers. This is done by proper Risk Management exercise so that pure risk losses do not upset the balance sheet. s you have )f business aging such i a loss. Think of a simple life insurance policy which is purchased by the head of a family. Risk Management also ensures that there are no wild fluctuations in the cash flows and the annual profits. In the event of . Risk Management can contribute to business profits at least in six indirect ways : i. the business enterprise is able to fulfill its responsibility to the society at large.g. if some hazardous material is required for a manufacture of a product which is very much in demand. Risk Management also helps ensure business continuity. iii. Risk Management. By handling pure risk aspects of speculative ventures the Management improves the quality of decisions into such ventures. rganization ransferring an risk and pttomline m insurance id therefore (transferring If premium. Lastly. the reason being that they all know that this firm will continue to be in business even in the case of major calamities. the management may not venture into that area at all for fear of Earthquakes. By insuring proper management of Pure risk the management of a firm ensures for itself peace of mind and confidence. For e. Business continuity is important particularly when you have valued customers in a highly competitive market. v. losses to personnel. vi. the concern over storage and use of such hazardous materials can be properly mitigated and the firm or enterprise is in a position to improve its top line. creditors and suppliers strongly prefer a company with a proper Risk Management philosophy. as we mentioned earlier is not necessarily confined only to business and commercial enterprises. If you are not in a position to continue supplies to these customers. The Process of Risk Management c. ii.g.

^Activity G: "Using the available resources to achieve maximum profit is the goal of Risk Manager. This Risk Management tool of buying life insurance gives peace of mind to the family. However the order in which any or many of this objectives are important to any organisation depends upon the firm's general business objectives. we can derive the possible objectives for the Risk Management process. They are as follows: 1. 8." Write down your views. a mere survival will be their priority. further enhances the security feeling of the family. The Process of Risk Management not only look at mere survival but also continuity and stable earnings. 5. Continuity of the firm or individual.Risk Management in General Insurance the death of the earning member. 4.8 OBJECTIVES OF RISK MANAGEMENT Any Management process begins with a statement of mission. Peace of mind. Fulfillment of responsibilities. Lower Risk Management costs and therefore higher profits. Similarly. the family is assured of financial protection. 7. therefore the Risk Management objectives for any organisations have to be integrated with the business objective of the organisation.g. 2. The above listing gives a fair range of the possible Risk Management objectives. . a statement of objectives. Ultimately. Continued growth. Stable earnings. 6. 2. Similar protection also ensures the well-being by the purchase of health and medical insurances. Compliance of several obligations imposed by either society or legislation. e. some firms might be on the brink of a disaster wherein. Uninterrupted business operations. What could be the possible objectives of Risk Management? From the discussion of the possible contributions of Risk Management. 3. proper storage of valuables helps the family to avoid the hassles of a burglary or a theft. An insurance policy which can respond to this kind of grievance. Some firms which are ongoing will Unit.

liability and personal areas. Once the risks have been identified and measured various tools of Risk Management are used to treat the exposures and ensure business continuity and profitability and stability of business. We have also discussed the treatment of Risk and how the risk management is beneficial to the individual and society and play important role in success and survival of the organization. Risk and uncertainty has economic value. that is why it must be managed to the benefit of the society. As Risk cost may be of private and social cost. Private Costs Costs incurred by individual or firm engaged in a particular activity. It consists of five steps and is the identification measurement and treatment of Pure risk exposures in property. . 2.10 KEY WORDS The Risk Management Process Risk Management is the identification measurement and treatment of pure risk exposures in property.^Activity H: Assume you are a Risk Manager of a firm. liability and personal areas Treatment of Risks Once the risks have been identified and measured various tools of Risk Management are used to treat the exposures.9 SUMMARY In this unit we have introduce that Risk is everywhere and without risk nobody can progress. We have also discussed about Risk Management Process. List down at least 5 points so that you can increase the profit and minimize the severity of loss. 2.

the Head and only Earning member of a family is expected to handle them.Risk Management in General Insurance Social Costs 30 Costs fall upon the society due to a particular activity.ASSESSMENT QUESTIONS i. 2. You .Unlimited Risks.11 SELF. Give the challenges faced by and how. Limited Resources .

Indian Insurance Industry.s gement Processes learnt in this unit. . n These graphs are intended to give you an idea of data organized in a manner to a make meaningful information available. o u iii. in Y axis . vi.12 ANNEXURE___________________________________ p s In the graphs included in the Annexure. You have been assigned to organize a one day Promotion Fair for publicising your company's new Detergent powder. of losses in the particular range. 2 Similar Rupee value of Fire claims and maj or losses on an annual total value basis . How does uncertainty affect an organization? Explain giving illustrations. What are the obj ectives of Risk u s Management? st e 2. 1 A sample Frequency Distribution of Fire Losses with the Rupee value in X n axis and No. Premium k Number of losses-year-wise Fig. R is .Figures for Indian t Insurance Industry. h ii. Does a Risk Management consciously practiced benefit a firm? Explain how? l d iv. Describe in brief the process of Risk ri o Management. h e Fig. 5 Average value of M received. Fig. 4 a claims on a year-wise basis. Fig. we have: i Fig. 3 Claims Ratio: Claims Incurred by Indian Insurance Industry vs. t Enumerate how would you go about the Risk Management Process in respect of h the e function? v v a v. s e You plan to conduct a Puppet show in a residential colony in your town. You have been given a reasonable u budget and five assistants.

FREQUENCY DISTRIBUTION GRAPH OF TOTAL LOSS ae ild co /our .Unit 2 The Process of Risk Management FIG. 1 .and .

ner to make 3 1 .tofthe • in X axis Insurance total value in received..

FREQUENCY DISTRIBUTION GRAPH OF TOTAL LOSS 500 400 300 200 100 CD co . 2 .Risk Management in General Insurance FIG.

etc. To identify all the potential losses. One must remember that no single method is likely to reveal all risks that an organization is exposed. to evolve a systematic approach. the Risk Managers need first the checklist of all the losses that could occur to any business which includes information regarding - 1) Nature. a good starting point. 4) Physical. Taking into consideration all above methods. check list etc. 2) Method of activities for example production method. of physical assets and intangible assets. the checklist can be used to discover which of the potential losses are normally available with Risk Management Associations. social. and 2. threat analysis. etc.Risk Management in General Insurance 3. the identification of the operative cause or perils. A detailed "Assets Exposure Analysis" Checklist is appended in the Annexure. In this unit we will discuss about the various methods regarding perception of risk. Risk identification is a process by which enterprises systematically and continuously identify property. The perception of risk. size. or political background in which the enterprises have to work. that is the ability to perceive that there is an exposure. coupled to the likely result. 5) Study of past records such as event analysis. which needs a good amount of imagination.1 INTRODUCTION____________ The task of risk identification breaks down into two sub-parts: 1. scope of the business. perhaps. Secondly due to budget constraints the risk manager must choose the best possible method which proves best and thirdly risk identification must be a continuous process. physical inspection of the premises is the most realistic method. This checklist provides. Other than using this. a Risk Manager can also construct his own checklist. Unit 3 Risk Identification -1 The possible exposures to loss are categorized as (1) Direct Exposures (2) Indirect or Consequential Exposures and (3) Third Party Liabilities. Secondly. the possible assets are divided into two major categories. legal. 6) Prospective techno-marketing report. Personnel exposures as soon as or before they emerge. One should study the losses already incurred by the Enterprise and losses reported in various Industry and . liability. In a generic checklist. sub contractor's conditions. Associations of insurers. etc. V 3) Place of activities that are at customers' premises or at shop floor etc. Loss Prevention Association of India.

3. Now we will see in detail the methods of identification used by risk manager. Planned interactions with other departments 6. Participating in International or National Risk Management meetings will also help generation of ideas. Statistics of past cases 7. Analysis of environment . 1. The Financial Statement method 3. On-site inspection 5. Identify the causes of the accident. to discover and describe the types of losses faced by a particular business. The Risk Analysis questionnaire 2. Seven methods are suggested here for this identification process.2 APPLICATION OF CHECKLIST____________________________________ The second step in risk identification is to use the checklist so developed.Business Press. J^Activity A: A worker from a floor shop fell from a ladder and injured seriously. The Flow Chart method 4.

Risk Management in General Insurance No one method will comprehensively complete the identification process and similarly identification is not an one-off process. I Units Risk Identification -1 By coupling these statements with financial forecasts and budgets the risk manager ca_n discover future exposures. By analyzing the balance sheet. which should be rectified. This fdlowg because every business transaction ultimately . 3. specific information concerning the firm's properties and operations like a) The nature of the organizations activities. operating statements. ^Activity B . b) Inter-relationships and inter-dependencies between various parts of the organization. make and implement risk handling decisions. Thirdly.4 THE FINANCIAL STATEMENT METHOD Second systematic procedures for determining which of the potential losses in the checklist apply to a particular firm and in what way is the financial statement method. It directs the risk manager to secure in a systematic fashion. some gaps may develop in the checklist itself. liability and personnel exposures of the firm. while applying the checklist for Exposure Analysis. and supporting records.3 THE RISK ANALYSIS QUESTIONNAIRE ______________________________________________________________________ The risk analysis questionnaire does more than provide a checklist of potential losses. e) Organizational weaknesses which may exacerbate risk situations To secure this information the Risk Manager will consider all the sources of information used in the other six methods. The difference is that the questions in the questionnaire direct the inquiry. d) Identification of people who provide technical support. Manager can identify all the existing property. 3. As a Risk Manager list out exposure faced by a employees carrying cash from factory to bank and to working site. c) Identification of profit and cost centre. the Risk.

and consequently should be more acceptable. Finally. In transit to manufacturing plant. liabilities of construction contractor and sub-contractor in case of injury or damage caused by contract work. In firm's own trucks. concise terms and applicable by either risk managers or professional consultants. This approach is reliable. rent items reveals whether the vehicles. based upon readily available data. Products. in addition to determining the best way to handle the exposure this tool must be supplemented with the financial records with other sources of information such as an inspection of the premises or legal documents. injuries to employees In inde pen dent Per son nel reta ilers ' han ds . coupled with some appreciation of the various losses that could occur. can help to identify potential losses: Table 3. each account title is studied in depth to determine what potential losses it creates. The following analysis illustrates in abbreviated fashion how one account title. customers. In transit to retailers. The results of the study are reported under the account titles. Risk burglary. Warehouse. Warehouse. liability losses arising out of truck. buildings are on lease basis or own asset. Common Carriers. Common Carrier.involves either money or property. Moreover it translates risk identification into financial terminology that is more familiar.1 Account Title Personnel or Activity Specific Property Loss A. In transit to Warehouse. Manufacturing Plant Property losses: Direct -Indirect -Net Income Fire windstorm. For example. objective. other human perils Risk Management in General Insurance Finished Goods: Manufacturing Plant. Potential Perils Inventory Raw materials: In suppliers hands In transit to warehouses. to other managers in the firm and to outsiders such as accountants and bankers. other physical perils. For example. In suppliers truck. Vandalism. from purchase and sales accounts it is possible to obtain details of suppliers. explosion. Under this method. presentable in clear. Analyzing the financial statements will suggest these additional steps. premises. Firm's own truck. Firm's own truck.

retirement. Hence a third systematic procedure for identifying the potential losses facing a | particular firm is the Flow-Chart approach. unemployment. you want to finance a sick unit. This method does not reveal the work processes and the physical layout of plants. The study of these record helps not only to provide evidence of potential losses but also loss probabilities and severities which helps risk manager to measure the risk.losses to firm/family Negligence. breach of warranty. . 3. poor health.5 FLOW CHART METHOD To know the work processes and physical layout of the plant we have to study the Flow Chart. Identify the risk factors revealed from books of accounts. profit and loss account and balance sheet of a firm. injuries to employees (workmen's compensation) Automobile accidents (no fault) Death. to obtain this information. ^Activity C: As a Financer Officer of a bank. we will study flow charts.

Figure above shows the major operations of a hypothetical firm. and other inputs at suppliers locations and ending with finished products in the hands of customers. 1 Liability Losses : Liability for bodily injury or property damage to customers because of defective products. . to visitors because of defects in the premises. suggests. a Flow Chart or series of flow charts is constructed. Legal responsibility under (1) the workmen's compensation law for bodily injuries to employees and (2) Automobile no-fault laws. the checklist of potential property. liability and personnel losses is applied to each property and operation shown in the flow chart above. the following potential losses: Property Losses : Replacement or repair of trucks. among others. or finished goods. raw materials goods in process. Shutdown or slowdown of manufacturing operations because of direct property osses. electricity. starting with raw materials.1 First. Personnel Losses : Losses to firm because of death or disability of key employees. Fig 3. manufacturing plant. More detailed pictures can and should be prepared. Second. For example. and to others because of negligence of the firm's trucks. subject to physical and human perils on the manufacturing premises or in transit. which shows all the operations of the firm.Unit 3 Risk Identification -1 Flow Chart Method Supplies Receiving Room Storage Manufacturing Paintshop Pac ring i ___ . machinery.

^ Activity D . Standard of house keeping 2. These departments are constantly creating or becoming aware of . Raw material used. 3. the nature of production 5. It also helps to reveal organizational weaknesses. Past claim records. By observing firsthand the firm's facilities and the operations conducted thereon the Risk Manager can learn much about the exposures faced by the firm as it reveals. Storage arrangement of final product 6. Nature of process carried on 4. 3. After completion of each stage of process. hazardous or extra hazardous 3. v 1.6 ON-SITE INSPECTION____________________________________________ On-site inspections are a must for the Risk Manager. inter-relationships and inter-dependencies between various departments. Included among these interactions are (1) extended visits with Managers and employees of other departments during which the Risk Manager attempts to obtain a complete understanding of their activities and the potential losses created by these activities and Unit 3 Risk Identification -1 (2) Oral or written reports from other departments on their own initiative or in response to a regular reporting system that keeps the Risk Manager informed of all relevant developments.7 INTERACTIONS WITH OTHER DEPARTMENTS A fifth way to identify the losses facing a business is through systematic and continuous interactions with other departments in the business. List out major points for a Flow Chart of a chemical factory. whether it is non-hazardous.Risk Management in General Insurance Thus flow chart can help to reveal the exposure of an organization to risks of disruption of its business.

liability and personnel losses that were ignored in its risk management planning. one Risk Manager was surprised to learn from his morning newspaper that his employer had purchased an expensive River Barge two weeks earlier. For example. From statistical record frequency of losses as well severity of accident reveals. 3. Write down inspection report taking into consideration the facts you have revealed during the inspection and laboratory reports of the sample. Risk Managers often hear about new exposures long after they are created. the firm might have even decided not to buy the barge. for two weeks the firm was exposed to some serious property. /^Activity E: You have done a site inspection of factory manufacturing soft drink. It also provides records of past losses including details of insurance claims which is a valuable information for the Risk Manager. Unfortunately.8 STATISTICAL RECORDS & LOSSES A sixth approach that will probably fewer exposures than the others will but which may identify some exposures not otherwise discovered is to consult statistical records of losses or near losses that may be repeated in the future. Moreover. . As a result. instead would have chartered one. if these losses had been explicitly considered. Indeed the Risk Manager's success in risk identification is heavily dependent upon the cooperation he or she secures from other departments.exposures that might otherwise escape the risk manager's attention.

9 ANALYSIS OF THE ENVIRONMENT A careful analysis of the external environment as well as internal exposures is a very useful approach to identifying the exposures of a particular firm. consumers and unions? How rapidly are these relationships changing? Study of environment or market survey is very important when a new product is going to be lunched in the market. important considerations are the nature of the relationships. businesses. xgT Activity F-. For example. To manage this risk proper use of market survey and market research on regular basis is necessary. State in few words the effect on production of cold drink due to ban on it by government.Risk Management in General Insurance 3. Following structure suggested identifies four components of the 'relevant' environment (1) customers (2) suppliers (3) competitors and (4) regulators. and their stability. or government agencies? Are there single or multiple suppliers of important services? What contractual arrangements have been made with suppliers? Does competition with others require speedy advertising campaigns and possibly encourage improper product claims ? What special obligations are imposed by outsiders such as government regulators. In analyzing each of these components. A firm may fail to sell its product at proper price due to better quality product may available in the market may be in lesser price. To many persons? Are the customers families. their heterogeneity. change in the customers' tastes or fashions or change in government policies. is the product distributed directly to one group of buyers or indirectly. through wholesalers and retailers. .

3. With the help of this we can find out the various risks and probable losses which the firms have to face in future. Asset Exposure Analysis Is a check list which list out all the assets and the corresponding exposures as well as various liability exposures. We have also discussed that Risk identification is a never ending task and no one method gives full information about the exposure to which an organization is exposed hence as we have discussed various benefits of each method and how these methods help the risk manager in his j ob combination of all techniques must be used.11 KEY WORDS Risk Identification Is a process by which enterprises systematically and continuously identify property.10 SUMMARY Ifi this we have introduced the concepts of Risk Identification and various methods applied for this process. personnel exposures as soon as or before they emerge. How the scrutiny of financial statements reveals the true picture of each department which creats potential losses? 4. Flow Chart Method Uses the operations of the firm in a process sequence to help identification of risks and exposures at various stages in the sequence. Serves as a starting point for use of other identification tools. 2. List out factors to be considered to identify a loss. 3.46 UnitS Risk Identification -1 3. Comment on "on site inspection is necessary where hazardous and extra hazardous process involve. Explain how the questionnaire give systematic information about organization? 3. Financial Statement Method Uses the various financial information like Balance Sheets to identify all types of exposures. liability. To carry out risk identification process effectively a risk manager needs a good imagination with periodic review of decisions." .12 SELF-ASSESSMENT QUESTIONS 1.

