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DIRM

Supplementary Study Materials

Committee on Banking, Insurance and Pension


The Institute of Chartered Accountants of India
New Delhi
This publication has been prepared for use by the members of the Institute.
The views expressed herein do not necessarily represent the views of the
Council of the Institute.

THE INSTITUTE OF CHARTERED ACCOUNTANTS OF INDIA

Edition : September, 2006


Reprint : March, 2016

Committee/ : Committee on Banking, Insurance and Pension


Department

E-mail : cobip@icai.in

Website : www.icai.org

Price : ` 300/-

Published by : The Publication Department on behalf of the Institute of


Chartered Accountants of India, ICAI Bhawan, Post Box No.
7100, Indraprastha Marg, New Delhi -110 002.

Printed by : Sahitya Bhawan Publications, Hospital Road, Agra 282 003.

March/2016/P1931(Reprint)
FOREWORD

Our Institute has always been proactive to macro economic changes in the
country by way of building and maintaining core competencies amongst the
members of the Institute so that they can synchronise the economic activities
of various stakeholders of our economy to such macro economic changes.
The Institute has constituted the Committee on Insurance and Pension for
identifying the emerging professional opportunities in the insurance and
pension sectors for the members, both in practice and in service and to train
and equip the members in those sectors through various modes.
I am happy to note that the Committee on Insurance and Pension has taken
the initiative to publish Supplementary Study Material for the Insurance and
Risk Management Course with features like case studies, short answer
questions, objective type question-answers. I am confident, that the format of
this Study Material will help the members to grasp the essence of the
contents.
I would like to place on record my appreciation for CA. Anuj Goyal,
Chairman of the Committee and other members of the Committee, whose
endeavour has culminated in publishing this Supplementary Study Material.
My best wishes are with the members enrolled for the Insurance and Risk
Management course and look forward to their appreciable level of
professional contribution to the booming insurance industry.

New Delhi (CA. T.N. Manoharan)


September 19, 2006 President
PREFACE

The Institute recognizing the potential of the insurance industry in terms of


underlying professional opportunities for its members launched the Post
Qualification Course in Insurance and Risk Management (DIRM) in April,
2003.
While the first set of Study Material for the course published in 2003 and
subsequently revised in 2005, I am pleased to present the Supplementary
Study Materials containing objective, short answer and Case Studies on the
contents of the various Modules of the Course so as to assist the aspiring
members who are pursuing the course in understanding the latest concepts in
simple and comprehensive manner. I am sure that this Supplementary Study
Material along with the original study material and the prescribed reference
books, would enable our members to acquire, maintain and develop
appropriate level of core competencies in the areas of Insurance and Risk
Management.
I place on record my gratitude to CA. T.N. Manoharan, President of ICAI,
CA. Sunil Talati, Vice-President of ICAI, CA. Charanjot Singh Nanda, Vice-
Chairman of the Committee on Insurance and Pension for their involvement
and encouragement and the members of the Committee on Insurance and
Pension CA. Kamlesh S. Vikamsey, CA. Harish Narendra Motiwalla,
CA. Jaideep Narendra Shah, CA. Rajkumar S. Adukia, CA. S
Santhanakrishnan, Smt. Anita Kapur, CA. K C Parashar, CA. Pawan Kumar
Sharma, CA. P S Prabhakar, CA. Mukul Bansal, CA. Pankaj Agarwal, CA. N.
Goutham Chand, CA. Anil Kumar Sharma, CA. Naveen Kumar Soni, CA. O.
P. Mutha for their valuable involvement in this regard. I appreciate the
efforts put in by the officials of Secretariat of the Committee on Insurance
and Pension for their contribution in publishing this Supplementary Study
Material.

New Delhi (CA. Anuj Goyal)


September 19, 2006 Chairman
Committee on Insurance & Pension
CONSOLIDATED CONTENTS

MODULE I
PRINCIPLES AND PRACTICE OF INSURANCE

Chapter 1
Introduction to Risk...........................................................................................I-1

Chapter 2
Introduction to Insurance............................................................................... ...I-9

Chapter 3
The Fundamental Legal Principles of General and Life Insurance................... .I-23

Chapter 4
Insurance Contracts..................................................................................................I-34

Chapter 5
Management of Insurance Organisations.................................................................I-47

Chapter 6
General Insurance Policies (Personal).....................................................................I-58

Chapter 7
General Insurance (Commercial).............................................................................I-76

Chapter 8
Life Insurance..........................................................................................................I-89

Chapter 9
Regulation of Investment Funds of Insurance Companies....................................I-102

Chapter 10
Laws Governing Insurance Management and Accounting....................................I-107

Chapter 11
Asset and Liability Management ..........................................................................I-113
MODULE II
TECHNICAL ASPECTS OF INSURANCE

Chapter 1
Underwriting.............................................................................................................II-1

Chapter 2
Fire Insurance ........................................................................................................II-10

Chapter 3
Marine Insurance....................................................................................................II-21

Chapter 4
Motor Insurance .....................................................................................................II-30

Chapter 5
Engineering Insurance ...........................................................................................II-38

Chapter 6
Miscellaneous Insurance ........................................................................................II-44

Chapter 7
Life Insurance Products .........................................................................................II-52

Chapter 8
Life Insurance Pricing Fundamentals ....................................................................II-62

Chapter 9
Social Security Schemes ........................................................................................II-73

Chapter 10
Group Insurance ....................................................................................................II-86

Chapter 11
Financial Gerontology and Super Annuating Policies ..........................................II-96

Chapter 12
Acturarian Valuation ...........................................................................................II-103
MODULE III
RISK MANAGEMENT AND REINSURANCE

Chapter 1
Economics of Insurance .........................................................................................III-1
Chapter 2
Introduction to Risk Management ........................................................................III-11
Chapter 3
Essentials of Risk Management...................................................III-20
Chapter 4
Probability ............................................................................................................III-27
Chapter 5
Decision Making Under Conditions of Uncertainty ............................................III-34
Chapter 6
Risk Management Process....................................................................................III-38
Chapter 7
Risk Management by Business and Enterprise Risk Management (ERM)...........III-47
Chapter 8
Reinsurance Theory ..............................................................................................III-54
Chapter 9
Methods of Reinsurance .......................................................................................III-60
Chapter 10
Treaty Wordings ...................................................................................................III-66
Chapter 11
Reinsurance Accounts and Administration ..........................................................III-73
Chapter 12
Reinsurance Regulations ......................................................................................III-79
Chapter 13
Reinsurance Markets ............................................................................................III-86
Chapter 14
Inward Reinsurance ..............................................................................................III-96
Chapter 15
Reinsurance Practice ............................................................................................III-98
MODULE IV
BUSINESS STRATEGIC PLANNING &
INFORMATION TECHNOLOGY

Chapter 1
Management of Insurance Companies ...................................................................IV-1
Chapter 2
BPO and Insurance ...............................................................................................IV-11
Chapter 3
Exchange Control and Taxation ...........................................................................IV-19
Chapter 4
System Development Process ..............................................................................IV-24
Chapter 5
System Analysis ...................................................................................................IV-35
Chapter 6
System Design ......................................................................................................IV-40
Chapter 7
System Implementation and Operation ............................................................... IV-48
Chapter 8
Computer Software and Configuration ................................................................IV-57
Chapter 9
Data Storage and Processing Methods......................................IV-71
Chapter 10
Information System Controls ...............................................................................IV-84
Chapter 11
Data Security and Integrity ................................................................................IV-100
Chapter 12
Information Technology and Insurance .............................................................IV-116
Chapter 13
Pricing and Marketing of Insurance ...................................................................IV-121
Chapter 14
Case Studies... IV-139
DIRM
MODULE I

PRINCIPLES AND PRACTICE


OF INSURANCE
MODULE I
PRINCIPLES AND PRACTICE OF INSURANCE

Chapter 1
Introduction to Risk...........................................................................................I-1

Chapter 2
Introduction to Insurance............................................................................... ...I-9

Chapter 3
The Fundamental Legal Principles of General and Life Insurance................... .I-23

Chapter 4
Insurance Contracts..................................................................................................I-34

Chapter 5
Management of Insurance Organisations.................................................................I-47

Chapter 6
General Insurance Policies (Personal).....................................................................I-58

Chapter 7
General Insurance (Commercial).............................................................................I-76

Chapter 8
Life Insurance..........................................................................................................I-89

Chapter 9
Regulation of Investment Funds of Insurance Companies....................................I-102

Chapter 10
Laws Governing Insurance Management and Accounting....................................I-107

Chapter 11
Asset and Liability Management ..........................................................................I-113
M O D U LE -I: PRIN CIPLES A N D PRA CTICE O F IN SU RA N CE

C hapter 1
Introduction to R isk

SEC TIO N -A

1. Thedegreeorlevelofrisk isrelated to thepossibility ofoccurrence.


a. W hen thepossibility ofoccurrenceofan eventishigher,then thedegreeofrisk
ishigher
b. W hen thepossibility ofoccurrenceofan eventislow er,then thedegreeofrisk
ishigher
c. both A and B
d. noneoftheabove
2. Perilm eans
a. D anger
b. Risk
c. Causeofloss
d. U ncertainty
3. R isk m eans
a. Fearofloss
b. A causeofloss
c. M easurableU ncertainty
d. U npredictability
4. Lifeinsurancecovershum an liferisk exposuresof
a. U ntim ely death
b. Suicide
c. U nem ploym ent
d. D ivorce
5. AM ortality Tableshow s
a. N um berofbirths
b. Incidenceofdeath atspecified ages
c. N um berofdeaths
d. Both num berofbirthsand deaths.
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6. W hich oneofthefollow ing isnota Peril?


a. Theft
b. Fire
c. Burglary
d. W etroad
7. A H azard
a. Reducesthechancesofloss
b. Createsthechancesofloss
c. Increasesthefrequency and severity ofloss
d. B and C
8. O rganisationsarem ainly concerned w ith m anaging:
a. Purerisks
b. Speculativerisks
c. Personalrisks
d. N oneoftheabove
9. Insuranceisa risk m anagem enttechniqueinvolving:
a. Risk retention
b. Risk avoidance
c. Losscontrol
d. Risk transfer
10. R isk ofprem aturedeath isa
a. Financialrisk
b. D ynam icrisk
c. Personalrisk
d. Subjectiverisk
11. A dverseselection refersto
a. Selection ofadversities
b. Selection oflosses
c. Selection ofrisks
d. Selection ofhigh risk atlow cost
12. R isk Selection in lifeinsurancerefersto
a. Selection ofhealthy lives
b. Selection ofunhealthy lives
c. Selection ofunhygieniclives
d. Selection ofhygieniclives
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13. C onsequencesofadverseselection
a. Escalation ofprem ium sand com plete collapse ofan insurance m arketw ith the
w ith-draw alofindividuals
b. Fallin prem ium sand partialcollapseofan insurancem arket
c. Fallin prem ium sand m any individualspurchaseinsurance
d. Fallin prem ium sand com pletecollapseofan insurancem arket
14. Insurancecovers
a. Speculativerisks
b. Investm entrisks
c. Im purerisks
d. Purerisks
15. R isk ofprem aturedeath is
a. Personalrisk
b. Liability risk
c. Property risk
d. Speculativerisk
16. D am ageto theproperty dueto floodsis
a. Personalrisk
b. Liability risk
c. Property risk
d. Speculativerisk
17. Selling defectivem edicinescreate
a. Personalrisk
b. Liability risk
c. Property risk
d. Speculativerisk

SEC TIO N A A N SW ER S
1. a 2. c 3. c 4. a 5. b 6. d
7. d 8. a 9. d 10.c 11.d 12.a
13.a 14.d 15.a 16.c 17.b

SEC TIO N -B

1. W hatarethecharacteristicsofrisk?
A ns:Thefollow ing arethecharacteristicsofrisk :

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Risk isthelikelihood ofan unfortunateoccurrence


Risk isunpredictable
Risk isuncertainty aboutthefuture
Risk ispossibility ofadversedeviation from expected outcom es
Risk isan outcom ethatisnotfavourable
A ll the above definitions of risk highlight one elem ent,nam ely the presence of
uncertainty w ith regard to theoutcom e.U ncertainty issubjectiveasitdependson the
individualsperception ofrisks.Itisobviousthatno tw o personsexposed to thesam e
risk w illperceiveitin thesam ew ay.Thelevelofuncertainty w illalso depend on the
inform ation availableon therisk.
2. W hatdo you m ean by C hanceofLoss?
A ns:Chanceoflossm eansthelikelihood oftheoccurrenceofan eventcausing aloss.Itis
therelativefrequency ofoccurrenceofan eventresulting in loss.Itistheratio ofthe
num berofexpected lossesto totalnum berofactuallossesthatactually occur.
Chanceofloss= N o.oflikely losses/Totalno.ofpossiblelosses
For exam ple,there are 2000 houses in a com m unity.O utof pastexperience and
records,thereisapossibility that20 ofthesehousesw illbedam aged by fireduring a
given period oftim e.Then,thechanceoflossdueto fireis1% (20/2000).
3. D escribePhysicalH azard
A ns:Physicalhazardsaretheconditionsin w hich thephysicalcharacteristicsofan object
oran individualtend to increasethefrequency ofloss.
Forexam ple,bad w eatherconditionsincreasethechanceofaccidentsforaeroplanes;
defective m aterials used in construction ofbuildings resultin collapse ofbuilding;
and unsafeconditionsin thew orkspaceincreasethechanceofaccidentsforw orkers.
4. W hatisM oralH azard? G ivean exam ple.
A ns:Itisthe situation w herein frequency and severity oflossincrease due to individuals
dishonesty.M oralhazard also occurs due to defective attitude of em ployees and
individuals.M oralhazard can be controlled orreduced by taking appropriate steps
and precautions.D ishonestindividualscontributeto m oralhazards.
Exam plesofm oralhazard are giving false inform ation in orderto collectthe claim ,
inflating theam ountofclaim intentionally,faking an accident,etc.
5. W hatisM oraleH azard? G ivean exam ple.
A ns:M oralhazard occursdue to defectin individualscharacterbutm orale hazard isdue
to an individualsindifferenceornegligence.A n individualsindifferenceto therisk
becauseoftheexistenceofinsurancecoverconstitutesm oralehazard.
Exam ples of m orale hazards are rash driving, leaving the car unlocked and not
checking w hetherthehousedoorsarelocked properly beforeleaving on aholiday,etc.

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6. C lassify differenttypesofrisks
A ns:Therearedifferenttypesofrisks,w hich m ay beclassified asfollow s:
Pureand speculativerisks
Subjectiveand objectiverisks
Fundam entaland particularrisks
Staticand dynam icrisks
7. D istinguish betw een purerisksand speculativerisks
A ns:Pure risks involve situations w here there is a chance ofloss oreven a break-even
situation butno profit.Purerisksdo nothavefavourableoutcom es;atbestw eareleft
in the sam e situation in w hich w e w ere before the eventcausing lossoccurred.Fires
in a go dow n or factory,an injury atthe w orkplace or on the road or a theftor
burglary athom eareallinstancesofpurerisks.
O n the otherhand,speculative risksm ay,in addition to the outcom esofa pure risk
cited above,have happy or favourable outcom es nam ely profit or gain.In other
w ords, speculative risks can have three possible outcom es, viz. loss, breakeven
situation or gain.A com m only cited exam ple of speculative risk is investm entin
sharesin w hich allthethreeoutcom esarepossible.
The difference betw een pure and speculative risks is highlighted to m ake the point
thatpure risks are generally insurable butnotspeculative risks,as the law oflarge
num bersisapplicableto purerisksand notto speculativerisks.
8. D istinguish betw een subjectiverisksand objectiverisks
A ns:Subjective risk arises out of an individuals m ental state. It is the result of
individualsuncertainty abouttheoutcom eofan event.Subjectiverisksoccurdueto
psychologicalfearabouttheoutcom eofan eventw hetheritw illbefavourableornot
to an individual.
O bjective risks,asthe term suggests,can be observed and forthatreason capable of
m easurem entunlike subjective risksw hich are notm easurable.H ere the probability
ofan eventoccurring can bedeterm ined in tw o w ays:oneby deductivereasoning (as
in the case ofa balanced coin being tossed)orby inductive reasoning (asin the case
ofan actuary determ ining theprobability ofdeath ofaperson atacertain age).
9. D istinguish betw een fundam entalrisksand particularrisks
A ns:Fundam entalrisksaregroup risks,w hich occurdueto social,econom icand political
changesin the country.Large num bersofpeople are affected by these fundam ental
risks.Fundam entalrisksalso arisedueto naturalcalam ities.
Exam ples:Crisis in the econom y,w idespread unem ploym ent,sudden w ars,poverty,
dram atic changes in governm ent policies, inflation, floods, earthquakes, fam ine,
volcaniceruptionsand othernaturalcalam itiesarealso described asfundam entalrisks.
Particularrisks on the contrary are personalin nature and affectonly individuals.
Thesearisefrom individualcausesand theconsequencesaffectindividuals.
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Exam ples:Injury dueto accidents,poorhealth condition,robbery,dam agedueto fire


etc.
G enerally, governm ents form ulate certain program m es to deal w ith fundam ental
risks w hereas affected individuals dealw ith particularrisks by using suitable risk
m anagem enttechniques.
10. D istinguish betw een staticrisk and dynam icrisk
A ns:Static risks can be pure orspeculative.N aturalevents such as storm snow falland
death are described as pure static risks.Industries in a stable econom y are a good
exam pleofstaticspeculativerisk.
D ynam ic risks can also be pure orspeculative risks.D ynam ic risks w illaffectthe
w hole econom y.These risksare beyond the controlofan individual.D ynam ic risks
ariseoutofsocio-econom icchangessuch asglobalization ofeconom y,im pactofIT,
inform ation explosion and other sim ilar m ajor changes affecting society.D ue to
dynam icrisks,society often benefitsbutonly in thelong term .
11. W hatarethesourcesofpurerisk?
A ns:Thesourcesofpurerisksincludethefollow ing:
Personalrisks
Property risks
Liability risks
Risksarising outoffailureofothers
12. D escribethem ethodsofhandling risk
A ns:Thedifferentm ethodsofhandling risk are:
Risk avoidance
Controlling losses
Risk retention
Transferofrisk
13. W hatarethestepsin therisk m anagem entprocess?
A ns:Thestepsin therisk m anagem entprocessare:
Setting objectives
Risk identification
Evaluation ofrisks
Selection ofappropriaterisk m anagem enttechnique
Im plem entation ofrisk m anagem enttechnique
Review therisk m anagem entdecision
14. D istinguish betw een risk m anagem entand insurancem anagem ent
A ns:Risk m anagem entasitisbeing practised today isofrelatively recentorigin.Even till

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M O D U LE -I: PRIN CIPLES A N D PRA CTICE O F IN SU RA N CE

the m iddle of the 20th century,itw as custom ary to callthe risk m anager as the
insurance m anagerand hisdepartm entw asreferred to asinsurance departm ent.H is
activities w ere m ainly focussed on insurance buying.Today m ostlarge com panies
have a fulltim e senior executive designated as Risk M anager.H is job is clearly
defined.H eisaspecialistw hosejob isto identify and analysetheriskshiscom pany
isexposed to,selectm ethodsw ith w hich theserisksm ay becontrolled orelim inated
and advise top m anagem enton insurance buying to indem nify the com pany against
insurable losses to reduce the im pactofpotentialfinancialloss.Thus,even though
insurance buying m ay rem ain a m ajor area of his w ork,itis notthe only area of
operation.Risk m anagem entisam uch w iderconceptthan insurancem anagem ent.
InsuranceM anagem entvsR isk M anagem ent
1. Believesexclusively in insurance 1. M akesasystem aticstudy ofallrisksan
astherisk m anagem enttool. organization isexposed to,evaluates
them and identifiesthebestand m ost
econom icalm ethod ofhandling each risk.
2. Expertiseisin theareaofinsurance 2. H asabetterunderstanding ofrisk in the
and tendsto look atrisk solely com pany asaprofessionalin risk
from an insuranceangle m anagem ent
3. Covering allorm ostoftherisk 3. Looksatrisk m anagem entfrom thecost
through insurancew ould bea including insuranceforthem anagem ent
heavy costforthecom pany ofrisks.H encecosteffective
4. Insurancem anagem entisof 4. H andlesrisksforthecom pany by
lim ited useto an enterprisein adopting integrated risk m anagem ent
m anaging risks. orenterpriserisk m anagem entpractices

SEC TIO N C
(C A SE STU D IES)
1. V am siis a college student.H e ow ns a high-m ileage bike thathas a currentm arket
value of Rs.80,000.The currentreplacem entvalue of his clothes,television set,
stereo set,and other personalproperty in a rented apartm enttotalRs.1 lakh.H e
w earsdisposablecontactlenses,w hich costRs.6,000 forasix-m onth supply.H ealso
has a w ater bed in his rented apartm entthathas leaked w ater in the past.A n avid
runner,V am siruns five m iles daily in nearby public park thathas the reputation of
being extrem ely dangerousbecauseofdrug dealers,num erousassaultsand m uggings,
and drive-by shootings.V am sisparentsboth w ork to help him pay histuition.
Foreach ofthefollow ing risksorlossexposures,identify an appropriaterisk m anage-
m enttechniquethatcould beused to dealw ith theexposure.Explain youransw er.
a. Physicaldam ageto thebikebecauseofacollision w ith anotherm otorist
b. Liability law suitagainstV am siarising outof the negligentoperation of his
bike.

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c. Totalloss of clothes,television,stereo,and personalproperty because of a


greasefirein thekitchen ofhisrented apartm ent
d. D isappearanceofonecontactlens
e. W aterbed leak thatcausesproperty dam ageto theapartm ent
f. Physicalassaulton V am siby gang m em bersw ho are dealing drugsin the park
w hereheruns
g. Lossoftuition from V am sisfatherw ho iskilled by a drunk driverin an auto
accident.
A ns:a. Transferring risk to insurancecom pany by taking m otorinsurance
b. Transferring risk to insurance com pany by taking third party m otor liability
insurance
c. Transferring risk to insurance com pany by taking household property
insurance.
d. Eitheravoid therisk oflosing thelensorretaining therisk w ith him
e. A voidance ofusing w aterbed because ithad leaked w aterin the pastorgetit
thatw aterbed repaired to controlthelosses.
f. A voidanceofrunning in thepark becauseitisnotoriousfordrug dealings.
g. Transferring risk by taking children seducation policy by parents.
2. Identify the types offinanciallosses likely to be incurred by each ofthe follow ing
parties.
a. A person w ho negligently injuresanotherm otoristin an auto accident
b. A restaurantthatisshutdow n forsix m onthsbecauseofatornado
c. A fam ily w hosefam ily head diesprem aturely
d. A n attorney w ho failsto filealegalbriefon tim eforaclient
e. A tenantw hoseapartm entburnsin afire
A ns:a. Liability loss
b. Property loss/Consequentialloss
c. Personalloss
d. Liability loss
e. N o financialloss to tenantw ith regard to apartm entbutpersonalloss to his
belongings.

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C hapter2
Introduction to Insurance

SEC TIO N A

1. Theeconom icprincipleoflifeinsuranceison thebasisof


a. thelaw oflargenum bers
b. thetheory ofprobability
c. thepooling ofresources
d. utm ostgood faith
e. subrogation
2. Lifeinsurancecontractprovides
a. econom icsecurity
b. em otionalsecurity
c. legalsecurity
d. physicalsecurity
e. environm entalsecurity
3. Them ostessentialfeatureofa lifeinsurancecontractis
a. sharing ofthelosses
b. replacing uncertainty through certainty
c. to bring theinsured to thesam eposition thatexisted priorto theeventoflosses
d. Both (a)and (b)above
e. A llof(a),(b),and (c)above
4. Theeconom ictheory ofinsuranceisbased on the
a. conceptofspreading risk
b. theoriesofprobability
c. law oflargenum bers
d. Both (a)and (b)above
e. Both (a)and (c)above
5. Theam ountofhum an lifevalueiscalculated by properly discounting the
a. currentearningsoftheinsured
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b. fraction oftheincom eoftheinsured thatisused forthedependents


c. saving potentialoftheinsured
d. potentialofconsum ption expenditureoftheinsured
e. socialstatusoftheinsured
6. For the calculation of hum an life value,if the rate of discount increases,the
econom icvaluew ill
a. decrease
b. increase
c. rem ain thesam e
d. becom ezero
e. beaffected butitisim possibleto predict.
7. N eedsapproach doesnotconsiderthe
a. clean-up funds
b. readjustm entincom e
c. incom eto supportthefam ily
d. im provem entofsocialstatus
e. retirem entneeds
8. W hich ofthefollow ing isincorrectw ith referenceto lifeinsurancepolicy?
a. Itisacom pulsory savingsoption to thepolicy holder
b. Itassuresthe repaym entofthe borrow ingsagainstthe unfortunate death ofthe
policyholder
c. Itattractssuitablestam p duty forthetransferofproperty in alifeinsurance
d. Itcan beused asacollateralin caseofsom etypesofproperty dealings
e. Itallow sincom etax rebateto thepolicyholder
9. W hich ofthefollow ing can bean advantagefortaking a lifeinsurancepolicy?
a. Itprovidessecurity in caseofan unexpected contingency.
b. Itprovidesthesafety netfortherepaym entofaloan taken forthedream hom e
c. Itassures the creditors forthe repaym entofthe principaland interestofany
loan taken by thepolicyholder.
d. Both (b)and (c)above
e. A llof(a),(b)and (c)above
10. A dvantageoftaking a lifeinsurancepolicy isthat
a. itcannothelp to develop an estateaschosen by thepolicyholder
b. itdoesnotencourageto w ithdraw thesavingsprem aturely
c. itisofno useto acquireadream hom e

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d. incom etax benefitisnotallow ed fortaking thelifeinsurancecoverage


e. N oneoftheabove
11. W hen aretheproceedsofa term insurancepolicy payable?
a. O nly on death during theterm
b. O nly on survivaltilltheend oftheterm
c. A nytim eduring theterm ofthepolicy
d. N everpayable
e. N oneoftheabove
12. U nder w hich policy is the sum assured payable in case ofsurvivalonly tillthe
end oftheterm ?
a. Term insurancepolicy
b. Term endow m entpolicy
c. Pureinsurancepolicy
d. Pureendow m entpolicy
e. Endow m entinsurancepolicy
13. W hatisthenatureoftheterm insurancepolicies?
a. Low cost-high risk
b. H igh cost low risk
c. M oderatecost m oderaterisk
d. Thebestchoiceforasavingsplan
e. N o usein theliferisk coverage
14. Tillw hen underthew holelifeinsurancepolicy isthepolicy coverageavailable?
a. U p to certain ageofthepolicyholder
b. Foratenureoftw enty years
c. Likethatofapureendow m entpolicy
d. Tillthedeath oftheinsured
e. Tilltheretirem entoftheinsured

SEC TIO N A A N SW ER S
1. (c) A s per the econom ic principle of life insurance,w ithin a substantially large
population,allthe m em bersare facing the sam e kind ofrisk.A llare likely to suffer
the losses equally butonly a few of them w illhave to face the harsh reality that
cannotbe predicted in advance through hum an intelligence.H ence,the conceptof
insuranceoperatesby pooling resources.
2. (a)Life insurance contractprovides the necessary econom ic supportin case ofthe
occurrenceofprem aturedeath orexcessivelongevity ofan individual,by w hich one

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M O D U LE -I: PRIN CIPLES A N D PRA CTICE O F IN SU RA N CE

can getthe security ofcash flow s forselfas w ellas forthe dependents in case of
disability orexcessivelongevity;and forthedependantsin caseofprem aturedeath.
3. (d)In any insurance contract,the lossesofthe unfortunate few are shared by a large
num berofpersonsfacing sim ilartypesofrisks.Therefore,thefinancialuncertainties
of those unfortunate few are shared by a large num ber of individuals in order to
assurecertainty ofcash com pensation from theinsurer.Butalifeinsurancecom pany
cannotrestoretheinsured to thesam eposition priorto theeventoflosses.
4. (e)In any insurance business,the sm allam ountofprem ium ischarged upfrontfrom
the insuredsw ho m ay suffersim ilartype oflosses.Butfinally,only the unfortunate
few insureds w ill face the harsh reality that is to be indem nified from those
prem ium s.Therefore,the risks are spread.But,the application ofthe law oflarge
num bersfinally leadsto theaccuracy ofestim ation oflosses.Theoriesofprobability
areused to estim atetheam ountofprem ium underactuarialprinciple.
5. (b) The concept of hum an life value is used to evaluate the requirem ent of life
insurancecoverageofan individual.Theobjectiveofsuch estim ation isto ensurethe
sam estandard ofliving to thedependentsofaperson even afterhispre-m aturedeath.
6. (a)A sthediscountrateincreases,thedenom inatorofeach factorw illgo up,w hilethe
num erator w ill rem ain the sam e. Therefore, the ultim ate hum an life value w ill
decrease.
7. (d)Clean up fundsare required to pay offthe debtsand the readjustm entfundsare
used to m aintain thesam estandard ofliving.Incom eto supportthefam ily ism eantto
supportthenecessitiesofthechildren and w ife.Lastly,retirem entneedsconsiderthe
financialrequirem entattheold age.Buttheneed forim provem entofsocialstatusis
notconsidered.
8. (c) U nder Section 38 of the Insurance A ct, 1938, transfer of property in a life
insurance policy can be done sim ply by an endorsem enton the back ofthe policy
docum ent.
9. (e)Lifeinsurancepolicy coveragecan betaken in allsuch casesasm entioned above.
10. (b)Life insurance isa type offorced and com pulsory savingsto the policyholder.In
othertypesofsavings,onem ay w ithdraw theaccum ulated sum atthetim eofeven a
m inorliquidity crisis.Butin case oflife insurance,the policyholderhasto suffera
substantialam ountoffinanciallossto sacrificetheinsurancecoverage.
11. (a) The very nature of the term insurance policies is such that the beneficiary
proceedsarepayableonly on death during theselected term and nothing ispayablein
caseofsurvivaloftheinsured untiltheend ofthecontracted term .
12. (d)In caseofpureendow m entpolicy,thepolicyholderreceivesthepolicy valueonly
on survivaltillthe end ofthe policy term .O therw ise,nothing isreceivable from the
insurer.
13. (a)Term insurancepoliciesonly considertherisk prem ium ,operationalexpensesand
a profitfactor.Therefore,due to the absence of any savings com ponent,they are
relatively cheaper.
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M O D U LE -I: PRIN CIPLES A N D PRA CTICE O F IN SU RA N CE

14. (d)W hole life insurance policy isthe longestterm insurance policy.In thiscase,the
proceedsofthe policy are rem itted by the insurerfollow ing the death ofthe insured,
irrespectiveofitstim ing.

SEC TIO N -B

1. D efineinsurance
A ns.Insurance can be defined both from an econom ic perspective and from a legal
perspective. From an ECO N O M IC PERSPECTIV E, insurance is a financial
interm ediation function by w hich individuals exposed to a specific financial
contingency each contribute to a pool from w hich covered events suffered by
participating individualsarepaid.
From aLEG A L PERSPECTIV E ,insuranceisan agreem entby w hich oneparty,the
policy ow ner,paysastipulated consideration called the prem ium to theotherparty
called the insurerin return forw hich the insureragreesto pay a defined am ountof
m oney orprovide a defined service ifa covered eventoccursduring the currency of
thepolicy.
2. W hatarethebasiccharacteristicsofinsurance?
A ns:Thebasiccharacteristicsofinsuranceare
Pooling oflosses
Thelaw oflargenum bers
Paym entoffortuitouslosses
Risk transfer
Indem nification
1. Pooling oflosses Pooling ofrisksorthesharing oflossesistheheartof
insurance.Pooling is spreading of losses incurred by the few over the
entire group,so that,in the process,average lossissubstituted foractual
loss. It im plies (i) the sharing of losses by the entire group; and (ii)
prediction offuture lossesw ith som e accuracy based on the law oflarge
num bers.
2. The law oflarge num bers M any lines of insurance risk reduction are
based on thelaw oflargenum bers.Itstatesthatthegreaterthenum berof
exposures,the m ore closely w illthe actualresultsapproach the probable
resultsthatareexpected from an infinitenum berofexposures.
3. Paym ent of fortuitous losses Paym ent is m ade for losses that are
unforeseen and unexpected and occursasa resultofchance.Thism eans
thelossm ustbeaccidental.
4. Risk transfer In this,a pure risk is transferred from the insured to the
insurerw ho typically is in a strongerfinancialposition and is w illing to
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M O D U LE -I: PRIN CIPLES A N D PRA CTICE O F IN SU RA N CE

pay the loss than the insured (e.g.risk ofprem ature death,poorhealth,
destruction ortheftofproperty)
5. Indem nification This m eans the insured is restored to his or her
approxim atefinancialposition priorto theoccurrenceoftheloss
3. W ritea briefnoteon theLaw ofLargeN um bers
A ns:M any lines ofinsurance risk reduction are based on the law oflarge num bers.The
law statesthatthe greaterthe num berofexposures,the m ore closely w illthe actual
results approach the probable results thatare expected from an infinite num berof
exposures.
Ifthere are a large num berofexposure units,the actuallossexperience ofthe past
m ay be a good approxim ation of future losses.To charge prem ium that w ill be
adequate for paying all losses, expenses and m argin for profit, this concept is
im portantto insurer because he can predictfuture losses w ith a greater degree of
accuracy asthenum berofexposuresincreases.
4. W hatdo you m ean by R isk Transfer?
A ns.In this,apurerisk istransferred from theinsured to theinsurer,w ho typically isin a
strongerfinancialposition and isw illing to pay forthelossthan theinsured (e.g.risk
ofprem aturedeath,poorhealth,destruction ortheftofproperty).
5. W hatdo you m ean by Indem nification?
A ns.Indem nification m eans the insured is restored to his or her approxim ate financial
position priorto theoccurrenceoftheloss.
6. W hataretherequirem entsofan insurablerisk?
A ns.Insurers norm ally insure only pure risks.H ow ever,allpure risks are notinsurable.
From theview pointoftheinsurer,therequirem entsofan insurablerisk are:
Therem ustbealargenum berofexposureunits
Thelossm ustbeaccidentaland unintentional
Thelossm ustbedeterm inableand m easurable
Thelossshould notbecatastrophic
Thechanceoflossm ustbecalculable
Theprem ium m ustbeeconom ically feasible
7. H ow doesinsurancedifferfrom gam bling?
A ns.Insurance isoften confused w ith gam bling.Butthere are tw o im portantdifferences
betw een them .
1. G am bling creates a new speculative risk,w hile insurance is a technique for
handling an already existing purerisk.
2. G am bling is socially unproductive,because the w inner s gain com es at the
expense of the loser. In contrast, insurance is alw ays socially productive,
becauseneithertheinsurernortheinsured isplaced in aposition w herethegain
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M O D U LE -I: PRIN CIPLES A N D PRA CTICE O F IN SU RA N CE

ofthew innercom esattheexpenseoftheloser.Theinsurerand theinsured both


have a com m on interestin the prevention ofa loss.Both partiesw in ifthe loss
doesnotoccur.
3. G am bling transactions never restore the losers to their form er financial
position. In contrast, insurance contracts restore the position of insureds
financially in w holeorin partifalossoccurs.
8. H ow doesinsurancedifferfrom speculation?
A ns.Insuranceisdifferentfrom speculation.Insurersinsurepurerisks.Purerisk isdefined
as a situation in w hich there are only the possibilities of loss or no loss,w hile
speculation deals w ith speculative risk.Speculative risk is defined as a situation in
w hich eitherprofitorlossispossible.
2. Thelaw oflargenum bers,w hich isthebasiccharacteristicofinsurance,can be
applied m ore easily to pure risks than to speculative risks. Based on this,
insurerspredictfuturelossexperience.
3. Finally,society m ay benefitfrom a speculative risk even though a lossoccurs,
butitisharm ed ifapurerisk ispresentand alossoccurs.
9.H ow doesinsurancedifferfrom hedging?
A ns.Though both insurance and hedging techniquesare sim ilarin thatrisk istransferred
by acontract,and no new risk iscreated,therearem ajordifferencesbetw een them .
First,an insurance transaction involves the transfer ofinsurable risks,because
the requirem ents ofan insurable risk can generally be m et.H ow ever,hedging is a
technique of handling risks that are typically uninsurable,such as protection
againstdeclinein thepriceofagriculturalproductsand raw m aterials.
Second,insurance can reduce the objective risk ofan insurer by application of
law oflargenum bers.In contrast,hedging typically involvesonly risk transfer,not
risk reduction.Therisk ofadversepricefluctuationsistransferred to speculatorsw ho
believe that they can m ake a profit because of superior know ledge of m arket
conditions.Therisk istransferred,notreduced,and prediction oflossgenerally isnot
based on thelaw oflargenum bers.

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10. W hatarethetypesofInsurance?
A ns.

TY PES O F IN SU R A N C E
SO CIA L
PRIVATE IN SU RA N CE
IN SU RA N CE
{Em phasison (Focuson individualequity)
socialequity
through
incom e
redistribution}
*O A SD I LIFE H EA LTH N O N -LIFE
*M ED ICA RE
W holelife[death]

D isability incom e

accident,injury.
expensehealth,
* U N EM PT.

Liability loss

Property loss
Endow m ent

com pensation
Long term care
incapacity

M edical

W orkers
A nnuity
Term

11. D ifferentiatebetw een Lifeand N on-Lifeinsurance


A ns.LIFE IN SU RA N CE isa branch ofprivate insurance and includesthe follow ing four
classesofinsurancecoverage:
1. death:called lifeinsurance\assurance
2. living acertain length oftim e:called endow m ents,pensionsand annuities.
3. incapacity:called disability and long term care
4. injury orincurring a disease:called health insurance,accidentinsurance,and
m edicalexpenseinsurance.
N O N -LIFE IN SU RA N CE is also a branch of private insurance and includes the
follow ing coverage:
1. property losses:dam ageordestruction ofhom es
2. liability losses:paym entsdueto professionalnegligence
3. w orkerscom pensation and health insurancein som ecountries
12. W hatarethedifferentusesoflifeand health insuranceto individuals?
A ns.Theprim euseoflifeand health insuranceforindividuals,fam iliesand businessesis
to providefinancialprotection.Theotherusesare:
A ssistsin m aking saving possible
Furnishesasafeand profitableinvestm ent
Encouragesthrift
M inim izesw orry and increasesinitiative

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M O D U LE -I: PRIN CIPLES A N D PRA CTICE O F IN SU RA N CE

Furnishesan assured incom ein theform ofannuities


H elpspreservean estate
13. H ow doessociety benefitfrom theinsurance?
A ns.Them ajorsocialand econom icBenefitsofinsuranceincludethefollow ing:
Indem nification for loss: Indem nification perm its individuals, fam ilies and
business firm s to be restored to their form er financial position after a loss
occurs.Thecom m unity also benefitsbecauseitstax baseisnoteroded.
Less worry and fear: W orry and fear are reduced for a fam ily and property
ow nerboth before and aftera loss because the insureds know thatthey have
insurancethatw illpay fortheloss.
Source ofinvestm entfunds:The insurance industry is an im portantsource of
fundsforcapitalinvestm entand accum ulation.Investm entsincrease society s
stock of capitalgoods,and prom ote econom ic grow th and fullem ploym ent.
Insurersalso investin socialinvestm ents,such ashousing,nursing hom esand
econom ic developm entprojects.In addition,the totalsupply ofloanable funds
isincreased by theadvancepaym entofinsuranceprem ium s,thecostofcapital
to business firm s that borrow is low er than it w ould be in the absence of
insurance.
Lossprevention:Society benefitswith the involvem entofinsurance com panies
directly and indirectly in thelossprevention activitiessuch as
H ighw ay safety and reduction ofautom obiledeaths
Fireprevention
Reduction ofw ork related disabilities
Prevention and detection ofarson losses
Prevention and defectiveproductsthatcould injuretheuser
Prevention ofauto thefts
Prevention ofboilerexplosions
Educationalprogram m eson lossprevention.
Enhancem entofcredit:Insurance enhances a person s credit.A nd itm akes a
borrow era bettercreditrisk because itguaranteesthe value ofthe borrow er s
collateralorgivesgreaterassurancethattheloan w illberepaid.
14. H ow m ightone assessthe im pactofthe Life Insurance Industry on the general
econom y?
A ns.TheU nited N ationsConferenceon Tradeand D evelopm ent[U N CTA D ]noted thatan
efficientinsurancem arketcan aid in overalleconom icdevelopm entin thefollow ing
w ays:
It can contribute to social stability by perm itting individuals to m inim ize
financialstressand w orry.

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M O D U LE -I: PRIN CIPLES A N D PRA CTICE O F IN SU RA N CE

It can reduce the financial burden on the state of caring for the aged and
destitutes.
Itcan benefittheeconom y by creating asourceoffinancing fornew businesses,
housing and farm ing,etc.
Itgeneratesem ploym ent.
Itcan perm itm ore favourable term sto borrow ers;decrease the risk ofdefault;
and m inim izefinancialdisruption dueto death ofkey em ployeeand ow ner.
It can prom ote better em ployee/em ployer relations and provide low cost
benefitsto abroad spectrum ofpersonsw ho m ay otherw isehavebeen unableto
obtain such protection.
Insurance and Econom ies:A study by the O rganization forEconom ic Cooperation
and D evelopm ent[O ECD ]observesthatinsurance providesatleastthree categories
ofservicesim portantto econom ies.Theseare:
Substituteforgovernm entsecurityprogram m es Thestudy ofO ECD countries
found a significantnegative relationship betw een socialexpenditures and life
insuranceprem ium s.
M obilizes savings Role of savings in econom ic developm ent is crucial.
Insurers actas financialinterm ediaries and reduce transaction costs betw een
saversand borrow ers,createliquidity and facilitateeconom iesofscale.
Fosters a m ore efficient capital allocation. Insurers gather substantial
inform ation to provide funds to the m ostattractive firm s and projects,show
continuing intereston them ,m onitor entrepreneurs and foster m ore efficient
allocation ofacountry sscarcefinancialcapital.
15. Insuranceentailscertain coststo Society Explain
A ns: The Costs of Insurance: A lthough insurance offers societies great social and
econom icbenefits,italso carriescertain costs.Theseare:
Costsofdoing business
Fraudulentclaim s
Inflated claim s
C osts of doing business: O ne im portant cost is the cost of doing business.A n
expense loading [the am ountneeded to pay allexpenses,including com m issions,
generaladm inistrativeexpensesand an allow anceforcontingenciesand profit]m ust
be added to the pure prem ium to coverthe expensesincurred by com paniesin their
daily operations.H ow ever,these additionalcostscan be justified from the insured s
view pointofengaging in a w ide variety oflossprevention activities.A nd from the
industry view point,itprovidesjobsto m illionsofw orkers.
Fraudulentclaim s:A second costofinsuranceencouragesm oralhazardslike
Faked auto accidents
Fakeslip and fallaccidents

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M O D U LE -I: PRIN CIPLES A N D PRA CTICE O F IN SU RA N CE

Phony burglaries,thefts,and vandalism


Falsehealth insuranceclaim s
M urders,etc.
Thesesocialcostsfalldirectly on society.
Inflated C laim s: Subm ission of inflated or padded claim s though loss is not
intentionally caused by theinsured like
A ttorneysforPlaintiffssueforhigh liability judgem entsthan thetrueeconom ic
lossofthevictim .
Inflatetheam ountofdam agein autom obilecollision claim s.
D isabled personsoften m anageto collectdisability incom ebenefitsforalarger
duration.
In sum m ary,the socialand econom ic benefits ofinsurance generally outw eigh the
socialcosts.Insurance reduces w orry and fear,contributes its service to econom ic
and socialstability and provides financialsecurity to individuals and firm s.So the
socialcosts ofinsurance can be view ed as the sacrifice thatsociety m ustm ake to
obtain thesebenefits.
16. Explain theeconom icbasisoflifeand health insurance
A ns.Theeconom icbasisoflifeand health insurancearisesoutoffam ily purposesorfrom
businesspurposes.W ecan classify theFA M ILY PU R PO SES as
sourcesoftheeconom icvalueofthehum an life
preservation offam ily econom icsecurity
m oralobligation to provideprotection
BU SIN ESS PU R PO SES
K ey person indem nification
Creditenhancem ent
Businesscontinuation
Em ployeebenefitplans
N EED S A PR O A C H :U ndertheconceptsw hich influencedem and forinsurancethis
needsapproach ishaving practicalvalue.M cgillsegm ented theneedsinto
Clean up Fund [hospital,doctor s,nurse sbills,burialexpenses,legalfees,etc.]
Readjustm entshock [to cushion theeconom icand em otionalshock]
Criticalperiod incom eforchildren
Lifeincom eforsurviving dependentspouse
Special needs [m ortgage redem ption, educational needs, em ergency needs
[illness,surgery,etc.]
Retirem entneeds
H ence the econom ic basis of insurance determ ines how m uch life and health
insuranceshould becarried likeany otherproduct.

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17. Explain H um an LifeValueC oncept and itssignificanceto lifeinsurance.


A ns.H um an lifevalue:Thehum an lifevalueconceptisonesegm entofthegeneraltheory
ofhum an capital.Therelationship betw een lifeinsuranceand hum an capitalhasbeen
acknow ledged through the hum an life value concept. In 1924, the late
D r.S.S.H uebnerproposed thisconcept.Itm easurestheactualfutureearningsorvalue
ofservices ofan individual,i.e.the capitalized value ofan individuals future net
earningsaftersubtracting selfm aintenancecostsuch asfood,clothing and shelter.
In connection w ith life and health insurance,the econom ic value ofa hum an life is
derived from both (a)itsearning capacity and (b)the financialdependence ofother
lives{ororganizations} on thatearning capacity.

SEC TIO N C
C A SE STU D IES
1. There are num erous definitions ofinsurance.Based on the definition ofinsurance
stated in the text,indicate w hethereach ofthe follow ing guarantees is considered
insurance.
a. A television setisguaranteed by them anufactureragainstdefectsfor90 days.
b. A new setofradialtiresisguaranteed by them anufactureragainstroad defects
for50,000 m iles.
c. A builderofnew hom esgivesaten-yearguaranteeagainststructuraldefectsin
thehom e.
d. A consigner of a note agrees to pay the loan balance if the originaldebtor
defaultson thepaym ents.
e. A largegroup ofhom eow nersagreeto pay forlossesto hom esthatburn during
theyearbecauseoffire.
2. Theexistenceofinsuranceprom ptssom einsuredsto deliberately causealossso asto
profitfrom insurance.Thesesocialcostsfalldirectly on society.G ivesom eexam ples
ofsuch fraud.
3. D oestherisk offirefulfilltherequirem entofan insurablerisk?
4. D oestherisk ofunem ploym entfulfillstherequirem entofan insurablerisk?

SEC TIO N C A N SW ER S
1.(a)-N o (b) N o (c) N o (d) N o (e) Yes

2. (a) Creating a fraudulentclaim


Staged orfakeauto accident.
Staged slip-and-fallaccident.
Falseclaim offoreign objectin food ordrink.

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Faking adeath to collectbenefits.


M urderforprofit.
Phony burglary,theft,orvandalism .
A rson orintentionalw aterdam age.
Staged theftofauto.
Staged hom eow neraccidentorburglary.
(b) O verstating am ountofloss
Inflating bodily injuriesin auto accident.
Inflating valueofterm staken in burglary ortheft.
Inflating dam ageclaim from m inorfenderbender.
M edicalprovidersinflating billing orcoding ofm edicalprocedures.
(c) M isrepresenting factsto receivepaym ent
Claim ing preexisting dam ageoccurred in currentaccident.
Claim ing dam agesto auto w hen noneoccurred.
Claim ing m inorinjury createspartialortotaldisability.
Receiving disability paym entsand w orking elsew here.
(d) M isrepresentation to receivepaym ents
Claim ing falsedisability.
Providing unnecessary m edicaltreatm ent.
Charging form edicaltestsnotcarried out.
U pcoding form edicineby issuing genericpillsand charging fornam ebrands
Personalinjury m illsofdoctors,law yers,and claim ants.
(e) M isrepresentation to obtain a policyorlowerprem ium s
M isrepresenting health inform ation on life insurance and then subm itting a
falseclaim .
M isrepresenting nam e, date of birth, or social security num ber and then
subm itting afalseclaim .
(f) Insiderand internalfraud
A gentorinsurerpocketing prem ium s,then issuing no policy oraboguspolicy.
A gentorinsurerissuing fakepolicies,certificates,ID cards,orbinders.
A gentorinsurerm aking falseentry on docum entorstatem ent.
3. Yes.

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Requirem ents D oestherisk offiresatisfytherequirem ents?


1. Largenum berof Y es.N um erousexposureunitsarepresent
exposureunits
2. A ccidentaland Yes.W ith the exception ofarson,m ostfire losses are
unintentionalloss accidentaland unintentional
3. D eterm inableand Yes.If there is disagreem entover the am ountpaid,a
m easurableloss property insurance policy has provisions forresolving
disputes.
4. N o catastrophicloss Yes. A lthough catastrophic fires have occurred, all
exposureunitsnorm ally do notburn atthesam etim e.
5. Calculablechance Yes.Chance offire can be calculated,and the average
ofloss severity ofafirelosscan beestim ated in advance.
6. Econom ically Yes.Prem ium rateper$100 offireinsuranceis
feasibleprem ium relatively low.

4. Yes.

Requirem ents D oestherisk ofunem ploym entsatisfythe


requirem ents?
1. Largenum berof N ot com pletely. A lthough there are a large num ber of
exposureunits em ployees,predicting unem ploym entis difficultbecause
ofthedifferenttypesofunem ploym entand labour.
2. A ccidentaland N o. A large proportion of unem ploym ent is due to
U nintentionalloss individualsw ho voluntarily quittheirjob.
3. D eterm inableand N ot com pletely. The level of unem ploym ent can be
m easurableloss determ ined,butthem easurem entoflossisdifficult.Som e
unem ploym ent is involuntary; how ever, som e
unem ploym entisvoluntary.
4. N o catastrophicloss N o. A severe national recession or depressed local
businessconditionscould resultin acatastrophicloss.
5. Calculablechance N o.Thedifferenttypesofunem ploym entgenerally aretoo
ofloss irregularto estim atethechanceoflossaccurately.
6. Econom ically N o.A dverse selection,m oralhazard,and the potentialfor
feasibleprem ium acatastrophiclosscould m aketheprem ium unattractive.

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C hapter 3
TheFundam entalLegalPrinciplesof
G eneralA nd LifeInsurance

SEC TIO N -A

1. H ow isthelegality oftheobjectofa contractsatisfied in caseofa lifeinsurance


contract?
a. Through theapplication oftheprincipleofindem nity.
b. Through theapplication oftheprincipleofsubrogation.
c. Through theapplication oftheprincipleofinsurableinterest
d. Through theapplication oftheprincipleofutm ostgood faith.
e. Through theapplication oftheprincipleofproxim atecause.
2. W hattype offactm ay be considered as m aterialfactin case ofan insurance
contract?
a. Factsthattend to renderarisk proposed greaterthan norm al.
b. Factsnecessary to explain theexceptionalnatureofrisk proposed forinsurance
w here,w ithoutthem ,theinsurerw illjustifiably believethattherisk isnorm al.
c. Factsw hich appearto suggestsom especialm otiveforinsurance.
d. Factsw hich show thattheproposerhim selfisin som ew ay abnorm al
e. A lltheabove.
3. W hich of the follow ing facts is/are not required to be disclosed by the
proponent?
a. Factsthatareapartoflaw
b. Factsthatreducetherisk oflosses.
c. Factsthatarepublished in thenew spapers.
d. Factsw hich can beobtained from theinform ation provided by theinsured.
e. A lloftheabove
4. W hatisthedifferencebetw een representation and w arranty?
a. A representation need only be substantially correct w hile a w arranty m ust
strictly and literally becom plied w ith
b. A n insurer cannot repudiate its liability against an im proper representation,
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unlessthatisproved to beam aterialonew hileany thing w rong in thew arranty


issufficientto avoid theliability.
c. A representation doesnotlead to any risk to the policyholderw hile a w arranty
m ay lead to seriouscontingency to thepolicyholder.
d. Both (a)and (b)above
e. A llof(a),(b)and (c)above
5. In w hich casetheprincipleofindem nity isapplicable?
a. A lltypesofinsurances
b. N on-lifeinsuranceonly.
c. Lifeinsuranceonly
d. Either(b)or(c)above
e. N oneoftheabove
6. In caseoflifeinsurancecontract,how istheconceptofindem nity follow ed?
a. Through theassessm entofprem ium paying capacity.
b. Through theassessm entofinsurancecoveragerequirem ent.
c. Through theassessm entofthetenureofinsurance.
d. Both (a)and (b)above
e. A llof(a),(b)and (c)above
7. W hatisthesim ilarity betw een insuranceand w agering contract?
a. Both arelegally enforceable.
b. Both typesofcontractsneed theexistenceofinsurableinterest.
c. Both typesofcontractsassessthepossibility oflosses.
d. Both typesofcontractsfollow theprincipleofutm ostgood faith.
e. In both typesofcontract,thecounterpartiesw illsufferthesam etypeoflosses.
8. X ispresently suffering from tuberculosisbutin the proposalfor obtaining the
required insurance coverage atthe norm alrate,he did notm ention it.Itisan
actof
a. Coercion
b. U ndueinfluence
c. Fraud
d. M isrepresentation
e. M istake
9. W hich ofthefollow ing relationshipsD O ES N O T haveany insurableinterest?
a. Proponentand hisow n life
b. H usband and w ife.
c. Fatherand son.
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M O D U LE -I: PRIN CIPLES A N D PRA CTICE O F IN SU RA N CE

d. Proponentand hisfriend
e. Em ployerand em ployee.
10. W hich of the follow ing relationships leads to lim ited am ount of insurable
interest?
a. Insurerand Insured.
b. Partnersin abusiness.
c. D ebtorand creditor.
d. Both (b)and (c)above.
e. A llof(a),(b),and (c)above.
11. In a typical case, the proponent of a life insurance contract w rote the age
w rongly w hile the insurer issued a policy other than the applied one.W hatw ill
betheim pactoftheein thecontractbetw een theinsurerand insured?
a. Itisacaseinvolving coercion and hencethecontractw illbenulland void.
b. Itinvolvesundue influence ofthe insureron the insured and hence no contract
isadm issiblebetw een theparties.
c. Itisam atterofm isrepresentation by theinsurerand so voidableatthew ishesof
theinsurer.
d. Theproponentisinvolved in theactoffraud and so theinsurercan suehim .
e. Both the parties have com m itted m istakes and hence the contract is
unenforceable.

SEC TIO N A A N SW ER S
1. (c)Principle ofinsurable interestis the m ostim portantfeature ofa life insurance
contractto m aintain the legality ofthe objectofthe contract.Ifthe existence ofthe
insurableinterestisnotconsidered properly,itw illam ountto gam bling.
2. (e)A llthe given situationsw illplace the insurerin a m ore risky position w hich isa
essentialpartform aking theunderw riting decisionsby theinsurer.
3. (e) These facts are expected to be know n to the insurers ow ing to their levelof
know ledge and understanding as w ell as their underw riting skills. H ence, the
proponentneed notbew orried abouttheirdisclosures.
4. (d) A ny representation m ade by the policyholder can lead to the risk of
m isrepresentation w hile a w arranty m ay lead to a serious contingency to the
policyholder.
5. (b) The principle of indem nity m eans m aking good the losses suffered by an
unfortunate person.Butin a life insurance contract,itis im possible to assess the
valueoflifeofan individualand so theprincipleofindem nity cannotbeapplied.
6. (d)O ne cannotbuy a life insurance policy forany unlim ited am ountatany pointof
tim e. The insurance com pany assesses the prem ium paying capacity and the
insurancecoveragerequirem entoftheproponent.Thisisdonein orderto ensurethat
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M O D U LE -I: PRIN CIPLES A N D PRA CTICE O F IN SU RA N CE

the insurance coverage should notbe cum bersom e to the insured.Sim ultaneously,
the insurance proceedsshould be sufficientenough to m aintain the sam e standard of
living,follow ing thestoppageofincom eoftheinsured.
7. (c)In a life insurance contract,the insurerassessesthe possibility ofthe lossesfrom
the m ortality tables.In a w agering contract,the possibility of losses is estim ated
eitherby em piricaljudgem entoranalytically depending on thesituation.
8. (c)Fraud occursw hen theproposerintentionally suppressesthem aterialinform ation
atthe tim e ofsubm ission ofan offer.In the life insurance business,the disease of
tuberculosis seriously affects the risk profile of the insured and hence itm ay be
considered asm aterialinform ation to theinsured.
9. (c)Exceptthe proponentand his ow n life,as w ellas husband and w ife,no other
em otionalrelationship leadsto any insurableinterest.
10. (e) The relationships in all the given cases lead to lim ited am ount of insurable
interest.In the firstcase,the insureris liable to provide the contracted benefits on
death or disability of the insured as contracted.W hile in the other tw o cases,the
extentofinsurable interestislim ited to the am ountofcapitalbroughtby the partner
to thebusinessand theam ountoutstanding in thebooksofthecreditor.
11. (e)Ifboth the parties to a contractcom m itted m istakes atthe tim e ofm aking the
contract,thecontractw illbetreated asnulland void.A saresultofthat,neitherofthe
party w illbeliableto otherregarding theexecution ofthecontractsincetheessential
ingredientofa contract i.e.consensusad idem ism issing in thiscase due to the
actsofboth theparties.

SEC TIO N -B
1. W hat are the fundam entalprinciples related to G eneraland Life Insurance
C ontracts?
A ns.The m ostim portantfundam entalprinciples related to G eneraland Life Insurance
Contractsare
1. U tm ostgood faith
2. Indem nity
3. Insurable interest
4. Subrogation
5. Contribution
6. Proxim atecause
2. Explain w hy an insurancecontractisconsidered ofutm ostgood faith and notof
caveatem ptor?
A ns.A n insurancecontractisbased on theprincipleofutm ostgood faith.Theprincipleof
utm ostgood faith is supported by three im portantlegaldoctrines:representations
concealm ent[intentionalfailure ofthe applicantforinsurance to reveala m aterial
factto the insurer] and breach of w arranty [prom ise m ade by the insured in the
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M O D U LE -I: PRIN CIPLES A N D PRA CTICE O F IN SU RA N CE

contract].Each party [insured and insurer]to the contractisentitled to rely on good


faith upon the representationsofthe other.The rule ofcaveatem ptor[letthe buyer
bew are]doesnotgenerally apply.The Insurerbelievesin the representationsofthe
Insured.Representationsofinsured are statem entsofhisorherage,w eight,height
occupation,state ofhealth,fam ily and personalhistory.A nd from the insurer sside,
itisintricateand highly technical.H ereboth thepartiesareunderan obligation notto
attem ptto deceive orw ithhold m aterialinform ation from the other.The insurance
contractis voidable atthe insurer s option ifthe representation is m aterial,[ifthe
insurerknow s the true facts,the policy w ould nothave been issued orw ould have
been issued on different term s] false, reliance [the insurer relies on the
m isrepresentation in issuing the policy ata specified prem ium ] and innocent or
unintentionalm isrepresentation.
3. Explain theprincipleofindem nity.A nd w hataretheexceptionsto thisprinciple
ofindem nity?
A ns.Itis one ofthe im portantlegalprinciples in Insurance.The principle ofIndem nity
statesthattheinsureragreesto pay no m orethan theactualam ountoftheloss,w hich
m eans the insured should not profit from a loss. A nd this principle has tw o
fundam entalpurposes:1.To preventtheinsured from profiting from aloss;and 2.To
reducem oralhazard.
Thisindem nity isdifferentfordifferenttypesofinsurance.
In property insurance ,the basic m ethod forindem nifying the insured isbased on
the actualcash value ofthe dam aged property atthe tim e oflossand thiscash value
can be determ ined through 3 m ajor m ethods such as 1.replacem ent cost less
depreciation,2.fairm arketvalue,and 3.broad evidencerule.
In liability insurance,theinsurerpaysupto thepolicy lim it.
In life insurance,the am ountpaid w hen the insured dies is the face value ofthe
policy.Lifeinsuranceisnotacontractofindem nity.
In business incom e insurance, the am ount is paid on the loss of profits and
continuing expensesw hen the businessisshutdow n because oflossfrom a covered
peril.
Exceptions:The m ajorexceptionsto the principle ofindem nity are 1.valued policy
[pays the face am ountex.Paym entforthe loss ofantiques];2.valued policy laws
[differ from state to state]; 3. Replacem ent cost insurance [no deduction for
depreciation ];4.Lifeinsurance[a valued policy].
4. W hat problem s m ight arise if life policies w ere contracts of indem nity and
property and liability policiesw erevalued contracts?
A ns.Theprincipleofindem nity statesthattheinsureragreesto pay no m orethan theactual
am ountoftheloss.In thecaseoflifepoliciestheam ountispaid w hen theinsured dies.
Theactualam ountoflossofhum anlifevalueiscapitalizedthroughthefacevalueofits
policy.Itisonly avalued contractand itcannotbeacontractofindem nity.
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M O D U LE -I: PRIN CIPLES A N D PRA CTICE O F IN SU RA N CE

Ifitisacontractofindem nity,theprincipleofpaying actualam ountofthelosscan-


notbeoperated.
5. W hatis an insurable interest? W hy is an insurable interestrequired in every
insurancecontract?
A ns.Itisan im portantlegalprinciple.Itstatesthattheinsured m ustbein aposition to lose
financially ifalossoccurs,orto incursom eotherkind ofharm ifthelosstakesplace.
To preventgam bling,to reducem oralhazard and to m easuretheam ountofthe
insured sloss[in property insurance]allinsurance contractsm ustbe supported by
an insurable interest.There isa difference betw een an insurable interestin property
and liability insuranceand lifeinsurance.
IN PRO PERTY A N D LIA BILITY IN SU RA N CE (a) O w nership of property can
supportan insurable interestbecause he losesfinancially ifhisproperty isdam aged.
(b)Potentiallegalliability also can supportan insurableinterestin theproperty ofthe
custom erbecause these firm sare legally liable fordam age to the custom ers goods
caused by theirnegligence.(c)Secured creditorsalso havean insurableinterestin the
property pledged to them .(d)A contractualrightalso can supportan insurableinterest.
(e)In property insurance,theinsurableinterestm ustexistatthetim eoftheloss.
IN LIFE IN SU RA N CE there isno question ofinsurable interestifthe life insurance
ispurchased on theirow n life.Ifthe life insurance policy ispurchased on the life of
anotherperson,this person should have an insurable intereston thatperson s life.
Close ties of blood or m arriage or a pecuniary interestw illsatisfy the insurable
interestrequirem entin life insurance.A nd thisrequirem entm ustbe m etonly atthe
inception ofthepolicy and notatthetim eofdeath.Lifeinsuranceisnotacontractof
indem nity butisavalued policy thatpaysastated sum upon theinsured sdeath.
6. Explain theprincipleofsubrogation.W hy issubrogation used?
A ns.Theprincipleofsubrogation strongly supportstheprincipleofindem nity.A ccording
to G eorge E.Rejda,subrogation m eans substitution of the insurer in place of the
insured forthe purpose ofclaim ing indem nity from a third person fora losscovered
by insurance.Ex.In an accidenttheinsured victim giveslegalrightsto theinsurerto
collectdam agesfrom the negligentthird party instead ofcollecting him selfdirectly
from the third party.The m ain purposesofsubrogation are a.to preventthe insured
from collecting twice forthe sam e loss,b.to hold the negligentperson responsible
forthelossand c.to hold down insurancerates.
Insurerm ustpay beforeheclaim ssubrogation.
Theinsured cannotim pairtheinsurer ssubrogation rights.
The insurercan w aive itssubrogation rightsin the contracteitherbefore orafterthe
loss.
Subrogation doesnotapply to life insurance and to m ostindividualhealth insurance
contractsbecauselifeinsuranceisnotacontractofindem nity and subrogation relates
to only contractsofindem nity.
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M O D U LE -I: PRIN CIPLES A N D PRA CTICE O F IN SU RA N CE

Finally,insurercannotsubrogate againstitsow n insured because itdefeatsthe basic


purposeofpurchasing insurance.
7. W hatarethedifferencesbetw een subrogation and contribution?
A ns.Theprincipleofsubrogation strongly supportstheprincipleofindem nity.A ccording
to G eorge E.Rejda,subrogation m eans substitution of the insurer in place of the
insured forthe purpose ofclaim ing indem nity from a third person fora losscovered
by insurance. Subrogation and Contribution are corollaries to the principle of
indem nity.Both these arise only in property insurance.Contribution arisesw ith the
liberty ofdouble insurance w hich m eans the assured can insure the sam e property
w ith m orethan oneinsurerand thattoo w ith overinsurance.Theconditionsto satisfy
this right of contribution are all the insurance m ust relate to the sam e subject
m atter,they should coverthe sam e interestofthe sam e insured,they should cover
sam e peril,and allofthem should be in force atthe tim e ofloss.W hen allthese
conditionsaresatisfied then theinsurerw ho haspaid firstin thefulltheassured,can
claim contribution from theotherco-insurers.A nd thisclaim am ountdependson the
aggregate ofrateable clause orcontinentallaw .Though the doctrinesofsubrogation
and contribution areim portantcorollariesofindem nity,they differw ith each other.
Subrogation C ontribution

Thelossshiftsfrom oneperson to Thelossisdistributed am ong insurers


another
Itisagainstthird party Itisin betw een insurers.
O neinsurerand onepolicy M orethan oneinsurer
Therightoftheinsured isclaim ed Therightoftheinsurerisclaim ed.

8. W hatisthelegaldoctrineofproxim atecause?
A ns.The legaldoctrine ofproxim ate cause isbased on the principle ofcause and effect.
A nd itdoesnotconcern itselfw ith the cause ofcauses.The law providesthe rule
causa proxim a non rem ota spectatur w hich m eansto beproxim ate,acausem ustbe
im m ediate cause,w hich is effectualin producing thatresultbutnotthe rem ote or
distantone.A nd thiscause hasto be selected by applying com m on sense standards,
i.e.thestandardsofam an in thestreet.
A n insurance policy is designed to provide com pensation only for insured perils
[nam ed in the policy as insured ex. fire, theft, etc.] but not for uninsured [not
m entioned in the policy]and excepted orexcluded [stated in the policy asexcluded]
perils.A nd theliability oftheinsurerarisesonly ifthelossiscaused by an insured.
Theselection ofproxim atecauseisnotan easy and sim pletask becauselossm ay be
caused by severaleventsacting sim ultaneously orone afterthe other.Itisnecessary
to differentiatebetw een theinsured peril,theexcepted periland theuninsured peril.

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M O D U LE -I: PRIN CIPLES A N D PRA CTICE O F IN SU RA N CE

A pplication ofthe doctrine:Itis,notthe latest,butthe direct,dom inant,operative


and efficientcausethatm ustberegarded asproxim ate.
Ifthere are concurrentcauses,i.e.causeshappening togetherand no excluded
perilisinvolved,thereisliability underthepolicy.
W hen an insured periland an excepted periloperate togetherto produce the
loss,theclaim w illbeoutsidethescopeofthepolicy.
Ifthe resultsofthe operation ofthe insured perilcan be easily separated from
theeffectsoftheexcluded peril,then thereisliability underthepolicy.
W here severalevents occur in unbroken sequence and no excepted perilis
involved,theinsurerisliableforalllossresulting from theinsured peril.
Ifan excepted perilprecedesthehappening ofan insured peril,thereisno claim
Ifthe insured perilisfollow ed by an excepted peril,there isa valid claim for
part,atleast,oftheloss.
If the happening of an excepted peril is follow ed by the occurrence of an
insured peril,as a new and independentcause,there is a valid claim forloss
caused by thehappening ofan excepted peril.
M odification ofthe doctrine:In the eventofloss,the onusofproof[orburden of
proof]is on the insured.H e has to prove thathis loss is proxim ately caused by an
insured peril.Theonusisshifted to theinsurer,iftheinsurerarguesthatthelossw as
caused by an excepted insurer w ill peril. They have to prove that the loss w as
proxim ately caused notby theinsured peril,butby theexcepted peril.
V alueofthedoctrine:Thisdoctrineservesnotonly to definethescopeofcoverage
underthe contractbutserves also to protectthe relative rights ofthe parties to the
contract.
Itm aintainsabalancebetw een therightsoftheinsuredsand insurers.
In theabsenceofthisrule,every losscould beclaim ed by theinsured and every
losscould berejected by theinsurer
It allow s for the application of com m on sense to the interpretation of an
insurancecontractto them utualadvantageoftheparties.

SEC TIO N C
(C A SE STU D IES)
1. M any proponentsfeelthatfilling up ofthe proposalform isa boring and tiresom e
job and theagentoftheinsurancecom pany should takecareofthat.Butactually,that
should notbe the case.The proposerhim selfissupposed to fillup the sam e on his
ow n.D espite that,m any prefer the agentto do the job and m ostof the tim e the
hapless agents do it w ithout asking for any details of the health status of the
proponent.This innocent act m ay run into a nightm are,if the policyholder dies
w ithin tw o yearsfrom the date ofcom m encem entofthe policy.In such a situation,
m andatory investigationsare carried outbefore passing such claim sand the insurer

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M O D U LE -I: PRIN CIPLES A N D PRA CTICE O F IN SU RA N CE

m ay rejectthe claim ,ifthe probe reveals thatthe policyholderhad w ithheld som e


inform ation w hich w asm aterialinform ation forthe purpose ofunderw riting by the
insurer.Itistheresponsibility oftheproponentto fillup theproposalform w hilethe
agentm ay only help him .Regulationstoo do notallow an agentto go beyond this.
a. D espiteacontract,how can theinsurerrepudiateitsliability?
b. H ow can you apply theconceptofw arranty in thiscontext?
c. H ow can you differentiatebetw een aw arranty and arepresentation?
d. D iscussthelegalauthority oftheinsurerto repudiateitsliabilities.
2. It is therefore the duty of the proposer to disclose, clearly and accurately, all
m aterialfacts relating to the proposed insurance. D iscuss the facts thatare to be
disclosed by theproponentasw ellasthefactsthatarenot.
3. K rishna purchased an autom obile service station from V enkata Rao.The purchase
price included the building,equipm ent,and otherassets.The businessw asfinanced
by a loan from N ationalBank,w hich held a m ortgage on the building.K rishna also
converted a one-carrepairbay into a short-orderrestaurant.W hen K rishna applied
forproperty insurance on the business,he did nottellthe insurance com pany about
the restaurantbecause his prem ium s w ould have been substantially increased.Six
m onthsafterthe businessopened,a carcaughtfire and dam aged the roofovera bay
in theservicestation area.
a. D o any ofthefollow ing partieshavean insurableinterestin thebusinessatthe
tim eofthefire
1. V enkatRao
2. K rishna
3. N ationalBank
b. V enkatRao told K rishna he could save m oney by taking overV enkatRao s
insurance instead ofbuying a new policy.W ould itbe appropriate forK rishna
to takeoverV enkatRao sinsurancew ithoutnotifying V enkatRao sinsurer?
c. Investigation ofthe fire revealed thatthe carow nerknew the gas tank had a
leak, but this inform ation w as not disclosed to K rishna w hen the car w as
broughtin forservice.Explain how subrogation m ightapply in thiscase.
d. D id K rishna show utm ostgood faith w hen he applied forproperty insurance on the
business?Explain.
e. Could K rishna s insurer deny coverage for the fire on the basis of a m aterial
concealm ent?Explain.

