Que.1 Explain price risk and its types.

Explain Risk management methods

Comprehensive business risk management is a multi-stage process that will vary depending on the needs and
requirements of each individual enterprise.The first stage is to determine exactly what the risks facing your
business are, in order to assess the likely and potential impact of each incident occurring.Once this process has
been completed, you can get down to evaluating the technique which will best suit your business and maximise
your risk management moving forward.
The risks associated with finance are:
Liquidity Risk: The possibility that the cash available to a bank exceed by customer’s calls on it, or the income
generated by a corporation, along with the funds raise through equity or debt issuance and/or borrowing, are
insufficient to cover operating commitment forcing the corporation to stop operations. It can also be through thin
markets sometimes resulting from distractions, which result in the unavailability of hedging instruments at
economic prices.
Most institutions generally face two types of liquidity risk, the first relates to the depth of markets for definite
products and the second to funding the financial-trading activities of the firm. For example, some firms have
contract limits for every futures contract based on the volume of turnover and outstanding. Senior managers have
to develop methods to identify and monitor the firm’s liquidity sources to ensure it can meet the funding demands
of its activities. This is achieved by examining the differences in maturities between assets and liabilities and by
analysing future funding requirements based on various assumptions, including the firm’s ability to settle down
positions quickly in adverse conditions.
Credit Risk (Counterparty Risk): This risk may occur due to the non-payment by the borrower or counterparty
such that loans, bonds or leases will not be repaid on time or in full or the counterparty will fail to perform on an
obligation to the institution. The likelihood of this happening is calculated through the repayment record or default
rate of the borrowing entity, determination of market conditions, and default rate of a loan portfolio of similar
Sovereign Risk: This is the risk that a government action will interfere with repayment of a loan or security. This
is measured, by the past performance of the nation and present default rate and situation such as political, social
and economic. It is controlled by severe credit analysis, limiting exposure as a percentage of portfolios, and
incorporating covenants into the loan documents.
Market Risk: This deals with unfavourable price or volatility that affects the assets contained in a firm’s or fund’s
portfolio. It can be defined as the doubt of a financial institution’s earnings which results from changes in market
conditions such as the price of an asset, interest rates, market volatility and market liquidity.
Settlement Risk: This refers to the risk that an expected settlement payment on a commitment will not be made
on time due to bankruptcy, inability or time zone differential and it is related to credit risk but not identical. For
example, a bilateral obligation in which one party makes a required settlement payment and the counterparty
does not. Settlement risk provides an important inspiration to develop netting arrangements and other safeguards
and is also called Delivery Risk.
Interest Rate Risk: The risk due to changes in interest rates results in financial losses related to asset or liability
management. It is measured by past and present market instability and the profile of the asset or liabilities of the
bank and its possible exposure through gap management.
Foreign Exchange Risk: The risk caused due to the rate change in the foreign exchange that cause foreign
exchange denominated assets to fall in value or foreign exchange denominated liabilities to rise in expense. It is
measured by marking-to-market the importance of the asset, or raise of the liability, by the actual movement of
the exchange rate between the currency of the asset or liability and the currency of the booked or pending asset
or liability, or country of earnings return.