Towers and Stacks (9) Wharves & Docks (4) Offices (10) Pipes & Wires (5) Warehouses (Above ground) (b) Underground Property (1) Cables and wires (2) Tanks (3) Shelters. castings (3) Boilers and pressure vessels (a) Fired vessels .EXPOSURES ANALYSIS Assets Physical Assets : Real Property (a) Buildings (1) Under Construction (2) Owned or Leased (3) Manufacturing (6) Garages & Hangers (7) Dwellings and farms (8) Tanks. groundwater (6) Piping and pipelines (c) Land: (1) Improved (2) Unimproved Personal Property (on and off premises and in transit) (a) Equipment and Machinery (1) Machines and tools (2) Dies.steam and hot water boilers Unit3 Risk Identification -1 (b) Unftedvessds . jigs. moulds.Risk Management in General Insurance ASSETS . caves & • Tunnels (4) Mines and Shafts (5) Wells.

paintings. raw materials. Receivable (4) Patents & Copyrights (5) Titles and deeds (6) Tapes. libraries (g) Safety equipment . jewellery. goods in process finished goods (f) Fine arts-antiques.transformers. steam Meters and gauges (5) Turbines-steam. fans. pumps. generators. gas. apparel. trams. programme (7) Own securities-negotiable & Non-negotiable (8) Other corporate securities (9) Cash (indicate currency) Miscellaneous Property - . gasoline.instruments. elevators (b) Furniture and fixtures (c) Electronic data processing equipment (d) Improvements and betterments (e) Stock-supplies. cards. water (6) (a) Conveyors and lifts. motors. installations (h) Valuable Papers (1) Blueprints (2) Formulas (3) A/Cs. compressors Engines-diesel. alarms. disks.

handbills. 2. lawns (f) Fences s (g) Firearms (h) Nuclear and radioactive property isotopes. cafeterias (k) Watercraft (including contents) boats. buoys drilling rigs. cyclotrons. Submersibles. exhibits (j) Recreational facilities-parks. plates. 4. models. barges. tracers. ships. accelerators. External assets (a) Markets (b) Resource availability 1. gardens. Intangible Assets (Assets not necessarily shown on balance sheet or earnings statement) 1. Reactors. fixed wing. Unit 3 Supplies Transportation Employees (fulltime and temporary) Public utilities Public Protection ^identification' . rotary wing (c) Animals (d) Antennas (e) Crops. gyms. lakes. yachts. 5. piston. betatrons (i) Promotional displays-signs.Risk Management in General Insurance (1) Commercial (2) Private passenger (3) Contractor's equipment (licensed) (4) Warehouse equipment (b) Aircraft (1) Missiles and satellites (2) Lighter than air (3) Aircraft-jet. 3.

economic and social stability. 2. real estate. demagnetisation of tapes (b) Fall ing obje ctsairc Communications Telephone. insurance. architecture. burn-out. underground and offshore (2) Air rights (3) Patents and copyrights Risk Management in General Insurance Exposures to Loss A. marketing.) (7) (3) Insurance (8) (4) Customer credit (9) (5) Employee Benefits (10) Royalties & Rents Leasehold interest Ownership of stock Cofoundations (Non-profit) Tax loss carry-forward Programme (d) Personnel (employees and executives) (1) Education and training (2) Experience (3) Key employees (e) Rights (1) Mineral and oil right-above ground. Internal Assets : (a) Research and development (b) Goodwill and reputation (c) Financial (1) Credit cards (6) (2) Credit lines (reed. advertising PR. television. newspaper (d) Locational climate. general management. met . sunspots. (e) Council and specialists . Banking. currency convertibility. radio. teletype. Generally uncontrollable and unpredictable (a) Electrical disturbances lightning. power surges. political. accounting. DIRECT EXPOSURES 1.

geyser. gaseous. 2. (c) Collision. sandstorm. sprinkler. tidal waves (tsunami). sewer backup (h) Weight of ice. tear. cyclone. on and off premises-watercraft. settlement. vibration. poor maintenance (f) Employee negligence (g) Explosion and implosion (h) Failure of environmental control . leakage.typhoon.malfunction of part. solid. aircraft. pests . volcano.liquid. erosion - (f) War insurrection.wear. ls. missiles. rising. rain dust. hurricane. rebellion. tornado. snow (i) Windstorm . abuse. avalanche re (i) (d) Sound and shock waves-sonic boom. flash flood. radioactive. landslide. Breakage of glass or other fragile items (b) Breakdown . lubricant etc. armed revolt.eors.temperature. pollution (e) Corrosion . hailstorm. humidity. waters. insect s. Generally controllable or predictable (a). sabotage anima (g) Water damage-flood. roden ts. groundwater. trees pressu (c) Land movement-earthquake. vehicles (d) Contamination . water hammer Fauna (e) Subsidence-collapse. mudslide.

colour. mildew. exercise of eminent domain. mischief. strikes. robbery i d) Invalidity of deed. collision ( 't) Unintentional error .dropping etc. rovers. barratry etc.curfews Primarily financial in nature (a) Employee dishonesty . expansion.forgery. (o) Rupture or puncture of tank or vessel (p) Smoke damage. (m) Perils of sea . backfiring etc. seizure. boycotts. civil disorders.nationalization. theft. (n) Physical change . larceny (b) Expropriation . defacing of property (w) Riots. patent.Risk Identification -1 (j) Fire (k) Installation and construction hazards . leakage. malicious. crane or ele vator fall (s) Transportation . confiscation i c) Fraud.shrinkage. lost of mislaid property ')) Obsolescence 1 . contractions. All direct Exposures as they affect : (a) Suppliers (b) Customers .. paint spray (r) Structural defects.employee. smudge (q) Spillage. computer. title. (I) International destruction-jettison. counsel in) Vegetation (v) Vandalism. forgery. copyright *e) Inventory shortage-mysterious disappearance. evaporation. burglary.overturn. embezzlement.pirates.

bonaliy BIC. (1) International destruction-jettison.Unit 3 Risk Identification -1 (j) Fire (k) Installation and Construction Wards-dropping etc. smudge (q) Spillage. forgery. evaporation. (o) Rupture or puncture of tank or vessel (p) Smoke damage. expansion. Primarily financial in nature (a) Employee dishonesty .employee. title. defacing of property (w) Riots. paint spray (r) Structural defects. confiscation (cf fraud. exercise of eminent domain. counsel (u) Vegetation (v) Vandalism. seizure. embezzlement. crane or elevator fall (s) Transportation .curfews 3.. malicious. contractions. civil disorders. copyright Inventory shortage-mysterious disaprjearanc (f) Obsolescence INDIRECT OR CONSEQUENTIAL EXPOSURES 1. (m) Perils of sea-pirates. mischief.nationalization. mildew.overturn. All direct Exposures as they affect: (a) Suppliers (b) Customers . backfiring etc. larceny (b) Expropriation . computer. (n) Physical change-shrinkage. patent. rovers. theft. boycotts. burglary. colour.forgery. leakage. strikes. robbery (d) Invalidity of deed. collision (t) Unintentional error .

patent 11. pair. Recall of product 15. Distribution (c) Production (d) Expansion (e) Economic Predictions (f) Political Predictions (g) Investments (h) Dividend declaration (i) Tax filing 14. Disruption of education system . Aviation Liability . Epidemic. rentals. Concentration of assets 4. Invasion of copyright.employee. product etc. executive. desire 5. communication. THIRD PARTY LIABILITIES (COMPENSATORY AND PUNITIVE DAMAGES) 1. depreciation V 10.Risk Management in General Insurance (c) Utilities (d) Transportation . supplier. Change in style. plague 9. group 12.racial. (b). recession. Spoilage Unit3 Risk Identification -1 C. Loss of rights resulting from records destruction 13. Increased replacement cost. political economic 7. disease. taste. (a) Pricing. Economic fluctuation inflation. Loss of integral part of set. Extra expenses. Bankruptcy . 3. counsellor 6.personnel and property (e) Employees 2. depression 8.

radio. samples.flammables. notes (f) Hold-harmless clauses (g) Surety agreements 6.Officers and employees licensed (c) Grounding and sister .ship liability 2. exhibits Automobile Liability (a) Operation of vehicles . Easements (a) In gross (b) Appurtenant (c) Positive or negative under common law . (a) As agents (b) Libel. slander. Directors and Officers Liability 7. defamation of character (c) Media use .owned or non-owned (b) Loading and unloading (c) Dangerous contents . Athletic . mortgages. TV. 3.Sponsorship of teams. recreational facilities etc.real or personal property (d) Performance or service (e) Loans. 5.(a) Owned and leased aircraft (b) Non-owned . explosives Contractual Liability (a) Purchase agreements (b) Sales agreements (c) Lease agreement . Newspaper. Advertiser's and Publisher's Liability 4.

trusts. (c) Credit society 10. health etc. (f) Inadequate enforcement of regulations (g) Improper Preparation of food aircraft.Risk Management in General Insurance (d) Rights or access of light. Owner's Liability . watercraft 13. profit sharing plans. profit sharing plans. accident. drainage. Malpractice Liability (a) Medical doctors. (c) Discrimination in employment 9. specialists (b) Lawyers (c) Engineers (d) Trustees of pension plans (e) Patent infringement 11. Fiduciary and Fringe Benefits plans liability (a) Pensions. Non-ownership Liability (a) Leased real or personal property (b) Bailee's Liability (c) Employees use of vehicle. nurses. health etc. water. investments (b) Insured . investments (b) Insured . trusts. Ordinary negligence (a) Of employees (b) Of agents (c) Of invited or uninvited guests (d) Of contractors or subcontractor (e) Failure to provide safety equipment. support 8. Employer's Liability (a) Pensions. warnings etc.

distributed. rigs.riparian. drainage.) Implied Warranty ) Express Warranty (1) By agents .:•. lateral support. I Rights of others . . air. operation Types-boats. view. leased. yachts. licenses. eminent domain. Reference from Risk Management by HI. mineral. (denlification -1 1 Attractive nuisance > Invited guests 1 Trespassers (false arrest) . ships.sales. advertising. oduct Liability (each product sold.u. . light. made) . submersibles.oad Liability i) Sidetrack agreements :') Right of way ) Grade Crossings Jirectors and Officers Liability (Stockholder derivative suits) Watercraft Liability Ownership. or general (2) By employees (3) Ofmerchantability (4) Of suitability or fitness for use (5) Oftitle (6) By sample ! elective Liability i) Industrial Contractors hired i Construction or demolition -. easement walls. platforms.

Take. In this unit we will see in detail about various methods of the identification of the operative cause or perils coupled to the likely result. The threats to the business in terms of both the severity and duration of the interruption probably would vary as shown. the threat of denying access to the place of business for which the completed form may appear as in Table below. picketing. Table 4.II Loss of (i) Burst services Main Total loss Second of process Supply . Denial of access to premises can arise from many causes. collapse of nearby buildings. blocking the road.2 THREAT ANALYSIS An alternative approach to the check list is to compile a list of the threats to the business. strike. There are several techniques for carrying out the analysis of risk identification process and there are other sophisticated methods which aim to identify the operative cause or perils in conjunction with the likely result. for example.1 INTRODUCTION In the previous unit we have discussed various methods regarding perception of risks. Some of them are detailed below: 4.1 Threat Cause Denial of (i) Strike Access Result Mitigating Factors Loss Assessment Damage Business Interruption Partial closure or total closure Good industrial relations Nil 2-5 weeks (ii) Pickets Total closure Suppliers not vulnerable Nil 1-2 months (iii) Road subsidence Total closure Second access to rear through adjoining factory yard Nil 1-2 days Unit 4 Risk Identification . for example quarantine regulations following epidemic.Risk Management in General Insurance 4. burst water/gas mains preventing access. government order and so on.

Draw a threat analysis table for this taking into consideration its causes. The varying impact between cause and effect is a function of the 'event' . assessment of loss due to loss of service. ranging from that of explosion. The effect of these three causes giving rise to the same event would be quite different. to burst water tube. There are many potential causes. At the other end of the spectrum. and loss of life. On the other hand a burst tube may result in only minor interruption. An explosion could lead to major interruption of processes. with no property damage or personal injuries. to failure of the priming pump. effect on hospital working. the destruction of property.3 EVENT ANALYSIS Event analysis is a technique for considering likely events which could cause problems and then investigating cause and effects. . ^Activity A: There is a shortage of water supply to a Hospital. the failure of the water priming pump may have no effect at all if a stand by pump can be brought into service immediately.(1) Water (ii) Frost (iii) Drought and usable water Partial loss likely to cause cessation of operations available In catchment area with high reserve capacity Nil Prolonged seasonal period Like this any threat to the business can find out with its causes. consider the event as 'failure of boiler services' . It is illustrated in figure below. results loss assessment etc. 4. including potential third party liability. for example.

Find out its causes and effects with event analysis technique. 4.Risk Management in General Insurance CAUSE EFFECT LIABILITY DAMAGES LOSS PRODUCING EVENT PROPERTY DAMAGES BODILY INJURY LOSS OF EARNINGS NATURAL PHENOMENON BREACH OF NATURAL LAWS HUMAN ACTIVITIES Fig 4.4 HAZARD LOGIC TREES (HLT) .1 .gTActivity B : Consider the event "Fire in a cotton factory".

Such analysis can be aided by the use of Hazard Logic Trees (HLT) whereby the various hazards which may precipitate the operation of the peril which is the cause of the loss producing event can be identified. Figure below takes the example of another type of loss producing event. As the name implies. the loss of warehousing facilities. and the . logical manner. In order to illustrate the technique. it is simply another technique for forcing one to carry through the exposure analysis process in a methodical. and those applying in any particular case will be dependent upon local circumstances. The lists of hazards shown are not exhaustive. Imagination plays an important role in the construction of HLTs.

in that the identification of hazards is a prerequisite to the implementation of measures to control them.2 LOSS PRODUCING EVENT -LOSS OF STORAGE FACILITIES FIRE OR EXPLOSION WATER DAMAGE ARSON SMOKING FOOD STORM BURST PIPE CLOSURE ELECTRICAL HEATING BURST MAINS SPONTANEOUS COMBUSTION OTHER FORMS OF DAMAGE DENIAL OF ACCESS AIRCRAFT VEHICLE FLOOD SUBSIDENCE MALICIOUS ACTS SUBSIDENCE ROAD EPIDEMIC HURRICANE CHEMICAL INTERACTION BOILER EXPLOSION SPREAD OF FIRE FROM OTHER LOCATION One advantage of constructing HLTs is that it forces one to breakdown the potential causes of loss producing events into their smallest components. . for too frequently it is the unexpected event which does occur. Table 4. Thereby providing at least a subjective pointer to the probability and severity of those events.Unit 4 Risk Identification . It is also of value at the risk handling state.II Prima facie remoteness of either perils of hazards does not justify their omission from the lists.

MORE OF MORE Increase in flow. etc. The objective is to examine the process as a whole in order to identify potential deviations from normal operating conditions. pressure. LESS OF LESS Decrease in flow. their causes and possible consequences..Risk Management in General Insurance ^Activity C : a) With the incidence given below prepare Hazard logic tree: b) Loss producing event . is for a small team to examine every stage of a process by applying a number of guide words as shown in Table below. pressure etc. PART OF PART OF Some of the intent in is achieved e.g. Unit 4 MORETHAN Risk Identification .5 HAZARD AND OPERABILITY STUDIES Such a study is designed to be used at the planning stage of a new plant. the composition of the system is different from what it should be. 4. List of Guide words Guide Words Meaning For continuous Process NONE For batch Process NO or NOT Complete negation of the design Intention. The technique.Shortage of supply of Raw Material to a manufacturing factory. which was developed by imperial Chemicals Industries Limited.II AS WELL AS REVERSE .

g. and it can be applied to either the planning stage of new plants. in looking at the thermal reactors in a chemical factory the use of the guide word NO would lead to an examination of the ways in which there could be no transfer from the raw material storage or no supply of gas to the reactors.. decomposition potential. 4.g.. Something quite different from the design intention.6 THE DOW INDEX In the 1960s the Dow Chemical Company in the U. the words MORE OF or LESS OF would direct attention to ways in which there could be increases or decreases in the flows or pressures of materials or gas. developed a system for the identification and evaluation of fire and explosion hazard potential based on a study of many plant accidents and near misses.A. It has subsequently been developed to cover storage units. • quantify the hazards according to heats of combustion. or reactivity with other materials present..S. reverse flow or chemical reaction. . by-products and catalysts present in a plant.OTHER THAN Additional component or phase present or another activity occurs concurrently. products. The next step would be to consider the possible causes and consequences of such events occurring. such as the raw material stores being empty or a pipeline being fractured. Opposite of the design intention e. For some example. • apply additional factors to allow for such special features as the quantity of material involved and the type of process. Likewise. work in progress. startup. to existing plants. and loading and unloading operations. shutdown. The technique is to: • list all raw materials. What else can happen apart from Normal operation e. or to a consideration of alternative processes in an existing plant. decomposition or reaction. maintenance etc. identify the dominant material on the basis of (a) quality present and (b) fire potential.

a concentration of flammable paint vapour within the explosive . two conditions are required to cause an exolosion. ^Activity D . 4. No credit is given for safety features. As shown.7 FAULT TREE ANALYSIS EXPLOSION IN OPEN PAINT SPRAYING BOOTH Sources of ignition Flammable paint spray in explosive concentration Fig 4. List out the hazards using Dow Index method in a factory manuf acturingliydrocloric acid. since it was the intention to employ the Guide to identify needs for safety features. can occur.2 Essentially. shown at the top of above figure.Risk Management in General Insurance The rating factors in the Dow Fire and Explosion Guide are based on operating and loss experience. the tree is constructed by asking what must occur before the loss producing event.

4. and using that date to produce final conditional probabilities.raployees. system that brings together the various techniques relating to both the perception of risk and the identification of operative causes and perils is the safety audit. whereas an electrical spark may be caused by a failure of the earthing system. For example. The latter may be introduced by the operative or someone else. And so on until all possible events that may lead to the loss producing event have been identified.8 SAFETY AUDITS A. when assessing he fire and explosion following checklist must be take into account: * Fire resistance of the building » Flammability of materials ards . * H ousek eepin g stand The analysis can be refined further to assist in calculating the probability of the loss producing event occurring by estimating the probability of each of the events on the basis of past experience. \fter verifying all these details. auditors proceeds towards analysis of the hazards and lerils to which the organization's activities are exposed. The next step down the tree is to investigate possible sources of ignition which are an electrical spark or nearby flames or lighted cigarettes. Discussion with management and .II limits and (denoted by the symbol) a source of ignition. xgTActivity E: Write few lines on use of fault tree analysis in the risk identification.Unit 4 Risk Identification . The management must define exact reference about audit. The audit team must have knowledge about: a) The organization. also spot inspection is carried out if necessary. its activities b) All regulations relating to the safety of its operations and products. \n audit may be undertaken either internally or outside consultants or by combination of >oth.

Finally. Unit 4 Risk Identification . the Dow Index and Fault Tree analysis can be used to assist in the . Event analysis is a much more specific technique.Risk Management in General Insurance • Sources of ignition • Fire alarm and extinguishing systems • Security and security patrols • Fire training to employees • Proximity of the local fire brigade • Water sources • Means of escape Further investigation is also carried if necessary. 2) Recommendations for improving safety.9 SUMMARY We have discussed the usefulness of the various techniques described above. The check list system suffers from the fact that it pre-identifies perils/hazards." 4. leaving the possibility that unidentified perils and hazards may not be addressed. Threat analysis is a crude means of ascertaining potential exposure by a broad examination of the business and its environment. which can be varied to suit circumstances from the 'broad brush' event analysis down to the consideration of specific hazards. ^Activity F: Comment on' 'Safety audit is a critical examination of industrial operations to identify risks and hazards. Thus a safety audit not only includes identification of risk but also evaluate and handling it. the following points are of relevance. contingency planning.II Similarly hazard and operability studies help to pinpoint at the planning stage of a project possible design defects which may lead to the occurrence of loss producing events. Finally report is prepared stating: 1) An analysis of the risk to which the organization is exposed.

Why do you have to identify Risks ? ii. Event Analysis It is a technique for considering likely events which could cause problems and then investigating causes and effects. Fault Tree Analysis This can be quantity the risk and identification of hazard. How do you start off in the identification process? iii You are a senior person in the Finance Department of an Automotive Sales outlet. Try to use any two of the identification methods you have studied in the unit to efficiently map the risks your firm faces. estimate the losses if threat materializes. identifying their cause and result of such threat as well as exploring the factors. Hazard Studies It enables to examine the process as a whole in order to identify potential deviations from normal operating conditions. I 4. . Safety Audit In addition to risk identification it helps in risk evaluation and risk handling decisions.identification of hazards and in the quantification of risk. At the end we have discussed regarding safety audit which brings various techniques together to find out risk.10 KEYWORDS Threat Analysis It is a method for identification of various threats to the enterprise. which can mitigate the threat as also. their causes and possible consequences.11 SELF-ASSESSMENT QUESTIONS i. You should state the business profile. of your firm before attempting this. etc. causes and perils 4. manpower. The Dew Index This method is developed for identification and evaluation of fire and explosion hazard.

b) Fault tree analysis. Narde & Banda are in the business of publishing books for Universities. Suppose you were the Consultant.II . However. Write short notes on: a) Event analysis. M/s. as well as finished goods like bound books. vi. to do the identification? List out the assumptions you make before you attempt this. Fire Brigade is summoned and they are unable to pinpoint the exact cause of the fire. how would you use one of the methods studied in this chapter. They have their own printing press located in a congested area of the city. What is the role of safety audit in the identification of hazards in the industrial operations? 70 Unit 4 Risk Identification . the Risk Consultant of the firm is expected to advise them on the cause aspect. binding materials. v. A major fire takes place in the early hours of a Sunday. How do checklist helps in risk identification? s vii. They have a godown for the storage of raw materials like paper.Risk Management in General Insurance iv. The godown is part of the printing press building. The firm employs forty workmen and five senior employees. List the advanced identification tools enumerated in this unit and briefly explain the purpose and method used in each.


should be included in the analysis. collated . Risk handling decisions can be taken only after monitoring the risk reduction measure-and other information like frequency and severity of loss producing events and other costs. not only their monetary value. Interpretation of data involves the use of statistical data and probability concept. . Information is needed concerning two dimensions of each exposure 1 ) The loss frequently or the number of losses that will occur. For each of these two dimensions it would be desirable to know at least the value of an average budget period and the variation in the values from one budget period to the next.2 DIMEN 5. 2) The severity of those losses. The collection and the interpretation of information forms an important part of risk management function.1 INTRODUCTION After the Risk Manager has identified the various types of potential losses faced by his or her firm. analysed and the results interpreted. these exposures must be measured in order 1 ) to determine their relative importance and 2) to obtain information that will help the risk manager to decide upon the most desirable combination of risk management tools . The total impact of these losses if they should be retained. Risk Manager should use probability concepts in identifying and analyzing loss exposures and in choosing alternative ways of handling exposures.Risk Management in General Insurance 5. Therefore relevant data must be collected . probability concepts are used to estimate : 1 ) The average number of losses or average aggregate amounts of losses from a specified peril in a given period. In particular. 2) The variability around these averages of the number of losses or aggregate amount of losses per period.

loss frequency cannot be ignored. the importance of an exposure to loss depends mostly upon the potential loss severity. There is no formula for ranking the losses in order of importance. the exposure with a certain potential loss severity may be ranked above a loss with a slightly higher severity because the frequency of the first loss is much greater than that of the second. i flood damage also amount of property damage is less than the liability arises due to loss i lives. although infrequent. Contrary to the view of most persons. and different persons may develop different rankings. is to place more emphasis on loss severity.3 NEED FOR EACH DIMENSION Both loss frequently and loss severity data are needed to evaluate the relative importance of an exposure to potential loss. is far more serious than me expected to produce frequent small losses and no large losses. \n example may clarify the point. however. The chance of a automobile collision loss may be greater than the chance of being sued as a result of the collision. The rational approach. \ potential loss with catastrophic possibilities.Unit 5 Risk Measurement ^Activity A: Which steps you will take if you want to find out number of exposures of your unit? 5. •£T Activity B : «rite down any incidence in which liability loss is greater than property loss. but the potential severity of the liability loss is so much greater than the damage to the owned automobile that there should •>e no hesitation in ranking the liability loss over the property loss. If two exposures are characterized by the same loss severity. not the potential frequency. . however. On the other hand.