SEC TIO N C A N SW ER S
1. (a) In thiscase,there isa high possibility thatthe agentm ay com m itm istake and
that m ay turn into a m isrepresentation on the part of the policyholder.
M oreover,thepolicyholderhasto provideaw arranty regarding thecorrectness
of allthe facts m entioned therein.Therefore,the contractw illbe treated as
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M O D U LE -I: PRIN CIPLES A N D PRA CTICE O F IN SU RA N CE

voidable atthe option ofthe insurerow ing to m isrepresentation,ifany thing


w rong isw ritten in theproposalform .
(b) A w arranty is a prom ise collateralto the m ain contract,so thatif there is a
breach,itm erely gives a rightto dam ages and does notgo to the rootofthe
contract.In insurancecontracts,how ever,aw arranty correspondsto acondition
in ordinary com m erciallaw ;thatisto say,itentitlestheparty,aggrieved by the
breaking ofaw arranty,to repudiatethecontracteitherab initio orfrom thedate
of the breach,according to the term s of the contract.A w arranty m ust be
com plied w ith strictly and literally.Itm akesno difference w hetherthe breach
ofw arranty is m aterialorim m aterial,fraudulentorinnocent,orw hetherthe
insurerw ould have been equally ready to insure atthe sam e prem ium ifaw are
ofthebreach.
(c) Thedifferencesbetw een arepresentation and aw arranty areasfollow s:
(i) A representation,even w hen m aterial,need only be substantially correct,
w hereasaw arranty m ustbestrictly and literally com plied w ith.
(ii) Before a m isrepresentation can be held to be sufficient to enable the
insurerto avoid the contract,itm ustbe show n to be m aterialto the risk.
O n the otherhand,w ith a w arranty,any breach issufficientto avoid the
contract,w hetheritism aterialornot.
(iii) W hereasa representation doesnotappearin the policy,a w arranty m ust
beincorporated in thepolicy,w hetherexpressly orby reference.
(d) To protect the claim ants and policyholders against any excessively harsh
application ofthe duty ofdisclosure on the partofthe proposerby the insurer,
Section 45 of the Insurance A ct, 1938, also called Indisputability or
Incontestability Clause,has given the authority to the insurer to repudiate a
claim in thefollow ing cases:
The policyholdersuppressed certain factsand those factsw ere m aterialforthe
underw riting decision m aking by the insurerifany death claim arises w ithin
tw o yearsfrom thedateofcom m encem entofrisk.
Butifany death claim occursaftertw o yearsfrom the date ofcom m encem ent
ofthe risk,an insurerm ay repudiate itsliability to honourthe claim underthe
follow ing criteria:
The policyholdersuppressed certain factsand those factsw ere m aterialforthe
underw riter s decision m aking by the insurer and also those facts w ere
intentionally suppressed by theinsured.
2. The duty ofdisclosure m ustbe observed throughoutthe negotiationsand continues
untilthey are com pleted and the contractisoperative.The contractisdeem ed to be
operative w hen the proposalisaccepted by the insurer.Thisiscalled the condition
ofcontinued insurability w hich operatesfrom thedateoftheproposaland thedate
ofitsacceptance.
M aterialfacts,w hich areto bedisclosed,includethefollow ing:
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M O D U LE -I: PRIN CIPLES A N D PRA CTICE O F IN SU RA N CE

(i) Factsw hich tend to renderarisk proposed greaterthan norm al.


(ii) Factsnecessary to explain theexceptionalnatureofrisk proposed forinsurance
w here,w ithoutthem ,theinsurerw ould justifiably believetherisk to benorm al
(Earlierproposalaccepted w ith specialconditions)
(iii) Facts w hich appear to suggestsom e specialm otive for insurance.e.g.gross
overinsurance(particularsofpreviousinsuranceto bedisclosed).
(iv) Facts w hich show thatthe proposer him self is in som e w ay abnorm al.e.g.
revivalm ay havebeen declined in an earlierpolicy.
In the absence of an enquiry, the follow ing facts need not be disclosed.
Consequently,they haveno effecton thevalidity ofthecontract:
f. Factsw hich lessen therisk proposed forinsurance
g. Facts w hich could or should be inferred by the insurer in the w ake of the
particularsbeing actually disclosed.
h. Factsofpublicknow ledge,such astheexistenceofastateofw ar,orfactsw hich
should beknow n to theinsurerin theordinary courseofhisbusiness.
i. M attersoflaw .
j. Factsw ith the possibility ofdiscovery w here the insurerhasbeen given enough
inform ation to provokeenquiry on hispart.Thedetailsfurnished by theproposer
in such circum stancesm ustbeadequateto fulfillhisduty ofdisclosure.
k. Facts w hich can be reasonably concluded are a m atter of indifference to the
insurer,or regarding w hich he has w aived inform ation.e.g.if the proposer
insertsadisk in an answ erto aproposalform question and theinsurerm akesno
furtherenquiry.
l. Factsw hich aresuperfluousto discloseby reason ofaw arranty in theproposed
insurance.
3. (a) Y es.K rishnaishaving insurableinterestatthetim eoffire.
(b) N o, It is not appropriate for K rishna to take over V enkat Rao s insurance
w ithoutnotifying V enkatRao sinsurer.
(c) Theinsurerofthecaraftercom pensating forthelossto theinsured,can recover
thelossfrom thefirestation ow ner/K rishna sinsurer.
(d) N o,K rishnadid notshow utm ostgood faith by notrevealing them aterialfactof
opening ashortorderrestaurantin acarrepairbay.
(e) Y es,the insurercan deny the coverage forthe concealm entofm aterialfactby
assum ing thatthefireisdueto restaurantoperations.

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M O D U LE -I: PRIN CIPLES A N D PRA CTICE O F IN SU RA N CE

C hapter4
Insurance C ontracts

SEC TIO N -A

1. W hatisthem inim um num berofpartiesrequired fora legally valid contract?


a. O ne
b. Tw o
c. Three.
d. Four.
e. Five
2. R am sendsa proposalalong w ith therequisitem oney to theN ew Vision Insurers
seeking therequired lifeinsurancecoverageforhim self.Lateron,hefound that
H orizon Insurersw illbe a better choice for him .U p to w hich pointoftim e,he
can cancelhisproposalforinsurance?
a. W ithin onem onth from thedateofdispatch oftheproposal
b. Priorto thereceiptofhisproposalby theinsurer
c. Beforetheevaluation ofhisproposalby theinsurer
d. Beforem aking any decision abouthisproposalby theinsurer
e. Beforetheacceptanceoftheproposaliscom m unicated by theinsurer
3. W hen is the C om m unication of A cceptance by post treated as com plete as
againsttheproposerortheofferer?
a. O n receiptby theofferer.
b. A ssoon astheletterisposted.
c. A nytim eduring thetransitoftheletter.
d. A ssoon astheletterofofferisaccepted by theofferee.
e. A ssoon astheletterisprepared by theofferee.
4. W hich ofthefollow ing rendersan offerto belapsed?
a. A cceptanceoftheofferin theprescribed m anner.
b. A cceptanceoftheofferw ithin theprescribed tim elim it.
c. Through acounterofferby theofferee.
d. By therevocation oftheofferby theofferee.

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M O D U LE -I: PRIN CIPLES A N D PRA CTICE O F IN SU RA N CE

e. N oneoftheabove.
5. W hich of the follow ing is not an essential requirem ent of a legally valid
contract?
a. Freeconsentbetw een theparties
b. Com petency to contractby theparties
c. Law fulconsideration
d. Legalobject
e. Expressly declared by theactto bevoid
6. W hich ofthefollow ing leadsto incapacity to contract?
a. M inorageofany party
b. U ndischarged insolvent
c. Citizen ofan enem y country
d. Both (a)and (b)above
e. A llof(a),(b)and (c)above
7. W hich ofthefollow ing considerationsisdeem ed aslaw ful?
a. Theconsideration w hich isforbidden by law
b. Theconsideration w hich w illdefeattheprovision ofany otherlaw oftheland
c. Theconsideration w hich w illim posesom erestrictionson both theparties
d. Theconsideration w hich w illlead to som efraudulentactivity
e. Theconsideration w hich isopposed to thepublicpolicy
8. W hich ofthefollow ing isN O T a partofthepolicy docum ent?
a. Theheading
b. Thepream ble
c. Theobjectiveclause
d. Theoperativeclause
e. Theproviso
9. W hatisthecontentofthepream bleofa lifeinsurancepolicy?
a. Thenam eand addressoftheinsurancecom pany
b. Theintention oftheinsurerand theinsured in briefand in generalterm s
c. Therightsand responsibilitiesoftheinsured and theinsurerundertheinsurance
contract
d. The conditions to be follow ed and privileges ofthe insured forenjoying the
insurancecoverage
e. Stam psand signatureoftheauthorized officeroftheinsurancecom pany
10. W hatisthecontentoftheoperativeclauseoflifeinsurancepolicy?

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M O D U LE -I: PRIN CIPLES A N D PRA CTICE O F IN SU RA N CE

a. Thenam eand addressoftheinsurancecom pany


b. Theintention oftheinsurerand theinsured in briefand in generalterm s
c. The obligations and responsibilities of the insured and the insurer under the
insurancecontract
d. The conditions to be follow ed and privileges ofthe insured forenjoying the
insurancecoverage
e. Stam psand signatureoftheauthorized officeroftheinsurancecom pany
11. W hen w ill an insurance com pany be liable to pay the benefits, if the
policyholdercom m itssuicide?
a. A fterthreem onthsfrom thepolicy date
b. A ftersix m onthsfrom thepolicy date
c. A ftersix m onthsfrom thedateofcom m encem entofthepolicy
d. A fteroneyearfrom thepolicy date
e. Therisk ofsuicidecannotbecovered
12. In order to avoid the forfeiture clause,prem ium s for atleasthow m any years
arerequired to bepaid by thepolicyholder?
a. O neyear
b. Tw o years.
c. Threeyears.
d. Fouryears.
e. Fiveyears
13. W hich ofthefollow ing isoneofthedutiesofan insuranceagent?
a. To disclosethescalesofcom m ission in respectoftheinsuranceproductoffered
forsale,ifasked by theprospect
b. To solicitorprocureinsurancebusinessw ithoutholding avalid license
c. To includetheprospectto om itany m aterialinform ation in theproposalform
d. To interferew ith any proposalintroduced by any otheragent
e. To dem and or receive a share of proceeds from the beneficiary under an
insurancecontract
14. Paym entofprem ium to an L.I.C .agentcannotbe regarded aspaym entto the
insurerbecause
a. L.I.C.agentsare notauthorised to collectprem ium in accordance ofrule 8 of
A gentsRegulation 1972
b. Satisfactory arrangem ents forpaym entofprem ium existin L.I.C offices and
hencepaym entofprem ium to an agentisnotnecessary
c. L.I.C.feelstheagentm ay m isappropriatetheprem ium
d. N oneoftheabove
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M O D U LE -I: PRIN CIPLES A N D PRA CTICE O F IN SU RA N CE

15. W hatis consideration on the partofthe insured in respectofa life insurance


contract?
a. A prom iseto takeanew policy
b. Thepaym entm adetow ardsprem ium by theinsured
c. Theinsured sprom iseto pay theprem ium underthepolicy
d. Proposal com pleted and signed by the person seeking insurance is called
consideration
16. Thepolicyholder sduty to disclosem aterialfactsliesatthetim eof
a. Taking apolicy
b. Revivalofthepolicy
c. Reinstatem entofsurrendered policy
d. A lltheabove
17. W hich oneofthefollow ing isconsidered an uninsurableperil
a. Lossesarising outoffire
b. Lossesarising outofw arand w ar-likeoperations
c. Property risk
d. Travelrisks
18. A ccording to the M arine Insurance A ct1963,a contractofm arine insurance is
valid
a. O nly w hen itisin w riting
b. O nly w hen itisverbal
c. O nly ifitfulfilstheessentialsofavalid contract
d. Itcan bean oralagreem entoraw ritten contract

SEC TIO N A A N SW ER S
1. (b)Foralegally valid contract,them inim um num berofpartiesshould beatleasttw o
the prom isorw ho m akesthe prom ise and the prom isee w ho receivesthe prom ise.
Both sidesofthecontractshould beaw areoftheirrespectiveconsiderations.
2. (e)In thiscase,Ram isoffering m oney to theinsurancecom pany and thereby seeking
insurance coverage from it.The contractbetw een Ram and the insurance com pany
w illbeestablished,iftheofferisaccepted by theinsurer.H ow ever,theofferm ay be
revoked by Ram anytim e prior to the com m unication of its acceptance by the
insurancecom pany.
3. (b)A ssoon asthe letterofacceptance isposted by the offeree,the com m unication
w ith respectto theacceptanceoftheoffered isdeem ed to becom pleteasperthelegal
requirem entofacontract.
4. (c)M aking a counterofferby the offeree im pliesanotherofferto the offererand the

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M O D U LE -I: PRIN CIPLES A N D PRA CTICE O F IN SU RA N CE

position oftheoffererand theoffereeisgetting changed by thatproposal.Therefore,


a counterofferinitiates anothercontractbetw een the tw o parties w hile the earlier
offergetslapsed.
5. (e)Ifthe contractis expressly declared by the A ctas void,itcannotbe called as a
legally valid contract.
6. (e)U nderthe Indian ContractA ct,1872,a m inor,an undischarged insolventorthe
citizen ofan enem y country arenoteligibleto sign acontract.
7. (c) A ny consideration that is forbidden by the law or defeated by the applicable
regulations or is opposed to the public policy, cannot be considered as a legally
acceptablecontract.H ow ever,through acontract,both thepartiesm ay putsom elaw ful
restrictionson eithersideaspartofthecontractualbenefitsto bederived by them .
8. (c)Thereisno partin alifeinsurancepolicy thatiscalled asobjectiveclause.
9. (b)Thepream bleofalifeinsurancepolicy describesbriefly theintention ofboth the
partiesto theengagem entofsuch akind ofcontract.
10. (c) In the operative clause, the responsibilities and obligations of both parties
insured and insurer are m entioned. The insured is liable to pay the prem ium s
regularly w hile the insurer is obliged to disburse the secured benefits on the
happening ofthecontracted event.
11. (d) In case of suicide by the policyholder w ithin one year from the date of
com m encem entofrisk,thepolicy shallbevoid,otherw isetheclaim can beadm itted.
12. (c)A spertheInsuranceA ct,1938,alifeinsurancepolicy,w hereundertheprem ium s
are paid fora continuousperiod ofthree years,cannotw holly lapse butw illacquire
som e guaranteed surrendervalue.This privilege is referred to as N on-forfeiture
regulation.
13. (a)Itshould bedoneasperregulation 8 thatspecifiesthecodeofconductofan agent
holding alicenseofagency.
14. a 15. b 16. d 17. b 18. a

SEC TIO N -B

1. W hatisthenatureofan InsuranceC ontract?


A ns.Thelifeinsurancecontracthasdistinguishing featuresw ith thecontractlaw.A n offer
and acceptance,legal capacity,valid consideration and a lawful agreem ent are
sufficientforany contractto be valid.A partfrom these requirem entsthe insurance
contracthassom em orecharacteristicslike
A dhesion
Conditional
U nilateral
A leatory
Personal

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M O D U LE -I: PRIN CIPLES A N D PRA CTICE O F IN SU RA N CE

2. G ivea briefnoteon
A dhesion contract
Valued policy
U nilateralcontract
Conditionalcontract
A leatory contract
Personalcontract
A ns.A dhesion C ontract:A contractofadhesion m eansthatthe insured m ustacceptthe
entire contract,w ith allitsterm sand conditionsw hich are fixed by the insurer.Itis
highly specialized and technicalin nature and prevents itfrom being a bargaining
contract.
Valued Policy:U nlike property insurance,life insurance contractisa valued policy
w hich m eans the insurer agrees to pay a stated sum of m oney irrespective of the
actualeconom ic loss w hich is opposite to the contractof indem nity applicable to
property insurance.
U nilateral C ontract: U nlike com m ercial contracts w hich are bilateral in nature,
insurance contractsare unilateralin nature.Itm eansthatonly one party,the insurer,
givesa legally enforceable prom ise and the insured cannotbe legally forced to pay
the prem ium s. But of course, the insurer is bound to accept them and provide
protection to theinsured w hen they pay prem ium sin tim ely m anner.
C onditionalC ontract:A n insurancecontractisaconditionalcontract.Theinsurer s
obligation to pay aclaim dependsupon theconditionsw hich areinserted in thepolicy
likepaym entofprem ium s,proofofdeath and in thecaseofproperty lossim m ediate
noticeoflossto theinsurer,etc.
A leatory C ontract:U nlikeacom m utativecontract,an insurancecontractisaleatory.
Itm eans thatthe values exchanged m ay notbe equalbutinvolve the elem entof
chance oran uncertain event.In this,one party m ay receive m ore in value than the
other.The insured m ay receive m ore than the am ounthe paid in prem ium sw hen the
lossoccursim m ediately aftertheacceptanceofapolicy.A nd theinsurerm ay receive
m orein valueifthelossdoesnotoccurto theinsured w hen thepolicy w asin force.
PER SO N A L C O N TR A C T:Property insurance is a personalcontractbetw een the
insurerand theinsured.In this,insurerinsurestheow nerofproperty againstlossbut
notthe property.Insured property isindem nified ifthere isany lossand itcannotbe
assigned to another party w ithoutthe insurer s consent.Butlife insurance can be
assigned to any onebecausetheassignm entdoesnotaltertherisk.
3. W hatarethebasicrequirem entsofan InsuranceC ontract?
A ns.Thebasicrequirem entsofan insurancecontractare:
O fferand acceptance.
Consideration.
Com petentparties.
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M O D U LE -I: PRIN CIPLES A N D PRA CTICE O F IN SU RA N CE

Legalpurpose.
O fferand acceptance:A n agentm erely solicitsorinvitestheprospectiveinsured to
m akean offer.Theapplicantforinsurancem akestheoffer,and thecom pany accepts
or rejects the offer. This accepting procedure is different for property, liability
insurance and life insurance.In property insurance,the offerand acceptance can be
oralorw ritten and theagentshavethepow erto bind theircom paniesthrough theuse
ofa binderw hich is a tem porary contract.Butin life insurance,the agentdoes not
have the pow erto bind the insurer.The application forlife insurance is alw ays in
w riting and itshould beapproved by theinsurerbeforeitisin force.
C onsideration:Itrefersto thevaluethateach party givesto theother.Theinsured s
consideration ispaym entoraprom iseto pay theprem ium and an agreem entto abide
by the conditions in the policy.The insurer s consideration is the prom ise to do
certain thingsw hich arespecified in thecontract.
C om petentparties:Insane persons,intoxicated personsand m inorsare notlegally
com petentto enterinto insurancecontracts.
Legalpurpose:A llillegalactivitiesw hich are contrary to the public interestare not
enforceable.A contractshould havealegalpurpose
4. D escribethebasicpartsofan InsuranceC ontract:
A ns.Insurancecontractsgenerally can bedivided into
D eclarations
D efinitions
Insuring agreem ent/O perativeclause
Exclusions
Conditions
M iscellaneousprovisions
G enerally,m ostoftheinsurancecontractscontain theseparts:
D eclarations:In thedeclaration partinform ation regarding property oractivity to be
insured by theinsurerispresented.Itisusefulforunderw riting and rating purposes.It
is generally found on the first page of the policy. In property insurance, the
declaration page contains inform ation regarding the identification of the insurer,
nam e of the insured, location of the property, period of protection, am ount of
insurance, am ount of the prem ium , etc. In life insurance, the declaration page
containstheinsured snam e,age,prem ium am ount,issuedateand policy num ber.
D efinitions:Insurance contractsgenerally contain a page ofdefinitions.They are in
eitherquotation m arksorin bold face type.Forex.The insurerisalw aysreferred to
as w e our or us and the insured is referred to as you and your .These
definitionsm akeeasy to determ inethecoverageunderthepolicy.
Insuring A greem ent:Itisthe m ostim portantpartin the contact.Itsum m arizesthe
m ajorprom isesand conditionsto fulfilthe prom isesby the insurer.In property and
liability insurance there are tw o form sofan agreem ent.1.Nam ed perilpolicy and 2
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M O D U LE -I: PRIN CIPLES A N D PRA CTICE O F IN SU RA N CE

allrisk coverage.In the nam ed perilpolicy the policy covers only the specified
perils,w hereasunderan allrisk coverage policy the policy coversalllossesexcept
those losses specifically excluded.A llrisks coverage is preferable to nam ed perils
coverage because ofitsbroad coverage and also asthe burden ofproofto deny the
paym entis placed on the insurerunlike the insured in the nam ed perilpolicy.Life
insurance isan exam ple ofallriskspolicy itcoversallcausesofdeath w ith som e
exceptionslikesuicide,aviation,w ar,etc.
Exclusions:Therearethreetypesofexclusionsin an insurancecontract:
a. Excluded perils[ex.Theperilofw arisexcluded in disability incom epolicy]
b. Excluded losses [ex.Professionalliability losses are excluded from personal
liability section ofhom eow nerspolicy]
c. Excluded property [ex.Carsand planesin ahom eow nerspolicy]
M ain REA SO N S fortheseexclusionsare:
Som eperilsareuninsurablelikew ars.
Som eperilsarepredictabledeclines[w earand tearand inherentvice]
Som eperilsareextraordinary hazards[in carsand cabs-cabsarem oreproneto
accidentsthan car]
To avoid duplication ofcoverage [ex.A caris excluded underhom e ow ners
policy becausecariscovered underthepersonalauto policy]
To avoid m oralhazard -Ifunlim ited am ountofm oney w ere covered fradulent
claim scould increase.
Finally exclusions are used because the coverage is notneeded by the typical
insured.
C onditions:To m eetprom isesby the insurer,the conditionssection im posescertain
dutieson the insured.Ifthe policy conditionsare notm et,the insurercan refuse to
pay theclaim .
M iscellaneous Provisions: In property and liability insurance, m iscellaneous
provisionsreferto cancellation,subrogation,and assignm entofthe policy;and in life
insurance,graceperiod,reinstatem entofalapsed policy and m isstatem entofage,etc.
M ostof the policy ow ners m ake a com m on m istake of notreading policies and
understanding the contractualprovisions thatappear in the policies w hich lead to
controversies in the settlem ent. To avoid this, study of basic parts of insurance
contractw ould beuseful.
5. Identify the m ajor types of exclusions typically found in insurance contracts.
W hy areexclusionsused by insurers?
A ns.EX CLU SIO N S are basic partof any insurance contract.There are three types of
exclusionsin theinsurancecontract.
a. Excluded perils[ex.Theperilofw arisexcluded in disability incom epolicy]
b. Excluded losses [ex.Professionalliability losses are excluded from personal

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M O D U LE -I: PRIN CIPLES A N D PRA CTICE O F IN SU RA N CE

liability section ofhom eow nerspolicy]


c. Excluded property [ex.Carsand planesin ahom eow nerspolicy]
M ain REA SO N S fortheseexclusionsare
Som eperilsareuninsurablelikew ars.
Som eperilsarepredictabledeclines[w earand tearand inherentvice]
Som eperilsareextraordinary hazards[in carsand cabs-cabsarem oreproneto
accidentsthan car.]
To avoid duplication ofcoverage [ex.A caris excluded underhom e ow ners
policy becausecariscovered underthepersonalauto policy.]
To avoid m oralhazard -Ifunlim ited am ountofm oney w erecovered,fradulent
claim scould increase.
Finally exclusions are used because the coverage is notneeded by the typical
insured.
6. D efinetheterm conditions in an insurancecontract.W hatisthesignificanceof
theconditionssection to theinsured?
A ns.The conditions section is an im portant part of an insurance contract. The
CO N D ITIO N S are provisions in the policy thatqualify orplace lim itations on the
insurer sprom iseto perform .So theconditionssection im posescertain dutieson the
insured.Ifthepolicy conditionsarenotm et,theinsurercan refuseto pay theclaim .
7. H ow do you constructan insurancecontract?
A ns.G enerally speaking,theconstruction oftheinsurancecontractasto itsvalidity w illbe
governed by the law and usages ofthe place w here the contractis m ade.Like any
otherlegalcontract,the construction ofan insurance contractalso depends on the
agreem entbetw een com petentparties,resulting from an offerand acceptance,m ust
com ply w ith legalrequirem ents as to form and have forits purpose a legalobject.
Therem ustbeavaluableconsideration,an insurableinterestand thecontractm ustbe
m ade w ith fullknow ledge of m aterialfacts and be free from fraud,m istake and
m isunderstanding.A nd policy form sare necessarily generalin character,since they
are draw n to m eeta generalsituation and notw ith reference to particularcases.But
becauseofam biguity in thew ording and varying circum stancessurrounding theloss,
the chance of disputes as to the interpretation m ay occur.To avoid this there are
certain legalprinciplesunderlying the interpretation ofthe application,asw ellasof
policy provisions,thatare keptin m ind by the courts as guiding principles in their
effortsto interpretthecontract.
Ex.
1. Courtsconsiderfireinsuranceisacontractofindem nity w hereaslifeinsurance
is not a contract of indem nity though the principle of indem nity is a
fundam entallegalprincipleofan insurancecontract.
2. In the case ofcontractofadhesion and endorsem ent,generally the courtsw ill

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M O D U LE -I: PRIN CIPLES A N D PRA CTICE O F IN SU RA N CE

givethebenefitofthedoubtto theinsured on theground thatthecontractisnot


abargaining contract.
3. Finally,itis the purpose of the law and function of the courtto enforce the
contractw hen there is no conflictor am biguity betw een the tw o com petent
partiesinsured and theinsurer.
8. D escribethescheduleofan insurancepolicy.
A ns.Lifeinsurancepoliciesaregenerally tw o types
N arration typeand
Scheduled type
In the N A RRATIO N TY PE the contractcontains continuous details in a long
narration w hich isnotpopularin m odern tim es.
SCH ED U LED TY PE ispopularin m odern tim es.Itcontains
D ateofexecution oroperation
parties nam es
Pream bleorrecitals[objectofthedeed]
O perativeclauseorconsideration [insurer sprom iseto pay thesum assured to
theinsured on thecondition ofscheduled paym ents]
Covenants of title and conditions [covenants like a.right to convey,b.for
freedom from encum brances, c. for further assurance and conditions like
declaration ofageinsurableinterest,valuableconsideration,etc.]
Scheduleorparcels[accuratedescription oftheproperty in property insurance
and BenefitSchedule [particulars of the assured,the eventinsured,the sum
assured,the payees,etc..]and payable schedule [particularsofthe paym entof
datesoffirstprem ium ,renew alprem ium etc..in lifeinsurance.]
H abendum [thequantity oftheinterestorestateoftheassignee].
Execution [prescribed articlesforexecution ofthedeed].
A ttestation ofsignature.
D elivery unlessadeed isdelivered itw illnotbeoperative.
Thereshould beagreatcarein drafting thepolicy.Thereshould notbeany am biguity
in thew ording and itshould reflecttheintention oftheboth theparties.
9. W hat is an endorsem ent or rider? If an endorsem ent conflicts w ith a policy
provision,how istheproblem resolved?
A ns. Insurance contracts generally contain endorsem ents and riders. The term s
endorsem entsand ridersare interchangeable.Endorsem entsin property and liability
insurancem odify,extend ordeleteprovisionsfound in theoriginalpolicy.In lifeand
health insurance,riders can be added thatincrease or decrease benefits,w aive a
condition ofcoverage presentin the originalpolicy oram end the basic policy.Ifan
endorsem entiscontrary to alaw orregulation,thepolicy isread and applied asifthat

I-43
M O D U LE -I: PRIN CIPLES A N D PRA CTICE O F IN SU RA N CE

endorsem entdid notexist.


10. W hy do deductibles appear in insurance contracts? Identify som e deductibles
thatarefound in insurancecontracts.
A ns.Thisprovision isgenerally found in property,health and auto insurancecontractsand
not in life insurance contracts because the insured s death is a total loss and
deductiblesreducethefaceam ountofinsurance.A ccording to Rejda,adeductibleis
aprovision by w hich aspecified am ountissubtracted from thetotallosspaym entthat
otherw isew ould bepayable.M ain purposesofthesedeductiblesare
To elim inatesm allclaim s[expensiveto handleand process].
To reduceprem ium s[largerdeductiblesarepreferableto sm allerdeductibles].
To reducem oraland m oralehazard [becauseofitinsured m ay notprofitoutof
lossand itencouragesinsured to becarefulofhisproperty]
D eductiblesin property insurancearetw o types:
Straightdeductibles[appliesto each loss]
A ggregate deductibles [allcovered losses are added togethertillthey reach a
certain levelforaparticularperiod.]
D eductiblesin health insurancegenerally are:
Calendaryeardeductible[aggregate]
Corridordeductible[itisasupplem entplan to m ajorm edicalexpenseplan]
Elim ination [w aiting]period deductibles[disability incom econtractfortheloss
ofw ork earnings]
11. W hatisC oinsurance?
A ns.Itisa contractualprovision in com m ercialproperty insurance.U nderthisclause the
insured m ustinsuretheproperty forastated percentageofitsinsurablevalue[actual
cash valueorreplacem entcost]to collectin fullforapartialloss.Ifthiscoinsurance
isnotm etatthetim eofloss,theinsured m ustsharein thelossasaco-insurer.Theco-
insuranceform ulais
A m ountofinsurancecarried
= x loss= am ountofrecovery
A m ountofinsurancerequired
A m ount of insurance required is the actual cash value of the property x %
coinsuranceclausein thepolicy.
The precaution in applying this coinsurance form ula is thatthe am ountpaid can
neverexceed the am ountofthe actuallossand should be lim ited to the face am ount
oftheinsurance.
The m ain PU RPO SE ofco-insurance isto achieve equity in rating [the insured w ho
m akes co-insurance receives a rate discountand w ho is under-insured is penalized
through application of the coinsurance form ula] But practical PRO BLEM S IN

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M O D U LE -I: PRIN CIPLES A N D PRA CTICE O F IN SU RA N CE

O PERATIN G CO IN SU RA N CE clausearisefrom changesin theactualcash valueof


the property due to inflation orw ith increase in inventory values w ith increase in
stock ,etc.
12. D escribe a typical coinsurance clause [percentage participation clause] in a
m ajorm edicalpolicy?
A ns.Coinsurance in health insurance is technically know n as Percentage Participation
Clause.U nderthistheinsured hasto pay acertain percentageofm edicalexpensesin
excess of the deductibles.The PU RPO SE to introduce this participation is 1.To
reduce prem ium s,and 2.To preventoverutilization ofpolicy benefitslike expensive
m edicalservices.

SEC TIO N C
(C A SE STU D IES)
1. Joshuaow nsam otorboatthatstruck and dam aged anotherboatanchored atam arine.
W hen theaccidentoccurred,Joshua sfriend,Zoe,w asoperating them otorboat.The
ow nerofthe dam aged boathasasked Zoe to pay forthe dam age.Joshua islisted as
thenam ed insured on thedeclarationspageofaboatow nersliability policy.Joshua s
policy included thefollow ing provisions:
W hatiscovered?
W e w illpay allsum s w hich an insured becom es legally obligated to pay as
dam ages due to bodily injury or property dam age arising out of the ow nership,
m aintenance,oruseofthedescribed vessel.
W hatisnotcovered
W e do notcoverliability arising from the ow nership,m aintenance,oruse ofthe
described vessel:
1. thatresultsfrom an intentionalactofan insured
2. to personsw hile they are being tow ed by the described vesselasw aterskiers,
aquaplaners,orsim ilarw atersports.
D efinitions
1. Thew ords you and your m ean thepersonsnam ed on thedeclarations.
2. Thew ords w e , us ,and our m ean thecom pany providing thisinsurance.
3. Bodily Injury m eansbodily harm ,sickness,ordiseaseto aperson.
4. Insured m eans you and:
your spouse;
your relativesifresidentsofyourhousehold;
personsundertheageof21 in your care;
aperson w ho operatesacovered vesselw ith your perm ission.

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M O D U LE -I: PRIN CIPLES A N D PRA CTICE O F IN SU RA N CE

Property dam age m eansan injury to orthedestruction ofproperty.This


includesthelossofuse.
a. The above provisions referto a described vessel.Identify the section of
thepolicy thatw ould describeJoshua sm otorboat.
b. Explain w hether Joshua s policy w ould provide coverage for the claim
againstZoe.Identify the policy provisionsthatw ould be relevantin this
situation.
c. The ow nerofthe dam aged boatuses the boatto transportcustom ers for
deepseafishing.Theow nerisalso holding Zoeresponsibleforthelossof
revenuesw hiletheboatisbeing repaired.Explain w hetherJoshua spolicy
w ould pay forthelostrevenues.
d. A ssum e thata skiertow ed by Joshua s m otorboatis injured because of
Joshua snegligence.Iftheinjured skiersued Joshuafortheinjury,w ould
Joshuabecovered underthepolicy?Explain.

SEC TIO N -C A N SW ER S
1. (a) D eclaration
(b) Joshua s Policy can provide coverage for the claim againstZoe.The policy
provision in thissituation isthatunderthe D efinitions aperson w ho operates
acovered vesselw ith your perm ission isalso included.
(c) Yes, Joshua s policy w ould pay for the lost revenues because under the
provision w hatis covered the dam age arising outof the use of described
vesselisalso covered.
(d) N o,becauseskiersarenotcovered undertheprovision w hatisnotcovered .

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M O D U LE -I: PRIN CIPLES A N D PRA CTICE O F IN SU RA N CE

C hapter5
M anagem entofInsurance O rganizations

SEC TIO N -A

1. Insuranceinstitutionsarebasically
a. Financialinstitutions
b. Investm entinstitutions
c. M utualfundsinstitutions
d. Lending institutions
2. Theregulatorofinsurancecom paniesin India is
a. SEBI
b. IRD A
c. LPA
d. TA C
3. The authority responsible in the redressalofdisputes betw een the insurer and
theinsured isknow n as
a. O m budsm an
b. A rbitrator
c. Judge
d. A dvocate
4. O m budsm an isa
a. G overnm entalbody
b. Sem i-governm entalbody
c. Sem i-quasibody
d. Sem i-judicialbody
5. Theinsuranceom budsm an pronounces
a. Statem ents
b. D ecree
c. Aw ards
d. Rew ards

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M O D U LE -I: PRIN CIPLES A N D PRA CTICE O F IN SU RA N CE

6. TheTA C in India ism ainly concerned w ith the


a. Regulating ofrates
b. Issuanceofpolicies
c. Investm entsofthefunds
d. Licensing oftheagents
7. W hich ofthefollow ing isnota partoftheunderw riting process?
a. Selecting policy holders
b. D eterm ining m arketsforinsuranceproducts
c. D eterm ining theinsurer sselection criteria
d. Supervising therateprocess
8. Ifan insurer charges low prem ium rate,he w illgain a com petitive advantage
through
a. Production efficiencies
b. Risk -selection process
c. A dverseselection
d. Both aand b
9. The acceptance of substandard exposure in return for other m ore profitable
businessisgenerally described as
a. U nderw riting audit
b. U nderw riting guide
c. Policy statem ent
d. A ccom m odation
10. W hich ofthefollow ing isreferred to asgeneralinsurance
a. Publicinsurance
b. Property insurance
c. Privateinsurance
d. Personalinsurance
11. Thebrokerin an insurancebusinessistherepresentativeofa
a. A gent
b. Insurer
c. Insured
d. Principal
12. A n individualexperiencem odification program m ethatusesthecurrentyearas
theexperienceperiod to develop theexperiencem odification factoriscalled
a. Schedulerating

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M O D U LE -I: PRIN CIPLES A N D PRA CTICE O F IN SU RA N CE

b. Retrospectiverating
c. Experiencerating
d. Policy rating
13. The gross prem ium includes besides risk prem ium a percentage of loading
factorfor
a. Expenses
b. Pastlosses
c. A dverseclaim sexperience
d. Profits
14. The process of evaluating risks and fixing rates in an insurance com pany is
called
a. U nderw riting
b. Ratem aking
c. U nderrating
d. Reinsurance
15. W hich ofthefollow ing m easuresareintended to low erfrequency oflosses?
a. Lossprevention m easures
b. Losscontrolm easures
c. Lossreduction m easures
d. Lossm inim ization m easures
16. The processofinsuring lossesfor an entire class,territory ,or book ofbusiness
isknow n as
a. Treaty reinsurance
b. Portfolio reinsurance
c. Facultativereinsurance
d. Proportionalreinsurance
17. Excessoflosstreatiescan beclassified as
a. Peroccurrence
b. Perrisk
c. A ggregateexcess
d. A lltheabove
18. W hich ofthe follow ing is the m osteffective form ofreinsurance for handling
lossfrequency variations?
a. A ggregateexcesstreaty
b. Facultativetreaty

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M O D U LE -I: PRIN CIPLES A N D PRA CTICE O F IN SU RA N CE

c. catastrophetreaty
d. pro ratatreaty
19. W hen a reinsurer shareshislossexposure(s)w ith other reinsurer(s),itiscalled
as
a. Reinsurance
b. Retrocession
c. Retention
d. Re-reinsurance
20. W ho am ong thefollow ing doesnotcom eunderthecategory ofclaim sadjusting
personnel?
a. A ssessor
b. Exam iner
c. Claim ssupervisor
d. A djuster

SEC TIO N A A N SW ER S
1. a 2. b 3. a 4. c 5. c 6. a
7. d 8. d 9. d 10.b 11.c 12.b
13.a 14.b 15.a 16.b 17.d 18.a
19.b 20.a

SEC TIO N -B

1. U nderw riting issaid to betheheartofinsuranceoperations.Explain thefactors


that are considered by insurance com panies w hen underw riting vehicle
exposures?
A ns:G enerally, insurers m easure the desirability of a vehicle by analyzing the
characteristicsofthe insured drivers.M any system sare used forevaluating the loss
potentialofprivate asw ellascom m ercialautom obile applicants.Som e ofthe m ajor
underw riting factorsthatareconsidered forevaluating thelosspotentialare:
i) A geofoperators
ii) A geand typeofautom obile
iii) U seoftheautom obile
iv) D riving record
v) Territory orradiusofoperation
vi) Sex and m aritalstatus
vii) O ccupation
viii) Personalcharacteristics
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M O D U LE -I: PRIN CIPLES A N D PRA CTICE O F IN SU RA N CE

ix) Physicalcondition
x) Safety equipm ent
A geofoperators U sually,considerably higherratesarecharged foryoung drivers.
Thisisdueto thegreaterinvolvem entofyoung driversin fatalaccidents.
A ge and type ofautom obile A correlation exists betw een the age ofthe vehicle
and its m echanical condition. The type of autom obile m ay also determ ine
underw riting acceptability.Sportsand luxury carstend to producehigherlossesthan
otherm odels.
U se ofthe autom obile U nderw riting ofautom obiles also takes into accountthe
type ofroadsthe autom obile runson (highw aysorcity roads,)the distance covered
by iton adaily basis,and thepurposeforw hich theautom obileisused (forbusiness
use,forpleasure,etc.)
D riving record The record orpriorlosshistory ofthe driveristaken into account
w hen evaluating aprivatepassengerautom obileapplicant.
Territory or radius of operation A ccidentfrequency depends notonly on the
territory in w hich the autom obile is used butalso on the distance travelled by the
autom obile.
Sex and m aritalstatus Young fem ale drivers are considered to be m ore careful
driversthan young m aledrivers,and arethereforeconsidered betterthan m aledrivers
in term soflossexposure.
O ccupation Som e occupations require extensive driving. This increases the
probability ofloss.
Personalcharacteristics The creditinform ation of applicants is often used by
insurers to evaluate their financial stability. U nderw riters have discovered a
correlation betw een poorcreditrisk and poorinsurancerisk.
2. W hat are the risk dim ensions of underw riting in the insurance business as
opposed to thesecuritiesbusiness?
A ns.Investors seek diversification of risks and com m ensurate m arket rates of return.
O therw ise, it m ay lead to pile up of high price/earnings (P/E) m ultiple stocks.
Therefore,generally,investorstry to m aintain abalancebetw een therealrisk and the
perceived risk and desireto haveabalanceofhigherand low erP/E stocks.P/E ratio
m easure risk adjusted ratesofreturn.They indicate the degree ofrisk asw ellasthe
expectation ofearningsand cash flow sin thenearterm .
Buyersofinsurancew antastableand creditquality m arket,w hich providesthem w ith
a reasonable ability to forecastand budgetrelated costs.The risk involved in the
insurancebusinessistheunexpected orfortuitouscausesoflossdefined in thepolicies.
U nderw riting firm s,on a portfolio basis,focus on m atching assets and liabilities.
H ow ever,they m aintain a reasonable degree of liquidity in order to pay claim s.
Further,in the insurance business,the insurerhas gotthe responsibility tow ards its
policyholdersapartfrom the investm entphilosophy ofm aintaining safe high-credit
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M O D U LE -I: PRIN CIPLES A N D PRA CTICE O F IN SU RA N CE

quality (low eryields)fixed incom e investm ents.G enerally,insurersm aintain a rate


ofreturn betw een 6 and 10 percent.
Insurersm ore orlessabide by the regulationsofthe regulatory authoritiesto avoid
losses.A spertheregulations,they hold stocksin theirinvestm entportfolios.
In thesecuritiesbusiness,investorsseek abalanceofrisk and slighttilttow ardshigh
risk and expectan array ofreturns.Thecapitalm arketfirm sproclaim aboutthehigh
returnsin the m arket.Butthisispossible because theirportfoliosw ould have large
inventories of higher risk investm ents.For exam ple,there is big correction in the
m arket in recent tim es w ith the bursting of Inform ation Technology bubble.
Therefore,those w ho invested heavily in such stocksare now correcting theirbook
values to the low erofcostorm arketas required by generally accepted accounting
principles(G A A P).
3. A m ajority ofinsuranceclaim spertain to lossescaused by fire.U nderw riting of
naturaldisastersalso constitutesa m ajor portion ofinsurance activities.W hat
are the possible losses that can arise due to disasters? Suggest a broad
fram ew ork fordisasterm anagem entin orderto m inim izesuch losses?
A ns.A naturaldisasterisdefinedasanynaturalphenom enon,w hichcausessuchw idespread
lossesto lives,property ortheenvironm ent,from w hich theaffected population cannot
recoverw ithoutexternalassistance.Cyclones,floods,storm s,earthquakes,drought,
forestfire,avalanches,etc.aresom eexam plesofnaturaldisasters.
D isastersare m ostly naturalbutthey can also be caused by m an.The w orld isprone
to naturaldisasters w hich are caused by the interplay ofnaturalforces and hum an
activities.
A broad categorization oflossesthatarisedueto naturaldisastersare:
D irect losses: These losses are in the form of dam age to buildings,its contents,
infrastructure,loss of hum an lives,costs of clearing the debris,restoration,loss
m itigation and disposal.
Indirectlosses:These are lossesthatresultdue to businessinterruption and pow er
failure, costs of transportation, detours, assistance, storage, accom m odation,
provision ofessentials,and com m unications.
Intangible losses:These include psychologicaltraum a and im pairm ents,losses of
intangiblevalues,and lossesdueto evacuation from areasunderrisk.
A risk m anagem entplan consistsofthefollow ing steps:
R isk Identification: Itinvolves identifying the extentand intensity of pastevents,
areasthatarehitby oneeventatthesam etim e,potentialrisk areas,and clim atictrends.
R isk Evaluation:Itinvolvesassessing theprobability oftheoccurrenceofadisaster
and theseverity ofthedisaster.
R isk C ontrol:Thisstep coversm easuresaim ed atavoiding,elim inating orreducing
thechancesofoccurrenceofloss-producing eventsand elim inating theseverity ofthe
disastersthatcould happen.
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M O D U LE -I: PRIN CIPLES A N D PRA CTICE O F IN SU RA N CE

R isk R etention: This step pertains to the ability of the country or the society in
particular to w ithstand disasters. There are tw o aspects of risk retention
psychologicaland financial.The psychologicalaspects have a lotto do w ith the
involvem entofgovernm entm achinery and voluntary agencies and also to a great
extenton thetenacity ofthepeople.
R isk Transfer:This is a risk financing m ethod and provides a m eans forhandling
risk w hich haveahigh severity oflossesand onecannotafford to retain such risks.
4. W hataretheparam etersto decidew hethera particularrisk isinsurableornot?
A ns.Thekey param etersto decidew hetheraparticularrisk isinsurableornotare:
M utuality:A large num berofpeople exposed to risk m ustcom bine to form a risk
com m unity.
N eed:The occurrence ofthe anticipated eventm ustplace the insured in a condition
offinancialneed.
A ssessability:Theexpected lossburden m ustbeassessable.
R andom ness:The tim e atw hich the eventoccurs m ustnotbe predictable and the
occurrenceoftheeventm ustbeindependentofthew illoftheinsured.
Econom icViability:Thecom m unity organized by theinsured personsm ustbeable
to m eetitsfutureloss-related financialneedson aplanned basis.
Sim ilarity ofthreat:The insured com m unity m ustbe exposed to the sam e threat.
Further,the occurrence ofthe anticipated eventm ustcreate the need forfundsin the
sam ew ay forallthoseaffected.
5. In reinsurance transactions,w hat does retention m ean? W hat are the steps
being considered by the Insurance R egulatory and D evelopm entA uthority to
im provetheretention capacity ofdom esticinsurancecom panies?
A ns.Reinsuranceagreem entsinvolveatransferoflossexposuresassum ed by theprim ary
insurerto the reinsurer.H ow ever,the reinsurerdoesnotassum e allthe exposuresto
w hich the prim ary insurer is exposed.The reinsurance agreem entrequires thata
portion oftheexposure,know n asretention,beretained by theprim ary insurer.
D om esic insurance com panies are facing low retention capacities ow ing to the
increasing outflow of their prem ium incom e from the country. The outflow of
prem ium is a resultofthe large am ounts ofreinsurance taken by private insurance
com panies,eitherw ith theirparentcom pany abroad orw ith otherlarge reinsurance
com panies.Privatesectorinsurancecom panieshaveretained only asm allpartofthe
risk thatthey haveinsured and reinsured am ajorportion oftherisk insured ow ing to
under-capitalization.
Further,reinsurers have hiked their prem ium s to close to one percentof the sum
assured.W ith this,thelow retention capacity oftheprivateinsurancecom paniesw ill
lead to an outflow ofprem ium s to the extentof40 percentofthe gross dom estic
prem ium incom eofallgeneralinsurancecom panies.

I-53
M O D U LE -I: PRIN CIPLES A N D PRA CTICE O F IN SU RA N CE

In contrastto the insurance com paniesin the private sector,insurance com paniesin
the public sector have seldom taken large reinsurance cover. Even in the w orst
cyclicalphase,the reinsurance taken by the fourpublic sectorinsurance com panies
hashardly exceeded 7 percentofthegrossdom esticprem ium incom e.Thishasbeen
possiblebecauseofthehigh retention capacity ofpublicsectorinsurancecom panies
w ith each com pany having an averagecapitalization ofaboutRs.2,500 crore.
Thus,in orderto cap prem ium outflow sfrom the country and im prove the retention
capacity of dom estic insurance com panies, the Insurance Regulatory and
D evelopm entA uthority isconsidering thefollow ing m easures:
Coinsurance Itis an arrangem entbetw een alldom estic insurance com panies
identicalto consortium financing by banks.In coinsurance,therew illbeonelead
insurerw ith severalotherinsurancecom panies.A llthem em bercom paniesin the
arrangem entw illhaveasharein prem ium collections.They w illsharetheclaim s
on aparipassu basis(paripassu fairely;atan equalrateorin an otherw isefair
w ay,w ith no person orgroup taking percentoveranother)
Syndicated insurance This is identicalto coinsurance arrangem ent,except
thatthem em bersofthesyndicatehavetheoption to exittheagreem ent.
Increased Capitalization Increasing the capitalization of the new private
sector com panies in the generalinsurance industry is likely to im prove the
retention capacity ofprivateinsurers.
6. D iscusstheobjectivesofratem aking activitiesin an insuranceorganization.
A ns.Ratem aking isoneofthefunctionsofactuaries.Thebasicobjectiveofratem aking is
to develop a rate structure thatw illenable the insurer to com pete effectively for
businessw hile earning a reasonable profit.A partfrom thisprim ary objective,there
arecertain secondary objectives.They are.
Corporateobjectives
Regulatory objectives
C orporate objectives-Prim ary insurerspreferratesthatare flexible,easy to apply,
prom ote loss controland provide forcontingencies.H ow ever,in reality,this is not
possibleto achieve.
Prim ary insurers prefer stable rates because the process of fixing a rate is very
expensive.In addition,frequentchangesw ould lead to custom erdissatisfaction.
To prom ote loss control, the rating system should provide low er rates to those
policyholders w ho undertake loss prevention m easures.A partfrom this,the rating
system should be understandable to agents,brokers,underw riters and especially
policyholders(w ho havelittleexpertiseregarding insurancem atters).
R egulatory objectives A ccording to regulatory objectives,rates
Should beadequate
Should notbeexcessive
Should notbeunfairly discrim inatory
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M O D U LE -I: PRIN CIPLES A N D PRA CTICE O F IN SU RA N CE

If the rate does notcom ply w ith regulatory norm s,itm ay invite harsh regulatory
actionsand unfavorablelegislation.
7. A property-liability insurer basically operates tw o kinds of businesses.
C om m enton this statem entand also explain the role ofinvestm entincom e in
ratem aking.
A ns.A property liability insurerbasically operatestw o kindsofbusinesses:
Insurancebusiness
Investm entbusiness
Insurance business Insurance business operations include w riting policies,
collecting prem ium s, and paying claim s. This is the revenue generator for an
insurancecom pany.Thesuccessofan insurerdependson thesuccessofhisinsurance
business.
Investm ent business This business includes the purchase of bonds,stocks and
other investm entvehicles for earning profit.In the investm entbusiness,profitis
derived from threesources:investm entincom e,realized capitalgains,and unrealized
capitalgains.
Roleofinvestm entincom ein ratem aking
Previously, investm ent incom e w as not considered by insurers w hen calculating
insurance rates.But,oflate,in som e countries,itisconsidered in the calculation of
rates.
Investm entprofits can be reflected in ratem aking by firstestim ating the realizable
investm entprofitfrom a particularinsurance line,and laterdeducting thatam ount
from the expense loading used in the rates.The inclusion ofinvestm entprofits in
ratem aking m ay affectliability insurance rates m ore than property insurance rates
because the am ountofinvestm entprofitearned on an insurance line w ould largely
depend on thelossreserveand theunearned prem ium reserves.

SEC TIO N C
C A SE STU D IES
1. RahulK um ar,the CEO ,Ram esh A dhikari,the G eneralM anager(U nderw riting),of
RK Insurance Com pany are discussing the various types of reinsurance options
available in the m arket.A dhikariinform ed K um ar thatthree types of reinsurance
optionsare available:facultative,treaty and financialreinsurance.H e also described
each option briefly to theCEO .A fterlistening to him ,theCEO said that,prim a-facie,
facultativereinsuranceseem sto bem oresuitableforthecom pany than othertypesof
reinsurance.H e asked A dhikari to provide him details on the different types of
facultative reinsurance available. D escribe the different types of facultative
reinsurancecontractsavailableto help A dhikarim akeasuccessfulpresentation.
A ns:In facultative reinsurance,the lossexposure isw ritten separately foreach individual
custom er by the reinsurer. The prim ary insurer provides the reinsurer detailed
I-55
M O D U LE -I: PRIN CIPLES A N D PRA CTICE O F IN SU RA N CE

inform ation abouteach exposure.The facultative reinsurerisnotbound by the rates


quoted orcharged by the prim ary insurer.W hen the reinsureraccepts a particular
exposure,heissuesacertificateofreinsuranceto form alizetheagreem ent.
Even though,in the case of facultative reinsurance,reinsurers have the right to
changeratesand chargehigherprem ium ,prim ary insurersstilloptforit.Facultative
reinsurance can be used by the prim ary insurer to protect its treaties, protect a
favourablecom m ission underitstreaties,orprotectaprofit-sharing agreem ent.A part
from this,a facultative agreem entisan independenttransaction and isunderw ritten
separately.Consequently,alossunderonefacultativeagreem entw illhavelittleorno
effecton eithertheterm sortheratesofothersubsequenttransactions.
Therearetw o categoriesoffacultativereinsurance:
Pro ratafacultativereinsurance
Excessfacultativereinsurance
Pro rata facultativereinsurance Facultativereinsuranceforproperty exposureshas
traditionally been w ritten on a pro rata basis.Itis sim ilarto a surplus share treaty,
exceptthatfacultativeagreem entsrelateto asinglesubjectofinsurance.
Excessfacultative reinsurance In thistype ofreinsurance contract,the reinsureris
responsible only forthose lossesthatexceed the insurer sretention,and itpaysonly
theam ountin excessoftheretention,upto reinsurancelim it.
2. A n insurerhas10,00,000 earned car-yearsand R s.4,000 ofincurred losses.The
costfor issuing a policy and collecting the prem ium w ould be R s.100 per car-
year.The other underw riting expenses vary w ith the size ofthe prem ium and
totalupto 20 percentofthe gross prem ium .C alculate the gross rate using the
pureprem ium m ethod.
(N ote:A ssum e thatthe fixed costdoesnotchange w ith the size ofthe prem ium ,the
rating class,ortherating territory).
A ns:Thepureprem ium m ethod consistsofthreesteps:
Calculating thepureprem ium
Calculating theexpenseloading
Com bining thepureprem ium and theexpenseloading into thegrossrate
The pure prem ium iscalculated by dividing the num berofearned exposure unitsby
theam ountofincurred losses.So,itis10,00,000/4000 Rs.250 percar-year.
So,thegrossrateis
G = (P + F)(1-V )
W hereG standsforgrossprem ium
P standsforpureprem ium
F standsforam ountoffixed expenses
V standsforpercentageofvariableexpenses

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M O D U LE -I: PRIN CIPLES A N D PRA CTICE O F IN SU RA N CE

G = 250 +100 (1 0.20)


So,G = 350/0.80
ThisgivesG as430.75.
Thegrossprem ium in theabovecaseisRs.430.75
3. O fthe required coverage am ounting to R s.1,80,000,a policyholder m aintained
only R s. 1,20,000. The deductible am ount w as R s. 10,000. W hich of the tw o
m ethods deductibleapplied firstand coinsuranceapplied first isfavourableto
theinsured in deciding thesettlem entam ountfora lossam ounting to R s.30,000?
A ns:
D eductibleA pplied First:
Loss D eductible= A m ountpayableto thepolicyholder
Rs.30,000 Rs.10,000 = Rs.20,000
(Coverage actually m aintained by the policyholder coverage required to be
m aintained)x A m ountpayableto thepolicyholder= Recoverableam ountofloss.
(Rs.1,20,000 /Rs.1,80,000)x Rs.20,000 = Rs.13,333.33.
CoinsuranceA pplied First:
(Coverage actually m aintained by the policyholder.Coverage required to be
m aintained)x Loss
(Rs.1,20,000/Rs.1,80,000)x Rs.30,000 = Rs.20,000
Recoverableam ountoflossis
Rs.20,000 Rs.10,000 = Rs.10,000
Therefore,by com paring the recoverable am ountofloss obtained by the tw o
m ethods, it is evident that the deductible applied first m ethod is m ore
favourableto theinsured sincehereceivesahigherrecoverableam ountofloss.

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M O D U LE -I: PRIN CIPLES A N D PRA CTICE O F IN SU RA N CE

C hapter 6
G eneralInsurancePolicies(Personal)

SEC TIO N -A

1. Personalaccidentpoliciescovertherisk of
a. U nem ploym ent
b. Sickness/illness
c. A ccidentalinjuries
d. N oneoftheabove
2. PersonalA ccidentpoliciesare
a. V alued policies
b. Indem nity policies
c. U nvalued policies
d. O pen policies
e. N oneoftheabove
3. D isability incom epoliciespay for
a. D isability arising outofsickness
b. D isability arising outofsickness/accident
c. D isability arising outofem ploym entinjuries
d. H ospitalization only forinjuries
e. N oneoftheabove
4. Personalliability insurancepoliciescoverdam agesto propertiesand injuriesto
otherpeopledueto
a. N egligence
b. W illfulm isconduct
c. W arlosses
d. Burglary
e. N oneoftheabove
5. The fire insurance policy in India doesnotprovide for com pensation for losses
arising outof

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M O D U LE -I: PRIN CIPLES A N D PRA CTICE O F IN SU RA N CE

a. Theft
b. A ircraftdam age
c. Im plosion orexplosion
d. Lightning
e. N oneoftheabove
6. W orkm en sC om pensation policy indem nifiesthelossesofthe
a. W orker
b. Em ployer
c. G overnm ent
d. Surveyor
e. N oneoftheabove
7. G olfer sindem nity policy providesprotection againstlossesordam agesto the
a. O nly golfplayers
b. G olfplayers& golfequipm ent
c. O nly golfequipm ent
d. G olfplayers& golfequipm ent& liability losses
e. N oneoftheabove

SEC TIO N A A N SW ER S
(1) c (2) a (3) b (4) a (5) a (6) b
(7) d

SEC TIO N -B
PER SO N A L A C C ID EN T PO LIC Y
1. D efineaccidentasgiven in thePersonalA ccidentpolicy.
A ns.A ccidentisdefined asany injury caused by accidental,violent,external,and visible
m eansresulting in death ordisablem ent.
2. Is the PersonalA ccidentinsurance,a contractofindem nity? G ive reasons for
youransw er.
A ns.N o,itisnota contractofindem nity because on som e conditionsbeing fulfilled the
CapitalSum Insured (CSI)is payable to the injured.Forexam ple,ifw ithin tw elve
m onths of its occurrence the injury be the sole cause of death, or of total and
irrecoverablelossofboth theeyes,orlossofuseoftw o handsortw o feet,thecapital
sum insured shallbe payable to the insured.Thus,the contractis based on agreed
value of loss.D ifferentcom pensations for differentclasses of insured negate the
principalofindem nity.

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M O D U LE -I: PRIN CIPLES A N D PRA CTICE O F IN SU RA N CE

3. H ow istheSum Insured orLim itofIndem nity fixed?


A ns.The sum insured isusually fixed in m ultiplesofthe annualearningsofthe insured,
For exam ple, at least five tim es the annual incom e in m ost cases. For G roup /
PersonalA ccidentInsurance,som etim estw o yearsannualsalary istaken.
4. C an a person recover anything under a PersonalA ccidentpolicy,ifhe dies a
naturaldeath?
A ns.N o,if the insured dies a natural death due to disease or old age or due to his
intentionalactlikesuicide,oreven w hen death resultsdueto W ar,Seizure,Capture,
M utiny and so on,heisnotentitled to recoveranything underthepolicy.
5. M ention the C onditions or Situations w hen only 50% ofthe C SI is Payable in
thePA C over?
A ns.Ifthe injury to the insured shallw ithin 12 calendarm onthsofitsoccurrence be the
soleand directcauseofthetotaland irrecoverablelossof:
the sightofone eye orofthe actuallossby physicalseparation ofone hand or
oneentirefoot
totaland irrecoverablelossofonehand oronefootw ithoutphysicalseparation,
50 % oftheCSIispayableto theinsured.
6. H ow iscom pensation forlossofcapacity assessed w ith thehelp oftheschedule?
A ns. If the injury shall im m ediately, perm anently, totally, and absolutely disable the
insured person from engaging in any em ploym entoroccupation ofany description,
then a lum psum equalto 100% ofthe CSIstated in the schedule is payable to the
insured.Iftheinjury shallbethecauseofthetotaland irrecoverablelossofuseorof
theactuallossofany otherpartofthebody,then apercentageoftheCSIasindicated
in thescheduleispayableto theinsured.
7. W hatis the com pensation payable in case oftem porary totaldisablem entin a
PA cover?
A ns.Iftheinjury shallbethesoleand directcauseoftem porary totaldisablem ent,then so
long asthe insured isdisabled in any em ploym entoroccupation a sum atthe rate of
onepercent(1% )oftheCSIasstated in thescheduleispaid perw eek,butin any case
notexceeding Rs.5,000/- or 25% of the m onthly salary w hichever is low er for a
period notexceeding 100 w eeksin respectofany oneinjury.Theschedulem ay differ
from insurerto insurer.
8. W hatis the liability ofthe Insurance C om pany,w hen the insured dies outside
his/herresidenceundera PA cover?
A ns.In the eventofdeath ofthe Insured Person due to accidentasdefined in the policy
outside his/her residence, the com pany shall reim burse expenses incurred for
transportation ofInsured sdead body to theplaceofresidencesubjectto am axim um
of2 % ofCSIorRs.1,000 w hicheveris less.This w illbe in addition to any other
com pensation fordeath payableunderthepolicy.
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9. H ow isC um ulativeBonusdeterm ined undera PersonalA ccidentcover?


A ns.Thecom pensation payableunderthepolicy fordeath,lossoflim b(s),orsightand for
perm anenttotaldisablem entarising outofaccidentalinjuriesshallbeincreased by 5
% in respectofeach com pleted year,during w hich thepolicy isin force,priorto the
occurrence ofan accidentforw hich CSIshallbe payable and ifno claim has been
m adeearlier.
10. W hataretheexceptionsundera PA policy?
A ns.The PersonalA ccidentpoliciescontain exceptionslike death,injury ordisablem ent,
directly orindirectly caused by,arising outof,orresulting from ,ortraceableto
(a) Intentionalselfinjury,suicide,insanity orinfluence ofintoxicating drinks or
drugsor
(b) In thecaseofw om en,by childbirth,pregnancy,etc.
(c) W hilstengaging in aviation orballooning.
(d) W hilst m ounting or dism ounting from a balloon or aircraft other than as a
passenger
(e) W ar,invasion,actofforeign enem y,hostilities,civilw ar,rebellion,revolution,
seizure,capture,arrests,restraintsand detainm ent.
(f) Ionizing radiation,contam ination from com bustion ofnuclearfission.

H EA LTH IN SU R A N C E
11. D escribethesalientfeaturesoftheIndividualM ediclaim insurancepolicy.
A ns. The individual M ediclaim policy covers reim bursem ent of H ospitalization/
D om iciliary H ospitalization expenses forillness/diseases orinjury sustained.The
com pany w ill pay to the Insured Person the am ount of such expenses as are
reasonably and necessarily incurred butnotexceeding the Sum Insured in any one
period ofinsurance.
12. W hatisthescopeofcoverunderthevariousclausesin a health insurancepolicy?
A ns.In theeventofany claim /sbecom ing adm issibleundertheschem ethecom pany w ill
pay to theinsured such expensesasm entioned below :
Room expenses,boarding expensesasprovided by the hospitalization/nursing
hom e.
N ursing expenses
_ Surgeon,anesthetist,m edicalpractitioner,consultantsand specialistsfees.
O therexpensesrelating to blood,oxygen,surgicalexpenses.
13. W hat Institutions can be considered as H ospital/ N ursing H om e under a
M ediclaim policy?
A ns.H ospital/N ursing H om em eansan institution in Indiaestablished forindoorcareand
treatm ent of sickness and injuries and it should have been registered w ith local
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authoritiesand should beunderthesupervision ofaqualified m edicalpractitioneror


should com ply w ith m inim um criteria ofhaving 15 in-patientbeds,fully equipped
operation theatreand fully qualified nursing staffand doctorsround theclock.
14. W hat are the benefits under a D om iciliary H ospitalization cover of health
insurance?
A ns.M edicaltreatm entexceeding three daysforsuch illness/disease/injury w hich in the
norm al course w ould require care and treatm ent at a hospital/nursing hom e but
actually taken athom e in India is referred to as dom iciliary hospitalization.The
benefitscan beavailed underthefollow ing conditions,nam ely:
thepatientcannotberem oved to thehospitaldueto his/hercondition
thereislack ofaccom m odation in thesaid hospital/nursing hom e.
15. W hatis considered as SurgicalO peration for the purpose ofR eim bursem ent
underthepolicy?
A ns.Surgicaloperation m eansany m anualand /oroperative procedure forcorrection of
deform ities and defects,repairofinjuries,diagnosis and cure ofdiseases,reliefof
suffering and prolongation oflife.
16. W ho isa Q ualified N urse?
A ns.Q ualified N urse m eans a person w ho holds a certificate of a recognized N ursing
Counciland w ho isem ployed on therecom m endationsoftheM edicalPractitioner.
17. M ention them ajorbasiccoverageprovided in an individualH ealth insurance.
A ns. H ealth insurers sell a w ide variety of individual health insurance coverages.
Im portantindividualcoveragesincludethefollow ing:
H ospital surgicalinsurance
M ajorm edicalinsurance
Long term careinsurance
D isability incom e insurance
18. W hatisa BasicH ealth Plan cover?
A ns.Itis principally a hospital-surgicalinsurance and ittakes care of routine m edical
expensesasw ell.H ow everitdoesnotpay forcatastrophiclosses.
19. W hatisa C om pletePlan undera health insurancecover?
A ns.U nderaCom pletePlan,thefollow ing arecovered-
H ospitalexpenses
Surgicalexpenses
O ut-patient,diagnostic,x-ray and laboratory expenses
Physician sin-hospitalexpenses
M aternity expenses

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20. W hatarethem ajorexclusionsin a m edicalinsurancepolicy?


A ns.The insurershallnotbe liable to m ake any paym entunderthispolicy in respectof
any expensesincurred by any insured in connection w ith:
Pre-existing illnessordiseases
H ospitalization during first30 daysofthecover
W arrelated injuries
Electivecosm eticsurgery
N onaccidentrelated dentalcare
W ork related injury
Fraudulentclaim s
Eyetest,glasses,hearing aid
Experim entalsurgery
21. H ow iscum ulativeBonusdeterm ined in a health insurancecover?
A ns.The sum insured underthe policy shallbe progressively increased by 5 % in respect
ofeach claim freeyearofinsurance,subjectto am axim um accum ulation of10 claim
free yearsofinsurance.In addition to cum ulative bonus,the insured w illbe entitled
to reim bursem entof the costof m edicalcheck-up once atthe end of every four
underw riting yearsprovided thereareno claim sreported during theblock.
22. D iscusstheim plication ofthefollow ing clausesin a health insurancepolicy
Pre-existing conditionsclause
Policy reinstatem entclause
A ns.The objectofthe pre-existing clause is to preventadverse selection.There m ay be
som e physicalorm entalconditionsofthe insured,w hich m ay have existed priorto
the date on w hich the policy takes effect.Pre-existing conditions w illbe covered
afteraw aiting period,w hich differsfrom insurerto insurer.
U nderthepolicy reinstatem entclause,w hen theprem ium isnotpaid even w ithin the
graceperiod,thepolicy lapses.H ow ever,thepolicy m ay bereinstated iftheprem ium
isreceived atleastw ithin 45 days.Som etim esafresh application isrequired.Thereis
aw aiting period forsickness,notaccidents,forthereinstated policy.

PER SO N A L A U TO IN SU R A N C E
23. D iscussthenatureand scopeofthePersonalA uto Insurancecover.
A ns.A policy ofm otorvehicle insurance is,in ordinary course,a com bined insurance.It
insuresthe dam age ofthe m otorvehicle and itsaccessories,liability fordam age for
property,death oforinjury to,the assured him selforspouse and italso insuresthe
m otorvehicle againstthe risk ofliability forinjury to,orthe death ofthird parties
caused by thedriver snegligence.

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24. D iscussthe Property accidentaspect ofthem otorinsurancepolicy.


A ns.In the m otorvehicle insurance policy,ifthe m otorvehicle isinsured,the ow nerw ill
be indem nified for any loss or dam age caused to itby accident.M otor insurance
being a contractofindem nity,the insured isentitled to indem nity only,and thattoo
in them annerstated in thepolicy.M edicalexpensesup to alim itarealso payable.
Iftheinsured carisdam aged,theinsurerisentitled athisoption to repairorreplace
the car or any partthereof or pay any am ountof the loss or dam age,in cash not
exceeding thesum insured orthevalueatthetim eoflossw hicheverisless.Ifthepart
is notlocally available oris exorbitantly costly to obtain from abroad,the insurer
often lim its the liability to paying in cash the catalogue price issued by the
m anufacturerorhisagentin Indiatogetherw ith thecostoffitting such part.
25. W hat are the different types of policies available and w hat is the lim it of
indem nity underthosepolicies?
A ns.The term softhe policiesdefine the nature and extentofthe indem nity provided by
thepolicy.Therearetw o typesofpoliciesnam ely:
i. Thethird party liability policy.
ii. A com prehensivepolicy.
Thethird party liability insuranceisacom pulsory undertheM otorV ehiclesA ct.Itis
often said that am otorcarpolicy isauniquecom bination ofseveraltypesofgeneral
insurance .
For exam ple,a private m otor car com prehensive policy indem nifies the assured
againstlossordam age to the insured carby accidentalexternalm eans,by fire,self
ignition,externalexplosion,lighting,frost,burglary,house-breaking ortheft,and by
m aliciousact.Thusitisvery clearthattheinsurerisliableto m akegood thelossofa
m otorcarto theow nerofthecar,forlossofcarm eanslossto theow nerofthecar.
26. D escribethe PersonalA ccidentA spect ofthePersonalA uto insurancepolicy.
A ns.Thepersonalaccidentaspectofthepolicy throw sup on otherrisks,w hich an insured
islikely to face.Besides,ensuring hispersonalsafety underan ordinary policy,the
extension clause indem nifies the assured forthe injury caused to him w hilsthe is
driving am otorcarnotbelonging to him orhired to him and also any person driving
theinsured caron theinsured sorderorw ith hisperm ission.
Further,by paying extraprem ium ,hem ay getextracoveroverand abovethegeneral
coverunderthestandard policy like:
(a) A ccidentsto hisw ifeand otherspecified relativesorfriends;
(b) Lossordam agedueto earthquakeorflood,etc.
The policy indem nifies the insured to the use of the insured car.H ow ever,it is
extended in tw o w ays,nam ely;itextendsto the insured notonly w hen he isdriving
hisow n insured carbutalso w hen heisdriving aprivatecarnotbelonging to him nor
hired by him .

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27. M ention theconditionsin a m otorvehiclepolicy to m aketheinsurerliable.


A ns.Som eoftheconditionsin am otorvehiclepolicy to m aketheinsurerliableare:
(a) The insured w illm aintain the vehicle in a good state of repair and efficient
condition;
(b) H e takes allreasonable steps and precautions to avoid accidents and to select
com petentand soberdrivers;
(c) H etakesallreasonablestepsto safeguard thecarfrom lossordam age.
28. M ention the provisions and conditions to be adhered to, under the M otor
V ehiclesA ctin respectto third party insurance.
A ns. The M otor V ehicles A ct has m ade it statutory and obligatory for a third party
insurance coverto be taken by every ow nerofa vehicle.The A ctspecifically states
thatno person shalluse exceptasa passengerorcause orallow any otherperson to
use a m otorvehicle in a public place,unlessthere isin force in relation to the use of
the vehicle by thatperson orotherperson,asthe case m ay be,a policy ofinsurance
com plying w ith therequirem entsoftheA ct.Thus,third party insuranceisam ustfor
running a m otorvehicle in a public place.The follow ing are som e ofthe im portant
provisionsto beadhered to in caseofthird party insurance,nam ely:
i. Itappliesto any otherperson otherthan apassenger;
ii. W hatisprohibited istheuserby him selforallow ing anotherperson to use;
iii. Such useshould beam otorvehicle;
iv. Such vehiclesshould beused in apublicplace;
v. The using orcausing ofuse by the otherperson should be w ithouta policy of
insurance.
vi. Thepolicy ofinsuranceshould com ply w ith theprovisionsoftheA ct.