Capital Risk: The risk may incur if the institution has insufficient capital for losses, which can result in bankruptcy
or regulatory closure. It has a sub-optimal equity-debt capital profile which negatively impacts the market price of
its stock. It is controlled by conditions and reserves from past earnings sufficient enough to cover operating
losses; and by evaluating the loan, securities and trading operations accurately for any pending losses or
Fraud Risk: The risk may occur if the banks own employees or its customers will defraud the bank. This is one of
the most complicated situations to measure or control. It is controlled by dividing trading and settlement
functions, periodic internal and external audits, and a centralised computer system to track and quickly or
accurately resolve the bank’s position, portfolio and operations.
Legal Risk: This risk is caused because of claims from dissatisfied employees, clients, improper documentation;
criminal or negligent conduct, workplace regulations or environmental defect will severely disrupt the company’s
Operations Risk: The risk that human or machine, error or failure will result in financial losses due to
documentation scarcity, securities processing, clearing issues, and systems failure. It is difficult to measure errors
but the loss can be substantial related to settlement problems or customer liability suits. It is controlled through
back-up data processing systems, computerised accounting or audit system that can flag a problem, and
reserves for related losses.
Overhead Risk: The risk that overhead expenses excessively saddle the company’s capability. It is measured by
the ratio of total expenses or net interest income and total of other income; other expenses tend to rise faster
than income in a time of inflation.
Regulatory Risk: The risk that changes in regulations will negatively affect. It is measured by the way a change
affect an established operation or restricts entry into a new operation, or affects capital reserve requirements, or
operating requirements of the respective national banking regulator.
Economic Conditions Risk: The risk, that an undesirable change in economic conditions can unduly put the
bank at risk. It is measured by how the loan portfolio will perform, what interest rates will do, how the securities
portfolio may refuse in market value, how liabilities may raise, deposit withdrawals increase resulting in liquidity

Que.2 An organization is a legal entity which is created to do some activity of some purpose.
There are elements of a life insurance organization. Explain the elements of life
insurance organization.

Activities & elements of life insurance organisations :
The money you pay for your business’s many insurance premiums might seem to be a waste, especially if you
never claim a loss. But the primary function of an insurance company is to safeguard your business against such
losses. The type of business you own determines the type of insurance you need. The government requires you
to have certain types of insurance to protect the public, and lenders require insurance to protect their investment.

Que.3 Explain the doctrine of indemnity, doctrine of subrogation and warranties and its
types and classification.
Que.4 Give short notes on :
Evidence and claim notice.

Subrogation is a legal doctrine whereby one person is entitled to enforce the subsisting or revived rights of
another for one's own benefit. A right of subrogation typically arises by operation of law, but can also arise by
statute or by agreement. Subrogation is an equitable remedy, having first developed in the English Court of
Chancery. It is a familiar feature of common law systems. Analogous doctrines exist in civil law jurisdictions.

Subrogation is a term denoting a legal right reserved by most insurance carriers. Subrogation is the right for an
insurer to legally pursue a third party that caused an insurance loss to the insured. This is done as a means of
recovering the amount of the claim paid by the insurance carrier to the insured for the loss.
BREAKING DOWN 'Subrogation'
Subrogation literally refers to the act of one person or party standing in the place of another person or party.
Subrogation in the insurance sector, especially among auto insurance policies, occurs when the insurance carrier
takes on the financial burden of the insured as the result of an injury or accident payment and seeks repayment
from the at-fault party.
One example of subrogation is when an insured driver's car is totaled through the fault of another driver. The
insurance carrier reimburses the covered driver under the terms of the policy, and then pursues legal action
against the driver at fault. If the carrier is successful, it must divide the amount recovered after expenses
proportionately with the insured to repay anydeductible paid by the insured.
Subrogation is not only relegated to auto insurers and auto policyholders. Another possibility of subrogation
occurs within the health care sector. If, for another example, a health insurance policyholder is injured in an
accident and the insurer pays $20,000 to cover the medical bills, that same health insurance company is allowed
to collect $20,000 from the at-fault party to reconcile the payment.
Subrogation Process for the Insured
Luckily for policyholders, the subrogation process is very passive for the victim of an accident from the fault of
another party. The subrogation process is meant to protect insured parties; the insurance companies of the two
parties involved work to mediate and legally come to a conclusion over payment. Policyholders are simply
covered by their insurance company and can act accordingly. It benefits the insured in that the at-fault party must
make a payment during subrogation to the insurer, which helps keep the policyholder's insurance rates low.
However, in the case of an accident, it is still important to stay in communication with the insurance company.
Make sure all accidents are reported to the insurer in a timely manner and let the insurer know if there should be
any settlement or legal action. If a settlement occurs outside of the normal subrogation process between the two
parties in a court of law, it is often legally impossible for the insurer to pursue subrogation against the at-fault
party. This is due to the fact most settlements include a waiver of subrogation.
Doctrinal basis of subrogation
Countries which have inherited the common law system will typically have a doctrine of subrogation, though its
doctrinal basis may be rationalised differently depending upon the extent to which Equity remains a distinct body
of law in that jurisdiction.
English courts have now accepted that the concept of unjust enrichment has a role to play in subrogation.[1] In
contrast, this approach has been stridently rejected by the High Court of Australia, where the doctrinal basis of
subrogation is said to lie in the prevention of unconscionable results: for example, the discharge of a debtor or
one party getting double recovery.[2]
Types of subrogation
The situations in which subrogation will be available are not closed and vary from jurisdiction to jurisdiction.
Subrogation typically arises in three-party situations. Some common examples of subrogation include:

Indemnity insurance. An indemnity insurer may be entitled to be subrogated to the rights of insured as
against a third party who is responsible for the damage to the insured.

Law of guarantees. A surety may be entitled to be subrogated to the rights of the creditor as against the
principal debtor.

Trust creditors. A creditor of a trustee may be entitled to be subrogated to the trustee's right of indemnity.

Subrogation to outgoing securities. A lender who advances funds for the purpose of discharging a
security may be entitled to be subrogated to the third party's security as against the borrower.

Bills of exchange. The indorser of a bill of exchange may be entitled to be subrogated to the holder as
against the acceptor (who is liable to indemnify the indorser).

Indemnity insurer's subrogation rights[edit]
'Subrogation' has been used in this context to refer to two distinct situations.
First, after paying out under a policy of indemnity insurance, an insurer may be entitled to stand in the shoes of
the insured and enforce the insured's rights against the third party tortfeasor who is responsible for the loss.

This is subrogation in its proper or core sense. Insurance Subrogation, and, specifically, the types and amounts

of payments that can be recovered, differs from jurisdiction to jurisdiction.
Secondly, after paying out under a policy of indemnity insurance, an insurer may be entitled to sue the insured
where the insured has already made good his loss. That is, the insurer has a claim against the insured so as to
ensure that the insured does not get double recovery.[4] This situation might arise if, for example, an insured
claimed in full under the policy, but then started proceedings against the third party tortfeasor, and recovered
substantial damages.[5] Strictly speaking, this is not a case of subrogation; it is a case of recoupment.
Travel Insurance subrogation process[edit]
In an "excess" or "supplemental" travel insurance policy where there is a 'first payer' clause, through the
subrogation process an insurer is legally entitled to seek cost-sharing up to a certain percentage from a
member's private group health insurance provider after the insurer pays out a travel insurance claim.[6] These
plans are less expensive but if there is a major claim made, Insurance carriers-such asRBC insurance[7] can
offer [7]
"Any of our policies are excess insurance and are the last payers. All other sources of recovery, indemnity
payments or insurance coverage must be exhausted before any payments will be made under any of our
— RBC Insurance Saltzman CBC 2016
While these supplemental travel insurance policies may be less expensive in the short run, they can have
devastating consequences if a serious and costly health crisis occurs while travelling.[6] This means that if a client
makes a claim, the insurer will recover that amount from the member's private group health insurance provider—
for example $100,000 of the $200,000 total. This can become problematic if the member later has a serious

illness because many private group health insurance providers have a lifetime maximum coverage amount$500,000 for example-for its extended health plans. If the member purchases travel insurance from their own
extended health-care provider, a claim would not have affected their lifetime maximum.[6]
Surety's subrogation rights
A surety who pays off the debts of another party may be entitled to be subrogated to the creditor's former claims
and remedies against the debtor to recover the sum paid.[8] This would include the endorser on a bill of exchange.

The surety will then have the benefit of any security interest in favour of the creditor for the original debt.