Another illustration would be the losses associated with relatively small medical expenses as contrasted with extremely large bills. For example. In determining loss severity the risk manager must be careful to include all the types of losses that might occur as a result of a given event as well as their ultimate financial impact upon the firm.S. This loss may be subdivided into two kinds of losses: 1) collision losses upto Rs. the more important types are much more difficult to identify. ^Activity C : Write your views on "To determine a loss severity of a firm is an important task of Risk Manager". Such a breakdown by size of loss shows clearly the desirability of assigning more weight to loss severity than to loss frequency. there is the probability that one building will be damaged because of the fire or the negligent manufacture.Risk Management in General Insurance 5. but the potential indirect and net income losses (such as the interruption of business while the property is being repaired) that may result from the same event are commonly ignored until the loss occurs. suggested about 25 years ago that instead of using numerical estimates. and their impact may be much greater than it would be for a firm that could more easily absorb these. 10000 and 2) losses over Rs. In the second category are the more important although they are less frequent. Relatively small losses. if retained. very large losses may have serious adverse effects upon the firm's financial planning.4 RISK EVALUATION A particular type of loss may also be subdivided into two or more kinds of losses depending upon whether the loss exceeds a specified amount. cause only minor problems because the firm can meet these losses easily out of liquid assets. For example. This same event may also cause liability and personnel losses.5 LOSS-FREQUENCY MEASURES One measure of loss frequency is the probability that a single unit will suffer one type of loss from a single peril. while the less important types of losses are obvious to the. which in turn may make it more difficult or more costly for the firm to borrow funds required for various purposes. larger losses may cause liquidity problems. 10000. Often. the risk manager of a large U.. Somewhat. The potential direct property losses are rather generally appreciated in advance of any loss. the risk manager might express this . business group. Richard Prouty. Finally. risk manager. The ultimate financial impact of the loss is even more likely to be ignored in evaluating the monetary value of any loss. consider the collision loss cited in the preceding paragraph. UnitS Risk Measurement 5.

type of probability as 1. physical damage to a building. 'Moderate' (meaning that it has happened once in a while and can be expected to occur sometime in the future) Example: Possibility of arising third party property claims is moderate. I and liability for bodily injuries or property damage to others) from the single peril. say windstorm and \plosion as well as fire. loss of the use of that building. given time to think about the exposures and study past experience. though unlikely to occur in the future) Example: Possibility of theft of truck is slight. can. "Definite" (meaning that it has happened regularly and can be expected to occur regularly in the future). This probability will be higher because of the additional possible auses of loss. istead of estimating the probability that a single unit will suffer one type of loss from a ngle peril during the coming year. 2. This . depending upon the sagnitude of the increase. Slight (meaning that. most risk managers an provide the necessary estimates. The probability category may or may not be higher. Another example is the probability that a single unit will suffer simultaneously more than | one type of loss (for example. the risk manager. Almost nil (meaning in the opinion of the risk manager the event will not happen) Example: Possibility of accident to motor car due to part of plane drop down from space is almost nil. Making these estimates also encourages a more areful systematic approach to risk management. hough not as precise as the probability measurements. 3. these measures have the advantage sat. in the same way. Example: Occurrences of own damage claims to motor vehicles are definite. estimate the robability that the unit will suffer that type of loss from many perils.

will suffer the same type of loss from the same single perils. an action that would result in any ultimate loss of the difference between the going-concern value of the business. the ensuing shutdown of the firm for six months might cause another Rs. For example. 9.00.60. 3.00. say five buildings. 6.000.000 loss might force the firm to shut its doors. say Rs.Risk Management in General Insurance probability will be lower because more than one type of loss would have to result from a single occurrence the probability category may or may not be lower. Loss severity also depends upon the number of units involved in the loss. To illustrate. The losses ultimately the loss could be the ruin of the business as going concern.This Rs.60. ^Activity D : Give two examples for the following: 1) Single unit suffers from one type of loss.00.000 loss. if . 5. 24. Another example is the probability that at least one of several units. 3) Several units suffer from one type of loss. 2) Single unit suffers from many types of losses.00.0001oss. 15. say Rs.000 causing a Rs. a fire could destroy a building and its contents valued at Rs.3.000 and the value for which the remaining assets could be sold.6 PREDICTION FROM SAMPLES 'f. This probability will be higher than the probability that any specific unit would suffer such a loss because there are several units that may have a fire.

5. Once the Risk Manager has determined what probabilities are most useful in decision naking. M/s. ^Activity E. These average losses can be compared with the premium the firm would have to pay an insurer for complete or partial protection. Not all these probabilities are worth the time and efforts involved in estimating a probability category. The variation (or estimated risk) in a loss frequency and loss severity sheds light on the predictability of the losses and how serious the losses might be in a bad year. it is important to recognize the timing of any losses as there adjacen well as their total amount. the average loss frequency times the average loss severity equals the total dollar losses expected in an average year. has Finally. They are also extremely useful in determining the best way or ways to handle an exposure to loss.00.8 LOSS SEVERITY MEASURES When developing a risk management program.7 BENEFITS OF MEASURES Loss-frequency and loss-severity data do more than identify the important losses. For example. a loss of Rs. On the other hand. and perils that are possible. he or she can use Prouty's our categories or some similar approach. For example. Note the number of losses he suffers due to this situation. one fire may cause considerable damage at all three warehouses. and 2) the ability of the firm to spread the cash outlay over a longer period. Raj is a manufacture of a Motor car and recently receives an order for export.000 because of 78 Unit 5 Risk Measurement 1) the time value of money. however. types of losses. the Risk Manager must have a good idea ) . § 5. 10. Probability category may be higher. in estimating loss severity.a firm t warehouses. the number of probabilities that could be estimated is extremely large. if more precise information is not available. . Suddenly a strike is declared in his company.000 a year for 20 years is not as severe as an immediate loss of Rs. which can be recognized by discounting future losses at some assumed interest rate. the probability that all of those units will suffer the same type of loss from the single perils will be lower and may move into a lower category. Given all the combinations of units.

( maximum possible loss and the maximum probable loss and these two measures ommonly used to measure loss severity : .

Risk Measurement Generally. 2. such as once every 40 years. i. 4. they may disagree on the value of the maximum probable loss even though they estimate the probability distribution to be the same. "Maximum foreseeable loss" is the dollar loss expected when none of the private protection system is functioning. The maximum probable loss is the most likely maximum amount of damage a peril may cause under average circumstances therefore. Alan Friedlander suggested four measures of physical damage losses due to fire per building per occurrence. and public protection. The fire in this case would probably burn until stopped by a fire wall. is usually less than the maximum possible loss. the probability of the occurrence declines as we move from the normal loss expectancy to the maximum possible loss. For the moment. Example: Private protection system such as sprinkler installation system. Example: In high sea there is a fire to natural gas plant and it burns until it stopped by department of government. Of these two measures. both automatic sprinkler etc of a firm and fire brigade of the government is in operation. Because different Risk Managers may select different percentages. "Normal loss expectancy" is the monetary loss expected from a single fire when both private and public protection systems are operative. A worse loss could occur but the chance of its occurrence is less than some percentage selected by the Risk Manager. arrives. The 1. summoned by an outsider. we will concentrate on occurrences causing only one type of loss. the maximum probable loss is the most difficult to estimate but also the most useful and valuable risk management exercise. or until the public fire department. the total amount of financial harm a given loss could cause under the worst circumstances. . smoke detector etc is not in service or inactive and only fire brigade is there at the time of fire 3. occupancy. until it burns all its fuel. Example: At the time of fire. UnitS "Maximum possible loss" is the loss expected from a fire when all private and public protection systems are inoperative or ineffective. private protection. The maximum possible loss is the worst loss that could possibly happen. In a recent article. "Probable maximum loss" is the monetary loss expected from a single fire when a critical part of the protection system such as an automatic sprinkler is out of service or ineffective. The four values depend upon innumerable factors such as construction.Risk Management in General Insurance 1) The maximum possible loss to one unit per occurrence and 2) The maximum probable loss to one unit per occurrence.e.

thus causing the loss potential to increase. explosions etc. though the probability may be low.L. ceilings and partitions.9 MAXIMUM PROBABLE LOSS (M. emergency planning must be there.In estimating the maximum possible loss and maximum probable loss the risk manager. To avoid the loss to take a shape of maximum potential loss. ideally. . 5. more than one unit may be involved in a single occurrence. Presence of combustible linings to walls. roofs. ^Activity F: What is the difference between maximum possible loss and maximum probable loss. height and shape of area potentially exposed to a single fire or explosion.) ESTIMATION . the following are considered: Factors to be Considered The following factors should be taken into account when assessing maximum probable loss: 1. The Union Carbide chemical leak in December 1984 is the best example of it. that a building and its contents will be damaged in the same occurrence. for example. 2. Size. Construction of roof. 3.P. walls and floors.PROPERTY LOSS _______________________________________________________________ For illustration in the estimation of Maximum Probable loss likely to affect Property. would take broad view of problem consider all types of direct and indirect losses that might result from a given peril and to make a plans to overcome the problem. Fire loss potentials. The probability is high. Some disasters require quick action such chemical and gas leakage. would include the possibly of net income and also recognize that. for example.

distribution and combustibility of contents (fire load). 9.P. 1. Nature. 6. 4. . Use of hazardous processes and substances and their degree of separation. The extinguishment arrangements including sprinklers and the adequacy or otherwise .Risk Management in General Insurance 4. Factors which should not be considered However. The absence of any normal source of ignition. 10.L. Fire resisting doors Unit 5 Risk Measurement 3. 7. s In view of the many permutations of the factors mentioned above. Risk of explosion from any source. List out the points to be considered while arriving at the estimate of loss. which can apply to different risks and their varying relevance to different risks. it is not practicable to relate a 'value' to each factor or the combination of factors. Suppose you are a Risk Manager of a chemical Factory and assign a job to calculate Maximum Probable Loss. It would appropriate in some cases for the total M. to be built up from separate assessments on - • Buildings • Machinery and other contents • Stocks particularly where the contents have low salvage value or highly susceptible to damage. Standards of Management and housekeeping. 5. Susceptibility of contents of damage by smoke heat and water. Any horizontal separations 2. Concentration of values within a small area. 8. the following factors should not be taken into account when assessing maximum probable loss. ^ Ac ti vit y G. Hazards arising from gases or corrosive materials.

of fire brigade facilities.
5.10 SUMMARY______________________________________________________
In this unit we have discussed that all individuals and firms face uncertainties caused by the
possibility of loss. Arisk Management program is begins with identification and measurement
of exposures to loss.
The identification process begins with the recognition of four categories of losses:

Direct losses of property, such as loss of a machine in a fire.

Indirect losses, such as loss of income due to most important machine burnt and
production stopped.

Liability losses, such as Third Party injury or death.

Loss of key personnel, such as loss of a research scientist.

[n this unit we have seen how the estimate of loss frequency and loss severity helps in
taking the sensible risk handling decision. The evaluation of maximum possible loss and
maximum probable loss necessitates a careful study of the all types of injuries or damages
that may arise out of the organization's activities and of the law including recent court
awards. To arrive at sensible decision the data must be collected, collated, analyzed and
the results interpreted. Once the maximum potential for loss is estimated, the risk manager
can develop an integrated plan to deal with it.
Loss Frequency

It is the number of losses that will occur during a specific
period of time.


The financial extent of impact ofeacn loss.


Most likely.

Maximum possible loss

It is a loss expected from a fire in all private and public
protection systems are inoperative or ineffective.

vlaximum probable loss

It is the loss due to fire after loss prevention and loss
reduction actions have been applied.


Risk Management in General Insurance


1. How the risk handling decisions depends upon loss frequency and severity of

Explain "severity of loss is the major factor to be taken into account while


How are exposures catagorised?


Differciate between probable maximum loss and maximum possible loss.


List out the factors taken into account while calculating maximum probable
loss which
affect property.

5.13 ANNEXURE_________________________________________________
^ _
As we have seen Risk identification and quantification are the initial steps towards
treatment of Risks. We now present an assessment questionnaire for a
specific industry -Construction Industry.
Following are the main considerations in risk assessment for construction


Physical hazards of methods of construction


Operational testing and commissioning


Types of constructional plant and equipment

Consider the following examples and hazards, as they relate to a normal building

Excavation and de-watering (collapse of sides)

welding (fire or explosion)

Design work (which can increase the hazard)

concreting in low temperatures (frost)

Use of jib cranes for heavy loads, or in soft ground conditions (over balancing

impact •

Partly completed work (storm or collapse)

over balancing risks 8 5 Risk Management in General Insurance 4. Remember that these are only a few of the broader issues and each stage of the construction process brings its own specific problems. Seasonal changes Subsidence. intermediate or immediate vlore specifically Fire 7. collapse) • Work in hazardous areas i. and with varying degrees of damage resulting. Frost Explosion 8. It is therefore difficult for the underwriter to assess. vibration or undermining Falls. or a combination of both • Seasonal • Intentional or unintentional « Sudden or gradual • Continuing or intermittent • Mechanical. extension of chemical works (explosion.Unit 5 Risk Measurement • Prefabricated concrete or cladding (impact) • Buildings with no separation (fire) • Tower cranes (collapse) • Work near to water (flood) • Work in remote areas (aggravated damage and higher reinstatement cost) • Structures supported by insecure foundations (subsidence. landslip 9. heave. Let us look at some of them : Causes of Loss or Damage These can be divided into broad groups: • Acts of God or Act of man.e. collapse. impact. from many directions. electrical or chemical • Initial. Water damage . fire) You will see that the hazards are numerous and can arise at any time during the construction period. Earthquake 5.

Riot. Winds DESIGN Rfi 10. Breakdown Design also plays a critical role in the evaluation of construction risk. • Contractor' familiarity with the design. Grime risk 11.6. civil commotion. • Design of temporary works . The questions which are addressed whether the design is standard one or prototype. malicious damage 12.

and to adjoining property. c . It also arises in respect of persons and property outside the contract site. or defective workmanship. Here the risk is to persons passing by the site. • Collapse of own or hired plant. r • Spreading fire to adjoining property. underpinning. either used or erected.g. Liability for the consequence of that damage may be actionable. gas. a • Valuable feedstock (during testing and commissioning). d t y A s p Unit 5 Risk Measurement • Pollution risk (work on petro-chemical. water. • The various disciplines on a site e. architects.g. Damage to underground services is a common occurrence and if great concern to underwriters with the recent appearance of fibre optic cables which are extremely expensive to replace. The risk may only result in pure economic loss but if damage is caused to the third party's own property. - piling. electricity. T h i Some of the particular liability hazards are: r • The use or proximity to inflammable substances. tunnelling. • cutting the supply of utilities to adjoining properties i. excavation - dewatering. or similar risks) which can take many forms. surveyors and employees of other contractors on site. and possible injury. with consequential loss of trade. visitors such as the Employers. • Dangerous chemicals. - use of explosives.e ects t The third party risk can arise in respect of property and persons within the contract site e. P • Fragile or valuable machinery.e. Underwriter will not cater for claims arising from deliberate or uncontrolled discharge ofpollutants. . • Design risks. welding.

General movement .- use of plant. Insufficient compactness of the ground 4. - laying of pipes and cables in built up areas. Weight of the structure 2 Moisture changes in the ground 3. - operational testing and commissioning The Construction Process • Following factors help in evaluating the process relating to risk: • Demolition • Earthmoving • Mass excavation • Trenching • Shaft sinking t • Pilling Foundations 1.

Actual method of erection 3. With the data of loss frequency and loss severity how the risk Manager takes a proper decision to identify the exposure of a firm? m Maximum Possible Loss. Method of Storing major component parts 5. Location of the temporary factory 7. • Mixers e. • Heavy presses (Motor industry.g. Fire 4. Tall Buildings Operational Testing and Commissioning s Main hazards are - • Breakdown of large generators.Risk Management in General Insurance System Building 1. Review i. board manufacture and other heavy industries) • Iron ore crushers • Explosion of black liquor boilers (pulp works) • Fire and explosion following introduction of feedstock in oil refineries and petro chemical plants. in plastic and rubber factories. in measuring MPL? Unit 5 Risk Measurement NOTES Explain the concept of . Size and value of their largest components 2. Which factors are taken into account and which are not. ii. Use some of the graphs in Appendix of Chapter HI to explain the concepts of frequency and severity of Fire losses of Indian insurance industry. Height of high-rise building 6. Building utilising high alumina Cement 2. Transit • Steel Framed Building 1.

We will now discuss regarding different types of categories which is exposed to the losses as follows: 1) Exposures of property 2) Liability exposures 3) Revenue exposures 4) Interest exposures v First we will see exposure to property 6. we designate the extent of risk which is faced in a particular contingency. which the accounting convention would classify as assets for e. Property again can be belonging to an individual or belonging to a commercial organization.Risk Management in General Insurance 6. Examples of movable property could be automobiles. . the Intellectual Property or Royalty or Goodwill etc.g. In contrast to tangible property. Now we will try to learn the meaning of the word exposure.2 EXPOSURES OF PROPERTY By property we mean tangible assets either of 1. leased from others or leased to others. Personal nature or 2. Hazard etc. finished goods of a factory. in respect of a particular property or liability. there are property or properties. Examples of immovable property could be Fixed Machinery. Commercial nature. In an earlier unit we had come across the concept of Probable Maximum Loss or Estimated Maximum Loss. property under construction or belonging to the government and similar public enterprises.. what we mean is that the property should be physically present and identifiable. The term 'exposure' indicates the extent of potential for a loss. Building etc. When we say tangible. Property can also be broadly classified into movable and immovable property.1 INTRODUCTION So far in the previous units we have seen the meanings of terms like Risk. Exposure in fact is close to this concept. By identifying and measuring the potential for exposure.

If the property is destroyed. stock of finished goods becoming unfashionable or absolute. Usually current asset can be valued at their replacement cost (mainly cash. we mean a causative factor. Physical perils: The examples are causes like fire. Economic perils: The examples are recession. change of government. By "Peril". negotiable securities. economic. For instance Terrorism is a peril. Though Risk Management largely is concerned about human and physical perils.3 TYPES OF EXPOSURES TO PROPERTY Another term peculiar to Risk Management is "Peril". Perils normally trigger off a loss situation which affects tangible property and causes either loss or damage to such property. Such value may be measured by: 1. human. Its replacement cost or current purchase price. The net present value of its expected future earnings. Human perils: The examples are causes like negligence. Calculating the exact property value is difficult in case where the replacement cost is unrelated to accounting book value. flood. Perils again can be broadly classified into physical.Unit 6 Exposures 6." . riots strikes. the actual cash value is a better measure of the exposure. stock of raw materials) ^Activity A: Comment on "In an inflationary economy. explosion. The Valuation of Potential Property Losses Risk Manager must place a value on potential losses. inflation. 2. of late economic perils are also getting a high level of attention. replacement cost at the time of future loss may not be the same as current replacement cost. Its current resale value or net realizable value. 3.