PER SO N A L LIA BILITY IN SU R A N C E


29. W hatarethepersonalrisks,a person can insureagainst?
A ns.A person can insure him selfagainstthe risk ofdeath,personalinjury ordam age,
deterioration ordestruction ofproperty,and also againsttherisk ofincurring liability
to third parties.
30. W hatism eantby Third-Party liability?
A ns.Third party liability istheliability w hich m ay ariseby an insured sow n conductorin
using hisproperty,butstilltherisk ofliability arising outoftheuseoftheproperty is
not covered by an insurance of that property. Liability policies are generally
expressed asproviding indem nity against liability in law .
31. W hatisthem eaning ofliability in /atLaw ?
A ns.The phrase liability in/atLaw isinvariably understood and prim arily used to cover
the liability arising out of negligence. For exam ple, the liability of a building
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contractor to a third party arising outof the faulty design of a structure w as held
covered though therew asno negligence.
Sim ilarly,in a householders com prehensive insurance policy,the w ord accident
covered nuisance liability w hich had occurred w ithoutthe negligence on the partof
theassured.
32. W hatisthedifferentinsurancecoveragesoffered in liability insurance?
A ns.U nderthe liability insurance category thefollow ing liability policiesarecovered:
Publicliability insurance,
Liability arising in connection w ith professionalnegligence,
Com pulsory insurance,
Em ployer sliability insurance,
G uaranteeinsurance.
33. Explain briefly each oftheabovem entioned liability insurancepolicies.
A ns.Liability insurance policiesare generally expressed asproviding indem nity against
liability in law .Thevariousliability insurancepoliciesarediscussed atlength below .
Publicliability insurance: Publicliability doesnotm ean liability ofthestateorits
agencies.Itm eansliability asim posed by law asopposed to self-im posed liability as
in contract. The Public Liability Insurance A ct, 1991, is intended to provide
im m ediate reliefto the persons affected by accidents occurring w hile handling any
hazardous substance and form atters connected therew ith and incidentalthereto.In
Indiathispolicy appearsasasequelto thefam ousBhopalG asLeak case.
ProfessionalN egligence:There are standard policies forprofessionalindem nities
coverforaccountants,insurance agents,solicitors,and law yers.These policiesalso
covertherisk oflossby theirow n negligence.Thelaw hasm adetheseprofessionals
liable in respectofany loss orinjury due to the negligence in the conductoftheir
professionalduties.
C om pulsory Insurance: For the w elfare of the em ployees, social w elfare
legislations have been passed in England and in India m aking itcom pulsory for
em ployersto insureforsafety ofthew orkm en.
The Indian A ctm akes itcom pulsory for the em ployer to insure his w orkm en by
providing certain benefits to them in the event of their sickness, m aternity and
em ploym entinsurance.Theem ployeesinsured undertheA ctareentitled to
(a) Sicknessbenefit
(b) M aternity benefit
(c) D isablem entand D ependentsbenefit.
Em ployer sLiability:Though in olden daysthe liability ofthe em ployerhasbeen
extended in thelaw oftortsby vicariousliability,in regard to hisliability tow ardsthe
em ployees, a num ber of defences w ere recognized, substantially reducing his
liability tow ards his em ployee.Forexam ple,the doctrine ofcom m on em ploym ent,
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thedefenceofvolentinon injuria w erevitaldefences.But,in duecourseoftim e,the


liability ofthe em ployerw asextended due to the developm entofthe industrialand
labourw elfarem easuresand legislations.N ow theem ployersaretem pted to takeout
insurancesagainstsuch liabilities.
G uarantee Insurance:G uarantee business ofinsurance com panies assum ed great
im portancein them odern tim es.Earlierthisw asdoneby contractsofguaranteeby
w hich afriend orarelativeoftheprom isororem ployeeused to stand asasurety for
the due perform ance ofthe prom ise by the principaldebtororforthe honesty ofan
em ployee.A sthe num berofcontractsincreased,itbecam e increasingly difficultto
find sureties,and asaresult,chancesofem ploym entand businesshad to belost.
In such a situation,the insurance com paniesdeveloped forthem selvesconsiderable
am ountof guarantee business .There are tw o m ethods by w hich this guarantee
w asgiven,nam ely:
i. the insurance com pany or the underw riter stands as a surety for the due
com pletion ofacontractorfidelity ofan em ployee;and /or
ii. the underw riter insures the prom isee or em ployer againstthe loss arising by
non-perform anceoftheobligatororthedishonesty oftheem ployee.
The firsttypesofcontractsare sim ple guarantee contractsand only the second types
involve elem ent of insurance. The chief types of policies included in guarantee
insuranceare:
i. Insuranceforperform anceofcontract;
ii. Insuranceofdebts;
iii. Fidelity policies.
A contractof guarantee insurance is a contractw hereby the insurer undertakes to
indem nify the insured from the loss caused as a resultofthe breach ofcontractor
infidelity.
Insurance for C om pletion ofC ontract:the subjectm atterofsuch contractisdue
perform ance of a contract.A enters into a contractw ith B butdoubts w hether B
w ould com plete the contract.In such a case A m ay insure B sdue perform ance ofa
contract.Thesearegenerally taken in casesofcontractsofem ploym ent.
Insurance for R epaym entofD ebt:A creditorm ay insure the repaym entofdebt,
w hich he advanced orw illadvance in future.Such policies som etim es covernon-
paym ents from specified causes only and in such cases only the causes for non-
paym entbecom e relevant.W hen the creditor insures the repaym entof a debt,on
defaultby thedebtor,thecreditorcan straightclaim them oney from theinsurer.The
insurance being a contractofindem nity,the insurerw illbe subrogated,on paym ent
to theinsured,to alltherightsofthecreditoragainstthedebtor.
Fidelity Policies:These are the m ostcom m on types ofguarantee policies and are
m ade usually for a term of one or m ore years.These arise generally out of the
contractofem ploym entw heretheem ployeehasan opportunity to bedishonest.The
risk covered isgenerally restricted to lossesoccurring w hiletheem ployeeisengaged
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in aspecified capacity.Even in theem ploym ent,therisk covered m ay vary according


to the specific term softhe policy in each case.Forexam ple,som e are restricted to
lossesarising by em bezzlem ent or fraud .
Fidelity policies m ay be com bined w ith liability policies, w hich are norm ally
restricted to liability incurred through the negligence of the em ployee w hile the
form erpolicies are m ainly intended to coverlosses caused to the em ployerby the
em ployee s theftorem bezzlem entofm oney orsecurities.A fidelity insurer,like a
fidelity guarantor,isentitled to subrogation.

W O R K M EN S C O M PEN SA TIO N IN SU R A N C E

34. D iscuss the rationale for the existence and developm ent of W orker s
C om pensation conceptand program m e.
A ns.W orkerstim eand again areinjured and becom esick becauseofjob-related accidents
and disease.Besidespain and suffering,these disabled w orkersalso dealw ith other
m entaltensionsand agony such aslossofearned incom e,paym entofm edicalbills,
partialorperm anentlossofbodily functionsorlim bsorjob separation.
W orker sC om pensation (W C )isa socialprogram m ethatprovides:
M edicalcare
Cash benefits
Rehabilitation services to disabled w orkers from job related accidents or
disease.Thesebenefitsreducetheeconom icinsecurity thatm ay resultfrom job
related disability.
35. Statebriefly theobjectivesofW orker scom pensation concept.
A ns.Thefollow ing arethebroad objectivesofthew orker scom pensation law s.
Broad coverage of em ployees for job-related accidents and diseases. The
w orker s com pensation covers m ostoccupation or job-related accidents and
diseases.
Substantialprotection againstlossofincom e.Thecash benefitsaredesigned to
restore a substantialproportion ofthe disabled w orker slostearnings,so asto
enablethedisabled w orkerto m aintain thesam estandard ofliving.
Sufficientm edicalcareand rehabilitation services.Thew orker scom pensation
law s require em ployers to pay hospital, surgical, and other m edical costs
incurred by injured w orkers,as w ellas rehabilitation services to restore the
disabled em ployeesto productiveem ploym ent.
Encouragem entofsafety.The w orker scom pensation law sencourage the firm s
to reduce job-related accidents and to develop effective safety program m es.
Experience rating isused to encourage firm sto reduce job-related accidentsand
diseases,becausefirm sw ith superioraccidentrecordspay low erW C prem ium s.

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Reduction in litigation.W orkers Com pensation law s are designed to reduce


litigation by m aking prom ptpaym entto disabled w orkers w ithoutrequiring
them to sue theirem ployer.The objective isto reduce orelim inate paym entof
legalfeesto attorneysand avoid delaysin trialsand appeals.
36. Listouttheoccupationsnotcovered undertheW orkersC om pensation cover.
A ns.A lthough the W C law s cover m ostoccupations,som e occupations are either not
covered orhaveincom pletecoverage,nam ely:
Farm w orkers
D om esticservants
Casualem ployees
Concernsw ith num ericalexclusions(lessthan 3-5)
Professionalathletes
37. W hataretheeligibility requirem entsto receiveW orkersC om pensation?
A ns.There are tw o principaleligibility requirem ents to be m etto receive the w orker s
com pensation benefits:
Thedisabled w orkershould w ork in acovered occupation.
Thew orkerm usthaveajob-related injury ordisease.
This m eans the injury or disease m ust arise out of and in the course of
em ploym ent.H ow ever,now them eaning oftheterm hasbeen broadened so as
to includethefollow ing:
A n em ployee w ho travelsisinjured w hile engaged in activitiesthatbenefitthe
em ployer.
Theem ployeeisinjured w hileperform ing specified dutiesataspecified location.
Theem ployeeison theprem isesand isinjured w hilegoing to thew ork area.
Theem ployeehasaheartattack w hilelifting som eheavy m aterial.
38. W hatarethebenefitsprovided undertheW orker sC om pensation Insurance?
A ns.TheW orker scom pensation insuranceprovidesfourprincipalbenefits:
U nlim ited M edical C are: G enerally m edical care is covered in full. But
m edicalcare being expensive,and to hold dow n costs,som e em ployersprefer
tying up w ith som em anaged careorganizationssuch asH M O s,and PPO s.
D isability Incom e:The disability incom e is paid afterthe w orkersatisfies a
w aiting period thatusually ranges from 3 to 7 days.Ifthe injury lasts orthe
w orkerisdisabled aftercertain num berofdaysorw eeks,benefitisgiven from
retrospectivedateofinjury.
Thew eekly cash benefitisbased on apercentageoftheinjured w orker sw eekly
w agetypically 2/3rd ,and issubjectto m inim um and m axim um paym ents.
D isability isclassified into fourcategories:
PT (Perm anenttotal)
TT (Tem porary total)
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TP (Tem porary partial)


PP (Perm anentpartial)
Tem porary totaldisability claim sare the m ostcom m on and accountform ajority of
cash claim s.
D eath benefits: The death benefits are paid to the eligible survivors,if the
w orkerdiesasa resultofa job-related accidentordisease.Tw o typesofdeath
benefitsarepaid:
Burialallow ance
W eekly incom ebenefitsarepaid to eligiblesurvivors.
W eekly incom esare a percentage ofthe diseased w orker sw ages(2/3rd)and is
paid to the spouse forlife oruntilshe/orhe rem ains,and also to a dependant
child untilaspecified age.
R ehabilitation services: In m ost cases, rehabilitation services are also
provided to restore disabled w orkers to productive em ploym ent. Besides
w eekly benefits,boarding and room ,travel,booksand equipm entchargesare
also given and also training expenses.
39. W ho isan Em ployerasdefined undertheW orker sC om pensation A ct?
A ns.A n Em ployer is a person w ho em ploys w orkm en .The em ployerw ho engages a
w orkm an forcasualduties(casualnotby tim e)isnotaw orkm an w ithin them eaning
oftheW orkm en sCom pensation A ct-1923.Thoseengaged in theinsured sbusiness,
profession,oroccupation are w orkm en
40. W hy do you adviceallEm ployersto takethepolicy?
A ns.Theliability ofan em ployerisabsoluteby statuteforthedeath oforbodily injuriesor
occupationaldiseases sustained by the w orkm en arising outof and in course of
em ploym ent.H encethispolicy issuggested to alltheem ployersin theirinterest.
FIR E IN SU R A N C E
41. D efineFireInsurance.
A ns.FireInsuranceisacontractofinsuranceby w hich theinsureragreesforconsideration
to indem nify the assured upto a certain extent and subject to certain term s and
conditions againstloss ordam age by fire w hich m ay happen to the property ofthe
assured during a specified tim e.There is said to be fire w ithin the m eaning offire
insurancew hen:
(a) Thereisactualignition.
(b) The fire is purely accidentalor fortuitous in origin so far as the insured is
concerned.
(c) Thefirehasburnt/dam aged theproperty oftheinsured.
43. Enum eratetheessentialcharacteristicfeaturesofa FireInsuranceC ontract.
A ns.A contractoffire insurance isa speciesofa contractofinsurance and itexhibitsall
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thefollow ing characteristics,nam ely:


(a) Thisisacontractofindem nity
(b) Itisacontractuberrim a fides
(c) Itm ustbedistinguished from w agering contractand acontractofguarantee
(d) Itisapersonalcontractand
(e) Thecauseoffireisim m aterialgenerally.
44. Statew hethera FIP isa personal/im personalcontract?
A ns.A contractoffireinsurance,though appearsto beaproperty insurance,isnotso and it
isapersonalcontractbetw een theinsurerand theassured,forthepaym entofm oney,
in case the loss is occasioned to the property ofthe contracting party by fire.The
purposeofthecontractisnotto insurethesafety oftheproperty butonly to savethe
insured from the losscaused by dam age to the property by fire.Therefore,w here a
property insured againstfireisconsum ed by firebutstillthereisno pecuniary lossto
theow neroftheproperty,theinsurerw illnotbeliableto pay any am ount.
45. In an FIP thecauseofFireissaid to beim m aterial.Justify.
A ns.In an FIP thecauseoffireisim m aterial.Iftheassured iscarefuland stillthereisfire,
itw ould be unjustto disentitle him to claim and even w hen he orhis servants are
negligentand thereisfire,even then itw ould beunfairto disentitlehim to claim ,for
itisprecisely forthesereasonsthataFIP istaken.O neshould understand thatitisthe
dam age and notthe cause of fire thatis insured.Butin the follow ing tw o cases
com pensation isnotgiven:
W hen dam ageiscaused voluntarily orw ilfully
W hen causeisw ithin an exception ofthecontract.

TR A V EL A C C ID EN T IN SU R A N C E
46. D iscussthescopeofcoveravailableundertheTravelA ccidentinsurancecover.
A ns.ThescopeoftheTravelA ccidentcoverextendsto alldom estictravellersirrespective
ofthe theirage and incom e group.The benefits underthis policy ofinsurance are
very large and w ide in depth forallthose w ho frequently traveland face the various
unforeseen risksofjourney.
47. W hich m odesoftransportarecovered underthispolicy cover?
A ns.Thiscoverisavailableto travellersby allm odes:Road/Rail/W ater/A ir,including by
theirow n m odeoftransport.
48. W hatisthebasicobjectiveofthisinsurancepolicy cover?
A ns.Thiscoverisvalid fortransitperiod subjectto m axim um of60 days.
Thecoverincludesincidentallocaltravelalso.Thebasicobjectiveofthispolicy isto
provide reliefin case ofaccidentaldeath and loss and /ordam age to accom panied
baggageduring thetravelling w ithin thecountry.
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M O D U LE -I: PRIN CIPLES A N D PRA CTICE O F IN SU RA N CE

49. W ho are the people covered under the policy cover? C an PA also be covered
besidestheavailablecover?
A ns.This policy is designed to provide cover for the insured,spouse,and dependant
children only.Com pensation underthe PersonalA ccidentw illbe in addition to all
otherexisting coversorinsurancecoversinsured m ightbeholding.
50. W hataretheotherC ausesofLossagainstw hich thepolicy extendsitscover?
A ns.The policy covers reasonable and actualem ergency incidentalexpenses upto Rs.
1000/- arising out of an accident resulting in a valid claim under a PA section.
Besides,the loss or dam age to accom panied baggage arising out of fire,storm ,
tem pest, hurricane, flood, inundation, riot, strike, terrorism , m alicious dam age,
accident,theftorburglary.
51. H ow isthelim itofIndem nity fixed forthiscover?
A ns.Thelim itofindem nity underthiscoverdependson thesum insured and otherw iseas
stipulated in the schedule.The sum insured perarticle isRs.500/-unlessotherw ise
declared and claim ofsum insured perarticle above Rs.500/-should be settled on
claim ed valuebasisw ithoutapplying depreciation and average.
52. W hatis the underw riting factors to be taken into consideration for fixing the
price?
A ns.The pricing ofthe policy dependsup on the num berofpersonsasm entioned in the
schedule.In caseofm orethan 8 persons,an additionalprem ium ofRs.40/-perhead
is charged.The service tax is charged extra.The cancellation of journey is to be
intim ated to the concerned authorities w ithin 2 days of the schedule journey.
Som etim es,extension ofthecoverw illbegranted subjectto revised dateschosen by
theinsured,butnotbeyond aperiod of60 days.
53. W hatarethegeneralexclusionsundertheTravelA ccidentcover?
A ns.The generalexclusions under the TravelA ccidentcover m ay be sum m arized as
follow s:
Lossofarticlesofjew ellry
Jew ellery m adeup offully/partially/sem ipreciousm etal/stones/
M oney
Securities
M anuscripts
D eeds
Bonds
BillsofExchange,Prom issory notes
Stocksorsharecertificates
Stam psand travelticketsortravellerscheques
Businessbooksand docum ents
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Recoveriesin baggageclaim sbased on Subrogation principlem ay bew aived if


uneconom ical.

A LL-R ISK S C O V ER FO R JEW ELLER Y A N D H IG H LY V A LU ED ITEM S


54. M ention thecategory ofpeoplew ho can availtheA ll-riskspolicy cover.
A ns.Thispolicy issuitable forpeople ow ning jew ellery orvaluables,w hich are prone to
accidentallossordam age.
55. D iscussthesalientfeaturesofthispolicy.
A ns.The policy covers valuables like jew ellery,ornam ents,paintings,w ork ofart,and
sim ilarartefactsofsentim entalvalue,etc.
The scope ofcoverislim ited to lossordam age due to fire,riot,strike,terroristact,
burglary,housebreaking,larceny,theft,and accidentallossordam age.
56. W hatarethebenefitsavailableunderthispolicy?
A ns.:The policy pays forany loss ordam age to the property insured caused by insured
perils.The am ountofclaim payable w ould be lim ited to the sum insured orm arket
valueatthetim eofloss,w hicheverislow er.
57. M ention theexclusionsofthiscover.
A ns.Them ain exclusion ofthiscoverisasfollow s:
In case ofpaintingsorw ork ofart,otherthan dam age by fire,partiallossesare not
covered.
58. W hataretherequirem entsunderthispolicy?
A ns.Som eoftheim portantrequirem entsofthispolicy are:
Com pleted proposalform should givefulland accurateinform ation.
A llitem s to be covered should be fully described for easy identification in
future.
U nless each ofthe item s is valued separately,the claim foreach item w illbe
lim ited to 5% ofthetotalsum insured.
Coverisnotgiven freely on accountofitsvulnerability to lossand m oralhazard.

SPO R TS IN SU R A N C E (G O LF IN D EM N ITY IN SU R A N C E PO LIC Y )

59. M ention thepeoplew ho areeligibleforthecoverundertheSportsm en Insurance.


A ns. A m ateur sportsm en pursuing Cricket, G olf, Law n Tennis, Badm inton, Squash,
A ngling,etc.,and personsusing sportsgunscan availthispolicy.
60. W hatisthescopeofcoveragein theG olfIndem nity policy?
A ns.The policy is given to am ateursportsm en (notto professionals)forcovering their
sports equipm ent, personal effects, legal liability to third parties and personal
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M O D U LE -I: PRIN CIPLES A N D PRA CTICE O F IN SU RA N CE

accidentrisks.Thecovercan also bem adeavailablein respectofnam ed m em bersof


insured sfam ily residing w ith him .
61. W hatarethelossescovered underthesaid policy?
A ns.Thefollow ing lossesarecovered underthepolicy:
Loss or dam age to sports equipm ent,accessories,and w earing apparelto the
extentofRs.2000 perperson selected.Thelim itcan beextended on paym entof
additionalprem ium .
Loss ordam age to personaleffects and w earing apparelw hile these are leftin
clubhouses,sportspavilion,etc.caused by fire,burglary,housebreaking,ortheft
to theextentofRs.1000 perperson foreach sportselected.
Legalliability ofthe insured and nam ed m em bersofthe insured sfam ily to the
public w hile engaged in orpractising the sport,up to a lim itofRs.500,000 for
any oneaccident.
A ccidental bodily injury to the insured and to the nam ed m em bers of the
insured sfam ily w hileengaged in orpractising thesportsup to Rs.15,000.
ForG olf,theinsurerw illpay theinsured attherateofRs.200 in respectofeach
hole.
62. C an sportsm en staying abroad availthispolicy?
A ns.N o,the sportsm en staying abroad cannottake thispolicy.The geographicallim itis
usually India.But,how ever,thecovercan beextended foreventsw orldw ide.
63. Statetheuniquefeaturesofthispolicy.
A ns.This is a unique policy designed especially foram ateursportsm en.The prem ium s
depend upon the num ber of sports selected and the num ber of fam ily m em bers
included.Som e ofthe benefits offered by this policy are notcovered by any other
policy and thereforeitisstrongly recom m ended foram ateursportsm en.

SEC TIO N C
C A SE STU D IES
1. M r.D hanrajinsured hisnew Santro carw ith R oyalSundaram C o.in them onth
ofA pril2002,and allow ed hisson to driveit.D hanrajdied in June2002.H isson
continued to drivethecarand caused an accidentin them onth ofJanuary 2003,
and claim ed indem nity underhisfather spolicy.Justify hisclaim .
A ns.Theinsurancecom pany contended thattheperm ission lapsed autom atically w ith the
death of his father.H ence the son is notentitled for any com pensation under the
policy.Thushisclaim isnotsustainable.
2. M r.Suresh,w ho w asthe ow ner ofa car,sold hiscar for itsprice and w hen the
chequecould notbeencashed heclaim ed indem nity from theinsurerfortheloss
ofthecar.Ishisclaim valid?
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M O D U LE -I: PRIN CIPLES A N D PRA CTICE O F IN SU RA N CE

A ns.In the above case,the claim putforth by M r.Suresh isnotjustified because,asthe


courtalso held thatthe lossw asthe lossofthe sale proceedsand notthe lossofthe
carand so theinsurerisnotliableto pay any com pensation.[EisingervG AFL].
3. M r.R anjitSingh had engaged a driver for hiscar,w ho had negligently driven
thevehicleand caused dam ageto a third party.IsM r.R anjitresponsiblein the
abovesituation?
A ns.A s per the com m on law ,the m aster is liable for the tortious acts of the servant
provided theservantdoessuch actin thecourseofhisem ploym ent.Thecom m on law
also recognizes the vicarious liability ofthe ow nerofthe m otorcar.In the law of
torts,ifa person negligently driveshisvehicle and causesinjury ordeath to the third
party,the driverw hose negligence caused the dam age isliable to the third party.The
driveristhe servantofthe ow ner,and since he isa person ofno m eans,the ow neris
liableforallhisactsso farthathehasdonesuch actsin thecourseofhisem ploym ent.
In theabovecasebased on theprovisionsofthecom m on law ,M r.Ranjitisheld liable
forthedam agecaused to thethird party.[PushpabaiSudershin vRanjitG and P Co].
4. M r.A m ar losthisfactory furniture valued atR s.200,000 ason the date offire.
H e w anted to recover a claim ofR s.2,50,000 for he had a policy ofR s.500,000.
O n enquiry hefound thatfornew furniturethecostw ould beR s.1,75,000.Ifthe
principleofindem nity isto beapplied how m uch ofhisclaim isto beaccepted?
A ns. Since the m arket value of the furniture lost w as Rs. 2,00,000 and the cost of
reinstatem entw ould costthe insurersonly Rs.1,75,000,the Insurersw ould optfor
reinstatem entand accepttheclaim ofRs.1,75,000.
5. M r.K ishore insured his m achinery and stock of goods stored in the factory
prem isesagainstdam ageby fireand a protection note w asgiven,subjectto the
usualconditionsofthe com pany spolicy,one w arranty clause being sm oking
and cooking be strictly prohibited in or aboutthe prem ises .The stocks w ere
dam aged by fire said to be of accidentalnature.But the insurance com pany
claim ed thatsm oking a cigaretteorbidicarelessly by som eem ployeeoccasioned
thefire.Isthedenialjustified?
A ns.In theabovecase,thecom pany denied theclaim on theground thattherew asabreach
ofw arranty asthefirew asoccasioned by sm oking w hich isstrictly prohibited.Butas
there w asno eye-w itnessto the origin ofthe fire,the courtheld thatthe cause offire
w asam atterofconjecture.[BhattacharjeevSentinalInsuranceCo.].
In thefam ouscase D ekhariTea Co vAssam BengalRoadwaysCo,itw asalso held
thatfires cannotalw ays be explained,and itm ustbe a m atter of conjecture.A s
regardsthe w arranty,asthe plaintiffhad putnoticesstrictly prohibiting sm oking in
and around theplaces,in factthereisno breach ofw arranty.H ence,thedenialon the
partoftheinsurancecom pany isnotjustified.O n theotherhand,thecom pany should
m akegood theloss.

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C hapter7
G eneralInsurance (C om m ercial)

SEC TIO N -A
1. Firelossesin a FIP iscovered only w hen
(a) thereisactualignition
(b) theignition isaccidentally caused
(c) therem ustbealossofsom eproperty
(d) alltheabove
(e) noneoftheabove
2. C ontractorsallrisk insuranceform spartof
(a) Personalgeneralinsurance
(b) Com m ercialgeneralinsurance
(c) G roup insurance
(d) Socialsecurity insurance
3. Professionalindem nity insurancedoesnotcover
(a) A ctsofcom m ission and om ission
(b) A ctsofnegligence
(c) Liability arising outoffailureofdoctorstreatm ent
(d) Crim inalA ct
4. Thestandard erection allrisk insurancepoliciesdo notcover:
(a) Firerisk
(b) N egligence
(c) Storm caused dam ages
(d) Rem ovalofdebris
5. Im plosion in fireinsurancem eans
(b) Inw ard burst
(c) Sudden burstw ith loud report
(d) D am agecaused by corrosion
(e) D am agecaused by tem pest

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M O D U LE -I: PRIN CIPLES A N D PRA CTICE O F IN SU RA N CE

6. Forcefulentry isthechiefcharacteristicof
(a) Theft
(b) A rson
(c) Larceny
(d) Burglary

SEC TIO N A A N SW ER S
1. d 2. a 3. d 4. d 5. a 6. d

SEC TIO N -B
1. Enum eratetheessentialcharacteristicfeaturesofa FireInsuranceC ontract.
A ns:A contractoffire insurance isa speciesofa contractofinsurance and itexhibitsall
thefollow ing characteristics,nam ely:
(f) Thisisacontractofindem nity
(g) Itisacontractuberrim a fides
(h) Itm ustbedistinguished from w agering contractand acontractofguarantee
(i) Itisapersonalcontractand
(j) Thecauseoffireisim m aterialgenerally.
2. W hatisthe difference betw een subject-m atter ofinsurance from the subject-
m atterofa contractofinsurance?
A ns.Them ain objectofthecontractofinsuranceisto indem nify theassured from theloss
caused by dam ageordestruction by fireoftheproperty oftheassured.Thisphysical
objectiscalled thesubjectm atterofinsurance.O n theotherhand,thesubject-m atter
ofcontractofinsurance is notthe physicalobjectorproperty ofthe assured butis
m oney and m oney alone.Itm ustbe noted thatw hatis insured is notthe physical
property oftheassured butonly lossofitby firebecauseby thiscontractlossby fire
cannotbe prevented.Itis notan insurance againstaccidents butan agreem entto
protectagainstdam ageby afireaccident.
3. Statew hethera FIP isa personal/im personalcontract?
A ns.A contractoffireinsurancethough appearsto beaproperty insuranceisnotso and it
isapersonalcontractbetw een theinsurerand theassured,forthepaym entofm oney,
in case the loss is occasioned to the property ofthe contracting party by fire.The
purposeofthecontractisnotto insurethesafety oftheproperty butonly to savethe
insured from the losscaused by dam age to the property by fire.Therefore,w here a
property insured againstfireisconsum ed by firebutstillthereisno pecuniary lossto
theow neroftheproperty,theinsurerw illnotbeliableto pay any am ount.
4. C an you have a separate consequentialloss policy w ithoutan ordinary FIP?
G ivesom eexam plesofconsequentiallosses.
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A ns.N o,there cannotbe a separate consequentiallosspolicy w ithoutan ordinary fire


policy.U ndera FIP,notonly can one insure the property butany consequentialloss
can also becovered.Theclaim underthishead can succeed only iftheinsurersadjust
theirliability forlossofproperty by fire underan ordinary policy.Thefollow ing are
som eoftheexam plesofconsequentiallossforw hich indem nity isprovided:
(a) Lossofprofits
(b) Standing charges
(c) Increased costofw orking
(d) Increased costofreinstatem ent
5. In an FIP thecauseoffireissaid to beim m aterial.Justify.
A ns.In an FIP thecauseoffireisim m aterial.Iftheassured iscarefuland stillthereisfire,
itw ould be unjustto disentitle him to claim and even w hen he orhis servants are
negligentand thereisfire,even then itw ould beunfairto disentitlehim to claim ,for
itisprecisely forthesereasonsthataFIP istaken.O neshould understand thatitisthe
dam age and not the cause of fire that is insured.But in the follow ing tw o case
com pensation isnotgiven:
W hen dam ageiscaused voluntarily orw ilfully
W hen causeisw ithin an exception ofthecontract.
6. State the significance of the doctrine of Proxim ate C ause w ith respect to fire
insuranceclaim s.
A ns.Thedoctrineof Proxim ateCause holdsavery significantplacein thedeterm ination
offire related claim s.Proxim ate cause m eans the active efficientcause thatsets in
m otion achain ofeventsw hich bringsaboutaresultw ithoutintervention ofany force
and w orking actively from anew and independentsource e.g.w hereinsured object
isburnt,cause isplainly fire and insured isentitled to recoverunlessthe insurercan
show thatthe fire w ascaused by exem pted perilorw illfully by insured orw ith his
consentsuch as:
1. W here there isan explosion during a fire,the concussion dam age fallsw ithin
exception and theinsured cannotrecover.
2. W here subjectm atter is burntbutfire,w hich burned it,w as due to natural
consequencesofexcepted peril,insured cannotrecover.
3. W here fire w assetin operation by earthquake,ifnotcovered by insured under
fire policy and then spread by naturalcauses,i.e.spread by w ind orone thing
catching firefrom anotherand so on,insured cannotrecover.
7. W hatisthescopeofcoverageundertheIndustrialA llR isk Insurance?
A ns.Industrial all risk insurance is available to all m ajor industrial units (other than
petrochem icalrisks) m anufacturing as w ellas storage,having allsum insured of
Rs.100 crores and above, in one or m ore locations in India. The policy covers
dam agesthatarecovered under:
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M O D U LE -I: PRIN CIPLES A N D PRA CTICE O F IN SU RA N CE

i. Fireand specialperilspolicy.
ii. Burglary insurancepolicy.
iii. M achinery breakdow n/boilerexplosion/electronicequipm entpolicy.
iv. Businessinterruption dueto fireand specialperilspolicy.
Thepolicy excludesthefollow ing:
i. Inherentvice,defects,deteriorationsand norm alw earand tear.
ii. Faulty m aterial/w orkm anship/defectivedesign and m aterial.
iii. Pollution,contam ination,shrinkage,rust,corrosion,scratching and tem perature
changes.
iv. Collapseorcracking ofbuildings.
v. W illfulact,negligence,w arand nuclearrisks.
vi. Larceny,fraud,dishonesty,inventory losses,shortageon delivery.
8. D iscussthecom prehensivecoverundertheC A R policy
A ns.TheCA R policy providesthefollow ing coversforlossesdueto:
(a) Collapse,collusion,im pact.
(b) A lltheaccidentaleventsduring construction likedropping orfalling,defective
w orkm anship and m aterial,lack ofskill,negligence,m aliciousactand hum an
error(handling risks).
(c) Lack of skill, negligence, m alicious and terrorist dam age (risks of hum an
elem ent).
(d) Theftand burglary,fire/lightning (location risks).
(e) Failure of safety devices, leakage of electricity, failure of insulation, short
circuit,explosion,etc.(operationalrisks).
(f) N aturalcalam itieslikeflood and earthquake,inundation,etc.
9. H ow istheprem ium fora C A R policy determ ined?
A ns.The factors that affect the risk associated w ith the project are considered w hile
w orking outtheprem ium .They include:
1. Thenatureoftheproject
2. Theprojectcost
3. Theprojectperiod
4. G eographiclocation
5. Theperiod oftesting
If the sum insured in the projectexceeds Rs.100 crores w ith the option of higher
deductibles,then a discountin prem ium isallow ed.The discountisalso given ifthe
projectsite isprotected againstthe fire.Projectsw ith period ofm ore than one year
areallow ed to pay theprem ium in instalm ents.W hereprojectsgetcom pleted before
the estim ated tim e period,the prem ium forthe balance period ofinsurance m ay be
refunded.
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10. H ow istheEA R Policy differentfrom theC A R Policy?


A ns.Erection allrisk insuranceissim ilarin itsnatureto thecontractorsallrisk insurance.
Itprovidescoverforthe erection ofthe m achinery.Itisa com prehensive insurance
policy that covers all the risks right from the beginning w hen the m aterials are
unloaded atthe projectsite tillthe tim e projectistested,com m issioned and handed
over. The erection all risk policy is appropriate for projects involving standing
structures . Such structures are exposed to various risks during the construction
period likethedam ageoftheplantand them achinery orthesupporting structures.
11. H ow is M achinery Insurance Policy differentfrom M achinery Loss ofProfits
policy?
A ns.M achinery (breakdow n)insurancepolicy coversallthecostsinvolved in bringing the
m achinery back to pre-breakdow n state.M achinery Insurance Policy coversalm ost
allthe stationary capitalequipm ent.The policy covers allsorts ofevents thatcan
causebreakdow nofthem achinery.A llaccidental,electrical,m echanicalbreakdow ns
due to internalcauses,externalcauses,operationaldeficienciesorhum an errorsare
covered underthepolicy.TheM achinery LossofProfitsInsuranceprim arily aim sat
covering the consequential losses, say, due to sim ultaneous failure of standby
equipm ent.M achinery loss ofprofits insurance helps to m ake good such losses.It
m inim isesthe effectsofthe consequentiallossesduring the interruption period and
helpstheentrepreneurto restorethebusinessoperationsto norm alcy.
Thepolicy coversthelossesdueto
1. D ecreasein turnover
2. Risein costofw orking
The losses as a resultofreduced turnoverbecause ofthe dam aged m achinery
and theadditionalexpenditurenecessarily incurred foravoiding orreducing the
fallin turnoverfortheinterruption period iscom pensated underthispolicy.
12. D oesa Boilerexplosion policy coverlossdueto fire?
A ns.This policy covers loss ordam age to steam generating equipm ents like boilers and
otherfired and unfired pressurevesselsagainsttherisk ofexplosion and collapsedue
to internalpressuresthatare inherentin allsuch equipm ents.The policy coversthe
dam age caused to the boilers and otherpressure plantdue to explosion (notdue to
fire).Foradditionalprem ium ,dam aging to the surrounding property ofthe insured,
liability on accountofdam age to the property notbelonging to the insured,can also
be insured.So a businessperson should availthis policy to be fully secured against
thelossesdueto fireand explosions.
13. H ow isa burglary policy beneficialfora com m ercialbusinessunit?
A ns.Thepolicy coversthefollow ing:
Stock in trade
G oodsheld in trustoron com m ission

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M O D U LE -I: PRIN CIPLES A N D PRA CTICE O F IN SU RA N CE

Fixturesand fittings,plantand m achinery thatism ovableproperty


Thepolicy offersprotection againstburglary and housebreaking.Forcefulentry isthe
chiefcharacteristicofburglary.O thercrim eperilsliketheft,larceny,robbery,etc.are
notcovered underthispolicy.
Thepolicyrequirespropercareoftheinsuredproperty.Ifthecashinthesafeisinsured,
thesafeshould belocked and keysofthelock should notlieanyw herenearthesafe.
14. H ow and w hen doesliability ariseundera productliability?
A ns.Liability arisesoutof
1. Tortorcom m on law
2. Statutory law quiteoften itisabsoluteorno faultliability
3. Contract
Product liability insurance covers the dam ages arising in such cases. A nd the
dam agesarising orthecom pensation thatisrequired to bepaid in such caseishuge.
H ence allthe industriesthatare exposed to such risksshould go forproductliability
insurancecover,even ifitisnotm andatory forthem to availthiscover.
15. W hatisthescopeofcoveravailableundera professionalliability policy?
A ns.Professionalindem nity insurance covers the professionals againstallthe liabilities
thatm ay arise due to the negligence orfailure in providing the service.Thatisw hy
this policy is also called Errors and O m issions Insurance (E& O Insurance) or
m alpracticeinsurance.
16. W ho aredefined as professionals?
A ns.Initially thepolicy w asdesigned forprofessionalslikedoctors,law yers,architectsor
engineers but now the policy is w idening its scope to accom m odate em erging
professions. The policy now includes various professions like psychiatrists,
m arketing ortechnology consultants,softw aredesigners,environm entalconsultants,
insuranceagents,brokers,etc.
17. H ow istheprofessionalliability coverdifferentfrom otherliability covers?
A ns.Theprofessionalliability insurancediffersfrom otherliability insurancepoliciesin a
few w ays.Theseareasfollow s:
(1) W hile other liability insurance policies usually specify the per occurrence
lim it,thereisusually am axim um lim itforeach claim ,butthereisno lim itper
occurrence in case ofa professionalliability policy.Further,no distinction is
m adebetw een bodily injury and property dam ageliability.
(2) Professional liability insurance is not restricted to accidental acts: faulty
diagnosis or faulty perform ance is also covered. D eliberate acts giving
unintended resultsarealso covered in thepolicy..
(3) Professionalliability policiesusually coverthe dam age caused to the property
in thecustody orcareoftheinsured asw ell.
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M O D U LE -I: PRIN CIPLES A N D PRA CTICE O F IN SU RA N CE

(4) Professional liability insurance does not allow the settlem ent of the claim
w ithoutthepriorapprovaloftheinsured.

18. Isa doctoralso equally liableforthenegligenceofhisassistantand nurse?


A ns.Thedoctorsprofessionalliability policy protectsthedoctorfortheactofthefollow ing
peoplesuch as:
The acts ofthe qualified assistants and the em ployees ofthe insured w ho are
nam ed in thepolicy arealso covered in thepolicy
Theclaim sshould relateto theactsorom issionscom m itted during theperiod of
thepolicy
The lim itof the indem nity granted under the policy for A ny O ne A ccident
(A O A )A ny O neYear(A O Y )(peraccidentperpolicy year)w illbeidentical

19. W hatisa respondentia bond?


A ns.Respondentia loansw ere given to the captain ofthe ship againstthe cargo to ensure
the safety ofjourney.They w ere paid back only ifthe cargo reached the destination
safely.

20. W hatarebottom ry loans?


A ns.Bottom ry loansin contrastto Respondentialoansw ereraised againsttheship/vessel.
H igh prem ium w ascharged on theloan to covertherisk.H encein m any respectsthey
w eresim ilarto presentday sm arinecargo and hullinsurance.

21. D efinethecontractofm arineinsurance?


A ns.M arine insurance isa contractbetw een the insurerand the insured.The insureras
per the agreem entundertakes to indem nify the insured in an agreed m anner and
appropriate against m arine losses incident to m arine adventure . The insured in
return paystheprem ium to theinsurer.

22. D efinethescopeofcoverageundertheM IP ?
A ns.Thecoverageunderm arineinsurancepolicy includesthefollow ing:
Theship (hulland m achinery)
Theinsurablegoodsand property exposed to m aritim eperils.
O therincidentalearningslikefreight,com m ission,etc.w hich w illbelostalong
w ith theproperty dueto them aritim eperils.
Thethird party liabilitiesincurred by theinsurerorotherperson responsiblefor
orinterested in theproperty.
Expensesincurred to preventand m inim iselosses
M aritim e perilsare the perilsthatare incidentalto the sea journey thatarise in
consequenceoftheseajourney.

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23. W hy isa m arinepolicy called asvalued policy?


A ns.M arine insurance is a valued policy because the value is agreed upon in advance,
unlikefireand otherinsurancew heretheindem nity islim ited to theactualloss.This
valuem ightbem oreorlessthan theactuallossoccurred.
24. W hatistheprotection assured undera crim einsurancepolicy?
A ns.Therearetw o typesoffinancialprotection thatareavailableagainstthelossescaused
by crim e. They are fidelity and surety bonds and burglary, robbery and theft
insurance.A bond isa legalinstrum entin w hich a third person (surety)ensuresthe
perform ance ofcontractproperly by the principalorthe obligator.A fidelity bond
dealsw ith assurance ofbonafide behaviourby an em ployee during the course ofhis
em ploym ent.In fidelity bond,thesurety assurestheem ployeroftrustw orthinessand
honesty oftheem ployeeand agreesto pay thedam agesthatarisedueto thedishonest
actsofthatem ployee.
25. D ifferentiatebetw een a fidelity bond and crim einsurance.
A ns.W hilein abond contractthesurety isrequired to pay forany losses,healso reserves
the rightto recoveritfrom the defaulting principal.W hereasin case ofan insurance
contract,the insurer is prepared to pay for the loss and w orks on the principalof
spreading thislossoverthegroup ofinsured people.Secondly,them attercovered by
bonds is underthe controlofthe insured and the losses covered by insurance are
m attersoutside the controlofthe individual.Thirdly,w hile the insurance contractis
cancellable,usually,by eitheroftheparty,thebondscannotbecancelled untilallthe
obligations of the principal are fulfilled.Lastly,insurance contract involves tw o
parties,w hereasbondsinvolvethree.
26. D iscussthescopeofcoverageunderIC C clausesform arinepolicy?
A ns.InstituteCargo Clauses C (BasicCover)coversthefollow ing :
a. i. Lossordam ageto thesubject-m atterinsured reasonably attributableto:
Fireorexplosion
Vesselorcraftbeing stranded,grounded,sunk orcapsized
O verturning orderailm entofland conveyance
Collision or contact of vessel / craft or conveyance w ith any external
objectotherthan w ater
D ischargeofcargo attheportofdistress
ii. Loss/dam ageto thesubject m atterinsured caused by:
G eneralAveragesacrifice
Jettison
b. G eneralAverage contribution and Salvage chargesincurred to avoid lossfrom
any cause(s)exceptthoseexcluded
c. Liability under Both to Blam eCollision clauseofcontractofA ffreightm ent

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InstituteCargo Clause B coverstheaforesaid risksofICC (C)and


a. i. Loss /dam age reasonably attributable to earthquake,volcanic eruption or
lightning;
ii. Lossordam agecaused by
Entry of sea,lake,or river w ater into vessel,craft,liftvan or place of
storage
totallossofany package lostoverboard ordropped w hilstloading into or
unloading from vesselorcraft
b. G eneralAverage contribution and Salvage chargesincurred to avoid lossfrom
any cause(s)exceptthoseexcluded
c. Liability under Both to Blam eCollision clauseofcontractofA ffreightm ent
InstituteCargo Clause A Com prehensivecover
a. A llRisksofloss/dam agetothecargoinsuredexceptthosespecificallyexcluded.
b. G eneralAverage contribution and Salvage chargesincurred to avoid lossfrom
any cause(s)exceptthoseexcluded
c. Liability under Both to Blam eCollision clauseofcontractofA ffreightm ent
27. Enum eratethegeneralexclusionsunderthem arineinsurancepolicy?
A ns.Theexclusionsunderam arineinsuranncepolicy includethefollow ing:
Loss,dam ageorexpenseattributableto w illfulm isconductof theinsured
O rdinary leakage,ordinary lossin w eightorvolum eorordinary,w earand tear
Inherentviceornatureofthesubjectm atter
D elay
Insolvency orfinancialdefaultoftheow ners,operators,etc.ofthevessel
Insufficiency orunsuitability ofpacking
W arand allied perils
SRCC-Strike,Riot,CivilCom m otion and Terrorism
28. W hataretheextensionsofC over?
A ns.TheICC B coverforextraneousperilsinclude:
a. Theft,pilferage,and non-delivery
b. Fresh /rain w aterdam age
c. D am ageby hook,oil,m ud,oracid
d. Breakageorleakage(notordinary leakage)
e. Countrydam age
f. Shortage
g. Bursting and tearing ofbags
h. SRCC Risksunderalltheclausescan beextended @ 0.0225%
i. O cean transitpoliciescan beextended to coverW ar& SRCC @ 0.02475%
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j. A irtransitpoliciescan also beextended to coverthew arand SRCC @ 0.025%


additionalprem ium .

SEC TIO N C
C A SE STU D IES
1. G ovind Rao,adealerin tim ber,supplied tim berto com panieson acontractbasis.H e
insured his business w ith U nity Insurance Com pany. G ovind Rao had different
paym entarrangem entsw ith each ofhisclients.W hilesom eclientsw ereasked to pay
in cash,othersw ereallow ed credit.
G reen Earth PublicLtd w asoneofthecom paniesthatpurchased tim berfrom G ovind
Rao.G ovind Rao received fully paid sharesofthecom pany aspaym entforthetim ber
sold to it.By financing the com pany during its tim e ofneed,G ovind Rao had also
becom ean unsecured creditorofthecom pany.
O n 10 A pril2000,G ovind Rao and G reen Earth signed adealfor1000 teak w ood logs.
Thedeliveryofthetim berw astotakeplacethenextday.U nfortunately,thatnightthere
w as a short circuit at the godow n w here the tim ber w as stored, and the entire
consignm entw as destroyed in the fire.G ovind Rao filed a claim w ith the insurance
com pany forthelosshehad incurred.U nity,how ever,rejected hisclaim and refused to
payfortheloss,allegingthatthetim berw hichw asdestroyedw assoldbytheinsuredto
G reen Earth and,therefore,G ovind Rao no longerhad any claim overit.
Q uestionsfordiscussion:
1. IsG ovind Rao entitled to receive com pensation from the insurance com pany forthe
losscaused by thefire?
2. W hat is insurable interest? W hat are the policy requirem ents for an insurance
interest?
A ns.1.A fterhaving finalized the sale ofthe tim berto G reen Earth Public Ltd.,G ovind
Rao has no insurable interestin the tim bersince ithas becom e the property ofthe
buyer,thatis,G reen Earth.
Insurable interestisthe legalrightofthe ow nerofa property to insure the property.
O ne ofthe conditionsofan insurance policy isthatthe policyholdershould have an
insurableinterestthroughouttheperiod ofthepolicy.Further,during thetenureofthe
policy, the policyholder m ay lose his insurable interest by w ay of transfer of
ow nership,etc.In such a situation,he is no longerentitled to claim forloss to the
insured property asthesold property no longerbelongsto him .
M oreover,a shareholder or creditor of a com pany cannot insure the assets of a
com pany,sincetheassetsbelong to thecom pany.Thecom pany,w hich isan artificial
person,hasan insurableinterestin thecom pany sassets.Thus,in thegiven case,the
tim berhas becom e the property ofG reen Earth and G ovind Rao is notentitled to
receiveany com pensation from theinsurancecom pany forthelossto thetim berdue
to thefire.

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2. Theow nerofaproperty hasthelegalrightto insurehisproperty ifitslossordam age


is likely to affecthim financially.This legalrightofthe ow neris called insurable
interest. The absence of an insurable interest renders an insurance policy void
because one of the conditions of the policy is thatthe policyholder m aintains an
insurableinterestthroughouttheperiod ofthepolicy.
Instead ofm aking the existence ofan insurable interesta precondition forobtaining
coverage,insurancepolicies,instead,lim itthepaym enton any claim to theextentof
the insured s interest. In addition to this, proof of loss form s that accom pany
insurance policiesrequire the insured to specify allintereststhathe m ay have in the
property.Lim iting the paym entofclaim s to the extentofan insured s interestand
requiring the insured to specify allinterests in the property is essentialforclaim s
adjusting.Ifitw erepossibleforan insured to beableto collectm orethan theinterest
hehasin theinsured property,itw ould serveasan incentivefortheinsured to cause
deliberate destruction to his property.A lso,an insured s interestcan change due to
circum stances such as m arriage,divorce,oradditionalm ortgages.This can create
opportunity forfalseclaim siftheam ountrecovered by theinsured asinsuranceisnot
lim ited to theinsured sactualinterest.
By identifying allinterestsin theproperty,an adjusterisableto treatallpartiesfairly,
w ithoutcom prom ising on the insurer srights.Italso enablesthe adjusterto identify
othercoverages.
3. ShankarRam an joined therailw aysin 1975.H estarted outasam echanicand w orked
in differentcapacitiesfrom 1975 to 1998.A sa m echanic,he had to use solventsto
rem ove engine grease from engine parts and tools as w ellas from his hands and
clothing.
A ftersom e yearshe gotprom oted assupervisor.H ow ever,hisexposure to solvents
did notstop there.A sa supervisor,he continued to inhale solventsduring the daily
inspections.
A ftersom etim e,Ram an experienced rashes,dizziness,breathlessness,and disturbed
sleep patterns. Because of his problem s, he even m ade life difficult for other
m em bersin hisfam ily.
Ram an usually m aintained a good rapportw ith hispeersand superiors.Butin 1990,
he had problem s w ith his im m ediate superiorPaw an Sarkar.Sarkareven allegedly
w aged a cam paign of harassm ent and intim idation against Ram an. D espite his
problem s,Ram an nevercom plained againstSarkarto higherauthorities.
U nableto beartheharassm ent,Ram an thoughtofquitting thejob.Buthisobligations
tied him dow n.So hefaced allkindsofproblem sw ithoutm aking an issueofit.
In 1995, Ram an began to suffer from w eight loss, headaches, nausea, anxiety,
m em ory loss,and otherhealth problem s.H e even soughtpsychiatric treatm entfor
depression in 1995.
O ne ofthe psychiatristsattributed Ram an sm entalproblem sto job stress.In 1998,
unableto continuew ith theorganization any m ore,Ram an decided to quitthejob.
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Even after one year of quitting the job,Ram an could notrecover com pletely.H e
approached Ayurvedic doctors and used herbal m edicines. U nfortunately all his
attem ptsw ererendered futile.
Ram an then claim ed com pensation from the railw ays for the ailm ents he had
contracted during the tenure ofhisservice and the financialburden he had to bearin
the process of undergoing treatm ent for these ailm ents. The railw ays forw arded
Ram an sclaim to itsinsurerFairInsuranceCom pany.Theinsurer,in turn,appointed
aclaim sadjusterto carry outthenecessary investigationsand to decideon theclaim s
am ountithad to pay Ram an.
The claim adjuster surveyed the w orkshop prem ises w here Ram an used to w ork,
spoke to Ram an s colleagues and subordinates,and noted dow n a few things to
discusslaterw ith the m anagem ent.The claim sadjustereven obtained the addresses
ofthe doctorsw ho had treated Ram an and had detailed discussionsw ith them about
Ram an shealth problem s.Later,w hilegiving them anagem enthisreporton w hatthe
claim am ount should be, the claim s adjuster stressed on som e vital aspects of
Ram an sjob w hich,ifsuitably m odified w ould notonly help Ram an com e back to
w ork w ithoutcausing any furtherharm to hishealth,butw ould also help therailw ays
low erthedisability expensesthey w ererequired to pay Ram an.
Q uestionsforD iscussion:
1. Claim s adjusters handling w orkers com pensation cases m ust investigate them
diligently.D iscuss,how w elltheadjusterinvestigated Ram an scom pensation case.
2. H ow w ill the com pensation adjuster s report to the railw ays m anagem ent help
controldisability expensesin future?
A ns.1.There isno realinvestigation into w orkers com pensation casesthatonly involve
m edicalexpenses.Theclaim sadjustertakesthepolicyholder sw ord asproofthatthe
accidenthappened on thejob and thattheinjury isw ork-related.
Theadjusterusually conductsan investigation iftheaccidentinvolveslosttim efrom
w ork.In such cases,he obtainsstatem entsfrom the claim ant,the em ployer,and any
w itnesses present.W ith the help ofthese statem ents,the adjustertries to establish
w hetherthe injury is w ork-related ornot,ifthe relationship betw een the em ployee
and the em ployer m ighthave prom pted exaggerated claim s by the claim ant,and
w hether the injury w as preexistent or not. The adjuster m ust also obtain
docum entation ofthe earningsofthe em ployee in orderto calculate the em ployee s
disability com pensation accurately.
2. For com pensation adjusters,controlling disability expenses is probably the m ost
im portantissue.Casesin w hich the claim antreturnsto w ork prom ptly and doesnot
lose any tim e from w ork are relatively sim ple and straightforw ard forthe adjusterto
handle.The biggestproblem thatcom pensation insurers face are from cases w hich
involvedisability extending overalong period oftim e.
Com pensation insurers cannot sim ply stop paying com pensation because they

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believethatthedisability should haveended.O ncetheinsureracceptsacaseasbeing


com pensable,he cannotend disability paym ents exceptby an agreem entw ith the
claim ant to do so or through an order of the com pensation com m ission. If the
claim antdisagreesw ith theinsurer,itm ay takem onthsto resolvethecasebeforethe
com pensation com m ission. The decision of the com pensation com m ission is
generally in favourofthe claim ant.The insurercan stop paym entifthe com m ission
allow s stoppage of paym ent to the claim ant and rules in favour of the insurer.
H ow ever,in such cases,theclaim antneed notreim bursepastpaym ents.
A djusters can controldisability expenses by insisting thatthe treating doctorgives
reasonsforw hy theclaim antcannotperform hisjob.Thisisnecessary becausem any
physicians certify disability w ithout understanding the physical dem ands of the
claim antsw ork.Foralm ostany kind ofim pairm ent,therearejobs,orcertain aspects
of a job,thatcan be perform ed by the affected person.Therefore,the physician
cannotassum eadisability purely on thebasisofan im pairm ent.
A djusters and em ployers can w ork together to m odify the job of an em ployee by
rem oving the m ost physically dem anding parts from the job. O n their road to
recovery,claim antscan be given w ork thathave lim ited duties.The claim sadjuster
can also controldisability expensesby constantly encouraging claim antsto return to
the job.In the process,they can find outfrom them the aspectsoftheirw ork w hich
they are stillunable to perform and suggestthe required m odificationsin the job to
theem ployer,w hich can help theclaim antto com eback to w ork quickly.

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C hapter 8
LifeInsurance

SEC TIO N -A

1. W hich ofthefollow ing needsaresatisfied by lifeinsuranceproducts?


a. Risk coverage.
b. Com pulsory savings.
c. Tax saving
d. Both (a)and (b)above.
e. A llof(a),(b)and (c)above.
2. W hatistheexem ption underthecondition ofautom aticrenew alavailableto the
insured?
a. Theinsured need nothaveto pay theprem ium .
b. Theinsured need nothaveto puthisconsentagain.
c. Theinsured need nothaveto undergo any m edicaltest.
d. Theinsured need nothaveto pay any extraprem ium forthehigherattained age.
e. A lloftheabove.
3. W hatisthebasison w hich theprem ium should becharged in caseofrenew alof
theterm insurancepolicy?
a. A ttained ageoftheinsured.
b. A geoftheinsured atthetim eoftaking thepolicy.
c. A verage age ofthe insured atthe tim e ofcom m encem entofthe policy and the
m aturity ofthepolicy.
d. Either(a)or(b)above.
e. A ny oneof(a),(b)or(c)m ay bechosen
4. Tillw hen istheinsured liableto pay theprem ium sin caseofa lim ited paym ent
w holelifeinsurancepolicy?
a. Theinsured isrequired to pay theprem ium sthroughouttheold age.
b. Theinsured isliableto pay theprem ium sforalim ited period.
c. Therisk ofdeath coverageisavailableforalim ited period only.
d. Theliability ofthelifeinsurerw illgradually decreaseto alim ited value.

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e. The liability ofthe insured to pay the prem ium s w illgradually increase butit
w illbelim ited to acertain value.
5. W hich ofthefollow ing policiesby natureconstitutethrifty savings?
a. Term insurance
b. Pureendow m ent
c. Endow m entassurance
d. Term endow m ent
e. Pureinsurance
6. W hich policy do you suggestto m anagetherisk ofexcessivelongevity?
a. Term insurance
b. Pureendow m ent
c. Endow m entassurance
d. Term endow m ent
e. Pureinsurance
7. W hich ofthefollow ing lifeinsurancepoliciesdo notassurethem inim um return
fortheinvestm entcom ponent?
a. U niversallifeinsurancepolicy
b. V ariablelifeinsurancepolicy
c. Endow m entassurancepolicy
d. Both (a)and (c)above
e. Both (b)and (c)above
8. W hataretheadvantagesoftheuniversaland variablelifeinsurancepolicies?
a. Incom etax-deferred cash accum ulation.
b. G uaranteed death benefitand otheroptionalbenefits.
c. Flexibility abouttheam ountofprem ium paym ents.
d. Choiceofthetim ing ofprem ium paym entto thepolicyholder.
e. A lloftheabove.
9. W hatcom ponentsdoesvery paym entin caseofan annuity certain consistof?
a. Principalcom ponent
b. Interestcom ponent
c. Risk prem ium com ponent
d. Both (a)and (b)above
e. A llof(a),(b)and (c)above
10. W hich of the follow ing statem ent(s) captures the sim ilarities betw een a life
insuranceand an annuity contract?

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a. Both protectagainsttheabsenceofany incom es.


b. Both thecontractstogethercom pletetheeconom icprogram m eofaperson.
c. Rateofm ortality influencesboth typesofcoverages
d. M oralhazard m ay arisein both thesituations.
e. A lloftheabove
11. W hatistheinitialpaym entby theannuitantknow n asin an annuity contract?
a. Purchaseprice
b. Prem ium
c. Cash value.
d. Policy value.
e. N oneoftheabove.
12. W hich ofthefollow ing statem ent(s)is/aretrueregarding an annuity plan?
a. A nnuity paym entm ustbe started im m ediately on receiptofthe purchase price
in allannuities
b. A nnuity plansaregenerally undertaken to covertherisk ofdeath
c. A singleannuity plan can beundertaken by m orethan oneannuitant.
d. Insurer is liable to refund the purchase price to the nom inee of annuitantin
every case.
e. A lloftheabove.
13. W hich ofthefollow ing statem ent(s)is/aretrueregarding theam ountofannuity
installm entpayableby theinsurer?
a. Itisnotrelated to theentry ageoftheinsured.
b. Itincreasesw ith theentry ageoftheinsured.
c. Itdecreasesw ith theentry ageoftheinsured.
d. Itcannotbepredicted so easily.
e. Itdependson m any otherfactorsalong w ith age.
14. Forw hich annuity,theinvestm entrisk isan integralpart?
a. Fixed annuity.
b. V ariableannuity.
c. Im m ediate annuity.
d. D eferred annuity.
e. A nnuity certain.
15. W hatdoesdeferred annuity plan consistof?
a. A ccum ulation period only.
b. Liquidation period only.

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c. Paym entperiod only.


d. Both (a)and (b)above.
e. A llof(a),(b)and (c)above.

SEC TIO N A A N SW ER S
1. (e) Life insurance products offer good savings plans along w ith different risk
coverages thatare related to our life.Life insurance savings also offer som e tax
incentivesto thepolicyholderaspertheincom etax rules.
2. (c)U nderthe conditionsofthe autom atic renew alfeature,the insured can renew the
insurancepolicy attheend ofeach fixed period w ithoutundergoing any m edicaltest
in orderto provehis/herinsurability.
3. (d)A n insurerm ay renew thepolicy on thebasisofany oneofthegiven tw o agesof
the policyholder.If the policy is renew ed on the basis of the attained age of the
insured,higher am ountof prem ium due to the increased age is to be paid by the
insured.If the age atthe com m encem entof the policy is chosen for renew al,the
differencein prem ium am ountisto bepaid along w ith interest.
4. (b) U nder a lim ited paym ent w hole life policy, the insured is liable to pay the
prem ium sup to acertain period oftim e.Butin return ofthoseprem ium s,therisk of
death coverageisavailableatany tim eirrespectiveoftheage.
5. (c) O ne can build up certain am ountof corpus based on the future needs atany
expected pointoftim ein future.D ueto thevery natureofthecontract,oneisforced
to save and the proceeds ofpolicy are payable only on m aturity oron early death
w hich m ay be predeterm ined on the basis ofthe am ountand tim e ofthe expected
fundsrequirem ents.
6. (b) In case of pure endow m entpolicy,the am ountof sum assured is paid to the
policyholderon survivaltillthe end ofthe policy term .D uring old age,funds are
required to m eetthem inim um physiologicalneedsw hilethew orking lifeofaperson
com esto an end.Therefore,such apolicy can offerthebestchoiceto m anagetherisk
oftheexcessivelongevity atalow cost.
7. (b)U nderthevariablelifeinsurancepolicy,thepolicyholderisrequired to choosethe
natureofinstrum entsw heretheinsurercan m aketheinvestm ents.By follow ing that
norm ,the totalproceeds are returned to the policyholderon m aturity,w ithoutany
assuranceofeven them inim um return.
8. (e)A llthegiven featuresareapplicableto both thepolicies
9. (d) In case of an annuity certain,the insurer pays a fixed sum of m oney to the
annuitantforacertain num berofyearsasagreed upon by both theparties.Thisfixed
am ount consists of principal and interest. In the initial years, the percentage of
interestism orew hileitisthereversein lateryears.
10. (e)Inboththecasesofannuityandlifeinsurance,theinsurerprotectsagainstthelossof
incom es to the insured based on the m ortality rate experienced by the insurable

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population.Lifeinsurancecontractsassuretherisk ofprem aturedeath w hileannuities


are m eantforthe problem sofexcessive longevity.Butin both the cases,the insured
m ay distortthefigurerelating to theactualagethatm ay betaken asam oralhazard.
11. (a)Theannuitantisrequired to buy thesuitableannuity contractby paying theproper
price ofthe sam e.The price m ay be eitherin lum psum orin installm entsasperthe
capacity ofthe annuitant.The price paid by the annuitantisknow n asthe purchase
price.
12. (c)A single annuity plan m ay be undertaken by a person individually orjointly w ith
others depending on the needs of the annuitant. For exam ple, one m ay take an
annuity plan forselfand spouse to getthe assurance ofregularcash flow forselfas
w ellasspousetilldeath.
13. (b)In annuity contracts,an insurerassum estherisk ofsurvivalofan annuitant.A sthe
age ofthe person increases,the possibility ofsurvivaldecreases.W ith increasing age,
therisk gradually decreasesand hencetheam ountofinstallm entspayableincreases.
14. (b)The annuitantisrequired to pay the purchase price firstto enable the insurerto
starttheinstallm entpaym entsaspertheterm softheannuity.Theinsurerinveststhe
purchase price to suitable financialinstrum ents thatyield the required patterns of
cash flow s.In variable annuity,the cash flow s depend on the perform ance of the
portfolio w heretheproceedsareinvested.
15. (d) D uring the accum ulation period, the purchase price is invested in suitable
financialinstrum entsto reach a certain value along w ith interest.Then thisvalue is
gradually paid to the annuitantregularly as perthe term s ofthe contract.The first
period iscalled asaccum ulation period w hilethesecond oneistheliquidation period.

SEC TIO N B

1. D escribethebasiccharacteristicsofterm lifeinsurance?
A ns.Term insurancehasseveralbasiccharacteristics.
Protection foralim ited num berofyears[tem porary protection]
U nlessthepolicy isrenew ed,theprotection expiresattheend oftheperiod.
Thesepolicieshaveno cash valueorsaving elem ent.
N othing ispaid in caseofsurvival.
Issued forone yearto a setnum berofyearssuch as10 or20 orto a stipulated
age65 or70.
Initialprem ium sarelow .
Prem ium sforterm coverage can escalate rapidly asthe duration ofthe policy
lengthens.
Thesepricesarem oreeasily com pared than arepricesofotherproducts.
H ence this m arketis m ore price com petitive than the m arketfor cash value
policies.

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Thesepolicieshaveno cash values,no dividendsand so easy to com pareon the


basisofprem ium s.
Term lapse ratesare higherthan otherpolicies[because ofsensitivity in price
and low profitm argin].
M ostterm insurance policies are renew able,for additionalperiods w ithout
evidence of insurability w ith increased prem ium at each renew al based on
insured sattained age.
M ostterm insurance policies are convertible fora cash value policy w ithout
evidence ofinsurability.Thisconversion m ay be perm itted on an attained age
ororiginalagebasis.
Traditionalterm prem ium soften arebased on aggregatem ortality experience.
R eentry term prem ium sarebased on aselect\ultim atem ortality split.
H encethescaleofprem ium ratesvariesnotonly by agebutalso by theduration
sincetheinsured lastdem onstrated insurability.
2. W hen istheuseofterm insuranceappropriate?
A ns.Term insurance is appropriate w hen incom e is lim ited,orthere are tem porary high
insuranceneeds.Itcannotbeused forretirem entorsaving purposesbecauseithasno
cash values.
3. W hatarethelim itationsofterm insuranceplans?
A ns. Term insurance prem ium s increase w ith age and eventually reach prohibitive
levels. Thus term insurance is not suitable for individuals w ho need large
am ountsoflifeinsurancebeyond age65 or70.
Term insurance is inappropriate ifw e w ish to save m oney fora specific need
like child s education, or for retirem ent because these policies do not
accum ulatecash values.
4. D escribew holelifeinsurance.
A ns.W holelifeinsuranceisacash valuepolicy thatprovideslifetim eprotection.