Conceptually this is an important point, as the subrogate will take the subrogor's security rights by operation of
law, even if the subrogee had been unaware of them.[10]
Subrogation rights against trustees
A trustee of who enters into transactions for the benefit of the beneficiaries of the trust is generally entitled to be
indemnified out of the trust assets; this is secured by way of an equitable lien or first charge over the trust assets.
This is a proprietary security interest.
Trust creditors (that is, persons who have become creditors of the trustee qua trustee) may be entitled to be
subrogated to the trustee's lien. This is a particularly precarious 'right' of trust creditors: a trustee may not have a
right of indemnity (for example, because the trustee has committed a breach of trust in incurring the liability to the
creditor in question) or it may be limited (for example, where the trustee has committed an unrelated breach of
trust and the clear accounts rule operates). In some jurisdictions it is possible for the trustee's right of indemnity
to be excluded altogether. In these cases, subrogation may be rendered worthless or impossible.
Lender's subrogation rights
Where a lender lends money to a borrower to discharge the borrower's debt to a third party (or which the lender
pays directly to the third party to discharge the debt), the lender may be entitled to be subrogated to the third
party's former rights against the borrower to the extent of the debt discharged.[11]
Where a bank, acting on what it believes erroneously to be the valid mandate of its client, pays money to a third
party which discharges the customer's liability to the third party, the bank is subrogated to the third party's former
remedies against the customer.
Effect of subrogation
Where subrogation is available, the subrogated party is entitled to stand in the shoes of another and enforce that
other party's rights. If the equity is established, the court may effect the subrogation remedy by way of equitable
lien, charge, or a constructive trust with a liability to account. Crucially, the claimant's rights are wholly derivative,
hence the claimant has no higher rights than the person to whom he or she is subrogated.

Damaged property an insurer takes over to reduce its loss after paying a claim. Insurers receive salvage rights
over property on which they have paid claims, such as badly-damaged cars. Insurers that paid claims on cargoes
lost at sea now have the right to recover sunken treasures. Salvage charges are the costs associated with
recovering that property.

The assignment of rights by an insured party to the insurance carrier to repair, scrap
or recover damaged property covered by a policy. Subrogation refers to the collection rights of proceeds from
the sale of the damaged property or through negotiation with a negligent third party.

Que.5 Explain the marketing mix (7 P’s) for insurance companies
Insurance marketing The term Insurance Marketing refers to the marketing of Insurance services with the aim to
create customer and generate profit through customer satisfaction. The Insurance Marketing focuses on the
formulation of an ideal mix for Insurance business so that the Insurance organisation survives and thrives in the
right perspective. Marketing --Mix For Insurance Companies
Head of the Department, Department Of Business Management, Sri Vasavi College Erode
Wherever there is uncertainty there is risk. We do not have any control over uncertainties which involves financial
losses. The risks may be certain events like death, pension, retirement or uncertain
events like theft, fire, accident, etc. Insurance is a financialservice for collecting the savings of the public and
providing them with risk coverage. Themain function of Insurance is to provide protection against the possible
chances of generatinglosses. It eliminates worries and miseries of losses by destruction of property and death.
Italso provides capital to the society as the funds accumulated are invested in productiveheads. Insurance comes
under the service sector and while marketing this service, due care isto be taken in quality product and customer
satisfaction. While marketing the services, it isalso pertinent that they think about the innovative promotional
measures. It is not sufficientthat you perform well but it is also important that you let others know about the quality
of your positive contributions.
Insurance marketing
The term Insurance Marketing refers to the marketing of Insurance services with theaim to create customer
and generate profit through customer satisfaction. The InsuranceMarketing focuses on the formulation of an ideal
mix for Insurance business so that theInsurance organisation survives and thrives in the right perspective.
Marketing --Mix For Insurance Companies
The to best meet the needs of its targeted market. The Insurance business deals inselling services and therefore
due weight-age in the formation of marketing mix for theInsurance business is needed. The marketing
mix includes sub-mixes of the 7 P's of marketing i.e. the product, its price, place, promotion, people, process &
physical attraction.The above mentioned 7 P's can be used for marketing of Insurance products and banking services, in the
following manner:
A product means what we produce. If we produce goods, it means tangible productand when we produce or
generate services, it means intangible service product. A product
is both what a seller has to sell and a buyer has to buy. Thus, an Insurance company sellsservices and therefore
services are their product. In India, the Life Insurance Corporation of India (LIC) and the General Insurance
Corporation (GIC) are the two leading companiesoffering insurance services to the users. Apart from offering life
insurance policies, they alsooffer underwriting and consulting services.
With a view of influencing the target market or prospects the formulation of pricingstrategy becomes significant.
The pricing in insurance is in the form of premium rates. Thethree main factors used for determining the premium