The Law of Torts is concerned with civil liability other than those arising out of breach of a contract.Which is responsibility to one's partners. If the Consumers Forum finds out that a particular supplier was deficient in service then they may award a monetary compensation to be paid by the erring organisation to the affected individual.5 LEGAL LIABILITIES_______________________________________________ It can be broadly classified into civil and criminal liabilities. 'responsibility' . These forums provide redressal to consumers whq are aggrieved at the action or inaction of certain product or service suppliers.4 LIABILITY EXPOSURES The term 'Liability' indicates in a very rudimentary manner. The non-adherence to these can result in civil liability. employees. Normally a prudent person is expected not to commit certain acts or alternatively do certain things as society would expect of him. regulations or be out of even common law or convention. The exposure to such suppliers will be out of causes like deficiency in service. If a flower pot kept in the balcony of their apartment happens to fall on a pedestrian on the road below and injures him. and the individual who had resorted to assault could be either imprisoned or a hefty fine imposed on him. (this family can be residing in the 20th storey). 6. Think of a family residing in a high-rise building of about 35 storeys. An assault by one individual on another attracts criminal punishment. of the various levels of Consumer Forums set up by the government. You would have come across in Newspapers. it will be useful to know that civil liabilities normally result in compensation to the affected party. the society and the public at large. This kind of responsibility to others can arise out of certain laws. Or it can arise out of even certain agreements or contacts entered into by various parties. Criminal Liability: As against this criminal wrongs result in some kind of a punishment to ensure that such crimes do not get repeated. delay in compliance and so on. Similarly if a trader contracts to supply certain type of . family members. the family can suffer a civil liability arising out of negligence.Risk Management in General Insurance 6. Civil Liability: Though the dividing line between civil and criminal is quite often a thin one.

6 PROFESSIONAL LIABILITY Professionals like doctors. Now we will discuss it in detail. Loss resulting from bodily injury or death cannot be measured in terms of money. Medical malpractice is a major concern in developed countries and without adequate (ftsusasvcc a:g^sVs\\cM\?to&\ks. Nowadays various liability losses are increasing due to increasing awareness of the society towards its rights such as product liability. Individuals. It is classified into two categories: 1. business can therefore face a variety of legal liabilities. public liability. Dentist fall into this category 2. 6. lawyers. Chartered Accountants. Solicitors fall into this category. liability of workmen's and environmental liability. nature of injury. . The legal liability is pay damages arising out of negligence in the performance of their professional duties. Professional negligence may result in financial loss. families. Hence calculation of liability depends upon number of factors such as age of the claimant. etc. architects can also face liabilities arising out of their professional practices. iUsNirtttafty/ impossible for medical practitioners to pursue their profession in these countries. earning capacity. Professional negligence may result in bodily injuries (fatal or otherwise) Doctors. there can be a breach of contract and the contract provisions may either provide for penalties or penalties can be invoked under the Law of Contracts. professional indemnity. accountants. ^Activity B : Write down two examples each in case of civil as well as criminal liability. Architect.Unit 6 Exposures goods in certain time and certain price to a customer and defaults either in time or in quality of goods promised.

bodily injury or illness caused by poison or other deleterious matter in the manufactured / supplied / treated / food. medicines and injections. animal and poultry feeding stuff. drink or other products. canned food stuff. acids and chemicals gas cylinders etc.g. damage to property caused by any goods manufactured / supplied / treated / sold / repaired / altered / serviced from/in the country and accident occurred outside the insured's place or premises.Risk Management in General Insurance Loss in the second category can be measured with more certainty as it involves actual financial loss sustained by the client. . Increasingly strict laws and court decisions favoring injured parties. The auditors made a mistake in the figures certified with a result the client suffered a loss and due to this a liability arises. aerated water. ^A ct ivi ty C : An architect fails to prepare plans and specification as per desired standard for a commercial complex. The claims of liability increases because of the wide variety of product e. The client had to submit annual certificate of actual gross revenue earned. emphasize the importance of this problem. 6. manufactured and sold to the public and if defective may cause death injury or property damage. Firm of Auditors were held liable for breach of contract in failing to complete certificate correctly.7 PRODUCT LIABILITY Product liability arises for death. Write down the liability arises in this case. electrical appliances. mechanical equipments.

warehouses.e. 1991 the liability shall be compulsory insured. processes and operations in India the number of accidents increases and ti give minimum relief which is based on "no fault" liability. . irrespective of any wrongful act. According to Public Liability Act 1991 imposes fault liability i. neglect or default on the owner to pay the relief and as per act this liability shall be compulsorily insured. Godown. It covers liability arises due to either breach of contract. etc." . The reason is because growth of hazardous industries.8 PUBLIC LIABILITY_______________________________________________ Public liability arises due to accidental bodily injury or damage to the property of any member of the society. Schools. The liability arises in public liability divided into three categories as follows: Public liability due to Non Industrial risk: Hotels.Unit 6 Exposures ^Activity D. Public liability due to Industrial risk: liability arises due to industrial and storage risks depots. Cinema Halls. Film studios. Tank farms. from a tort or from liabilities imposed by status. Compulsory public liability: in this case liability arises due to handling of any hazardous substance which results into death or bodily injury to any person or damage to property of any person. Shops. 6. A defect in a batch of injections and capsules results in a injuries to a large number of people.^Activity E: Explain "As per Public Liability Act. etc. Enumerate the liability arises due to this incidence.

Similarly there are serious concerns on the manufacturing company's responsibilities towards the environment. 1923. Business.98 Risk Management in General Insurance 6. 6. Waste disposal is the source of many problems for the society. x£gTActivity E: Being a Risk Manager of a paper factory. faces criminal proceedings. Each of these pollution problems can lead to lengthy litigation and extremely large liability losses. The risk Manager should provide the most efficient solution for this growing problem. Firms engaging in production or storage of hazardous substances are required by law to be responsible for any loss or damage to life or property of others. and municipalities recognize significant liability exposures from their past and current operations. Due to industrialization the number of accidents results into death or bodily injury increases and to give protection to the employee the act was passed. find a solution for polluted water which is generated in the pulp process. employer is liable to pay compensation to the employee in respect of death or injury or disease arising out of and in the course of employment. Business firms are responsible for creating obnoxious level of heat. noise or vibrations. Even the Managing Director of the parent American company which owned Union Carbide in India has been held personally responsible for negligence. . While Union Carbide is expected to provide compensation to the victims. firms. According to Workmen's Compensation Act.10 EMPLOYRE'S LIABLITY Employer's liability arises under common law or statutory law to pay compensation to his employees for 'occupational' accidents or illness.9 ENVIRONMENTAL LIABILITY Society has become increasingly aware of the damage and injury caused by the release of contaminants into air and the disposal of industrial waste on land and into water courses. Remember the Bhopal gas tragedy that occurred in 1984. their Chairman at that time.

or bridges also require bstantial investments which cannot obviously come from just few individuals. 6. houses etc. Quite often cause of the size of investment involved. Now we will proceed to analyze who effectively can have this kind of exposures.Unit 6 Exposures ^Activity H. Why is the quick resumption of operation a problem for some business? Give examples to explain your answer. cars. I inance Parties ot all assets are acquired or built up by using only the funds of the owners. with institutional help. ie asset or property. It is ramon practice now to borrow money from banks and similar financial institutions to quire assets even a personal nature like two wheelers. In this case also the lending institutions come into play and offer either loans or similar forms of "lancial assistance to the promoters to help them put up these projects. In ail such cases where institutions have invested or have lent money they too have a financial stake in the continued survival and success of such ventures. Similarly large estments say e. WHICH CAN HAVE EXPOSURES We have had a brief overview of the kind of exposures an individual or a firm can face. Hence those who have ownership iterest in the asset will be the ones who will be directly affected by any loss or damage to . Either during the o instruction or during the operations if any loss or damage takes place to the assets so •' eloped. then .g. If a large commercial shopping center is owned by any individual or firm. in building up infrastructure projects like roads.. there are serious interruptions to the business to which the finances are provided. )wners of the Asset Basically anybody who has financial interest in the continued survival or performance of .ny asset will have the exposure in respect of the asset. any loss or damage to such property will primarily affect such owners. then these institutions also are likely to lose their investments . the financial institutions step in and they lend oney to individuals as well as promoters of projects for building up the assets.12 INTEREST.

Financer. contracted parties are also affected due to exposure of various kinds. In such cases these kinds of tenants or similar persons who have a contractual relationship with the owners of the asset also carry the exposures in respect of the asset. Lnit 6 Exposures . Unfortunately one unit burnt due to fire and production stopped. Contracted Parties In the example of the commercial complex cited above. When such a complex is put up it is obvious that it will require a sufficient level of occupancy of the various floor spaces being offered. In this unit we have also discussed how liability arises in civil and criminal cases. The occupants also have stakes in the survival of the commercial complex.13 SUMMARY____________________________________________________ In this unit we have introduced the concept of exposure. 6. There are direct and indirect losses have to bear to continue the operations of the business firms. ^Activity I: Bank has financed a big project of chemical factory. human or economical perils. it is not only the owners who have financial interests. may also have to be forgone. Due to increase awareness in the society different types of exposures arises like Professional liability. Employer's liability. Moreover any rent they may have either paid or supposed to pay. etc. Product liability. Enumerate the various exposures involved in this case. We have discussed in detail the liabilities arises due to revenue Risk Management in General Insurance the repaying capacity of the borrowing entity might also get affected resulting in default of loans or interest payments etc. as their business operations cannot continue. Different types of property can be affected by physical. depending upon the terms of the rental agreement. We have also discussed that owner of the property. Therefore the financial institutions which have assisted such individual or commercial acquisitions do have an interest and a corresponding exposure on these assets. If any major catastrophe takes place the occupants are bound to lose.

Employers Liability : It is to pay compensation to the employees for 'occupational' accidents or illness. How are exposures categorized? ii. Give two examples for each liability. Product Liability : It arises for death. from a tort or from liabilities imposed by status. Criminal Liability It results in some kind of a punishment to ensure that such crimes do not get repeated. Give a note on Liability Exposure. Identify some perils in the Property Exposures. In the case of a textile mill which is located on leased land and which has: Loans from commercial banks for capital. Advances from buyers for fabrics. Public Liability : It covers liability arises due to either breach of contract. Enumerate the Exposures of various parties in respect of the various assets of the Mills. iv. Perils normally trigger off a loss situation. .6. iii. Enumerate this state with examples. borrowings from Textile Development Council for Machinery up-gradation. Peril A causative factor. bodily injury or illness caused by poison or use of defective product.14 KEYWORDS Exposure The extent of potential loss. Liability Responsibility Civil Liabilities It normally results in compensation to the affected party. Sometimes indirect losses are more than direct losses. 6.15 SELF-ASSESSMENT QUESTIONS i. which affects tangible property and causes either loss or damage to such property. Professional Liability : The legal liability is pay damages arising out of negligence in the performance of their professional duties.

Risk Avoidance. Risk avoidance means the chance of loss has been eliminated. person. Risk control consists of three elements. For example. A successful risk avoidance results in the total elimination of exposure to loss due to a specific risk. various methods are developed. The exposure to loss can often be reduced but not eliminated. For other exposures.3 WAYS OF AVOIDING RISK One way to control pure risk is to avoid the property. 7. people generally avoid such business. or the risk of premature death cannot be avoided by the firms or individuals. discontinuing some operations or selecting a particular peril where a particular peril is not available. the risk of liability suit. In the process of risk management risk control is a major part. individual avoid such choice of careers. Unit 7 Risk Control -1 7. Risk Reduction. In this unit we will discuss about these elements in details.Risk Management in General Insurance 7. avoidance is the only reasonable alternative. When the chance of loss is high and loss severity is also high. 3. When there is a significant chance of death or disablement. avoidance is the best and sometimes the only practical alternative. 2. Businessmen avoid investing in some countries where there is always labour unrest. activity with which the . Loss Control. Sometimes to avoid risk means abandoning some activity and losing some benefits accompanying it.1 INTRODUCTION So far you have seen the process of Risk Identification. If there is chance of financial failure. Risk Measurement. Sometimes risks are unavoidable. We shall now learn about the various methods and tools which are available for managing the risk so identified and measured. Those are 1. From olden days men have been searching and developing ways and means of controlling and managing the risk being encountered for their safety. survival and success.2 AVOIDANCE______________________________________________________ Sometimes the best method of dealing with an exposure to loss is to avoid all possibilities of the loss occurring. In practice it means not introducing new product. ending the production of an exiting product. We cannot get anywhere if we avoid taking risk. the risk of bankruptcy. Risk is an unavoidable fact of life.

Similarly. Let us look at an example for the declinature part. Now let us look at avoidance through the process of abandonment. If a geographical area is known to be highly earthquake prone then a firm which would like to expand its business activities in such a zone can simply avoid building any business unit there so as to avoid the severity of any possible earthquake. On the liability front. on the face of it looks to be very simple to adopt. I.The world is so much networked today through air travel that it will be impossible for avoiding investments in aviation. otherwise the defective products might result in liability exposures related to the quality of the product. then the firm which utilizes it can as well replace this boiler with a new one. By abandoning an exposure which is already present. . For instance if a boiler and pressure vessel plant situated inside a factory has become substantially old and it has been found that it can cause possible leak of gas or air due to its poor condition. then the firm as well can choose to abandon the asset and avoid the exposure associated with the risk altogether. an individual who is not having a bank safety locker facility can think twice over acquiring expensive jewellery which is prone to theft. Similarly parents who have very adventurous teenage children can avoid the exposures due to automobile accidents by selling their fast and expensive car. a firm which is engaged in manufacture of general pharmaceuticals can avoid any investment in pesticides or insecticides producing plants if it considers. Similarly if a manufacturing process is found to produce qualitatively defective products on a continuous basis then the manufacturing firm can give up the process in favour of a better process. there are exposures of hijack etc.exposure is associated by 1. There are exposures of the aircraft crashing. But to avoid these entire risks one cannot even dream of avoiding air travel . Declining to assume the exposure 2. If the exposure due to an asset or a liability is of such a nature that it poses continuous financial implications for the firm. Though avoidance as a risk control tool. Avoidance by itself may sometimes be impossible. the liability exposure due to any leak in such plants is too severe for it to handle. The airline business is full of risks. there are exposures of cargo getting lost. in practice it is seldom so. There are three main reasons which make avoidance a complex issue.


Risk Management in General Insurance


That brings us to the fact that sometimes there is an exposure associated
with an
asset or an activity can in fact be for out weighed by the benefits such
assets or
activity can bring about to the society. The Euro tunnel which links mainland
with United Kingdom is a submarine tunnel which has made the travel
between these
two areas such a convenience that any exposures which could be
associated with
such under the water structure is not sufficient reason to avoid building such a


Sometimes even avoidance of one type of exposure can lead to creation of
It is quite a common practice nowadays for large corporations particularly in
the Fast
Moving Consumer Goods industry to get their manufacturing done by third
This type of contract manufacturing facilitates them to avoid problems
related to
labour unions as also enable them to save costs significantly. But having
avoided such
exposures the new exposures of the quality considerations as well as
Interruption and viability of the business of contractor is added to the list of
of the original corporation.

Any person involved in the process of risk mapping and management will
necessarily have to identify measure and then analyse risk which necessarily
had to be avoided. But as mentioned earlier this is a very complex exercise
which involves inputs from all other sections of an enterprise.
To realize the complexity think of this: when the famous Shanmukanandha
Auditorium in Mumbai was devastated in a major fire few years back it took the
resolve and opportunity evaluation by the managing committee to reconstruct the
edifice in its previous place and restore its old glory. This was perhaps a
simpler decision when compared to the big dilemma facing the New York
Port Trust who are the original owners of the ground on which the World Trade
Centre Towers were built. The issue before New York Port Trust is whether at all
a similar sky scraper built in the area which will again stand exposed to the kind of
attacks by terrorist on 11th September. This is a classic avoidance issue.

^Activity A;


examples of risk avoidance where you have lost the benefits accompanying it.

Unit 7

Risk Control -1

Sometimes it may be possible to avoid risk without any undue difficulty or exposure, but it
is never costless.

They may be monetary costs (such as additional bank charges for paying wages by
credit transfer to avoid the risk of paying in cash) or opportunity costs (such as the
income forgone by abandoning the production of a certain hazardous product).


They can be direct or indirect costs. The changeover to payment of wages by credit
transfer, the extra bank charges would be the direct costs and indirect costs may be
incurred in having to increase wages to overcome opposition from employees to the
new system of payment.

Loss control is another major step in Risk Management. Loss control measures are aimed
at either lowering the chance or probability that a particular type of loss will occur or if it
occurs reduce its severity and impact. In contrast to loss avoidance which eliminates the
risk but forces the firm to avoid or discontinue the activity. Loss control measures have
unique ability to prevent or reduce losses and enable the firm to continue.
Loss Prevention programs seeks to reduce or eliminate the chance of loss whereas the
Loss reduction programs seek to reduce severity of the loss. But sometimes there will be
an overlap that some loss control programs double up as both loss prevention and loss
reduction programs.
There are a variety of ways in which losses can be prevented from happening either totally
or the chances of loss occurring can be reduced significantly. Thus successful loss prevention
activities lower the frequency of loss. If the benefits derived from loss prevention exceeds
the cost, it is useful.
Large industrialist often employs safety engineers at the time of construction to identify
sources of loss or injury and apply preventive measures and safety devices so to reduce
the chances of losses and accident.
One major concern in human safety in factories is the accidental injury to workman.
Particularly in construction industry sites workers are required to work in very hazardous

Risk Management in General Insurance

conditions. Either it could be working at a great height by using unsafe support systems or
even at the ground level it would mean working with heavy equipment like excavators and
bulldozers. By providing a proper scaffolding and support system for access to higher
levels of construction, the workers getting injury due to fall can be reduced or totally
eliminated. Similarly by providing safety meshes around moving equipment, accidents to
workers can be either totally prevented or minimized.
Some losses are due to environmental hazard such as poor layout of machine, inadequate
light or ventilation, inadequate smoke detector or insufficient fire fighting equipment. Some
losses are related to human shortcomings and errors such as bad judgment, inadequate
training, supervision or lack of attention to safety requirement. Good safety programs can
be developed and implemented to deal with these situations.
Concerns on individual safety have forced governments all over the world to enact legislation
to make it compulsory to have seat belts in automobiles as well as ensure two wheeler
riders wear safety helmets. Fire accidents in textile mills where a huge amount of waste
collects or deposits itself in and around electric equipment and points of ignition can be
prevented by installing fire and smoke detectors as well as having sprinkler systems. These
systems ensure timely detection of any increase in temperature or presence of smoke and
activate the sprinkler which will douse the area where detection has taken place with
appropriate fire extinguishing agent like water or carbon dioxide.
Other examples of loss prevention activities include use of safety guards on saw blades,
security guards in banks, drive training and safety education programs, warning printed on
drugs and dangerous chemicals.
Similarly ports have cyclone warning information systems with the help of which they are
able to alert the incoming and outgoing vessels about an impending cyclone or weather
disturbance. However in spite of all this early warning systems, accidents do occur,
exposures do get materialized and a loss results,.
Many loss prevention measures reduce death or injuries, establishing engineering solutions
or using cost benefit analysis. After taking all above precautions some accidents occurs,
this takes us to next aspect of loss control, namely, Loss Reduction.

These take place after the loss has happened and ceased to continue. dried there. Loss minimization programmes are a type of loss reduction programmes. If the garments owner was aware of the potential for flooding then he would have taken adequate care to store the garments well above the ground level on specially designed racks so that the flood water could not have reached the bottom layers of the garment stacking. several measures can be taken which can bring about reduction in the severity of the loss event. 7. To get an idea of loss minimization programmes.7 LOSS REDUCTION I As the name implies Loss Reduction aims at reducing or mitigating the impact and extent of a loss event. However having been affected by the flood waters entry. These aim at reducing the extent of loss or transfer the loss actually happening. If this warehouse happens to be located in a low lying area and if there are heavy rains which flood the location and the flood waters rise to such a level within the warehouse then most of the stored garments will be affected by flood water damage. The other types of loss reduction programmes are called as salvage programmes. Once a loss triggers off either during the course of a loss occurrence or immediately after it. the best way to reduce the loss or minimize the loss is to make sure that these garments. think of a huge volume of garments which is meant for exports and which is stored in a large warehouse. . particularly the affected ones are removed to a properly elevated place of safety.Unit 7 Risk Control -1 >gf Activity B : What preventive measures you will take at the time of construction of a high rise building. washed there and any textile processing method which can restore the quality if available should be used.

. Then comes the question of further loss reduction by salvaging efforts. This realisation then would reduce the impact of the loss as compared to the total rejection of these garments. If the garments after proper cleansing and finishing can be sold as 'seconds' there could be a fair amount of realisation of the original price.In case all these metho ds do not result in restoring the pre lost quality of the fabrics then they may not be fit for exports or even sale as new.