TH E N A TU R E O F W H O LE LIFE IN SU R A N C E:
It provides for the paym ent of the face am ount upon the insured s death
regardlessofw hen death occurs
The face am ounts payable under w hole life policies typically rem ain atthe
sam elevelthroughoutthepolicy duration,although dividendsareoften used to
increasethetotalam ountpaid on death
In m ostpoliciesthe grossprem ium also rem ainsatthe sam e levelthroughout
theprem ium paym entperiod w ith som eexceptions.
U niversal life policies can function as w hole life insurance if they have
sufficientcash value

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W H O LE LIFE C A SH V A LU ES:
A llw holelifepoliciesinvolvesom epre-funding offuturem ortality costs
Cash valuesare available to the policy ow neratany tim e by surrendering the
policy
Facility ofobtaining a loan w ith rate ofinterestupto thatofthe policy s cash
value
Loan isdeducted from thegrosscash valuew hen death claim ispayable
W hole life policies m ay be participating ornon participating w ith som e non
guaranteed elem ent.
5. D escribethelim ited paym entw holelifeinsurance
A ns.LIM ITED PA Y M EN T W H O LE LIFE IN SU RA N CE policy rem ainsin fullforcefor
the w hole oflife butprem ium sare payable fora lim ited num berofyearsonly,after
w hich thepolicy becom espaid up foritsfullfaceam ount.
Itisdifferentfrom vanish pay policy w herethereisno guaranteeofnotrequired
paym entsbeyond thestated prem ium paym entperiod .
The greaterthe num berofprem ium paym ents,the m ore closely the contract
resem blestheordinary lifeform .
A nnual level prem ium s of these policies are larger than ordinary life plan
because the actuarial equivalent of the prem ium s payable for the insured s
entire lifetim e.
Thehighertheprem ium sforapolicy,thegreaterthecash values.
The size ofthe cash value variesinversely w ith the length ofprem ium paying
period.
Itcontainsthesam enon-forfeiture,dividend,settlem entoptionsofordinary life
policy.
The one end extrem e in lim ited paym entlife insurance is the single prem ium
w holelifepolicy and anotherend isordinary lifeinsurance.
Itis notw elladopted to those w hose incom e is sm alland w hose need for
insuranceprotection isgreat.
Thispolicy fitsm any businessinsurancesituations
6. W hatisan endow m entinsurance?
A ns.A n endow m entpolicy paysthe face am ountofinsurance ifthe insured diesw ithin a
specified period;ifthe insured survivesto the end ofthe endow m entperiod,the face
am ount is paid to the policy ow ner at that tim e. The m athem atical concept of
endow m entinsurance = term life insurance + pure endow m ent[to pay the face
am ountifthe insured diesduring the period + to pay the m aturity am ountonly ifthe
insuredislivingattheendofaspecificperiod,w ithnothingpaidincaseofpriordeath.]
The econom ic concept divides endow m entinsurance into tw o parts :decreasing
term insuranceand increasing savings.
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7. Explain them ajorcharacteristicsofuniversallifeinsurance


A ns.U niversallife insurance is an im portantvariation ofw hole life insurance.Itcan be
defined as a flexible prem ium policy that provides lifetim e protection under a
contract that unbundles the protection and saving com ponents. It is sold as an
investm entratherthan asprotection.
M ajor characteristics:
G reaterprem ium flexibility [frequency in m odeofpaym entand in theam ountof
paym entsubjectto sufficientcash valueto coverm ortality costsand expenses.]
A djustablefaceam ount
Contem porary interestrates
U nbundling ofthe savings,expenses,and protection elem ents and associated
pricing.
Increased disclosure through the statem entw hich show s the m ortality charge
forthecostofinsurance,expensechargeforsalesand adm inistrativeexpenses,
and interestcredited to the cash value account.[annualprem ium expense
and adm inistrativecharges m ortality charge+ interest= cash valueaccountat
end ofyear.]
Tw o form sofuniversallife insurance:1.paysa leveldeath benefitduring the
early policy years 2. A n increasing death benefit [This is m ore expensive
becausetheinsurerm ustpay ahigherdeath benefit].
A partialcash w ithdraw al[nota loan] can be m ade w ithoutterm inating the
policy.Interestis notcharged forthis,butthe death benefitis reduced by the
am ountofw ithdraw al.
Policy loansareperm itted atcom petitiveinterestrates.
Ifthepolicy perm its,additionalinsuredscan beadded to thepolicy.
Favourableincom etax treatm entastraditionalcash valuepolicies.
Lim itations:
M isleading ratesofreturn [insurersadvertisegrossreturnsw hich do notreflect
salescom m issions,expensesand thecostofinsuranceprotection].
Incom plete disclosure [the policy ow neris notgiven inform ation on how the
expenses are allocated betw een the protection and saving com ponents in the
policy]
D ecline in interestrates[w hen there isa decline in interestrate the cash value
and prem ium paym entprojectionsbased on higherinterestratesarem isleading
and invalid]
A dm inistrativecostsarehigh.
U ncertainty cash flow shasproven achallengeoperation ofthispolicy.
Insurerhas the rightto increase currentm ortality charge up to the m axim um
lim it.
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Policy ow neroften lacksa firm com m itm entto pay prem ium s.A sa resultthe
policy m ay lapsebecauseofnon-paym entofprem ium s.
8. D efinean annuity
A ns.A n annuity can bedefined asaperiodicpaym entthatcontinuesforafixed period or
forthe duration ofa designated life orlives.The person w ho receives the periodic
paym entsorw hoselifegovernstheduration ofpaym entisknow n astheannuitant.
The fundam entalpurpose ofa life annuity isto provide lifetim e incom e thatcannot
beoutlived.
9. C lassify annuities.
A ns.A nnuitiesm ay beclassified in num erousw ays,based on
N um beroflivescovered
M ethod ofprem ium paym ent
Tim ew hen incom ebegins
M ethod ofdisposing ofproceeds
D enom ination in w hich benefitsareexpressed
10. W hatdo you m ean by num beroflivescovered in an annuity?
A ns.W hen annuity paym ents are m ade w ith reference to one life orm ultiple lives itis
know n as num ber of lives covered. W hen annuity covers tw o or m ore lives,
especially w ife and husband,itisknow n asjointand lastsurvivor annuity w hich
continues the sam e incom e untilthe death ofthe lastsurvivor.Jointlife annuity
providesaspecified incom efortw o orm orenam ed persons,w ith theincom eceasing
upon thefirstdeath am ong thecovered lives.
11. H ow do you classify annuitiesbased on them ethod ofprem ium paym ent?
A ns.Them ethod ofprem ium paym entsin an annuity can be
Singlepaym entby beneficiaries
Periodicpaym ents
12. H ow do you classify an annuity based on tim ew hen incom epaym entscom m ence?
A ns.A nnuitiescan beclassified in tw o w aysbased on tim e
A deferred annuity
A n im m ediateannuity
A deferred annuity is an annuity purchased w ith either a single prem ium or
periodic prem ium s.The firstannuity benefitism ade afterthe passage ofm ore
than one paym entinterval.M ore flexibility isperm itted in prem ium paym ents
w ith thelongerdeferralperiod.
A n im m ediate annuity isan annuity purchased w ith a single prem ium and the
first annuity paym ent is due [alm ost] im m ediately, generally one paym ent
interval[am onth orayear]from thedateofpurchase.
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13. D ifferentiateG roup LifeInsurancefrom IndividualLifeinsurance


A ns.G roup insurancediffersfrom individualinsurancein severalrespects.
G roup Insurance IndividualInsurance
Coverageofm any personsunderone Coverageofsingleperson in one
contract Contract
A m astercontractisform ed betw een A contractisform ed betw een the
theinsurerand thegroup policy insurerand individualpolicy ow ner
ow nerortheem ployer
Em ployeesreceiveacertificateof Individualpolicy ow nerholdsthe
insurancethatshow sthey areinsured contract
Itcostslessthan individualinsurance. Itcostsm orethan group insurance
A dm inistrativeand m arketing expenses A dm inistrativeand m arketing
arereduced asaresultofm ass expensesarem oreasaresultof
distribution m ethods. individualattention
Individualevidenceofinsurability is Individualevidenceof
usually notrequired insurability isnecessary.
G roup selection ofrisksisused Individualselection ofrisksisused
Experiencerating isused theactual Experiencerating isused the
lossexperienceofthegroup isam ajor actuallossexperienceof
factor. theindividualsisam ajorfactor.
G roup underw riting. Individualunderw riting
Flexibility in contractdesign Rigidity in contractdesign.
G roup insuranceschem esarein the
natureofsocialsecurity.By recognizing
thistheStatesgranttax advantagesto
thecontracting parties.
14. Explain the eligibility requirem ents that are com m only required in group
insuranceplans
A ns.Theeligibility requirem entsforgroup insuranceare
Eligible groups:Eligible groupsare determ ined by insurance com pany policy
and statutes.Som eofthegroupsw hich aregenerally considered aseligibleare
a. Em ployer em ployee groups:H ere em ployertakesa m asterpolicy for
thebenefitofhisem ployees.Iftheschem eisnon contributory,i.e.w here
the em ployer bears the full cost,all eligible em ployees m ust join the
schem e.If the schem e is contributory,i.e.,w here the em ployer bears
som epartofthecost,ahigh levelofparticipation by theem ployeesin the
schem eisessential.
b. C reditor debtorgroups:Them asterpolicy istaken outby thecreditor
to coverthe outstanding am ountofloansgranted to debtors.The m aster
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policyholderm ay beabank,an em ployeroran organization.


c. Professionalgroups:A ssociations ofD octors,Law yers,Engineers,etc.
can beform ed on thebasisoftheirprofession.
d. C ooperative societies: The group should have a reliable identity and
should have been form ed for a specific purpose other than obtaining
G roup Insurancebenefits.
e. N odalA gencies:State and CentralG overnm entdepartm entsand w elfare
organizations are being allow ed to take G roup Insurance schem es
covering som e specific groups ofw eakersections ofthe society such as
landlessagriculturallabourers,handloom w eavers,taxidriversand other
labourgroups.
Eligibility requirem ents:
1. Befulltim eem ployees
2. Satisfy aprobationary period
3. A pply forinsuranceduring theeligibility period
4. Beactively atw ork
15. W hatarethem ajorform sofgroup lifeinsurance?
A ns.Them ajorform sofgroup lifeinsuranceplansare
G roup term lifeinsurance
G roup G ratuity schem e
G roup superannuation schem e
16. D escribethebasiccharacteristicsofgroup term lifeinsurance.
A ns.G roup term lifeinsuranceisthem ostim portantform ofgroup lifeinsurance.
The insurance provided is yearly renew able term insurance [the prem ium
charged coversthe risk forone yearand itw ould be renew ed atthe end ofthe
yearattheoption ofthegroup policy holderand thisisastep rateprem ium (the
prem ium increases w ith the increase in the age), w hich provides low cost
protection to theem ployeesduring theirw orking careers
The prem ium rates are determ ined by conditions of em ploym ent, w orking
environm entand occupationalhazards.
The am ountofterm insurance on an em ployee s life is typically one to five
tim estheannualsalary orearnings.
The term insurance rem ains in force as long as the em ployee is partof the
group.
Ifthe em ployee quitsorislaid off,he hasthe rightto convertthe group term
insuranceto an individualcash valuepolicy w ithin 31 daysw ithoutevidenceof
insurability
G roup term insurance cannotbe converted into an individualterm insurance
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policy.
M ostgroup plansallow a m odestam ountoflife insurance to be w ritten on the
em ployee sspouseand dependentchildren.
Theinsuranceon thespouse slifecan beconverted to an individualcash-value
policy
G roup term life insurance is used by com m ercial banks and other lending
institutions to insure the lives of debtors.Itprovides the cancellation of any
outstanding debtiftheborrow erdies
D isadvantages:
This insurance is tem porary and term inates w hen the individualis no longer
partofthegroup.
Itis expensive for an older w orker to convertto an individualpolicy after
retirem ent

SEC TIO N C
C A SE STU D IES
Term ,w holelife,endow m ent,annuity policiesorthecom bination ofpoliciesareavailable
in them arket.
Suggestsuitablepoliciesforthegiven situations:
1. Y ou arein 30s.Y ou aretheeldestson in yourfam ily.O nebrotherand sisterare
dependenton you fortheireducation and m arriage.
2. Y ou arein 40s.Y ou juststarted anew business.Y ourentirefam ily isdependent
on you.Tillyou settlein yourbusinessyou cannotcreateacapitalfund foryour
fam ily m aintenance.
3. Y ou purchased acarby taking loan from A uto Finance.Y ou w antto retain that
carto yourfam ily m em berseven in yourabsence.
4. Y ou w antto raiseloanson yourpolicy w hen you arein need.
5. Y ou w antto com bineinsuranceplansw ith som efinancialgoalslikechildren s
education and m arriage
6. Y ou know thatcom pounding factorisim portantforplanning retirem ent.
7. Y ou do notw antto takerisk w ith yourV RS Funds
8. Y ou w antsafeand guaranteed returnsfrom yourV RS Fundsinvestm ent.
9. Y ou w antfixed returnsfrom yourV RS Fundsinvestm ent.

A N SW ER S
1 & 2 :Forthesesituationsthesuggested bestpolicy isTerm InsurancePolicy.Theseplans
offer life insurance cover for specific num ber of years,atleastcost.Since entire
prem ium goestow ardsthe costofinsurance,there isonly risk coverand no saving
elem entisinvolved.
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3. The bestpolicy forthis situation is M ortgage Redem ption Insurance policy.These


plans offer life insurance cover for specific num ber of years like tillthe loan is
cleared [oron death,outstanding loan iscovered]attheleastcost.
4. The bestpolicy forthissituation isw hole life insurance policy.In term policiesand
in endow m entpoliciesyou cannotavailloans.
5. The bestpolicy forthis situation is endow m entplans orm oney-back plans.These
policiesprom isenotonly thepolicy faceam ounton thedeath oftheinsured during a
fixed term ofyears,butalso thefullfaceam ountattheend oftheterm iftheinsured
survivestheterm .
6. Considerdeferred annuity plans.
7,8& 9 Thebestpolicy isim m ediateannuity plansorsingleprem ium annuity plans.

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C hapter9
R egulation ofInvestm entFundsof
Insurance C om panies

SEC TIO N A

1. Sourcesofinvestm entfundsforinsurersinclude
a. Issuanceofpolicies
b. Issuanceofloans
c. Issuanceofshares
d. Issuanceofonly stock
e. N oneoftheabove

2. C ash inflow sfrom investm entactivitiesinclude


a. Interestincom e
b. Capitalgains
c. A m ountrealized from saleofsecurities
d. D ividends
e. A lltheabove

3. Lifeinsurancecom paniesgenerally investin


a. A hortterm investm ents
b. Long term investm ents
c. O nly bonds
d. O nly equity shares
e. N oneoftheabove

4. Factorsw hich do notinfluenceinvestm entpolicy ofinsurerinclude


a. Creditrating
b. Risk
c. Return
d. A dvertisem ent
e. N oneoftheabove

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5. Investm entoutflow sgenerally resultdueto


a. Initialinvestm ents
b. Trading losses
c. Transaction costs
d. A lltheabove
6. Tradeoffin investm entsim ply thecorrelation betw een
a. Risk/return
b. Long term /shortterm
c. Liquidity/profitability
d. Liquidity /solvency
e. A lltheabove
7. Theobjectiveofregulation ofinsurer sinvestm entsis
a. To protecttheinsurer
b. To m aintain solvency
c. To earn good returns
d. To ensuresafety ofpolicyholders funds
e. N oneoftheabove
8. Investm entregulationsin India arenow defined by
a. IRD A
b. Centralgovernm ent
c. Stategovernm ent
d. M inistry ofFinance
e. N oneoftheabove
9. Theregulationsrestricting theinvestm entquantum ofan insurerin a particular
com pany/group/industry isexpressed in
a. Solvency norm s
b. Exposure/Prudentialnorm s
c. Liquidation norm s
d. Capitalnorm s
e. N oneoftheabove
10. G eneralinsurancecom paniesprudently should investin
a. H igh liquid securities
b. O nly in bonds
c. Short-term securities
d. Long-term investm ents
e. N oneoftheabove
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SEC TIO N -A A N SW ER S
(1) a (2) e (3) b (4) d (5) d (6) e
(7) d (8) a (9)b (10) c

SEC TIO N -B
1. D efinetheinvestm entactivitiesofa lifeinsurer.
A ns.The aggregate investm ent activities of any country s life and health insurance
industry aream ajorsourceofcapitalforthenationaleconom icgrow th.Theinsurers
investin the debtand equity issues of alltypes of corporations,shopping m alls,
apartm ents and other real estate. They are the m ajor purchases of G overnm ent
Securities.Thetotalinvestm entportfolio ofalifeinsurancecom pany can bedefined
on thebasisofliabilitiesthatthey support.
2. H ow areassetsclassified foran insurer?
A ssetsareclassified according to thenatureoftheliabilitiesforw hich theassetsare
held and invested.A ssets used to supportcontractualobligations for guaranteed,
fixed benefitpaym ents norm ally are held in generalaccountw hile assets held to
supportotherliabilitiesassociated w ith investm entrisk are held in specialaccounts
called separate accounts e.g.(valuable annuities,pension products,variable life
insurance,etc.).
3. W hy is the perform ance ofinvestm entportfolio so critically im portantfor an
insurer?
A ns.Theinvestm entperform anceofthegeneralaccountofalifecom pany affectsprofits,
dividends,interestcreditson term ,etc.Separateaccountperform anceaffectsvariable
life and annuity productsand pension fundsw hen benefitsby contractdepend upon
investm entresultsthatarepassed directly to contractholders.Thepricesofinsurance
productsaredependenton theinvestm entreturnsan insurerearns,especially theunit
linked insurance products. Insurers that earn above average returns can price
products favourably to retain custom ers in a com petitive m arket.Thus,investm ent
m anagem ent is a process involving asset liability m anagem ent, integration of
investm entm anagem entand productdesign m anagem ent.H ence the perform ance is
so critically essentialforthesustainability ofan insurer.
4. W hat are the factors that influence and constrain the investm ent policy of
insurer?
A ns.Theim portanteconom icconstraintsthatinfluenceoracton theinvestm entpolicy of
an insurerinclude inflation,m onetary and fiscalpolicy ofgovernm entinvestm ent
m arketopportunities,insurer s m arketshare,com petition,tax liabilities,etc.The
regulatory constraints,rating agencies view s,brokers,agents,currency rates,trade
balances,and geographic location ofliabilities are also to be considered in setting
investm entpolicy by internationalinsurers.Further,the investm entpolicy of life
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insurer establishes a level of risk tolerance for individual assets as w ell as for
m ism atched assets and liabilities.H ence,the prim ary objective of an investm ent
policy should be to create an investm entportfolio w ith cash flow s,thatm atchesan
insurer s expected liability cash flow s and assetliability risk m anagem entstrategy,
and striking abalancebetw een solvency and profitability.
5. H ow can you strikea tradeoff in investm entdecisions?
A ns.Trade off in investm ent decisions necessarily involves understanding the central
conceptofinvestm entrisk and to acknow ledge the relationship ofinvestm entrisk
and expected return.G reaterthe degree ofrisk associated w ith an investm entim ply
greater expected returns.The objective of investm entportfolio m anagem entis to
m axim ize investm entreturn fora given levelofrisk orm inim ize risk fora desired
levelofreturn.Investm entrisk can be defined asthe potentialvariability ofreturns.
The trade offin tw o areasrequiresspecialportfolio m anagem entconsideration than
otherinvestors.The insurance pricing (actuarial)risk is one specialarea,w hich
takesinto accountthe rate ofreturn to calculate prem ium .Itisalso used to discount
the price ofinsurance to policy ow ners.The discounting practice hastw o im portant
im plications nam ely:The asset-liability m atching (system atic)risk is the second
consideration specialto financialinterm ediaries.The changing m arketinterestrate
can affectthe value ofcom pany sassetsand liabilitiesand also the behaviourofits
custom ers.Like otherinvestors,life insurersalso preferhigherreturnsto m inim ize
thecostofinsuranceproductsand to m axim izeprofitability,keeping in m ind theidea
ofinvestm entm arginsorspreads.
6. C ritically exam ine the rationale of governm ent intervention in insurance
m arkets.
A ns.G overnm entsw orldw ide intervene in insurance m arketseitherdirectly orindirectly
through regulation ofoperationsortaxation ofincom e.W hateverm ay be the nature
and degree of intervention the basic purpose is to protectthe consum ers,to raise
revenue to support social program m es and to ensure order and efficiency in the
functioning of insurance m arkets. Insurance regulation is universal but different
approachesare follow ed w orldw ide.The m ain focusofthe State isalw aysto ensure
safety and solvency ofthe insurer.Com petition is encouraged butis alw ays under
check in the areasofpolicy contentand in pricing prem ium s,w here a sem blance of
uniform ity isdesired by thepolicyholders.
Insurersareregulated forseveralreasons,including thefollow ing:
To m aintain insurersolvency,
To com pensateforinadequateconsum erknow ledge,
To ensurereasonableratesand
To m akeinsuranceavailableto thosew ho need it.
7. Identify them ain areasofinsuranceoperationsthatareregulated in India.
A ns.G overnm entalintervention isinevitablein thegeneralinterestofthepublic.Thelaw s
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thatare in place to regulate the operations of the insurers invariably concern the
follow ing areas:
Form ation ofinsurancecom panies;
Licensing ofagentsand brokers;
Financialrequirem entsform aintaining solvency ;
Insurancerates;
Investm ents
Salesand claim spractices;
Taxation and
Rehabilitation orliquidation ofinsurers.
Thusitisclearthatregulation ofinsurancecom paniesisin theinterestsofthepublic.

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C hapter 10
Law sG overning Insurance
M anagem entand A ccounting

SEC TIO N -A

1. TheLIC w asnationalized in theyear


a. 1955
b. 1962
c. 1956
d. 1966
e. N oneoftheabove
2. TheG IC w asnationalized in theyear
a. 1977
b. 1947
c. 1972
d. 1975
e. N oneoftheabove
3. Thecontrollerofinsuranceisnow replaced by the
a. IRD A
b. IIRM
c. IBRD
d. SEBI
e. N oneoftheabove
4. W hich ofthefollow ing isnotthefunction oftheIR D A ?
a. To regulateand prom oteorderly grow th oftheinsurancem arket
b. To registerinsurancecom panies
c. To investin thecapitaloftheinsurancecom pany
d. To supervisethefunctioning oftheTA C
e. N oneoftheabove
5. W hich ofthefollow ing sourcesoffundsisnotcredited into theIR D A fund?
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a. G overnm entgrants,fees,charges
b. Fundsform centralgovernm ent
c. Percentageofprescribed incom efrom theinsurer
d. D onationsfrom charitableand non-governm entalinstitutions
e. A lloftheabove
6. TheIR D A fund cannotbeutilized forthe
a. Salariesofm em bersand em ployees
b. A ny otherexpensesrelated to thefunctionsoftheauthority
c. A llow ancesand perksoftheem ployeesand m em bers
d. A dvertisem entofprivateinsurancecom pany
e. A lloftheabove
7. C apitaladequacy norm sofan insurerspecify the
a. M axim um quantum ofcapital
b. M inim um paid up equity capital
c. M inim um reservecapital
d. M axim um reservecapital
e. N oneoftheabove
8. Solvency m arginsreferto theadequate
a. Excessofassetsoverliabilities
b. Excessofoverliabilitiesoverassets
c. Excessofliabilitiesovercash
d. Totalofassetsand liabilities
e. N oneoftheabove
9. The person engaged in the forecasting and pricing of insurance products is
know n as
a. A uditor
b. A ctuary
c. A dvocate
d. Consultant
e. N oneoftheabove
10. A sperIR D A regulationstheregistration ofan insurerm ay besuspended ifhe
a. Indulgesin m anipulativeinsurancebusiness
b. Failsto provideperiodicalreturns
c. Failsto m akeinvestm entsaspernorm s
d. Failsto furnish inform ation asrequired by theregulator
e. A lltheabove
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11. The IR D A has m ade it obligatory for the insurance com panies to procure
businessfrom
a. Socialsector
b. U rban sector
c. Tertiary sector
d. Ruralsector
e. N oneoftheabove
12. A ssignm entprovisionsrefersto
a. Thetransferofpolicies
b. Purchaseofpolicies
c. Buying and selling ofpolicies
d. D istribution ofpolicies
13. A bsoluteassignm entim plies
a. Com pletetransferofallrights
b. Transferofsom erights
c. N o transferofany rights
d. Transferofonly obligations
14. C ollateralassignm entim plies
a. Tem porary /conditionaltransfer
b. A bsolutetransfer
c. Transferofonly obligations
d. Transferofallrights

SEC TIO N A A N SW ER S
(1) c (2) c (3) a (4) c (5) d (6) d
(7) b (8) a (9) b (10) e (11)a (12)a
(13)a (14) a

SEC TIO N -B

1. Enum eratethecircum stancesw hen a m em bercan berem oved from theofficeof


IR D A ?
A ns.A m em ber can be rem oved from office by the Central G overnm ent under the
follow ing circum stances:
1. W hen heisadjudged an insolvent
2. W hen hehasbecom ephysically orm entally incapable
3. W hen hehasbeen convicted ofany offencew hich involvesm oralturpitude
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M O D U LE -I: PRIN CIPLES A N D PRA CTICE O F IN SU RA N CE

4. W hen he has acquired financialinterestw hich is likely to prejudicially affect


hisfunction asam em ber
5. W hen he has abused his position so as to render his continuation in office
detrim entalto thepublicinterest
2. O utlinethefunctionsofIR D A ,w hich highlightsitsdevelopm entalrole?
A ns.O utoftheinnum erablefunctionsoftheIRD A ,thosethathighlightitsdevelopm ental
roleforthegrow th oftheinsurancem arketsin Indiaareasfollow s:
To regulate,prom ote and ensure orderly grow th ofthe insurance businessand
reinsurancebusiness.
To protectthe interestsofthe policyholdersin m attersconcerning assigning of
policy,nom ination,insurable interest,settlem entofinsurance claim ,surrender
valueofpolicy,otherterm sand conditionsofcontractsofinsurance.
To prom oteefficiency in theconductofinsurancebusiness.
To callforinform ation form ,undertake inspection of,conducting enquiresand
investigations, including audit of the insurers, interm ediaries, insurance
interm ediariesand otherorganizationsconnected w ith theinsurancebusiness.
To regulateinvestm entoffundsby insurancecom panies
To regulatem aintenanceofm argin forsolvency.
To settle disputes betw een insurers and interm ediaries or insurance
interm ediaries.
To specify the percentage of life insurance business and general insurance
businessto beunderw ritten by theinsurerin theruralorthesocialsector.
3. D efinereinsuranceand outlinesom eofthefunctionsofreinsurance.
A ns.Reinsurance is a contractof insurance betw een a prim ary insurer and a reinsurer
w hereby the prim ary insurertransfersallora partofitsbusinessto the reinsurerin
return for a com m ission called the ceding com m ission. Further, w ith a good
reinsurancearrangem ent,theprim ary insurercan:
1. M axim isetheretention w ithin thecountry
2. D evelop adequatecapacity
3. Securethebestpossibleprotection forthereinsurancecostsincurred
4. Sim plify theadm inistration ofbusiness
The reinsurance program m e com m encesfrom the beginning ofevery financial
year.Ifan insurerw ants to w rite inw ard reinsurance business,itm usthave a
w ell-defined underw riting policy.

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SEC TIO N C
C A SE STU D IES
1. The insurance regulator w ill w ork tow ards creating an environm ent that
generates confidence am ong potentialpolicyholders.W hy is there a need for
creating such an environm ent? W hat m easures has the IR D A taken in this
regard?
A ns.Tillrecently,governm entow ned com paniesoffered insurance servicesin India and
hencetherew aslittledoubtin them indsofthepolicyholdersaboutthesafety oftheir
savings.H ow ever,the sam e levelofconfidence cannotbe expected in the case of
private com panies.To gain thisconfidence,itisessentialthatthere w illbe a fairly
high leveloftransparency in theiroperations.Further,as the risk involved is high,
there should be adequate capitalbase forcom paniesoffering these services.Larger
capital base is also essential to spread the business and increase the volum e of
businessin orderto gain the econom iesofscale.In thisregard,IRD A hasissued the
follow ing guidelines:
M inim um paid-up capitalofRs.100 crore,forlife/generalinsuranceand Rs.200
crore,in caseofreinsurancebusiness.
D epositw ith RBI,the leastof(a)Rs.10 crore,in cash orm arketable approved
securities,or(b)asum of1% (forlifeinsurance),3% (forgeneralinsurance)of
thetotalgrossprem ium w ritten in India.In caseofreinsurerthedepositam ount
isRs.20 crore.
A nnualactuarialinvestigation.
Solvency m argins.
2. W hatstrategiesdo you recom m end to a new privatesectorinsurer?
A ns.Insurance iscom paratively a new businessto the Indian corporate w orld asthe LIC
and G IC and itssubsidiariesw eretheonly playersin thism arket.In thisnew m arket,
thefollow ing strategicissuesareto beidentified:
Tap potentialm arket:Thereisvastuntapped m arketforinsurancein India.
Investm entsin secured assets:Foran insurancecom pany therisk arisesfrom its
liabilitiesside,i.e.due to the policiesunderw ritten.Thus,investing in secured
assetsshould reduceriskson theassetsside.
Custom ized products:A large untapped m arketalso gives scope to custom ize
theproducts.Therew asno properproductinnovation thathasbeen taking place
in thecountry.
M arketresearch: To identify the m arket to research identity the needs of
custom er has to be undertaken. W hile LIC has m ore than 100 types of
policies,the levelof aw areness is very low .H istoricaldata w illenable the
new players identify the depth in the m arketand the scope for developing
variousproducts.

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3. W hy arem ostoftheIndian com paniesventuring into theinsurancesectorgoing


through theJV sroute?
A ns.There are three im portantreasons due to w hich m ostofthe Indian com panies are
going through theJV srouteto enterinto theinsurancebusiness:
Regulatory prescriptions: Regulations require the Indian players to open an
insurance firm in collaboration w ith a foreign player,w hich has an equity
holding ofnotm orethan 26 percentin thecom pany
New Business: Insurance is a new type of business and there is no proper
experience for the private players in this business. O n the other hand,
w orldw ide the insurance m arket is w ell developed and there are m any
com paniesoperating on agloballevel.In orderto gain theirexpertise,JV sw ith
such playersbecom esessential.
Funds:Insurance isa business,w hich requiresa large capitalbase,due to the
risks involved. Independent start-ups of insurance business by Indian
com panies alone, w ill thus not be a feasible option. Instead, w hen the
regulations perm it,itis betterforthe Indian players to have a foreign partner
w ho can bring in capitalasw ellasexpertise.

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M O D U LE -I: PRIN CIPLES A N D PRA CTICE O F IN SU RA N CE

C hapter 11
A ssetand Liability M anagem ent

SEC TIO N -A

1. Liquidity risk arisesdueto


a. M ism atch in m aturitiesofassetsand liabilities
b. N on-w ithdraw alofdepositson theduedate
c. D efaultin repaym entsofloans
d. Both (a)and (b)above
e. A lltheabove

2. W hich ofthefollow ing m ay bepresentin a loan asset


a. Creditrisk
b. Interestraterisk
c. Liquidity risk
d. Both (a)and (b)above
e. A lltheabove

3. W ith the convergence offinancialinstitutions,insurance com paniesare facing


thechallengeof
a. A ssetm anagem ent
b. Liability m anagem ent
c. Financialm anagem ent
d. Investm entm anagem ent
e. A lltheabove

4. The risk ofinadequate pricing because ofoption em bedded in the contractof


insuranceiscalled as
a. A ssetrisk
b. Pricing risk
c. Liquidity risk
d. A ctuarialrisk
e. N oneoftheabove

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5. R isksw hich cannotbetotally elim inated by theinsureriscalled as


a. M arketrisk
b. Creditrisk
c. System atic risk
d. O perationalrisk
e. A lltheabove
6. W hich ofthefollow ing statem entsexplain theroleofA LM ?
a. Itinvolvesstrategicm anagem entofbalancesheet
b. Itinvolvesm anaging risksdueto ratefluctuations
c. Itinvolvesm anaging creditrisk and contingentrisks
d. Both (a)and (b)above
e. A lltheabove
7. C apitalm anagem entaim sto balancetheinterestsof
a. O w nersand m anagem ent
b. O w nersand policyholders
c. O w nersand regulators
d. M anagersand custom ers
e. N oneoftheabove
8. The changesin the assetand liability valuesdue to changesin the interestrates
w illnotbereflected in thebooksofaccountsiftheinsurerusesthe
a. M arketvaluebasis
b. Book valuebasis
c. Replacem entvalue
d. Reinstatem entvaluebasis
e. A lloftheabove
9. C apitalrequirem entaspertherisk profileand sizeoftheassetsiscalled as
a. Risk based capital(RBC)
b. M arketbased capital
c. Targetcapital
d. G row th capital
e. N oneoftheabove
10. Investm ents thatare neither approved securities or approved investm ents are
called as
a. M andated investm ents
b. N on-m andated investm ents

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M O D U LE -I: PRIN CIPLES A N D PRA CTICE O F IN SU RA N CE

c. Risky investm ents


d. Risk-freebonds
e. N oneoftheabove
11. R atesw hich reflecttheincidenceofdeath by agearecalled as
a. M ortality rates
b. M orbidity rates
c. A nnuity rates
d. Prem ium rates
e. N oneoftheabove
12. R ates,w hich reflecttheincidenceofsicknessby agearecalled as
a. M ortality rates
b. M orbidity rates
c. A nnuity rates
d. Prem ium rates
e. N oneoftheabove
13. R eservesm aintained by generalinsurancecom paniesforclaim s/lossesincurred
butnorreported on thebalancesheetdatearecalled as
a. IBN R claim s
b. O ut-standing claim s
c. Contingentclaim s
d. Bad claim s
e. N oneoftheabove

SEC TIO N A A N SW ER S
(1) a (2) e (3) c (4) d (5) c (6) e
(7) a (8) b (9) a (10) b (11)a (12)b
(13) a

SEC TIO N -B
1. W hat is m eaning of a financialinterm ediary? W hat is the speciality of these
FI s?
A ns.A FinancialInterm ediary (FI) is a firm thatbrings together users and providers of
funds.In theabsenceofFI s,householdsgenerating excesssavingsby consum ing less
than theirincom e w ould have the basic choice ofeitherholding cash as an assetor
investin the securities issued by corporations directly.Financialinterm ediaries help
channelize household savings to the corporate sector.Even sm allhouseholds often
preferto hold financialclaim sissued by FI sratherthan thoseissued by corporations.
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M O D U LE -I: PRIN CIPLES A N D PRA CTICE O F IN SU RA N CE

2. Enum eratetherisksfaced by insurancecom paniesasfinancialinterm ediaries.


A ns.Insurers assum e various types of risks in providing their services to the public.
Insurersidentify and m anagerisksaccording to aclassification ofrisksdeveloped by
the actuarial profession. Insurance com panies, w hich are basically financial
interm ediaries,facesom euniqueriskssuch as:
A ssetrisk.
Pricing risk
Interestraterisk
M arket/System aticrisk
Creditrisk
O ff-balancesheetrisk
Technology risk
O perationalrisk
A ll the above risks are interrelated.The effective m anagem ent of these risks is
centralto theperform anceofan insurancecom pany asan FI.
A ssetR isk:
A ssetrisk reflectstheriskinessoftheassetportfolio ofthelifeinsurer.A ssetrisk or
A ssetD epreciation risk refersto therisk ofdeclineordecreasein thevalueofassets
dueto:
defaultby borrow ers
declinein them arketvalueofinvestm entsdueto fluctuationsin interestrate.
A ssetrisk reducesthecapital.Itcan beaverted by carefulfinancialm anagem ent
through credit and investm ent analysis, using readily available asset m arket
values.To calculate the quantum ofadequate capitalrequirem ent,a creditrisk
w eightism ultiplied by thefacevalueoftheasseton thebalancesheet.
Pricing R isk
Pricing R isk orPricing inadequacy risk refersto therisk thatthevalueofinsurer s
liabilitiesm ay exceed valueoftheirassets.Thism ay bedueto:
Inadequatepricing ofthepolicy
H igherm ortality/m orbidity rate
H igherPolicy lapses
Increasein expensesthan anticipated
Thisinsurancerisk capturestherisk ofadversechangesin m ortality risk and
M orbidity risk.M ortality risk refers to the risk of death,w hile the m orbidity risk
refers to the risk ofillhealth.A lthough,w ith the help ofm ortality tables,Insurers,
have accurate idea of the insured s tim ing of death, som etim es unexpected
contingenciessuch asA ID S,can upsetthese predictions.A sa result,insurersadjust
insurancein forceforthecurrentlevelofreservesand m ultiply theresulting num ber
by an insurance risk factor.Sim ilar calculations are carried outfor accidentand
health insurance,w hich coversm orbidity (illhealth risk).
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H ence,to avoid pricing risk,during productdesigning and pricing,theabovefactors


and assum ptionsinfluencing the pricing decisionsshould be carefully considered or
itm ay affecttheliquidity position oftheinsurers.
Interest-rate risk:In m ism atching their assets and liabilities,as a part of their
assettransform ation function,FI sexpose them selvesto interest-rate risk.The
asset transform ation function involves buying prim ary securities and issuing
secondary securities.The prim ary securities purchased by FI s have m aturity
and liquidity characteristics different from those of secondary securities
exposing FI s to interest-rate risk.W henever an FI holds longer-term assets
relativeto liabilities,itpotentially exposesitselfto refinancing risks.
Sim ilarly,w henever an FI holds shorter-term assets relative to its liabilities,itis
exposed to reinvestm entrisk.Thisisbecauseofuncertainty abouttheinterestrateat
w hich itcould reinvestfundsborrow ed foralongerperiod.
M arket risk: FI s face m arket risk w hen they actively trade their assets and
liabilities, instead of holding them for longer-term investm ent, funding or
hedging purposes.M arketrisk occurs,w hen priceschangein a direction opposite
to thatexpected.A sa result,the m ore volatile are assetprices,the greater are
the m arketrisks faced by FI s,and so they need to m easure m arketrisk on a
day-to-day basis.
C reditrisk:Creditrisk arises,w hen prom ised cash flow son the prim ary securities
held by FI sare notpaid in full.The FI sface no creditrisk,w hen allthe financial
claim sheld by theFI sarepaid in fullon m aturity and interestpaym entsarem adeon
prom ised dates.Sim ilarly,ifaborrow erdefaults,theprincipalloaned and theinterest
paym entsexpected to bereceived areatrisk.
O ff-balancesheetrisk:W ith thegrow th in theiroff-balancesheetactivities,theFI s
are increasingly being exposed to off-balance sheetrisks.These activities include
thoserelated to contingentassetsand liabilities,notshow n in thebalance-sheet,but
affectthe future ofthe FI(e.g.lettersofcreditissued,loan com m itm entsby banks,
m ortgaging servicing contracts,positioning in Futures,Forw ards,Sw aps,and other
derivatives).
Technologicaland operationalrisks:Theseriskshavebeen am ajorconcern ofFI s
in recentyears.A llm ajorFI sfocuson im proving theiroperationalefficiency w ith
m ajor investm ents in internal and external com m unications, com puters,
technologicalinfrastructure [A utom ated tellerm achine (A TM ),A utom ated clearing
houses (A CH ),Clearing house interbank paym entsystem (CH IPS)].These efforts
aim atim proving perform ance,increasing profits,low ering operationalcosts,and
capturing new m arketsfortheFI.
Technological risk occurs w hen technological investm ents do not produce the
anticipated costsavings.
O perationalrisk occursw heneverexisting technology m alfunctionsorback-office
system sbreak dow n.

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Foreign exchange risk:G lobalFI shave the advantage and the potentialto expand
their operations and investm entactivities abroad directly or to expand a financial
asset portfolio so as to include foreign securities as w ell as dom estic securities.
Foreign exchangerisk isthe risk thatexchange rate changescan affectthe value of
an FI sassetsand liabilitieslocated abroad.
C ountry or Sovereign risk:FI s face a m uch m ore serious creditrisk,in case of
country orsovereign risk.Itisthe risk thatrepaym entsfrom foreign borrow ersm ay
beinterrupted becauseofinterferencefrom foreign governm ents.
Liquidity risk: Liquidity risk arises w henever an FI s liability holders, such as
depositors,policyholders dem and im m ediate cash for their financialclaim s.This
situation m ay forcetheFI seitherto borrow additionalfundsorsellofftheirassetsin
a very shortperiod oftim e and atlow pricesto m eetthe dem and forw ithdraw alof
funds.
Insolvency risk:Insolvency occursw henevertheinternalcapitalorequity resources
ofan FI s ow ners are inadequate to m eetlosses incurred due to one orm ore risks.
Insolvency risk is a consequence or outcom e of excessive interest rate, m arket,
credit,off-balancesheet,and liquidity risks.
O ther risks:These are often called eventrisks.Involving sudden and unexpected
changesin financialm arketconditionsdue to w ar,revolution,orsudden collapse in
stock m arkets,fraud,theft,m alfeasance,breach oftrust,and otherm acroeconom ic
riskssuch asinflation and unem ploym ent.
3. C an insurancereducetheirrisk by diversification?
A ns.D iversification reduces risk, because prices of different securities do not m ove
exactly together.But,insurersfacetw o typesofrisk:
U niqueRisk
System aticorM arketRisk
U nique risk is derived from the uniqueness of each firm ,from its unique
environm ent.Theuniquerisk ofeach stock iscountered by uniquerisk ofother
stocksthusreducing overallrisk.
System atic or m arket risk is the unavoidable risk thatstem s from factors
w hich influenceallbusinessesalikesuch associetalinfluencesand factors.The
num berofsecuritiesdeterm ine the risk profile.Ifa portfolio consistsofa few
securities,the firm s face greater unique risk and diversification ofportfolio
elim inatesagreaterpartofuniquerisk.Them inim um rateofreturn required by
investors to hold a security depends upon the opportunity costoffunds,i.e.
thereturnsavailablefrom alternativeassetinvestm ents.
4. D iscussA LM asa m ultidisciplinary exercise.
A ns.A sset-liability M anagem ent(A LM )isam ultidisciplinary undertaking.Itinvolves
Productcontractdesigning

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M O D U LE -I: PRIN CIPLES A N D PRA CTICE O F IN SU RA N CE

A ssetm anagem ent


Productsshould satisfy consum ers w antsorexpectationsasto price,service,
perform ance,etc.and preventbook valuecash w ithdraw alsleading to liquidity
problem s.
A sset m anagem ent involves a thorough valuation of its assets to earn
m axim um return on its invested assets keeping in view the com pany s risk
posture.
A sset-liability m anagem entessentially involvesm anaging the
A ssetportfolio structure
A m ountofduration m ism atch allow ed
Extentofasset-liability m ism atch allow ed
Basically assets risk also im plies a credit risk of life insurer w hich in turn
includestherisk ofdefaulton investm ents.Thereforetheinvestm entpolicy sets
lim its on portfolio exposure by industry,geographic region,type ofbusiness,
individualcom pany.Besidescreditrisk,anotherfactorim portantin the A LM
exerciseistheliquidity factor,w hich isam ajorconcern forinsurers.To reduce
the m agnitude and probability of adverse cash flow s, insurers, use various
techniquesto controlcash flow ssuch as
liability controls
A ssetcontrols
Liability Controls focus of liability controlis to discourage or preventbook
value cash w ithdraw als leading to liquidity problem s. These controls are
generally included in the contractitselfby w ay ofprovisionsand conditionsto
create additionalcash flow s eitherto policy ow ners ifthey persist,orto the
insurer,w hen w ithdraw aloptionsareexercised.
O n the otherhand,A ssetControlsfocuson ensuring a m axim um rate ofreturn
from an investm entportfolio foragiven levelofprofitability and solvency risk.
A ssetControlsinsiston sufficientliquidity to m eettheircurrentobligations.
5. W hatistheneed forcapitaladequacy?
The m odern FI s today are exposed to num erous risks due to their inherentrisky
contracts,resulting from both on-and offbalance sheetactivities.Som etim esthese
risks could be from their dom estic business and also from their international
contracts.H ow ever,to ensure stability survivaland grow th in the m arket,an FI
especially an insurerneedsto protectagainsttherisk ofinsolvency,i.e.shield itfrom
failing orfrom liquidation.Theprim ary m eansofprotection to shield an FI,against
the risk of insolvency and failure is an FI s capital.H ence the need to m aintain
adequatecapitalisto beem phasized.
Thus, capital adequacy reflects the adequate quantum of capital to m eet the
follow ing functions.

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To absorb unanticipated losses.


To protectuninsured depositors,bond holders,and creditors in the eventof
insolvency and liquidation.
To protectFIinsurancefundsand thetax payers.
To acquiresufficientinvestm entsnecessary to providefinancialservices.
6. W hatism eantby C apitalM anagem ent?
A ns.Insurance executives and m anagers face tw o critically im portant and conflicting
objectives.O n the one hand,they m ust satisfy the ow ners of the firm ,w ho are
interested in m axim izing the return on their equity (R O E),w hich m eansthattheir
interestsgenerally liein m inim izing theirequity investm ent(i.e.thefirm scapital).
O n the otherhand,the executivesm ustsatisfy theircustom ers(policy ow ners)and
regulators,w ho are interested in the financialsolidity ofthe firm ,w hich m eanstheir
interestsliein m axim izing thefirm scapital.
C apitalM anagem entisconcerned w ith balancing these interests.The term capital,
capitaland surplus,netw orth,and equity allreflectthedifferencebetw een assetsand
liabilities.
7. O utlinethefunctionsofcapitalin a com pany.
A ns.C apitalw ithin alifeinsurerservesfourfunctionssuch as:
Protectthepolicy ow nersin theeventofinsurerinsolvency.
M inim ize or elim inate the directcosts to other insurers and taxpayers from
insolvency assessm ents.
A bsorb unanticipated losses and thereby inspire confidence and enable the
insurerto continueasagoing concern.
Providebasisforfuturegrow th.

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SEC TIO N C
C A SE STU D IES
G iven below is a table thatshow s the relative assetrisk w eights for Life and Property
Casualty insurers.
R isk Based C apital(R BC )FactorsforSelected A ssets
A ssets Lifeinsurers Property insurers
Bonds
G overnm ent 0.0% 0.0%
A A A -A * 0.3% 0.3%
BBB 1.0% 1.0%
BB 4.0% 2.0%
B 9.0% 4.5%
CCC 20.0% 10.0%
In orneardefault 30.0% 30.0%
Residentialm ortgages 0.5% 5.0%
Com m ercialm ortgages 3.0% 5.0%
Com m on stock 30.0% 15.0%
Preferred stock 2.0% 2.0%

1. Interpretthegiven table.
2. H ow istherisk based capitaldecided foran insurancecom pany?
A ns.
1. RBC orrisk based capitalrequirem entshavebecom eessentialareaofconcern in the
financialm anagem entof insurance com pany.This strategy ensures both solvency
and liquidity requirem entsofthese com panies.A sperthe above given inform ation,
an insurerw ith Rs.100 m illion in com m on stock w ould have a risk-based capital
requirem entofRs.30 m illion,w hile forone w ith Rs.100 m illion in BBB corporate
bondsonly Rs.1 m illion w ould berequired.
2. Thefollow ing factorsareconsidered forcom puting Risk Based Capital(RBC):
(i) Risk characteristics ofthe com pany based on its size,nature ofbusiness (say
life,m otor,fire,etc.),quality ofinvestm entsm ade,etc.
(ii) Risk w eightage for each class of assets.For exam ple,differentw eights are
applied to investm ent in governm ent securities,private loans,equities,real
estateand otherinvestm ents.
(iii) Total adjusted capital w hich consists of statutory capital, asset valuation
reserveand any othervoluntary reserves
(iv) Capitalderived from risk-w eighted form ulaasperpoint(ii)above.

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Thetw o capitals,viz.asper(iii)and (iv)arecom pared to find outw hetherthecapital


isadequatein relation to therisk ofthecom pany.
Theregulatorstakedifferentactionsdepending on theTotalA djusted Capital(TA C)
and theA uthorised Controllevel(A CL).Forexam ple,in U S theA CC isdeterm ined
based on a form ula thattakesinto accountthe insurance com panies risks,viz.asset
risks, insurance risks, interest risk and business risk. In India the IRD A has
prescribed m ethodology for calculations of solvency m argins,w hich needs to be
reported to theregulatorin theprescribed form s.

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DIRM
MODULE II

TECHNICAL ASPECTS OF
INSURANCE
MODULE II
TECHNICAL ASPECTS OF INSURANCE

Chapter 1
Underwriting.............................................................................................................II-1

Chapter 2
Fire Insurance ........................................................................................................II-10

Chapter 3
Marine Insurance....................................................................................................II-21

Chapter 4
Motor Insurance .....................................................................................................II-30

Chapter 5
Engineering Insurance ...........................................................................................II-38

Chapter 6
Miscellaneous Insurance ........................................................................................II-44

Chapter 7
Life Insurance Products .........................................................................................II-52

Chapter 8
Life Insurance Pricing Fundamentals ....................................................................II-62

Chapter 9
Social Security Schemes ........................................................................................II-73

Chapter 10
Group Insurance ....................................................................................................II-86

Chapter 11
Financial Gerontology and Super Annuating Policies ..........................................II-96

Chapter 12
Acturarian Valuation ...........................................................................................II-103
C hapter 1
U nderw riting

SEC TIO N -A

1. Theterm underw riting foran insurancecom pany im plies


a. cash flow incom e
b. assetgeneration
c. assum ption ofliabilities
d. generating reserves
e. noneoftheabove
2. Personnelengaged in theunderw riting departm entarecalled as
a. underw riters
b. auditors
c. salesexecutives
d. actuaries
e. noneoftheabove
3. Producers ofinsurancebusinessare
a. agents
b. accountants
c. auditors
d. directors
e. noneoftheabove
4. U nderw riting involvesthe
a. selection ofthepolicyholders
b. classification ofhazards
c. selection ofagents
d. classification ofpolicies
e. noneoftheabove
5. Theobjectivesofgood underw riting policy aim satachieving
a. expansion ofm arket
b. ensuring aprofitablebook ofbusiness
II-1
M O D U LE -II:TECH N ICA L A SPECTS O F IN SU RA N CE

c. diversification
d. investm entin shares
e. noneoftheabove
6. W hich ofthefollow ing statem entsdescribetheprinciplesof underw riting?
(i) selection and classification ofpolicyholders
(ii) charging equitableprices
a. (i)only
b. (ii)only
c. Both (i)& (ii)
d. N either(i)& (ii)
7. Theprocessofunderw riting involvesessentially
(i) A cceptanceof risk atstandard rates/loaded rates
(ii) Rejection ofrisk
a. (i)only
b. (ii)only
c. Both (i)& (ii)
d. N either(i)& (ii)
8. Sourcesofinform ation forunderw ritersforrisk evaluation include
a. proposalform
b. new spapers
c. censusrecords
d. financialrecords
e. noneoftheabove
9. Stringentunderw riting standardsarea safeguard for
a. A dverseselection
b. Selectiveselection
c. Preferred selection
d. G roup selection
e. N oneoftheabove
10. Im plem entation oftheunderw riting guidelinesisdoneon a daily basisby the
a. Staffunderw riters
b. Lineunderw riters
c. G roup underw riters
d. Board underw riters
e. N oneoftheabove
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M O D U LE -II:TECH N ICA L A SPECTS O F IN SU RA N CE

11. The corporate policy thatdefinesthe objectivesofthe m anagem entconcerning


thecom position ofthebook ofbusinessis
a. Investm entpolicy
b. U nderw riting policy
c. Salespolicy
d. A dvertisem entpolicy
e. N oneoftheabove
12. Insurancepricing isgenerally referred as
a. ratem aking
b. underw riting
c. undertaking
d. docum enting
e. noneoftheabove
13. U nderw riting guides are issued by the staffunderw riters to line underw riters
for
(i) U niform ity in pricing
(ii) Serving asready reckoner
a. (i)only
b. (ii)only
c. Both (i)& (ii)
d. N either(i)& (ii)
14. U nderw riting resultsarerepresented by the
a. solvency ratio
b. com bined lossand expenseratio
c. liquidity ratio
d. profitability ratio
e. noneoftheabove
15. U nderw riting results ofproperty and liability insurance business is influenced
by
(i) prem ium volum es
(ii) reservescreated forIBN R losses
a. (i)only
b. (ii)only
c. Both (i)& (ii)
d. N either(i)& (ii)

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M O D U LE -II:TECH N ICA L A SPECTS O F IN SU RA N CE

16. Therenew albusinessperform anceofan insurerisreflected in the


a. Successratio
b. Retention ratio
c. Lossratio
d. Incurred claim sratio
e. N oneoftheabove
17. In general,insurance businessreporting a considerable am ountofim precision
existsin theestim ateoffinallosscostsdueto thefollow ing factors
(i) lossdevelopm entdelays
(ii) stringentunderw riting standards
a. (i)only
b. (ii)only
c. Both (i)& (ii)
d. N either(i)& (ii)
18. Theunderw riting practicesnecessary forim plem enting theunderw riting policy
aredescribed by m eansof
a. U nderw riting guides
b. U nderw riting process
c. Ratem aking policies
d. U nderw riters
19. Individualunderw ritersorgroupsofunderw ritersforspecialty linesoperate
a. D ecentralized underw riting authority
b. Relatively centralized underw riting authority
c. Standardized underw riting authority
d. Centralized underw riting authority
20. W hich of the follow ing affects the underw riting and pricing of an insurance
product?
a. Binding authority oftheproducer
b. Reservepolicy issuanceofthecom pany
c. Contingency com m ission agreem ent
d. U nderw riting guides
21. W hich ofthe follow ing practiceshelp to check adherence ofthe insurersto the
rating plansand pricing thatthey havefiled?
a. Financialaudit
b. Field audit
c. U nderw riting audit
d. M arketconductexam ination
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M O D U LE -II:TECH N ICA L A SPECTS O F IN SU RA N CE

22. W hich ofthefollow ing isnottheresponsibility ofthelineunderw riters?


a. Classifying risks
b. Selecting insured
c. Supervising theratem aking process
d. D eterm ining propercoverage

SEC TIO N A A N SW ER S
(1) c (2) a (3) a (4) a (5) b (6) c
(7) c (8) a (9) a (10) b (11) b (12) b
(13) c (14) b (15) c (16) b (17) a (18) a
(19) b (20) b (21) c (22) b

SEC TIO N -B

1. U nderw riting istheheartofinsuranceoperations .Elucidate.


A ns.U nderw riting is the process ofevaluation and classification of risk .Itis this core
function ofthecom pany thatdeterm inesthefinancialsoundnessofthecom pany.Itis
rightly term ed as assum ption ofliability .W ith the issuance ofevery policy,the
insurerm akesafutureprom iseand isthereforeundertaking aliability.
U nderw riting essentially involves the selection of policyholders after thoroughly
evaluating all hazards, establishing prices and then determ ining the term s and
conditions of the insurance policy.The underw riters aim to generate profits and
m inim ize losses through a w ell-balanced underw riting policy. The objectives of
underw riting include producing a large volum e ofprem ium incom e thatissufficient
to m aintain and enlarge the insurance com pany soperationsand to achieve a better
spread of the risk portfolio, thereby earning a reasonable am ount of profit on
insuranceoperations.
2. Enum eratesom eoftherating m ethodsby generalinsurers.
A ns:Ratem aking orinsurancepricing involvestheselection ofclassesofexposureunitson
w hich statistics can be collected regarding the possibility ofloss.The rates charged
m ustbeenough to pay forany expensesorlossesincurred,m ustnotbevery high and
m ustnotbe inequitable.The system ofrating m ustbe sim ple,stable and provide the
insured w ith a strong incentive to adoptloss control.Lastly the rates m ustincrease
w hen loss exposure increases.The various rating m ethods adopted by property and
liability insurersfollow anum berofm ethodsto calculateprem ium ssuch as:
Judgm entrating m ethod
U nderthis,each exposure isindividually evaluated and the rate determ ined by
the underw riter s judgm ent.This m ethod is frequently used in ocean m arine
insurance because the vessels, ports, w aters and cargoes carried are very
diverse.
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M O D U LE -II:TECH N ICA L A SPECTS O F IN SU RA N CE

C lassrating m ethod
U nderthism ethod,exposuresw ith sim ilarcharacteristicsare grouped together
and charged the sam e rate.Som e ofthe m ajorfactorsin life insurance are age,
health,genderetc.This m ethod is also called m anualrating because the rates
are published in a rating m anual.There are tw o w aysofdeterm ining the class
rates:
* Thepureprem ium m ethod:pureprem ium isthatpartofthegrossrate,w hich
isutilized to pay lossesand adjustm entexpenses.
* The lossratio m ethod:underthism ethod,the actuallossratio w hich isthe
ratio ofincurred lossesand loss-adjustm entexpensesto theearned prem ium s
is com pared to the loss ratio that w as expected and the rate is adjusted
accordingly.
M eritR ating m ethod:
M eritrating is a rating plan by w hich class rates (m anualrates)are adjusted
upw ard ordow nw ard based on individualloss experience.Som e ofthe m erit
rating plansinclude:
* Schedule rating:underthisplan,each exposure isindividually rated.A basis
rate isfixed foreach exposure and thisisthen m odified by debitsorcreditsfor
undesirableordesirablephysicalfeatures.
* Experience rating:underthisrating plan,the classorm anualrate isadjusted
upw ard or dow nw ard based on pastloss experience.The insured s pastloss
experienceisthebasisforfixing theprem ium forthenextpolicy period.
* R etrospective rating: in retrospective rating,the insured s loss experience
during the currentpolicy period determ ines the actualprem ium paid forthat
period.
3. D iscussthevarioushazardsencountered in theprocessofunderw riting.
A ns: The process of underw riting inherently has the danger of adverse selection and
hazards.Theseare:
Physicalhazards
M oralhazardsand
M oralehazards.
Physicalhazards: include hazards thataffectthe physicalcharacteristics of
w hatever is being insured.A ny harm to the tangible qualities of the subject
m atterofinsurance can be called a physicalhazard,e.g.a building m ade of
w ood represents a higherlevelofphysicalhazard than one m ade ofbrick;an
untrained driver, and faulty fire- safety equipm ent are both exam ples of a
physicalhazard.
M oral hazards: these hazards refer to the defects that exist in a person s
character that m ay increase the frequency or the severity of loss. Such a
characterm ay tend to increase the lossforthe com pany,e.g.a w eak financial
II-6
M O D U LE -II:TECH N ICA L A SPECTS O F IN SU RA N CE

condition that m ay lead certain people to w ilfully cause loss and secure
insurancem oney.
M orale hazards:include a situation ofa w ilfulcarelessnesson the partofthe
policyholder because of the existence of insurance.By such negligence and
indifference the possibility ofloss is increased,e.g.careless acts like keeping
thedoorofone shouseopen and going out,thereby increasing thepossibility of
a burglary,orleaving the carkeysin the carand increasing the risk oftheftare
instancesofm oralehazard.
4. O utlinetheunderw riting process.
A ns:The underw riting processessentially involvesa seriesofstages,atthe end ofw hich
the status of a risk is decided.Itis only after the risk has been w eighed and all
possible alternativesevaluated thatthe finalunderw riting isdone.W hen a proposal
forinsuranceisreceived,theunderw riterhasfourpossiblecoursesofaction:
A ccepttherisk atstandard rates
Chargeextraprem ium depending on therisk factor
Im posespecialconditions
Rejecttherisk
The underw riting process involves the follow ing steps w hen evaluating a
potentialrisk.Theseareasfollow s:
* A ssim ilating inform ation abouttheapplicantfrom aw idevariety ofsourcessuch
as application or the proposalform ,the agents* report,governm entrecords,
physicalinspection reportofthesurveyor,in caseofproperty underw riting and in
the case oflife insurance,a physician sreporton the applicantsblood pressure,
heartcondition,urinary system ,etc.areconsidered claim files.
* Evaluating and m aking a decision,w hether to accepta proposal,rejectitor
acceptitw ith certain m odifications,such as changing rating plans and policy
term s.
* Executing thedecision afterperusing allthealternativesand m aking adecision.
If the proposal is accepted,then the applicant should be briefed about the
decision along w ith allthe m odifications m ade.If rejected,the underw riter
m ustconvey this decision to the agentw ith clear,valid and sound reasons
explaining w hy theparticularapplication hasbeen rejected.
* Preparing thedocum entsw hich includesthew ork sheetto besentto thepolicy
w riting departm entand also issueofcertificatesofinsurance.
* Recording inform ation about the applicant and the policy for accounting,
statistical and m onitoring purposes, specially the details like the location,
coverages,lim its,and risk features.
* M onitoring theactivitiesasto any changesin thelossexposuresoftheinsureds,
through regularprem ium auditsand auditreports.
* M aintaining the recordsofbusinessw hich involvesevaluating the profitability
II-7
M O D U LE -II:TECH N ICA L A SPECTS O F IN SU RA N CE

ofallthebusinessw ritten during aparticularperiod oftim e,covering aspecific


territory and foracertain typeofinsurance.
5. D efinetheprinciplesofunderw riting.
A ns:Theprinciplesthatguidean underw riterbeforeaccepting arisk are:
Selecting insuredsasperthecom pany sunderw riting standards
Striking properbalance w ithin each rate classification,so thatthe average rate
in thegroup isenough to pay forallclaim sand expenses.Therefore,unitsw ith
sim ilarloss-producing features are placed in the sam e class and charged the
sam e rate,ensuring thata below average insured is com pensated for by an
aboveaverageinsured.
Charging equitable rates based on the risk factors,thatis charging less for
youngerpersonsand m oreforolderpeople.

SEC TIO N C
(C A SE STU D IES)
1. A top equestrian,V ijay M allay,insured hisprize show horse,K arishm a,forRs.2.5
lakhs.A ftera seriesoflack lustre perform ances,K arism a died suddenly from w hat
appeared to be colic,a com m on killerdisease ofhorses.H ow ever,the underw riters
settled theclaim ofRs.2.5 lakhsalthough m any observersfeltthatthesettlem entw as
m ore than the horse w as w orth alive due to its poor perform ance justprior to its
death.
D uring the sam e tim e,the CBI w as involved in an investigation regarding horse
killingsand related insurancefraud.They arrested oneM r.A bu Salim ,w ho said that
he w aspaid to killhorsesso thattheirow nerscould collectany insurance proceeds.
Further,A bu Salim also revealed the nam esofhisclientsw herein V ijay M allay w as
also m entioned.D uring thetrial,theow nertestified thatK arishm ahad notdied outof
naturalcause,butinstead died ofelectrocution w hich can be easily be disguised as
colic.
From theinform ation provided answ erthefollow ing questions:
1. A saresponsibleunderw riterhow w ould you evaluatetherisk factorsw hileissuance
ofsuch apolicy?
2. Ism oralhazard presentin thecase?
3. Can thecom pany callback theinsurancesettlem entforRs.2.5 lakhs?
4. Identify thedam agecom pensation liability oftheow ner.
A ns:1.A sa prudentunderw riter,atthe tim e ofissuance ofthe policy,besidesthe costof
thehorse,thecharacteroftheow ner,and hispastlossrecord aresom eofthefactors
to beconsidered.
2. The m oralhazard in the presentcase isevidentin the factthatthe ow nerkilled the
horseto gettheinsurancebenefits.

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M O D U LE -II:TECH N ICA L A SPECTS O F IN SU RA N CE

3. The insurer has every rightto order the restitution of the Rs.2.5 lakhs insurance
settlem entand also to pay forthecostofhisincarceration.
4. The ow ner can be convicted for a clear case of fraud,w ith a liability of fine and
im prisonm entaspertherulesofthecrim inalcodeprocedure.Furtherheisalso guilty
ofm anipulating thecauseofdeath w ith aw illfulintention to cheatthecom pany.

II-9
C hapter 2
FireInsurance

SEC TIO N -A
1. A firePolicy isa
a. valued policy
b. unvalued policy
c. indem nity policy
d. agreed valuepolicy
e. noneoftheabove
2. Insurableinterestin a FIP m ustbepresent
a. attheinception ofthepolicy
b. during thecontinuanceofthepolicy
c. on thedateofloss
d. atthetim eofloss
e. alloftheabove
3. C auseoffiregenerally in caseofa lossis
a. m aterial
b. im m aterial
c. intentional
d. unintentional
e. noneoftheabove
4. thedoctrineofsubrogation and contribution is
a. applicablein afirepolicy
b. notapplicablein afirepolicy
c. applicableonly in caseoffloaterpolicies
d. notapplicablein floaterfirepolicy
e. noneoftheabove
5. To w hich ofthefollow ing assetsa reinstatem entpolicy isnotapplicable?
a. building
b. land
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M O D U LE -II:TECH N ICA L A SPECTS O F IN SU RA N CE

c. furniture
d. plant& m achinery
e. noneoftheabove
6. Excessin a firepolicy im plies
a. adiscount
b. am alus
c. adeductible
d. abonus
7. Fire floater and declaration policies are issued to those com panies w hose
turnoveris
a. very high
b. very low
c. hugeand fluctuating values
d. perm anentvalues

SEC TIO N A A N SW ER S
1. c 2. e 3. b 4. a 5. b 6. c
7. c

SEC TIO N B

1. W hatisthem eaning of Fire ?


A ns:To constitute fire,there m ustbe com bustion and ignition.The m eaning how ever
doesnotextend to chem icalactionsw hich do notresultin actualignition though they
correspond in theireffects to fire.Thus,lightning m ay be a form offire,butloss
occasioned by lightning unaccom panied by ignition,isnot,in theordinary m eaning a
losscaused by fire.H ow ever,w herelightning resultsin ignition,alossoccasioned by
such ignition isalossby fire.To startafire,therearethreeessentialfactors:
a. Therem ustbeaflam m ablegasand vapour.
b. Therem ustbeoxygen present.
c. Therem ustbesourceofheat,e.g.flam eoraspark.
2. D efineFireInsurance
A ns:Fire Insurance is a contract of insurance by w hich the insurer agrees for
consideration to indem nify the assured upto a certain extentand subjectto certain
term s and conditions against loss or dam age by fire w hich m ay happen to the
property ofthe assured during a specified tim e.There is said to be fire w ithin the
m eaning offireinsurancew hen:

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M O D U LE -II:TECH N ICA L A SPECTS O F IN SU RA N CE

a. Thereisactualignition.
b. The fire is purely accidentalor fortuitous in origin so far as the insured is
concerned.
c. Thefirehasburnt/dam aged theproperty oftheinsured.
3. Enum eratetheessentialcharacteristicfeaturesofa FireInsuranceC ontract.
A ns:A contractoffire insurance isa speciesofa contractofinsurance and itexhibitsall
thefollow ing characteristics,nam ely:
a. Thisisacontractofindem nity
b. Itisacontractuberrim a fides
c. Itm ustbedistinguished from w agering contractand acontractofguarantee
d. Itisapersonalcontractand
e. Thecauseoffireisim m aterialgenerally.
4. W hatis the difference betw een subject-m atter ofinsurance from the subject-
m atterofa contractofinsurance?
A ns:Them ain objectofthecontractofinsuranceisto indem nify theassured from theloss
caused by dam ageordestruction by fireoftheproperty oftheassured.Thisphysical
objectiscalled thesubjectm atterofinsurance.O n theotherhand,thesubject-m atter
ofcontractofinsurance is notthe physicalobjectorproperty ofthe assured butis
m oney and m oney alone.Itm ustbe noted thatw hatis insured is notthe physical
property oftheassured butonly lossofitby firebecauseby thiscontractlossby fire
cannotbe prevented.Itis notan insurance againstaccidents butan agreem entto
protectagainstdam ageby afireaccident.
5. Statew hetheran FIP isa personal/im personalcontract?
A ns:A contractoffireinsurance,though appearsto beaproperty insurance,isnotso and
itis a personalcontractbetw een the insurer and the assured,for the paym entof
m oney,in casethelossisoccasioned to theproperty ofthecontracting party by fire.
Thepurposeofthecontractisnotto insurethesafety oftheproperty butonly to save
theinsured from thelosscaused by dam ageto theproperty by fire.Therefore,w here
aproperty insured againstfireisconsum ed by firebutstillthereisno pecuniary loss
to theow neroftheproperty,theinsurerw illnotbeliableto pay any am ount.
6. W hatisthecoverageoffered in a standard fireand specialperilpolicy?
A ns:U nderastandard firepolicy,theinsurancecom pany agreesforaspecified prem ium ,
to pay theam ountofsuch dam ageorreinstateorreplacesuch property,iftheinsured
property bedam aged ordestroyed by any oftheperilsspecified asunder:
Fire
Lightning
Explosion /Im plosion
A ircraftD am age
II-12
M O D U LE -II:TECH N ICA L A SPECTS O F IN SU RA N CE

Riot,Strike,and M aliciousD am age


Storm , Cyclone, Typhoon, Tem pest, H urricane, Tornado, Flood and
Inundation.
Im pactD am age
Subsidenceand Landslideincluding Rockslide
Bursting and /oroverflow ing ofW aterTanks,A pparatusand Pipes.
M issiletesting operations
Leakagefrom A utom aticSprinklerinstallation
Bush Fire
7. C an you have a separate consequentialloss policy w ithoutan ordinary FIP?
G ivesom eexam plesofconsequentiallosses.
A ns:N o,there cannotbe a separate consequentiallosspolicy w ithoutan ordinary fire
policy.U nderan FIP,notonly can oneinsuretheproperty butany consequentialloss
can also becovered.Theclaim underthishead can succeed only iftheinsurersadjust
theirliability forlossofproperty by fireunderan ordinary policy.Thefollow ing are
som eoftheexam plesofconsequentiallossforw hich indem nity isprovided:
a. Lossofprofits
b. Standing charges
c. Increased costofw orking
d. Increased costofreinstatem ent
8. Isan FIP a contractofinsurance?
A ns:Y es,an FIP isaspecialcontractofinsurance,theobjectofw hich isto indem nify the
otherparty from losscaused to him by dam ageordestruction ofhisproperty by fire.
In certain contracts,otherthan contractsoffire insurance,such a duty to indem nify
theow nerfrom any lossto theproperty,including lossby firem ay beeitherim posed
or im plied by the law or m ay be undertaken by the express term s of the contract
(bailm ent,tenancy contracts).
9. In an FIP thecauseofFireissaid to beim m aterial.Justify.
A ns:In an FIP thecauseoffireisim m aterial.Iftheassured iscarefuland stillthereisfire,
itw ould be unjustto disentitle him to claim and even w hen he orhis servants are
negligentand thereisfire,even then itw ould beunfairto disentitlehim to claim ,for
itisprecisely forthese reasonsthatan FIP istaken.O ne should understand thatitis
the dam age and notthe cause offire thatisinsured.Butin the follow ing tw o cases,
com pensation isnotgiven:
W hen dam ageiscaused voluntarily orw ilfully
W hen causeisw ithin an exception ofthecontract
10. G ivesom eexam plesofrem otecausesoffire.
A ns:A loss forw hich fire is notthe proxim ate cause butonly a rem ote cause,is not
II-13
M O D U LE -II:TECH N ICA L A SPECTS O F IN SU RA N CE

recoverable underan ordinary fire insurance policy.Exam ples ofrem ote causes of
lossby fireare:
anticipated profits
continuing expenditure
increased expenditure
depreciation
liability
11. W hatism eantby Lossby Fire?
A ns: For a loss covered by an FIP,there m ustbe an actualfire or ignition.A ny loss
attributed to the fire w hetherby actualburning orby cracking orscorching orby
sm okeorotherw isew illalso haveto beborneby theinsurer.
12. W hatisa covernote? D iscussitsvalidity.
A ns:A covernoteisnotapolicy ofinsurance.Itisonly an interim protection note.Itisa
tem porary and lim ited agreem ent.Theeffectofthecovernoteisthatifthefiretakes
place betw een the date ofthe receiptofthe covernote and the date ofintim ation by
the insurance com pany regarding the acceptance or refusal of the policy, the
insurancecom pany w illberesponsible.
13. W hataresalvageexpenses? W ho incurstheseexpenses? W hatistheim plication
of sueand labor clausein an FIP policy?
A ns:Salvage expensesare those expensesincurred by the assured in salvaging orsaving
theproperty.Itistheduty oftheassured to m inim izethelossby saving theproperty
and preventing the spread offire,because a fire insurance contractis a contractof
indem nity.In m odern firepoliciesw ith aview to encouragetheassured to takesteps
to save the property a clause is inserted know n as the sue and labor clause under
w hich the insurance com pany w illbe liable to pay the expenses incurred by the
assured in salvaging theproperty even though nothing hasbeen saved.
14. State the significance of the doctrine of Proxim ate C ause w ith respect to fire
insuranceclaim s.
A ns:Thedoctrineof Proxim ateCause holdsavery significantplacein thedeterm ination
offire related claim s.Proxim ate cause m eans the active efficientcause thatsets in
m otion achain ofeventsw hich bringsaboutaresultw ithoutintervention ofany force
and w orking actively from anew and independentsource e.g.w hereinsured object
isburnt,cause isplainly fire and insured isentitled to recoverunlessthe insurercan
show thatthe fire w ascaused by exem pted perilorw illfully by insured orw ith his
consentsuch as:
1. W here there isan explosion during a fire,the concussion dam age fallsw ithin
exception and theinsured cannotrecover.
2. W here subjectm atter is burntbutfire,w hich burned it,w as due to natural
consequencesofexcepted peril,insured cannotrecover.
II-14
M O D U LE -II:TECH N ICA L A SPECTS O F IN SU RA N CE

3. W here fire w assetin operation by earthquake,ifnotcovered by insured under


fire policy and then spread by naturalcauses,i.e.spread by w ind orone thing
catching firefrom anotherand so on,insured cannotrecover.
15. W hatarethegeneralexclusionsin a standard firepolicy?
A ns:Thefollow ing arethegeneralexclusionsin astandard firepolicy:
i. This policy does notcoverthe first5 % ofeach and every claim subjectto a
m inim um of Rs. 10,000/- in respect of each and every loss arising out of
lightning,STFI,landslide,and rockslide.
ii. The first Rs. 10,000/- of every loss in respect of w hich the insured is
indem nified by thispolicy.
iii. Loss,destruction ordam age caused by w ar,invasion,civilw ar,m utiny,civil
com m otion,and so on.
iv. Loss,destruction or dam age caused by ionizing radiation,radioactive toxic,
explosives,etc.
v. Losscaused by contam ination and pollution.
vi. Losscaused to bullion,preciousstones,w orksofart,foran am ountexceeding
Rs.10000/-
vii. Loss ordam age caused to the stocks in the cold storage prem ises caused by
changein tem perature.
viii. Lossordam age caused directly orindirectly by earthquake,volcanic eruption,
etc.
ix. Loss ofearnings,loss by delay,loss ofm arket,orany otherconsequentialor
indirectloss.
x. Lossordam agecaused dueto spoilagedueto retardation orcessation ofw ork /
operations.
xi. Lossby theftduring oraftertheoccurrenceofany insured peril.
xii. Loss or dam age to any electrical m achine due to overrunning or excessive
pressure,shortcircuiting,selfheating orleakageofelectricity,etc.
xiii. Terrorism dam age.
16. W hatistheliability oftheinsurancecom pany ifthevalueoftheproperty lostis
ofgreatervaluethen thesum insured?
A ns:A fire contractis a contractofindem nity and therefore only the actualloss can be
recovered by the assured.The am ountrecoverable dependsupon w hetherthe policy
is a valued or unvalued one.Fire policies are supposed to be unvalued or open
policies,w herein theam ountofinsurancespecified in thepolicy doesnotnecessarily
representthem easureofindem nity.In such casestheam ountiscalculated according
to theintrinsicvalueorthem arketvalueon thedateofthefire.
In the leading case Butter v Standard Fire Insurance Co the insured w as held
entitled to recoverthe value ofthe stock asatthe date offire,though,in factitw as

II-15
M O D U LE -II:TECH N ICA L A SPECTS O F IN SU RA N CE

greaterthan itsvalueatthetim eofinsuring.


The contract of fire insurance is a contract of indem nity,and the insured is not
adequately indem nified againstthe lossofproperty,unless,so farasm oney can do
so,heisrestored to theposition w hich heoccupied atthetim eofloss.
Prim a-facie, therefore, the basis of calculation is either the m arket value of the
property destroyed orthecostofreinstatem ent.Itisto benoted that,w hattheinsured
is entitled to recoveris the value ofthe property.W hicheverbasis is adopted,itis
only asabasisforcalculating therealvalueoftheproperty,and theinsured doesnot
recoverm ore than the m arketvalue orthe costofreinstatem entas such.In m any
cases the m arketvalue ofthe property destroyed represents its realvalue.In such
cases,paym entofthe m arketvalue is an adequate indem nity,since the insured,by
purchasing sim ilarproperty in the m arketw ith thatm oney can be said to have been
com pletely restored to hisoriginalposition.
Theoretically,them arketvalueand thecostofreinstatem entoughtto bethesam e.In
practice,how ever,there isa difference betw een them .In a leading case, Equitable
Fire Insurance Co v Q uinn ,itw as held thatthe insurers w ere liable to pay the
m arketvalue atthe tim e offire,w hich exceeded the costprice although the insured
had notinsured theprofit.
In anothercase, M cCuaig v Q uackerCity Insurance Co ,w here a steam boatw as
insured against fire, the insurers w ere held liable to pay the real value of the
steam boatnotw ithstanding thefactthattherew asadepreciation in thevalueofsteam
boatscaused by circum stancesw hich m ightonly betem porary.
H ence,the view thatin allcases the basis ofcalculation is the m arketvalue ofthe
property,itissubm itted,isnotapplicable.There are casesin w hich,the losscannot
be m ade good exceptby reinstatem ent.The insured is notrestored to his original
position,ifheisunableto reinstatetheproperty outoftheproceedsoftheinsurance.
Paym entofm arketvalue therefore doesnotgive the insured an adequate indem nity,
sincehecannotreinstatetheproperty w ith thissum representing itsm arketvalue,but
is necessarily com pelled to incur further expenditure before he can restore the
property to itsoriginalposition.Consequently,abasisofcalculation m ustbeadopted
w hich giveshim adequateindem nity,and thebasisisthecostofreinstatem ent.
H ow ever,w here the cost of reinstatem ent is taken as a basis of calculation,the
reinstatem ent contem plated is a reinstatem ent sufficient to restore the property
insured to the condition in w hich it w as at the tim e of loss.But very often,by
reinstatem ent the assured w ill be m ore than fully indem nified because an old
property isnow substituted by anew property.
In certain cases,neitherreinstatem entnorm arketvalue can be the basisofvaluation
asreinstatem entisim possibleand them arketvaluedoesnotexist.Theproperty m ay
nothave m arketvalue,exceptperhaps as scrap and itm ay be capable ofphysical
reinstatem entbutitm ay notbecom m ercially practicableto do this.In such cases,the
testistherealvalueto insured atthetim eofloss.