rates under a life insurance plan aremortality, expense and interest. The premium rates are revised if there are
any significantchanges in any of these factors.
•Mortality (deaths in a particular area) When deciding upon the pricing strategy the average
rate of mortality is one of the main considerations. In a country like South Africa the threat tolife is very important
as it is played by host of diseases.
• Expenses:
The cost of processing,commission to agents, reinsurance companies as well as registration are all incorporated
intothe cost of installments and premium sum and forms the integral part of the pricing strategy.

•Interest:The rate of interest is one of the major factors which determines people's willingness
to invest in insurance. People would not be willing to put their funds to invest in insurance business if the
interest rates provided by the banks or other financial instruments are muchgreater than the perceived returns
from the insurance premiums.
This component of the marketing mix is related to two important facetsi)
Managing the insurance personnel, andii) Locating a branch.The management of agents and insurance
personnel is found significant with theviewpoint of maintaining the norms for offering the services. This is also to
process theservices to the end user in such a way that a gap between the services- promised and services-offered is bridged over. In a majority of the service generating organizations, such a gap isfound
existent which has been instrumental in making worse the image problem. Thetransformation of potential
policyholders to the actual policyholders is a difficult task that depends upon the professional excellence of the
personnel. The agents and the ruralcareer agents acting as a link, lack professionalism.
The insurance services depend on effective promotional measures. In a country likeIndia, the rate of illiteracy is
very high and the rural economy has dominance in the nationaleconomy. It is essential to have both personal
and impersonal promotion strategies. In promoting insurance business, the agents and the rural career
agents play an important role.Due attention should be given in selecting the promotional tools for agents and
rural career agents and even for the branch managers and front line staff. They also have to be given proper
training in order to create impulse buying. Advertising and Publicity, organisationof conferences and
seminars, incentive to policyholders are impersonal communication.Arranging Kirtans, exhibitions, participation in
fairs and festivals, rural wall paintings
and publicity drive through the mobile publicity van units would be effective in creating theimpulse buying and the
rural prospects would be easily transformed intoactual policyholders.
Understanding the customer better allows to design appropriate products. Being aservice industry which involves
a high level of people interaction, it is very important to usethis resource efficiently in order to satisfy customers.
Training, development and strongrelationships with intermediaries are the key areas to be kept under
consideration. Trainingthe employees, use of IT for efficiency, both at the staff and agent level, is one of
theimportant areas to look into. Human resources can be developed through education, trainingand by
psychological tests. Even incentives can inject efficiency and can motivate people for productive and qualitative
The process should be customer friendly in insurance industry. The speed andaccuracy of payment is of great
importance. The processing method should be easy andconvenient to the customers. Installment schemes
should be streamlined to cater to the ever growing demands of the customers. IT & Data Warehousing will
smoothen the process flow.IT will help in servicing large no. of customers efficiently and bring down
overheads.Technology can either complement or supplement the channels of distribution costeffectively. It can
also help to improve customer service levels. The use of data warehousingmanagement and mining will help
to find out the profitability and potential of variouscustomers product segments.