2. Examples of various measures : Loss probability reducing measures: Fittings of safety guards to dangerous machinery. Loss severity reducing measures : Storage of water susceptible goods above floor level. Again there are specialist agencies like Salvage Corps. Physical devises. minimizing: to limit the loss as far as possible. installation of sprinkler systems and smoke vents. In the developed world there are specialist Recovery companies who have developed expertise in salvaging and recycling goods and commodities of any type. Separation of vehicular and pedestrian traffic.Risk Management in General Insurance In the same manner we find that automobiles which meet with major accidents are also recovered and then. Salvaging also has a special meaning in the realm of Maritime Trade. 3. Unit? Risk Control -1 Another classification of risk reduction measures is as follows: 1. fittings of water tight compartments in the ship. stairs. salving: to preserve as much as possible of the value of damaged property or the ability of injured persons. Loss reduction measures also can be classified as follows: 1. There are frequent casualties on the high seas and the Inland Water ways and Port premises in which ocean going vessels or other type of waterborne vessels get affected due to various types of perils and then sink. Training to employees in the form of first aid for personal injuries or protection of damaged plant to prevent further is necessary to cut the losses. Specialist scrap buyers buy this kind of wreckages and they cannibalise the damaged vehicle to retrieve at least some parts which can be reconditioned and sold as 'seconds'. Such casualties not only result in financial loss to the owners of the ship or vessel but also they sometimes block ocean ways or port areas preventing the maritime transit. V. limiting stocks of explosives/combustible material. 4. Procedural devices 3. Education and training 2. etc. spillage and slippery surfaces from gangways. provision of first aid facility. . education to employees regarding hazard. Mixed measures: Replacement of combustible with fire resistant building material. fire walls and doors in the buildings. removing potential sources of ignition. because they cannot be reconditioned or repaired they are sold as scrap. preventative: eliminating the cause of loss. removal of obstacles. protective: protecting things or persons exposed to damage or injury. which help in recovering the wreck and removing it to a designated place.

security locks. warning devices for leakage of gases and radioactive materials. fire and burglary alarm with connection with police and fire station.In brief we will see these measures 1. effective internal audit system. . 3. safety guards. and automatic switch off devices of machines if fault arises. stand by equipment. valves. ^Activity C: a) Write down risk reduction measures for the cotton industry assuming that you are a Risk Manager. 2. specialized courses for key staff. security petrol including night watchman. stocks and alternative sources of power services. b) Suggest a method for reduction of loss due to cotton waste. productivity security. Physical devises: Venting of toxic and explosive fumes. inspection of premises before closure for evening or weekend. fire prevention. separation of hazardous process. Procedural devices: Periodical conditions of safety devises. Education and training: Courses in security.

the bull's eye of the target is the third step in the sequence. It could be a defective electrical wiring which can spark off and ignite materials which can easily catch fire. Environmental Sciences have all blended and have contributed in the . 4. The sequence is as follows: 1. Those with Human Relation approach. Engineering Sciences. History and Social Environment 2. defective workmanship or defective handling.8 LOSS CONTROL TECHNIQUES Loss Control Techniques normally are classified. With increasing sophistication in equipments and tools and equally increasing concern for human safety. Examples can be numerous but the underlying phenomenon is one of either a defective material.Risk Management in General Insurance 7. It can be lack of proper lubrication in moving machinery parts which can lead to high levels of friction and heat and result in jamming of equipment. While Heinrich's Domino Theory still is acclaimed to have validity. It can be poor braking system in a automobile which can lead to serious accidents. it is no wonder that Management's responsibility and accountability to ensure loss prevention and minimisation has increased tremendously. a pioneer in safety concepts. Faults or the person (inherited or acquired faults of the person constituting approximate reasons for committing unsafe acts or for the existence of mechanical or physical hazards). It has however to be remembered that neither the engineering approach nor the human approach can be used in isolation of each other. According to him this is what primarily drives other five factors in motion. Accidents 5. a recent day expert. Injury >s According to Heinrich. a. Those with Engineering approach b. Dan Petersen has added a sixth factor to Heinrich's sequence namely Management Fault. a defective design. 3. The Engineering approach traces emphasis on the mechanical or physical causes of accidents. In reality there are numerous such causes. Heinrich.W. Unit? Risk Control -1 Safety engineering has developed into an exclusive faculty by itself with the interdisciplinary cross pollination of knowledge across Medical Sciences. According to 'Domino Theory' a preventable accident has one of the five factors in a sequence that results in an injury. We will now understand 'The Domino Theory' proposed by H. Information Technology. in accident control. Unsafe act and/or mechanical or physical hazard.

Particularly after few major industrial disasters. Using the Engineering approach. Similarly starting from the Time and Motion study which was evolved in the mid forties to the latest Psycho Biological tools have given immense scope for proper analysis from the human safety point of view.development of safety engineering. Loss prevention or Loss minimisation programmes aim to map the trigger factors which can set in motion a loss sequence. Education and Research and Communication. COMBINATION AND TRANSFER Separation reparation is a process of segregating a firm's exposure to various locations brought by oncentrating them at one location. Loss Prevention and Human Safety plays a priority item on the agenda on any management.9 RISK CONTROL: SEPARATION. recoveries.. In summary. In the Annexure to this chapter there is a brief outline of institution based in India which specializes in Loss Prevention. there are techniques which we have seen earlier like Hazard and Operability Studies. these all provide predictive techniques involving the process. Similarly there is another body called as National Safety Council which also provides useful information on Safety practices to industries. By such spreading of the xposure to various locations. A tyre manufacturer who caters to the length and >readth of the country can produce tyres at one single location and transport them to arious convenient distribution centres all over the country. With a result. practically every activity of human endeavor currently has a state of the art Loss prevention and reduction programmes available. products and sequences. even if such an event iappens in one of the locations the stock can be redistributed from other locations and aereby the continuity of the supplies to the customers can be maintained. These techniques comprise recycling. the chances of the stock of tyres getting affected in Fire azard is limited to the quantity at any one location. They either attack this trigger points or if after the trigger is set off they try to control the consequences through selective techniques. relocation and similar tools. While basic concerns remain the same. Fault Tree Technique. Many Industrial undertakings either by regulation or as part of their social and corporate responsibility have a dedicated safety department in their premises. alternate sources of production or supply. 7. the access to information across various disciplines has resulted in advanced methods of Loss prevention and minimisation. Therefore. Root Cause Analysis etc. .

We know that the larger the size of the sample. 1/25 of 100 will only meet with an accident.e. If the underlying probability is that 1 out of every 25 vehicles will meet with an accident in a year. Segregation in effect uses the Law of Large Numbers by increasing the exposure units and thereby enabling the firms to predict what its loss experience will be.e. a specified number of exposure units under the control of the firm are relocated." Combination In separation. On a similar basis if a company depends upon only 3 or 4 major suppliers for the supply of its critical inputs then even if one or two of them suffer any problem then the company Unit 7 Risk Control -1 . Such process being hazardous by nature. In combination. there may be certain areas where hazardous processes are being carried out or hazardous goods are being stored. if they so happen that for the 100 vehicles owned by this company. one of 25 may closely apply to this sample. It may so happen that even 40 vehicles can meet with an accident if the company is unfortunate. If the number of vehicles owned is increased from 100 to let us say 500 it may so happen that the underlying probability i. the numbers of exposure units themselves are being increased so that again the Law of Large Numbers comes into play and then the chances of loss are reduced. In a large factory complex. it is not just that 4 vehicles i. By increasing the number of exposure units the firm is in a position to have a loss history closer to the underlying probability. the closer will be the probability of the loss to the underlying probability.116 Risk Management in General Insurance Similar segregation techniques are used even in the layout of plants and factories. E. j£$ Activity D : Comment on "In separation of hazardous process perfect party walls plays an important role. To illustrate this point think of an automobile company which owns 100 vehicles.g. the textile factory layouts normally separate this process into an exclusive area and build what are called as 'perfect party walls' between this area and the rest of the textile factory. in textile factories there is a process called as 'singeing' whereby the fabric is given a final finishing touch by running the fabric over a controlled flame.

Risk Financing. elaborately in succeeding chapters. • Transfer of activity that creates the Risk Control.will be affected. a) List out the points for the given project taking into account loss control. A) Transfer of Activity that creates the Risk Control: There are number of advantages if specialists are appointed for hazardous task which are as follows: 1. Diversification into many different products or services is another example of combination technique. This type of transfer can happen in many ways by we shall be looking at few of them in this chapter. b) "In case of Dairy project alternative arrangement for water and power is of prime importance.e. ^Activity E. . On the other hand if the sourcing of supply is done from a large number of suppliers then there is always a possibility of securing supplies from the alternate sources. specialist can complete the work more safely. • Transfer of the financial losses arising from the risk i." Risk Transfer One ultimate tool largely used in risk control is a process of Transfer of Risk. the business risk in one or few lines of business can always be balanced by lesser business risks in some other activities. Being more experienced and skilled in a work. By diversifying. Purchasing of insurance is a major Risk Transfer activity. which we shall study. At the moment we will confine ourselves only to two methods namely.

as also injury to workers in construction site. The equipments can handled more easily by specialists than the principal as it may prove uneconomical to the principal. 3. maintenance of equipment. One another way of transfer of risk is instead of transferring the property or activity. In the case of procurement of materials there are issues of quality. employ construction equipment and also arrange for proper and timely financing. In view of this situation. the risks which could have been otherwise resting with the construction company are now conveniently transferred to other entities. Principal may avoid the difficulties and bad publicity due to accident by employing sub-contractor or even mere carrying out the work itself may cause. problems of trade unionism etc. Unit 7 Risk Control -1 B) Transfer of the financial losses arising from the risk i. To understand Risk Transfer let us take the example of the major contract for building a flyover being awarded to a large construction company. But the actual physical property is in the custody and control of the borrower. as well as accidental layoffs. In the same manner even property which creates exposures can be transferred to others by way of a sale or lease etc. the construction company has to procure materials of construction. the risk itself can be transferred to another party. In each of these activities there is a certain amount of exposure and risk. With so many risks associated with every type of activity in the construction process this construction company has a very onerous task on its hand. Similarly even in the case of use of construction equipments like bulldozers. construction. To execute this contract. By doing this as part of the Hire Purchase Agreement the Hire Purchase company transfers the risk to the borrower. wherein the higher purchase company still owns the asset but is not having custody or control of the asset this hire purchase company may impose on the borrower the safety of the asset in question. Labour supply can be subcontracted to a Labour supply firm and similarly construction equipment can be leased from a leasing firm. If all these exposures have to be handled by a construction company then it will be left with little time for the core activity. This is an example the activity which creates a exposure or risk has been transferred to other entities.e. In a Hire Purchase contract the title to the goods which are brought under the Hire Purchase scheme passes off only when final installment is being paid up. namely. Therefore the construction company can resort to transfer of risk by subcontracting various activities listed above to different firms specializing in each of these areas. Risk Financing. In the case of employment of labour there are issues of availability of labour.Risk Management in General Insurance 2. excavators there are problems of availability. By this process of subcontracting. timely supply and costs. A n . employ labour.

other method of Transfer of Risk is Risk financing. In Risk financing
technique, the risk which is originally associated with a person or firm is not
transferred to another person or firm but the latter is asked to finance any
exposure which results on account of relationship between the two parties.
It may be describes as arrangement made to manage the loss exposures
presented by currency fluctuations, interest rates changes and crop price
To explain this, let us take the case of Franchise relationships like that of
McDonald or Burger King or Pizza Hut etc. When a franchisee
acquires a franchise from McDonald, any risk associated with food
poisoning is still primarily resting with the parent company McDonald.
However if any compensation is to be paid by McDonald, as a result of the
food poisoning, then the actual payment will be done by the franchisee under
the terms of the contract. Under the risk financing there is no transfer of
either the property or activity but then what takes place is only the funding of
any exposure.
^Activity F:
"Risk transfer may take the form of transfer of the activity that creates the risk."


Because Safety involves the welfare of workers as also public at large, the
government has also ensured that certain obligations are based on those
involved in activities of manufacturing and production to make sure that
they follow certain minimum safety standards. Various acts have been
enacted to enforce these obligations. Some of the legislation which govern
safety and Loss prevention are:

Factories Act


Explosives Act


Workmen's Compensation Act


Public Liability Act


Risk Management in General Insurance

Many Local Governments and State Governments have also introduced safety regulations
specific to certain types of risk like High rise buildings. Similarly specialist organisations
have a role to play in special areas for instance for the oil and gas industry. The Oil Industry
Safety Directorate which works under the Ministry of Petroleum and Natural Gas has
evolved safety standards for the industry.
7.11 SUMMARY_____________________________________________________
In this unit we have introduced several methods for handling both pure and speculative
risks. They include avoidance, loss prevention, loss control, risk finance and risk transfer.
The concept of risk avoidance involves abandoning some activities or declines the risk.
This is the appropriate tool when the chance of loss is high and loss severity is also high.
We have discussed various methods of successful loss prevention and loss reduction. In
loss prevention, activities lower the chance of loss. Loss reduction activities are designed
to reduce the severity of losses that do occur. A example is an automatic fire sprinkler
systems that does not stop fire but prevent from spreading.
In this unit we have also discussed how the risk can be controlled by using methods like
separation combination and transfer. Towards the end we have seen the set up of LOSS
PREVENTION ASSOCITION OF INDIA for promotion of safety and loss control
through education, training and consultancy.

One way to control pure risk is to avoid the property,
person, activity with which the exposure is associated

declining to assume the exposure,


abandoning an exposure which is already present.

Loss Control Measures

These are aimed at either lowering the chance or
probability that a particular type of loss will occur or if
it occurs reduce its severity and impact.

Loss Reduction Measures

These aims at reducing or mitigating the impact and
extent of a loss event.


Risk Control -1

Risk Transfer

It is a process of
segregating a
firm's exposure
them at one

It is process by which the number of exposure units
themselves is being increased so that again the Law of
Large Numbers comes into play and then the chances
of loss are reduced.
It is achieved through arranging Financing of the
exposure by another party or transfer to a third party
like Insurer.

i. Distinguish between the concepts of Separation and Combination with suitable
ii. If you were the owner of a Shopping Mall, which sells floor space as well as leases
out space, how would you handle the exposures you have as an owner by using Risk
transfer and financing methods?
iii. Explain the concept of Avoidance with an example.
iv. Distinguish Loss Prevention from Loss Reduction.
v. Is Loss Prevention possible in the case of State like Orissa i.e. of Storms, Cyclones?
Or would you suggest Loss Reduction measures? Which kind?
Loss Prevention Association of India
Promoting safety and loss prevention
Way back in the 1970s, there was a growing concern in the general insurance industry
about the magnitude of fires, road mishaps, industrial accidents, damage to cargo - resulting
in loss of life and property, most of which was avoidable. It was this concern for preventing
such losses and containing their consequences that prompted the general insurance industry
to promote the Loss Prevention Association of India Ltd. or LPA as it popularly came to
be known.

To organise. namely (a) The General Insurance Corporation of India (b) The New India Assurance Co. sea or air and to take such steps generally as may be necessary to minimise the incidents of losses to the General Insurance Industry. 2. Ltd. prevent and/or minimise all losses to persons or property of any kind or nature whatsoever arising out of insurable peril of any nature whatsoever on land. 3. Risk Control -1 To adopt. LPAhad a handful of specialists operating from its head office at Mumbai. When it started. He shall. having offices at Delhi. The liability of the members is limited. (a) Ordinary Members. Constitution The Association is a company limited by guarantee and not by shares. Today. It shall have three classes of membership. organise. it has emerged as a premier safety organisation with multifaceted expertise. Ltd. The following five persons shall be eligible and will be recognised as the ordinary members of the Association. (e) The United India Insurance Co. Kolkata. however be entitled to receive such services as may be provided by the Association and decided by them from time to time. Chennai. Ltd. training and consultancy. Associate Members shall not any voting rights.Risk Management in General Insurance Loss Prevention Association of India was set up in January 197 8 as a company limited by guarantee. Ltd. To provide organisation and train men with necessary equipment to attend to the prevention and/or minimisation of losses to persons or property of any kind or nature whatsoever arising out insurable perils of any nature whatsoever. engaged in promotion of safety and loss control through education. (d) The National Insurance Co. (c) The Oriental Insurance Co. and such other bodies corporate and/or other person as the committee of the Association may at any time and from time to time decide to admit as an ordinary member of the Association shall be admitted and recognised as such. Objectives of LPA are : 1. Unit 7 4. Hyderabad and Kochi. \ Such other persons who are admitted by the Association as Honorary Members shall be and be called Honorary Members. and (c) Associate Members. (b) Honorary Members. suggest and propagate for the prevention and/or minimisation of losses due to fire explosions or by reason of perils to which property in transit eit he r . namely. To organise and provide a Salvage Corps of trained men to be always ready to attend at fires with a view to safeguard the interests' Insurance Companies and to take charge of salvage and to deal with the same and generally to take such steps to minimise the risk of fire and the consequences thereof.

bulletins. companies. To undertake risk managements and advice safety audits. Clearing and Forwarding Agencies. magazines. Factory Inspectors and advisory services. 13. land or air is subject or any other loss or damages arising by any reason or by accidents caused howsoever. Automobile Associations. provide expert advice on quick and economic rehabilitation after major losses. burglary and pilferage and to ensure and encourage enforcement of regulations issued by various organisations. 8. 11. 7. State Electricity Boards. Police. To investigate into causes of losses and build up and keep statistical records. 6. Port Trusts and Customs. 5. To educate or train members of the public on the measures to be taken to prevent incidents losses and/or damages and to minimise risks to prevent waste of such property. 12. Road Transporters. ha . To maintain and provide library. journals. Ship owners. State Government. Indian Institute of Packaging and the like. fire advisors. To publish periodicals. Indian Transport Authorities. To maintain liaison with insurance. audio visual aids. Safety First Association. Protection or research at various levels in order to carry out all or any of the objects of the Association. T o sp o ns or re se ar ch in to fir e ha za rd s an d re lat ed pr o bl e m s an d an y i m pr o ve m en ts in pa ck ag in g. 9. books. Road Research Institute. To review existing regulations and practice in the light of experience and to suggest improvements and modifications to ensure safety in operation and to prevent theft. Railways. hoardings and literature on loss prevention and / or loss minimization with or without collaboration with similar organizations in India and other sea. Inspectorates of Explosives. 10. Bureau of Indian Standards.

123 . 14. To establish a chain of workshops or approve existing workshops for repairs to insured vehicles and organize quick survey facilities.ndling and transportation of different types of cargo.

001 in a period of a year then in any period pay of insurance (this could be common to all these units). 1000 as premium and the total collection of this premium from all these housing units would be Rs.lpaindia. training and consultancy have been the cornerstones of LPA's safety promotion strategy for the industrial sector. Generally premiums once paid for a particular period of insurance are not returned back even if there have been no claims during the period of insurance (there are few exceptions to this practice). Rupe Discuss "Insurance is an especially appropriate risk management tool.gT Activity A. admin 100. If the probability of any of these houses in this sample catching fire and may getting totally destroyed is let us say . This statement holds good only in respect of General Insurance with which we are now concerned about. Insurance Policies are normally issued and executed for a specified period of time and this period is called as Period of Insurance. The other branch of Insurance known as Life insurance which deals with the life of persons has a different mechanism for payment of premiums and refund of Reference from book of III.Risk Management in General Insurance Education. 1 Million. assume each of them cost Rs.3 MECHANICS OF INSURANCE____________________________________ comp any Insurance of property which If there are 1000 housing units in a town. If all these houses are to be insured and the rate of premium is 1 %." es collec ted as premi um. . the insura nce 8. Comp any has to pay out will be a lakh of Rupee s. insura nce. We will now start learning about how the transfer of risks takes place through insurance and how insurance process operates. Out of the total one Millio n . For additional information please refer the following site: Site www.000. you can expect one house out to suffer such a loss which means that the amount of money the Insurance Rs. Unit 8 Insurance : A Risk Financing Tool entire arrangement of this relationship between the Insurance Company and the insured is structured in the form of a document which is called as the Contract of Insurance or more popularly the Policy of Insurance. isters then each house would pay Rs.

100.900.000 is left with it to take care of future losses as well as provide reasonably for its management expenses as well as a decent profit. 19Q .000 and remaining Rs.

All possible exposures have already been identified and also measured in terms of frequency and severity. Once this is done using the various types and levels of insurance coverages available the Risk Manager would proceed to classify the exposures or risks on the following basis: 1. For instance compulsory automobile Third Party Insurance and Employers Liability insurance. certain loss events actually taking place and certain amounts of compensation or indemnity paid to the sufferers of the loss. Essential coverages 2.01 the Insurance Company will have nothing left to pay for future losses and will also run short of money for its management expenses. Available coverages 1. This is how General Insurance works. certain probabilities. The Essential Coverages It includes those that are compulsory because they are required by law. certain collections by the way of premium contributions from this population." 8. Desirable coverages 3.4 INSURANCE AS A RISK TRANSFER TOOL Insurance Method In this method there will be a two step process.001 starts increasing than the surplus left with the Insurance Company will start diminishing and at the point of time when the probability reached 0. JS^Activity B : Illustrate with example: "From the collection of premia. Coverages available in insurance will be the focal point of the exercise. the insurer pays current misfortunes and the surplus left is used for future losses. .Risk Management in General Insurance But if the probability of 0. It is all about a certain size of the population to be insured. Desirable coverages are those which provide protection against losses that can seriously impair the operations of the firm.