II-16
M O D U LE -II:TECH N ICA L A SPECTS O F IN SU RA N CE

17. C an an insurance com pany be com pelled to replace/reinstate the dam aged
property? Isitoptional?
A ns:Reinstatem entliterally m eansreplacem entofw hatislostorrepairing the dam aged
property and bringing to itsoriginalvalueand utility.Thew ord reinstate in apolicy
offire insurance refers to buildings orchattels,w hich have been dam aged,and the
w ord replacerefersto thosew hich havebeen totally destroyed.
U nder an insurance policy, the norm al liability of the insurer is generally to
indem nify theassured,by paying thevalueofthething lostortheexpensesincurred
by theassured in repairing thedam ageoccurred by an eventinsured against.Though
usually theinsurer,in certain cases,m akespaym entofm oney w ith theconsentofthe
assured,itm ay dischargetheirliability by reinstatem ent.
The rightof reinstatem ent is usually stipulated as an option to the insurerin the
sense thaton the happening ofthe loss,the insurerw illhave rightto electeitherto
pay theassured in m oney orto reinstatetheproperty.
The assured w illnothave the rightto com pelthe insurerto reinstate,northe insurer
hasa rightto com pelthe assured on paym entofm oney to apply the proceedsofthe
policy in reinstatem ent.The assured has alw ays an unbridled rightto utilize the
policy proceedsashepleasesw ithoutany interferencefrom theinsurers.
The rightofthe insurerto reinstate the property instead ofpaying the m oney m ay
spring up:
Eitherfrom acontractin theform ofaclauseunderthepolicy,or
U nderastatute.
Thistypeofclauseisnotinserted in allbranchesofinsurances,e.g.itisnotand
cannotbeincluded in lifepolicies.
O nly in indem nity insurances, in appropriate branches of insurance, like fire,
burglary, steam boilers, or m otor vehicles insurances, this clause called the
reinstatem entclause ,entitling theinsurersto exercisean option,on thehappening
of the insured event, either to reinstate or to pay the insured m oney can be
incorporated.This only em pow ers the insured to exercise the option and underno
circum stances the assured can com pelthe insurerto reinstate.The insurers on the
otherhand,can exercise thisoption by expressly giving a m otive to the assured orit
m ay beinferred from theirconduct.
18. W hataretherightsofco-insurersto com binein reinstatem ent?
A ns:W hen tw o orm ore insurersgrantinsuranceson the sam e subject-m atterand ifthey
com binetogetherto reinstate,theassured cannotpreventthem from joining to do the
w ork and w hen once they com plete reinstatem entthey are discharged from their
liability.This rightof com bination som etim es m ay be a valuable rightw here the
policies relate to separate intereston the sam e subject-m atter because the costof
reinstatem entm ay then bevery m uch lessand m oreeconom icalthan them easureof
loss.

II-17
M O D U LE -II:TECH N ICA L A SPECTS O F IN SU RA N CE

19. D iscusstheim plication ofthedoctrineofsubrogation in a fireinsurancepolicy.


A ns:The doctrine ofsubrogation isa necessary incidentto the contractofindem nity and
thereforeapplicableto acontractoffireinsuranceand oneofm arineinsurance.
U nderthisdoctrine,asapplicableto fireinsurance,theinsurerhasarightofstanding
in the shoes ofthe insured and availhim selfofallthe rights and rem edies ofthe
insured,w hetheralready enforced ornot.The principle ofsubrogation prevents an
insured w ho holds a policy of indem nity from recovering from the insurer a sum
greaterthan theeconom iclosshehassustained.
Therefore,ifalossoccursundersuch circum stancesthathehasan alternativerightto
recoverdam ages,undercom m on law ,tortorstatuteand ifthelossisalso covered by
thepolicy and so hecan recovertheentirelossfrom theinsurerand ifheso receives,
the insurer is entitled to, or is subrogated to, the form er alternative rights and
rem ediesofthe insured and thisistechnically called subrogation .The insurerin
thisisentitled by subrogation only up to theam ounthehaspaid theinsured.
The im portanttype ofrightin respectofw hich subrogation arisesare rightsarising
outofa tort,contractorstatute.The rightofsubrogation isexercisable atcom m on
law after the am ounthas been fully paid,butcondition 9 in the standard policy
enablestheinsurerto claim againstthethird party even beforethepaym entism ade.
H ow ever,the insurercannotrecoverfrom a third party before he hasindem nified his
ow ninsured,butcanonlytakestepstoholdthethirdpartyliablependingthesettlem ent
oftheclaim underthepolicy.Itisfrom actualpaym entunderthecontractofindem nity
thatthe rightof subrogation springs.A s subrogation m eans substitution,w here the
assured him self cannotbring an action,the insurer also cannotclaim anything by
subrogation.Forexam ple,w here the w ife ofthe assured setfire to hishouse and the
insurers paid,itw as held in M idland Insurance v Sm ith thatthe insurers cannot
recovertheinsurancem oney astheassured had no rightofaction againsthisw ife.
Sim ilarly,w here tw o shipsbelonging to the sam e ow nercollide by the faultofone,
the insurersofthe ship notin faultw illnotbe entitled to any claim on the ow nerfor
actsoftheothership,though theinsurersofthecargo ow ned by thethird party w ould
havehad aclaim againsthim .
Lim itationson thedoctrine:Thedoctrineofsubrogation
i. D oesnotapply to lifeand personalaccidentpolicies;
ii. Insurerm ustpay beforehecan claim subrogation;
iii. A ssured m usthavebeen ableto bring action.
20. W hataretheunderw riting factorsto beconsidered fora fireinsurancecover?
A ns:U nderw riting the peril of fire focuses on the physical hazards presented by a
particular loss exposure.To assure a thorough review of these hazards property
underw riters use an approach that scrutinizes four specific areas. These are
traditionally referred as CO PE: construction,occupancy,protection,and external
exposures.

II-18
M O D U LE -II:TECH N ICA L A SPECTS O F IN SU RA N CE

Construction ofthe covered property is ofprim ary concern to the underw riter.The
building construction is directly related to its com bustibility w hen exposed and its
construction as fuel once ignited. The Insurance Services O ffice (ISO ) divides
building construction into six classifications:
i. Fireresistive
ii. M odified fireresistive
iii. M asonry noncom bustible
iv. N oncom bustible
v. Joisted m asonry
vi. Fram e
O ccupancy factors affectthe frequency and severity oflosses.These factors w hich
vary from oneoccupancy to anothercan begrouped into threeheadings:
i. Ignition sourcesorfirecauses
ii. Com bustibility
iii. D am ageability
Fireprotection can beoftw o types:publicorm unicipalprotection provided by tow ns
and cities,and privateprotection provided by theproperty ow neroroccupant.
Externalexposures are those outside the area ow ned orcontrolled by the insured.
Theseexposuresfallinto categories:
i. Single-O ccupancy Exposures
ii. M ultiple-occupancy Exposures
W hen the property being underw ritten consistsofa single building,fire division,or
group of buildings ow ned and controlled by the sam e policyholder, a single-
occupancy exposure exists.A m ultiple-occupancy exposure occurs w heneverother
portionsofthesam efiredivision areow ned and controlled by personsotherthan the
policyholder.
SEC TIO N C
(C A SE STU D IES)
1. RelianceG eneralInsuranceCom pany Ltd.deliversafirepolicy to M r.A jay on A pril
15.H ow ever,theinsured paid theprem ium atalatterdate.U nfortunately therew asa
firein theprem isesresulting in lossofproperty insured.Thecom pany laterdenied its
responsibility on the basis ofthe factthatthe prem ium w as overdue atthe tim e of
loss.D iscuss.
A ns:N o, the com pany cannot now deny its claim . For w hen an insurance com pany
delivers a policy w ithoutrequiring im m ediate paym entofthe prem ium ,they incur
responsibility fortherisk,becausehaving delivered thepolicy,they areheld to have
given creditforthe prem ium .M oreover,w hen once the contractis concluded w ith
the prem ium and otherparticularsfixed,the policy draw n and delivered,the insurer
becom es liable for loss by fire,and itis im m aterialw hether the prem ium is paid
beforeorafterthefire.
II-19
M O D U LE -II:TECH N ICA L A SPECTS O F IN SU RA N CE

2. M r.A m ar losthisfactory furniture valued atR s.200,000 ason the date offire.
H e w anted to recover a claim ofR s2,50,000 for he had a policy ofR s500,000.
O n enquiry hefound thatfornew furniturethecostw ould beR s1,75,000.Ifthe
principleofindem nity isto beapplied how m uch ofhisclaim isto beaccepted?
A ns:Since the m arket value of the furniture lost w as Rs 2,00,000 and the cost of
reinstatem entw ould costthe insurers only Rs 1,75,000,the insurers w ould optfor
reinstatem entand accepttheclaim ofRs1,75,000.
3. M r.Shetty,ow ner ofan inn,took outan FIP w ith BajajA lianz Ltd.A fire took
place and his inn w as destroyed.The assured included in his claim the sum
w hich he had to pay by w ay of rent, the cost of hiring alternative
accom m odation,and loss caused by custom ers notfrequenting the inn during
theperiod ofrepair.Justify hisclaim .
A ns:N o,hisclaim isnotjustified.W here a fire destroysproperty,from the use ofw hich
the insured expects to earn a profitin the ordinary course ofbusiness,he does not
m erely lose hisproperty.H e also losesin addition the chance ofearning the profit,
w hich hem ighthaveearned iftheproperty had notbeen destroyed.
Butthisanticipated lossofprofitisregarded asvery rem ote and isnotrecoverable
under an ordinary fire policy on the property lostby fire.A ccordingly,insurance
upon a hotel,shop orfactory coversonly the value ofthe hotel,shop orfactory but
does notcoverthe loss ofbusiness.In the above case,none ofthe above item s is
covered by the policy. A nticipated profit is to be distinguished from the profit
ascertained atthedateoflossto ascertain thevalueofthesubject-m atterand in fixing
theam ountrecoverableunderthepolicy.[W rightvPole]
4. M r.K ishore insured his m achinery and stock of goods stored in the factory
prem isesagainstdam ageby fireand a protection note w asgiven,subjectto the
usualconditionsofthe com pany spolicy,one w arranty clause being sm oking
and cooking be strictly prohibited in or aboutthe prem ises .The stocks w ere
dam aged by fire said to be of accidentalnature.But the insurance com pany
claim ed thatsm oking a cigaretteorbidicarelessly by som eem ployeeoccasioned
thefire.Isthedenialjustified?
A ns:In the above case,the com pany denied the claim on the ground thatthere w as a
breach of w arranty as the fire w as occasioned by sm oking w hich is strictly
prohibited.Butastherew asno eye-w itnessto theorigin ofthefire,thecourtheld that
the cause of fire w as a m atter of conjecture. [Bhattacharjee v Sentinal
InsuranceCo.]
In thefam ouscase D ekhariTea Co vAssam BengalRoadwaysCo,itw asalso held
thatfires cannotalw ays be explained,and itm ustbe a m atter of conjecture.A s
regardsthe w arranty,asthe plaintiffhad putnoticesstrictly prohibiting sm oking in
and around theplaces,in factthereisno breach ofw arranty.H ence,thedenialon the
partoftheinsurancecom pany isnotjustified.O n theotherhand,thecom pany should
m akegood theloss.
II-20
C hapter 3
M arine Insurance

SEC TIO N -A

1. Them arineinsurancehasitsorigin in
a. England
b. U SA
c. India
d. France
e. N oneoftheabove
2. A m arinecargo insurancepolicy isa
a. open policy
b. valued policy
c. unvalued policy
d. indem nity policy
e. noneoftheabove
3. Insurableinterestisnecessary in a m arineinsurancecontracton
a. thepolicy issuedate
b. on thepolicy term ination date
c. atthetim eofloss
d. aftertheloss
e. noneoftheabove
4. Theprofitm adeby theship ow nerby transporting hisow n cargo orthecargo of
anotherperson isknow n as
a. carriage
b. franchise
c. excess
d. freight
e. noneoftheabove
5. A ny expenditurevoluntarily incurred forthecom m on safety oftheship iscalled
as
II-21
M O D U LE -II:TECH N ICA L A SPECTS O F IN SU RA N CE

a. particularaverage
b. generalaverage
c. totalloss
d. constructiveloss
e. noneoftheabove
6. C argo insuranceiscodified underthe
a. ITC clauses
b. ICC clauses
c. IIC clauses
d. IH C clauses
e. N oneoftheabove
7. W hich ofthefollow ing perilsareuninsurablein a m arinepolicy
a. fire
b. barratry
c. delay
d. collision
e. noneoftheabove
8. A clauseaim ed to bring aboutcooperation betw een theassured and theinsurer
such thattherightsofneitherparty isaffected w ith regard to thegoodsis
a. inchm areeclause
b. w aiverclause
c. collision clause
d. proxim atecauseclause
e. noneoftheabove
9. U nseaw orthinessand unfitnessclauseis
a. an im plied w arranty
b. an expressw arranty
c. an im plied condition
d. an expresscondition
e. noneoftheabove
10. Salvagecharges generally form
a. apartofthem arinecontract
b. arenotapartofthecontract
c. apartofthegeneralaverageclause
d. apartoftheparticularclause

II-22
M O D U LE -II:TECH N ICA L A SPECTS O F IN SU RA N CE

e. noneoftheabove
11. W illfulm isconductcom m itted by them asterand thecrew oftheship iscalled as
a. jettison
b. barratry
c. collision
d. m aritim e adventure
e. noneoftheabove

SEC TIO N A A N SW ER S
1. a 2. c 3. c 4. d 5. b 6. b
7. c 8. b 9. a 10.b 11.b

SEC TIO N -B

1. O utlinetheim portanceofm arineinsuranceto trade.


A ns:A m arineinsurancepolicy isindispensablefortradeand com m erce.Itsim poer
Significantin internationaltradethan banking
Providessecurity forcreditin internationaltrade
Integralpartofoverseastrade
Regarded ashandm aid to com m erce
LO C issued by theim porterbank on thestrength on m arineinsurancecover
2. Statetheclassification ofM arineC argo Policies
A ns:M arinepoliciescan beclassified into variouscategoriesasfollow s:
(A ) O n thebasisofSubjectM atter
Cargo
Freight& D isbursem ent
H ull
BuildersRisk
(B) O n thebasisofD uration
V oyage
Tim e
M ixed
(C) O n thebasisofspecificterm sofinsurance
Singlejourney
FloaterBuildersRisk
PortRisk

II-23
M O D U LE -II:TECH N ICA L A SPECTS O F IN SU RA N CE

3. M ention theIm port/ExportC argo clausesand coverageofm arineinsurance.


A ns:Thebroad classification used fortheO cean Transitcoverforcargo is
TheInstituteCargo Clause(ICC) A
TheInstituteCargo Clause(ICC) B
TheInstituteCargo Clause(ICC) C
InstituteCargo Clauses C coversthefollow ing losses:
1. Fireorexplosion
2. V esselbeing stranded,grounded,sunk orcapsized.
3. O verturning orderailm entofland conveyance
4. Collision or contactof vessel/craftor conveyance w ith any externalobject
(otherthan w ater)
5. D ischargeofcargo attheportofdistress
6. G eneralaveragesacrifice
7. Jettison
8. G eneralaveragecontribution & salvagecharges
9. Liability underboth to blam ecollision clause
Institute Cargo Clause B in addition to the above 1-9,the follow ing are
covered
10. W ashing overboard
11. Earthquake,volcaniceruption orlightning
12. Entry ofsea,lake,orriverw aterinto vessel,craft,liftvan orplaceofstorage
13. Totalloss of any package lostoverboard or dropped w hilstloading into or
unloading from vesselorcraft
InstituteCargo Clause A cover
A llrisksofloss/dam ageto thecargo otherthan exclusions.
4. M ention thegeneralexclusionsofan M IP.
A ns:1. W illfulm isconductoftheinsured
2. O rdinary leakage,ordinary lossin w eightorvolum eorordinary w earand tear
3. Inherentviceornatureofthesubjectm atter
4. D elay
5. Insolvency orfinancialdefaultoftheow ners,operators,etc.ofthevessel
6. Insufficiency orunsuitability ofpacking
7. W arand allied perils
8. SRCC-Strike,Riot,CivilCom m otion and Terrorism
H ow ever,W ar,SRCC riskscan becovered by extrapaym entofprem ium .In addition
to theabove,ICC B & ICC C excludem aliciousdam agew hich can becovered by
additionalprem ium .

II-24
M O D U LE -II:TECH N ICA L A SPECTS O F IN SU RA N CE

5. Enum eratetheextension availableunderIC C B in a m arineinsurancepolicy.


A ns:U ndertheICC B cover,extraneousperilsinclude
a. Theft,pilferage,and non-delivery
b. Fresh /rain w aterdam age
c. D am ageby hook,oil,m ud,oracid
d. Breakageorleakage(notordinary leakage)
e. Country dam age
f. Shortage
g. Bursting and tearing ofbags
6. D iscussthedifferenttypesofM arineInsurancePolicies
A ns:Thedifferenttypesofm arineinsurancepoliciesareasfollow s:
Specificpolicy thistypeofpolicy isissued to coveraparticularrisk proposed
by an insured on an individualproposal.Thespecificpolicy w illhaveto beduly
stam ped and signed.Itcontainsthedetailsof
conveyanceorvesselnam e
B/L,RR num ber
D ate,sum insured,term sand conditionsofcover
V oyage,description ofcargo
Prem ium ,etc.
Cover N otes W hen insurance is arranged by the consignee atthe tim e of
opening ofthe LO C,he m ay notbe aw are ofthe vessel,billnum ber,date,etc.
Forw antofdetailstheinsurerw illnotbein aposition to issueastam ped policy,
and henceaCoverN oteisissued.
Floating or O pen Policies this is taken by big com m ercial firm s and
industrial establishm ents having enorm ous volum e of trade, regular and
frequentdispatches,and w hen itis difficultto approach insurers foreach and
single transit.This policy covers allthe despatches from a specified place to
specified placesin thepolicy during theperiod ofinsurance.
O pen Cover -This arrangem entis beneficialfor overseas trade.Itcovers all
shipm ents in accordance w ith the agreem ent.Itis issued forone yearin the
form of an agreem ent to cover shipm ents by sea/ rail/ road/ betw een tw o
specified term inion a w orldw ide basis.The policy isnotstam ped and separate
policiesareto beissued foralltheshipm entsdeclared underopen cover.
7. W hataretheunderw riting considerationsto betaken beforea policy ofM arine
Insuranceisissued?
U nderw riting criteriato evaluateinclude:
Seaw orthinessofthevessel
W atersnavigated and theseason

II-25
M O D U LE -II:TECH N ICA L A SPECTS O F IN SU RA N CE

Experienceoftheoperators
Susceptibility ofthecargo
Packaging standards
Sizeand valueofindividualitem sofequipm ent
Financialstatusofthepolicyholder
Pastlosshistory
Labourrelations
The underw riters should properly evaluate the conditions that m ay increase the
hazardsofafirelossand so should check theinstallationsofsuch equipm ent.
8. D iscussthevarioustypesofm arinelossclaim s.
A ns:A m arine claim upon a policy of m arine insurance goods m ay arise upon the
happening,asaresultofinsured perilsofany ofthefollow ing:
i. TotalLoss actualorconstructive
ii. Particularaverage partialloss
iii. G eneralaverageloss
iv. Expensesw hich are:
Sueand labourchargesand particularcharges
Salvagecharges
Forw arding expenses
Extracharges
A ctualTotalLoss
A ctualtotallossofthesubjectm atterm ay occur
w here it is destroyed by an insured peril (sinking of the ship,collision,or
destruction by fire,enem y in tim esofw ar)
w hereitlosesitsspecies,unfitforhum an consum ption
lossisirretrievable
itisphysicaltotallossand itisabsolute
M easureofindem nity foractualtotallossistheinsured valueunderthepolicy.
ConstructiveTotalLoss
Thisarisesshould allorany ofthefollow ing occur:
actualtotallossisunavoidable
w herethepreservation costofthegoodsexceedstheirvalue
w herethepossession ofthegoodsisunlikely
w here the costof repairing,and forw arding to the destination exceeds their
value
w herethereisalossofvoyage
itisacom m ercialtotalloss
to claim a CTL,the assured m ustgive a notice ofhisintention to abandon the
II-26
M O D U LE -II:TECH N ICA L A SPECTS O F IN SU RA N CE

goods
M easure of indem nity for CTL is the sum insured less any proceeds of sale
w hich aredueto theinsurers.
Particularaverage/Partialloss
itisapartialloss/dam agecaused fortuitously by an insured peril
m easureofindem nity forPA to cargo dependsupon
w hetheritistotallossofpartofcargo
dam aged cargo
salvageloss
G eneralA verageLoss
Section 66 ofM IA ,1963 definesG A asfollow s:
A G A loss m aybe either a sacrifice or an expenditure,extraordinary in nature,
voluntarily and reasonably incurred,in tim eofgeneralperilforthecom m on safety of
them aritim eadventure .
allinterests atrisk nam ely the ship,cargo and freightw hich have been saved
from loss by G A m easures are liable to contribute rateably to m ake good the
sacrificeand expenditure
thesevaluesareknow n as contributing values
the sum necessary to reim burse the interestw hich have suffered the G A lossis
called A m ountM adeG ood or A llow ance
Sueand LabourC harges
A llreasonableexpensesincurred in averting orm inim izing aloss
Therem usthavebeen an operation ofan insured peril
Thechargesarepayablein fullirrespectiveofthevalueofthegoods
Thesechargesareincurred shortofdestination
Thesechargesfollow upon lossordam age
ParticularC harges
Section 64 (2)oftheM IA ,1963 statesthatexpensesincurred by oron behalfof
the assured forthe safety orpreservation ofthe subjectm atterinsured,other
than G A and Salvagechargesarecalled Particularcharges
Particularchargesareincurred atdestination
These chargesare conditionalon the attainm entofthe franchise percentage of
loss
Theseexpensesareincurred w herelossisthreatening orim m inentbutavoided
by expenseforthatpurpose(reconditioning expenses)
Salvagecharges
Third parties w ho voluntarily and independently of contract render services to

II-27
M O D U LE -II:TECH N ICA L A SPECTS O F IN SU RA N CE

m aritim e property atsea w hich are of m aterialassistance in saving the im periled


property areentitled to claim salvage.
Forw arding C harges
Forw arding Chargesincludeexpensesincurred in unloading,storing,and forw arding
theinsured goodsataplaceotherthan thedestination port,on theterm ination ofthe
transit, excluding those charges arising from fault, negligence, insolvency, or
financialdefaultoftheassured ortheirservants.
Extra C harges
These charges include expenses of protests,survey and other proofs of loss,
com m issions,expensesrelated to auction sale,etc.
Payableonly w hen aclaim isadm itted
Thesecharges follow theclaim
9. D iscusstheim portantdocum entsto befiled forsubstantiating cargo claim s
O riginalinsurancepolicy /declaration
O riginalcopy ofsalesinvoice
Billoflading
Billofentry
Letterofsubrogation
Lossoverboard certificatein caseoflossduring loading,ordischarge
Specialpow erofattorney (ifapplicable)
Railw ay receipt / Transport Receipt / Bill of Lading / postal receipt / air
consignm entnote
O pen assessm entreportby thecarrier
Survey reportofindependentsurvey
Claim form and claim bill
Bankerscertificate

SEC TIO N C
(C A SE STU D IES)
Three friends A shok Jadhav,LalitK apoor,and G ovid hadari team ed up to starta
lobsterexportbusiness.Jadav ow ned a ship w hich w asused in the businessforfishing as
w ellasfortransporting the processed lobstersto foreign shores.They insured theirship,
the cargo,freight,profitsand com m ission,fora totalofRs.80 lakhs.Expecting to obtain
enorm ousprofitson theircargo,itw asovervalued by theinsured.
A few m onthslater,the ship sank in m id-ocean asithad a hole.Consequently the cargo
w as also lost. The insured approached the insurance com pany to file a claim for
com pensation forthelostcargo.H ow ever,theinsurancecom pany refused paym entofthe
entire claim am ount.Itonly m ade partialpaym entofthe claim stating thatthe cargo w as
II-28
M O D U LE -II:TECH N ICA L A SPECTS O F IN SU RA N CE

insured foran am ountm ore than its actualm arketvalue.M oreover,investigation by the
insurancecom pany surveyorrevealed thattheinsured had intentionsto sink theship.
The vesselw as retrieved by the insurance com pany and w as offered forsale as salvage.
Theinsured approached thecourtto preventthesaleoftheship.
Q uestions
1. W asthe insurance com pany violating the insurance contractby refusing paym entto
theinsured?Justify youransw er.
2. D iscusstheduty ofan insurerpertaining to salvage.
A ns:1.A n insurance contractlegally binds an insurer to pay the policyholder for the
dam ages orlosses caused by the perils againstw hich the policyholderhas insured
him self.In thegiven case,thesinking oftheship and thelossincurred by theinsured
w asdueto w illfulorfraudulentactoftheinsured and notby theperilsagainstw hich
theship w asinsured.A n insurerisnotliableforrefusing to acceptaclaim pertaining
to a losscaused by the fraudulentactofthe insured.Such lossesare notcovered by
insurancepolicies.
H ow ever,in taking over the ship to sellas salvage,the insurer w as violating the
insurance contractbecause salvage belongsto the insureronly afterhe hasm ade the
paym entof the loss suffered to the insured.In this case,the insurer should have
rejected any furtherdealings w ith the insured once itw as apparentthatthe insured
had involved in fraudulentactby intentionally causing the ship to sink to claim the
insurance am ount.Instead,the insurance com pany took overthe insured sproperty
forsalvagew ithoutthelatter sapproval.
Thus,the insurerw asnotacting w ithin the fram ew ork ofthe insurance contractand
w asliableto belegally penalized.
2. The term salvage refers to partially dam aged property.Salvage belongs to the
insurerafterthe insurerhaspaid the insured forthe lossincurred.Thus,insurersare
entitled to any m aterialthatrem ainsafterdam age provided they pay the fullam ount
fortheloss.H ence,an insurercan claim hisrighton thesalvageonly afterhem akes
thepaym entforitto theinsured.
The insureris also entitled to the salvage afterpaying the claim am ountw hen the
insured isunw illing to retain itorunableto disposeit.

II-29
C hapter 4
M otor Insurance

SEC TIO N -A
1. O riginally them otorinsurancepoliciesw ereissued to coveronly
a. ow n dam agelosses
b. only accidentallosses
c. third party liability losses
d. w arlosses
e. noneoftheabove
2. Besidestheow ner,insurableinterestin a m otorinsurancefora financed vehicle
ispresentw ith the
a. Financier
b. M ortgager
c. Bailor
d. G arageow ner
e. N oneoftheabove
3. W hich ofthefollow ing vehiclesareexem pted from com pulsory insurance
a. vehiclesow ned by thegovernm ent
b. vehiclesow ned by film stars
c. vehiclesow ned by thebanks
d. vehiclesow ned by thepoliticians
e. noneoftheabove
4. A covernoteisvalid only for
a. 15 days
b. 25 days
c. 60 days
d. 90 days
e. noneoftheabove
5. A ssessm entofm otorlossesaredoneby the
a. underw riter
b. agent
II-30
M O D U LE -II:TECH N ICA L A SPECTS O F IN SU RA N CE

c. surveyor
d. om budsm an
e. noneoftheabove
6. Forspeedy settlem entofthethird party claim s,thecasesarereferred to
a. M A CT
b. Consum erforum s
c. Sessionscourt
d. Fam ily courts
e. N oneoftheabove
7. K nock-for-knock agreem entappliesto a situation involving collision betw een
a. m any vehicles
b. tw o vehicles
c. only oneinsured vehicle
d. uninsured vehicles
e. noneoftheabove
8. Settlem entoflossesin a m otoraccidentclaim isusually arrived on thebasisof
a. O m budsm an report
b. FIR report
c. Survey report
d. Lossnotice
e. N oneoftheabove
9. O n saleofa m otorvehicletheinsurancepolicy isalso
a. autom atically transferred
b. nottransferable
c. conditionally transferable
d. transferableonly on application to theinsurer
e. noneoftheabove
10. W hich ofthefollow ing giveriseto adverseclaim sexperience
a. traffic density
b. high costoflabour
c. inflated claim s
d. costofspareparts
e. alltheabove
SEC TIO N A A N SW ER S
1. c 2. a 3. a 4. c 5. c 6. a
7. b 8. c 9. d 10.e
II-31
M O D U LE -II:TECH N ICA L A SPECTS O F IN SU RA N CE

SEC TIO N -B
1. D iscussthenatureand scopeoftheM otorInsurancecover.
A ns:A policy ofm otorvehicle insurance is,in ordinary course,a com bined insurance.It
insuresthe dam age ofthe m otorvehicle and itsaccessories,liability fordam age for
property,death oforinjury to,the assured him selforspouse and italso insuresthe
m otorvehicle againstthe risk ofliability forinjury to,orthe death ofthird parties
caused by thedriver snegligence.
2. W hat are the different types of policies available and w hat is the lim it of
indem nity underthosepolicies?
A ns:The term softhe policiesdefine the nature and extentofthe indem nity provided by
thepolicy.Therearetw o typesofpoliciesnam ely:
(i) Thethird party liability policy
(ii) A com prehensivepolicy
The third party liability insurance iscom pulsory underthe M otorV ehiclesA ct.Itis
often said that am otorcarpolicy isauniquecom bination ofseveraltypesofG eneral
Insurance .
Forexam ple,aprivatem otorcarcom prehensivepolicy indem nifiestheassured against
lossordam age to the insured carby accidentalexternalm eans,by fire,selfignition,
externalexplosion,lightning,frost,burglary,house-breaking ortheft,and by m alicious
act.Thusitisvery clearthattheinsurerisliableto m akegood thelossofam otorcarto
theow nerofthecar,forlossofcarm eanslossto theow nerofthecar.
3. M ention theconditionsin a m otorvehiclepolicy to m aketheinsurerliable.
A ns:Som eoftheconditionsin am otorvehiclepolicy to m aketheinsurerliableare:
a. The insured w illm aintain the vehicle in a good state of repair and efficient
condition;
b. H e takes allreasonable steps and precautions to avoid accidents and to select
com petentand soberdrivers;
c. H etakesallreasonablestepsto safeguard thecarfrom lossordam age.
4. Explain thefollow ing:
K nock forknock agreem ents
N o faultliability
A ns:K nock for knock agreem ents are agreem ents betw een the insurers, to avoid
confusionsand com plicationsatthe tim e ofsettlem entofclaim s.Suppose there are
otherinsurances on the sam e vehicle,the insurers are liable to pay only a rateable
proportion.
Sim ilarly,w hen tw o m otorists,insured undercom prehensive policies,are involved
in a m otoraccident,both m ay be liable.Both casesinvolve doctrinesofsubrogation
and contribution involving costs and m ultifarious litigation. To avoid this
com plication,insurersenterinto agreem entsknow n as knock forknock .
II-32
M O D U LE -II:TECH N ICA L A SPECTS O F IN SU RA N CE

It is an agreem ent betw een both the insurers that irrespective of w hoever w as
responsible forthe accident,provided the liability iscovered underthe policy,each
insurerw illindem nify hisinsured in respectofthe dam age to the vehicle insured by
itand w illnotenforcesubrogation rights.
O n sim ilarlines, third party sharing agreem ents are entered into underw hich each
w illshareequally thethird party costsand dam ages.
N o Faultliability also know n as liability w ithoutfault isto m aketheow nerof
the vehicle liable unconditionally.Thisclause statesthatw here death orperm anent
disablem entofany person hasresulted from an accidentarising outofthe use ofa
m otor vehicle or m otor vehicles, the ow ners of the vehicles shall, jointly and
severally,beliableto pay com pensation provided in theA ctin respectofsuch death
ordisablem ent,w hich isgenerally Rs.25,000 in caseofdeath and Rs.12,000 in case
ofperm anentdisablem ent.
Thissection ofthe A ctm akesthe liability absolute;w hetheratfaultorno fault,the
ow nerofthe vehicle ism ade liable to pay thisam ount.Further,the liability isalso
m ade jointand several w hereby theassured m ay dem and from any oneorsom eor
allofthem w here there are m ore than one vehicle ow nerinvolved.The paym entof
com pensation is m ade certain,expedientand expeditious by dispensing w ith the
necessity ofproving any faulton the partofthe payerand by providing im m unity
debarring any defencesagainstthereceiverofthecom pensation.
5. D iscussthe nature and scope ofthe third party or com pulsory insurance ofthe
m otorvehicles.
A ns:In law oftorts,ifaperson negligently driveshisvehicleand causesinjury ordeath to
a third party the driverw hose negligence caused the dam age is liable to the third
party.U nderthevicariousliability clauseofthecom m on law ,theow neron behalfof
thedriverisliableto thethird party.
The objectofthistype ofpolicy isto protectthe insured againsthisliability to third
parties arising outofan accidentcaused by the use ofa m otorvehicle on a public
road and itisalso m adecom pulsory.Thepersonsrequired to beinsured are:
a. W ho usesthevehicleexceptasapassenger,i.e.adriver.
b. O ne w ho causes orallow s any otherperson to use the vehicle,otherthan an
ow ner,onew ho isin possession ofthevehicleunderacontractofloan orhiring.
6. M ention the provisions and conditions to be adhered to, under the M otor
V ehiclesA ctin respectofthird party insurance.
A ns:The M otor V ehicles A ct has m ade it statutory and obligatory for a third party
insurance coverto be taken by every ow nerofa vehicle.The A ctspecifically states
thatno person shalluse exceptasa passengerorcause orallow any otherperson to
use a m otorvehicle in a public place,unlessthere isin force in relation to the use of
the vehicle by thatperson orotherperson,asthe case m ay be,a policy ofinsurance
com plying w ith therequirem entsoftheA ct.Thus,third party insuranceisam ustfor
II-33
M O D U LE -II:TECH N ICA L A SPECTS O F IN SU RA N CE

running a m otorvehicle in a public place.The follow ing are som e ofthe im portant
provisionsto beadhered to in caseofthird party insurance,nam ely:
(i) Itappliesto any otherperson otherthan apassenger;
(ii) W hatisprohibited istheuserby him selforallow ing anotherperson to use;
(iii) Such useshould beam otorvehicle;
(iv) Such vehiclesshould beused in apublicplace;
(v) The using orcausing ofuse by the otherperson should be w ithouta policy of
insurance.
(vi) Thepolicy ofinsuranceshould com ply w ith theprovisionsoftheA ct.
7. Istherea statutory contractbetw een an Insurerand D river?
A ns:A ccording to section 147 (5)oftheM otorV ehiclesA ct,theA ctstatesthat,aperson
issuing a policy of insurance under this section,shallbe liable to indem nify the
person orclassesofpersonsspecified in the policy in respectofany liability w hich
the policy purportsto coverin the case ofthatperson orthose classesofpersons.In
factby virtue ofthe provision ofthis section the insureris liable to indem nify any
specified classofdriver,butisnotthereby liableto theinjured third party him self.
This section gives statutory recognition to the practice ofextensions ofthe policy.
Theeffectofthisprovision isto createacontract,betw een theinsurersand any driver
ofthevehiclew ho isofaclasscovered by thepolicy.
A satisfactory form of policy therefore not only covers the liability of the
policyholderw hiledriving hisow n carbutalso extendsto indem nify:
(a) Thepolicy holderw hiledriving another scar;
(b) O therpersonsw hiledriving thepolicy holder scar.
In fact,itisa second statutory contract,w hich runssubsidiary to the m ain contract,
and itstandsorfallsw ith the m ain contract.Ifthe ow nersellsaw ay hisvehicle,his
contractcom esto an end and along w ith itthesecond contractalso disappears.
8. D iscusstheeffectofthefollow ing on claim s:
Insolvency;
D eath.
A ns:Insolvency
U nder the provisions of section 154,the A ctprotects the rights of the third party
againstinsolvency oftheassured.Thebroad effectofthesection isthatallrightsand
liabilities arising betw een the insured and the insurers in the case of com pulsory
m otorinsuranceshallrem ain unaffected,notw ithstanding thatathird party hasbeen
given largerrightsagainsttheinsurersthan theassured him selfhad.
D eath ofparties
The generalprinciple ofactio personalis m oritur cum persona does notapply to
accidentsunderthisact.U nderthe provisionsofthe A ct,ifthe death ofa person in
w hosefavouracertificateofinsurancehad been issued,occursafterhappening ofan
II-34
M O D U LE -II:TECH N ICA L A SPECTS O F IN SU RA N CE

eventw hich hasgiven riseto aclaim undertheprovisionsofthischapter,shallnotbe


a barto the survivalofany cause ofaction arising outofthe said eventagainsthis
estateoragainsttheinsurer.
From thisthefollow ing rulesm ay belaid dow n:
(i) W heretheow nerofthem otorvehiclesdiesin theaccidentand theinjured party
is alive,the injured third party can m ake his claim againstthe estate of the
deceased ow nerunlesshedied beforetheaccident.
(ii) W herethethird party diesasaresultoftheaccidenthislegalrepresentativecan
m akeaclaim forthecom pensation beforetheappropriatetribunal.
(iii) W heretheow nerofthevehicleand thethird party diein theaccident,theestate
ofthedeceased ow nerw illbeliableto theestateofthedead third party.
(iv) W here the third party isnotdead in the accident,he can him selfm ake a claim
w ithin six m onthsofthe accident;in such a case itdoesnotm atterw hetherthe
ow nerisaliveordead in theaccident.
9. W hat is the liability of the insurer in case of H it and R un m otor accident
cases?
A ns:A hitand run m otoraccidentm eansan accidentarising outofthe use ofa m otor
vehicle orvehiclesthe identity w hereofcannotbe ascertained inspite ofreasonable
effortsforthepurpose.A ccording to theCentralgovernm entinstructionsto theG IC,
the insurerhas to pay com pensation in such hitand run cases to third parties in
respectofdeath ofany person:
(a) Fixed sum ofRs.8500.
(b) In respectofgrievoushurtafixed sum ofRs.2000.
Before thisprovision,w here the w rongdoerisnotidentified,w hich isvery com m on
in a case w here a vehicle driver hits a poor pedestrian,though the victim has a
statutory rightto getcom pensation,heisdenied on theground thathisrespondentis
unidentified.Itisjust,thatin such casesG IC should provide fullcom pensation for
such victim s.
SEC TIO N -C
(C A SE STU D IES)
1. M r.Suresh,w ho w asthe ow ner ofa car,sold hiscar for itsprice and w hen the
chequecould notbeencashed heclaim ed indem nity from theinsurerfortheloss
ofthecar.Ishisclaim valid?
A ns:In the above case,the claim putforth by M r.Suresh isnotjustified because,asthe
courtalso held thatthe lossw asthe lossofthe sale proceedsand notthe lossofthe
carand so theinsurerisnotliableto pay any com pensation.[EisingervG AFL].
2. M r.R ahul,theow neroftheinsured carsold aw ay thecarand thereafter,w hile
driving another car m et w ith an accident and claim ed indem nity from the
insurer.Justify hisclaim .
II-35
M O D U LE -II:TECH N ICA L A SPECTS O F IN SU RA N CE

A ns:M r. Rahul cannot claim any am ount by w ay of com pensation from the insurer
becausethepolicy ceased to haveeffecton thesaleoftheinsured carand so hecould
no longergetany benefitofinsuranceunderthepolicy.
3. M s.Payalm etw ith an accidentw hiledriving hercar,and itw asdueto defective
brakes.Sheclaim ed com pensation from theinsurersforthedam ages.D ecide.
A ns:M s.Payalcannotclaim any com pensation in theabovesituation becausetheInsurers
are notheld liable w here there isinherentdefectin the vehicle.M oreover,w hen the
vehicle isnotroadw orthy and in a dangerouscondition the insurerisabsolved from
his liability to indem nify such an insured,w heneverany condition ofthe policy is
breached by theinsured.Theinsurerw illnotm akethelossgood,sim ilarly w herethe
lossisdueto w antoffootbrakes.
4. M r.R anjitSingh had engaged a driver for hiscar,w ho had negligently driven
thevehicleand caused dam ageto a third party.IsM r.R anjitresponsiblein the
abovesituation?
A ns:A s per the com m on Law ,the m aster is liable for the tortious acts of the servant
provided theservantdoessuch actin thecourseofhisem ploym ent.Thecom m on law
also recognizes the vicarious liability ofthe ow nerofthe m otorcar.In the law of
torts,ifaperson negligently driveshisvehicleand causesinjury ordeath to thethird
party,thedriverw hosenegligencecaused thedam ageisliableto thethird party.The
driveristheservantoftheow ner,and sinceheisaperson ofno m eans,theow neris
liableforallhisactsso farthathehasdonesuch actsin thecourseofhisem ploym ent.
In theabovecasebased on theprovisionsofthecom m on law M r.Ranjitisheld liable
forthedam agecaused to thethird party.[PushpabaiSudershin vRanjitG and P Co].
5. ParulA garw alreceived a brand new M arutiZen from herhusband on herbirthday.
The carw asinsured againstdam age orlossw ith W heelsInsurance Com pany foran
am ountofRs5 lakhsw ith adeductibleofRs75,000 from hercoverage.
O ne day,Parul,w ho w asan experienced driver,took the caroutto visitherfriend.
O n the w ay to herfriend s place,she had to stop ata traffic signal.A lthough she
stopped hercarto avoid jum ping the signal,a speeding driverfrom behind ram m ed
into hercar.The im pactofthe collision w assuch thatParulsuffered severe injuries
and she had to be hospitalized.H er car w as reduced to a w reck.Investigations
revealed thatthecarthathitParulscarw asbeing driven by oneM r.RanjitG arg.
Parulfiled a claim forlossw ith herinsurance com pany and received Rs4,25,000 as
dam age claim . The insurance com pany, in turn, sued Ranjit on behalf of its
policyholder,Parulforthe sam e am ountthatithad paid her.Ranjitapproached the
courtchallenging thevalidity oftheinsurancecom pany ssuit.
Q uestionsforD iscussion:
1. W hatisthe principle on the basisofw hich the insurance com pany accepted Paruls
claim and laterfiled asuitagainstRanjit?

II-36
M O D U LE -II:TECH N ICA L A SPECTS O F IN SU RA N CE

2. W hatisa deductible? H ow doesan insured benefitby having a deductible clause in


hisinsurancecoverage?
A ns:1 The insurance com pany paid the claim am ountto Paruland laterfiled a suitfor
claim ing the sam e from Ranjitby follow ing the processofsubrogation.In com m on
parlance, subrogation is the process of legally substituting a person in place of
another.In subrogation,legalproceedings are initiated by the insurance com pany
againsta third party thathas a liability to the policyholder.Subrogation gives the
insurance com pany the rightto collectthe claim am ountfrom a third party after
paying the insured s claim .Itis one ofthe m osteffective procedures ofpost-loss
claim s handling. Subrogation is com m on in claim s that pertain to autom obile
dam age, property insurance, and w orker s com pensation claim s. A lthough the
policyholder sdeductible m ay be included in the claim ,otherlossessuffered by the
policyholdersuch as m edicalexpenses,w hich are notincluded in the coverage are
nottaken into accountduring subrogation.
2. D eductible is the am ountthatan insurer deducts from the am ountof loss before
paying therem aining am ountto thepolicyholder.Forexam ple,ifacertain com pany
hasa Rs50,000 deductible in itsfire insurance policy,the insurerw illonly pay for
claim sthatexceed Rs50,000.Thus,alossofRs1,00,000 caused dueto afireorsom e
otherinsured perilw ould produceapaym entofonly Rs50,000 from theinsurer.
The rule related to a deductible clause is the higherthe deductible,the low eristhe
insuranceprem ium foralossexposure.Thism eansincreasing thedeductibleam ount
in the insurance policies leads to considerable savings in the prem ium .Businesses
too stand to benefitfrom increasing the size of the deductible in their insurance
policies. By doing so, they can achieve a savings in their insurance prem ium s.
H ow ever, in the process, the deductible portion in the insurance m ust not be
increased to such an extentthatitbecom esfinancially difficultforthe individualor
firm to beartherisk assum ed.

II-37
C hapter 5
Engineering insurance

SEC TIO N -A

1. W hich ofthelossesarenotcovered by a BoilerExplosion policy


a. Explosion
b. Fire
c. Collapse
d. D am ageofsurrounding property
e. N oneoftheabove
2. Explosion doesnotm ean
a. Sudden and violenttearing apart
b. Collapsedueto externalpressure
c. Bursting apartdueto high pressure
d. Bursting oftheboilerdueto chem icalreaction
e. N oneoftheabove
3. A boilerexplosion policy specifically coverslossescaused to
a. D am ageofsurrounding property
b. Third party personalliability
c. Third party property dam age
d. Lossesnotcaused by inherentdefects
e. A lloftheabove
4. W arrantiesin a boilerexplosion policy areinserted to ensure
a. Safety oftheboilers
b. Sound m aintenanceoftheequipm ent
c. Certificationsby authorized persons
d. To check fraudulentclaim s
e. A lltheabove
5. A tthe tim e ofloss,ifthe value ofthe pressure plantis greater than the sum
insured,theobligation oftheinsureristo pay forthe

II-38
M O D U LE -II:TECH N ICA L A SPECTS O F IN SU RA N CE

a. Totallosses
b. D eny theclaim
c. Pay rateableshareofloss
d. Pay only halftheloss
e. N oneoftheabove
6. TheBoilerexplosion policy cannotbeissued on
a. A greed valuebasis
b. M arketvaluebasis
c. Book valuebasis
d. Replacem entvaluebasis
e. N oneoftheabove
7. R efund ofprem ium during thestandstillperiod isnotpayablew hen caused by
a. Shortageofraw -m aterials
b. Breakdow n ofplantand m achinery
c. W orkersstrike
d. Lack ofprovision ofstandby equipm ent
e. N oneoftheabove
8. TheM achinery breakdow n policy coversany dam agecaused to m achinery
a. A tw ork
b. A trest
c. W hiledism antling forrepairs
d. Shifting orre-erection
e. A lltheabove
9. M B policiescannotbeissued on the
a. Firstlossbasis
b. W ith abonusclause
c. W ithoutexcessclause
d. Forplantslocated outsideIndia
e. A lltheabove
10. D eductibleFranchise/Excessistheam ountoutofeach claim by the
a. Insured
b. A gent
c. Broker
d. Insurer
e. N oneoftheabove

II-39
M O D U LE -II:TECH N ICA L A SPECTS O F IN SU RA N CE

11. R efund ofprem ium isnotperm issiblein a M achinery breakdow n policy in case
of
a. Lockoutperiod
b. W hileatw ork
c. W hileatrest
d. Standstillperiod dueto shortageoffuel& raw m aterial
e. N oneoftheabove
12. TheM achinery lossofprofitspolicy coverslossofgrossprofitonly dueto
a. Increasein output
b. D ecreasein output
c. D ecreasein costofw orking
d. Lockoutperiod
e. N oneoftheabove
13. Them inim um tim eexclusion period forLO P policiesin caseofpow erplantsis
a. 15 days
b. 14 days
c. 30 days
d. 45 days
e. N oneoftheabove
14. Thebasisoftotallosssettlem entin an EA R policy ispayableon thebasisof
a. A ctualvaluelesssalvage
b. M arketvalueplussalvage
c. Reinstatem entvalue
d. V aluedecided by IRD A
e. N oneoftheabove
15. W hich ofthefollow ing isnotA ctofG od perils
a. Earthquake
b. Flood
c. N egligence
d. Storm /Tem pest
e. N oneoftheabove

SEC TIO N -A A N SW ER S
1. b 2. b 3. e 4. e 5. c 6. a
7. c 8. e 9. e 10.a 11.a 12.b
13.b 14.a 15.c

II-40
M O D U LE -II:TECH N ICA L A SPECTS O F IN SU RA N CE

SEC TIO N -B
1. D efinethescopeand aim of engineering insurance
A ns:Engineering Insuranceschem esaim atprotecting businesshousesfrom eventualities
thatcould give rise to a loss and disrupttheirday-to-day functioning.Such losses
arise due to the failure of m achineries, explosion of boilers and breakdow n of
com puters and sophisticated electronic equipm ent. A m ajor breakdow n due to
m echanicalfailure could also resultin consequentialloss ofprofits.A llthese risks
can becovered undervariousengineering policies.
Engineering Insurance coversare available atthe tim e ofputting up ofa factory or
even during an expansion. These insurance covers are the Storage-cum -erection
policies forindustrialrisks,the Contractors allrisk policy forcivilw orks and the
Contractors plant & m achinery policy,w hich takes of the Contractors Insurance
requirem ents.The A dvance lossofprofitspolicy isa sophisticated insurance cover,
w hich takescareoflossesarising outofdelay in com pletion ofaprojectw ellbeyond
thestipulated period w herethedelay iscaused by an insured peril.
2. D efine the term explosion and explain the scope of coverage in a Boiler
explosion policy
A ns:The term Explosion refersto the sudden and violentrending ortearing apartofthe
perm anentstructureofaboilerorpressureplantorany partorpartsthereofby force
of internal steam gas or fluid pressure causing bodily displacem ent of the said
structureand accom panied by theforcibleejection ofitscontents.
TheBP policy explicitly coversthefollow ing:
1. D am age (other than by fire) to the boilers and/or other pressure plant or
surrounding property described in theschedule.
2. Liability arising dueto death oforbodily injury to any person provided heisnot
em ployed orunderapprenticeship w ith theinsured.
3. Liability arising from dam age to any property w hether the insured is
responsibleforitornot
3. StatethegeneralexceptionsofBoilerExplosion policy.
A ns:Thefollw ing lossesarenotcovered underthepolicy:
dam agesarising directly orindirectly from fire orexplosion orcollapse orany
othercause.
D am ages caused by w ar,hostilities orw arlike operations,naturalcalam ities,
etc.Sim ilarly,dam agesfrom nuclearreaction,nuclearradiation orradioactive
contam ination areexcluded.
Loss resulting from any experim ent requiring overloading or abnorm al
conditions.
D efectsthatare gradually developing and w ould require repairsatsom e future
datearenotcovered underthispolicy.
II-41
M O D U LE -II:TECH N ICA L A SPECTS O F IN SU RA N CE

W earing aw ay orw astage ofm aterials ofany partofthe boilerorfailure of


individualtube(iftherearem ultipletubesin theboiler).
D am agesdueto negligence.
Consequentiallosses
D am agesdueto know n flaw s
4. D iscusstherulesofrating form id-term increaseordecreaseofsum insured.
A ns:Ifthesum insured isincreased during thecurrency ofthepolicy,
(a) Shortperiod scaleofratesshallapply to increased am ounts.
(b) Ifthepolicy isrenew ed thereafterfor12 m onthsforan am ountnotlessthan the
increased sum insured,thedifferenceofprem ium betw een shortperiod scaleof
rateand pro-rataratem ay berefunded.
(c) Ifthe sum insured isdecreased during the currency ofthe policy,shortperiod
scaleofratesshallapply on thereduced sum insured.
5. W hat are the facts to be disclosed in a proposal form of a boiler explosion
policy?
A ns:Them aterialfactsthatneed to bedisclosed in aproposalform includethefollow ing:
Totalsum insured
D etailsofboilerand pressureplants
D etailsofsurrounding property ofthe insured including property held in trust
orcom m ission
Legalliabilitiesto third parties
O n paym entof additionalprem ium ,does the insured w ish to cover express
freight,overtim eand holiday ratesofw ages,ow ner ssurrounding property and
third party liability?Ifyesprovidelim itsofindem nity.
Statehow boilerisfired,e.g.oil,gas,coalorpulverised fuel.
W hatism axim um load on asafety valvepersquareperinch?
W hatisthew orking pressure?
6. D iscussthescopeofcoverageofa M achinery breakdow n insurancepolicy
A ns:Thepolicy coversthedam agecaused to them achinery w hetherthey areatw ork orat
restoreven w hen dism antled forrepairing oroverhauling.Sim ilarly dam agescaused
during shifting them from one place to another or subsequentre-erection are also
covered.
7. W hatisthebasisofindem nity underan M B policy?
A ns:thebasisofindem nity isasfollow s:
In casesw heredam ageto an insured item can berepaired,thecom pany w illpay
expenses necessarily incurred to restore the dam aged m achine to its form er
state ofserviceability plusthe costofdism antling and re-erection incurred for

II-42
M O D U LE -II:TECH N ICA L A SPECTS O F IN SU RA N CE

the purpose ofeffecting the repairs as w ellas ordinary freightto and from a
repair shop, custom s duties if any, to the extent such expenses have been
included in thesum insured.
N o deduction shallbem adefordepreciation in respectofpartsreplaced except
for(i)w earand tearpartsand (ii)partsforw hich m anufacturershavespecified
a fixed life foruse and the like butthe value ofany salvage w illbe taken into
account.
In cases w here an insured item is destroyed,the com pany w illpay the actual
value ofthe item im m ediately before the occurrence ofthe lossincluding costs
forordinary freighterection and custom sdutiesifany,provided such expenses
havebeen included in thesum insured,and such actualvalueisto becalculated
by deducting properdepreciation from thereplacem entvalueoftheitem .
A ny extra chargesincurred forovertim e,night-w ork,w ork on public holidays,
express freightare covered by this insurance only if especially agreed to in
w riting.
Thecostofany provisionalrepairsw illbeborneby thecom pany ifsuch repairs
constitutepartofthefinalrepairsand do notincreasethetotalrepairexpenses.
8. W hatisthem ain aim ofa Lossofprofitsinsurancepolicy?
A ns:U nderthis policy the com pany m akes good the losses arising from unforeseen and
sudden dam ages to any m achinery described in the schedule,during the period of
policy,on thebasisofthefollow ing requirem ents:
The liability ofcom pany forclaim s rem ains w ithin the lim itspecified in the
schedule.
Theaccidentshould happen during period specified in thepolicy and should be
covered by standard m achinery insurance policy or boiler & pressure plant
insurancepolicy.
Theterm sand conditionsofthepolicy havebeen fulfilled.
Thestatem entsand answ ersin theproposalform aretrue.
Thecoverprovided underthispolicy shallbelim ited to lossofgrossprofitdueto
(a) Reduction in outputand
(b) Increase in costofw orking and the am ountpayable as indem nity thereunder
shallbe
(a) In respectofreduction in output
(b) In respectofincreasein costofw orking
Thereduction in fixed chargesifany during theperiod ofbusinessisdisrupted,shall
bededucted from thecom pensation am ount.

II-43
C hapter 6
M iscellaneousInsurance

SEC TIO N A

1. M iscellaneousinsurancepoliciescoverlossesconcerning
a. person
b. property
c. pecuniary risks
d. liabilities
e. alltheabove
2. W orkm en scom pensation policy takescareoftheliability ofthe
a. Em ployer
b. O w ner
c. Tenant
d. M ortgagee
e. N oneoftheabove
3. C rop insurancein India to allloaneefarm ersis
a. com pulsory
b. notobligatory
c. optional
d. voluntary
e. noneoftheabove
4. W hich ofthefollow ing lossesarenotcovered by thepersonalaccidentpolicy
a. naturaldeath
b. disability
c. accidentaldeath
d. suicide
e. noneoftheabove
5. Foritem sofhigh sentim entalvalue,a burglary policy can beissued asa
a. floaterpolicy
b. declaration policy
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M O D U LE -II:TECH N ICA L A SPECTS O F IN SU RA N CE

c. valued policy
d. open policy
e. noneoftheabove
6. W hich ofthefollow ing doesconstitute m oney
a. bank notes
b. coins/currency
c. stam p papers
d. jew elry & ornam ents
e. alltheabove
7. W hich ofthe follow ing lossesare notcovered by the Plate and G lassinsurance
policy?
a. w illfulbreakage
b. superficialdam ages
c. scratches
d. cracked orim perfectglass
e. alltheabove
8. Fidelity G uaranteepolicy coverstheem ployeragainstpecuniary lossescaused by
a. naturalcalam ities
b. servants
c. dishonestem ployees
d. custom ers
e. noneoftheabove
9. TheD & O insurancepolicy isaim ed to protecttheinterestsofthe
a. policyholders
b. shareholders
c. custom ers
d. em ployeesand creditors
e. alloftheabove
10. W hich statem entregarding the liability ofthe insurance com pany for a D & O
policy istrue
(i)Theunderw riterisliablew hen thepolicy isin force
(ii) Theunderw riterisliableeven afterthepolicy iscancelled orlapsed.
a. only (i)
b. only (b)
c. both (a)& (b)

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M O D U LE -II:TECH N ICA L A SPECTS O F IN SU RA N CE

d. neither(a)or(b)
e. noneoftheabove

SEC TIO N -A A N SW ER S
1. e 2. a 3. a 4. a 5. c 6. e
7. e 8. c 9. e 10.c

SEC TIO N -B

1. W hataretheriskscovered underm iscellaneousinsurancepolicies


A ns:Theriskscovered by m iscellaneousinsuranceareclassified into fourm ain categories
concerning
Person
Property
Pecuniary risksand
Liabilities.
2. W hat w as the rationale behind initiating the W orkm en s C om pensation
Insurance?
A ns:TheobjectiveofthisA ctisto takeovertheliability oftheem ployerundertheA ctin
return forpaym entofappropriate prem ium to the insurer.Itprovidescom pensation
for w orkers for death and disability due to accidentarising outof and during the
course of em ploym ent for w hich the em ployer is liable under the W orkm en s
Com pensation A ct,1923.The A ctthusprovidesa com prehensive protection forthe
tim ely paym entofcom pensation to theinjured em ployee.Thecom pensation am ount
isdirectly proportionalto thew agesdraw n by theem ployee.
Iftheaccidenthasbeen caused directly becauseof:
Theinfluenceofintoxicantsconsum ed by thew orker
H isw illfulrem ovalordisregard ofany safety guard orotherdevice m eantfor
hissafety or
H isw illfuldisobedience to any expressorderorrule m eantforhissafety;then
theem ployerisonly liableifitresultsin death and nototherw ise.
3. O utlinethesalientfeaturesand theobjectivesofthecrop insuranceschem e.
A ns:The objective behind the crop insurance policy w as, first to provide insurance
coverageand financialsupportto farm ersin theeventofnaturalcalam ities,and pests
& diseases,and secondly,to encourage the farm ers to adoptprogressive farm ing
practices,high valueinputsand highertechnology in agricultureand to help stabilise
farm incom es,particularly in disasteryears.
TheSalientfeaturesoftheschem eare:
The crops in the follow ing broad groups in respectofw hich (i)the pastyield data
II-46
M O D U LE -II:TECH N ICA L A SPECTS O F IN SU RA N CE

based on Crop Cutting Experim ents (CCEs) is available for adequate num ber of
years,and (ii) requisite num ber of CCEs are conducted for estim ating the yield
during theproposed season:
a. Food crops(Cereals,m illets& pulses)
b. O ilseeds
c. Sugarcane,cotton & potato (annualcom m ercial/annualhorticulturalcrops)
O therannualcom m ercial/horticulturalcropssubjectto availability ofpastyield data
w illbe covered in a period ofthree years.H ow ever,the crops,w hich are covered
nextyear,w illhaveto bespecified beforethecloseofpreceding year.
A ll farm ers including sharecroppers, tenant farm ers grow ing notified crops in
notified areasareeligibleforcoverage.
Theschem ecoversthefollow ing groupsoffarm ers:
a. O n a com pulsory basis: A ll farm ers grow ing notified crops and availing
SeasonalA griculturalO perations (SA O )loans from financialinstitutions,i.e.
loaneefarm ers.
b. O n a voluntary basis:A llnon-loanee farm ers grow ing notified crops w ho opt
fortheschem e.
4. D efinethescopeofA viation insurancepolicy?
A ns:Them ostcom m on coveragesofaviation insuranceare:
A ircraftliability insurance
H ullcoverage
Personalaccident
A ircraftLiability Insurance:
Theliability in caseofaviation insuranceisdivided into tw o categories:
Passengerliability
D eath and injury to third parties
There are som e policies thatcover both these categories as w ellas property
dam age w ith a single lim itto coverallthree ofthem (like floating policies in
fidelity guarantee).The aircraft liability insurance also provides coverage of
m edical paym ents for injuries sustained w hile travelling in or entering or
alighting from the aircraft.This policy coverage is available only ifthe policy
includes passengerbodily injury liability.Som e policies also provide forH ull
coveragew hichincludecoverageofthebodyandm achineryoftheaircraft.Som e
policiesprovideopen perilscoverageboth on ground and in flightw hereasothers
restrictthe open perils coverage to ground only.In-flightpolicies do notcover
crash orcollision.They coverperilsoffire,lightning orexplosion in air.
5. H ow is insuranceofa person policy differentforlifeinsurancepolicy?
A ns:W hile in life insurance a claim can be m ade only on the death ofa person orthe
attainm entofa specific age, insurance ofperson policy providescoveragainstany
personalaccidentorspecified diseases.Secondly,the Life Insurance Corporation of
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M O D U LE -II:TECH N ICA L A SPECTS O F IN SU RA N CE

India provides the form er policy, w hile the latter is provided by the G eneral
InsuranceCorporation ofIndia.Likelifeinsurancetheam ountto beaw arded in case
ofaccidentispre-decided in thepolicy.Personalaccidentinsuranceisnotacontract
ofindem nity.The coverage is linked to the incom e ofthe insured.G enerally,sum
insured isrestricted to 5/6 tim esofannualincom eor50/60 tim esofm onthly incom e
in case ofsalaried em ployees.The schedule ofthe policy specifiesthe am ountto be
paid in case ofdeath ofthe insured,totalorpartialloss ofeyesight,am putation or
irrecoverablelossoflim bsw ithoutphysicalseparation.
Personalinsurance also covers m any insurances like personalaccidentinsurance,
disability insurance,baggage,m edical,individualliability covers forprofessionals
likedoctors,architects,etc.
6. H ow is Burglary defined in a Burglary insurancepolicy?
A ns:Burglary is defined as forcefuland illegalentry into the business prem ises forthe
purposeofstealing. Forcefulentry istheprerequisiteforburglary.Itisnecessary to
differentiate it from theft, robbery or housebreaking. W hile Robbery requires a
forcefulpersonalcontact.Itis an aggravated form ofburglary w here force is used
againstaperson.
7. W hatisthecoveravailableforlossin a burglary policy?
A ns:Burglary insurance is notonly forthe goods ow ned by the person butalso forthe
goodsheisresponsibleforlikethoseheld in histrust.Italso includestherelationship
ofbailm entoragency regarding thegoods.Thepolicy w ith w idercoverexcludesthe
item sthatarespecifically covered underotherpolicies.
Them ain policiesavailableundertheburglary insuranceare:
(i) Burglary businessprem isesinsurancepolicies.
(ii) Burglary privatedw ellingsinsurancepolicies.
(iii) Com bined fireand burglary insurancepolicies.
(iv) A llrisk insurancepolicies.
(v) Baggageinsurancepolicies.
(vi) Jew ellery and valuablesinsurancepolicies.
8. D iscussthescopeofcoveravailableundera Bankers Indem nity Insurance
A ns:A bankers blanketcover provides insurance againstfire perils,burglary,cash in
transit,fidelity guaranteeand m arineinsurance.Thispolicy providescom prehensive
insurancecoverto thebanking sector.
C overage: This policy covers the directlosses ofm oney and/orsecurities discovered
during the period specified in the policy.M ore specifically,itcovers the
follow ing losses:
Prem ises - By fire,riotand strike,burglary orhouse breaking orhold up resulting in
lossto m oney/securitiesattheprem ises.
Transit Lost, stolen, m islaid, m isappropriated or m ade aw ay either due to
II-48
M O D U LE -II:TECH N ICA L A SPECTS O F IN SU RA N CE

negligenceorfraud ofem ployeesoftheinsured w hilstin transit.


Forgery Lossby bogus,fictitiousorforged orraised cheque/drafts/FD Rsorforged
endorsem ents.
D ishonesty Lossofm oney and/oroperationsdueto dishonesty.
H ypothecated goods By fraud and/ordishonesty orcrim inalactoftheinsured em ployees.
Registered postalsending Loss ofparcels by robbery,theftorby othercauses to the
parcelsinsured w ith thepostoffice.
Appraisers Infidelity orcrim inalactsby appraiserson theapproved list.
Janata agents Infidelity orcrim inalactsby Janataagents/ChhotiBachatY ojanaA gents/
Pygm y collectors.
9. Enum eratetheexclusion ofthispolicy
A ns:Thepolicy categorically excludeslossesdueto:
1. D efaultofD irectororpartneroftheinsured otherthan salaried
2. W arand allied risks
3. A ctsofG od
4. Incendiaries
5. D irectorindirectnuclearreactions
6. A ctsofom ission by the concerned em ployee afterdiscovery ofa lossin w hich
thesaid em ployeew asinvolved
7. Lossesofm oney,securitiesorpersonalpropertyoftheinsured,thenom inalvalue
and description ofw hich havenotbeen ascertained by theinsured beforeloss
8. Trading lossesand
9. Lossessustained ordiscovered beyond theperiod specified in thepolicy.
10. D iscussthecoverageand exclusionsofaPlateG lassInsurance
A ns:The policy specifically indem nifies dam ages to glass,lettering or ornam entation
described in the schedule caused by breakage or by accidentalchem icalspills or
acids.The policy also coversrepairerreplacem entofsashesorfram es,boarding up
or protecting w indow s in the event of unavoidable delay in replacem ents, and
rem ovalof fixtures or other obstructions to replace the glass.Policies also cover
breakage of other than regular glass, such as neon signs, half-tone screens,
m em orialw indow s,glassbricks,and fluorescentlights.
H ow ever,thepolicy excludesthefollow ing risks:
Fireorexplosion
Earthquakes
Riots,strikes,w arand kindred risks
11. W hy isFidelity G uaranteeInsurancepolicy becom ing a necessity?
A ns:Fidelity G uarantee Insurance (FG I)isa necessity in today sscenario bexause ofthe
increasing frauds.

II-49
M O D U LE -II:TECH N ICA L A SPECTS O F IN SU RA N CE

12. Enum eratethedifferenttypesofFidelity G uaranteeInsurancepoliciesavailable.


A ns:Thedifferentpoliciesinclude
Individualpolicy w herethebehaviourofonly oneperson isguaranteed.The
individualsnam eisw ritten in thepolicy.
C ollective policy The behaviour of m ore than one individual (usually the
w hole staff)isindem nified in the single policy.The schedule ofsuch a policy
containsthenam esofalltheindividualsw hosebehaviourisguaranteed..
Floating policy or the Floater The problem w ith the collective policy isthe
assignm ent of the am ount of guarantee to each individual.It is difficult to
estim atetheam ountoflossthatan individualcan createaloneorw ith others.
Positions policy This policy is sim ilar to a collective policy (actually an
im provem entoverit).Instead ofthe nam es ofthe individual,the positions are
listed in thepolicy w ith thedutiesand theam ountguaranteed fortheirbehaviour.
Blanketpolicy A sthenam esuggests,thispolicy coverstheentirestaffofan
organisation.N o nam eorposition isshow n in thepolicy.Thepolicy issuitable
fororganisationsw ith largestaff.
Excessfloating policy Thisisa m ix ofthe floating and cum ulative policies.
The individualam ountsare bundled w ith the nam esofeach em ployee butfor
unforeseen and unusually big losses,an additionalfloating am ountis fixed.
Thatisw hy thepolicy isknow n asan excessfloating policy.
13. Enum erate the risk exposures ofthe D irectors and O fficers and the available
insurancepolicy to insuretheserisks.
A ns:D irectorsand O fficersareexposed to potentialrisksthatm ightcom ein theform of:
M isrepresentation ofthefirm sfinancialstatus
Lack ofdiligenceand failureofsupervision
Conflictsofinterest
Im prudentdecisionsand
M ism anagem entoffunds
D & O insurance policy enablesthe directorsto w ork peacefully w ith the know ledge
thatsom ebody else w illtake care ofthe lossesin case the com pany failsto fulfillall
its obligations.Itoffers a broad protection to the insured.Though notm andatory,
m ostofthetop corporationsin thew estpurchaseD & O insurance.