Journal of Management and Science - JMS ISSN 2250-1819 (Online) / ISSN 2249-1260 (Printed)
A. Flow of activities: all the major activities of banks follow RBI guidelines. There has to beadherence to certain
rules and principles in the banking operations. The activities have beensegregated into various departments
accordingly.B. Standardization: banks have got standardized procedures got typical transactions. In factnot only
all the branches of a single-bank, but all the banks have some standardization inthem. This is because of the
rules they are subject to. Besides this, each of the banks has itsstandard forms, documentations etc.
Standardization saves a lot of time behind individualtransaction.C. Customization: There are specialty counters at
each branch to deal with customers of
a particular scheme. Besides this the customers can select their deposit period among theavailable

alternatives.D. Number of stores: numbers of steps are usually specified and a specific pattern is followedto
minimize time taken.E. Simplicity: in banks various functions are segregated. Separate counters exist with clear
indication. Thus a customer wanting to deposit money goes to ‗deposits‘ counter and does not
mingle elsewhere. This makes procedures not only simple but consume less time. Besidesinstruction boards in
national boards in national and regional language help the customersfurther.
Distribution is a key determinant of success for all insurance companies. Today, thenationalized insurers have
a large reach and presence in India. Building a distributionnetwork is very expensive and time consuming.
Technology will not replace a distributionnetwork though it will offer advantages like better customer service.
Finance companies and banks can emerge as an attractive distribution channel for insurance in India. In
Netherlands,financial services firms provide an entire range of products including bank accounts, motor,home
and life insurance and pensions. In France, half of the life insurance sales are madethrough banks. In India also,
banks hope to maximize expensive existing networks by sellinga range of products.The physical evidences
include signage, reports, punch lines, other tangibles,
employee‘s dress code etc.
A. Tangibles: banks give pens, writing pads to the internal customers. Even the passbooks,chequebooks, etc
reduce the inherent intangibility of services.B. Punch lines: punch lines or the corporate statement depict the
philosophy and attitude of the bank. Banks have influential punch lines to attract the customers. Banking
marketingconsists of identifying the most profitable markets now and in future, assessing the presentand future
needs of customers, setting business development goals, making plans-all in thecontext of changing
In India, banks hope to maximize expensive existing networks by selling a range of products. It is anticipated
that rather than formal ownership arrangements, a loose network
of alliance between insurers and banks will emerge, popularly known as bank assurance. Another innovative
distribution channel that could be used are the non-financialorganisations.
We can‘t deny the fact that if foreign banks are performing fantastically, it is
not only due to the sophisticated information technologies they use but the result of a fair synchronization of new
information technologies and a team of personally committedemployees. The development of human resources
makes the ways for the formation of humancapital

Que.6 Explain the benefits of reinsurance. Elaborate on the application of reinsurance.


Reinsurance is an arrangement by which an insurance company transfers all or a portion of its risk under a
contract (or contracts) of insurance to another company. The company transferring risk in a reinsurance
arrangement is called the ceding insurer. The company taking over the risk in a reinsurance arrangement is
the assuming reinsurer. In effect, the insurance company that issued the policies is seeking protection from
another insurer, the assuming reinsurer. Typically, the reinsurer assumes responsibility for part of the losses
under an insurance contract; however, in some instances, the reinsurer assumes full responsibility for the original
insurance contract. As with insurance, reinsurance involves risk transfer, risk distribution, risk diversification
across more insurance companies, and coverage against insurance risk. Risk diversification is the spreading of
the risk to other insurers to reduce the exposure of the primary insurer, the one that deals with the final