Annual Maintenance contracts for equipments are one such possibility. Desirable Coverages These are those which provide protection against losses that can seriously impair the operations of the firm but would not certainly be so severe as to put the firm out of business. viability or continuity. A major fire or explosion in a Petrochemical / Refinery can be an example of this category. There can also be losses which are capable of being controlled by taking suitable loss prevention or control measures and in such cases the prevention cost could be even cheaper than corresponding insurance premiums. Moreover losses due to small time frequent thefts can also be prevented by . larceny of grocery from a shop are examples of this category. Once the listing as above is done. 3. ^Activity C : Write down two examples of Essential. Also in this category can be included losses which have a high severity in their impact. pumps. 2.Unit 8 Insurance : A Risk Financing Tool Sometimes it may be required under the terms of any contract entered that certain level and type of insurance coverage will be required to be taken. there can be a review of how the coverages indicated above could be either purchased or dropped or exposures can be transferred to other than insurance mechanisms. The losses protected under these types of coverages are normally. Losses due to accidents whilst the goods either finished or raw materials are in transit. computers.electrical breakdown of machines etc. The machinery breakdown of motors. The Annual Maintenance contracts which were mentioned above are once again an example of this type. Desirable and Available coverages. could be examples of this type. Construction insurances taken by Construction contractors fall into this category. Available Coverages It includes the types of protection that are not covered in the earlier two categories. frequency losses which would not impact the firms. There can be losses that can be transferred to somebody other than an insurance company for a cost less than the insurance premium. theft of household goods.

Capital Asset Pricing Model. By carrying out this type of classification. Essential contracts will be on the top of this list. let us look at an illustration as provided below: Let us take the example of a building owner.Risk Management in General Insurance increasing the level of security. Available contracts however will be the least on priority. Desirable coverages will be either included or dropped based on the cost considerations.'' ^ 8. Portfolio Theory Method etc. But since they have a high level of statistical requirement. One more method called as a . the Risk Manager will be able to prepare a list of necessary insurance coverages. There are other quantitative methods available like the Worry method. (Please refer the annexure to this unit) This method appears too simplistic to study but in fact is the real life situation is not so simple. In respect of a possible loss due to fire or earthquake the building owner can either retain the risk or introduce several loss control measures to bring down the possibility of as a third alternative purchase insurance. To understand this method. The various cost benefit implications are listed in the sample Loss Matrix. After this there has to be a certain amount of priority listing. Thirdly there are losses which are again frequent in nature but are of such insignificant quantum that this can rather be retained within the firm. Frequent breakdowns in machinery of lesser criticality can be rather borne by the firm because the insurance might be expensive compared to the total would be losses due to this kind of breakdowns.5 THE LOSS MATRIX The Loss Matrix is a tool to quantify the effectiveness of various options available for a Risk Manager. We will now examine one of them: it is simpler to use but still quite effective. ^Activity D : State in brief "In certain cases losses can be transferred to somebody else than insurance in less cost than premium. In order to however decide about the cost effectiveness there are several methods available. we are not highlighting them here.

Utmost Good Faith 2. ^Activity E: State in few lines the use of loss matrix regarding the decision about to retain the risk or purchase a insurance.e. The only difference being that the method uses what is called as Critical Probability Level. the proposer of the risk is in substantially better position to know about the risk than the insurer himself. Since there is a knowledge gap.Unit 8 Insurance : A Risk Financing Tool Critical Probable Method is more or less patterned on the Loss Matrix. This can be defined as the probability that certain type and level of losses will exceed the premium savings. Losses above the Critical Probability level will be desirably insured and losses below that level can be better retained. Proximate cause Now we will discuss these in detail: Principle of Utmost Good Faith: An insurance contract is supposed to be a contract of Utmost Good Faith.6 CERTAIN LEGAL ASPECTS OF INSURANCE CONTRACTS ________________________________________________________________ Insurance contracts are subject to certain special principles evolved under common law and generally followed by courts in India. Insurable Interest 3. . The principle emanates out of the fact that a risk which is being offered to an insurer for coverage. These principles are known as fundamental or basic principles of law of insurance. These are as follows: 1. it becomes the duty of the insured i.. Indemnity 4. to render full information to the insurer. 8. the person or the firm proposing to avail insurance from an insurer.

Any suppression of information or misleading information. liquid or gaseous). etc. In order to enable an insurer to make this kind of pre existing diseases. hazardous. which could have been crucial for insurers' decision. name of destination. Insurance not being a gamble. double gunny bags) type of goods (solid. occupancy i. the insured Unit 8 Insurance : A Risk Financing Tool . will result in avoidance of any obligation by the insurer under the contract. Marine Insurance : Mode of transport (road / rail / air) method of packing (in plastic container. etc. etc. type of vehicle. ^Activity F: "Insurance is not possible unless material facts are revealed "Explain with examples. Ultimately they also have to decide about what price the risk deserves for coverage. This rationale is that if anything happens to the person or property insured. They also have the right to impose certain conditions either to improve the risk or to restrict their liability if the risk is not a very good one.whether non hazardous.decription of goods . there should be a rationale for any one to have insurance for any property or person.e. which mean that they also have to make business profits to grow and survive. year of manufacture. residence.134 Risk Management in General Insurance Insurers also operate on commercial principles. Mediclaim Insurance: Completed age. then the person proposing for insurance. full disclosure of information (material facts) about the risk to be insured is necessary and only the insured can provide it. nature of process carried out etc. Motor Insurance: Carrying capacity. Therefore they have every right to decide whether they should be offering coverage for a particular risk or not. Principle of Insurable Interest: Another major fundamental principle in insurance contracts is the principle of Insurable Interest. 2. Examples of material facts : Fire Insurance : Construction of the building.

By contract: By contract the person is liable for safety of property. 3. 4. etc. damage of subject matter. Such property. In hire purchase agreement the hirer is responsible for damage or loss of property hired. Other e. Liability: It exists due to liability which may be incurred by way of damages and other costs. or liability capable of being insured. 2. The insurable interest arises due to 1. warehouse keeper. "The financial interest between the insured and the subject matter of insurance gives legal right to insure" The essential features of the insurable interest are 1. The relation must be of a nature that insured benefits from its safety and loses due to its loss. third party liability.g. in the life of person's husband or wife. Life: Every person has insurable interest in his own life. 2 Property: It arises due to ownership of the property. may be define as.An owner of a building would suffer financial loss if it is destroyed or damage by fire. The insurable interest. Laundryman. must be subject matter of insurance. etc. For example public liability. 2. By status:: A bailee is responsible for damage to goods in his possession due to his negligence. There must be some right. 3. By common law: For example ownership . . By financial interest in the other person being a business partner. motor vehicle repairer. property. Three main categories of application of insurable interest are 1. right etc. 3. Otherwise this person is not entitled to any compensation and therefore is not entitled to any insurance coverage also.should suffer financially. This relationship must be recognized by law. Executors and trustees responsible for property in their charge.

The following example will illustrate the points: 'A' has a fire policy for Rs.Risk Management in General Insurance ^Activity G: Write down when the insurable interest arises with three examples in each case.3.e.3. Insured is prevented from making any profit from. the person or firm insuring it (the insured) should be neither better off nor worse off than they were before the accident took place.and not Rs.2006 then no claim will be payable as he has no insurable interest on the date of fire.2006 and property totally burnt then he will receive only 100. 100.where as the value of the property is Rs. out of loss or damage. As we have said earlier insurance contracts are not meant for giving undue financial benefits.0007. Suppose "A" has not sold the property and fire occurs on 14. He in other words placed in the same financial position before the loss occurred.0007-.2006 and a fire occurs on 14. 150. The principle of indemnity follows the principle of insurable interest i. 3.3. i) An insured can recover a loss under the policy only if he has insurable his financial loss is only Rs. The principle of indemnity arises under common law which requires that an insurance contract should be a contract of indemnity and nothing more than that. If a person or a firm has financial interests then if something happens to the property insured then. If the indemnity is not applied then the transaction would be a mere gambling. 1500007. ii) Insured can recover a loss only to the extent of his insurable interest. 100. According to this principle no one can gain financially out of insurance unduly.0007-. He sells the property on 11. Principle of Indemnity Indemnity means compensation for loss or injury sustained.0007. .

Motor insurance is the best example of this as garages are authorized to repair the damage vehicle. Contribution : The Principle of Contribution also makes sure that the insured sets no more money than he lost. the owner of the firm should not be gaining by getting new machinery or its cash value. Replacement: It the damaged property is beyond repair then indemnity on the basis of replacement is offered. Reinstatement: It refers to property insurance where an insurer undertakes to restore or rebuild a building or piece of machinery damaged by fire or by breakdown under engineering policy. They also expect the insured to have certain responsibilities i. to do certain actions or not to do . after an accident to such old machinery. liability and other non-life insurance. the Third Party. there are two corollaries called as Principle of Subrogation and Principle of Contribution. if a firm has insured its old machinery for certain values. Measurement of Indemnity : In property. Therefore on the value of the machinery. Also insurers not only expect proper disclosure at the time of going on cover.Unit 8 Insurance : A Risk Financing Tool To illustrate. If there are more than one insurer insuring either the whole or part of the affected property then the total amount recoverable from all these insurers in the event of a loss should not be more than the actual loss. Unlike benefit types of policies and personal accidents policies. The method by which indemnity is measured is to be measured depends upon the nature of insurance involved. Following this Principle of Indemnity. Repair: This method is of extensive use as method of providing indemnity. Subrogation: It ensures that if an insurer pays a large amount to the insured on account of any loss and if this loss has been caused by a Third Party. This means that the total loss amount will be apportioned among various insurers. insurer can assume the rights and remedies of the insured after paying the loss and work on claiming it from those who caused this loss i. the exact amount of compensation is not known in advance.e. reasonable amount for depreciation will be applied if the machinery has to be replaced.e. Methods of indemnification: Cash payment: Majority of cases the claim will be settled by giving the insured a cheque for the amount payable under the policy.

acting simultaneously or one after other.Risk Management in General Insurance certain actions during the currency of the insurance policy. as the single cause which is within the scope of the policy and the claim is payable. Insured met with an accident and admitted in the hospital for treatment. ^Activity H: Write down methods of indemnification with two examples each. 2. i. During the treatment period he contracted an infection and caused his death. Many losses will have a unique set of circumstances and establishment of proximate cause will arise from the application of common sense. then it becomes necessary to find out the most important. A motor vehicle dashed by other vehicle and met with an accident. . It defines not only the scope of coverage under the contract but also to protect relative rights of the parties to the contract thus maintaining a balance. E. Hence the practical effect is to keep the scope of insurance within the limits intended by the parties. effective and powerful cause which brought the loss. insured and insurer.g. This cause is defined as "proximate cause" all other causes are considered as remote The claim is payable if the loss is resultant of peril insured against. Principle of Proximate Cause If the loss is brought about by one event. Example: 1. then the insurers have the right to avoid payment of losses particularly if such breach of Warranty contributed either to the occurrence of the loss itself or increases the extent of the loss. These kind of conditions are called as Warranties and if such Warranties are not observed by the insured. no question of liability arises but if the toss is due to more than two or more causes. The proximate cause of death was disease and not the original accident hence claim is not payable under personal accident policy. 4.e. the insurer may insert a condition in the insurance policy that during the entire period of insurance cover the insured will maintain proper Fire protection equipment..

With the principle of indemnity. the insurer subrogates the rights of the insured and exercises their recovery rights. If the property is insured with more than one insurer. If the cost of insurance premium is more than to retain the risk or the cost of preventive measures. then other form to protect the property is the best solution. Comment on "Proximate cause" maintain the true intention of the parties to the contract regarding the rights between the insured and insurer. which are considerations for the Insurance contract.Unit 8 Insurance : A Risk Financing Tool ^Activity I. It allows the purchaser to substitute a small certain premium for a large uncertain loss. Insurance is a legal contract and based on certain principles.7 SUMMARY______________________________________________________ In this unit we have introduced Insurance as a appropriate Risk Management Tool when the chance of loss is low and the severity of loss is high. We have also discussed the risk can be classify into three types of coverages and can decide whether the coverage can be transferred or retained. After the loss is paid. claim is paid in contribution. .8 KEY WORDS Insurance It can be defined as a process through which the losses of few are compensated from the contributions of many to a fund. We have also seen the mechanism of insurance and essential terminology used in Insurance. which is administered by an insurer. Proximate cause defines scope of the policy and protect relative rights of the parties to the contract. one cannot insure his property or liability. insured places in the same financial position before the loss. 8. Unless there is insurable interest. 8. We have discussed the utmost good faith in which disclosure of material fact is essential. Premiums The contributions to the pool.

namely. This rationale is that if anything happens to the person or property insured. who have an insurable interest in the subject matter of insurance. Available coverages It would include the types of protection that are not covered in the earlier two categories. . Period of Insurance It is the specified period of time for which an Insurance document is structured. the insured should suffer financially. Contract of Insurance or Policy of Insurance The document evidencing arrangement of this relationship between the Insurance Company and the insured. Claim The demand the contributors make on the insurance company in the event of a loss suffered by them.Risk Management in General Insurance Insured The contributors of Premium. the person or firm insuring it (the insured) should be neither better off nor worse off than they were before the accident took place. then the person proposing for insurance. Desirable coverages These are those which provide protection against losses that can seriously impair the operations of the firm. Principle of Utmost Good Faith Insurable Interest Principle of Indemnity 140 Means it requires the Insured to render full information to the insurer. Essential covers The essential contracts includes those that are compulsory because they are required by law. If a person or a firm has financial interests then if something happens to the property insured then.

10ANNEXURE LOSS MATRIX Payout (Rs.) 500000 No Losses Nil 10000 510000 Total Payout Nil Retain the risk and Losses which could 300000 No Losses implement Loss Prevention Measures Non-insurable accidental losses 2000 Cost of Safety measures 12000 Decision Fire Occurs Retain the risk Losses which could have been insured & and claimed Non-insurable accidental losses Total Payout have been insured Cost of Safety 12000 measures Purchase Total Payout 314000 Total Payout 12000 Insurance Premium 10000 Insurance 10000 Insurance Losses recovered (500000) Non-insurable losses 5000 Total Payout 15000 Premium Noninsurable losses Total Payout 5000 15000 .) No Fire Payout (Rs.Unit 8 Insurance : A Risk Financing Tool 8.

This could be movable assets like goods which are in transit or immovable assets like buildings. These properties on the move can be again covered on a Named Peril basis or on a Comprehensive basis. All these developments have influenced the growth of insurance industry in a variety of forms to provide the necessary protection. in general. there can be additional perils covered like impact by vessels. This coverage is basically available for property onshore and static. This could be small units like residential houses to huge installations like a big manufacturing factory. For property on the move. Again this could be on land or offshore. Even goods which are on movement on land can be covered against Inland Transit policies.1 INTRODUCTION As we have seen in the earlier units insurance happens to be the most convenient Risk Transfer Mechanism. or covers for goods in transit either across International borders or on high seas or in air. storm. and Liability. 9. Lightning. (in all our discussions the term "peril" means the cause which brings about the loss event). the property class of insurance is offering protection to a great variety of subject matter and therefore it forms the largest portfolio of any insurance company. s By and large. . cyclone etc. Explosion.flood. But insurance can be broadly classified to fall into three major categories : Property. For offshore property in addition to the perils mentioned. or All Risks insurances. Damage due to impact by aerial devices etc.146 Risk Management in General Insurance 9. Normally property clause offers protection against perils like Fire. We shall now see each of these classifications in greater detail. as also catastrophic perils like earthquake. Because there is a great variety in the interest or subject matter to be insured. accidents resulting into injury or death. Casualty. There are covers which specify the kinds of perils covered as well as there are covers which are broader in coverage and which are generally called as Comprehensive. and Damage due to impact by Rail or Road vehicles. While these kind of perils form the basic coverage. growing consciousness about the legal rights of recovery.. the insurances available are either covering carriers like ocean going vessels or passenger ferries etc. there can be additional perils like perils of weather . Increasingly complex conditions of modern life.2 PROPERTY INSURANCE_____________________________________ ^_ All types of tangible property are the subject matter of the property class of insurance. landslide etc. machinery etc. Due to industrialization. property damage have become almost inevitable. there is also great variety in the types of insurance covers.

In all such cases in order to ensure that the principle of Utmost Good Faith is complied with. Therefore any one acquiring such horses from a stud farm will necessarily like to insure them for such values. they operate more on a agreed value or reimbursement basis. Horticulture all operate on similar principles of previously agreed basis for valuation. Race horses which are of special breed and lineage do have a tradable value on them. Prawn Farming. (There of course will be methods of relating the Sum Insured to the economic status of the person insured). As for sickness benefits such policies would be more on a reimbursement basis subject to an overall limit. Hence the Principle of Indemnity undergoes a modification in Casualty Insurances. In the case of various levels of physical disability resulting out of the accident. If an accident results in the death of the insured person. e. All General Insurance policies are issued for a period of one year (other than Construction insurances or long term specially agreed insurances) and casualty class is no exception. Casualty insurances provide indemnity for both occurrences caused by perils external to the subject matter of insurance as well as to perils inside the subject matter. Sometimes even an inspection or a medical examination might be necessary before accepting such proposals. Exotic insurance schemes like those of Sericulture. When we say Agreed value we mean that the amount for which insurance is effected (Sum Insured) is agreed at a particular level between the insurer and the insured.Risk Management in General Insurance Unlike property insurances the life of either human beings or other human beings cannot be quantified. Once exception to this assumption is that where a living being is traded. In such transactions the valuation can always be verified by the way of expert opinion. the policy would pay 100% of the Sum Insured. A road accident is an example for the former and a heart attack is covered under medical insurance for the latter. This declaration aims at making the insured disclose all material information which is relevant for insurer's decision to accept or not to accept the proposal or impose certain conditions. like horses or cattle then an economic value can be attached to this kind of being. However in the case of beings where an economic value can be attached the Sum Insured is fixed in relation to such value. .g. depending upon the percentage of loss of earning capacity the compensation is paid as same percentage of the Sum Insured. a declaration from the insured will be taken along with the proposal for insurance. For instance a typical Personal Accident cover provides compensation in the case of death or various types of physical disability. In the case of Personal Accident and Sickness insurances.

These factors include the general system of legislation in the country. Liability insurances have a different yardstick altogether for methods of fixing the policy values as well as methods of Indemnity. Pollution Liability extension is one such case. Examples of legal liability policies are: Comprehensive General Liability.4 LIABILITY INSURANCE We have seen earlier that in a civil society there are lot of obligations and responsibilities on the part of citizens to fellow citizens as well as to the public at large or society at large. Lift Owners Liability. Ship Owners Liability. Aviation Liability. General Liability policies take care of the compensations or awards imposed by the courts as well as associated defense costs and these policies are available to any type of firm or enterprise. Many of such legal liabilities insurances exist separately and many times they also are included in certain other property or casualty policies. Employer's liability policies cater to the responsibility of employers for ensuring the welfare of their employees. As more and more types of legal liabilities evolve. etc. Employer's Liability." 9.Unit 9 Types of Insurance Covers ^Activity B : Explain the statement "The Principle of Indemnity undergoes a modification in Casualty Insurances. Hence a separate class of insurances called as Liability Insurances provides indemnity in respect of legal liabilities. insurers rise up to address these kinds of concerns. however the amount quantified for discharging the legal liability depends on so many factors. Also contractual relationship between various members or units of the society also creates legal obligations. . Liability policies of specific industries like aviation and that of ship owners address the legal obligation on the part of these owners or users to compensate for both property and personal injury of passengers and Third parties. Since the exposure to these liability producing events are again a function of the probability of such events. Many of these liability policies can be suitably amended to provide for liabilities in respect of environmental preservation.