SEC TIO N C
(C A SE STU D IES)
H em antPatel,areal-estatebroker,lived in D elhiw ith hisw ifeand tw o children.H eow ned
a bungalow in K arolBagh w hich w asinsured w ith Elite Insurance Com pany,N ew D elhi,
forRs35 lakhs.
O n D ec 31st1999,H em antw entto the localclub w ith his fam ily to attend a N ew Y ear
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M O D U LE -II:TECH N ICA L A SPECTS O F IN SU RA N CE

party.W hen they returned hom e in the early hoursofthe nextday,they found thattheir
househad been burgled and m any valuableshad been taken.
W hile the police investigation w asgoing on,the insurersenthissurveyorto look into the
cause of the loss,the com pliance of the insured w ith the term s of the policy,and the
am ountoflosssuffered by thepolicyholder.
D uring the course ofinvestigation,the surveyorobserved significantdiscrepanciesin the
statem entsgiven by theinsured.Thesediscrepanciespertained to thelistofitem sreported
to havebeen stolen by theinsured and them ism atch betw een thetruevalueoftheseitem s
and the am ountsupposedly involved in the burglary.W hen the surveyor subm itted his
reportto the insurance com pany,he m entioned thatthe financialcondition ofthe insured
w asnotgood beforetheburglary and hehad increased theinsurancecoverageon hishouse
justafew daysbeforetheburglary took place.
H em ants claim form w as therefore rejected by the insurance com pany on grounds of
fraud.H em antfiled alaw suitagainsttheinsurancecom pany.
Q uestionsforD iscussion:
1. W as H em anteligible to receive the claim am ountforthe reported loss thathe had
suffered?W hy do insurersm akepaym entsforsuspiciousclaim s?
2. W hatare the precautions thata loss adjusterhas to take w hile handling claim s for
losscaused by theft?
A ns:1.H em antfailed to give convincing repliesto the questionsposed by the surveyor.
Even theinform ation hesupplied w asfullofdiscrepancies.Further,heincreased the
valueoftheinsurancecoverageon thehouse,w hich provesthattheinsured sm otive
behind obtaining insurancew aspurely to obtain financialgain ratherthan protection
againstrisk.Therefore,H em antis noteligible to receive the claim am ountforthe
reported loss.
Insurersoften m akepaym entstow ardssuspiciousclaim sforfearofbeing blam ed for
tardinessin claim settlem ent.The fearoflossofgoodw ill,and the need to m aintain
good standing w ith the insurance regulators is also responsible for the insurers
m aking hasty settlem entsofsuspiciousclaim s.
2. A n adjuster should thoroughly review relevantpolicy provisions w hile handling a
claim for loss due to theft.If the policyholder has theftcoverage for the type and
locationofpropertyconcerned,thentheverificationofthelossbecom esaverydifficult
task forthe adjuster.W hile verifying a theftclaim ,both the lossitselfasw ellasthe
am ountoflossdueto thefthasto beverified.Sincelittleorno evidencerem ainsaftera
theft,itis easy fora dishonestinsured to fabricate claim s.Even ifa thefthas truly
occurred,thereisno evidenceto provethattherew asathiefinvolved in theincident,or
to prove the existence ofthe property involved in the theft,oreven to prove the true
value orquantity ofthe property involved.The statem ents ofthe insured aboutthe
nature,quantity and valueoftheproperty thathasbeen allegedly stolen areaccepted as
evidence in courts.The failure ofthe insured to provide receiptsto validate hisclaim
cannotform thebasisfordenialoftheclaim by theadjuster.
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M O D U LE -II:TECH N ICA L A SPECTS O F IN SU RA N CE

C hapter 7
LifeInsuranceProducts

SEC TIO N -A

1. By availing theconversion featureofa lifeinsurancepolicy,onem ay shiftto


a. w holelifepolicy
b. endow m entpolicy
c. long-term assurancepolicy
d. Either(a)or(b)above
e. Either(b)or(c)above.
2. W hatarethefeaturesthathelp in designing theendow m entassuranceplan?
a. Term endow m entand pureinsurance.
b. Term endow m entand pureassurance.
c. Term insuranceand pureendow m ent
d. Term assuranceand endow m entinsurance.
e. Term insuranceand endow m entinsurance.
3. In w hich ofthefollow ing cases,thehighestam ountofprem ium ischarged?
a. Term insurance.
b. Pureendow m ent
c. Endow m entassurance
d. Term endow m ent
e. Pureinsurance.
4. W ho decides the broad patterns of investm ents for the capitalm arket linked
variablelifeinsurancepolicies?
a. Theinsurancecom pany
b. Thepolicyholder.
c. Them arketsituation.
d. Theoveralleconom icscenario.
e. A llthefactorsm entioned above.
5. W hich ofthefollow ing isnota featureofuniversallifeinsurancepolicy?
a. Thecash valueofthepolicy grow satafixed ratew ith respectto tim e.
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M O D U LE -II:TECH N ICA L A SPECTS O F IN SU RA N CE

b. Theinsured can vary hisannualdeath benefitcoverage.


c. Theinsured can vary theam ountofprem ium payable.
d. Theinsured can m akepartialsurrendersofthepolicy.
e. Theinsured can takeloan againstthecash valueofthepolicy.
6. H ow isthepurchasepriceofa deferred annuity plan paid?
a. Through alum psum am ount.
b. Through installm entsoveraperiod oftim e.
c. Eitherthrough alum psum am ountorthrough installm ents.
d. By deferring theduedateofthepaym entoftheprem ium s.
e. N oneoftheabove.
7. In w hich ofthefollow ing annuities,theaccum ulation period isnotapplicable?
a. Im m ediate annuity.
b. D eferred annuity.
c. Singlelifeannuity.
d. Jointlifeannuity.
e. A lloftheabove
8. W hatistherisk m anaged by a lifeannuity?
a. Prem aturedeath.
b. Tem porary disability.
c. Excessivelongevity.
d. Perm anentdisability.
e. Criticaldiseases.
9. W hat is the characteristic feature of the accum ulation period of the annuity
contract?
a. Theannuity am ountisgradually paid back to theannuitant.
b. Theannuitantm ay w ithdraw him self/herselffrom theschem e.
c. Theinvestm entm adeby theannuitantgradually grow s.
d. Theannuitantm ay takeloan from thepurchasepriceoftheannuity.
e. Theinsurerisliableto refund thepolicy m oney to theannuitant.
10. H ow doestheLifeInsuranceC orporation ofIndia refund theprem ium s(single
orinstallm ents)ofa deferred annuity asperthepresentcondition?
a. W ithoutany interestiftheannuitantdiesw ithin 3 years.
b. Interestattherateofthesm allsavings,iftheannuitantdiespriorto thedeferred
date.
c. Y early com pounding ata rate of3% ,provided the annuitantdiesafter3 years
from thedateofcom m encem entbutpriorto thedateofm aturity.
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M O D U LE -II:TECH N ICA L A SPECTS O F IN SU RA N CE

d. Either(a)or(c).
e. Either(b)or(c)aschosen by theannuitant.
11. H ow isthepurchasepriceforan im m ediateannuity paid?
a. By installm entsoveraperiod oftim e.
b. By alum psum am ount
c. Eitherthrough installm entorby alum psum am ountaschosen by theannuitant.
d. From thesalary oftheannuitant.
e. N oneoftheabove
12. W hy isthew ord profitredundantin lifeinsurancebusinessused?
a. Theinsurancecom paniescannotearn any profit.
b. Theinsurancecom paniesarenotcarrying outthebusinessthey arew orking for
thecharitableinterestoftheirpolicyholders.
c. Theinsurancecom panies com m itm entsarecontingentliabilitiesonly.
d. Theinsurancecom paniescannotm eetalltheliabilitiesatatim e.
e. Theinsurancecom panieshonourtheunlim ited volum eofliabilities.
13. W hich ofthefollow ing isan investm entplan ofLIC ?
a. Bim aPlus
b. Jeevan A sha
c. A shaD eep
d. Jeevan dhara
e. N oneoftheabove
14. W hich ofthefollow ing isnota children splan?
a. Jeevan Balya
b. Jeevan K ishore
c. Jeevan Sukanya
d. Jeevan A kshya
e. N oneoftheabove
15. TheW holelifeplansin India,
a. Pay death benefitsafterapersonsexpiry
b. Pay death benefitsafterretirem ent
c. Pay policy benefitsaftertheperson attainsacertain age,say 80-85 years.
d. N oneoftheabove
16. Term assuranceprovidesthefollow ing benefits
a. D eath benefitsiftheperson dies
b. D eath and survivalbenefits
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M O D U LE -II:TECH N ICA L A SPECTS O F IN SU RA N CE

c. Periodicpaym entsatpredictableintervals
d. D eath benefitsw ith bonus.
17. Endow m entplans
a. A lw aysparticipatein profits
b. A renoteligibleforloans
c. A rem ostpopularin India
d. N on oftheabove
18.W hich ofthefollow ing isa children spolicy?
a. Jeevan Sneha
b. Jeevan V ishw as
c. Jeevan D hara
d. Jeevan Sukanya
19.V aristha Pension Y ojana
a. Isan LIC plan
b. Providesan effectiveyield of9% p.a.
c. Surrendervaluecan bepaid on m eritsiftheperson iscritically ill
d. A lloftheabove
20.W hich ofthefollow ing isa health insuranceschem e?
a. N ew Jeevan D hara
b. Jeevan A adhar
c. Jeevan Chayya
d. A shaD eep

SEC TIO N A A N SW ER S
1. (d)A policyholdercan availthe conversion feature in a policy and m ay shiftto a
w hole life policy oran endow m entpolicy asperthe requirem ent.There isno such
policy called long-term assurancepolicy.
2. (c) Term insurance and pure endow m ent are the tw o building blocks of the life
insurance products. Every product incorporates these tw o features in varying
proportionsto suitthespecificrequirem entsofaparticularclassofcustom ers.
3. (c)The endow m entassurance policiesconsiderthe tw o com ponents risk coverage
and m aturity benefits in the sam e policy.In orderto take both the features,the
insurerneedsto chargem oretow ardsthecoverageofboth.
4. (b)Thecapitalm arketlinked variablelifeinsurancepoliciescontain tw o com ponents
risk prem ium and investm ent prem ium . Since the hard earned m oney of the
policyholderis invested in various types offinancialinstrum ents,the choice ofthe
policyholder,depending upon his/herreturn requirem ents and risk taking abilities,
II-55
M O D U LE -II:TECH N ICA L A SPECTS O F IN SU RA N CE

should begiven dueim portance.


5. (a)In case ofuniversallife insurance policy,the cash value grow sata variable rate
depending upon thedevelopm entsin them arket.
6. (c)The annuitantofa deferred annuity plan m ay pay the purchase price eitherby a
lum psum am ountorthrough installm entsasconvenientto him .H ow ever,lum psum
paym entw illallow the annuitantto getsom e discountfollow ing the tim e value of
m oney.
7. (a)Since the annuity paym entsstartsim m ediately afterthe paym entofthe purchase
price,theaccum ulation period isnotapplicable.
8. (c) In case of life annuity, one receives m oney at regular periodical intervals
throughoutlife.D uring theold age,onecannotcontinueactivew ork life.A llsources
ofearningsm ay dry up and the levelofsavingsm ay gradually deplete.M oney m ay
notbeavailableto m eeteven thebasicphysiologicalneeds.A contractoflifeannuity
assuresthem uch needed regularcash flow during thesedays.
9. (c)In a deferred annuity contract,the annuitantpaysthe purchase price earlierthan
thecom m encem entofthepolicy.Then he/sheisrequired to w aitforadefiniteperiod
as chosen by him /her to startthe paym ents.This w aiting period is know n as the
accum ulation period during w hich the proceedsare invested to grow w ith respectto
tim e.
10. (d) The given choice is the correct one as per the procedures practised by Life
InsuranceCorporation ofIndia.
11. (b)Thepurchasepriceofan im m ediateannuity ispaid in lum psum .
12. (c)A tthetim eofcom m encem entofapolicy,theinsurerundertakestheobligation to
m eetthe liability assoon asthe claim arises.A sa going concern,there isno end for
such expected claim s.Therefore,an actuary isrequired to certify thepresentvalueof
the expected am ountofoutflow asclaim sto estim ate the valuation surplusand not
thebusinessprofit.
13.a 14.d 15.c 16.a 17.c
18.d 19.d 20.d

SEC TIO N -B

1. D escribebriefly thenatureofw holelifeplans.M ention som eoftheplansw hich


areavailablein them arket.
A ns.W holelifeinsuranceisacash valuepolicy thatprovideslifetim eprotection.
TH E N A TU RE O F W H O LE LIFE IN SU RA N CE:
It provides for the paym ent of the face am ount upon the insured s death
regardlessofw hen death occurs
The face am ounts payable under w hole life policies typically rem ain atthe
sam elevelthroughoutthepolicy duration,although dividendsareoften used to

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M O D U LE -II:TECH N ICA L A SPECTS O F IN SU RA N CE

increasethetotalam ountpaid on death


In m ostpoliciesthe grossprem ium also rem ainsatthe sam e levelthroughout
theprem ium paym entperiod w ith som eexceptions.
U niversal life policies can function as w hole life insurance if they have
sufficientcash value
W H O LE LIFE C A SH V A LU ES:
A llw holelifepoliciesinvolvesom epre-funding offuturem ortality costs
Cash valuesare available to the policy ow neratany tim e by surrendering the
policy
Facility ofobtaining a loan w ith rate ofinterestupto thatofthe policy s cash
value
Loan isdeducted from thegrosscash valuew hen death claim ispayable
W hole life policies m ay be participating ornon participating w ith som e non
guaranteed elem ent.
Som eoftheLIC w holelifeplansare
w ith profitplan [plan2]
lim ited paym entw holelifew ith profits[plan 5]
singleprem ium w holelifeplan [plan 8]
convertiblew holelifepolicy plan [plan 27]
Som eoftheA llianzBajajw holelifeplansare
lifetim ecare econom y plan
cash carehealth plan
lifetim ecaretotalplan
Som eoftheTA TA A IG plansare
TA TA m ahalifeplans
2. D escribe briefly the nature of endow m ent plans.M ention som e of the plans
w hich areavailablein them arket.
A ns:U nlike term policies,endow m entpolicies prom ise notonly to pay the policy face
am ounton the death ofthe insured during a fixed term ofyears,butalso to pay the
full-faceam ountattheend oftheterm iftheinsured survivestheterm .
M oney back policies,Children s policies,W om en s policies - allare having the
elem entsofendow m entplans.
Som eoftheLIC Endow m entplansare
w ithoutprofits[plan 11]
w ith profitsplan [plan 14]
lim ited paym entendow m entw ith profits[plan 48]
Jeevan Surabhiand Jeevan Sanchay plans[m oney back plans]

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M O D U LE -II:TECH N ICA L A SPECTS O F IN SU RA N CE

Som eoftheICICIPrudentialplansare
ICICIPru saven product
ICICIPru A ssureInvest
H D FC Standard endow m entplansare
Endow m entA ssurancePlan
TA TA A IG endow m entplansare
A ssureSecurity and grow th plan
A llianzaBazazendow m entplansare
SaveCareeconom y plan
3. D escribe briefly the nature ofterm plans.M ention som e ofthe plansw hich are
availablein them arket.
A ns:Term insurancehasseveralbasiccharacteristics.
Protection foralim ited num berofyears.[tem porary protection]
U nlessthepolicy isrenew ed,theprotection expiresattheend oftheperiod.
Thesepolicieshaveno cash valueorsaving elem ent.
N othing ispaid in caseofsurvival.
Issued forone yearto a setnum berofyearssuch as10 or20 orto a stipulated
age65 or70.
Initialprem ium sarelow .
Prem ium sforterm coverage can escalate rapidly asthe duration ofthe policy
lengthens.
Thesepricesarem oreeasily com pared than arepricesofotherproducts.
H ence this m arketis m ore price com petitive than the m arketfor cash value
policies.
These policieshave no cash values,no dividends-so easy to com pare on the
basisofprem ium s.
Term lapse ratesare higherthan otherpolicies[because ofsensitivity in price
and low profitm argin.]
M ostterm insurance policies are renew able,for additionalperiods w ithout
evidence of insurability w ith increased prem ium at each renew al based on
insured sattained age.
M ostterm insurance policies are convertible fora cash value policy w ithout
evidence ofinsurability.Thisconversion m ay be perm itted on an attained age
ororiginalagebasis.
Traditionalterm prem ium soften arebased on aggregatem ortality experience.
R eentry term prem ium sarebased on aselect\ultim atem ortality split.
H encethescaleofprem ium ratesvariesnotonly by agebutalso by theduration
sincetheinsured lastdem onstrated insurability.
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M O D U LE -II:TECH N ICA L A SPECTS O F IN SU RA N CE

Term insurance is appropriate w hen incom e is lim ited,orthere are tem porary high
insuranceneeds.Itcannotbeused forretirem entorsaving purposesbecauseithasno
cash values.
Som eoftheLIC Term Plansare
Bim aSandesh plan 94
Convertibleplan plan 58
Som eoftheICICIPrudentialplansare
LifeG uard [term levelassurance singleprem ium ]
LifeG uard [term levelassurance instalm entprem ium plan]
LifeG uard Term A ssurancew ith Return ofPrem ium
Som eoftheH D FC Standard plansare
Loan coverterm assurance
Term assuranceplan
Som eoftheA llianzBazazTerm Plansare
Risk care
Term careplan
4. W hatarethefeaturesand benefitsofinvestm entplans?
A ns:Basically itw asa type ofw hole life insurance w hose valuesm ay vary directly w ith
the perform ance ofa setofearm arked investm ents.N ow m any m arketsare offering
these U LIPsin children plans[ICICISm artK id policy]endow m entand retirem ent
plans [LIC S Forty Plus policy]also.These plans give an option to the investorto
choose betw een three fund options debt,equity,and balanced.In these products,
prem ium scan be paid quarterly,halfyearly oryearly.O utofthe prem ium am ounts,
deductionsw illbem adetow ards
Initialadm inistrative charges
Investm ent m anagem ent charges [ there w ill be an extra charge if the
policyholderutilizes the sw itch over(from equity to debtordebtto balance)
option]
A nnualadm inistration charges
Risk cover
and thebalancew illbeinvested in aselected fund [debtorequity orbalance].
Insurance Com panies charge anyw here betw een 20 -35 percentas upfrontcharges
fortheirunit-linked plans.So,every tim eyou m akeyourprem ium paym ent,only
a partofitisactually invested in thefund ofyourchoice.
In case ofdeath during the prem ium paying term orthe term ofthe policy,the sum
assured [Rs.1 Lakh in exam ple]orvalue ofpolicy fund,w hicheverishigher,ispaid
to the beneficiaries.In case ofsurvivalup to m aturity,the value ofthe fund ispaid
out.The returns on thatday [m aturity or death]on the plan depend upon the
perform ance ofthe m arket,be itequity or debt.So ifthe fund value fallsbelow
II-59
M O D U LE -II:TECH N ICA L A SPECTS O F IN SU RA N CE

am ountinvested on thatday,the policyholderw illreceive a lesseram ount.H ence


one can see thatthe risk here is transferred to the policyholder as nothing is
guaranteed.
U nit-linked plans are essentially sim ilar to m utual fund products w herein the
prem ium isinvested in variousfundsin keeping w ith policyholders risk appetite.
H ow ever,thedifferencein am utualfund investm entisthatthem oney isvirtually at
callby the custom er.In case ofunit-linked insurance plans,itis im possible to
predict w hether the m arket w ill be in an upsw ing on the day of the
policyholder sdeath or on m aturity.The N etA ssetV alue [N A V ]w illreflectthe
underlying value of assets,w hich in turn is dependent on the m ovem ent of the
Sensex.
Benefits:
A U nit linked plan providing an opportunity for the discerning investor to
benefitfrom thereturnsavailablein theCapitalM arketw ithoutgoing fordirect
investm entin thecapitalm arket
U nlike traditionalproducts w here investm entdetails and various charges are
keptunderw raps,U LIPsprojectalltheseinform ation upfront.

SEC TIO N C
(C A SE STU D IES)
1. Term ,w hole life,endow m ent,annuity policies or the com bination of policies are
available in the m arket.The bestpolicy is the one thatbestm eets your financial
needs.Y ou haveto selectthepolicy according to yourneeds.
Suggestsuitablepoliciesforthegiven situations:
1. Y ou are in the age of 25.Y ou justjoined an organization.Y ou are recently
m arried.N ow you cannotspend m oreon lifeinsurance.
2. Y ou arein 50s;both ofyourchildren arein them iddleoftheireducation.
3. Y ou aretheonly earning m em berin yourfam ily.Y ou purchased aflatby taking
loan from housing finance.A slong asyou arethereyou can pay EM Is regularly.
Y ou w antto retain thehouseforyourfam ily m em berseven in yourabsence.
4. Y ou are in the beginning ofcareer;you w antto com bine both insurance and
saving.Butthe com bination ofthissaving and insurance iscostly.Rightnow
you cannotinvestm uch,having dependentsand you w antto investlaterafter
settling in thecareer.
5. Y ou w antto getlifetim eprotection.
6. Y ou believethatyou cannotsavem oney w ithoutbeing forced to do so.
7. Y ou w antto leave an estate to yourfam ily afteryou.Butyou cannotpay the
prem ium safterretirem ent.Y ou areundisciplined in yoursaving habitsand you
arenotfinancially savvy.

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M O D U LE -II:TECH N ICA L A SPECTS O F IN SU RA N CE

8. Y ou w antto setup asaving stream ,beyond term plans


9. Y ou w antto plan forretirem entatan early age.
10. Y ou w antto investyourV RS fundsforretirem entneeds
A ns:
1 & 2 Forthesesituationsthesuggested bestpolicy isTerm InsurancePolicy.Theseplans
offer life insurance cover for specific num ber of years,atleastcost.Since entire
prem ium goestow ardsthe costofinsurance,there isonly risk coverand no saving
elem entisinvolved.
3. The bestpolicy forthis situation is M ortgage Redem ption Insurance policy.These
plans offer life insurance cover for specific num ber of years like tillthe loan is
cleared [oron death,outstanding loan iscovered]attheleastcost.
4. The bestpolicy for this situation is Convertible term insurance policy.This plan
offerslife insurance coverforspecific num berofyears,and atthe sam e tim e italso
facilitates to convert this policy into endow m ent policy [w hen your incom e
increases]w hich includessaving elem ent.
5 & 6 The bestpolicy forthese situations is w hole life insurance policy.Itprovides the
paym ent of the face am ount upon the insured s death regardless of w hen death
occurs.
7. The bestpolicy forthissituation isLim ited Paym entw hole life insurance policy.In
this plan the policy rem ains in fullforce for the w hole of life,butprem ium s are
payable fora lim ited num berofyearsonly,afterw hich the policy becom espaid up
for its full face am ount.The prem ium -paying period m ay be expressed as a set
num berofyearsorto aspecified age.
8. The bestplan for this situation is Endow m entplans or m oney-back plans.These
policiesprom isenotonly thepolicy faceam ounton thedeath oftheinsured during a
fixed term ofyears,butalso thefullfaceam ountattheend oftheterm iftheinsured
survivestheterm .
9. Considerdeferred annuity plans.
10. Thebestpolicy isim m ediateannuity plan orsingleprem ium annuity plan

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M O D U LE -II:TECH N ICA L A SPECTS O F IN SU RA N CE

C hapter 8
LifeInsurancePricing
Fundam entals

SEC TIO N -A

1. O n w hich basistheprem ium isdecided in a lifeinsurancecoverage?


a. Educationalqualification oftheinsured.
b. Socialstatusoftheinsured.
c. Risk Profileoftheinsured
d. Earning potentialoftheperson
e. Spending habitoftheinsured
2. O n w hatdoestheaccuracy ofthestatisticsofm ortality depend?
a. Sourcefrom w hich thedatahasbeen collected.
b. A nalyticalability oftheuserforthecalculation ofm ortality.
c. A vailability ofgovernm entapprovalin thatcontext.
d. A lloftheabove.
e. N oneoftheabove.
3. Law oflargenum bersplaysan im portantroleforthe
a. estim ation ofthepastm ortality rate
b. determ ination ofthefuturetrendsofm ortality
c. calculation ofthepresentm ortality rate
d. assessm entoftheaccuracy ofm ortality estim ation
e. evaluation ofthenecessary am ountofdeath risk coverage
4. H ow can them ortality statisticsbeobtained?
a. Censusfigures
b. From theofficeoftheD eath and Birth Registrar
c. Recordsofalifeinsurancecom pany
d. Both (a)and (c)above
e. A llof(a),(b)and (c)above

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M O D U LE -II:TECH N ICA L A SPECTS O F IN SU RA N CE

5. Them ortality investigationsarecarried outin orderto


a. assessthechangesin m ortality experienced by any population
b. estim atetheextentby w hich therateofm ortality haschanged
c. analyzethereasonsforchangesin m ortality table
d. review theapplicability oftheexisting m ortality tables
e. A lloftheabove
6. W hatis the insured required to pay in order to getterm insurance benefits in
caseofthelevelprem ium concept?
a. Increasing am ountastheageincreases.
b. D ecreasing am ountastheageincreases.
c. Equalam ountdespitetheincreasein age.
d. A ny am ountasagreed by theinsurerand theinsured
e. U npredictable
7. Theam ountofnetprem ium in a lifeinsurancepolicy isequalto
a. grossprem ium m inustherebateseligiblefortheinsured
b. pureprem ium plustheadditionalloading fortheinsured
c. naturalprem ium plustheinterestto bepaid by thepolicyholder
d. naturalprem ium m inustheinterestexpected to beearned from investm ents
e. naturalprem ium plusadditionalloading dueto extrarisk.
8. W hich ofthefollow ing areprem ium related expenses?
a. Com m ission payableto theagent.
b. A dm inistrativeexpensesforrecruiting and training theagents.
c. Expensesforthepublicity and prom otion oftheproducts
d. Both (a)and (b)above.
e. A llof(a),(b)and (c)above
9. W hich ofthefollow ing istrueaboutthefirstyearexpensesofan insurer?
a. Theexpensesincurred in thefirstyeararesignificantly high.
b. Theexpensesincurred in thesubsequentyearsisless.
c. A n insurercannotspend beyond acertain lim it
d. Both (a)and (b)above
e. A llof(a),(b)and (c)above
10. D ueto w hich ofthefollow ing adversepossibility som em argin ischarged by the
insureralong w ith officeprem ium ?
a. Behaviouroftheinsured in future
b. D evelopm entsin thefinancialm arkets.
c. M ortality experienceam ong theinsureds.
d. Insuranceregulations.
e. N oneoftheabove.
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M O D U LE -II:TECH N ICA L A SPECTS O F IN SU RA N CE

11. W hatshould theinsurerdo fortheadequacy and consistency oftheprem ium s?


a. Review itsfinancialposition periodically by com paring theactualposition w ith
thatoftheactualone.
b. A ssessthecom patibility oftheratesofprem ium sforvariousbenefitsoffered.
c. Exam ine that the prem ium s for the policies of sim ilar duration are
approxim ately sim ilar.
d. Both (a)and (b)above.
e. A llof(a),(b)and (c)above
12. Through w hich channelcan an insurergeneratesurpluses?
a. Savingsfrom alow erm ortality.
b. Excessinterestearnings.
c. Savingsfrom alow erlevelofcontingency.
d. Both (a)and (b)above
e. A llof(a),(b)and (c)above.
13. The reason behind the differentlevels ofm ortality am ong the insured lives is
dueto
a. betterlevelofcareundertaken by theinsurersfortheinsured lives
b. thecarefulselection processundertaken by them
c. death oftheinsured livesfollow som especialrulesofm ortality
d. higherstrength oftheinsured livesto fightagainstdeath
e. N oneoftheabove
14. W hatdo them ortality tablesdevelop?
a. N aturalprem ium .
b. Levelprem ium .
c. Single prem ium .
d. A nnuallevelprem ium .
e. U niform levelprem ium
15. W hatistheam ountofprem ium payableby a norm alinsured?
a. N etprem ium and officeprem ium
b. Pureprem ium and officeprem ium
c. N aturalprem ium and officeprem ium
d. Risk prem ium and officeprem ium
e. M ortality prem ium and officeprem ium
16. W hatdoesofficeprem ium consistof?
a. Prem ium related expenses
b. Policy related expenses
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M O D U LE -II:TECH N ICA L A SPECTS O F IN SU RA N CE

c. Risk related expenses


d. Both (a)and (b)above
e. Both (b)and (c)above
17. M ortality tableisused forpricing
a. Individuallifeinsurancepolicies.
b. M otorinsurancepolicies.
c. H ealth insurancepolicies.
d. G roup insurancepolicies.
18. Pricing in thecontextofthischapterm eans
a. Profitsofan insurancecom pany.
b. Surplusdeterm ined aspervaluation.
c. Costofservicing claim .
d. Them ethod used to determ inegeneralratelevels.
19. Fair pricing in insurancem eans
a. Pricing thatbringshandsom eprofitsto theinsurer.
b. Pricing thatiseconom icalfrom thepointofview ofthecustom er.
c. Pricing thatisacceptableto theregulator.
d. Pricepaid isadequateto therisk.
20. Singleprem ium policiesarenotw ithin thereach ofevery person because
a. Itrequiresalum psum paym entupfront.
b. Itrequirespaym entofprem ium frequently.
c. Itisnoteconom icalfrom thepointofview ofthepolicyholder.
d. Insurersoffersingleprem ium policiesonly to selected custom ers.
21. Levelprem ium underlifeinsurancem eans:
a. Theam ountofprem ium rem ainsthesam ethroughouttheterm ofthepolicy.
b. Theam ountofprem ium variesw ith thelevelofrisk.
c. Itm eanscharging prem ium com m ensuratew ith therisk.
d. N oneoftheabove.

SEC TIO N A A N SW ER S
1. (c )In any insurance business,a large volum e ofresources is pooled form a large
num berofpersonsforthe benefitofthe unfortunate few .The prem ium sare decided
on thebasisoftherisk profileoftheinsured.
2. (a) The levelof accuracy of the m ortality statistics depends on the source of the
required data.The source m ay be prim ary orsecondary.O theroptionsdo nothave
any rolein determ ining theaccuracy ofthecollected data.
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M O D U LE -II:TECH N ICA L A SPECTS O F IN SU RA N CE

3. (d) A ccording to the law of large num bers,as the num ber of trials increases,the
variation ofthe resultsdecreases.Proceeding on the sam e line,ifan infinite num ber
oftrialsarem ade,theactualand expected resultsw illcoincide.
4. (e)A llthethreegiven optionscan givethem ortality rateexperienced by agroup of
people in a country and any of these three m ay be used to prepare the m ortality
statistics.
5. (e)M ortality investigations are carried outby the life insurance com panies forthe
reasons m entioned in the given options. W ith the im provem ent in m edical
technology,alow errateofm ortality isbeing experienced.
6. (c )The risk ofdeath ofthe insured increasesalong w ith hisage.A sa resultofthat,
the am ount of risk prem ium should be higher for a higher age. But this is not
convenientforthe needsofthe insured.A sa result,the conceptoflevelprem ium is
follow ed to enable the insured to pay an equalam ountofprem ium throughoutthe
term .Initialprem ium sexceed the costsofrisk thatultim ately subsidize them during
thelateryears.
7. (d)Theam ountofnetprem ium isrequired to coverjusttherisk ofoccurrenceofthe
insurable event.Life insurance is a long-term contractand prem ium s are collected
from a large num berofinsureds.Thislarge poolofresourcesisinvested in safe and
secured financialinstrum entsforitsappreciation.Benefitsoftheseappreciationsare
passed on to the policyholders up to the extentofinterestexpected to be earned in
future.
8. (e)A llthegiven threeexpensesareconsidered asprem ium related expensesasthese
vary w ith theam ountofprem ium .
9. (e) First year expenses are the expenses incurred by an insurer for procuring a
proposal,assessing therisk,decision m aking aboutunderw riting,insuranceofpolicy
docum ent,etc.M ostoftheseexpensesareonetim eexpensesand so aresignificantly
high com pared to subsequentyears.Butunderthe Insurance A ct,1938,an insurer
should notspend m orethan 90% ofprem ium earningsasfirstyearexpensesand 15%
oftherenew alprem ium .
10. (c ) Life Insurance prem ium s are decided on the basis of the rate of m ortality
experienced by agroup ofindividuals.Butvariouseventslike,occurrenceofnatural
calam itiese.g.flood,earth quake,and breaking outofepidem ic,etc.m ay lead to a
higherlevelofm ortality.Itm ay ultim ately resultin asubstantially higheram ountof
outflow from theexchequeroftheinsurer.H ence,am argin isrequired.
11. (e)H ere,allthegiven stepsareexpected to befollow ed by an insurerto keep asound
financialhealth.If the expenses (claim s settlem entas w ellas operational) of the
insurerarem orethan theearnings,theprem ium am ountsarerequired to berevised to
achieve consistency.The prem ium rates should be com patible w ith the level of
benefits.Policies ofsim ilarduration are expected to serve equitable risk profile,to
earn equalinterestand costthesam eam ountofadm inistrativecharges.
12. (e) Savings from a low er level of m ortality w ill finally lead to low er expenses
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M O D U LE -II:TECH N ICA L A SPECTS O F IN SU RA N CE

tow ards claim s settlem ents and thus increases the volum e of life funds. Excess
interestearningsw illenableabetterlevelofsurpluses.Savingsfrom alow erlevelof
contingencieshelp theinsurerto facelow ervolum eofclaim sin em ergency situation
than thatw asexpected.
13. (b)D ifferentlevelsofm ortality experienced by theinsured livesism ainly dueto the
factthatthe livesto be insured are selected w ith utm ostcare againstthe inclusion of
any extra risk ofm ortality than thatofthe norm alone.Therefore,the inferiorlives
areleftbehind w hilethenorm allivesareconsidered.
14. (a) From the m ortality tables,one m ay easily find outthe probability of death or
survivalofan individualofacertain age.N aturalprem ium isobtained by m ultiplying
theam ountoffinancialbenefitsw ith thatoftheprobability asestim ated above.
15. (a)N etprem ium considersthe conceptofrisk prem ium and the expected am ountof
interest to be earned by investing the proceeds of the prem ium s. W hile office
prem ium considers the operationalexpenses required to be m ade by the insurerto
servethepolicyholdersand contingentsituations,sum ofthesetw o ischarged by the
insurerfrom anorm alinsured asinsuranceprem ium .
16. (d)O ffice prem ium consistsofprem ium related expenseslike,com m ission payable
to the agentand policy related expenses like stam p duty to be paid by the insurer,
adm inistrative expenses,etc.Butthe risk related expensesare considered aspartof
thenaturalprem ium .
17.a 18.d 19.d 20.a 21.a

SEC TIO N -B

1. Briefly describetheratem aking function.


A ns.Ratem aking refersto thepricing ofinsurance.Thedifferencebetw een thepricing of
the otherproductsand insurance isthatin pricing ofthe otherproductsthe com pany
know s in advance the cost of production to establish a price.But the insurance
com pany doesnotknow in advancew hatitsactualcostsaregoing to be.A n actuary
w ho determ inesthe ratesin insurance isa skilled m athem atician w ho involvesin all
phasesofinsurance com pany operations,planning,pricing and research.A n actuary
calculates prem ium s thatw illm ake the business profitable,enable itto com pete
effectively w ith otherinsurers,and allow itto pay claim sand expensesasthey occur.
A lso actuarieshelp resolvem anagem entproblem sin underw riting,sales,claim sand
productdevelopm ent.
2. Explain w hy the rates of insurance are fair [equitable], adequate, and not
excessive.
A ns:Basically thesethreearethepricing objectivesofan insurer.
1. R ate adequacy: To avoid financial problem s and insolvency, insurance
com pany rates m ustbe adequate in the lightof benefits prom ised under the
com pany sinsurance products.Rate adequacy m eansthat,fora given block of
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M O D U LE -II:TECH N ICA L A SPECTS O F IN SU RA N CE

policies,totalpaym entscollected now and in the future by the insurerplusthe


investm entearningsattributableto any netretained fundsaresufficientto fund
thecurrentand futurebenefitsprom ised pluscoverrelated expenses.
2. R ate equity: Equity m eans charging prem ium s com m ensurate w ith the
expected losses and othercosts thatinsureds bring to the insurance pool.The
pursuit of equity is one of the goals of underw riting [classification and
selection ofinsureds].
3. R atesnotexcessive:Rates should notbe excessive in relation to the benefits
provided.By establishing a ceiling on the rates,this objective is achieved.
Com petition discouragesexcessivepricing.
3. Explain various elem ents that influence effective pricing of life insurance
products.
A ns:Pricing elem entsofany insurerare
1. The probability of the insured event occurring: Itis show n by m ortality
tablesin life insurance and m orbidity tables in health insurance.The partof
risk prem ium can be calculated by m ultiplying sum assured w ith relevant
inform ation in thesetables.
2. The tim e value ofm oney:The tim e value ofm oney through rate ofinterestis
the second factortaken into accountforcalculation ofprem ium .By deducting
interestcom ponentfrom risk prem ium ,netprem ium can becalculated.
3. Loading to cover expenses,taxes,profits,and contingencies:By adding all
theseofficeexpensesto netprem ium ,tabularprem ium can becalculated.
4. The benefits prom ised:The fourth factoris the benefits prom ised underthe
contract. A loading in this respect is also included to arrive at the actual
prem ium payable.Tabularprem ium + benefitsprom ised = officeprem ium .
A favourable experience by the insurer,in respectofthe above factors,leadsto the
generation of surplus. The surplus so generated is shared am ong the eligible
policyholdersand theow ners.
A n unfavourableexperienceleadsto creation ofdeficit,w hich hasto betaken careof
by them anagem ent/ow ners.
4. W hatare the variousprem ium paym entplans? Explain w hy there are various
prem ium paym entplansin them arketforlifeinsurancepolicies.
A ns:
1. Y early renew able term life insurance:This plan provides coverage forone
yearonly butguarantees renew alirrespective ofthe insurability ofthe policy
ow ner.Prem ium depends on the rate ofm ortality.A s age increases,prem ium
rate increases. Therefore, there is a possibility that those in good health
discontinuethepoliciesbecauseofburdensom eprem ium .
2. Single prem ium plan: In this system ,prem ium w illnotincrease year after
year.O nly onesinglelum psum iscollected attheinception to coverrisk forthe
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M O D U LE -II:TECH N ICA L A SPECTS O F IN SU RA N CE

selected period ofinsurance.Thepresentvalueoftotaldeath claim santicipated


to be paid by the insureroverthe period ofinsurance iscalculated ata chosen
rateofinterest.To arriveatthesingleprem ium payableby each policyholderis
arrived atby dividing thetotalvalueby thenum berofpersonstaking insurance
atinception.The totalfund created by collection ofsingle prem ium s w illbe
utilized to pay claim syearafteryear.
3. Levelprem ium plan:In thissystem ,prem ium payable throughoutthe period
ofinsurance is leveloruniform .In this system ,reserve builds up undereach
policy because the prem ium charged in the initialyears ofthe policy is m ore
than w hatisrequired to coverthe death risk.The difference betw een the face
value ofa policy and the reserve underthe policy iscalled the netam ountat
risk .
4. Flexible prem ium plan:Flexibility ofdeciding the am ountofprem ium to be
paid isallow ed by m any insurersto policy ow ners.Ex.U niversallife policies.
O ut of the am ount paid, m ortality charges and expenses are deducted and
balanceaccum ulatesand theinsurergivesinterestcreditto theinsured.
5. Explain theprocedureofcalculation oflifeinsuranceprem ium sorratem aking
in lifeinsurance
A ns.Though m ost policies in life Insurance are purchased w ith annual,sem i annual,
quarterly or m onthly,the netsingle prem ium [N SP] form s the foundation for the
calculation ofalllifeinsuranceprem ium s
TheN SP isbased on threebasicassum ptions
1. Prem ium sarepaid atthebeginning ofthepolicy
2. D eath claim sarepaid attheend ofthepolicy year
3. The death rate is uniform throughout the year [insurers develop their ow n
m ortality table]
Theam ountneeded to pay death benefitsisdiscounted forcom pound interest.
In Term insurance :The N SP forterm insurance can be calculated easily.There is
specified period ofprotection.Thefaceam ountispaid iftheinsured diesw ithin that
specified period and nothing ispaid ifthe insured diesafterthe period ofprotection
expires.
In ayearly renew ableterm insurancethecostofeach year sinsuranceisdeterm ined
by m ultiplying theprobability ofdeath by theam ountofinsurancem ultiplied by the
presentvalueofO neRupeeforthetim eperiod thefundsareheld.
In a five year term insurance the costof each year s m ortality m ustbe com puted
separately and then added togetherto determ ine the netsingle prem ium .The sam e
m ethod is follow ed even in ordinary life insurance to calculate N SP exceptthat
thecalculationsarecarried outto theend ofthem ortality table[age99 ]

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M O D U LE -II:TECH N ICA L A SPECTS O F IN SU RA N CE

N ET A N N U A L LEV EL PR EM IU M :
Consum ersfind itm ore convenientto pay insurance in installm entsthan netsingle
prem ium dueto largeam ountofcash required forit.
If prem ium s are paid annually,the netannuallevelprem ium (N A LP) cannotbe
determ ined by sim ply dividing thenetsingleprem ium (N SP)by thenum berofyears
overw hich the prem ium sare to be paid.Itproducesan insufficientprem ium due to
the loss ofintereston the sm alleram ounts ofinvestm entand the risk ofprem ature
deaths.So the m athem atical adjustm ent for the loss of prem ium s and interest is
accom plished by dividing the net single prem ium by the present value of a life
annuity due[PV LA D ]ofRs.1 fortheprem ium paying period.
N SP
N A LP =
PV LA D O F Rs.1 fortheprem ium paying period
The seriesofprem ium paym entsare refered to aslife annuity due.Ifitispaid in an
ordinary lifepolicy,thatiscalled aw holelifeannuity due.
Ifitispaid fortem porary period [term insurance]itiscalled tem porary life annuity
due.Even for ordinary life insurance,the sam e procedure is used exceptthatthe
calculationsareextended to theend ofthem ortality table.
G RO SS PREM IU M : The gross prem ium is determ ined by adding a loading
allow ance to the net annual level prem ium w hich includes operating expenses
[production,distribution,m aintenance],a m argin forcontingenciesand contribution
to profits.

SEC TIO N -C
(C A SE STU D IES)
1. A ssum e thatyou are asked to explain how prem ium s in a life insurance policy are
calculated.Based on thefollow ing inform ation,answ erthequestionsbelow :
a. Com pute the netsingle prem ium fora five-yearterm insurance policy in the
am ountof$1000 issued atage40.
b. Com putethenetannuallevelprem ium forthesam epolicy asin part(a)
c. Isthe netannuallevelprem ium the actualprem ium paid by the policyow ner?
Explain youransw er.

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M O D U LE -II:TECH N ICA L A SPECTS O F IN SU RA N CE

Ageat Num berliving Num ber


beginning of atbeginning of dying during Presentvalueof$1 at5%
year designated designated Year Factor
year year
40 9,377,225 28,319 1 0.9524
41 9,348,906 30,758 2 0.9070
42 9,318,148 33,173 3 0.8638
43 9,284,975 35,933 4 0.8227
44 9,249,042 38,753 5 0.7835

A N S.(a)
Age No.of Prob. Costof
beginning lives D ies deaths P.V. insurance
ofyear
40 9,377,225 28319 .0030 1000 .9524 2.8572
41 9,348906 30758 .0033 1000 .9070 2.9931
42 9,318,148 33173 .0035 1000 .8638 3.0233
43 9,284,975 85933 .0038 1000 .8227 3.1263
44 9,249,042 38753 .0041 1000 .7835 3,2124
15.2123

A nsw er:N SP = 15.2123


(b)TheN etA nnualLevelPrem ium (N A LP)iscalculatedas:age40$1dueim m ediately= $1.
A ge41, 9,348,906
x 1 x .9524 = 0.9495
9,377,225
A ge42, 9,318,148
x 1 x .9070 = 0.9013
9,377,225
A ge43, 9,284,975
x 1 x .8638 = 0.8553
9,377,225
A ge44, 9,249,042
x 1 x .8227 = 0.8115
9,377,225
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M O D U LE -II:TECH N ICA L A SPECTS O F IN SU RA N CE

N SP
N etannuallevelprem ium =
PV LA D of$1

15.2123
= = 3.3673
4.5176
(c) The netsingle prem ium m ustbe converted into a netannuallevelprem ium ,w hich
m ustbethem athem aticalequivalentofthenetsingleprem ium .
The netsingle prem ium cannotbe determ ined by sim ply deciding the netsingle
prem ium by the no.ofyearsoverw hich the prem ium sare to be paid.Such division
w ould producean insufficientprem ium ,i.e.for2 reasosns:
(i) the netsingle prem ium based on the assum ption thatthe entire prem ium is paid in
advanceatthebeginning oftheperiod.Ifprem ium sarepaid in instalm ents,and som e
personsdieprem aturely,theinsurersuffersthelossoffutureprem ium s.
(ii) Installm entpaym ents resultin the loss of interestincom e because of the sm aller
am ountsthatareinvested.

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M O D U LE -II:TECH N ICA L A SPECTS O F IN SU RA N CE

C hapter 9
SocialSecurity Schem es

SEC TIO N -A

1. W hatisthenam eofthesocialsecurity schem epension plan w ithdraw n recently


by LIC forpeopleaged 55 and above?
a. LandlessA griculturalLabourers sG roup Schem e
b. RuralG roup Schem e
c. V arishthaPension Bim aY ojana
d. K rishiShram ik Sam ajik SurakshaY ojana
2. JanashreeBhim a Y ojana w asintroduced
a. Forthem iddleclasspeople
b. Fortheupperm iddleclasspeople
c. Forpoorpeople
d. For people living below the poverty line,belonging to specific occupation/
profession.
3. O A SD Istandsfor:
a. O ld A geSatisfying and D irectInsurance
b. O rphan A ged Seriously D isabled Illiterate
c. O ld A geSurvivorsand D isability Insurance
d. O ld A geSeniorand D isability Insurance.
4. U nem ploym entInsuranceisa com ponentof:
a. E.S.I.A ct
b. SocialSecurity A ct
c. W orkersCom pensation A ct
d. N oneoftheabove
5. O A SIS reportrecom m ended a new pension system on thebasisof:
a. IndividualRetirem entA ccount
b. W orkerscurrentaccount
c. Balanceaccountofw orkerafterheisdeceased

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M O D U LE -II:TECH N ICA L A SPECTS O F IN SU RA N CE

d. N oneoftheabove
6. TheG ram in personalaccidentpolicy doesnotcover
a. naturaldeath
b. accidentaldeath
c. disability
d. accidentalinjuries
e. noneoftheabove
7. W hich ofthefollow ing perilsarenotcovered underthehutinsurancepolicy?
a. earthquakes
b. w ar
c. terrorism
d. flood
e. noneoftheabove
8. W ho am ongstthe follow ing do notcontribute in the Em ployeesFam ily pension
schem ein India?
a. em ployer
b. em ployee
c. governm ent
d. unions
e. noneoftheabove
9. TheG ratuity A ctprovidesforpaym entto theem ployeeatthetim eof
a. retirem ent
b. resignation
c. death
d. disability
e. noneoftheabove
10. TheED LIschem ew asprim arily aim ed to protectthefam ily in caseof
a. untim ely death
b. retirem ent
c. oldage
d. disability oftheem ployee
e. noneoftheabove
11. W hich outofthefollow ing isnota SocialSecurity insuranceschem esin U S?
a. M edicare& M edicaid schem es

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M O D U LE -II:TECH N ICA L A SPECTS O F IN SU RA N CE

b. Fidelity guaranteeinsurance
c. D isability insurance
d. U nem ploym entinsurance
e. N oneoftheabove

SEC TIO N A A N SW ER S
1. (c) 2. (d) 3. (c) 4. (b) 5. (a) 6. (a)
7. (b) 8. (d) 9. (a) 10.(a) 11.(b)

SEC TIO N -B

1. D efinesocialsecurity and describeitsnature.


A ns: This conceptfirststarted in the w estern countries during the 30 s atthe tim e of
depression. In one w ay w e can say that social security em erged as a result of
econom ic insecurity.
Socialsecurity becam eam ajorareaofconcern in m any countriesofthew orld w hen
society w as slow ly shifting from agro-based econom y to an industrial econom y.
Peoplestarted m oving to citiesfrom villagesin orderto satisfy theireconom icneeds
and to getsom e security.Thischange cam e aboutin Europe forthe firsttim e during
the19th century.
Thisdevelopm ent,w hich latercam eto beknow n asindustrialrevolution had itsow n
advantages and disadvantages.Itresulted in inappropriate living conditions forthe
m igrantpopulation and created friction betw een the upperand low erclasses in the
society.This happened firstin Europe and laterin U SA .In orderto dealw ith this
situation,the governm ents in these countries cam e up w ith the idea of providing
socialsecurity through variousschem esto thew eakersection ofthesociety w hich
consisted m ainly ofthe m igrantpopulation w orking in the industries,the industrial
revolution had given birth to.
The intention ofthe G erm an chancellorO tto von Bism arck,w ho introduced social
security,w asto provide benefitsto the w orkers.The basic idea behind thisschem e
w asto help theretired w orkersthrough thecontribution ofthepresentw orkers.This
led to developm entofsocialsecurity m easures(accidentinsurance,disability and old
ageinsurance),w hich w ereadopted in the20th century.
In U SA ,during the tim e of depression,the governm ent felt the need for social
security legislation.Itbecam e vitalto supportthe em ployeesw ho losttheirjobsdue
to the depression.N ecessary legislation w as passed in 1935 and it later becam e
effectivein 1937.
2. W hatarethecausesofeconom icinsecurity?
A ns:Thefollow ing aresom eofthem ajorcausesofeconom icinsecurity:
U nem ploym ent
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M O D U LE -II:TECH N ICA L A SPECTS O F IN SU RA N CE

Prem aturedeath
O ld age
Poorhealth
Inflation
Substandard w age
N aturaldisasters
* Personalfactors
Letsdiscussthem briefly:
U nem ploym ent: This is one of the vital factors that cause econom ic insecurity.
People lose theirjob due to restructuring oforganisation and technologicalchanges.
Thisresultsin:
Lossofincom e
M orepeopleareforced to go in forparttim ejobs(leading to reduced incom e)
U ncertainty aboutincom e
N o jobs
Prem ature death:Itoccursw hen the head ofthe fam ily expiresw ithoutfulfilling his
obligations.Itcouldbehischild seducation,m arriageofhissonordaughter,paym ents
ofbills,instalm ents,etc.A gain the levelofinsecurity is m ore w hen the head ofthe
fam ily has notinsured his life orhealth orhas previously saved very little.Butifa
person w ho dieshasa very little by w ay ofcom m itm entsto fulfilw ith regard to the
otherfam ily m em bers,itisnotconsidered aprem aturedeath in insuranceparlance.
O ld age:A fterthe retirem entage,people no longerhave a steady incom e and even if
they seek re-em ploym ent,they earn less.People in thiscategory often develop heath
problem sand poorhealth leadsto m oreexpenditure.Theseexpensescan befaced only
ifthereisreasonablesavingsorfinancialassetsorannuitiesand health insurance.
Poor health and disability: It can be due to illness or injury,w hich affects the
earning capacity.The inability to pursue gainfulem ploym entasa resultcan be long
term orshort-term .From thefam ily spointofview itisam ajorm edicalexpenditure.
Ifthe head ofthe fam ily is the victim ,the insecurity increases allthe m ore as the
sourceofincom eitselfisblocked.
Inflation:Ifthere isan increase in pricesw ithouta com parable increase in incom e,
inflation occurs.This is a problem especially for salaried people and pensioners.
They find itdifficultto m anagetheincreasein pricelevel.
Substandard wage: The governm entshould fix up a m inim um w age to alleviate
poverty and exploitation by the em ployer.A m inim um levelofincom e isneeded to
m eet the basic expenses. By substandard w age w e m ean w age low er than the
m inim um subsistencew agelevel.
N aturaldisasters:The m ostunavoidable are the naturaldisasters like earthquakes,
fam ines,floodsand hurricanes.They causehugelosses.N othing can bedoneaboutit
as m ost of the properties are uninsured or underinsured.The level of econom ic

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M O D U LE -II:TECH N ICA L A SPECTS O F IN SU RA N CE

insecurity isatitshighestin such tim es.


Personalfactors:Tillnow w e have seen the externalfactors thatcause econom ic
insecurity.Buteconom icinsecurity can also develop on accountoffactorsw ithin us.
Self-m otivation isthekey to successin life.Ifw elosethat,low incom eorno incom e
w ould be the consequence. There m ay be other personal reasons for econom ic
insecurity like:
Addiction to alcoholand drugs:Thiscan lead to tw o things:lossofincom e,and loss
ofhealth.Both ofthem are interrelated.A ddiction to these can cause a heightened
levelofinsecurity.
D ivorce:Them ostaffected peopleasaresultofdivorcearechildren and thew om en.
Thissituation ism ore prevalentin w estern countriesthan in India.Lack ofincom e
and em otionalneedslead to a higherlevelofinsecurity.In orderto overcom e these
socialm aladies,governm entssetup suitablesocialsecurity program m es.
G am bling:Thisunnecessary expenditureleadsaperson to hugedebts.Thism ay also
driveaperson to fraud,forgery and othersuch practices.
3. D escribethenatureofsocialsecurity in India.
A ns: The literature relating to developm ental issues points out that it is not easy for
developing countries to pay forsocialsecurity system s.This assum ption has to be
challenged.Studies by U N ICEF and W orld Bank prove thatthe success ofsocial
security program m esdepend on thesupportofthepublic.
In India socialsecurity is stillin the early stage ofdevelopm entw hile in reality a
largenum berofpeoplearein need ofsocialsecurity support.Sincethesepeoplelive
below the poverty line just earning enough to m ake both ends m eet through
agriculturaloperation,their livelihood depends on the vagaries of w eather.W hen
they are hitby naturalcalam itiessuch asdrought,cyclone,failure ofm onsoons,etc.
they haveno choiceexceptto look to thegovernm entforreliefand support.Theneed
forsocialsecurity supportis also feltw hen the breadw innerofthe fam ily dies and
especially w hen itisaprem aturedeath.
The situation w ith regard to regularw orkersin the industrialsectorisa lotbetteras
they enjoy m any socialw elfare benefits as em ployees.H ow ever,there are large
num ber of seasonalw orkers in the industry w hose situation is no better than the
agriculturalw orkersparticularly in tim esofindustrialdepression w hen they have to
face unem ploym entforlong period.They are forced to join during such tim es,the
unorganised sectorin urban areas.Thus the need forsocialsecurity supportis felt
m ostby people in tw o categories:the agriculturalw orker in the villages and the
labourersbelonging to theunorganised sectorin theurban areas.
Since the num ber of people involved w ho need social security support is huge,
finding resources is the m ajorissue forthe governm ent.H ow ever,the governm ent
has m ade a beginning by affording som e form of socialsecurity to these people
through socialinsurance.

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M O D U LE -II:TECH N ICA L A SPECTS O F IN SU RA N CE

In India the governm enthas launched severalsocialinsurance schem es.A llthese


havebeen developed and im plem ented through nationalised insuranceorganisations.
The follow ing are som e of the socialinsurance schem es introduced through Life
InsuranceCorporation ofIndia.
LandlessA griculturalLabourersand G roup InsuranceSchem e
G roup Insurance Schem e for beneficiaries of the Integrated Rural D evelopm ent
Program m e
RuralG roup LifeInsuranceSchem es
K rishiShram ik Sam ajik SurakshaY ojana
Socialsecurity in India hasnotdeveloped truly to m eetthe need ofthe targetgroup.
Thisisdueto tw o reasons:scarcity offundsand largenum bersinvolved.
4. Enum erate the schem es categorized as social insurance under the general
insurancebranch
A ns:The socialinsurance schem esinitiated by the governm entaim to provide protection
and financialassistance to the sm allfarm ers and w orkers.A llthese schem es and
policies have been categoriesed under Integrated RuralD evelopm entProgram m e.
Som eoftheschem esareasfollow s:
CattleInsurance
Sheep and goatinsurance
Poultry insurance
A quaculture(shrim p/praw n)insurance
Sericulture(silk w orm )insurance
A nim aldriven cartinsurance
Failed w ellinsurance
Saltw orksinsurance
5. D iscussthecoverageundertheH utInsuranceschem e.
A ns: H ut insurance em erged w ith funds given by banks, financial institutions
and cooperatives. This policy w as initiated in rural areas to insure against fire,
earthquakes,etc.Them axim um coveragew asRs.6,000 (Rs.5,000 forstructureand
Rs.1,000 forcontents).This policy covers upto tw o hundred huts in a single area,
w ith Rs.3 rate perthousand.The state governm entcoversruraland sem iruralareas
underthispolicy.Thefollow ing risksarecovered:
Fire
Lightning
Flood
Cyclone
Terrorism
Landslide
Im pactby rail/vehiclesoranim als
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M O D U LE -II:TECH N ICA L A SPECTS O F IN SU RA N CE

6. W hy istheEm ployeesProvidentFund Schem em adem andatory?


A ns:A ny em ployerw ho hasm orethan tw enty em ployeesw orking underhim isstatutorily
obliged to have a ProvidentFund.The objective ofprovidentfund isto save m oney
both at the em ployer and the em ployees end. This w ill enable them to save a
reasonable am ountofm oney inclusive ofinterest.Laterthism oney can be utilized
forthe econom ic security during the tim e ofretirem ent.The accum ulated fund w ith
interestform spartoftheterm inalbenefitpayableto the em ployeeorhisbeneficiary
in theeventofdeath.
7. W hatisthescopeofcoveragegiven in theEm ployees StateInsuranceSchem e
A ns:TheE.S.Iactisapplicableto non-seasonalfactoriesw ith certain restrictionsrelating
to num ber of em ployees. This schem e is applicable to industrial, com m ercial,
agricultural and other sectors, including hotels, restaurants, shops, cinem as,
transport,new spaper,w herethenum berofem ployeesshould bem orethan tw enty to
becovered undertheschem e.
Theschem eprovidesfor
M edicalbenefitto w orkersand theirdependants,atE.S.I.hospitals,dispensaries,
diagnosticcentresand occupationaldiseasecentres.
fam ily w elfare services, health education and check up, basic health care,
surgicalprocedures,etc.
Cash benefit w hich is payable to em ployees if they are sick or disabled
tem porarily orperm anently due to em ploym ent,w hich isusually equalto 50%
ofthew ages.
In caseoftem porary orperm anentdisablem entthecash benefitispaid athigher
rates.
8. D iscuss the rationale for the existence and developm ent of W orker s
C om pensation conceptand program m e.
A ns:W orkerstim eand again areinjured and becom esick becauseofjob-related accidents
and disease.Besidespain and suffering,these disabled w orkersalso dealw ith other
m entaltensionsand agony such aslossofearned incom e,paym entofm edicalbills,
partialorperm anentlossofbodily functionsorlim bsorjob separation.
W orker scom pensation isa socialprogram m ethatprovides:
M edicalcare
Cash benefits
Rehabilitation services to disabled w orkers from job related accidents or
disease.Thesebenefitsreducetheeconom icinsecurity thatm ay resultfrom job
related disability.
9. Statebriefly theobjectivesofw orkerscom pensation concept.
A ns:Thefollow ing arethebroad objectivesofthew orkerscom pensation law s.
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M O D U LE -II:TECH N ICA L A SPECTS O F IN SU RA N CE

Broad coverage of em ployees for job-related accidents and diseases. The


w orkers com pensation covers m ost occupation or job-related accidents and
diseases.
Substantialprotection againstlossofincom e.Thecash benefitsaredesigned to
restore a substantialproportion ofthe disabled w orker slostearnings,so asto
enablethedisabled w orkerto m aintain thesam estandard ofliving.
Sufficientm edicalcare and rehabilitation services.The w orkerscom pensation
law s require em ployers to pay hospital, surgical, and other m edical costs
incurred by injured w orkers,as w ellas rehabilitation services to restore the
disabled em ployeesto productiveem ploym ent.
Encouragem entofsafety.Thew orkerscom pensation law sencouragethefirm sto
reducejob-relatedaccidentsandtodevelopeffectivesafetyprogram s.Experience
rating is used to encourage firm s to reduce job-related accidents and diseases,
becausefirm sw ith superioraccidentrecordspay low erW C prem ium s.
Reduction in litigation.W orkers Com pensation law s are designed to reduce
litigation by m aking prom ptpaym entto disabled w orkers w ithoutrequiring
them to sue theirem ployer.The objective isto reduce orelim inate paym entof
legalfeesto attorneysand avoid delaysin trialsand appeals.
10. Listouttheoccupationsnotcovered undertheW orkersC om pensation cover.
A ns: A lthough the W C law s cover m ostoccupations,som e occupations are either not
covered orhaveincom pletecoverage,nam ely:
Farm w orkers
D om esticservants
Casualem ployees
Concernsw ith num ericalexclusions(lessthan 3-5)
Professionalathletes
11. W hataretheeligibility requirem entsto receiveW orkersC om pensation?
A ns: There are tw o principaleligibility requirem ents to be m etto receive the w orkers
com pensation benefits:
Thedisabled w orkershould w ork in acovered occupation.
Thew orkerm usthaveajob-related injury ordisease.
This m eans the injury or disease m ust arise out of and in the course of
em ploym ent.H ow ever,now them eaning oftheterm hasbeen broadened so as
to includethefollow ing:
A n em ployee w ho travelsisinjured w hile engaged in activitiesthatbenefitthe
em ployer.
Theem ployeeisinjured w hileperform ing specified dutiesataspecified location.
Theem ployeeison theprem isesand isinjured w hilegoing to thew ork area.
Theem ployeehasaheartattack w hilelifting som eheavy m aterial.
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12. W hatarethebenefitsprovided undertheW orkersC om pensation Insurance?


A ns:TheW orker scom pensation insuranceprovidesfourprincipalbenefits:
U nlim ited M edical C are: G enerally m edical care is covered in full. But
m edicalcare being expensive,and to hold dow n costs,som e em ployersprefer
tying up w ith som em anaged careorganizationssuch asH M O s,and PPO s.
D isability Incom e:The disability incom e is paid afterthe w orkersatisfies a
w aiting period thatusually ranges from 3 to 7 days.Ifthe injury lasts orthe
w orkerisdisabled aftercertain num berofdaysorw eeks,benefitisgiven from
retrospectivedateofinjury.
The w eekly cash benefitis based on a percentage ofthe injured w orker s w eekly
w agetypically 2/3rd ,and issubjectto m inim um and m axim um paym ents.
D isability isclassified into fourcategories:
PT (Perm anenttotal)
TT (Tem porary total)
TP (Tem porary partial)
PP (Perm anentpartial)
Tem porary total disability claim s are the m ost com m on and account for
m ajority ofcash claim s.
D eath benefits: The death benefits are paid to the eligible survivors,if the
w orkerdiesasa resultofa job-related accidentordisease.Tw o typesofdeath
benefitsarepaid:
Burialallow ance
W eekly incom ebenefitsarepaid to eligiblesurvivors.
W eekly incom esare a percentage ofthe diseased w orker sw ages(2/3rd)and is
paid to the spouse forlife oruntilshe/orhe rem ains,and also to a dependant
child untilaspecified age.
R ehabilitation services: In m ost cases, rehabilitation services are also
provided to restore disabled w orkers to productive em ploym ent. Besides
w eekly benefits,boarding and room ,travel,booksand equipm entchargesare
also given and also training expenses.
13. D iscusstheobjectivesand justification ofhaving a socialinsuranceschem e.
A ns: Social insurance program m es refer to com pulsory governm ent insurance
program m esthatare differentfrom those ofotherprivate and governm entinsurance
com panies.These program m esprovide security to those w ho need itattim esw hen
they face grave financialinsecurity resulting from prem ature death,unem ploym ent,
poor health,job related disabilities and lastbutnotthe leastfrom old age.These
program m esare extrem ely necessary to protectthose fam iliesw ith lim ited incom es.
The basic reasonsforthe establishm entofSocialInsurance(SI)program m escan be
sum m arized asfollow s:
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M O D U LE -II:TECH N ICA L A SPECTS O F IN SU RA N CE

SI program m es are enacted to solve com plex social problem s, w here


governm entintervention isnecessary.
SIprogram m esare necessary in som e casesw here certain risksare difficultto
insure privately. (e.g. unem ploym ent, w here the State can tackle this by
im plem enting Statesponsored unem ploym entinsuranceprogram m es).
SIprogram m es provide a base ofeconom ic security to the population,w hen
they need it.(long-term financialconsequencesresulting from prem aturedeath,
disabilities,unem ploym ent,etc.)
14. Enum eratethebasiccharacteristicsofSocialInsurance.
A ns.Socialinsurance program m eshave certain characteristicsthatdistinguish them from
otherprivateand governm entprogram m es.
C om pulsory program m es: These program m es being com pulsory have tw o
inherent advantages.They provide equitable floor of incom e to the entire
population and m oreoveradverseselection isalso reduced.
Floor ofincom e:These program m esare designed to provide floorofincom e
w ith respect to covered risks, to enable them to substitute w ith their ow n
savings and investm ents and private insurance so as to m aintain a reasonable
standard ofliving.
Em phasis on social adequacy rather than individual equity: Social
adequacy m eansthatbenefitspaid should provideacertain standard ofliving to
all contributors. It m eans the benefits in particular concentrate or favours
certain groupssuch as(low -incom epersons,largefam ilies,and retired aged).It
also m eansthatthebenefitsreceived by thesegroupsexceed theircontributions
unlikein privateinsurance.
Benefits related to earnings: Social Insurance benefits are proportionately
related to the w orkers earnings.Thus som e consideration is in factgiven to
individualequity.
Benefitsprescribed by Law :Law prescribesthese program m es,in the sense,
G overnm ent perform s the eligibility requirem ents and adm inistration and
suspension ofprogram m es.
N o m eanstest:SocialInsurancebenefitsarepaid asam atterofrightand notas
a m atterofneed.M eans testis applicable in public assistance w here w elfare
applicants m ustprove thattheirincom e levelis below certain threshold level
butin caseofSIprogram m es,applicantsareeligibleforthebenefitsasam atter
ofstatutory rightifthey fulfillcertain eligibility requirem ents.
Fullfunding unnecessary:SocialInsurance program m esneed nothave to be
fully funded program m esform any reasons.Firstly they have indefinite future,
and because oftheircom pulsory nature,new w orkersw illjoin the program m e
and pay taxes to supportthem .Even from econom ic view point,fullfunding
w illrequire levying ofhighertaxesw hich w ould resultin deflation and cause
substantialunem ploym ent.
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M O D U LE -II:TECH N ICA L A SPECTS O F IN SU RA N CE

Financially self-supporting: Social Insurance program m es are usually


financially self-supporting: that is, these program m es are financed from
contributionsofcovered em ployees,em ployers,self-em ployed,and from Trust
fund investm ents.
15. D iscuss the eligibility criteria for the entitlem ent of benefits under O A SD I
schem es.
A ns:TheO A SD Iprogram m ecom m only know n asSocialSecurity program m eisthem ost
popularSocialSecurity program m es in the U SA ,initiated as a resultofthe Social
Security A ct,1935.ThisO A SD Iprogram m e coversw orkersand groupsengaged in
alm ostallspheressuch as:
Em ployeesin privatefirm s
Civilian em ployees
Stateand localG overnm entem ployees
Em ployersofnon-profitorganizations
Self-em ployed
O thergroups Church m inisters,m ilitary personnel,etc.
16. Briefly discussthem ajorbenefitsundertheM edicareprogram m e.
A ns:O ne of the m ajor benefits of the Social Security Program m e is the M ED ICA RE.
M edicare covers the m edicalexpenses of alm ostallpersons of age 65 and older.
M edicarealso coversdisabled personsyoungerthan age65,w ho havebeen entitled to
disability benefitsforatleast24 m onths.Besides,the program m e also coverspersons
below theage65,w ho need long term kidney dialysistreatm entorkidney transplant.
TheM edicareprogram m ehasthefollow ing coverages:
H ospitalInsurance(Part-A )
Supplem entary M edicalInsurance(Part-B)
M edicare+ Choice
H ospitalInsurance(Part-A )
InpatientH ospitalcare iscovered upto 90 daysforeach benefitperiod.A benefit
period startsw hen the patientfirstentersthe hospitaland endsw hen the patienthas
been outofthe hospitalorskilled nursing facility for60 consecutive days.Forthe
first 60 days, M edicare pays all the covered costs except for initial hospital
deductibles.The patientsw ho are in hospitalafter90 dayscan use a lifetim e reserve
of 60 additionaldays.H ospitaldeductibles and coinsurance charges are adjusted
each year,w ith changesin costsoftreatm ent.Inpatientcarein skilled nursing facility
isalso covered upto am axim um 100 daysin abenefitperiod.Thefirst20 daysofthe
covered services are paid in full.The next80 days,the patientbears coinsurance
charges.To be eligible forthis benefit,the patientm ustbe hospitalized firstforat
least3 daysand need skilled nursing care.

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M O D U LE -II:TECH N ICA L A SPECTS O F IN SU RA N CE

17. D iscussthesourcesoffinancefortheO A SD Iprogram m es.


A ns:O A SD Iprogram m esareusually financed from apayrolltax paid by:
Em ployers
Em ployees
Theself-em ployed
Interestincom eon thetrust-fund investm ents
Tax revenues
The em ployee s contribution is m atched by an identical contribution from the
em ployer. The self-em ployed are allow ed som e deductions, w hich reduce the
effective tax-rate.
The H ospitalInsurance (PartA )ofM edicare isfinanced by m onthly prem ium sand
by thegeneralrevenuesoftheState.
18. D iscusstheobjectivesofU nem ploym entInsurance.
A ns:U nem ploym entInsurance program m es are the federalState program s in the U SA
thatpay w eekly cash benefitsto w orkersw ho are involuntarily unem ployed.These
program m es are a result of the provisions of the SS A ct,1935.U nem ploym ent
Insurancehasseveralbasicobjectives.
Providecash incom eduring involuntary unem ploym ent.
W eekly cash benefits are paid to the unem ployed w orkers during periods of
short-term involuntary unem ploym ent.
H elp unem ployed w orkersfind jobs.
Encourageem ployersto stabilizeem ploym ent.
H elp stabilizetheeconom y.
19. D iscuss the coverage and the eligibility requirem ent for the unem ploym ent
insurance.
A ns:Thefollow ing groupsarecovered fortheunem ploym entbenefits:
A privatefirm .
Stateand Localgovernm ents.
N on-profitable,charitable,educational,orreligiousorganizations.
A griculturalfirm .
D om estic em ploym ent.
A n unem ployed w orkershould m eetthefollow ing eligibility requirem ents:
Should havequalifying w agesand been unem ployed during thebaseyear.
The base year usually is the firstfour of the lastfive-calendar SS quarters
preceding theunem ployed w orker sclaim forbenefits.
Beableand availableforw ork.
Theapplicantm ustbephysically and m entally capableofw orking and m ustbe
available for w ork. The claim ant should also have registered at a public
em ploym entofficeand seek w ork.
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M O D U LE -II:TECH N ICA L A SPECTS O F IN SU RA N CE

A ctively seek w ork and befreefrom disqualification Theapplicantshould


nothave been specifically disqualified from benefits,w hich include actssuch
asvoluntarily quitting his/herjob,participation in labourdisputes,discharged
form isconduct,etc.
Serve a one-w eek w aiting period Finally, a one-w eek w aiting period
elim inates short-term claim s,reduces costs,and provides tim e to process the
claim antw agerecordsand processestheclaim .
20. ListoutthebenefitsavailableundertheU nem ploym entInsuranceschem e.
A ns:The various benefits available underthe unem ploym entinsurance forthe claim ant
can belisted asfollow s:
I. C ash benefit W eekly cash benefit is paid for each w eek of total
unem ploym ent.Thecash benefitdependsupon thew orker spastw ages,w ithin
acertain m inim um and m axim um am ount.
II. Extended benefit Som etim es,during periods ofhigh unem ploym ent,som e
w orkers exhaust their regular unem ploym ent benefits for w hom under the
extended benefitprogram m e,claim antscan receive up to 13 additionalw eeks
ofbenefitsw hicheverisless.H ow ever,thereisan overalllim itof39 w eeksfor
both regularand extended benefits.

