Ques. no. 1 - Explain price risk and its types.

Explain Risk
management methods.
Ans. -Price risk represents the uncertainty about the magnitude of cash
flows because of the probable changes in the input and output prices.
Output price risk stands for the risk of changes in the prices which an
organisation may ask for its goods and services. Input price risk means
the risk of changes in the price which a company has to pay for materials,
labour and other inputs in the production process.

There are three basic types of price risk:

Commodity price risk

Exchange rate risk and
Interest rate risk

Commodity price risk is born of the fluctuations in the prices of

commodities, like copper, coal, oil, gas and electricity. These constitute
the inputs for some companies and outputs for others. With economic
globalisation, output and input prices for various organisations are being
influenced by the foreign exchange rate fluctuations. The input and
output price can also fluctuate because of the changes in interest rates.

Risk management methods

Loss control- The activities which decrease the expected cost of

losses by lowering the occurrence of losses and/or their extent are
referred as loss control. Sometimes loss control is also termed as
risk control. Usually, the actions basically affecting the frequency of
losses are referred as loss prevention methods. Actions primarily
influencing the severity of losses that do occur are often called loss
reduction methods.
Loss financing- Methods applied to obtain funds for paying for or
offsetting losses that occur are termed as loss financing. There are
four broad methods of financing losses:
Retention- With retention, a business or individual retains the
obligation to pay for a part or the entire loss incurred. Firms can
pay retained losses using either internal or external funds.
i.
Insurance- The typical insurance contract requires the insurer
to provide funds to pay for the specified losses in exchange
for receiving a premium from the purchaser at the inception
of the contract.
ii.
Hedging- Financial derivatives, such as forwards, future
options and swaps, are used extensively to manage various
types of risk, most notably price risk.
iii.
Other contractual risk transfers-To use one or more of a
variety of other contractual risk transfers that allow business
to transfer risk to another party.
Internal risk reduction- In addition to loss financing methods that
allow business and individuals to reduce risk by transferring it to

another entity, businesses can reduce risk internally. There are two
major forms of internal risk reduction:
i.
Diversification and
ii.
Information.

Ques.no.2: An organisation is a legal entity which is created to do

some activity of some purpose. There are elements of a life
insurance organisation. Explain the elements of life insurance
organisation.
Ans. Elements of an Insurance Organization are:
Important activities
The important activities in a life insurance company are:
Procuring applications or proposals from prospective buyers of life
insurance.
Scrutinizing and making decisions on the proposals for insurance.
This is called underwriting.
Issuing the policy document, incorporating the term and conditions
of the insurance cover.
Keeping track of the performance of the insurance contract by
either party, like payment of premium or payment of benefits.
Attending to the various requirements that may arise during the
term of the contract like nominations, assignment, alteration of
terms, surrenders and payment of claims.
Other supporting activities like advertising, investment of funds,
maintenance of accounts, management of personnel, processing of
data, compliance with regulations and laws.
Internal organization
Within an insurance office, the following departments are likely to
exist. These may be located in the branch office or in the divisional/
Head offices. These departments are to be identified by the activities
being carried out, although they may be called by different names.
Business development or agency or marketing concerned with
the development of agency force, market development and
business growth.
New business, which would receive scrutinize and take
underwriting decision on the new proposals for insurance and
also issue the policy.
The following departments are likely to be centralized in the
Head Offices, as they require specialized skills and also because
they impact the whole organization.
Investments of funds, studying the opportunities for maximizing
returns.
Advertisement, publicity and public relations.
Actuarial, studying the experience, doing valuations, declaring
bonuses, monitoring the adequacy of premiums, setting
underwriting standards, studying morality rates, etc.
The distribution system
Agents are the ones who do the job of meeting, explaining and
persuading people. They have to be licensed under the Insurance
Act. A licensed agent can work with only one life insurer of the
choice and is paid commission on the premiums collected through
his agency. Another type of intermediary is the broker .
Functions of the agent