Since limits of liability are not clearly determined in many of liability policies. The term Legal Liability implies that the extent of liability either is determinable like in the case of employer's liability or has to be decided by courts in specific cases. For instance the fees of the advocates. socio-economic influences etc. . Though we have seen the categorization of insurance covers available to the above three. Whereas in the case of general liabilities one has to go by many of the factors mentioned above taking into account also the previous case histories as decided by the courts. For instance a factory owner who is required by law to avail of a Workmen's Compensation Policy can find it easy to buy coverage for compensations exactly as prescribed in the Workmen Compensations Act. Normally these policies also provide for the associated expenses which are incurred in the carrying out of the proceedings. So in the4atter case it would appear that the parties to the case have to wait for an award from the concerned court. the same factory owner who has to buy protection for pollution liability has only to depend upon his own risk perception as well as previous cases decided by the courts of law. the standard of living. there are still many more types of insurance which do not strictly fall into any one of these categories. However since there are long delays in the judicial process.Theft or Burglary at Bank premises. Under these regulations limits are prescribed for liabilities towards property damage and the formula is prescribed for calculating compensation in the case of personal injury. Therefore insurance policies covering Legal Liability for automobiles can very specifically cover the limits of liability in the policy. One classic example is the Financial Risk covers. the approach of judiciary. the limit being the policy limit. The latest in this kind of multi class insurances are those relating to Information Technology Industry. like in the case of Bankers Indemnity Policies . there is always a hidden exposure in respect of these liabilities. These types of covers straddle over many classes of insurance. Part of them could be Property. There are legal liability sections catering to the Bank's responsibility towards its customers as well as other partners in banking. Unlike this. general economic conditions. Liability policies provide for an out of court or agreed settlement between the parties. Legal Liability arising out of Automobile accidents is governed by the Motor Vehicles Act and related regulations.Risk Management in General Insurance Legislation and regulations which are specific to the kind of liability. The only requirement for such settlements to be honored by the insurance company is that the insurer should be fully involved in the process of settlement. the expenses incurred in traveling to appear before courts all are recoverable from such liability insurances.

system of work and suggest risk reduction measures comply with the factory act and other safety regulations. Those services are as follows: • Risk reduction advisory and inspection services • Risk financing and other advices • Claims handling services Risk reduction services include inspection of premises. The transfer of the activity that creates a risk 2. The transfer of the financial losses arising from the occurrence of the risk." Explain with examples. there is always a hidden exposure in respect of these liabilities. 9. Risk Transfer Insurance provides a means for handling risks with a low probability of suffering a large loss which an organization cannot afford to retain itself. Insurance is the most important form of (b) It is better to buy insurance for risks with low frequency and high loss severity. plant. Fidelity and credit insurer advice on audit and credit control systems.Unit 9 Types of Insurance Covers ^Activity C: "Since limits of liability are not clearly determined in many liability policies. The other reason besides risk transfer to buy insurance is the value of the various services which an insurer may provide as a part of insurance package. Similarly fire and theft insurers are advice on risk reduction measures during the planning stage of the building plant. The transfer of risk can take two forms: 1. installation of firefighting equipments in a chemical factory. . The commonest example of (a) is the subcontracting of particularly hazardous activities such as underwater pipelines in civil construction.5 THE REASONS FOR BUYING INSURANCE The reasons for buying Insurance can be dealt with under the headings of risk transfer and other reasons.

Risk Management in General Insurance

Insurer and brokers are usually willing to advice on exemption, indemnity, employee benefits,
and insurance clauses in the contracts and so on.
When a loss occurs, insurers provide a variety of services and advices according to the
class of insurance concerned. They offer expert advice on salvaging of damaged property,
names of specialist repairs.
^Activity D :
List out the services provided by the insurer as part of the insurance package.

In its earliest form insurance started more or less on the patterns of a gamble.
Itstarted with the maritime trade, wherein the owners of ships and cargo which were
meant for far away destinations used to pay some amounts of money into a pool. If
the voyage was successfully completed, then the amounts were returned and if not,
the losses were paid from the pool. What we will have to remember is that as
insurance developed it was no longer a gamble. We have seen earlier that gambling
involves Speculative Risk. One may gain or one may lose in a gamble.
But Insurance involves Pure Risk. This is one of the fundamental principles of
insurance which is stated in what is called as 'Principle of Indemnity'. Under this
principle any one who is insured if he or she suffers a loss, they should be placed in
the same position financially as they were before the loss. This means there cannot be
any financial gain out of a policy of insurance. Now let us see as to why people or
firms should insure. The reasons are many:
1. Insurance provides Indemnity: If an individual or a firm suffers a loss which
is payable under an insurance policy then they get compensated sufficiently so
as to regain their financial position as it was before the loss occurred. This way
insurance has been a great provider of relief.
Just look at this. A massive earthquake which shook Gujarat on 26th of
January 2001 claimed a death toll of almost 20,000 lives. Economic loss to the
country is


Unit 9

Types of Insurance Covers

estimated at a whopping level of 25,000 Crs. of rupees. Of this, the Insured losses
are in the range of Rs. 500 Crs. By insured losses we mean that the amounts payable
under various types of insurance policies is just about Rs. 500 Crs. Compare this
with the total general insurance premium in India which will amount to roughly
Rs. 12,000 Crs. You will be able to appreciate that one loss and just one loss has
reduced the insurers by almost Rs. 500 Crs.
This is just an illustration as to how insurance is beneficial. Similarly the recent floods
in Europe have caused an Economic loss of almost Rs. 20,000 Crs. Compared to a
country like India the penetration of insurance is very high in countries of Europe and
therefore one can conclude that substantial part of this estimated economic loss would
have been picked up by insurers.
When we talk of indemnity, it is not just an amount of compensation. In the case of
lives lost, particularly, of heads of families or the earning members, the insurance
industry restores economic well being to the family by providing Indemnity. Similarly
in the case of firms manufacturing or providing services the business are able to
regain their viability and start working again.
2. Reduction of Uncertainty: In the opening chapters of the book we have studied
the economic cost of risk. Risk causes worry and if the uncertainty is not either
reduced or removed totally then an individual or a firm shy away from the risk bearing
activity. By transferring the risk for a small consideration, the individual or firm are
free to undertake such activities. We have earlier seen, the risks which beset a
construction company, which is about to build a huge flyover.
Even though we have seen possibilities of transferring the risk of supply of materials,
the labour etc., to subcontracting companies, either the original construction companies
or subcontractors themselves may not sometimes be able to achieve such a transfer.
If the supply of materials contract is worth, let us say Rs. 500 Crs. and if substantial
part of this supply of materials is accumulated in one location, a major natural
catastrophic event like the earthquake or flood can damage the materials in a great
So even if the construction company has managed to transfer the risk to the material
supply contractor, the extent of loss is so huge that the contractor may become
financially bankrupt with this loss. If, either the original construction company or the
subcontractor have availed insurance for the storage of the materials, then the risk
associated with a catastrophe like earthquake or flood would have been insured
under the policy of insurance. The insurer then, steps in to compensate the construction
company or the subcontractor which will help him to arrange for re-supply of the

Risk Management in
General Insurance

materials . Hence the uncertainty about the survival of the
Construction Company or subcontractor after such a huge loss is
totally transferred to the insurer for an appropriate premium.
Insurance meets the financial consequences of certain risks provides a
form of peace of mid. Insurance of asset is important as far as the
businessman is concern but also to industry and commerce. If the
people do not invest in the business then it would be fewer jobs, less
goods, the need for higher imports and greater reduction in the
wealth. Buying insurance allows the entrepreneur to transfer the risks
of business to an insurer.
Insurance also acts to stimulate the activities of the business which
already in existence. Release of funds for investment which would
otherwise to be held in reserve to meet future losses such as fires,
thefts, serious injuries and so on. Hence firms are free to continue its
business and with this peace of mine it can develop its business
^Activity E :
It is really possible to just invest money in the premium and transfer the risk
of loss to
somebody else?

3. Investments: Another major contribution from Insurance Companies
to the national wealth is in the form of investments. As we have seen
the mechanics of insurance is such that premiums are collected and
claims are paid out of such collections.
However, though premiums are collected throughout a financial year,
claims need not necessarily happen on everyday of the financial year.
Also the extent of claims need not be so bad that they will wipe out
whatever collections are available with the insurance company.
On account of both the reasons, the insurers always have a surplus
in financial terms which can be gainfully utilized by them.

Investments can be in the form of tangible assets like Real Estate or in the form of securities like stocks. Insurance .Normally insurers do it in the form of investments. Insurers are also sometimes required by law to invest a sizeable portion of their investment funds into socially relevant areas. Till recently. By making these investments insurers add to the Gross Domestic Product of the country. in India. shares. bonds etc.

This will in turn have a cascading effect on many other segments of the economy which depend upon petroleum products. If there is no insurance against these kinds of losses then the crude price will suffer high volatility. they will naturally try to recover the lost values in their pricing. Give reasons why "The insurers always have a surplus in financial terms which can be gainfully utilized by them in investment. Added to this. the legal liabilities and costs out of medical negligence are so high that medical practitioner simply cannot render services if they do not have adequate insurance against negligence. in areas like housing finance. when insurers provide indemnity for such losses at places of production. if losses to the oil wells or offshore platforms which supply crude. then the oil firms can balance their prices appropriately. jgT Activity F. Stability: Insurers also help in providing stability of pricing in products and services. Through this kind of a contribution Insurers in India have helped not only the government but also the private sector by providing funds for their projects as well as working capital etc." 4. regional and similar such reasons. this is already a very volatile commodity where pricing is affected by political. It will be interesting to note that insurance also comes handy in services which are critical to human welfare. it may not be always possible for all firms to bring about price increases because of competition.Unit 9 Types of Insurance Covers companies were required to invest almost 70% of their inventible surplus. social welfare schemes etc. Take for example the crude oil imports. take place. Infrastructure projects. If firms providing products and services are uninsured and if they suffer losses to their premises or inventory due to either manmade perils or perils of nature. Therefore. Moreover. then these firms will have naturally to offset such losses by increasing the price of crude. . Small and medium business may lose out if they increase prices due to uninsured losses and they may eventually even go out of business unable to compete with the other suppliers. In countries like Untied States of America which are highly litigious.

The surveyors and specialists advise on pre loss and post loss control. The same result is there by closure of the business.the sources of income are maintained and they can continue to contribute to the national economy. ^Activity H: How does loss control help to increase profit? 6. There is a depression to the 'society if the employees cease to work as people have less money to spend and then the consequences are different. . develops expertise in the technology of different forms of loss control. not only to increase their profit but also to contribute to general reduction in the economic waste which follows from losses." 5. Loss Control: Insurers do have interest in reducing the frequency and severity of losses. the social benefit is that the j obs may not be lost . loss reduction and loss control. If the losses are aggregated throughout the country the effect is considerable. s Formation of Loss Prevention Association of India plays an important role in loss prevention. As such insurers plays a major role in loss control over many years. Now a days insurance industry pools its resources and funds in continuing research work into prevention and control of many forms of loss. Social Benefits : Funds are available to stimulate the business activities. Insurance alone keeps people in jobs but play significant role in ensuring that there are not unnecessary hardships.Risk Management in General Insurance ^Activity G: State your views for the following statement: "Insurance provides stability to the business which results in stable prices and services.

These are described as invisible earnings. To cover special assets different policies are designed. Third party insurance. In the same way countries spread risks. The primary function of insurance is to act as a risk transfer mechanism when the chance of loss is low but the severity is high. and imports are sending money out. Packages policies are introduced to provide different covers in a single policy and it becomes a very popular form of insurance. In addition to insurance. tourism is one form of invisible earnings. Invisible earnings: Insurance allow people and organization to spread risk among them. We have also discussed the various benefits of the insurance. Peace of mind. charging lower premium to farmers supports the national economy ^Activity I: Describe the social benefits of the insurance sector. Universal Health insurance. a visible export trade exits but in case of insurance. . We have discuss the various reasons to buy insurance. goods are invisible but it also brings money into India. Where goods are tangible. Due to reinsurance arrangement large amount of premium flow into India every year. loss control and social benefits help to stability and increase the national economy as a whole.Unit 9 Types of Insurance Covers By providing different types of social insurance like solatium funds. 7. casualty or liability. Large insurances are transacted world wide i. 9.7 SUMMARY ___________________________________________________________________ In this unit we have explained the various types of insurance available to cover property.e. property and liability insurance. Major portfolio is of property insurance. As a national trading we have to import goods and export goods which other people buy.

Casualty Insurance : It deals with losses relating to people as well as interest like live stock. what would you tell the audience? iii. 9. If you are asked to address a Chamber of Commerce meeting. Liability Insurance : It provides indemnity in respect of various legal liabilities. s . on the Benefits of Insurance. Write a note on insurance benefits. What kind of subject matter is covered under the three categories of insurance classes you have studied? ii.9 SELF-ASSESSMENT QUESTIONS__________________________________ i.Risk Management in General Insurance 9. Are casualty covers subject to the principle of Indemnity? iv.8 KEY WORDS Property Insurance : Insurance of all types of tangible property.

when the severity of losses is relatively low and the frequency of loss is also low. retention is desirable. risk avoidance and risk reduction decisions are taken without taking into account their financial costs and benefits but before taking any decision regarding retention. As important as the other tools available. 10. Minor breakdowns in machinery which do not disrupt the production process are example of such losses.Risk Management in General Insurance 10. Retention sometimes could be the most cost effective way of managing risk. Charging losses to operating costs 2. In general. As seen in the last unit. Business firms retain the risk when: • Loss costs are small and will be funded by current cash flow. Business often assumes the risk of losing items of relatively small value such as hand tools for a manufacture or utensils in case of restaurant.2 RETENTION AS CONSCIOUS DECISION ___________________________ Retention as a deliberate measure of Risk Management happens in the following ways. • Loss exposures re retained and recognized in an unfunded reserve account • A self insurance plan is operates. • Loss exposures are retained and funded with a cash flow. >s We will see in this unit the methods of financing risks internally: 1. Setting up contingency (self Insurance) funds 3. Firstly when the exposure or risk are of either very low probability or of very low severity the effect of such losses on either the property or business continuity are so low that it could be easier for the firm to retain such losses on its books.1 INTRODUCTION Retention is an equally important tool of Risk Management. . Use of captive insurance companies. Ultimately as Risk Management is all about balancing of risk and resources. financial aspect and benefits derived from them is taken into account.

3 RETENTION AS A COMPULSION There were also circumstances under which retention gets compulsorily imposed in the Risk Management Process. in Marine Transit policies for finished goods there may always be small shortages when the goods are delivered to final destination. Hence in a war or a war like situation. In the previous chapter we saw the Loss Matrix method through which an evaluation between the financial impact if certain types of exposures are retained and the cost of transfer was done. By improving the methods of packing as well as using reputed cargo carriers.Unit 10 Retention The factory may have spare machinery so that if any operating machinery breaks down it can easily be removed and substituted by the spare. War Risk of such a catastrophic nature that the economic impact of war could be too huge for any firm or an insurance company to carry. the occurrence of such loss can be minimized. Also the procedure for preferring claims for such small shortages is so tedious that it would make more sense to retain such losses on the books. To illustrate. Retention can be used where the cost of transfer to insurance and similar tools is more expensive than the effect of retention itself. Sometimes business has to retain the risk as there are gaps in their insurance program or somebody neglect to purchase needed coverage. Secondly. But such breakdown exposures can easily be carried by the firm itself as even if a transfer is available in the firm of insurance the procedure for transfer as well as making claims might be cumbersome. The classic example is that of War Risks. However since it can lead to an economic collapse if small or medium firms are allowed to canyon without any protection. war cover for properties on land is seldom available. in most countries the government becomes the Insurer of last resort. ^Activity A: "Charging of losses from current cost is one of the effective risk management tools. Moreover there might be also effective loss minimisation or loss control measures which also can bring about the ultimate exposure to low frequencies or low severity so that the firm can retain such losses." Do you agree? 10. . Thereby making it cost ineffective.

wherein if the vessel carrying the cargo is not fulfilling certain standards like Country of Registration. Quite often. Anything above that will have to be borne by the insured. A simple case of such imposed retention is in Marine Transit. Compulsory retention also takes place through insurers in placing a loss limit for a particular type of insurance. depending upon the hazard profile of the risk as well as its loss history. retention also becomes a compulsion because the transfer for such risks is simply not available. What these mean is that for each and every loss for which a claim is made on the insurer. the insurers had to collect huge premiums from the insured. then insurers will not be providing cover for such cargo. Another reason for compulsory retention is when it is attempted to be transferred. Hence they offer significant reduction in premiums. Such deductibles are more often imposed to make sure that the insured becomes prudent and does not pass on his negligence to the insurer. the insurer expects the insured or the claimant to retain a certain extent of loss and pays only the balance. For instance in the case of pollution liability.164 Risk Management in General Insurance Sometimes covers like war are not simply available through any transfer mechanism or sometimes they are too expensive for any one to purchase. Retentions also are useful in making the insured maintain the risk with better standards. the Dead weight Tonnage (DWT) and similar parameters. which pays for the legal liability arising out of polluting or contaminating the environment. Sometimes when risk transfer takes place through insurance.500 then for every claim for a loss made under this policy the owner of the automobile will have to bear the first Rs. if an insurance policy against automobile accidents carries an excess of Rs. the insurers may impose certain deductibles otherwise called as excess or franchise. Retention through deductibles also is at times useful in effecting savings in insurance premiums. 500. Wherever it was made available on limited extent. Therefore. then the insurers liability will be only restricted to the limit mentioned in the insurance contract. Since insurers do not have to respond to small and frequent losses which are falling below the level of deductibles. Post September 11th. To give you an example. the insurer cannot be expected to have a limitless liability. the insurer places a ceiling on the amount of liability for which insurers will be responsible. The rule is. the cover for Terrorism was hardly available. Such deductibles as mentioned in the previous paragraph also remove the hassle and administration involved in making claims for small losses. If at all an award is passed by a court in respect of an insured for a certain amount. By making the insured bear a proportion of the loss the insurer ensures that the insured maintains the risk properly and thinks twice before making a claim. they are freed of administrative costs. the higher the deductible the lower will .

^Activity B . it is to be learnt. it is necessary that the cost of losses will be spread evenly over the time in order to avoid sudden financial crises due to effect of a large loss occurring. Some firms may give Risk Management in General Insurance a accounting reorganization to the expenses of retained risks by maint ainin g an unfun . While selecting the method of retention. Monetary deductibles are normally used for Property Damage Indemnities. Deductibles. For example many large firms retain some or all of their health insurance or workers' compensation costs because these losses are predictable accurately.Unit 10 Retention be the premium. Time deductibles are used in the case of Business Interruption covers. So if there is a time deductible of 30 days for every loss in a Business Interruption cover. Its ability to do so depends upon the availability of surplus of receipts over other payments through out the year or more than sufficient liquid funds available either in the form of bank balance or overdraft facility.4 THE CHARGING OF LOSSES AGAINST OPERATING COSTS_________ An organization will need to absorb the additional expenses of loss against the operating budget within a short duration. fairly predictable. Therefore the size of the loss that could be absorbed along with the current expenses will depends upon the size of surplus plus liquid reserves and/ or short coming borrowing. 10. can be pure monetary deductibles or at times can be expressed in the form of time units. For small. investment funds. Availability of money when it is needed but avoids the idle cash bank balance makes no contribution in the earning is the success of financial arrangement. regular losses the funds are available but in case of large fluctuations in normal cash flow.Actually all losses are not paid in full as soon as they occur but can be spread over a considerable period of time. whereby the deductible turns out to be the waiting period before which the interruption can be counted for indemnity. the management is reluctant to set aside additional liquid funds for replacement of damaged property . List out the usefulness of the deductibles as a form of retention. then the insurer will calculate the period to be compensated by deducting 30 days from the total interruption period.

Interest on investment of funds is of insured's asset which may increase or decrease as per contribution to the fund.5 CONTINGENCY FUNDS (SELF INSURANCE) When large and unpredictable losses are decided to retain internally against operating costs. As the fund needs to be in the form of readily realizable asset. contribution towards contingency fund is not taxable. Such a fund can be financed by transfer of capital or by paying periodically like a premium for insurance but like premium. insurer's administrative costs and profit margin hence expenses are minimum. •1 . Give examples to explain your answer. Improve claims settlement procedures as no dispute regarding settlement of claims. Self insurance plans have the following advantages: 1. It is advisable to insure those risks which are of very high potential although the frequency is very low because it may bankrupt the organization if it handled through the internal contingency fund. No provision for agents/broker's commission. 2. the solution is to set up an internal contingency fund so that costs of losses can be spread over considerable period. ^ Ac ti vit y C: The ability to absorb the losses against operating costs depends upon financial position of the organization. Hence amount to be transferred to the fund depends upon the exiting liquid reserves and expected returning from the alternative use. 1. 2.ded loss reserve account to provide a most realistic firms' financial position.secondly it cannot be used for the expansion of the business. it cannot be used for investment as the organization loses it's interest . Improved loss prevention incentives. 10.