SEC TIO N C
(C A SE STU D IES)
W hatistheliability oftheem ployerin thefollow ing cases?
1. A w orkm an suffered an injury by an accidentarising outofand in thecourseof
em ploym entand w as perm anently disabled.Butthe accidenthad been caused
by his w illfuldisobedience to an order issued for the purpose ofsecuring the
safety ofw orkm en.
A ns:N o,theem ployerisnotliableforany com pensation becausethelaw doesnotprovide
forw illfuldisobedienceasaground forcom pensation.H ow evertheinsurancepolicy
coverseven theinjuriesand death resulting from thenegligenceofthew orker.
2. A w orker in X Y Z Ltd.a plastics m anufacturing unit,broke his leg and w as
totally disabled for 3 m onths. W hat is the benefit under the W orkers
C om pensation law s?
A ns:A fteraone-w eek w aiting period,thedisabled w orkerw ould receivetw o-thirdsofhis
w eekly w age up to a m axim um of qualified num ber of w eeks according to the
disability.
3. A w orker lost his m entalbalance as a result of an injury by accident w hile
w orking in thefactory and com m itted suicide.
A ns:Y es,thew orkerisentitled to w orkerscom pensation becausetheinjury w ascaused to
thew orkm an in thecourseofem ploym ent.
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M O D U LE -II:TECH N ICA L A SPECTS O F IN SU RA N CE

C hapter 10
G roup Insurance

SEC TIO N A

1. Em ployeebenefitschem esareplanssponsored by
a. em ployers
b. em ployees
c. governm ent
d. noneoftheabove
2. Em ployeebenefitschem esincludebenefitscovering therisksof
a. salariesand w ages
b. prem aturedeath,disability,superannuation and unem ploym ent.
c. fringebenefits
d. noneoftheabove
3. Em ployeebenefitsarem oreclear
a. in theunorganized sector
b. in theagriculturalsector
c. in theorganized sector
d. in thesem iorganized sector
e. noneoftheabove
4. Em ployeebenefitschem esim prove
a. em ployer-em ployee relations
b. em ployeeloyalty
c. industrialrelationsclim ate
d. alloftheabove
e. noneoftheabove
5. Fortheintroduction ofa group schem ew eneed a
a. H om ogeneousgroup
b. Insured group
c. A sm allgroup ofpersons
d. A largegroup
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M O D U LE -II:TECH N ICA L A SPECTS O F IN SU RA N CE

6. The group schem e specially designed to discharge the gratuity liability ofthe
em ployeriscalled
a. G roup superannuation schem e
b. G roup gratuity insuranceschem e
c. G roup insuranceschem e
d. ED LIschem e
7. G roup superannuating schem e in conjunction w ith group insurance schem e is
taken
a. To m eetstatutory requirem ents
b. To offergroup insuranceprotection
c. To ensurethateven in thecaseofprem aturedeath,theem ployee sw idow gets
areasonablepension
d. N oneoftheabove
8. G roup savingslinked insuranceisa
a. G roup insuranceschem ew ith asurvivalbenefit
b. Schem eoffered in lieu ofED LIschem e
c. Schem eform eeting em ployer sliabilitiesunderPaym entofG ratuity A ct,1972
d. Schem eoffered by N ationalSavingsO rganisation
9. In India, m ost group insurance schem es are m arketed by the insurance
com paniesthrough
a. A gents
b. Brokers
c. D irectly by thecom pany
d. Banks

SEC TIO N -A A N SW ER S
1. a 2. b 3. c 4. d 5. a 6. b
7. c 8. a 9. c

SEC TIO N -B
1. W hatarethecharacteristicsofgroup insurance?
A ns:G roup insurance isa m eansthrough w hich a group ofpersons,w ho usually have a
business orprofessionalrelationship to the contractow ner,are provided insurance
coverageunderasinglecontract.
D istinguishing characteristics:
G roup underw riting The prem ium to be collected and m axim um sum
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M O D U LE -II:TECH N ICA L A SPECTS O F IN SU RA N CE

assuredtobegrantedforagroupw illbedecidedon:1.Thenatureofthegroup.2.
The size ofthe group.3.The age distribution in the group.4.The type ofgroup
schem esoughtfor.N o individualevidenceofinsurability isusually required,and
benefitlevelscan besubstantial,w ith few ,ifany,im portantlim itations.
A num berofcontrolling factorsofgroup underw riting are:
1. H om ogenous lives - Itaim s atobtaining a group of hom ogeneous lives,to
predictthe m ortality orm orbidity rate.Itaim satcontrolling adverse selection
by individualsw ithin agiven group.
2. Theinsuranceshould beincidentalto thegroup -Thatis,them em bersofthe
group should have com e together for som e purpose other than to obtain
insurance.
3. There should be a steady flow ofpersonsthrough the group -Thatis,there
m ustbeinflux ofnew young livesinto thegroup and an outflow from thegroup
oftheolderand im paired livesto assum ethatthey arein averagehealth.
4. There should be an autom atic basisfor determ ining the am ountofbenefits
on individuallivesto avoid adverseselection.
5. C ontributory plansand non-contributory plans-Forcontributory plans[an
em ployee pays a portion ofthe prem ium ],generally atleast75 percentofthe
eligible em ployeesm ustjoin the plan ifcoverage isto be effective.In the case
ofnon-contributory plans [em ployer-pay-allplan],100 percentparticipation
is required.By covering a large proportion of a given group,the insurance
com pany gainsasafeguard againstan undueproportion ofsubstandard lives.
The use of a m aster contract The m aster contract is a detailed
docum ent setting forth the contractual relationship betw een the group
contractow nerand theinsurancecom pany.Theinsured personsunderthe
contract, usually em ployees and their beneficiaries, are not actually
parties to the contract,although they m ay enforce their rights as third-
party beneficiaries. The four-party relationship [em ployer, insurer,
em ployee,and dependents]found in a group insurance plan can create a
num ber of interesting and unusual problem s that are com m on only to
group insurance.
Low er adm inistrative cost The nature ofthe group approach perm its
the use ofm ass-distribution and m ass-adm inistration m ethodsthatafford
econom ies of operation not available in individual insurance. Sm all
proportions of com m ission, sim plified accounting techniques and
adm inistrative procedures,m inim um costof m edicalexam inations and
inspection reportsetc.help to low eradm inistrativecosts.
Flexibility in contractdesign Thegroup insuranceprogram m eusually
isan integralpartofan em ployee benefitprogram m e.In m ostcases,the
contractcan bem oulded to m eettheobjectivesofthecontractow ner,and
as long as the requests do not entail com plicated adm inistrative
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M O D U LE -II:TECH N ICA L A SPECTS O F IN SU RA N CE

procedures,open the w ay to possibly seriousadverse selection,orviolate


legalrequirem ents.
The use of experience rating The point at w hich a group is large
enough to be eligible for experience rating varies from com pany to
com pany,based on thatinsurer s book ofbusiness and experience.The
size and frequency ofm edicalclaim svary considerably acrosscountries
and am ong geographicregionsw ithin acountry and m ustbeconsidered in
determ ining a group insurance rate. The com position [age, sex, and
incom e level]ofa group w illalso affectthe experience ofthe group and,
sim ilarlly,w illbean im portantunderw riting consideration.
2. D iscusstheadvantagesofgroup insurance.
A ns:Theadvantagesofthegroup m echanism are:
Effectivesolution to theneed forem ployeebenefits
Extended protection to largenum berofpersons
Enable life insurance com paniesto reach vastnum bersofindividualsw ithin a
relatively shortperiod and atlow cost.
Extended protection to alargenum berofuninsurablepersons.
Tax effectivevehicle
Substitution to governm entsecurity program m es.
3. D iscussthelim itationsofgroup insurance.
A ns:Thelim itationsofthegroup m echanism are:
From the view pointofthe em ployee,group insurance hastem porary coverage,
[in caseofretirem ent,quitting,term ination ofplan].
Those w ho are having large am ounts of group life insurance during their
w orking yearsfailto recognizetheneed for,orareunw illing to facethecostof,
individuallifeinsurance.
G roup plans typically failto provide the m echanism for any analysis of the
financialneeds of an individual a service thatis norm ally furnished by an
agentorotheradvisor.
4. W ho aretheeligiblegroupsforgroup insurance?
A ns:Theeligiblegroupsforgroup insuranceare:
Em ployer em ployeegroups
M em bersoftradeunion
Tradeassociations
Creditor debtorgroupsliketheloaneesofahousing financecom pany and the
like.
M iscellaneousgroupslikeprofessionalassociations,collegealum niassociations,
veteran associations, religious groups, custom ers of large retail chains, and
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M O D U LE -II:TECH N ICA L A SPECTS O F IN SU RA N CE

savings account depositors, poorer sections of the society such as poura


karm ikas,landlessagriculturalw orkersand thelike.
N on conventionalgroupslikeCo-operativesocieties,w elfarefundsetc.
5. W hatarethem ajortypesofgroup insuranceschem es?
A ns:Them ajortypesofgroup insuranceschem esareasfollow s:
G roup life insurance: a group life insurance is further classified into three
types group term life insurance, group gratuity schem e and group
superannuation schem e
G roup disability incom e insurance:group disability incom e insurance can be a
short-term disability oralong-term disability plan
6. H ow m any w aysgroup benefitplanscan befunded?
A ns:G roup benefitplanscan befunded in differentw ays.Them ajoralternativesavailable
to theinsurerareasfollow s:
Em ployerfunded plans
Trustee-adm inistered fund
Insured schem es
7. D iscussthetechniquesofm arketing group insurance.
A ns:M arketing group insurance can be done through generalagenciesorbranch offices
and through brokersand em ployeebenefitconsultants.Them arketcan besegm ented
by 1.Size ofgroup,2.Type ofgroup,and 3.Funding m ethod.G roup insurance in
Indiaism ostly m arketed directly by executivesoftheinsurancecom pany.Butin the
presentm arket,banksand otherinstitutionalagentshavealso em erged asthem arket
interm ediariesforgroup insurance
8. M ake a com parison betw een the trusteesadm inistered gratuity schem e and an
insured schem ein term sofadvantagesto theem ployerand theem ployees.
A ns:A n insurancecom pany isw ellexperienced and efficientin adm inistering thepension
plan.Trusteesm ay lack such expertise.Therefore a prudentem ployerm ay preferto
entrustthe adm inistration and m anagem entofthe pension schem e to the insurance
com pany.Thisw ay,theem ployercan concentrateon otherprom otionalactivitiesof
thebusiness.
Itisobserved thatthe costsinvolved in insurance schem esare high w hen com pared
to atrustee-adm inistered schem e.
To choosebetw een thesetw o alternatives,em ployersin ourcountry keep in m ind the
expected yield on contribution and the size of the group.W here the num ber of
em ployees is large the em ployerm ay go forthe trustee-adm inistered fund.In such
organisations,experienced and trained staffcan efficiently adm inisterand investthe
largecontributions.O n theotherhand,theem ployerselectsan insured schem ew here
thenum berofem ployeescovered underthepension schem eissm all.Thisisbecause

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M O D U LE -II:TECH N ICA L A SPECTS O F IN SU RA N CE

w ith sm allcontributions,thetrusteescannotfollow thesuggested investm entpattern


and they also lack theexpertiserequired form anaging thepension schem e.
W ith a trustee-adm inistered fund,em ployees are provided w ith a w ide range of
benefits.Such benefits include disablem ent pension,discretionary pension,early
retirem entpension and illhealth retirem entpension.O n theotherhand,in an insured
schem e the benefits available for the em ployees are lim ited to pensions that are
dependenton life.Theinsuranceschem esavailableto theem ployerarestandardized
and nottailor-m ade.
The rate at w hich a fund is built m ay be changed if required under a trustee-
adm inistered fund.Thisisnotpossiblein an insured schem e.
Them ostfavourablecharacteristicofan insured schem eisthatitm akessurethatthe
em ployees gettheir pensions regularly and w ithoutany difficulty.Itrelieves the
trusteesfrom theresponsibility ofadm inistering thefund and atthesam etim eoffers
financial security to the em ployees. The insured pension schem e also has the
advantage ofoffering a reasonable pension in the eventofthe prem ature death ofa
m em ber,ifthe em ployeradopts a gratuity insured schem e in conjunction w ith the
superannuation schem e.
9. D escribeG roup insurancein lieu ofED LI
A ns:G roup insurance in lieu ofED LI [Em ployees D epositLinked Insurance Schem e
under PF] has been in operation in our country rightfrom 1952.In a significant
am endm entbroughtto the ProvidentFund A ctin 1976,G overnm entintroduced life
insurancecoverfortheem ployeesincluded in thePF schem e.Em ployersw ereasked
to rem it a fee of 0.5% of their w age bill and in return G overnm ent offered life
insurance coverto the em ployees.Thisschem e isknow n asthe Em ployeesD eposit
Linked InsuranceSchem e.
10. D escribeG roup lifeinsurance
A ns:G roup life insurance is one ofthe m ostcom m on form s ofem ployee benefitplans.
Em ployer-em ployeegroupsaccountform ostofthegroup coverage.
N atureofthecoverage:
M inim um sizeoflivesisrequired.
M aintanenceofareasonableaverageageisrequired
Individualeligibility requirem ents:1.Conditionspertaining to theirem ploym ent.
2.H em ustbeactivelyatw ork[thisrequirem entassuresareasonablem inim um of
health and physicalw ell-being and protects the insureragainstserious adverse
selection].3.A com pletion of w aiting or probationary period.U nder a non-
contributory plan,theem ployeeautom atically iscovered afterthecom pletion of
theprobationary period.U ndercontributory plan,theem ployeeisgiven aperiod
oftim e,know n as the eligibility period,during w hich he orshe is entitled to
apply forinsurancew ithoutsubm itting evidenceofinsurability.

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M O D U LE -II:TECH N ICA L A SPECTS O F IN SU RA N CE

D uration of coverage once the insurance becom es effective for a particular


em ployee,the protection continuesforaslong ashe orshe rem ainsin the service of
the em ployer. U pon perm anent term ination of service, the em ployee s coverage
continues for31 days beyond the date ofterm ination.This extension ofcoverage
givesthe em ployee an opportunity to replace the expiring protection w ith individual
insurance, to obtain em ploym ent w ith another firm w ith group insurance, or to
converttheexpiring term insuranceto acash-valueform ofinsurance.
11. D escribeG roup Superannuation Schem e.
A ns:Retirem entbenefitslikeprovidentfund and gratuity arepaid in lum psum ,w hich m ay
notbe invested w isely orsim ply spentaw ay by the recipients.Therefore,pension is
becom ing m ore and m ore popularforproviding a regularincom e afterretirem ent.
Im proved longevity on the one hand and the desire ofem ployersto retain loyaland
com petentem ployeesin theirserviceon theother,havem adepension m uch sought-
afterretirem entbenefit.A n em ployercan provideforpension by building lup afund
forthepurpose.Thecontributionsm adeby theem ployerareallow ed asm anagem ent
expenses underthe I.T.A ct,subjectto the m axim um of27% ofthe salary ofeach
em ployee.The em ployer s contribution is a non-taxable perk in the hands of the
em ployees.Thefund hasto bem aintained in an irrevocabletrustapproved by theI.T.
com m issioner.Instead of the em ployer him self m anaging the fund for providing
pension to hisem ployeeshecan think ofopting forthegroup superannuation schem e
offered by an insurer.
12. D iscusstheschem esoffered to non-conventionalgroups.
A ns:Forthenon-conventionalgroupsthefollow ing schem esareoffered.
1. Schem ecovering outstanding housing loans.
2. Schem esoffered to m em bersofcooperativebanks,creditsocieties,etc.
3. V ehicle loans granted by em ployers to theirem ployees can be covered under
group schem es.
4. G overnm enthasbeen encouraging group insurancecoverfortheeconom ically
w eaker sections of the society such as landless agricultural labourers,
beneficiariesoftheintegrated ruraldevelopm entprogram m esand thelike.

SEC TIO N C
(C A SE STU D IES)
1. V asundhara is president of a consulting firm that has ten em ployees. The only
em ployee benefitprovided by the firm is a paid tw o-w eek vacation forem ployees
w ith one orm ore years ofservice.The firm s profits have substantially increased,
and V asundhara w ould like to provide som e additionalbenefits to the em ployees.
N ancy w ould likeadviceconcerning thetypesofbenefitsto provide.A ssum eyou are
an em ployee benefitsconsultant.Based on the follow ing considerations,answ erthe
follow ing questions:
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M O D U LE -II:TECH N ICA L A SPECTS O F IN SU RA N CE

a. V asundharaw ould liketo providelifeinsurancefortheem ployeesequalto tw o


tim estheirsalaries.W hattypeoflifeinsurancedo you recom m end?
b. Several em ployees have expressed an interest in having incom e after
retirem ent. Explain to V asundhara how em ployees can have incom e after
retirem ent.
c. V asundhara w ould also like to provide health insurance benefits to the
em ployees.Identify the m ajortypes ofgroup health insurance plans thatshe
m ightconsider.
d. A rethereany othergroup insurancebenefitsthatV asundharashould consider?
Explain youransw er.
A ns:
a. G roup life insurance Itis the m ostcom m on group insurance provided to
em ployees.G roup lifeinsuranceisasim pleand econom icw ay ofproviding life
insuranceto em ployees.
b. G roup superannuation schem e A fterretirem ent,em ployeesneed financial
security.Theprovidentfund and thegratuity provided by theem ployerm ay not
besufficientin an inflationary econom y.Secondly such lum psum paym entsare
often utilised by the em ployeesto m eettheircurrentcontingentliabilities.The
em ployersobserved thattheem ployeesactually also need aperiodicalpaym ent
overand abovethenorm alterm inalbenefits.Such paym entism adein theform
ofpensionsby creating asuperannuation fund.Superannuation schem eaim sat
providing old agepensionsto em ployeesafterretirem ent.
c. G roup disability incom e insurance W orkers com pensation provided to
em ployees in the eventof w ork-related disability is often inadequate.These
benefitsalso failto coverdisability due to accidentsthatare notw ork-related.
The group disability incom e insurance available in m ost of the foreign
countries(butnotin India)provideseconom ic security to the em ployeesin the
eventofdisability.G roup disability incom e insurance is oftw o types -short
term plansand long term plans.
Short-term disability incom einsurance
Thisplan isalso know n asthe sick leave plan.Itpaysbenefitto the em ployees
for a short period of about six m onths.The em ployees are credited w ith a
certain num berofsick daysforeach m onth w orked.Iftheem ployeetakesm ore
sick daysthan heactually earned,then hissalary isreduced accordingly.
Such plansalso have an elim ination period,generally fora w eek.Itm eansthat
the benefitsare notpaid forthe firstw eek ofillnessordisability.By im posing
such a condition, the em ployer tries to reduce the m oral hazards like
m alingering and excessiveabsenteeism .U ndershort-term plans,only disability
thatisnotw ork-related iscovered.The am ountto be ascertained asdisability
incom ebenefitdependsupon theearningsoftheem ployee.Theshort-term plan
m ay orm ay notbeinsured.
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M O D U LE -II:TECH N ICA L A SPECTS O F IN SU RA N CE

Long-term group disability incom eplan


Thelong-term group disability incom eplan paysbenefitsforam inim um period
oftw o yearsand upto a m axim um age of65 years.Such benefitsare norm ally
paid on am onthly basis.Long-term benefitplansalso requireaw aiting period
of about3 m onths or m ore.These benefits are generally offered to fulltim e
em ployees only.U nder long-term disability plans,benefits are given to the
em ployees for both w ork-related and non-w ork-related injuries or disability.
D isability in thiscontextgenerally m eanstotaldisability.
d. G roup savings linked insurance schem e G roup savings linked insurance
schem e is a group insurance schem e,w hich is very popularsince itoffers a
survivalbenefitin addition to the death benefitavailable undera group term
assurancepolicy.
W here life insurance benefitsare notlinked to any statutory requirem ent,there
is often a dem and to link it w ith a survival benefit, particularly w hen the
em ployees com e forw ard to m ake contributions. The central governm ent
em ployee sgroup insuranceschem eisan exam pleofsuch acom bination.
Thisschem ew asintroduced w ith theobjectiveofproviding,low costinsurance
on a w holly contributory and self-financing basis,w ith a survivalbenefitto
help the fam ilies of the governm entem ployees in the eventof death of the
em ployees w hile in service,and a lum psum paym ent to the em ployees on
cessation ofem ploym ent.
Insurance com panies now offer a sim ilar schem e, w hich w as originally
form ulated to suitthe requirem ents of large public sector organisations like
BH EL,H H A L,H M T,LIC,G IC,etc.The schem e has since been extended to
reputed privatecom paniesand educationalinstitutions.
The group savings linked insurance schem e can be a contributory or non-
contributory schem e.Partoftheprem ium collected isthesavingsprem ium that
is accum ulated at the rate declared from tim e to tim e; a part is utilised to
providelifecoverin caseofdeath.
M ain features:
The em ployeracts as a facilitatorand coordinatorin m aintaining the schem e
and in m aking m onthly deductionsfrom salary
Contribution consists of risk prem ium and the savings portion.The savings
portion earnsinterestatthedeclared rate,com pounding yearly
A sperregulations,the life coverprem ium and contribution forsavingsshould
bein theratio 1:2 respectively
Em ployeesaregrouped into severalagreed categoriesbased on theirsalary and
therefore the contribution and coverage depend on the category to w hich the
em ployeebelongs

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Benefits
1. In the eventofdeath ofthe em ployee,the nom inee gets an assured sum w ith
accum ulated savingsand intereston thesam e.
2. O n retirem ent/resignation/term ination,only the accum ulated savings portion
w ith interestispayable.M onthly contribution ofem ployeesisexem pted under
Section 88 ofIT A ct1961.
R equirem ents
Thenum berofm em bersjoining theschem ehasto beatleast75% ofthetotalnum ber
ofem ployees.Theschem ehasto bem adecom pulsory forallthenew em ployees.
Theprem ium payableisbased on thew eighted m ean oftheagesofthem em bers.
Contribution isuniform foreach category.

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C hapter 11
FinancialG erontology and
SuperA nnuating Policies

SEC TIO N -A

1. Them eaning oftheterm G erontology is


a. Thescientificstudy ofold age.
b. Thescientificstudy ofyoung age
c. Thescientificstudy ofm iddleage
d. Thescientificstudy ofgenes
2. O ld peoplehaveto overcom etw o problem soffinancialim plications.They are
a. Experienceand senility
b. D eclining earning pow erand poorhealth.
c. Exerciseand physicalfitness
d. N oneoftheabove
e. A lloftheabove
3. In India thepercentageofold peoplein thepopulation is:
a. Increasing
b. D ecreasing
c. Rem ain thesam e
d. N o dataavailableto reach any conclusion
4. The persons em ployed in organized sector are better off than those in the
unorganized sectorbecause:
a. They haveassured incom eand em ployeebenefits
b. They arebettereducated
c. They aresubjectto very strictrulesand regulationsfram ed by theem ployer.
d. They areunderthecontrolofthetradeunion
5. O A SIS m eansin thiscontext:
a. A green patch w ith w aterresourcesin them idstofthedesert
b. A w aterfall
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c. Theprojectcalled O ld A geforSocialand Incom eSecurity


d. A projectforthew elfareofthefem alechild
6. V arishtha Pension Bim a Y ojana is:
a. A new LIC pension plan fortheyouth
b. A w ithdraw n pension plan forthepersonsaged above55
c. Thesam easJeevan D hara
d. A specialpension plan forw orking w om en
7. The insurance plans specifically m eant to m eet regular incom e needs, post
retirem ent,arereferred to as:
a. A nnuities
b. Endow m entplan
c. W holelifeplan
d. Term assurance
8. A geing atthebaserefersto
a. Increased lifeexpectancy dueto declinein thefertility
b. Increased lifeexpectancy dueto increasein thefertility
c. Increased lifeexpectancy dueto declinein them ortality.
d. Increased lifeexpectancy dueto increasein them ortality.
9. A geing attheapex refersto
a. Increased lifeexpectancy dueto increasein m ortality am ong theolderpersons.
b. Increased life expectancy due to reduction in m ortality am ong the older
persons.
c. D ecreased life expectancy due to reduction in m ortality am ong the older
persons.
d. Increased lifeexpectancy am ong theolderpersons.

SEC TIO N -A A N SW ER S
1. a 2. b 3. a 4. a 5. c 6. b
7. a 8. a 9. b

SEC TIO N B
1. W hataretheproblem sofageing?
A ns:There are tw o processes in the ageing ofpopulation;one is ageing atthe base and
second ageing atthe apex ofthe population.(the form erisdue to the decline in the
fertility and latterbecauseofreduction in m ortality am ong theolderpersons.) W hen
thepopulation ages,theshareofolderpeoplein population increasesw hiletheshare
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M O D U LE -II:TECH N ICA L A SPECTS O F IN SU RA N CE

ofchildren and youth decrease resulting in a rise in the m edian age (Conception,
1996).M edian agesum m arisestheagestructureofthepopulation.
These people becom e m ore vulnerable to health problem s. This leads to
physical disabilities such as blindness, deafness and other health related
problem s.
Theneedsoftheaged areno longerm etby theyoungerm em bersofthefam ily.
Em erging changesin technology havem inim ised theroleoftheelderly people,
as their know ledge and skills are outdated. A nd nuclear fam ilies are also
grow ing atam uch fasterrate.In thissituation,w ho w illtakecareoftheelderly.
Therehasalso been avastim provem entin thefield ofm edicineand health care,
w hich hasextended thelifespan ofm any.
2. D escribe O A SIS
A ns:G overnm ent of India launched the project called O A SIS (O ld A ge Social and
Incom e Security).Thisstudy indicated thatbetw een 1991 and 2016,the population
ofold aged,i.e.60 years and above w ould increase by 107% to 113.0 m illion and
w ould continueto grow rapidly in theyear2026 to 179 m illion w hich w illbe13.3%
ofthepopulation.
3. D escribethedifferentattributesto understand theproblem sofageing
A ns:Theaged population refersto peoplew ho havecrossed atleast60 years.They arenot
ahom ogeneousgroup.A nd theattributesarealso notsim ilar.To actually understand
theproblem sofageing,thediversity m ustbeunderstood.
Som eofthecharacteristicsofaged personsaregiven below :
Sex com position:A geand sex arethebasictoolsforany dem ographicanalysis.For
elderly population itisan indication ofdifferentialm ortality thattook place during
theirlife.M alesw hen com pared to fem aleshave higherm ortality rate.Thisleadsto
sex im balance w hen they becom e old.A ccording to the Censusso far,unlike other
countries,India has m ore num berofm ales.The sam e w as also true forthe elderly
population till1991.Itisinteresting to noteaccording to U N projections,thenum ber
ofw om en population (80+)islikely to increase.
A gecom position:A lm osttw o-thirdsoftheaged population,i.e.60 to 69 isdeclining
by each decade w hile others are increasing.Butin absolute term s,population is
increasing in alm ostallagegroup categories.In 1961 therew asan increasein theage
group category of70-79 w hen com pared to othercategories.
Place ofR esidence:Itisseen thatthree outoffourelderly are found in ruralareas.
Thisisexpected sincethree-fourthsoftheIndian population livesin ruralareas.
M aritalStatus:The distribution ofm aritalstatusam ong the elderly isvital.Itisan
age w herein everyone requires a partner.Children and grandchildren tend to spend
lessand lesstim ew ith theelderly people,asthey arebusy w ith theirow n activities.A
study show s thatthe percentage ofw idow ed w om en w as m ore w hen com pared to

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M O D U LE -II:TECH N ICA L A SPECTS O F IN SU RA N CE

thosew ho arecurrently m arried and in caseofm alesitw astheotherw ay round.This


indicated thatthew ivesw erem uch youngerto theirhusbandsand thereforetended to
outlivetheirhusbands.
Literacy level: M ajority of elderly population is illiterate and thatincludes both
m alesand fem ales.In 1961 only 29% ofm alesand 4% offem ales(60+)w ereliterate.
In 1991 itjum ped to 41% and 13 % .
Em ploym ent: U sually during old age the level of incom e reduces, and
sim ultaneously expense pertaining to health increases.Rem aining em ployed even
aftertheageof60 isnotdesirable.Butthisatthesam etim ehascertain advantages.It
reducesboredom ,lonelinessand unw antedness.
4. W hatarethealternativew aysofm anaging theretirem entrisk?
A ns.A lternatives w ays ofm anaging the retirem entrisk:There are m any individuals
w ho w ork even aftertheirretirem entageto receiveincom e.They fully avoid therisk
ofoutliving theirincom e.Even iftheperson continuesto w ork,itisforsurethatafter
acertain age(65 and above)hew illnotbephysically strong to givehisbestand earn
sufficientincom e.
5. From an individualspointofview w hatarethetw o im portantcontingencies?
A ns.Therisk ofprem aturedeath and theproblem ofliving too long afterretirem ent.
6. W hatare the dynam icsoffinancialsecurity? H ow to overcom e the problem sof
outliving assets?
A ns.A tpresentthe currentpopulation isliving a longerlife span afterthe retirem entage.
Sim ultaneously people are retiring earlieras organisations are also providing early
retirem entpackagesto the em ployeesso thatthey can em ploy youngerpeople w ith
betterskillsatm uch lesscost.
There are actually tw o risks linked w ith retirem ent.The firstbeing the risk ofthe
person being leftw ith insufficientassetsto m anageduring thepostretirem entphase.
Thesecond risk istherisk ofoutliving theassetsthathad been accum ulated.Even if
the assetsare utilised properly afterretirem ent,itisdifficultto calculate how m uch
ofthe assetshould be used every yearin orderto ensure thatthe incom e from the
assetslaststilltheend oftheindividualslifetim e.
The second risk is m uch easierto explain.The annuity principle can be utilised to
changean accum ulation into an incom eso thatan individualcannotoutlivetheasset
collected.A nnuities are considered as vital tools in adm inistering and m anaging
retirem entrisk and they arethebestsolution forthesecond problem .
7. D escribetheretirem entplanning process.
A ns.Retirem entplanning issim ilarto thatoflife insurance planning.Itconsistsofthree
steps.
The firststep isto estim ate the future incom e needed afterretirem ent.Itisalso

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M O D U LE -II:TECH N ICA L A SPECTS O F IN SU RA N CE

im portantto identify existing resourcesto m eettheseneeds


The second step is to decide how these funds w illbe accum ulated.The fund
m ustbe sufficientenough to contribute the difference betw een the resources
thatare available and w illbe needed to give the necessary retirem entincom e.
Further appropriate am ount needs to be added to m eet health care and
hospitalisation expenses,astheold arem oreproneto health related problem s.
Finally,the individualhasto decide how the fund isto be consum ed.H e needs
to consider his likely period of life after retirem entand the provisions to be
m adeforthespouse.
8. W hatarethefinancialneedsoftheaged?
A s the individualgrow s olderhis stam ina decreases.There com es a tim e w hen the
individualisno longerable to w ork and atthistim e hisincom e ceases.Even ifthe
individualgetsinto aparttim ejob,itw ould bestrenuousforhim and w ould givehim
very m eagre incom e.Ithas been estim ated thatatleast80% ofthe incom e earned
during serviceisnecessary to m aintain thesam estandard ofliving afterretirem ent.If
theparttim eem ploym entand theinterestfrom savings/annuitiesdo notm akeup this
80% ,thereisaproblem .Theindividualconcerned w illhaveto reconcilehim selfto a
fallin thestandard ofliving.
A s an individualgrow s olderhe tends to spend less foritem s ofluxury.Expenses
relating to health increasesforhim .Itm ightbe a tem porary sickness,orsom e long-
term disability.In such a situation w hat can the individual do? H e should have
planned in advance the accum ulation of funds to m eet the expenses directly or
through insurance.
9. D escribe threelegged stool in thecontextofeconom icsecurity.
A ns.In thew est,retirem entneedsarem etthrough threesources:
Socialsecurity
Em ployerssponsored benefitschem es
Privatesavings
These3 aretraditionally considered thethreelegson w hich theretirem entstool
stands.
In India the situation is com pletely different the governm entdoes nothave
sufficientfundsto m eettherequirem entsofthegrow ing population ofaged.

SEC TIO N -C
(C A SE STU D IES)
1. In our country,m ostpeople are conditioned to think thatpost-retirem entliving
m eansscaling dow n thestandard ofliving.Butin reality,thatissom ething ofam yth.
A little planning,som e forethoughtand a clearunderstanding ofoptionsm ay be all
thatisneeded to live a retired life like a prince,albeitofa sm allnation.Savingsfor

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retirem entshould be in the risk free instrum entsthatofferregularcash flow sasper


the requirem ents.
a. W hattypeofrisksisonerequired to facein thepost-retirem entdays?
b. H ow can thelifeinsuranceproductshelp oneto m eetthefinancialrequirem ents
in thosedays.
A ns.
a. The greatestburden on an old m an isthe need to be econom ically dependent.
W ith retirem ent,the regularincom e ofa person stopsand one m ay notbe able
to startanotherw orking lifeduring thepostretirem entdays.O neisrequired to
depend on the earlier savings m ade w hile w orking.A tthe sam e tim e,som e
expenses,especially the m edicalexpenses,generally go up ow ing to the very
natureofthegeriatricproblem s.Even asm allincreasein pricesm ay w orsen the
situation.D ue to these reasons,one m ay end up w ith an em pty purse as the
possibility offurtherinflow offundsm ay dry up.Even the required am ountof
m oney m ay notbeavailableto satisfy them ostbasicphysiologicalneeds.
b. Life insurance products can provide the required am ountoffunds to a person
during these days.O ne m ay buy a suitable annuity plan eitheron retirem entor
during thew orking life,depending upon theconvenience.A tthetim eofbuying
such plan,one m ay decide the nature ofcash flow sasperthe expected future
requirem ents.In India,thepension m arkethasnotyetdeveloped properly.LICI
has developed a few such products to m eet the varying requirem ents of
differenttypesofindividuals.O nem ay chooselifeannuity orannuity certain or
joint-life lastsurvivorannuity depending upon the needsofselfasw ellasthe
spouse. LICI also offers a refund option to m eet the necessities of other
dependents.Butw hatever m ay be the choice,one can getthe assurance of
regularincom eduring thepost-retirem entdays.
2. A spertheIndian psyche,itiscom fortableto think thatyoung son(s)w illtakecareof
theparentsduring theirold age.Theannuity plan can actasabonusto such thinking.
In theageofnuclearfam ilies,onem ay feellonely follow ing theend ofw orking life.
D uring thepost-retirem entperiod,everyonedesiresto befinancially m oresecureand
independent.Proper post-retirem entplanning can help one to retain the financial
freedom asenjoyed during theactivew orking life.
a. W hat type of annuity product w ill you suggest to retain the financial
independenceofselfasw ellasthespouse?
b. D o you feelthenecessity to liquidateapension schem eand should thatbeatthe
option oftheannuitant?
A N S.
a. Thesuggested annuity productshould bejoint-Lifeand LastSurvivorA nnuity.
U ndersuch plan,theinsurerw illstartthepaym entoftheinstallm entsasperthe
requirem ent of the annuitant.The periodical paym ent w ill continue till the
survivalofthe annuitantasw ellasthe spouse.Follow ing the death ofeitherof
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M O D U LE -II:TECH N ICA L A SPECTS O F IN SU RA N CE

them ,the am ountofannuity installm entw illbe reduced by 50% ofthe norm al
annuity.The annuity plan forthe surviving spouse w illcontinue aslong ashe/
she survives.In case ofa deferred annuity program m e,the annuitantm ay also
prefer a cash option,if required,to w ithdraw a lum psum am ount from the
accum ulated fund.
b. N o such option should be given to the insured.Ifthe option is available,one
m ay notbe able to resistthe tem ptation ofw ithdraw ing thatm oney assoon as
any need arises,how everm inoritm ay be.This m ay also resultin em ptiness
during the very old age of the annuitantw hen allother sources of earnings
m ightdry up.In thatcase,the very econom ic purpose (to provide a regular
incom e to the annuitantduring old age)ofannuity w illnotserve itspurpose at
all.Since the basic objective has failed,no such option should be allow ed
during the lifetim e ofthe annuitant.H ow ever,considering the interestofthe
survivors (successors)ofthe annuitant,thatoption m ay be allow ed only after
thedeath oftheannuitant.

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C hapter 12
A ctuarialV aluation
SEC TIO N -A
1. Lifefund isdefined as:
(a) Theprem ium balanceaccum ulated afteradding theexpenses.
(b) Theprem ium balanceaccum ulated beforeadding theexpenses.
(c) Theprem ium balanceaccum ulated afterdeducting theexpenses.
(d) Theprem ium balanceaccum ulated afterm ultiplying theexpenses.
2. Theform ula forthecalculation ofprospectivereserve:
(a) tV x = A x+t Px x+t
(b) t+1V X = A x+t Px+tax+t
(c) tV x+t= A x Px+t x+t
(d) tV x = A x+t Px+t x+t
3. V aluation surplusisdefined as:
(a) [Lifefund presentvalueoffuturepreview s]+ [presentvalueoffutureclaim s]
(b) [Lifefund + presentvalueoffuturepreview s]x [presentvalueoffutureclaim s]
(c) [Lifefund x presentvalueoffuturepreview s] [presentvalueoffutureclaim s]
(d) [Lifefund + presentvalueoffuturepreview s] [presentvalueoffutureclaim s]
4. D eath strain isdefined as:
(a) Sum insured (s)+ policy value
(b) Sum insured (s)% policy value
(c) Sum insured (s) policy value
(d) Sum insured m ultiplied by policy value
5. Expected death strain isequalto:
(a) Q x (s+v)
(b) Q x (s+v)
(c) Q x (s-v)
(d) Q x (s-v)
6. M ortality surplusisequalto:

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(e) [Q x qx][S V ]
(f) [Q x S Q x V qx S + qx V ]
(g) [Q x qx][S V ]
(h) a& b
7. G iven thatA = principal;I= interest;n isno ofyears.W hatisthe form ula for
accum ulated valueof1:
(a) S = A [1+i]
(b) S= A + [1+i]n
(c) S = A [1+i]n
(d) none
8. Presentvalueisequalto (un)=
(a) 1/(1+i)
(b) 1/(1+i)n
(c) [1+i] n
(d) b & c
9. A ccum ulated valueofseriesofpaym entsissym bolized by w holepaym ent m ade
attheend ofyear:
(a) Sn+(1+i)
(b) Sn+
(c) (1+i)+ (1+i)2 + (1+i)3 + + (1+i)n
(d) b & c
10. Presentvalueofseriesofpaym entsofallim m ediateannuity:
(a) n+ (b)an+ (c)a& b (d)none
11. Theprocessofvaluation in a lifeinsurancecom pany istaken up by:
(a)A n A ctuary
(b)Chartered A ccountant
(c)A financialanalyst
(d)A surveyor
12. V aluation in lifeinsurancem eans:
(a) Theprocessofarriving attheprojectofalifeinsurancecom pany
(b) Theprocessby w hich thevalueofalltheexisting policiesisascertained in alife
insurancecom pany
(c) Theprocessofdeterm ining thenetprem ium foralifeinsurancepolicy
(d) Theprocessofarriving atthe bonus in alifeinsurancecom pany
13. Them athem aticalestim ation oftherisksinvolved in lifeinsuranceisbased on:

II-104
M O D U LE -II:TECH N ICA L A SPECTS O F IN SU RA N CE

(a) Thelaw sofprobability


(b) Thelaw sofgrevity
(c) Parkinson slaw
(d) M illerslaw ofinsurance
14. W hatisactuarialrisk?
(a) Itistherisk thatactuariesareexposed to
(b) Itisanotherexpression form arketrisk
(c) Itissaveaslegalrisk
(d) Itistherisk thatarisesfrom an insurerdeveloping fundsvis a vistheissuance
ofinsurancepoliciesand otherliabilities
15. Pricing risk m eans:
(a) Risk arising outofpricing an insuranceproducttoo high
(b) Therisk caused dueto inadequatepricing ofproducts
(c) Risk arising outofinterestratem ovem ents
(d) Therisk ofbecom ing insolvent

SEC TIO N A A N SW ER S
(1) c (2) a (3) d (4) c (5) c (6) d
(7) c (8) d (9) d (10) b (11) a (12) b
(13)a (14) d (15) b

SEC TIO N B

1. Statethecontribution principleand nam ethethreefactorsin thisprinciple.


A ns.The contribution principle aim s to obtain equity during the distribution ofsurplus.
A ccording to thisprincipleaw ay ofobtaining reasonableequity w ould beto return
to each class of policy ow ners a share of the visible surplus proportionate to the
contribution oftheclassto thesurplus
Thethreefactorsin thisprincipleare:
(i) Loading savings
(ii) Excessinterests
(iii) M ortality savings
2. N am ethedifferentm ethodsfordistribution ofdirigiblesurplus?
(a) Contribution m ethod
(b) Sim plereversionary m ethod
(c) Com pound reversionary bonussystem
(d) Bonusin cash
II-105
M O D U LE -II:TECH N ICA L A SPECTS O F IN SU RA N CE

(e) Bonusin reduction ofprem ium


(f) O netim ebonus
(g) Interim bonus
(h) G uaranteed bonus
(i) Finaladditionalbonus
3. N am ethedifferentm ethodsofliability valuation.Explain prospectivem ethods?
A ns.Therearedifferentm ethodsofliability valuation asfollow s:
(a) Prospectivem ethod
(b) N etprem ium m ethod
(c) M odified netprem ium m ethod
(d) G rossprem ium m ethod
(e) G rossprem ium m ethod forw ith profitpolicies
(f) Retrospectivem ethod
Prospective m ethod:itisthe currentvalue offuture prem ium and the currentvalue
ofclaim s.
(a): prospective reserve = (Life fund + P.V offuture prem ium s) (P.V offuture
claim s)
Theform ulaforprospectivem ethod is:
V
t x = (S.
A )A x+t Px. x+t
W here:
(a) Itisthe deviation elapsed since the date ofcom m encem entofthe policy.Itis
reckoned in integralnum berofyears.
(b) X istheageasin during thelastbirthday (or)nextbirthday asperthepractice
oftheoffice.
(c) It is obtained by calculating the difference betw een the calendar year of
valuation and calendaryearofcom m encem entofthepolicy butadjustm enthas
to be m ade w ith regard to the m onthsofvaluation and the m onth in w hich the
policy begins
(d) X +tisthe valuation age.Itiscalculated by adding the deviation elapsed (t)to
theage(x)
4. W hataretherisksinvolved in providing insurancecover? D escribepricing risk.
A ns.1. A ssetrisk
2. Pricing risk
3. Interestraterisk
4. M iscellaneousrisks
Pricing risk:Thisisalso called asthepricing inadequacy risk.Thisistherisk caused
due to inadequate pricing ofproduct.The risk arises as the future operating results

II-106
M O D U LE -II:TECH N ICA L A SPECTS O F IN SU RA N CE

arenotanticipated w hilepricing theproduct.Thusthepriceisinadequateform eeting


futureliabilities.Therefore,dueto inadequatepricing ofproduct,liabilitiesincrease.
W hen theliabilitiesrisebeyond theassetsavailable,itcausesinsolvency.
The inadequate pricing is the resultof occurrence of events atrates higher than
anticipated relating to thefollow ing
(x) M ortality
(x) M orbidity
(x) Lapse(or)expenses
(x) Low erinvestm entincom e
(x) Low ersales
(x) Increased costs to be m etw hile providing health care as required under the
policy
5. W hataretheassum ptionsunderlying ratecalculations?
A ns.Som eofthefactorsthatneed to bebornein m ind by theinsurerw hilecom puting the
interestrateare:
(a) W hen istheprem ium paid?(e.g:annually,sem iannually?)
(b) W hatisthedeviation forw hich theprem ium hasto bepaid (no.ofyears)
(c) H ow w illm ortality ratesbedeterm ined?
(d) W hatw illbecom eofthem oney from thetim eitisreceived tillitispaid back to
thepolicyholder
(e) A geoftheassured
(f) Sex oftheassured
(g) M ortality tableto beused forthatparticularcustom er
(h) Rateofinterest
(i) Sum set aside to cover the expenses incurred by the insurer to m eet
contingenciesand m argin forprofit
(j) Benefitsto beprovided underthepolicy
(k) Prem ium can bepaid asalam psum
(l) Prem ium can bepaid throughouttheexistenceofthepolicy on aregularbasis

SEC TIO N C
(C A SE STU D IES)
1. Iam paying R s.100 yearly attheend oftheyearfrom 2006 to end of2010,atthe
rateof6% regularly,W hatisthepresentvalueoftheannuity paym ents.
Sol: G iven thatn= 5:i= 6 % ,paym entsRs.100 peryear
=> presentvalue= a5+= 100 v+100v2 + 100v3 + 100v4 + 100v5
=> a5+= 100 [v+v2+v3+v4+v5].@ 6%
II-107
M O D U LE -II:TECH N ICA L A SPECTS O F IN SU RA N CE

100 [(1/1.06)+ (1/1.06)2 + + (1/1.06)5]


100 [0.9434 + 0.8899 + 0.8396 + 0.7921 + 0.7473]
100 (4.2123)
421.23
2. In a savingsaccountplan,a person paying R s.2073/-atthe end ofeach ofthe
yearitispaying attherateof7% p.a.Ifhepays10 yearsannuity paym entsw hat
w ould beaccum ulated valueofthatpaym ents?
Sol: G ivethat:paym entsofRs.2073;i= 7% ;n = 10 years
=> A ccum ulated value:S10+= 2073 (1+07)+ 2073 (1.07)2 + + 2073(1.07)10
= 2073 [(1.07)+ (1.07)2 + + (1.07)10]
= 2073 [1.07 + 1.1449 + 1.2250 + 1.3108 + 1.4026 +
+ 1.5007 + 1.6058 + 1.7182 +1.8385 + 1.9672]
= 2073 [14.7837]= 30646.6101

II-108
DIRM
MODULE III

RISK MANAGEMENT AND


REINSURANCE
MODULE III
RISK MANAGEMENT AND REINSURANCE

Chapter 1
Economics of Insurance .........................................................................................III-1
Chapter 2
Introduction to Risk Management ........................................................................III-11
Chapter 3
Essentials of Risk Management...................................................III-20
Chapter 4
Probability ............................................................................................................III-27
Chapter 5
Decision Making Under Conditions of Uncertainty ............................................III-34
Chapter 6
Risk Management Process....................................................................................III-38
Chapter 7
Risk Management by Business and Enterprise Risk Management (ERM)...........III-47
Chapter 8
Reinsurance Theory ..............................................................................................III-54
Chapter 9
Methods of Reinsurance .......................................................................................III-60
Chapter 10
Treaty Wordings ...................................................................................................III-66
Chapter 11
Reinsurance Accounts and Administration ..........................................................III-73
Chapter 12
Reinsurance Regulations ......................................................................................III-79
Chapter 13
Reinsurance Markets ............................................................................................III-86
Chapter 14
Inward Reinsurance ..............................................................................................III-96
Chapter 15
Reinsurance Practice ............................................................................................III-98
M O D U LE-III:RISK M A N A G EM EN T A N D REIN SU RA N CE

C hapter1
Econom icsofInsurance

SEC TIO N A

1. N extbestuseofresourceiscalled:
a. W isdom
b. Expected cost.
c. O pportunity cost.
d. M arginalcost.
e. N oneoftheabove.
2. Econom ic theory states that prices exactly m easure opportunity costs if all
m arketsare:
a. Com petitive
b. Im perfect
c. Perfectly com petitive
d. O pen m arkets
e. N oneoftheabove.
3. O neofthefollow ing isnotessentialforcom petitiveinsurancem arket:
a. Econom icefficiency isachieved by m arketcom petition.
b. Each firm and supplier in a com petitive m arketm akes continuous efforts to
innovate.
c. Ifthe m arketdoes notsufferfrom significantim perfections,there w illbe no
need forgovernm entregulations.
d. N ot only product and factor m arkets but also financial m arkets including
insurancem arketssufferfrom asubstantialdoseofim perfections.
e. N oneoftheabove.
4. M arketfailureiscom m only discussed in term softhesegeneralproblem s:
a. M arketstructure.
b. M arketinform ation.
c. Publicgoods.
d. A lltheabove.
e. N oneoftheabove.
III-1
M O D U LE-III:RISK M A N A G EM EN T A N D REIN SU RA N CE

5. O neofthefollow ing isan asym m etricinform ation problem :


a. Lem onsproblem .
b. A ge.
c. Sum assured.
d. A lltheabove.
e. N oneoftheabove.
6. Ifa few buyersorsellersareableto influencethepriceofa product/service,w e
callit ..
a. Inform ation perfection.
b. Pricediscovery.
c. M arketpow er.
d. A lltheabove.
e. N oneoftheabove.
7. Thesearethew aysin w hich m arketpow erarises:
a. Barriersto entry.
b. Productdifferentiation.
c. Pricediscrim ination.
d. A lltheabove.
e. N oneoftheabove.
8. Insurersin India have to secure license from IR D A to startinsurance business.
Itisan exam pleof:
a. M arketperfection.
b. M arketim perfection.
c. Barriersto entry.
d. A lltheabove.
e. N oneoftheabove.
9. Productdifferentiation in insurancecan beoffered through:
a. Q uality product.
b. A ftersaleservice.
c. Provision ofriders.
d. B& C.
e. N oneoftheabove.
10. W hen a single firm can produce a num ber ofproducts/servicesatcostslow er
than thoseby m ultiplefirm s,itisa caseof
a. Econom iesofscale.
b. Econom iesofscope.
III-2
M O D U LE-III:RISK M A N A G EM EN T A N D REIN SU RA N CE

c. Com petitiveadvantage.
d. A lloftheabove.
e. N oneoftheabove.
11. The tendency ofindividualsto alter their behaviour because ofthe presence of
insuranceisreferred to as:
a. Lem onsproblem .
b. Principal-A gentproblem .
c. M oralH azard problem .
d. Info-gapproblem .
e. N oneoftheabove.
12. O neofthefollow ing doesnotform partofPublicG oods;
a. Publiceducation.
b. Publicparks.
c. Fireprotection services.
d. H otelsand Restaurants.
e. N oneoftheabove.
13. O neofthefollow ing isnottrue:
a. Externalitiesoccurw hen actualcostsofproducing a good /service are greater
than accounting costs.
b. Externalities occur w hen a firm s production or an individuals consum ption
has directand uncom pensated effectson others.
c. Positiveexternality occursifothersbenefit;negativeexternality occursifcosts
areim posed on others.
d. M ost environm ental problem s involve externalities and m ost of them are a
consequenceofshifting costs.
e. N oneoftheabove.
14. W hen a failure of a financial institution leads to failures of other financial
institutionsin them arket,itisa caseof:
a. M arketfailure.
b. Cascading failure.
c. Rippleeffect.
d. O rchestrated failure.
e. N oneoftheabove.
15. O ccurrenceofrunsin India isnorm ally notpossible,becauseof:
a. Regulators.
b. M onopoly m arketstructure.
III-3
M O D U LE-III:RISK M A N A G EM EN T A N D REIN SU RA N CE

c. G overnm entintervention.
d. W eak publicresponse.
e. N oneoftheabove.

SEC TIO N -A A N SW ER S
1. c 2. c 3. e 4. d 5. a 6. c
7. d 8. c 9. d 10.b 11.c 12.d
13.e 14.b 15.b

SEC TIO N -B

1. O utlinetheconditionsforperfectly com petitivem arkets.


A ns.The conditions necessary for a perfectly com petitive m arket(including insurance
m arket)to existrequire perfectand fullinform ation,perfectforesighton the partof
m arketparticipants and instantaneous m arketadjustm ents ofprices and quantities.
W em ay discusstheconditionsin som edetail.
1. A largenum berofsm all,autonom ousbuyersand sellersso thatno singlebuyer
orsellernorany group ofbuyersorsellerscan influence the m arket.They are
price takers and cannotinfluence the price of the productas determ ined by
forcesofdem and and supply.Thisassum ption also im pliesthatneitherbuyers
norsellerscollude.
2. There existno barriers to entry into orexitfrom the m arket.Ifthe potential
entrants see thatthe existing firm s in the industry are reaping excess profits,
they try to m akean entry into them arket.Itisnotadequateiftheexisting firm s
takeappropriateaction to m aintain theirposition and profitsin them arketafter
the potentialentrants enterthe industry.The existing firm m ustanticipate the
entry ofnew com petitorsand take appropriate stepsto prevententry.Existing
firm s w illseta price thatw illyield only norm alprofits,ifthere is a threatof
new entry.In a com petitive m arket,firm s w illexitfrom the industry,ifthey
cannot m ake even norm al profits or they expect to m ake greater profits in
anotherindustry in them arket.
3. Buyersand sellersin the m arketare w ellinform ed aboutthe products.Thatis,
producersand consum ershavealltheinform ation thatisrequired form aking a
decision in regard to the productorservice in question.N o one has superior
know ledge,w hich isnotavailableto another.
4. Producers produce and sell identical products. That is, there exists no
differentiation ofproducts.A s a result,buyers have no reason to pay m ore or
lessthan them arketpricefortheproductsofany firm in theindustry.
2. Therearefourw aysin w hich m arketpow erarises. Explain them briefly.
A ns. (i)Barriersto Entry orExit.
III-4
M O D U LE-III:RISK M A N A G EM EN T A N D REIN SU RA N CE

(ii) ProductD ifferentiation.


(iii) PriceD iscrim ination.
(iv) Econom icsofScaleorScope.
(i) Barriersto entry orexit:
Suppliersaresaid to possessm arketpow eriftherearebarriersto entry ofnew firm s
into or exit of existing firm s from the industry.G overnm ents often set up such
barriers for the supposed benefitof the public.A s barriers to entry becom e m ore
form idable,them arketpow erofexisting firm sincreases.M arketpow erm eanssom e
discretion over price for the firm s. M arket pow er m ay also m ean the ability to
influence the policies of governm ent and consum er preferences. A n exam ple of
governm entcreating barriersto entry.Insurersin Indiahaveto securealicencefrom
IRD A to enter insurance business and should have a certain m inim um financial
capitalbasebesidesotherregulations.
To m aintain theirprofitsorm arketshare,allfirm sattem ptto create barriersto entry
ofnew firm sinto an industry.Theexisting insurancefirm sm ightcreateentry barriers
by developing highly sophisticated expertise in selecting lives for insurance by
devoting financial,technicaland hum an resources.
Creation ofbarriersto entry to acquirem arketpow erby collusiveaction ofinsurance
com panies is generally view ed w ith suspicion.Barriers to entry ofnew firm s into
insurance m arkets are being reduced w orld overw ith the spread ofthe process of
liberalization.
(ii) ProductD ifferentiation :
M arketpow erissaid to existin them arketifan insurancecom pany can differentiate
itsproductsfrom thoseofitscom petitorsin them indsofitscustom ers.Theexistence
ofproductdifferentiation issaid to existifbuyerspreferthe productsofa firm over
those of its com petitors.The differences betw een products need notbe real;The
custom ers have to perceive difference in product quality, convenience, service,
m arketreputation etc.Insurers alloverthe w orld try to differentiate theirproducts
from those of other insurers in respectof provision of riders,after sales service,
conferring additionalbenefits,etc.
(iii) PriceD iscrim ination :
In purely com petitivem arkets,allfirm schargethesam epriceforidenticalproducts.
Pricediscrim ination issaid to occurw hen afirm chargesdifferentpricesto different
groupsofcustom ersforthe sam e product.Thisw illlead to the firm gaining m arket
pow erand securing higherthan norm alprofits.Insurance com paniesm ay attem ptto
practicepricediscrim ination butfortheregulatory restrictionsim posed by regulatory
authorities. W hen the com petition in insurance m arkets becom es intense, each
insurer tries to m aintain or increase its m arketshare and secure higher profits or
m aintain itsprofitsby resorting to m arketsegm entation and chargedifferentpricesin
each segm ent.

III-5
M O D U LE-III:RISK M A N A G EM EN T A N D REIN SU RA N CE

(iv) Econom icsofscale:


W hen a firm saverage costofproduction decreasesasoutputincreases,the firm is
said to beobtaining scaleeconom ies.In such asituation,thelargerthefirm ,thelow er
isitsaverageunitcostofproduction.Thisw orksasabarrierto entry ofnew firm sas
the new firm s cannot successfully com pete w ith the existing large firm s in the
m arket.W ith m arketw idening and deepening,there should be even less concern
aboutm arketim perfectionsbecauseofscaleeconom ies.
3. Explain theproblem sofasym m etricinform ation.
A ns.i) Lem ons problem s
ii) PrincipalA gentproblem s
iii) Problem sofadverseselection
iv) M oralhazard problem s
(i) Lem ons problem s:A lem ons problem occursw heninsuredknow slessthanthe
insurer aboutthe insurer and its products.Insureds purchase insurance policies in
good faith. Insurance, especially life and health insurance, is a technical and
com plicated subjectand very few insured have the know ledge to understand the
financialstrength ofthe insurer.A bulk ofinsurance regulation ism eantto take care
of the lem ons problem for insurance custom ers. That is the m ain reason for
G overnm entintervention asw ellasregulation in the m arketand m andating certain
disclosureson thepartofinsurers.
(ii) Principal-A gent Problem s: The agent is interested in m axim izing his or her
personalgain.Thism ay notbe alw ayscom patible w ith the objective ofm axim izing
the gain of the principal. The principal agent problem s relating to insurance
business include the m ethod of ensuring thatthe agentdoes notm is-representor
w ithhold the necessary inform ation about the insured and its products from
custom ersorw ithhold vitalinform ation relating to thecustom erfrom theinsured.
Theprincipal-agentproblem scanbetoalargeextentaddressedbyprovidingincentives
anddisincentivesaim edataligningtheinterestsoftheprincipalw iththoseoftheagent.
(iii) Problem s of A dverse Selection: This problem arises w hen the custom er better
know sthe custom erssituation than the sellerofinsurance.The problem ofadverse
selection iscom m on in insurance m arketsalloverthe w orld.To fix a fairprem ium
thatreflectstheexpected valueofthelossesofthepotentialinsured,theinsurerm ust
havefulland relevantinform ation abouttheinsured.Theinsurancecom pany cannot
alw ays be sure thatthe potentialinsured has provided allrelevantinform ation.By
w ithholding som e vitalinform ation regarding theirinsurability,som e ofthe insured
m ay beableto obtain favourablepricesand term sand conditions.
(iv) M oral H azard Problem s: The tendency of individuals to alter their behaviour
becauseofthepresenceofinsuranceisreferred to asm oralhazard problem .Insurers
are overly concerned aboutthe possibility thatthe beneficiary undera life insurance
policy m ightattem ptatshortening the life ofthe insured.A notherexam ple ofm oral

III-6
M O D U LE-III:RISK M A N A G EM EN T A N D REIN SU RA N CE

hazard:Insurance com panies m ightbe concerned aboutselling a disability incom e


policy underw hich theinsured m ightobtain paym entthatism orethan hecould earn
from em ploym ent.
4. W hatdo you understand by FreeR iderproblem sorPublicG oods?
A ns.A purely public good isavailable to everyone w hetherthey pay foritornotand can
beenjoyed byadditionalpeopleatnocosttoanyone.A classicexam pleofapurepublic
good that is often cited is national defence.Public benefit from national defence
including thosew ho do notpay tax and itdoesnotcostany m oreto add consum ers ,
w hetherthrough birthsorim m igration.A notherfeature ofthe public goodsisthatthe
overallopportunity costofadditionalusersisessentially zero.A stheopportunity cost
iszero,from theperspectiveofthesociety thepriceshould bezero.
A sno one can be excluded from the enjoym entofthe public good everyone thinks
w hy botherto pay forit the problem ofa free rider.M ostpublic goodssufferthis
free riderproblem .Ifsom e beneficiariesdo notpay forthe good,a producerin the
private sector w ill not earn adequate revenue to cover production costs i.e. the
producerincurslossesand hencetheproduction activity ofthatgood in theeconom y
m ay be ham pered.Ifthe supply ofthe good is to be ensured to the consum ers,the
governm entw illhave to produce thatgood.G overnm ents generally provide public
goods,by financing them from societalrevenues(m ainly taxes).The existence ofa
tax system isjustified to an extentby theexistenceofpublicgoods.
W hile pure publicgoodsarenotallthatcom m on,m any goodshavesom e public
goodness in them .Exam plesofpublicgoodsincludepubliceducation,lighthouses,
police,public parks,public libraries,fire protection services,and basic research and
developm ent.
Insurance industry is characterized by the existence of free rider problem s. For
exam ple, w hen an association of insurance com panies lobbies for favorable
legislation,allinsurance com panies w hetherm em bers ofthe association ornot-
m ay benefit. Insurance related free rider problem s can occur w hen individuals
know that they w ill receive free em ergency m edical care and so decide not to
purchaseprivatehealth insurance.
5. A ttem pta noteon ExternalitiesorSocialC osts.
A ns.Externality the fourth category of m arket failure is considered the m ost
appropriate forrisk analysis.Externalities occurw hen actualcosts ofproducing a
good or service are greater than accounting costs.Thatis,producers can im pose
positive and negative spillovereffects on others.M ostenvironm entalproblem s
involveexternalitiesand m ostofthem areaconsequenceofshifting costs.
Externalities occur w hen a firm s production or an individuals consum ption has
directand uncom pensated effects on others.Positive externality occurs ifothers
benefit;negativeexternality occursifcostsareim posed on others.
W hen externalities are present (such as a m anufacturing facility w hich pollutes

III-7
M O D U LE-III:RISK M A N A G EM EN T A N D REIN SU RA N CE

environm ent) direct costs of production (input costs) do not reflect fully true
econom ic costsofproduction,because ofim position ofuncom pensated costson the
neighborhood.A stheproducerisableto shiftapartofthetrueproduction costs,costs
of production are understated,and the firm s product prices are low er than they
should truly be.A saresult,thefirm w illproduceoutputlargerthan w hatisoptim alor
socially desirable,thereby further contributing to pollution.Thus,w here negative
externalitiesarepresentin theproduction ofagood orservice,too m uch ofthegood,
orservicew illbeproduced orconsum ed,thepricew illbelow and too littleresources
and effortw illbe devoted to m itigate orelim inate the externality.In contrast,w here
positive externalities are present,too little ofthe good orservice w illbe produced,
price w illbe high in the m arketand notm uch effortand resourcesw illbe deployed
forthepurposeofenhancing thepositiveexternality.
Itis observed thatlife and health insurance industries w itness both negative and
positive externalities. O ne striking exam ple of negative externality existing in
insurance relates to fraudulent claim s m ade by insured w hich lead to higher
prem ium s for everyone.Black and Skipper cite an extrem e exam ple of negative
externality som etim es associated w ith life insurance the designated beneficiary
com m itting m urderw ith aview to collecting death claim proceeds.

SEC TIO N -C
(C A SE STU D IES)

1. G ainfulInsurance com pany haslotofplansfor expansion and consolidating its


position in the m arket.R ight now it is enjoying 10% m arket share on new
prem ium sand ithasam bitiousplansfor expansion.H ow ever in a m arketlike
India w herein there are lotsofproblem sin term sofcapacity,w illingness,trust,
and understanding needs,itisnotthateasy to capturea biggersharein m arket.
W ith m arket-oriented policies of the governm ent, com petition has becom e
highly ram pant in the m arket across various segm ents.M r.Bharadw aj,has
taken over recently as C EO of the com pany and the Board has lot of
expectations from him . H is perform ance is being closely observed. H e is
encountering m any problem s.H ew anted to havenew blood in theorganization
and therefore recruited som e fresh M BA sunder cam pusrecruitm ent.Som e of
them arm ed w ith facts of econom y and industry and general psyche of the
public,opened a big fightand requested forplan ofaction.D iscuss.
A ns.M odern day econom ies m ake im perial dem ands on the businessm en to m anage
m ultiplerisksin abusinessand to do itin acosteffectivem anner.Realw orld m arkets
neverliveup to thetextbook description ofperfectly com petitivem arkets.H ow ever,
com petition results in allocative efficiency of resources of the society, besides
optim izing consum erchoiceand value.
Ifafew buyersorsellersareableto influencethepriceofaproductorservice,w ecall
itm arketpow er.The allocation of resources in such a m arketis sub optim al.In
III-8
M O D U LE-III:RISK M A N A G EM EN T A N D REIN SU RA N CE

insurance m arkets,m arketpow erexistsalm ostexclusively on the side ofthe sellers.


Therearefourw aysin w hich m arketpow erarises.
(i) Barriersto entry orexit:
A n exam pleofgovernm entcreating barriersto entry.Insurersin Indiahaveto secure
a licence from Insurance Regulatory and D evelopm entA uthority (IRD A )to enter
insurancebusinessand should haveacertain m inim um financialcapitalbasebesides
otherregulations.To m aintain theirprofitsorm arketshare,allfirm sattem ptto create
barriers to entry ofnew firm s into an industry.The existing insurance firm s m ight
create entry barriers by developing highly sophisticated expertise in selecting lives
for insurance by devoting financial, technical and hum an resources. Likew ise,
insurers m ight develop particular expertise in certain activities, such as product
design and developm ent,investm entand m arketing.M rBharadw ajshould think in
term s of creating som e barriers so that G ainful Insurance Com panys position
becom essom ew hatstronger.
(ii) ProductD ifferentiation:
M arketpow erissaid to existin them arketifan insurancecom pany can differentiate
itsproductsfrom thoseofitscom petitorsin them indsofitscustom ers.Theexistence
ofproductdifferentiation issaid to existifbuyerspreferthe productsofa firm over
those of its com petitors.The differences betw een products need notbe real;The
custom ers have to perceive difference in product quality, convenience, service,
m arketreputation,etc.,G ainfulshould also aim bringing outaslew ofproductsduly
em bedding thevariationsin productsw ith thatofcom petitors.
(iii) Price D iscrim ination:
In purely com petitivem arkets,allfirm schargethesam epriceforidenticalproducts.
Pricediscrim ination issaid to occurw hen afirm chargesdifferentpricesto different
groupsofcustom ersforthe sam e product.Thisw illlead to the firm gaining m arket
pow erand securing higherthan norm alprofits.G ainfulInsurancecan considerprice
discrim ination duly keeping in view theregulatory restrictionsim posed by IRD A .
Econom iesofScope arise w hen a single firm can produce a num berofproductsor
servicesatcostslow erthan those by m ultiple firm s.A firm enjoying econom iesof
scope can obtain m arket pow er. Available em pirical evidence suggests that
econom iesofscopeexistforjointproduction ofsom einsurancelines,w hereasthere
isno clearevidenceregarding econom iesofjointm arketing.
The m ajor psychological problem s,w hich fresh M BA s explained,are real risks.
They can be explained as the follow ing problem s of asym m etric inform ation that
occurw hen oneparty to atransaction hasrelevantinform ation thattheotherdoesnot
have.Such problem sofasym m etricinform ation aregrouped underfourheads.
i) Lem ons problem s.
ii) Principal A gentproblem s.
iii) Problem sofadverseselection.

III-9
M O D U LE-III:RISK M A N A G EM EN T A N D REIN SU RA N CE

iv) M oralhazard problem s.


The field staff,particularly advisors are suffering on accountofbasic inform ation
gaps,m is-inform ation and dishonesty on thepartofsom eclients.
M r.Bharadw ajexplained to the new recruitsthatthese are the realitiesofindustry.
U nderim perfectm arketconditions,itis noteasy forthe free flow ofinform ation.
Precisely on accountofthisreason,som e people are m aking profits.Butcounseling
the prospects and bringing aboutaw areness in them abouthow insurance industry
can help individuals to m anage theirpersonalrisk and business risk,w ill,to som e
extent,m itigatetheproblem s.A fterall,theinsuranceindustry fundsarerequired for
long-term investm entslikeinfrastructureofthecountry.

III-10
M O D U LE-III:RISK M A N A G EM EN T A N D REIN SU RA N CE

C hapter2
Introduction to R isk M anagem ent

SEC TIO N -A

1. O neofthefollow ing isnottrue.


a. Risk isoften thoughtofin term sofchanceofloss.
b. Theelem entofsurpriseisan im portantelem entofasituation ofuncertainty.
c. The im portance of uncertainty arises from its influence on the process of
decision-m aking.
d. U ncertainty isastateofhum an m ind.
e. N oneoftheabove.
2. The relative variation of the actualoutcom e from the anticipated outcom e is
know n as:
a. Risk.
b. U ncertainty.
c. D eviation.
d. D igression.
e. N oneoftheabove.
3. Thecauseofthelossisdefined as:
a. U ncertainty.
b. H azard.
c. Peril.
d. Risk.
e. N oneoftheabove.
4. IfVerm a scarisdam aged in a collision w ith Valm ikiscar,such collision is
a. U ncertainty.
b. H azard.
c. Peril.
d. Risk.
e. N oneoftheabove.
III-11
M O D U LE-III:RISK M A N A G EM EN T A N D REIN SU RA N CE

5. D efective w iring in a cinem a hall w hich increases the chance of fire, is an


exam pleof:
a. M oralhazard.
b. Peril.
c. Risk.
d. Physicalhazard.
e. N oneoftheabove.
6. Ifsom ebody issetting fireto an insured godow n stocked w ith inventory,w ith an
intention to m akeundueprofits,itiscaseof
a. M oralehazard
b. M oralhazard.
c. Evilm ind
d. A dverseselection.
e. N oneoftheabove.
7. Ifyou arekeeping yourm ain dooropen,so thatburglarscan m akeeasy entry,it
isa caseof:
a. M oralehazard
b. M oralhazard.
c. Evilm ind
d. A dverseselection.
e. N oneoftheabove.
8. D am ageto property by flood,earthquakeorfireisa caseof;
a. Purerisk
b. Speculativerisk.
c. D ynam icrisk.
d. Staticrisk.
e. N oneoftheabove.
9. Sham purchases 500 R IL shares w ith intent to m ake profit.W hat risk is he
taking?
a. Purerisk
b. Speculativerisk.
c. D ynam icrisk.
d. Staticrisk.
e. N oneoftheabove.
10. Insurancecom paniesgenerally insure-
a. Purerisk
b. Speculativerisk.
III-12
M O D U LE-III:RISK M A N A G EM EN T A N D REIN SU RA N CE

c. Society risk.
d. A & B.
e. N oneoftheabove.
11. D ynam icrisksarem oreclosely related to:
a. Purerisk
b. Speculativerisk.
c. D ynam icrisk.
d. Staticrisk.
e. N oneoftheabove.
12. R isksw hich affectthew holesociety likenaturalcatastrophesareexam plesof:
a. D ynam icrisk.
b. Fundam entalrisk
c. Particularrisk
d. N aturerisk
e. N oneoftheabove.
13. W hen thereisrobbery in H orizon Bank and itlostR s1 crore,itisa caseof:
a. Fundam entalrisk.
b. Particularrisk
c. Bank risk
d. D ynam icrisk
e. N oneoftheabove.
14. W hen there isa failure ofa system ,hum an errors,inadequate proceduresand
controls,w ecallitas .
a. O bjectiverisk.
b. O perationalrisk.
c. H um an risk.
d. System srisk.
e. N oneoftheabove.
15. Thebasisofm odern insurancetheory is:
a. Law ofLargeN um bers.
b. Theory ofProbability.
c. U tility Theory.
d. A lltheabove
e. N oneoftheabove.