Agents of the LIC are not authorised to collect premiums other than
the first premium along with the proposal. If a policyholder pays
premium to an agent, the LIC not accept any liability for the same.
The premium is treated as paid only when it is paid into office.
Ques.no.3. Explain the doctrine of indemnity, doctrine of
subrogation and warranties and its types and classification.
Ans. Doctrine of indemnity
The contract of marine insurance is in the nature of indemnity. In any
situation the insured is not allowed to earn a profit out of claim. Profits
could be made in the absence of the principle of indemnity. The insurer
agrees to indemnity the assured only in the manner and only to the extent
agreed upon. Marine insurance fails to provide complete indemnity due to
large and varied nature of the marine voyage. The basis of indemnity is
always a cash basis as underwriter cannot replace the lost ship and
cargoes and the basis of indemnification is the value of the subject matter.
This value may be either the insured or insurable value. If the value of the
subject matter is determined at the time of taking the policy, it is called
Insured Value.
Doctrine of subrogation
The aim of doctrine of subrogation is that the insured should not get more
than the actual loss or damage. The main characteristics of subrogation
are:
i.
The insurer subrogates all the remedies, rights and liabilities of
the insured alter payment of the compensation.
ii.
The insurer has the right to pay the amount of loss after reducing
the sum received by the insured from the third party. But in
marine insurance the right of subrogation arises only after
payment has been made, and it is not customary as in fire and
accident insurance, to alter this by means of a condition to
provide for the exercise of subrogation rights before payment of
a claim. After indemnification, the insurer gets all the rights of
the insured on the third parties, but insurer cannot file suit in his
own name.
Warranties
A warranty enables the assured to undertake that some specific thing
shall or shall not be done or that particular conditions shall be met or
whereby he consents or denies that a specific state of fact exists. They are
statements according to which an insured person assures to do or not to
do something or to fulfil or not to fulfil a particular condition.
Warranties are of two types:
1. Express warranties: Which are expressly included or incorporated
in the policy by reference.
2. Implied warranties: These are not mentioned in the policy at all
but are tacitly under stood by the parties to the contract and are as
fully binding as express warranties.

Warranties are classified as:

i.
Affirmative It is the promise which insured gives to exist or not
to exist certain facts.
ii.
Promissory It is the promise in which insured promises that he
will do or not do a certain thing up to the period of policy.
In marine insurance, implied warranties are very important. These
include non-deviation, legality of venture and seaworthiness of the
ship. All these warranties must be literally complied with.

Ques.no.4. Give the short notes on:

i.
Evidence and claim notice
ii.
Subrogation
iii.
Salvage
Ans. Evidence and claim notice
Evidence
To admit a claim, appropriate evidence related to the policy is needed.
In marine insurance the policy is generally issued on mutual
understanding and good faith of both the parties. However, at the time
of claim, the insurer should satisfy itself about the information
furnished by the insured. The value of subject matter, nature of the
subject matter, warranties, insurable interest, etc., are some of the
matters to be considered at the time when the claim arises.
Notice of claim
In the event of the occurrence of the insured contingency, the insured
has to serve a prompt notice of claim. The notice receipt or the
endorsement of the course of action under taken by the insured does
not imply the acknowledgement of liability of the loss. The notice for
damage should be given before the survey by the insurers
representative. After performing the survey, the survey report signed
by him is availed.
Subrogation
Where the insurer pays for the complete loss, either of the whole, or in
the case goods, of any apportionable fraction, of the insured subject
matter, he hereafter becomes entitled to take over the interest of the
assured in whatever might remain of the subject matter so paid for,
and he is thereby subrogated to all the rights and remedies of the
assured in and in respect of that subject matter.
Salvage
The salvage is the remuneration or reward payable according to
maritime laws to salvors who voluntarily and independently of contract
render services to maritime property at sea. Salvage charges insured in
preventing a loss by perils insured against might be recovered as a loss
by those perils. The salvage awarded to salvors is apportioned over the
values saved. This charge is not recoverable from marine underwriters.