Risk retention. A competent personal should be appointed from outside for administration of the self insurance program.Unit 10 Retention 5. Profit from the funds belongs to the insured. Catastrophies as well as number of losses during the year may bankrupt the organization. 5. 2. Self insurance plans are distinguished from other insurance operations by having the transfer of risk and redistribution of the costs of losses takes place within one business entity. This cost should not be incurred if the risk is transferred 4. Although self insurance requires risk retention. Although a business receives some advantages. These services should be purchased from outside if self insurance is preferred. some disadvantages are also there which are as follows: 1. 3. It is not advisable to assume a risk before the financial arrangement is completed and the funds are available for the payment of loss. Insurer provides valuable services in the form of advice on loss prevention. Jg$ Activity D : List out four points on "Unless payments to the self-insurance fund are calculated scientifically and paid regularly a true self insurance systems does not exit. Contribution towards the funds is not qualified for tax benefit. salvaging and claim settlement. Further it implies that adequate financial arrangements made in advance to provide funds to pay for losses." . it implies to combine a number of its own similar exposures to loss sufficient to predict the losses accurately. Unless payments to the self-insurance fund are calculated scientifically and paid regularly a true self insurance systems does not exit. deliberately or unplanned. should not be confused with the concept of self insurance.

Flexibility of operations 6. Risk control 4. Assess to reinsurance market 5. fellow subsidiaries and associated companies as the same way as to pay insurance premium. I- . 3. Internal funding of risks 2. 2. Definition of captive: Commercial or industrial concerns establish an insurance company to insure or reinsure risks emanating from its owner. Off shore tax havens ^ We will see these points briefly : 1. Risk control Due to retaining risks captives get automatically and directly benefits from any improvement in its loss experiences due to saving in the claim costs. There are a number of reasons for the formation of captive companies which are as follows: 1. Earnings on investments belong to the captive. Global insurance arrangement 7. Claim settlement is without any delay and any profit generated belongs to the captive only. Saving on insurance costs 3. Transfer to reserves for unexpired risks and outstanding claims are taken into account while calculating taxable profits which gives a significant tax advantages over internal contingency funds. Internal funding of risks Premium paid to captive are qualify for tax benefits for its parent company. which otherwise includes in the premium of the insurance companies. subsidiary and associated companies.6 CAPTIVE INSURANCE COMPANIES The next step of internal funding is the formation of captive insurance companies with additional advantages and benefits. Saving on insurance costs The are expenses are nil for marketing and sales if the business is acquired from parent organizations.Risk Management in General Insurance 10.

Advantages are discussed in the next unit. 7. interpretation of policy conditions and handling of claims as they are not bound by tariff regulations. They can also provide cover which is not easily available in the market for example product recall. . Offshore tax havens Tax haven is that levies a significantly lower rate of corporation tax than the country of domicile of the parent company. Captive controls the local insurers and reinsure the risks write with the captive. Retention Assess to reinsurance market By building up substantial reserves. Flexibility of operations Captive can offer conditions which suit their parent companies regarding timing for payment of premium. until they are they will be subject to a lower rate of tax so captives funds built up rapidly. Hence although parent company will have to pay its going rate of tax on profit remitted by the captive. 5. ^Activity E: Discuss the benefits of formation of Captive Insurance Companies. calculate the premium on client's direct loss experience and flexible underwriting for unusual risks. 6.Unit 10 4. Global insurance arrangement Risk handling strategies is different in multi national companies and policy adapted is difficult in different countries and because of this local insurer is required to insure domestic risks. the captives have easily assess to reinsurance market and offer cover for excess of loss with substantial deductible. Legislation in India does not permit setting up of Insurance Captives.

We have also discussed way s of risk financing by 1. Setting up contingency (self Insurance) funds 3. Under which circumstances does it make sense to retain risks ? ii. 10. . Charging losses to operating costs depends upon the surplus and liquidity available with the organization. the insurer expects the insured or the claimant to retain a certain extent of loss and pays only the balance. What these mean is that for each and every loss for which a claim is made on the insurer.9 SELF-ASSESSMENT QUESTIONS i. Use the Loss Matrix in the annexure of Chapter XI and explain which is betterretention or buying insurance. Retention can also be used where the cost of transfer to insurance and similar tools is more expensive than the effect of retention itself. Each method has its own peculiarity. Retention may be deliberate decision or it may be compulsory in the form of deductibles. Setting up contingency (self Insurance) funds is a decision of the organization to retain losses internally which are too large and unpredictable. Charging losses to operating costs 2. s Firstly when the exposure or risk are of either very low probability or of very low severity the effect of such losses on either the property or business continuity are so low that it could be easier for the firm to retain such losses on its books. While captive insurance companies are formed for additional benefits and advantages. Retention is basically applicable when loss probability is low and loss severity is also low.Risk Management in General Insurance 10.8 KEYWORDS ________________________________________________________________ Retention is a risk treatment method. 10. Use of captive insurance companies. Deductibles (otherwise called excess or franchise).7 SUMMARY We have discussed the process of risk retention which proves one of the effective tool of risk management.

in the last five decades. ART (Alternate Risk Transfer) has become the topic of discussion in the Board Rooms across the world. caused economic losses of US$ 30 Billion and insured losses of US$ 17 Billion. With this kind of enormity of losses. Back home.1 INTREDUCTION We have discuss how the risk management makes an effective contribution to achievement of corporate objective and helps to take a proper decision regarding risk transfer and ultimately arrive at the decision that INSURANCE is the best solution for transfer of risk. there have been occurrences of such catastrophic nature that insurance had failed to serve as a very reliable method of Risk Transfer. insurers world over are struggling to find moneys to pay these losses. The economic loss was put at US$ 4. Hurricane Andrew. then many of the insurers will go bankrupt. But it is observed that the incidences of catastrophes insurances which cannot be covered by the traditional technology of insurance and reinsurance. The earthquake in Gujarat in January 2001 reported almost 20. US A in 1992. Similarly. still the capacity for bearing .2 BACKGROUND OF ART The happenings in the rest of the financial services industry as well as more acute awareness of having holistic Risk Management programmes has led to discovery and use of other forms of risk transfer. As you would be studying or having studied already. Even if the remaining insurers charge hefty premiums. s Quite often. insurance ultimately also has to be on commercial lines and therefore has to produce investment returns for the stakeholders.174 Risk Management in General Insurance 11. the Earthquake in California in 1994 caused economic losses of US$ 44 Billion and insured losses of US$ 15. which devastated Florida. 11. the Cyclone.000 deaths. While insurance has been the most popular and oldest form of risk transfer. The service sectors like banking and insurance have been prepared for the world wide fundamental economic changes with new mechanism or technology called ART (Alternate Risk Transfer).US and India. There have also been manmade disasters like that of September 11th and the rebels on the Colombo airport destroying almost 14 aircrafts.5 Billion with insured losses in the range of US$ 100 Million (compare the ratio of insured losses as against economic losses in these two parts of the world . If the losses exceed the capital and reserves of insurers. This gives the level of insurance penetration in both the parts). which would otherwise be called as Acts of God. These losses are losses.3 Billion.

one single catastrophe." 11. The kind of losses. even it it i& pooled from all over the world. will be still well below the money required for. The frequency and severity of these catastrophic losses are alarming but particularly whether losses are occurring with increased recurrence. 4. List out the points on "Need for Alternative Risk Transfer. Like in every other business. . the probability and the magnitude. Insurers world over have limited capital.3 FAILURE OF INSURANCE AS A SOLE RISK TRANSFER MECHANISM________________________________________________ In the preceding paragraph. 2. jgT Activity A. Over the years with declining interest rate and poor economic conditions the world over. bond markets and other areas of investments. 3. occurrences like Nine Eleven. there are always demand -supply equations and also business cycles resulting in alternating cycles of low returns and high returns on investments. insurers will be left with some surplus to take care of their management expenses and desired profit levels . Therefore.If this does not happen then there is no proper return on capital employed and therefore insurance as a avenue for investment will lose its attraction. which are being faced by insurers. there is no more balancing possible. either out of natural catastrophes or out of manmade disasters is so great in magnitude. What are the reason for which insurance had failed to live up? 1. Insurers have always been balancing their technical losses with income from their investments they make in stock markets. the Return on Investments in these areas has also been coming down. we had mentioned that Alternative Risk Transfer methods are being discovered and used. of which were simply unimaginable. 5.. Insurers are witnessing for the first time. This capital is deployed in the hope that after paying for all the losses.

Reinsurance. and Network capacity.4 ART The abbreviation ART stands for 'Alternative Risk Transfer. pools and Finite Risk covers.' Particularly for large corporations. flood and other natural catastrophic perils and their ever increasing exposures have brought some revolution and break traditional reinsurance practice for the purpose of increasing the financial capacity to cover these uncontrolled. hurricane. The earthquake. • Large direct corporate With many 'uninsurable' risks emerging as also because of the limitations imposed by insurers. So the insurer. ." 11. unlimited. The incidence of unlimited catastrophe insurance loss has made the underwriters look for ART technology to create more capital and more financial strength. Therefore. the faculty of risk management had to resort to solutions from other than insurance. unexpected catastrophic exposures which is beyond the capacity of Insurance. Risk managers had to find alternate sources of financial protection. risk management does not simply mean buying traditional insurance.Risk Management in General Insurance For all these reasons there has been diminishing of capacity for insurers to carry risks. ART as it stands today includes not only captive insurance companies but also extends to the areas given below: • Industry and exposure specific mutuals. which are the order of the day today. bankers and investors have come together with their roles in the risk transfer technology for their mutual benefits. The term ART was mainly used to describe various forms of self. ^Activity B : Comment on "Insurance industry cannot cope up with the situation created by natural calamities. This inadequacy ART came into existence.

aggregate programs. For reasons mentioned in the previous paragraphs. have a substantial need for a very effective risk management. • Across class. • Insurance derivatives. • Blended programs. • Basket aggregate. man made loses such as floods in Mumbai and Gujarat.Unit 1 1 Emerging Trends in Risk Management • Programs from insurers that involve commitment of capacity often across lines of coverage and across several years. 11.5 CAPTIVE INSURANCE COMPANIES Large corporations particularly spreading over many countries and continents. • Holistic financials of risk. . • Risk retention groups. The variety is amazing but for the limited purpose of discussion. etc. • ART covers entire portfolio of risk with adjustments and returns to the Investors. in India. we shall be looking at only few specific ART solutions : C: Write down few points on scope of ART taking into account the current natural calamities. By adopting an external supply of risk transfer these corporations are still subject to the vagaries of insurance markets. insurers can not provide all risk solutions. bomb blasts in Maharashtra. • Environmental liability and credit risks. • ART products are long term contracts as against annual contracts in insurance and reinsurance arrangement. • Loss portfolio transfers.

f) Captives are dedicated to their parent or group. The other way round. a Return on Capital employed. c) Captives themselves insure their risk portfolio with Reinsures. which can take place between two uninterested parties. 1. Therefore they also aim at having stabilized financial performance over the years. The normal friction. e) Most captives are located in Tax Havens. Guernsey Islands. The advantages of using Captives are as follows: a) The risks of the parent or group companies are taken off their balance sheet and moved to the captives. is reduced because of the special relationship. all provide substantial ease of registration and operation of captives. Certain territories like Bermuda. These are special purpose insurance outfits created to cater to the needs of the parent or group companies. These territories also provide a variety oftax benefits including exemptions." Unit 11 Emerging Trends in Risk Management 11. As of now there are more than 2300 captives all over the world. d) Any surplus produced by the captives provides the promoters. Hence captives are a very popular form of risk transfer. captives also have assured customers. Singapore.178 Risk Management in General Insurance Therefore large conglomerates resort to creating what are called as Captive Insurance Companies. These benefits in turn go to the parent company. xgTActivity D : Justify the statement "captives are a very popular form of risk transfer. b) The captives provide an arm's length comfort for transferring risks and preferring and getting claims. Therefore they can provide customized solutions to these customers.6 SECURITISATION It seems that .

insurers suffer from lack of funds. the cost and the limitation proved a problem for Disneyland. These bonds have limited tenure and therefore if no earthquake losses happen on during the tenure of the bond then the bondholders earn all their coupon rates and incur no losses whatsoever. a subsidiary of Disney group of USA. Mutual Funds and Banks. Catastrophic bonds have really caught up the fancy of investors as well as insurers that the have been hundreds of such bonds issued as of now. Investors in ART products are Corporate Financial Institutes. Insurance Securitisation involves the process of transfer of property and casualty risks from insurer to the investors with the issuance of a security. The bonds operate in such a way that if any earthquake happens in area where the Theme Park is located. Other investors in capital markets sometimes find lack of proper avenues for investment. While conventional insurance covers could have still been available. These Bonds carry a coupon rate or what is an equivalent of interest paid on bonds. when they were to setup the Theme Park in Tokyo. An added advantage to the investors is that these bonds are liquid in that they can be traded. We will now look at a recent example for understanding this better. 179 . The purchases are investors from the Capital Markets. There are major catastrophes either natural or man-made recurring in a period of time. Put all these three together and you will find that there is scope for what are called as Securitisation of Insurance Risks. the ultimate returns depends upon the occurrences of catastrophic events and reference of performance index. they issued what are called as Catastrophe Bonds for Earthquake for the value of the US$ 100 million. Disneyland Tokyo. then all losses due to earthquake would be paid for by the bond holders. Transfer of risks in insurance market to investors in the capital market is done through Securitisation to cope up with the incidence of huge catastrophic losses and avoid their consequent insolvency. In simple terms. Securitisation. they faced a major concern on the earthquake proneness of the location. provides access to the Insurance business for capital market investors without actually running an insurance company. These investors are not insurance exports or underwriters. Therefore. They simply invest for Insurance Company through capital market.

7 FINITE RISK PRODUCTS Another major development in the development of ART products is Finite Risk products. Currently. observes that the main functions performed by finite risk products are: A.Risk Management in General Insurance Jg$~Activity E: Write your opinion on "ART brings the convergence of insurance markets with capital markets by way of securitisation. then the provider of this product and the user. B. Finite Risk Products derive their terminology from the fact that the ultimate liability of the provider of this facility is limited at a particular financial level. If the loses are minimal or controllable and any surplus emerges then it is shared between the provider and customer in the form of profit commissions." 11. If the losses exceed a certain pre-agreed level then additional premiums have to be paid by the customer to the provider. These are multiline products in the sense that they cut across several classes of insurances like Property. 100 crores over a 5 year period. Casualty and Liability. Swiss-Re. if the loss limit agreed was Rs. Rs. Optimization of balance sheet structure although finite risk products were largely used by insurance companies of late even companies in non-insurance sectors have found them useful. It is more of a participative program wherein the provider as well as the customer. In the same manner. 60 crores in this period. the reverse also holds good. For example. one of the major players in the field of financial reinsurance. share their experience of the loss history over a period of time. . Smoothening of fluctuations of the customers' loss experience over a given period. share this surplus in the form of certain amount of premium paid by the user to the provider being returned as profit commission. These are also multi year products as contrasted with annual contracts. but losses didn't exceed let us say. most of them are used more for the benefit of insurers rather than the insured.

then they resort to the derivative products. To draw an example from the capital market. a fee has to be paid for the derivative products. the exchange rate between various currencies is again a highly speculative risk area. then the provider of Derivative services compensates the user for such over shooting. even insurers can protect themselves against fluctuations in the performance of the risk. similar to the premium paid by a customer to the insurance company. the same way. as the name implies.Unit 11 Emerging Trends in Risk Management ^Activity F: Explain how the Finite Risk Products are more beneficial to the insurer than the insured. traders in large volume of exchange related businesses hedge their risks in exchange rates with such derivatives? Similarly. any customer. To understand it better. for a portfolio of insured risks or even for a single risk. 11. . let us look at the portfolio of risks comprising Oil refineries which refine crude oil for producing finished petroleum products like petrol. Large volume users of foreign exchange have to protect themselves against volatilities of exchange rates. One such possibility is. Particularly when the core product in question is of volatile nature. diesel.8 DERIVATIVE PRODUCTS______________________________________ Normally derivative products are. then derivatives help the user of such products to smoothen out the effects of such wild fluctuations. derived from certain core financial service products. Obviously. that linking the performance of a risk. If the loss percentage of a particular refinery exceeds the general performance of the pool of refineries then such excess exposure will be compensated by the providers of the derivative product. etc. to the index of the performance of similar risks. The derivative is linked to these dollar value and if the dollar-rupee exchange rate fluctuates above a certain pre set limit. By doing this the customer or the insurance companies ensure that their losses are not adverse. Which means that the risk of huge increase in exchange rate is transferred to the service provider for say a fee or premium: Generally. Either the refinery owners or insurers of certain refineries can protect themselves through a derivative product linked to the loss history of the pool of let us say about 100 refineries.

introduction of credit insurance by state owned companies like New India Assurance and prospect of Agriculture Insurance have the potential of Rs." . 11.182 Risk Management in General Insurance ^Activit y F. 50000 crores in India. As per recent IRDA regulations on solvency margins for insurers. But in future due to increasing operations of B ANCASSURANCE by General Insurance companies. Recently IRDA is set to allow insurers to invest in interest derivatives to hedge risks in order to ensure that their future liabilities do not exceed their assets. reinsurers. Re insurance protection for catastrophic losses arising from single event is not so large so at present Indian General Insurer does not find much difficulty for re insurance protection. so there will be need of ART products in Insurance Industry in near future.rising market expectations for more efficient risk financing programs and revolutionary development of Indian Capital Market to the world class standard are all including factors for insurers. How the derivative products helps insurance companies so that loss ratio should not be adverse. reinsures and bankers to make proper use of essential ART products of transfer of insurance risks from insurance market to capital markets for wider capital base with minimum cost ^A ct ivit y G : Express your views on "Use of ART products is essential as India is going to be the economic power house in the world with growth in all sectors including insurance sector.9 DEVELOPMENT OF ART IN INDIA Art products have not found significant place in Indian Insurance Industries.

Punter feels that there are certain factors that will continue to drive the development of ART: • Consultants and intermediaries. • Provide holistic or enterprise wide covers from a client's perspective. some outside the traditional insurance industry such as Management Accountants and Investment Bankers are seeking to expand their involvement in all aspects of Corporate Risk Management and financing. As traditional insurers. • Extend the period of cover beyond the normal one-year insurance to multi year contracts to provide greater stability.casualty hazards to include other non-core risks to the company's business. These represent the demand side of the ART process. • Provide risk-financing instruments that respond with greater speed. . This in effect sums up the developing trends in ART industry. • Alternative solutions and capital will advance so that whenever there is a contraction in the supply of traditional reinsurance capacity due to either cyclical or catastrophic losses. clarity and security.Unit 11 Emerging Trends in Risk Management 11. • Investors are always interested in new opportunities particularly in a low or a noncorrelated asset class like insurance. These include how to insure risks such as environmental exposures and financial risks such as foreign exchange rates.10 SUMMARY Dr. Alan Punter who specializes in Alternative Risk Transfer products summarizes the emerging trends as follows: • ARTs extend the range of risk covered beyond the traditional property. interest rates. On the supply side Dr. one can expect the dividing line between insurance and non-insurance financial services to get thinner and thinner. stock market prices and commodity prices.

Captive Insurance companies These are special purpose insurance outfits created to cater to the needs of the parent are group companies. Finite Risk Products These are multiline products in the sense that they cut across several classes of insurances like Property. What are the advantages of setting up a Captive Insurance Company? Do you think India needs products like derivatives? Given the poor Insurance penetration in our country.12 SELF-ASSESSMENT QUESTIONS In the previous unit.11 KEYWORDS Alternative Risk Transfer (ART) Are non insurance methods which offer risk transfer solutions. can you elaborate why? List out some of the ART tools. Finite Risk Products derive their terminology from the fact that the ultimate liability of the provider of this facility is limited at a particular financial level. is conventional insurance better or ART? Analyse. you were explaining the benefits of Insurance. - . Particularly when the core product in question is of volatile nature. 11. Securitisation In simple terms. when you were addressing the Chamber of Commerce.Risk Management in General Insurance 11. securitisation provides access to the Insurance business for capital market investors without actually running an insurance company. These are also multi year products as contrasted with annual contracts. 1. Derivatives From certain core financial service products. Casualty and Liability. Do you still stand by our statements? If not. then derivatives help the user of such products to smoothen out the effects of such wild fluctuations.