How Reinsurance Works

Reinsurance may be divided into three types: (1) treaty, (2) facultative, and (3) a combination of these two. Each
of these types may be further classified as proportional or nonproportional. The original or primary insurer (the
ceding company) may have a treaty with a reinsurer. Under a treaty arrangement, the original insurer is obligated
to automatically reinsure any new underlying insurance contract that meets the terms of a prearranged treaty,
and the reinsurer is obligated to accept certain responsibilities for the specified insurance. Thus, the reinsurance
coverage is provided automatically for many policies. In a facultative arrangement, both the primary insurer and
the reinsurer retain full decision-making powers with respect to each insurance contract. As each insurance
contract is issued, the primary insurer decides whether or not to seek reinsurance, and the reinsurer retains the
flexibility to accept or reject each application for reinsurance on a case-by-case basis. The combination approach
may require the primary insurer to offer to reinsure specified contracts (like the treaty approach) while leaving the
reinsurer free to decide whether to accept or reject reinsurance on each contract (like the facultative approach).
Alternatively, the combination approach can give the option to the primary insurer and automatically require
acceptance by the reinsurer on all contracts offered for reinsurance. In any event, a contract between the ceding
company and the reinsurer spells out the agreement between the two parties.

When the reinsurance agreement calls for proportional (pro rata) reinsurance, the reinsurer assumes a
prespecified percentage of both premiums and losses. Expenses are also shared in accord with this prespecified
percentage. Because the ceding company has incurred operating expenses associated with the marketing,
evaluation, and delivery of coverage, the reinsurer often pays a fee called a ceding commission to the original
insurer. Such a commission may make reinsurance profitable to the ceding company, in addition to offering
protection against catastrophe and improved predictability.

Nonproportional reinsurance obligates the reinsurer to pay losses when they exceed a designated
threshold. Excess-loss reinsurance, for instance, requires the reinsurer to accept amounts of insurance that
exceed the ceding insurer’s retention limit. As an example, a small insurer might reinsure all property insurance
above $25,000 per contract. The excess policy could be written per contract or per occurrence. Both proportional
and nonproportional reinsurance may be either treaty or facultative. The excess-loss arrangement is depicted in
In addition to specifying the situations under which a reinsurer has financial responsibility, the reinsurance
agreement places a limit on the amount of reinsurance the reinsurer must accept. For example, the SSS
Reinsurance Company may limit its liability per contract to four times the ceding insurer’s retention limit, which in
this case would yield total coverage of $125,000 ($25,000 retention plus $100,000 in reinsurance on any one
property). When the ceding company issues a policy for an amount that exceeds the sum of its retention limit and

SSS’s reinsurance limit, it would still need another reinsurer, perhaps TTT Reinsurance Company, to accept a
second layer of reinsurance.

Assume 30–70 split, premiums of $10,000, expense of $2,000, and a loss of $150,000. Ignore any ceding

Benefits of Reinsurance

A ceding company (the primary insurer) uses reinsurance mainly to protect itself against losses in individual
cases beyond a specified sum (i.e., its retention limit), but competition and the demands of its sales force may
require issuance of policies of greater amounts. A company that issued policies no larger than its retention would
severely limit its opportunities in the market. Many insureds do not want to place their insurance with several
companies, preferring to have one policy with one company for each loss exposure. Furthermore, agents find it
inconvenient to place multiple policies every time they insure a large risk.

In addition to its concern with individual cases, a primary insurer must protect itself from catastrophic losses of a
particular type (such as a windstorm), in a particular area (such as a city or a block in a city), or during a specified
period of operations (such as a calendar year). An aggregate reinsurance policy can be purchased for coverage
against potentially catastrophic situations faced by the primary insurer. Sometimes they are considered excess
policies, as described above, when the excess retention is per occurrence. An example of how an excess-peroccurrence policy works can be seen from the damage caused by Hurricane Andrew in 1992. Insurers who sell
property insurance in hurricane-prone areas probably choose to reinsure their exposures not just on a propertyby-property basis but also above some chosen level for any specific event. Andrew was considered one event
and caused billions of dollars of damage in Florida alone. A Florida insurer may have set limits, perhaps $100
million, for its own exposure to a given hurricane. For its insurance in force above $100 million, the insurer can
purchase excess or aggregate reinsurance.