Ques.no.5. Explain the marketing mix (7ps) for insurance

companies.
Ans. - The marketing mix is inclusive of the combinations of the 7ps of
marketing, i.e., product, place, price, people, promotion, process and
physical attraction.
1. Product: A product signifies what is produced. If goods are
produced, it implies a tangible product and services are produced or
generated, it implies intangible service product. A product is what a
seller has to sell as well as what a buyer has to purchase. Hence, an
insurance firm sells services, thus making services as their product.
The policyholders naturally look for a reasonable return for their
investment and the insurance firms have their objective in
maximizing their profit margins. Hence, while freezing on the
product-mix, the associated services or the plans ought to be such
that they motivate individuals in buying the product.
2. Pricing- Aiming at the target market or prospectus, the process of
formulating the pricing policy becomes really important. In a
developing country such as India, where the prospects disposable
income level is low, the pricing decisions also influence the
conversion of possible policyholders into policyholders instead.
These strategies might be high pricing or low pricing aimed at
maintaining the standard of the policyholders.
3. Place Significant dimension to the Place Mix is associated with
the insurance branch locations. In the process of locating branches,
the branch manager has to take into account a number of elements,
for instance easy accessibility, presence of infrastructural facilities
and the management of premises and branch offices.
4. Promotion - The success of insurance services is dependent on the
kind of promotional measures undertaken. Advertising and publicity,
organizing seminars and conferences, and providing incentives to
the policyholders are the important facets of impersonal
communication.
5. People- To compete successfully in the service industry involve a
high level of interaction among people. It is essential to efficiently
utilize this resource to ensure customer satisfaction.
6. Process- The insurance industry ought to be characterised by a
customer-friendly process. The accuracy and speed of payment are
of high significance. The method of processing ought to be simple
and convenient to customers. Installment schemes need to be
appropriately organized to cater to the ever-increasing customer
demands. IT and data warehousing will ease the process flow.
7. Physical distribution- Distribution is a primary success
determinate with regard to all insurance firms. The nationalized
insurers operate on a wide domain in the country now.

Ques.no.6 Explain the benefits of reinsurance. Elaborate on

the application of reinsurance.
Ans. Benefits of Reinsurance
I.
Increase in risk-taking capacity- As the direct insurer can
reinsure part of certain risks; it can therefore accept more of the
original risk. It could be that a particular insurer has calculated
that it would not want to provide fire insurance cover for
manufacturers of plastic goods for the sum insured in excess of
Rupees 10 lakhs. Should it then receive an enquiry from a
potential insured for a sum of Rupees 40 lakhs, it would be in a
difficult position if there was no reinsurance. The said insurer
could accept only 10 lakhs and ask the client to approach one or
more insurers for the balance sum insured of 30 lakhs.
II.
Stabilization- Reinsurance enables the direct insurer to
stabilize its loss levels by removing some of uncertainty.
III.
Developing confidence- One of the advantages of insurance is
instilling confidence in the insured. In the knowledge that a large
number of uncertainties have been removed, a manufacturer
may be more willing to invest money in its business. Similarly,
the existence of reinsurance gives confidence to an insurer and
encourages expansion of that companys business.
IV.
Catastrophe protection- If the worst possible state of affairs
occurred to produce losses of catastrophic proportions, then
reinsurance acts as a cushion to protect insurers against the
possibility of the financial resources of a direct insurer getting
seriously strained.
V.
Spread of risk- Reinsurance like insurance is a mechanism by
which insurer can spread their losses. The direct insurer, or for
that matter a reinsurer, will not want a concentration of liability
in any one type of business: any one class of risk, any one
geographical area or in any specific classification.
Application of Reinsurance
The major areas of the application of reinsurance are:
I. Life assurance- Life reassurance, as is commonly referred
to, can be arranged on original terms and on risk premium
basis. The reassurer would pay reinsurance and profit
commission to ceding office as in the case of reinsurances in
general insurance business.
II.
Risk premium basis- After the first one or two years of
policy being in existence, the life office will be able to start
building a reserve fund against a potential death claim. As the
reserve funds build up beyond the retention level, the rate of
increase in the reserve will be greater than the increase in the
mortality rate. The overall effect is that the premium will rise
in the early stages of the reassurance and reduce in the later
stages.
III.
Reassurance pools- Reassurance pools are known to exist
for all those insured with a history of diabetes or coronary

heart disease. Similar pools, on the general insurance side,

are known for difficult risks like atomic risks, etc.