Other benefits of reinsurance can be derived when a company offering a particular line of insurance for the first
time wants to protect itself from excessive losses and also take advantage of the reinsurer’s knowledge
concerning the proper rates to be charged and underwriting practices to be followed. In other cases, a rapidly
expanding company may have to shift some of its liabilities to a reinsurer to avoid impairing its capital.
Reinsurance often also increases the amount of insurance the underlying insurer can sell. This is referred to as
increasing capacity.

Reinsurance is significant to the buyer of insurance for a number of reasons. First, reinsurance increases the
financial stability of insurers by spreading risk. This increases the likelihood that the original insurer will be able to
pay its claims. Second, reinsurance facilitates placing large or unusual exposures with one company, thus
reducing the time spent seeking insurance and eliminating the need for numerous policies to cover one
exposure. This reduces transaction costs for both buyer and seller. Third, reinsurance helps small insurance
companies stay in business, thus increasing competition in the industry. Without reinsurance, small companies
would find it much more difficult to compete with larger ones.

Individual policyholders, however, rarely know about any reinsurance that may apply to their coverage. Even for
those who are aware of the reinsurance, whether it is on a business or an individual contract, most insurance
policies prohibit direct access from the original insured to the reinsurer. The prohibition exists because the
reinsurance agreement is a separate contract from the primary (original) insurance contract, and thus the original
insured is not a party to the reinsurance. Because reinsurance is part of the global insurance industry,
globalization is also at center stage.

Legal and Regulatory Issues

In reality, the only tangible product we receive from the insurance company when we transfer the risk and pay the
premium is a legal contract in the form of a policy. Thus, the nature of insurance is very legal. The wordings of the
contracts are regularly challenged. Consequently, law pervades insurance industry operations. Lawyers help draft
insurance contracts, interpret contract provisions when claims are presented, defend the insurer in lawsuits,
communicate with legislators and regulators, and help with various other aspects of operating an insurance

Claims Adjusting

Claims adjusting is the process of paying insureds after they sustain losses. The claims adjuster is the person
who represents the insurer when the policyholder presents a claim for payment. Relatively small property losses,
up to $500 or so, may be adjusted by the sales agent. Larger claims will be handled by either a company
adjuster, an employee of the insurer who handles claims, or an independent adjuster. The independent
adjuster is an employee of an adjusting firm that works for several different insurers and receives a fee for each
claim handled.

A claims adjuster’s job includes (1) investigating the circumstances surrounding a loss, (2) determining whether
the loss is covered or excluded under the terms of the contract, (3) deciding how much should be paid if the loss
is covered, (4) paying valid claims promptly, and (5) resisting invalid claims. The varying situations give the
claims adjuster opportunities to use her or his knowledge of insurance contracts, investigative abilities,
knowledge of the law, negotiation skills, and tactful communication. Most of the adjuster’s work is done outside
the office or at a drive-in automobile claims facility. Satisfactory settlement of claims is the ultimate test of an
insurance company’s value to its insureds and to society. Like underwriting, claims adjusting requires substantial
knowledge of insurance.

Claim Practices

It is unreasonable to expect an insurer to be overly generous in paying claims or to honor claims that should not
be paid at all, but it is advisable to avoid a company that makes a practice of resisting reasonable claims. This
may signal financial trouble. Information is available about insurers’ claims practices. Each state’s insurance
department compiles complaints data. An insurer that has more than an average level of complaints is best

As in other organizations, an insurer needs competent managers to plan, organize, direct, control, and lead. The
insurance management team functions best when it knows the nature of insurance and the environment in which
insurers conduct business. Although some top management people are hired without backgrounds in the
insurance business, the typical top management team for an insurer consists of people who learned about the
business by working in one or more functional areas of insurance. If you choose an insurance career, you will
probably begin in one of the functional areas discussed above.