III-13
M O D U LE-III:RISK M A N A G EM EN T A N D REIN SU RA N CE

SEC TIO N -A A N SW ER S
1. e 2. a 3. c 4. c 5. d 6. b
7. a 8. a 9. b 10.a 11.b 12.b
13.b 14.b 15.d
SEC TIO N -B
1. D ifferentiatebetw een R isk and U ncertainty .
A ns.W e often find the term s risk and uncertainty used interchangeably.H ow ever,a
distinction needsto be draw n betw een the tw o.Risk isoften thoughtofin term sof
chance(orprobability)ofloss.U ncertainty fallsinto tw o broad categories.Thereare
those forw hich the probability ofoccurrence iscalculable eitheron a priorigrounds
orthrough the statisticalanalysisofa seriesofsim ilareventsthathave occurred in
the past.The rem ainderdo notlend them selvesto such m easurem enteitherbecause
theiroccurrence follow s no discernable pattern orbecause they are unique events.
The im portance ofuncertainty arises from its influence on the process ofdecision-
m aking ofindividuals,businessesasalso society.
W hilerisk isastateofnature,uncertainty isastateofhum an m ind.Itistherefore
possible to considera situation risky ifa num berofoutcom es is possible and the
actualoutcom ethatm aterializesisnotknow n in advance.Thus,risk isdefined asthe
relative variation ofthe actualoutcom e from the anticipated orexpected outcom e.
Forinstance,fora m anufacturing firm ,the developm entofa new productisrisky as
the profitsfrom the sale ofthe productin the m arketare uncertain before the actual
sale.Likew ise,the developm entof a new drug by a pharm aceuticalcom pany is
characterized by risk because ofthe range ofpossible outcom es w ith regard to the
m arketreception forthedrug.
2. W hatishazard? Explain differenthazards.
A ns.A condition thatcreatesthechanceoflossorincreasesthechanceofalossisterm ed
a hazard .Threem ajortypesofhazardsareusually distinguished.
a. Physicalhazard
b. M oralhazard and
c. M oralehazard
Physicalhazard:A physicalcondition thatheightens the chance of loss is called
physicalhazard.A large num berofexam plesofphysicalhazard from ourdaily life
can be cited,such asdefective electricalw iring in a cinem a hallw hich increasesthe
chance offire,bad and poorly m aintained roads thatincrease the chance ofm otor
accidents and defective locking system on the m ain door of an apartm ent that
increasesthechanceoftheft.
M oralH azard :M oralhazard isacondition characterized by defectsin thecharacter
ofan individualsuch asdishonesty thatincreasesthefrequency oflossorseverity of
loss orboth.M oralhazard is a com m on occurrence in insurance and is noteasy to
III-14
M O D U LE-III:RISK M A N A G EM EN T A N D REIN SU RA N CE

control.Exam ples:m aking a fraudulentinsurance claim ,subm itting an insurance


claim for an inflated am ountand setting fire to an insured godow n stocked w ith
inventory.
W ith a view to controlling m oralhazard,insurers take a num ber of steps such as
careful underw riting practices, and by including a num ber of provisions in the
insurancepolicy such asexclusions,deductiblesand riders.
M oraleH azard :Som etim es,adistinction isdraw n betw een m oralhazard and m orale
hazard.W hile,as defined earlier,m oral hazard refers to a deliberate dishonesty
resulting in increasing the frequency or severity of loss,m orale hazard refers to
carelessnessorindifference to lossbecause ofthe presence ofinsurance.Exam ples
includeleaving them ain doorofahouseopen to m akeentry ofaburglareasy,leaving
carkeysin an unlocked cardoor,and carelessnessin regard to m aintenanceofhealth
because of existence of a health insurance policy.Such careless acts increase the
chanceofloss.
3. D ifferentiatebetw een purerisk and speculativerisk.
A ns.A traditionalclassification ofrisk distinguishes betw een pure risk and speculative
risk.Purerisk existsw hen asituation ischaracterized by uncertainty asto w hetheror
not loss w ill occur. Pure risk does not adm it the possibility of gain but only
potentiality for loss. Exam ples of pure risk include prospect of untim ely and
prem ature death,likely dam age to property by flood,earthquake,lightning and fire
and catastrophic m edicalexpenses.Speculative risk is presentw hen an eventcan
result in either a gain or a loss or status quo.Exam ples of situations involving
speculative risk include individualsdecisionsto buy sharesorinvestm entdecisions
ofbusinessfirm sorbusinessventuresand investing in realestate.
Three prim e reasons w arrant the distinction to be draw n betw een pure and
speculativerisks.W hileinsurancecom paniesbasically insurepurerisks,speculative
risks are generally not considered insurable, barring a few exceptions like
institutionalportfolio investm ents.
Second, w hile the law of large num bers can be easily applied to pure risks,
speculative risksare noteasily am enable to the application oflaw oflarge num bers
w hich facilitates prediction of future loss experience by insurance com panies.A
notable exception isthe efficientm annerin w hich casino operatorsapply the law of
largenum bersto thespeculativerisk ofgam bling.
Third,w hile the society isharm ed by the presence ofpure risk w hen a lossoccurs,
society m ay benefitdespitetheoccurrenceoflossfrom aspeculativerisk.Thereisno
doubtthatthesociety doesnotbenefitfrom thelossarising from apurerisk situation.
A com pany developing a new technology to produce com putersata low ercostm ay
benefitthesociety,asaw holew hilesom eexisting com putercom paniesm ay becom e
bankruptbecauseofthisdevelopm ent,isan exam plein thisregard.
H ow ever,itis possible thatin som e situations both pure and speculative risks m ay
exist.Likew ise,som e of the speculative risk decisions,w hich are m otivated by
III-15
M O D U LE-III:RISK M A N A G EM EN T A N D REIN SU RA N CE

earning profit,m ighthavean im pacton purerisk exposures.Forexam ple,developing


and introducing anew productinto them arketby am anufacturing firm m ainly entails
speculativerisk.In addition,thedecision m ightalso lead to apurerisk exposuresuch
aspotentialproductliability.
4. Explain dynam icand staticrisks,Fundam entaland Particularrisks.
A ns.D ynam ic risks arise from the changes that take place in every society, that is,
econom ic,social,technological,environm ental,and politicalchanges.Staticrisksare
thosethatw ould existin theabsenceofsuch changes.
D ynam icrisksareclosely related to thespeculativerisksw hereasm ostpurerisksare
exam plesofstaticrisks.
Fundam entaland ParticularR isks
Fundam entalrisksarethosew hich affectthew holeofsociety oram ajorpartthereof,
such as uncertainties arising out of the econom ic or political system or natural
catastrophessuch asearthquakesand floods.They are im personalin both cause and
effect.Particularriskson theotherhand affectm ainly theindividualorfirm and arise
from factors over w hich he m ay exert som e control. This distinction assum es
im portance as a social insurance and governm ent insurance program m es or
governm entsubsidiesm ay benecessary to dealw ith situationsoffundam entalrisk.A
particularrisk isarisk thatdoesnotaffecttheentirecom m unity orgroupsofpersons
w ithin theeconom y butaffectsonly individuals.
Exam ples such as bank robberies and carthefts affectthe particularindividuals or
firm sexperiencing such losses.In contrast,a fundam entalrisk isa risk thataffectsa
group ofpersons,orthe entire econom y.Risks such as naturaldisasters,w ar,high
inflation and cyclicalunem ploym entare som e ofthe exam plesoffundam entalrisk.
TherecentG ujaratearthquakeisanotherexam ple.
5. Explain thefollow ing : (a) Subjectiveand O bjectiveR isks
(b) O perationalR isks
(c) FinancialR isk
(d) StrategicR isk
A ns.Subjectiveand O bjectiveR isks: W hetherrisk is based upon the state ofm ind of
an individualoritisprecisely observable subjectiveorobjectiverisk.Ifthetypeof
risk is m ore precisely observable and therefore m easurable it is referred to as
objective risk.In this type of risk,the actualexperience m ay differ from the one
expected.O n theotherhand,subjectiverisk basically em anatesfrom aperson sstate
of m ind or m ental attitude. A s a particular individuals perception of risk in a
particularsituation m ay be differentfrom another,there is a possibility ofm aking
differentdecisionsby tw o individualsin a situation thatisseem ingly identical.Itis
clear,therefore,thatitisnotsufficientto know thedegreeofobjectiverisk.W ehave
to also learn the attitude tow ardsrisk ofa person w ho isacting on the basisofthis
know ledge.
III-16
M O D U LE-III:RISK M A N A G EM EN T A N D REIN SU RA N CE

O perational/InternalR isks:O perational/internalrisksare those thatarise from


the operationsofan organization orfirm orthe activitiesofan individual.Thistype
ofrisk isassociated w ith failuresofa system ,hum an errors,inadequate procedures
and controls and deficiencies in inform ation system s. W e m ay observe that
individualsororganizationshave som e controloverthem .Exam plesofthisclassof
risks include autom obile accidents, strike by em ployees of a firm and w ork
stoppages,loss of dam age to property as a resultof fire,uncertainty aboutlegal
liability arising from production ofdefectiveorfaulty products.
FinancialR isk:FinancialRisk arisesfrom individualsororganizationsusing financial
institutionsorow nership ofsuch instrum ents.Financialrisksare those occasioned by
changes in interest rates, transactions involving foreign currency, share issues,
extension ofbusinesscreditand em ploym entand use ofderivative instrum ents.They
are prim arily externalto the individualorbusiness.Therefore,thistype ofrisk isnot
underthedirectcontroloftheindividualorbusiness.Individualsm aking investm ents,
orborrow ingfundsfrom afinancecom panytobuyacaroraresidentialhouseorafirm
extending creditto itscustom eraresom einstanceoffinancialrisk.
Strategic R isk: Strategic risks basically arise from econom ic, dem ographic,
political,technologicaland socialfactorsthatim pacton individualsand businesses.
A num ber of exam ples are cited such as consum er preferences, legal system ,
regulatory environm ent,terrorism and globalw arm ing.W hile itis notpossible to
controlthese factorsand risksinvolved,itisw ithin the capability ofindividualsand
businessesto takestepsto m itigatethedeleteriouseffectsofsuch risks.
6. Traceoutthehistoricaldevelopm entoftheconceptofrisk.
A ns.The firstnotable step in providing a form aland m athem aticalbasisforthe theory of
probability w as taken in 1654 by tw o French m athem aticians Blaise Pascaland
Pierre de Form at to resolve a puzzle thathad been teasing m athem aticiansasw ell
as gam blers for over 150 years.The puzzle is :H ow are the stakes betw een tw o
playersin agam eofchanceto bedivided ifthegam eisstopped beforeitcom esto an
end and oneplayerisahead oftheother.Thesolution they suggested w asthatthetw o
playerssharethestakeson thebasisoftherespectiveprobability thateach w ould w in
the gam e.Though the response ofPascaland Ferm atw as to a puzzle in a gam e of
chance,their dem onstration of the m ethod of calculating the probability of each
player w as a vitalintellectualbreakthrough.In the nextfifty years after 1654,a
num berofinnovations and discoveries thatare usefulas building blocks w ith the
developm ent of tools of risk m easurem ent w ere developed such as statistical
sam pling, statistical significance, various applications of probability theory to
practicalproblem s and early efforts for defining norm aldistribution and standard
deviation.Thethreeotherm ajorcom ponentsofthescienceofrisk m anagem entasw e
understand today nam ely the notion ofutility and the concepts ofregression to the
m ean and diversification havebeen developed in courseoftim e.

III-17
M O D U LE-III:RISK M A N A G EM EN T A N D REIN SU RA N CE

SEC TIO N -C
(C A SE STU D IES)

1. M r SunilPurushotam w as aw akened by a phone callat2.30 am on a w intry


D ecem ber night.Earlier thatnightthe firstm ajor storm ofthe year hashitthe
coast.Praveen,a risk m anager,had gone to bed unaw are ofstorm s intensity
and w asstartled to discover thata devastation hasbeen done.The voice on the
other end ofthe line belonged to a police officer,the nightpatrolling party,w ho
explained that there is no proper equipm ent to tackle the problem of storm .
Property has been dam aged and m any hum an lives w ere lost besides som e
m issing livestock.The districtadm inistration did notanticipate these problem s
and thereforew asrunning shorton arrangem ents.
W ere that not bad enough,the officer concluded the callby noting that the
storm w asreally agonizing.Vehiclesthatcan be used for rescue operationsare
not available.Som e private vehicle drivers are not cooperating and som e of
them aredrunk and behaving badly.D iscuss.
A ns.Thisdram aticstory unfoldshow risk strikesusand how unprepared w eare,m oreso
in acountry likeIndia,w hererisk m anagem entasaconcepthasnotgonethrough the
m indsofm any.W elivein aw orld ofrisk and uncertainty.U nexpected eventscan and
do occur and disruptive effects can be enorm ous.This exam ple show s both the
tangible and intangible consequencesofrisk -a tragic losshasoccurred,to be sure,
butthe dam age isnotlim ited to physicalinjury and property dam age.There m ay be
political im plications in as m uch as the incident reflects poorly on devastation
m anagem entpractices and relief operations.Certainly,the im pacton the victim s
fam ilies is m uch m ore than econom ic. The tim e the risk m anager/district
adm inistration spends attending to this m atter could have m ore productive uses
elsew here.Finally,the resources used to pay forthe dam ages are public resources
thatotherw isecould havebeen used to carry outany w elfareactivity.
2. O ver the years,the O lym pic gam es have presented a host of interesting and
challenging exposuresto loss.R evenuesfrom thegam estypically com efrom the
saleoftelevision broadcasting rights,ticketsales,and com m ercialsponsorships.
Identifying all of the risks associated w ith the O lym pics is alw ays a m ajor
undertaking.In the past,m ore than one thousand officialvehicles have been
required,ranging from vans and buses for shuttling athletes and personnelto
the various events, to stretch lim ousines for transporting visiting foreign
dignitaries.Thus,thecollision periland itsassociated lossesm ustberecognized
and m anaged.In planning for the 2000 Sum m er gam esin Sydney,A ustralia,a
totalof10,000 athletesw ereexpected,togetherw ith about5000 officials,50,000
volunteerw orkersand 9 m illion spectators.
Sources of risk are carefully analyzed throughout the preparations for each
O lym pics.Because m any ofthe sportsare inherently dangerous,the possibility
III-18
M O D U LE-III:RISK M A N A G EM EN T A N D REIN SU RA N CE

ofpersonalinjury to com petitorsasw ellasspectatorsisalw ayspresent.A nd the


factthatsom e ofthe athletesm ay be young teenagersonly com plicatesthe risk
m anagem ent challenge.The organizers of the Sydney G am es w ere especially
concerned abouttechnologicalrisks(such ascom puterm alfunctionsthatm ight
interrupt electronic scoring system s), security (including the threat of
terrorism ) and crow d control. Transportation issues in A ustralia are also
im portant.A rranging fora governm entalguaranteethattrain schedulesw ould
bedisrupted by no m orethan 5 m inuteseven ifan individualcom m itted suicide
on thetrackssolved oneinteresting risk m anagem entproblem .
D iscuss.
A ns.M anaging publicrisk ofsuch am agnitudeisrealchallenge.Itrequireslotofplanning
and carefulexecution.A ny glitch on any partcan goofup thew holeoperationsand it
m ay result in a catastrophic loss.Som e very serious loss exposures m ay not be
obvious. For exam ple, w eather-related perils can force the postponem ent of a
ticketed event,such as the opening cerem ony.The cancellation of the television
coverage contract,often the largestsingle source ofrevenue,w ould be devastating.
Such acancellation actually did occurin 1980,w hen theU nited Statesboycotted the
M oscow O lym picsto protesttheSovietinvasion ofA fghanistan.

III-19
M O D U LE-III:RISK M A N A G EM EN T A N D REIN SU RA N CE

C hapter3
EssentialsofR isk M anagem ent

SEC TIO N -A

1. O neoftheearliestreferencesto theterm risk m anagem entw asm adein theU S


w hen itappeared in thism agazine;
a. TheH arvard BusinessReview.
b. TheBusinessW eek.
c. TheForbesm agazine.
d. TheLifem agazine.
e. N oneoftheabove.
2. O neofthefollow ing isnottrue.
a. Thesubjectofrisk m anagem entdoesnothavealong history.
b. Theessenceofrisk m anagem entliesin m aking theareasw herew ehavesom e
controlovertheoutcom ew hilem inim izing theareasw herew ehaveabsolutely
no controlovertheoutcom e .
c. The focus of risk m anagem ent, particularly by corporates, has undergone
changeovertim e.
d. Thecorporateshavebecom efarlessconcerned w ith traditional high frequency,
low severity risks
e. N oneoftheabove.
3. O neofthefollow ing isnota step in risk m anagem entprocess.
a. Identify potentiallosses.
b. Evaluatepotentiallosses.
c. Selecttheappropriatetechniquefortreating lossexposures.
d. Risk pricing
e. N oneoftheabove.
4. Theapproachesused forrisk identification includeuseof-
a. Lossexposurecheck lists.
b. Flow charts.
c. Statisticalanalysisofhistoricaldata.

III-20
M O D U LE-III:RISK M A N A G EM EN T A N D REIN SU RA N CE

d. A nalysisoffinancialstatem ent.
e. N oneoftheabove.
5. A ccording to R ejda, A ccountsR eceivables ,can beclassified as;
a. Property lossexposure.
b. Liability lossexposure.
c. Businessincom elossexposure.
d. Crim elossexposure.
e. N oneoftheabove.
6. A ccording to R ejda, K idnapping ofkey personnel ,can beclassified as;
a. Foreign Lossexposure
b. Crim eLossexposure.
c. H um an ResourcesLossexposure.
d. BusinessIncom elossexposure.
e. N oneoftheabove.
7. O neofthefollow ing isnottrue.
a. Frequency oflossrelatesto the probable num berofparticularlossesthatm ay
occurduring som egiven period oftim e.
b. Severity ofloss refers to the probable m agnitude oflosses thatm ay occur,if
they occur.
c. A loss potentialthatis sm alleven though frequent,is m uch less im portantas
com pared to potentiallossexposuresthatare infrequentbuthasa potentialfor
bankruptcy.
d. Both frequency and severity have to be considered in the risk m anagem ent
process.
e. N oneoftheabove.
8. O neofthefollow ing isnota techniquefortreating lossexposures:
a. H edging.
b. Risk Financing.
c. Risk retention.
d. Insurance.
e. N oneoftheabove.
9. O neofthefollow ing isnottrue:
a. Com m ercialinsurance is a technique of transferring risk from one party to
anotherforaprice.
b. O necan com binealargenum berofindependentexposureunitsin oneportfolio;
an insurancecom pany isableto reducetherisk ofitsaggregatelosses.
c. Firm sthatenterinto contractsto supply goodsatafixed pricein thefutureface
III-21
M O D U LE-III:RISK M A N A G EM EN T A N D REIN SU RA N CE

the risk thata rise in pricesbetw een entering into the contractand the delivery
datem ay involvethem in aloss.
d. Retention refersto thefinancing oflossesinternally.
e. N oneoftheabove.
10. Insuranceissuggested in thefollow ing case:
a. Frequency ofloss low and severity ofloss low
b. Frequency ofloss high and severity ofloss low
c. Frequency ofloss low and severity ofhigh low
d. Frequency ofloss high and severity ofloss high
e. N oneoftheabove.

SEC TIO N -A -A N SW ER S
1. a. 2. d 3. d. 4. e. 5. a. 6. a.
7. e 8. e. 9. e. 10.c.

SEC TIO N -B

1. O utlinethestepsofrisk m anagem entprocess.


A ns.Stepsin R isk M anagem entProcess
Identify potentiallosses.
Evaluatepotentiallosses.
Selectappropriatetechniquefortreating lossexposures:
Risk Control-Risk avoidanceand LossControl
Risk Financing -Retention,N on-insurancetransfers,
Com m ercialinsurance.
Im plem entand adm inistertheprogram m e.
2. Explain theprocessofrisk identification.
A ns.Them ostim portantelem entofand thefirststep in therisk m anagem entprocessisthe
identification ofrisksand exposuresto loss.Thisinvolvesa system atic and careful
analysisofallm ajorand m inorpotentiallossexposures.A n essentialprerequisitefor
a conscious choice ofappropriate and efficientm ethods fordealing w ith losses if
they occuris the recognition ofallsources ofpossible losses.A loss exposure is a
potentiallossthatm ay be connected w ith a particularcategory ofrisk.A ssuch,the
classification oflossexposuresisthe sam e asthe one adopted forpure risks,thatis,
lossesassociated w ith life,health,property and liability risks.
Thefollow ing categorization ofrisksthatcan im pingeon thefinancialsecurity ofan
individualw illbefound useful.
a. M aintenance ofa large Em ergency Fund:O nce itis agreed thatprudence

III-22
M O D U LE-III:RISK M A N A G EM EN T A N D REIN SU RA N CE

dem ands thata fund has to be setaside form eeting em ergencies,individuals


and businesseshave to m aintain a largerfund to m eetunanticipated lossin the
absenceofinsuranceindustry.
b. D eprivation ofcertain goodsand services:Because ofthe threatofliability
law suits,a num beroffirm sm ay refrain from producing certain products.Itis
estim ated thatoutofapproxim ately 250 firm s around the w orld,w hich w ere
producing childhood vaccines,only afew firm snow rem ain in thatbusiness.
3. Explain theprocessofevaluation ofpotentiallosses.
A ns.Subsequentto identification ofrisk,the second step in the risk m anagem entprocess
relatesto analyzing,evaluating and m easuring theim pactoflosseson theindividual
orcorporate unitby estim ating the potentialfrequency and severity oflosses.W hile
frequency oflossrelatesto the probable num berofparticularlossesthatm ay occur
during som egiven period oftim e,severity oflossrefersto theprobablem agnitudeof
losses that m ay occur, if they occur. This w ill enable ranking of various loss
exposuresaccording to theirrelative im portance.A losspotentialthatissm alleven
though frequent,ism uch lessim portantascom pared to potentiallossexposuresthat
are infrequent (such as destruction of a factory by devastating fire or accidental
deaths)buthasa potentialforbankruptcy.Thus,though both frequency and severity
have to be considered in the risk m anagem ent process, severity of course, is
substantiallym oreim portant.Itispossiblethatafirm m aybecom ebankruptbyasingle
catastrophicloss thesizeofthelossfrom asingleeventcan betruly crippling.In the
risk m anagem entprocess,itistherefore necessary forestim ating m axim um probable
loss and m axim um possible loss.The m axim um probable loss is an estim ate ofthe
w orstlossthatislikely to happen such asthelossthatcould likely to resultiflightning
strikesan individualshom e orthe firm sbuilding.The m axim um possible lossisan
estim ateofthew orstpossiblelossthatm ightresultfrom thelightning.
4. O utlineappropriatetechniquesfortreating lossexposures.
A ns.Thetechniquesarebroadly classified asfollow s:
a. Avoidance:This is the m ostdrastic w ay of handling the risk.This happens
w hen theactivity causestherisk.Forexam ple,thepotentialconsequencesofan
escape ofa highly toxic gas m ay be so catastrophic thata chem icalcom pany
m ay decideto avoid therisk by ceasing to produceoruseit.
b. R isk Financing: This covers all m ethods em ployed to fund either the
probability of loss-producing events occurring or the potentialsize of losses
thatdo occur.Forexam ple,installation offireextinguishersto m inim izelossin
caseoffire.Them ethodsare:
i) R isk R etention:Retention refers to the financing of losses internally -
either fully retained or partially retained.Losses thatoccur w hen prior
planning fortheirfinancing hasbeen done are also retained.Retention is
resorted to w hen no other risk m anagem enttreatm entis available like

III-23
M O D U LE-III:RISK M A N A G EM EN T A N D REIN SU RA N CE

w hen insurancecoverageisnotavailableorvery expensive.Further,non-


insurance transferm ay be unavailable.Thus,retention m ay in factbe a
residual m ethod.Retention can be effectively used w hen the potential
lossesarehighly predictable.
ii) Insurance:Com m ercialinsuranceisatechniqueoftransferring risk from
one party (individualorbusiness)forw hom the risk is costly to another
party w ho isw illing and isableto beartherisk.Insuranceisthusoneofa
num berofavailable instrum ents forhedging risk.Itis an instrum entfor
postlossfinancing.
iii) N on-InsuranceTransfers:They aretechniques(otherthan insurance)by
w hich a risk exposure and itspotentialfinanciallossesare transferred to
anotherparty w ho isin abetterposition to exerciselosscontrol.A num ber
of instances of non-insurance transfers can be cited.A com puter lease
agreem entby a firm m ay contain a clause to the effectthatm aintenance,
repairsetc.,ofthecom puteraretheresponsibility ofthecom puterfirm .A
publishing firm m ay specify thattheauthorand notthepublisherislegally
liableforplagiarism ,ifany.
iii) C om bination Thism ethod takesadvantage ofthe law oflarge num bers.
O ne can com bine a large num berofindependentexposure units in one
portfolio;an insurancecom pany isableto reducetherisk ofitsaggregate
losses.The bestexam ple w ould be in the case ofa large group,w hich by
centrally pooling the risk ofbreakage ofits shop w indow s could predict
annuallossesw ithin narrow lim its.
v) H edging Firm sthatenterinto contractsto supply goodsatafixed pricein
the future face the risk that a rise in prices betw een entering into the
contractand the delivery date m ay involve them in a loss.H edging gives
protection to the sellerforIndian im portersby allow ing them to forw ard
purchasespecificforeign currencies.Thusregardlessoftheexchangerate
the im porters liability w ill be lim ited to the cost of purchasing the
currency.
vi) R esearch:thisisdoneto im provetheinform ation on w hich decisionsare
taken.Forexam ple,w hen m arketing a new productm ay go form arket
research to reduceuncertainty.
2. Explain R ajda s m atrix for determ ining appropriate technique for tackling
losses.
A ns.Forthepurposeofdeterm ining theappropriatetechnique(s)fortackling losses,Rajda
suggests a m atrix.The m atrix classifies the various loss exposures on the basis of
frequency and severity.

III-24
M O D U LE-III:RISK M A N A G EM EN T A N D REIN SU RA N CE

R isk M anagem entM atrix


TypeofLoss Frequencyof SeverityofLoss AppropriateRisk
Loss M anagem ent
Technique
1 Low Low Retention
2 H igh Low LossControland
Retention
3 Low H igh Insurance
4 H igh H igh Avoidance

A scan be noticed,the selection ofthe m ethod forhandling losses,both severity and


frequency oflosshaveto beconsidered.W hen thefrequency and severity oflossare
low,(thatis,w here the lossissm alland occursinfrequently such aslossofa cheap
transistorradio in thehouseorlossofthetypistsdictionary in theoffice)retention is
them ostappropriaterisk m anagem enttechnique.W hen thelossfrequency islow and
severity is high (third type of loss exposure in the table), the m ost appropriate
technique to choose is insurance.Exam ples of this type of loss exposure include
naturaldisasters,explosions,fires,law suitsand prem aturedeaths.

SEC TIO N -C
(C A SE STU D IES)
You aretheRisk M anagerforalargem ultinationalenterpriseinvolved in them anufacture
of products through a hazardous process prone to pollute.Your m ain operations are in
Finland, a country know n for its rigorous and costly pollution, m anufacturing and
em ployeesafety standards.M oreover,Finnish w orkersarehighly paid by w orld standards.
O ne ofyourem ployeeshassuggested the relocation ofthe m osthazardousaspectsofthe
m anufacturing processto adeveloping country in A frica.Theem ployeearguesthatsuch a
m ovew ould besound risk m anagem entbecausethecostsofcom pliancew ould below erin
the A frican country,w hich haslessrigorouspollution,m anufacturing,and w orkersafety
law s.M oreover,because w orker w ages w ould be low er,the costs of w orker disability
paym entsand otherjob-related injuriesand illnessesw ould be less.Finally,the em ployee
notesthatunem ploym entisram pantintheA fricancountry,andthegovernm entandpeople
w ould w elcom etheopportunity to w ork forthecom pany.
A stheRisk M anageroftheM ultinational,yourgoalisto m inim izevolatility in corporate
cash flow and to do so atthelow estcostconsistentw ith ethicalbehaviour.Ifyou m aintain
the hazardous operations in Finland,costs w illrem ain high.Ifyou relocate them to the
developing country,costsw illdecreaseand peoplew illhavem orejobs.
W hatisyourrecom m endation? D iscuss.
A ns.Them anagem entofrisk isaprocessw ith theobjectiveofidentifying risk exposures
III-25
M O D U LE-III:RISK M A N A G EM EN T A N D REIN SU RA N CE

faced by an individual/organization w ith a view to selecting the best available


technique for treating such exposures. The corporates have becom e far less
concerned w ith traditional high frequency,low severity risks but have started
devoting greaterattention to risksthatcould lead to corporatecollapseand corporate
bankruptcy. There is therefore a need to adopt a com prehensive approach for
m anaging risk. This com prehensive strategy for treating risk is referred to as
integrated risk m anagem ent (IRM )or enterprise risk m anagem ent .(ERM ).To
achieve the goaland to m ake the program m e effective,a periodic review of the
program m e iscalled in orderto determ ine w hetherornotthe objectivesofthe risk
program m earebeing realized.
In the given case,the problem ofrelocation has to be view ed from risk angle also.
W hatkind ofrisksthecom pany hasto facew hen itislocated in an A frican country?
W hatare the locallaw s? Isthe governm entthere positive to foreign investm ent? D o
they allow repatriation? H ow are theirpollution law s? Isthere any country risk? A
Risk A udithas to be conducted to identify potentialsources of risk and then the
m ethods to address to those issues? W hatw illbe the financialoutflow involved in
accepting any solution? A re there any health issues? U nless these things are
addressed and solutions found,itis prem ature to suggestto the Board any type of
solution.

III-26
M O D U LE-III:RISK M A N A G EM EN T A N D REIN SU RA N CE

C hapter4
Probability

SEC TIO N -A
1. Probability can takevalues
(a) - to
(b) - to 1
(c) -1 to 1
(d) 0 to 1
2. Probability can expressed as:
(a) ratio
(b) Proportion
(c) percentage
(d) alltheabove
3. W hen rolling a dietheprobability that3 occursisequalto
(a) 1/2
(b) 1/3
(c) 1/6
(d) 1/5
4. M ean isa m easureof
(a) location (centralvalue)
(b) dispersion
(c) correlation
(d) none
5. W hich ofthefollow ing ism easureofcentralvalue
(a) M edian
(b) Standard deviation
(c) M ean deviation
(d) Q uartiledeviation

III-27
M O D U LE-III:RISK M A N A G EM EN T A N D REIN SU RA N CE

6. Theaverageof7 num bers7,9,12,X ,5,4,11,9.Them issing num beris


(a) 13
(b) 14
(c) 15
(d) 8
7. C orrectform ula forvarianceofnsam pleobservationsx1,x2 xn is:


(a)



(b)

(c)

(d)

8. W hatistheform ula forbionom ialdistribution?



(a)

(b)


(c)

(d)

9. Therelationship betw een varianceand standard deviation is


(a) varianceisthesquarerootofstandard deviation
(b) standard deviation isthesquareofthevariance
(c) varianceisequalto standard deviation
(d) squareofthestandard deviation isequalto variance
10. Theform ula fortheco-efficientofvariation is

(a) =

(b) =


(c) =

(d) =

III-28
M O D U LE-III:RISK M A N A G EM EN T A N D REIN SU RA N CE

11. Theexpected valueofa setofpossibleoutcom esequalsto


(a) E.V.= .Pi.xi
(b) E.V.= Pi.xi
(c) E.V.= .Pi.xi2
(b) E.V.= Pi.xi2
12. G iven thatpi= 0,.05,0.08,0.20 & 0.67 and their outcom es ni= 5,7,6,& 2
respectively,theexpected valueis
(a) 6.35
(b) 4.80
(c) 3.35
(d) 7.29
13. Therisk averseutility function isgiven by
(a) EU = Pi.V (xi)
(b) E.U = Pi.U (xi)
(c) E.U = Pi.U (xi)2
(d) E.U = Pi.U (xi)
14. Varianceofthefollow ing frequency ofdistribution is:
Class Frequency
2-4 2
4-6 5
6-8 4
8-10 1 isapproxim ately equalto
(a) 2.5
(b) 2.9
(c) 5.0
(d) N one
15. Theform ula forthem ean is

(a) =


(b) =


(c) =

(b) x =

III-29
M O D U LE-III:RISK M A N A G EM EN T A N D REIN SU RA N CE

SEC TIO N -A A N SW ER S
1. (d) 2. (d) 3. (c) 4. (a) 5. (a) 6. (c)
7. (a) 8. (c) 9. (d) 10.(a) 11.(b) 12.(c)
13.(d) 14.(b) 15.(c)

SEC TIO N -B
1. G ivebriefly theconceptofprobability?
2. W hatarethestepsincluded in thecalculation ofstandard deviation?
3. Find m ean,m edian,& m odeforthefollow ing data
42,53,71,63,82,91,48,53,67,98,53
4. W rite briefly about theoretical probability distributions w hich are used in risk
m anagem ent?

A N SW ER S
1. There are no.ofeventsin day to day life aboutw hich one isnotsure w hetheritw ill
occur (or) not. But one is alw ays curious to know w hat chance is there for a
happening (or) event to occur. For instance, one m ay be interested to estim ate
w hetheritw illrain today ornot.O ne w ould like to evaluate thischance ofw inning
forhead in a definite no.oftosses.W hatisthe chance thatthere are fouracesin one
hand in agam eofcardsam ong fourplays,etc.i.e.thenum ericalevoluation ofchance
factorofan eventisknow n asprobability.
2. (i) Find them ean
(ii) Subtractthem ean from each individualvalue
(iii) Squaretheindividualdifferencesfrom them ean
(iv) Totalthesquareofdifferences
(v) Thesum ofthesquared deviation isdivided by thetotalno.ofm easurem ents
(vi) Theresulting num beristhem ean ofthesquared deviation,i.e.variance
(vii) Standard deviation isobtained by taking thesquarerootofthevariance
3. M ean (x ) = xi
n
42+53+71+63+82+91+48+53+67+98+53
=x
11
721
= = 65.55
11
M edian = A rrangein increasing ordecreasing orderand in w hich m id valueism edian
= x M edian = 42,48,53,53,53 63,67,71,82,91,98
= 63
III-30
M O D U LE-III:RISK M A N A G EM EN T A N D REIN SU RA N CE

M ode= m ostrepeated value


W herem odeis53
3. (i) Bionom ialD istribution
(ii) Poisson distribution
(iii) N orm aldistribution
(i) Bionom ialD istribution:(a)Itisadiscreteprobability distribution;
(b)theprobability thatan eventw illoccuratany pointin tim eisP.and the
probability thattheeventw illnotoccurisgiven by theeqn,q = 1-P;w here
no.of________ asntheprobability ofx successorisntrailsisgiven by
P (x -x)= nx px.qn-x
n!
(q) Pxqn-x
x!(n-x)!
(ii) Poisson D istribution: The probability of an event under the poisson
distribution isgiven by theform ula.
m n.em
P=
n!
W here p istheprobability thatan eventnoccurs
n istheno.ofeventsforw hich isprobability estim ateisrequired.
m isthem ean orexpected lossfrequency
e isthebaseofthenaturallogarithm sequalto 2.71828
(iii)N orm aldistribution
The norm al distribution is a continuous probability distribution. It is
com pletely defined by itsm ean and standard deviation.Thegraph ofN .D .
isbellshaped and sym m etric.M orevaluesarelocated around them ean
thecenter.

O
m ean x
III-31
M O D U LE-III:RISK M A N A G EM EN T A N D REIN SU RA N CE

SEC TIO N -C
(C A SE STU D IES)
1. In acultivating land,thelossoccurrenceyearly,in rupees,and theprobability ofloss
occurrence also are given.Find the m ean am ountoflossand expected value ofloss
for5 years.

Year Lossin rupees Probabilityofloss


1 6 lakhs 0.05
2 28 lakhs 0.18
3 30 lakhs 0.28
4 15 lakhs 0.35
5 58 lakhs 0.14
137 lakhs 1

2. In acricketteam therunsscored betw een playersaregiven below :


27,53,48,98,61,52,72,40,20,31
W hatisthevariancescorebetw een players?

A N SW ER S
1. A ns.
Year Lossin Probability Am ount (lossx
rupees ofloss ofloss Prob.ofloss)
1 6 lakhs 0.05 0.3 0.3
2 28 lakhs 0.18 5.04
3 30 lakhs 0.28 8.4
4 15 lakhs 0.35 5.25
5 58 lakhs 0.14 8.12
137 lakhs 1 27.11

M ean am ountofloss= =

Expected am ountofloss= 27.11

III-32
M O D U LE-III:RISK M A N A G EM EN T A N D REIN SU RA N CE

2. A ns.
D eviation Squared
Scores M ean score from m ean score deviation
27 55.2 -28.2 795.24
53 55.2 -2.2 4.84
48 55.2 -7.2 51.84
98 55.2 42.8 1331.84
61 55.2 5.8 33.64
52 55.2 -3.2 10.24
72 55.2 16.8 282.24
40 55.2 -15.2 231.04
20 55.2 -35.2 1239.04
81 55.2 25.8 665.64
552 0 5145.6

M ean score: =

variance( )= =

S.D .( )= = 22.68

III-33
M O D U LE-III:RISK M A N A G EM EN T A N D REIN SU RA N CE

C hapter5
D ecision M aking U nder
C onditionsofU ncertainty

SEC TIO N -A

1. A ccording to Bernoulli, the satisfaction (or) utility derived from m arginal


increases in w ealth is _________ related to the level of w ealth previously
possessed.
a. proportionally
b. Equally
c. a& b
d. Inversely
2. A ccording to the risk averse person:M ore w ealth is preferred to less w ealth;
increasing w ealth gives__________levelsofsatisfaction.
a. decreasing
b. increasing
c. equal
d. noneoftheabove
3. Theprem ium equalto theexpected valueoflossiscalled________prem ium .
a. netprem ium
b. netsingleprem ium
c. fairprem ium
d. noneoftheabove.
4. The degree ofrisk aversion ofindividualscrucially determ inesthe given below
patterns.
a. consum ption
b. savings
c. aggregateconsum ption and savingsand lifeinsuranceconsum ption.
d. alloftheabove.
5. A ccording to Bernoullithe value of a risky opportunity for an individualto
becom ericherisdeterm ined by his(or)her_______ levelsofw ealth.

III-34
M O D U LE-III:RISK M A N A G EM EN T A N D REIN SU RA N CE

a. current
b. futureexpected
c. pre-existing
d. noneoftheabove.
6. W hatistheform ula forexpected valueofan event?
a. EV = PiX i
b. EU = PiU (X i)
c. Pi X i
d. N one
7. G iven thatP1 = 0.25,P2 = 0.55,P3 = 0.20 and X 1 =15,000 ,X 2 =20,000 and X 3 =
8,000 respectively,w hatistheexpected valueoftheabovevalues?
a. 17,350
b. 18,750
c. 16,350
d. noneoftheabove
8. Iftheindividualisrisk neutral:
a. helikesrisk
b. hedislikesrisk
c. heisneitheraverseto risk nordoeshelikerisk
d. noneoftheabove

SEC TIO N -A A N SW ER S
1. d 2. b 3. c 4. d 5. c 6. a
7. c 8. c

SEC TIO N -B
1. W hatisexpected utility rulein insurance?
2. N am ethevariouseconom ictheoriesofconsum ption and briefly explain.
3. D escribebehaviouralpattern ofhum an shortcom ingsaccording to D anielK ahnem an
andA m osTversky?
4. W hatisthe endow m enteffect according to behaviouraleconom ists?
5. N am ethetw o characteristicsofutility function forarisk averseindividualexhibit?

A N SW ER S
1. The application of the expected utility rule relates to individuals choice am ong
investm entalternatives.The sam e rule is also applicable to determ ine w hether an

III-35
M O D U LE-III:RISK M A N A G EM EN T A N D REIN SU RA N CE

individualw illpurchase insurance in orderto m inim ize uncertainty.By purchasing


insurance policy,one pays a prem ium to avoid a risky outcom e.O rpurchase ofan
insurance policy involves the sacrifice of certain w ealth in order to avoid the
possibility ofalossofw ealth.
2. Thevariouseconom ictheoriesofconsum ption are:
(a) A bsoluteincom ehypothesis
(b) Relativeincom ehypothesis
(c) Lifecyclehypothesisand
(d) Perm anentincom ehypothesis
The econom ic theories of consum ption assum e that rational consum ers seek to
m axim ize their lifetim e utilities w hile allocating incom e betw een current
consum ption and saving. This assum ption im plies that individuals divide their
incom e betw een current consum ption and future consum ption in a m anner that
resultsin optim izing theirpattern ofconsum ption overlifetim e.
3. Behaviouralpattern ofhum an shortcom ing according to D anielK ahnem an and A m os
Tversky are:
(a) H um ans som etim es act on em otion that destroys self-control, an essential
prerequisiteforrationaldecision m aking
(b) People experience w hat psychologists call cognitive difficulties .In other
w ards,they often do notunderstand fully w hatthey aredealing w ith.
4. Endowm entEffect:Itdescribesthetendency ofpeopleto setahigherselling priceon
an item thatthey ow n orendow ed w ith than w hatthey w ould be w illing to pay to
purchase an identicalitem ifthey did notow n it.The endow m enteffecthas been
found to have a pow erful influence on investm ent decisions that could not be
explained by therationalinvestorm odel.
5 Thetw o characteristicsare:
(a) M ore w ealth is preferred to less w ealth.Increasing w ealth gives increasing
levelsofsatisfaction
(b) The increm entalutility orsatisfaction from unitsincreasesin w ealth decreases
as w ealth increases,i.e.for a poor person an addition of Rs.200 to his /her
w ealth w illm ake a greatim pacton his/herw ealth than the sam e increase of
w ealth to arich person.

SEC TIO N -C
(C A SE STU D Y )
If you invested sum of m oney 2,00,000 in a private bank thatw illearn 20% on your
investm entforoneyearw ith probability of0.35 and alossof15% w ith probability of0.65,
w hatisyourexpected utility?

III-36
M O D U LE-III:RISK M A N A G EM EN T A N D REIN SU RA N CE

A N SW ER S
G iven thatC = 2,00,000
Earn 20% w ith probability -0.35
Loss15% w ith probability -0.65
theexpected utility = Pi U (X i)
earn = 2,00,000 X 0.20 = 40,000
loss= 2,00,000 X 0.15 = 30,0000
(X i)= 2,00,000 + 40,000 = 2,40,000
(X 2)= 2,00,000 -30,0000 = 1,70,0000
E.U = 0.35 X U (2,40,000)+ 0.65 X U (1,70,000)
= 0.35 X ln (2,40,000)+0.65 X ln (1,70,000)
= 4.3359 + 7.8283
= 12.1642

III-37
M O D U LE-III:RISK M A N A G EM EN T A N D REIN SU RA N CE

C hapter6
R isk M anagem entProcess

SEC TIO N -A

1. Thejob ofrisk m anagem entcan bebroken dow n into follow ing elem ent/s.
a. RiskA ssessm ent
b. Risk Control.
c. Risk Financing
d. A lloftheabove
e. N oneoftheabove.
2. com prisesofidentification and analysisofpotentiallossexposures
a. Risk Control
b. RiskD ynam ics
c. RiskA ssessm ent
d. Risk Initiation.
e. N oneoftheabove.
3. M aking useofa m atrix plotting in lossfrequency and lossseverity,isknow n as
a. RiskA nalysis
b. Risk G rid
c. Risk M apping
d. Risk Convergence
e. N oneoftheabove.
4. Lossfrequency can becategorized underthis/thesehead /s.
a. Rare LossEventsuch asa personshouse located in an earthquake zone thatis
likely to sufferlossrarely
b. LossEventthatoccursoccasionally likeadam ageto aperson scar
c. FrequentLossEventsuch asm ild illness
d. A lloftheabove
e. N oneoftheabove.
5. O neofthefollow ing isnottrue:
a. Financialconsequencesofrelatively cheap utensilofafam ily m ay bequitelow.
III-38
M O D U LE-III:RISK M A N A G EM EN T A N D REIN SU RA N CE

b. Financialconsequencesofdam agescaused to cararerelatively m oderate.


c. Financialconsequences of catastrophic loss such as destruction of house are
high.
d. A lloftheabove.
e. N oneoftheabove.
6. Individualinvestorsw ho arerisk aversew ould preferinvesting in:
a. Stock M arket
b. Bond M arket
c. D erivativesM arket.
d. Bank deposits.
e. N oneoftheabove.
7. Before deciding upon the specific risk control m easures to be adopted it is
necessary to conduct Exercise.
a. RiskA nalysis.
b. Risk Control
c. CostControl
d. Cost-Benefit
e. N oneoftheabove.
8. Thetechniquesofrisk controlavailableforindividualsand othersareclassified
underthis/thesehead /s.
a. LossAvoidance.
b. LossPrevention.
c. LossReduction.
d. A lloftheabove.
e. N oneoftheabove.
9. A fter receiving a doctor s advice that there is a risk of prem ature death by
cancer,an individualm ightcom pletely stop sm oking.Itis
a. LossPrevention.
b. LossAvoidance
c. LossReduction
d. LossU nderstanding.
e. N oneoftheabove.
10. M ost frequently occurring m inor health problem s (flu, cold, etc.) w hich do
im ply low loss severity can be reduced in frequency of occurrence by taking
appropriateaction.Itis
a. LossPrevention.
b. LossAvoidance
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M O D U LE-III:RISK M A N A G EM EN T A N D REIN SU RA N CE

c. LossReduction
d. LossU nderstanding.
e. N oneoftheabove.
11. Individualsinvesting in equity sharesand m utualfundsfor purposesofw ealth
accum ulation and retirem entneedsare invariably subjectto investm entrisk.A
risk reduction techniquethatisappropriateform itigating theinvestm entrisk is
portfolio diversification.Itis
a. LossPrevention.
b. LossAvoidance
c. LossReduction
d. LossU nderstanding.
e. N oneoftheabove.
12. Individuals m ight have got num erous risk-financing options w hich, m ay
how everbeclassified as
a. N oneofthese.
b. Risk Retention.
c. Risk Sharing
d. Risk Transfer
e. A lloftheabove.
13. O neofthefollow ing isnota form ofrisk transfer:
a. H oldH arm lessA greem ents
b. Incorporation.
c. Partnership
d. Insurance
e. N oneoftheabove.
14. A num ber of factor/s is /are considered by individuals before m aking risk-
financing decisions.
a. Expected cost
b. Financialposition
c. D egreeofrisk aversion
d. A lloftheabove
e. N oneoftheabove.
15. A house ow ner includes in the lease agreem ent a clause m aking the tenant
responsibleforallinjuriestheguestsm ay sufferw hileon theleased prem ises.It
is .form ofrisk transfer.
a. H edging

III-40
M O D U LE-III:RISK M A N A G EM EN T A N D REIN SU RA N CE

b. Insurance
c. H oldH arm lessA greem ent
d. D iversification
e. N oneoftheabove.

SEC TIO N -A A N SW ER S
1. d. 2. c. 3. c. 4. d. 5. e. 6. d
7. d 8. d. 9. b. 10.a. 11.c. 12.e.
13.c. 14.d. 15.c.

SEC TIO N -B
1. O utlinetheprocessofR isk A ssessm ent.
A ns.The first step in the process of risk m anagem ent by individuals,businesses and
society is the assessm ent of risk. Risk assessm ent com prises identification and
analysis of potential loss exposures. Such assessm ent has to be continuous and
com prehensive.Individualsasw ellastheirenvironm entare notstatic butdynam ic
and do change,and so risk assessm enthasto be an ongoing activity.A person srisk
profile undergoes significant change w hen he or she m arries and has children.
Likew ise,a person sinventory ofassetsgrow sw ith fresh acquisition ofassetsover
tim e and,as a result,his property risk profile changes overhis life tim e.The legal
environm enta person faces is altered by enactm entofnew statutes and changes in
case law.Because ofthese and otherchanges,individualsw illhave to continuously
and suitably adjusttheirrisk m anagem entefforts.
A business organization s exposure to loss is now m anaged by using a new risk
m anagem enttechnique called risk m apping m aking use ofa m atrix plotting in loss
frequency and loss severity.The risk m apping technique m ightnotbe particularly
usefulform anaging risk exposuresofindividualsand fam ilies.H ow ever,itm ightbe
instructiveto understand thetechniquew ith aview to applying itw hilediscussing the
techniques of risk control and risk financing for individuals and fam ilies. Loss
frequency m easures the likelihood of occurrence of a loss eventand loss severity
indicatesthepotentialfinancialim plication oftheevent.
2. W hatarethetechniquesofrisk controlavailableforindividualsand others?
A ns.The techniques of risk control available for individuals and others are classified
underthreeheads:
a. LossAvoidance
b. LossPrevention,and
c. Lossreduction
(i) LossAvoidance:
By refraining to expose oneselfto certain types oflosses,one can avoid loss.
III-41
M O D U LE-III:RISK M A N A G EM EN T A N D REIN SU RA N CE

Transportation risk can be avoided by notflying,w hich m ightnotbe alw ays


possible.A notherexam pleoflossavoidanceisdiscontinuing an activity w hich
an individualm ighthave hitherto been engaged and w hich leadsto a loss.For
exam ple,afterreceiving adoctor sadvicethatthereisarisk ofprem aturedeath
by cancer, an individual m ight com pletely stop sm oking. Likew ise,
discontinuanceofany activity thatm ay contributeto loss.H ow ever,onehasto
note thatindividualsare notalw aysrationalin m aking decisions.Furtherm ore,
itm ay notalw ays be possible to avoid risky activities fearing potentialloss.
M oreover,discontinuance of an activity w hich is involving a loss exposure
m ight still create a liability loss exposure from the transactions carried out
earlier. For exam ple, w ithdraw al of a drug by a pharm aceutical com pany
becausethefirm hascom eto know ofitsdangerousside-effectsm ay stillcreate
liability exposureon pastscaletransactions.
(ii) Prevention ofLoss:
Itisalm ostim possibleto avoid m ostsituationsofrisk asrisk isapartand parcel
ofeveryday life.A ssuch,individualsand fam iliescan take necessary stepsto
reduce the probability oflossoccurring,w here feasible.A ction can be taken to
ensurethatlossfrequency isreduced,w herepotentialfrequency ofrisk ishigh.
For exam ple, m ost frequently occurring m inor health problem s (flu, cold,
headache,etc.)w hich do im ply low lossseverity can bereduced in frequency of
occurrenceby taking appropriateaction aim ed atlossprevention.
(iii) LossR eduction:
Loss reduction activities w ould be appropriate w here the potentialseverity of
loss is im portant. The activities taken for reduction of risk severity w ould
m itigate the loss,though com plete prevention ofloss is noton the cards.The
lossreduction activitiesw illhopefully shifttheconsequencesoflossto theleft
to them oderateregion from thecatastrophicregion.
3. Explain R isk R etention and R isk Transfer.
A ns.1. R isk R etention:
M eeting thelosscostsby theindividualorfam ily by internalizing them iscalled
risk retention.The losses thatare internalized w ould be financed outofone s
ow n incom eorw ealth.W hilethedecision to retain alossexposureand finance
itoutof one s ow n funds m ay be a conscious decision of the individualor
fam ily.In m any cases,itm ay be a defaultoption oran involuntary option if
theoption oflosstransferisnotavailableorisnotaffordableoriftheindividual
isunaw areofthelossexposure.Theexpected costofrisk financing through the
m ethod ofrisk retention involvesan uncertain am ountforw hich theindividual
orfam ily m ustbeprepared.
2. R isk Sharing:
Risk sharing as a technique ofrisk financing options available to individuals
III-42
M O D U LE-III:RISK M A N A G EM EN T A N D REIN SU RA N CE

and fam iliesisablend oftheothertw o financing options,nam ely risk retention


and risk transfer. M ost non-life insurance contracts contain provisions for
allocation oflossesbetw een insurerand insured.Lossesbelow a specified size
borne by the insured are called deductible provisions. Further, deductibles
operateon aperlossbasis;thatis,thedeductibleprovision isapplicableforeach
lossevent.D eductiblesarenorm ally specified in rupeeam ount.H ow ever,in case
ofcoverageoflossesresultingfrom floodsandearthquakes,theyareexpressedas
apercentageofthetotalvalueoftheinsured sproperty.In m any health insurance
polices, aggregate deductibles are specified and the deducible operative in
term softhecum ulativeam ount.In otherw ords,any lossduring apolicy period,
in excess of the aggregate deductible am ount (w hich is to be borne by the
insured),istheliability oftheinsurer.
A s regards,provision of co-insurance,the allocation of losses betw een the
insurerand theinsured isexpressed on apercentagebasis(say 80 percentofthe
covered losses by the insurer and 20 percent retained by the insured).Co-
insuranceasaform oflosssharing isquitecom m on in health insurance.Itm ay
also benoted thatw herehealth careclaim islarge,som etim es,health insurance
policiescontain aprovision restricting theloss-sharing upto aspecified levelof
covered loss.D isability insurers use a w aiting period,called an elim ination
period, as a loss sharing provision. For exam ple, the insurance policy m ay
stipulatethattheinitialperiodofdisability,say15days,isretainedbytheinsured.
4. Explain variousform sofrisk transfer.
A ns.Risk transferinvolvesagreem entby the transferee to assum e the lossorrisk thatthe
transferorisdesirousofescaping.Theprocessofrisk transferinvolvesapaym entby
the transferorto the risk bearerortransferee.Itisnorm ally done through insurance.
Through the process of transfer,the degree of risk is som etim es reduced as the
transfereem ay bein aposition to predictlossby applying thelaw oflargenum bers.
Fiveform sofrisk transferarediscussed by insurancetextbooks.
H oldH arm lessA greem ents
Incorporation
D iversification
H edging
Insurance
5. W hatisH old H arm lessA greem ent?
A ns.H old H arm less Agreem ents:M any kinds ofcontracts,by incorporating appropriate
provisions,m ay transferresponsibility forsom etypesoflossesto som eoneelsew ho
isnotobligated to bearit.They arealso called indem nity agreem ents.Theclausesin
the agreem ents m ay fix the responsibility for paying for various losses on som e
individual or individuals.An exam ple of this type of agreem ent: A house-ow ner
including in the lease agreem ent a clause m aking the tenant responsible for all
III-43
M O D U LE-III:RISK M A N A G EM EN T A N D REIN SU RA N CE

injuriestheguestsm ay sufferw hileon theleased prem ises.Itisacaseofshifting the


responsibility forpaym entoflossesto the tenantw ithoutany actualreduction in the
originalrisk because generally no greater predictive ability in regard to potential
lossescan beexpected on thepartofthetenantthan on thehouse-ow ner.
6. Explain insuranceasa risk transfertool.
A ns.InsuranceasR isk Transfer:
Insurance isconsidered a specialform ofthe technique ofrisk-transfer.Itis,on one
side,an econom ic orsocialinstitution designed to perform certain specialfunctions
and on theother,asalegalcontractbetw een tw o parties,theinsured (transferor)and
theinsurer(transferee).
Taking thelatteraspectfirst,in certain situations,thebestw ay to m anageaparticular
risk, m ay be to purchase insurance. This is because of the insurer s ability to
efficiently handle risk through the operation oflaw oflarge num bers.Itdoes not,
how ever,im ply an autom aticassum ption thattheonly w ay to handleaparticularrisk
exposure isinsurance.Such an assum ption isnotw arranted.Som e ofthe corporate
risk m anagers,in fact,use insurance as a lastresort,w hen otherrisk m anagem ent
techniquesarenotconsidered adequateby them selves.
Insuranceasan econom icinstitution operateson theprincipleofrisk pooling and risk
reduction,besidesam echanism ofrisk transfer.Pooling isthesharing oftotallosses
am ong agroup.Theaggregateam ountofuncertainty isbroughtdow n facilitating risk
reduction by com bining underone m anagem enta group ofobjects orpersons so
thatthetotallossesto w hich theinsured group issubjectbecom espredictablew ithin
narrow lim its .Through thisprocess,theoverallrisk forthegroup isreduced and the
resultantlossesarepooled,generally through them ethod ofpaym entofan insurance
prem ium .Thus,the insureds,through the m echanism ofinsurance,transferspecific
risksto thegroup and exchangeapotentially largeand uncertain lossforarelatively
sm allcertain paym ent,i.e.theinsuranceprem ium .
7. W hatfactorsdeterm inerisk financing decisions?
A ns.A num ber of factors are considered by individuals before m aking risk-financing
decisions or choosing the category appropriate to them outof the three available
options,risk retention,risk reduction and risk transfer.
Thefactorsinclude
a. Expected cost
b. FinancialPosition
c. D egreeofRisk Aversion
d. ExternalConstraints
The expected value and the variability ofcostofvarious risk-financing options are
prim e considerationsin regard to the choice people m ake.The financialposition of
theindividualm aking thechoicealso influenceshis/herdecision.Thedegreeofrisk
aversion ofthe individualw illalso be an influencing factorin the choice ofrisk-
III-44
M O D U LE-III:RISK M A N A G EM EN T A N D REIN SU RA N CE

financing decision.Finally,thechoiceofan individualofthetypeofrisk financing he


or she m akes m ay be constrained by external factors e.g. M otor ow ners are
constrained by legislation in m any countries to the purchase of m otor vehicle
insurance.A nother exam ple is the constraintthatinsurance be purchased for the
purpose of protecting the collateral.W hen financial institutions extend credit or
provide loans forhom e purchase orcarpurchase,they im pose a condition thatthe
debtorspurchaseproperty insurance.

SEC TIO N -C
(C A SE STU D IES)
D as and A ssociates is a m anagem entconsulting firm w ith headquarters atM um baiand
operationsspread alloverthe country.The com pany w asform ed in 2000 by itsprom oter
directorA nup D as.D aspresently m aintains150 consultantsand 100 em ployeesw orking in
supporting roles.The firm has developed a reputation for being especially helpful in
solving personneland financialm anagem entproblem s.A sD asand hism anagem entteam
plan forthefuture,they w antto bevery system aticin identifying key issues,opportunities,
and potentialproblem sthatm ay confrontthecom pany in theyearsahead.
O ne area thathasnotreceived m uch attention to date isthatofpure risk exposures.Thus,
D as has recently assigned one of his top consultants to take on the responsibility for
identifying allofthe potentialrisks confronting his firm .A fterthe exposures have been
identified,D asw antsto know therelativeim portanceofeach one.Forexam ple,istherisk
oflossdueto firepotentially m oredam aging than therisk ofadverseliability judgm ents?
W hatlossesare m ostlikely to happen in a given year,and how m uch w ould probably be
lostin each case?Can consistency beexpected from oneyearto thenext?D asbelievesthat
itisim possible to m ake good risk m anagem entdecisionsw ithoutfirsthaving answ ersto
theseand sim ilarquestions.D iscuss.
A ns.H um an nature isfundam entally adolescent(e.g., bad thingsw on thappen to m e )
and short-sighted (e.g.,tends tow ard im m ediate gratification instead of long-term
gratification).D isasterpreparation and m ostothercom ponentsofrisk m anagem ent
require leadership that is m ature (e.g., bad things happen all the tim e and can
happen to m e as easily as to anyone else) and far-sighted (e.g., able to delay
gratification and m ake long-term investm ents for a greater good). To achieve
m aturity and far-sightedness,m any thingsarerequired overm any years.K ey am ong
thosethingsareacadem iceducation and lifeexperiencethatincludetheform ation of
positive values, ethics, and know ledge of the political, econom ic, and business
conditionsm ostlikely to producepositiveresultsfrom hum an nature.
The first step in the process of risk m anagem ent by individuals,businesses and
society is the assessm ent of risk. Risk assessm ent com prises identification and
analysis of potential loss exposures. Such assessm ent has to be continuous and
com prehensive. A s individuals as w ell as their environm ent are not static but
dynam ic and do change,risk assessm enthas to be an ongoing activity.A business

III-45
M O D U LE-III:RISK M A N A G EM EN T A N D REIN SU RA N CE

organizations exposures to loss is now m anaged by using a new risk m anagem ent
technique called risk m apping m aking use ofa m atrix plotting in lossfrequency and
lossseverity.
The second step in the risk m anagem entprocess is to controlthe risk by selecting
thosetechniquesthatw illreducethefrequency oflossand reducetheseverity ofloss.
Beforedeciding upon thespecificrisk controlm easureto beadopted itisnecessary to
conducta cost-benefitexercise.Thatis an evaluation ofthe expected benefits and
costsinvolved to determ inew hetherthedecision taken iseconom ically sound ornot.
D espiteone sbestefforts,lossexposurescan neverbeelim inated;onehasto think of
financing losses,w hen losseshappen.The question ofsourcesoffundsforrepairing
lossesisaddressed to techniquesoflossfinancing.Lossfinancing (and the various
sourcesoffundsavailable forthispurpose)isrequired to repairorreplace dam aged
property,to m eetexpensesinvolved in legaldefence and any advance judgm entsor
aw ard in casesoflegalliability,to pay m edicalbillsand otherhealth care expenses
and to replacelostw agesand taking careofthefinancialconsequencesofprem ature
death orlossoflife.
W hileoneend oftherisk-financing continuum ,isrisk retention,theotherend ofthe
continuum is risk transfer.In risk transfer,the financialim pactofloss is shifted to
anotherparty.Risk transferinvolvesagreem entby thetransfereeto assum ethelossor
risk thatthetransferorisdesirousofescaping.Theprocessofrisk transferinvolvesa
paym entby thetransferorto therisk bearerortransferee.Itisnorm ally donethrough
insurance.
Basing on the above analysis the consultants need to look atalldim ensions and
estim ateprobablecausesofrisks,how to m anagethem ,and how to fund them in case
itreally occurs.

III-46
M O D U LE-III:RISK M A N A G EM EN T A N D REIN SU RA N CE

C hapter7
R isk M anagem entby Businesses
and EnterpriseR isk M anagem ent(ER M )

SEC TIO N -A

1. O neofthefollow ing isnottrue;


a. Itis betterneverto have suffered a loss than to sufferand collectunderan
insurancepolicy .
b. The enterprise m ightfailentirely notw ithstanding thatithas the finestrisk-
financing program m eitcould everdevise.
c. There is am ple evidence that a significant proportion of firm s never fully
recoverfrom theeffectsofam ajorfireand som ehaveto bew ound up w ithin a
shorttim eeven iffully insured.
d. A reduction in loss expectancies broughtaboutby risk controlm easures w ill
usually also reducethecostoftherisk-financing program m e.
e. N oneoftheabove
2. O neofthefollow ing isnottrue;
a. allexposuresto risk m ustbeidentified;
b. allexposuresneed to be evaluated according to cause and effect,theaim being
to quantify probabilitiesand severities;
c. thepossibility ofavoiding orelim inating any oftherisksshould beinvestigated,
and iffeasibletheappropriatestepsshould betaken;
d. in the case of other risks,risk reduction m easures need to be explored and
im plem ented;
e. N oneoftheabove
3. Businessenterprisesnorm ally do notfacethisrisk;
a. InterestRateRisk
b. Foreign ExchangeRisk
c. Com m odity PriceRisk
d. PersonalA ccidentRisk
e. N oneoftheabove.

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M O D U LE-III:RISK M A N A G EM EN T A N D REIN SU RA N CE

4. O ne of the follow ing techniques can be adopted by a business enterprise to


transferrisk:
a. D iversification.
b. H edging
c. Incorporation.
d. A & B
e. A lltheabove.
5. A n oilcom pany,in order to protectitselffrom future price risk,enters into a
futuresagreem entw ith anotherparty.Itisa caseof
a. Speculation
b. PriceProtection
c. H edging
d. G am bling
e. N oneoftheabove.
6. A firm suninsured lossesareultim ately paid by
a. M anaging D irector
b. Shareholders
c. D ebtorsofthecom pany
d. Tax payersin thesociety
e. N oneoftheabove.
7. Theeconom icreason/sforthecorporatebusinessunitsengaging in firm -specific
risk m anagem entactivities
a. Risk transferconfers benefits on the firm m anaging its risk exposure through
risk transferby covering potentialbankruptcy costs.
b. W hileshareholderscan achievereduction in firm specificrisk through portfolio
diversification,theotherstakeholdersarenotin such acom fortableposition.
c. Risk transferthatthecash flow sw illbeavailableto m eettheobligationsto debt
holdersand forfutureinvestm entprojectsthatenhancethefirm svalue.
d. A & B
e. A lltheabove
8. O neofthefollow ing isnottrue;
a. Creditand m onetary risk ishandled by theCorporateTreasurer
b. Reputation risk ishandled by m arketing and publicrelationspersonnel.
c. Forhandling operationaland com m odity risk,strategic businessunitsdevelop
appropriate controls.
d. Financialrisk ishandled by CEO ofthecom pany.
e. N oneoftheabove.
III-48
M O D U LE-III:RISK M A N A G EM EN T A N D REIN SU RA N CE

9. O neofthefollow ing isnotfinancialrisk:


a. InterestRateRisk
b. PriceRisk
c. CreditRisk
d. Foreign ExchangeRisk
e. O perationalRisk
10. A n earthquake dam age to a m ultinational com panys property in a country
w ould less likely to have any correlation w ith its exposure to interest rate or
foreign exchangerisk in a country located in anotherpartofthew orld.Thisis
a. Silo approach.
b. N aturalhedging
c. D iversification
d. InternationalM anagem ent
e. N oneoftheabove.
11. Enterprise R isk M anagem ent norm ally does not cover one of the follow ing
activities;
a. Technologicalchangesthataffectafirm sstrategicgoals
b. Tem porary break dow n ofan enterprise sED P system
c. Changesin regulatory regim ethatadversely affectthebusinessenvironm ent.
d. Stock m arketupheavalsaffecting thepricing structureofan enterprise
e. N oneoftheabove.
12. Thisinsuranceisbased on spreading risk overtim e.
a. Financialinsurance.
b. Infiniterisk insurance.
c. Finiterisk insurance.
d. Tim erisk insurance
e. N oneoftheabove.
13. It is a process of creation of securities such as bonds, derivative contracts
(Futures, O ptions, Sw aps etc.,) w hose price m ovem ents are linked to an
insurancerisk.
a. Securitization.
b. Bonding
c. Factoring
d. Forfeiting
e. N oneoftheabove.

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M O D U LE-III:RISK M A N A G EM EN T A N D REIN SU RA N CE

14. Itisa choiceto buy orselltheassetatsom efuturedateatan agreed price;


a. O ption.
b. Futures.
c. Forw ards.
d. Collar.
e. N oneoftheabove.
15. A callholderisalw aysspeculating on .in prices.
a. Rise
b. fall
c. stability
d. fluctuation
e. N oneoftheabove.

SEC TIO N -A A N SW ER S
1. e 2. e 3. d 4. e 5. c 6. d
7. e 8. d 9. e 10.b 11.d 12.c
13.a 14.a 15.a

SEC TIO N -B

1. R egardlessofthe techniquesthatm ay be em ployed ateach stage ,every risk


m anagem ent program m e m ust proceed according to the logical sequence of
eventsifitisto stand any chanceofsuccess .Explain
A ns. A llexposuresto risk m ustbeidentified;
A llexposuresneed to beevaluated according to causeand effect,theaim being
to quantify probabilitiesand severities;
The possibility of avoiding or elim inating any of the risks should be
investigated,and iffeasibletheappropriatestepsshould betaken;
In the case of other risks,risk reduction m easures need to be explored and
im plem ented;
Theresidualrisksneed to beevaluated so thatdecisionscan betaken aboutthe
bestm ethodsoffinancing them ;and finally
The results of the w hole program m e need to be m onitored and regularly
review ed in thelightofchanging conditions.
2. Explain D iversification and H edging astoolsofhandling risks.
A ns.D iversification policy adopted by a businessfirm acrossvariouslinesofbusinesses
and/orgeographiclocations,m ainly from theangleofbusinesssynergies,econom ies
ofscale and costreduction,also helps the firm transferrisk across business units.
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M O D U LE-III:RISK M A N A G EM EN T A N D REIN SU RA N CE

Furtherm ore,com bining in one firm ofdifferentlinesofbusinessand /ordifferent


geographicallocations m ay help in the reduction oftotalrisk exposure by the firm
through w hat is know n as the portfolio effect of pooling individual risks w ith
differentco-variances.
A ssum e,that a business unit has production facilities at tw o different locations.
H eavy floodsm ighthave caused dam age to the production facilitiesin A ssam ;itis
highly unlikely that the sam e floods w ould cause any dam age to the second
production facility located in A ndhraPradesh.
H edging isam eansoftransferring aspeculativerisk (risk offluctuationsin price)to
a third party -eithera speculatororanotherhedger.Forexam ple,an oilcom pany,to
protectitselfagainstprice risk (fluctuationsin pricesofjetfuel)entersinto a futures
agreem entw ith a counter-party,say a speculator.In effect,the speculator(counter-
party) is assum ing the price risk associated w ith jet fuel transferred by an oil
com pany w hich produces and supplies jetfuelto the oilm arket.Ifby the hedging
agreem ent,the operating profits ofthe oilcom pany im prove,the projectinvolving
transferring ofpricerisk to aspeculatorin thefuturesm arketyieldsnetpresentvalue
to thefirm and should increasethefirm svalue.
3. O utlinesom eoftheriskscovered underEnterpriseR isk M anagem ent.
A ns.1. D am age to a crop affecting the quality, quantity or m arketability of grain
suppliers.
2. Technologicalchangesthataffectafirm sstrategicgoals.
3. Tem porary breakdow n ofan enterpriseselectronicdataprocessing system .
4. D isruptionsto theproduction activitiesofafirm by politicalupheaval.
5. A dversecom m odity pricechanges
6. Changesin regulatory regim ethatadversely affectthebusinessenvironm ent.
7. Lapsesin duediligencerelating to M ergersand A cquisitions.
4. Explain thefollow ing:
a. CaptiveInsuranceCom panies.
b. FiniteRisk Insurance.
c. M ulti-yearinsurancecontracts.
d. M ultipleTriggerContracts.
A ns.Captive insurance com panies:A captive insurance com pany is ow ned by a non-
insurance businessunitforthe purpose ofaccepting the risk exposuresofthe parent
com pany.Itisacaptiveoftheparentbecauseitisunderthecontrolofthelatter.The
captive m ay be on shore (one dom iciled in the country)type oroff-shore type (in
another country in w hich there are less restrictive regulatory law s, in regard to
m inim um capital requirem ents and investm ent allocation).Establishing a captive
insurancecom pany,how ever,m ay takeconsiderabletim eand substantialm oney m ay
berequired.

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M O D U LE-III:RISK M A N A G EM EN T A N D REIN SU RA N CE

Finite risk insurance. U nlike traditional insurance contracts w hich are based on
spreading acrossa poolofsim ilarrisk exposures,finite risk insurance contractsare
risk transfercontractsbased on theconceptofspreading risk overtim e.In thistypeof
contracts,the insured transfers lim ited extentof risk.The m ain objective of such
contractsissm oothing thelossesduring thecontractperiod.
M ulti-live/m ulti-yearinsurance contracts generally com bine a num berofrisks and
the policy period extends overm ultiple years.The risks thatare com bined m ay be
pure riskssuch asproperty,liability and auto risksorcom bination ofpure risksw ith
financialrisks.
M ultiple Triggercontractspoolrisksw hich togethercould seriously affectthevalue
ofthe firm .Forthe shareholders ofa com pany,the effectofthe risk on the firm s
earnings is im portant,not the source of the risk.M ulti-trigger policies generally
com bine a pure risk w ith a financialrisk.The policy is "triggered" and paym entis
effected only,w hen therisky eventin each category occurs.Forexam ple,an electric
pow ergeneration com pany m ightbuy a policy thatis"triggered"ifone ofthe firm s
pow ergeneration plantsbreaksdow n (thefirstrisk),during aperiod w hen thepow er
ratesarem arked by considerablevolatility (thesecond risk).

SEC TIO N -C
(C A SE STU D IES)
The globaleconom y has becom e a reality for m any firm s.A s internationaloperations
expand,itisim portantform anagem entto recognize thatthe sam e risk m ay resultin very
differentestim atesforthem axim um probablelossand m axim um possiblelossin different
countries.W ith differing lossfrequency and severity estim ates,the m ostappropriate risk
m anagem enttechniquesare also likely to vary from country to country.Severalexam ples
illustratethispoint.
In the U nited States,risk m anagersoften concentrate m uch tim e and effortin identifying,
evaluating and m anaging liability exposures.H ow ever,the restof the w orld is notas
litigious,thusm aking liability lossesoutside ofthe U nited Stateslessproblem atical.The
analysisofpotentialproperty lossesm ay also vary.Forinstance,the proliferation ofvery
old buildingsthrough outEurope presentsunique problem s.In Pacific Rim countries,the
potentialfor catastrophic loss due to typhoons or other w indstorm s is very real.Risk
evaluation in countries experiencing frequentcurrency devaluation (such as Brazil)can
also bechallenging,becauseproperty valuationsbecom eobsoleteso quickly.
Risks of loss due to crim e also vary considerably from one country to the next.For
exam ple,in Eastern Europe and the form er SovietU nion,deficiencies in the com puter
infrastructurem akesitnearly im possibleto track stolen vehiclesin thesam ew ay thatitis
possiblein m ostW estern countries.A nd therisk oflossto em ployeesdueto kidnapping or
otherviolenceisw ellknow n in m any Latin A m erican countries.O ften,thedynam icrisk of
political unrest m erely exacerbates such problem s, m aking the risk m anagers job
continually challenging.
III-52
M O D U LE-III:RISK M A N A G EM EN T A N D REIN SU RA N CE

D iscuss the challenges of Risk M anagers in the lightof changing globalscenario and
EnterpriseRisk M anagem entpractices.
A ns.The optim alRM D epartm entreporting structure is difficultto define and can vary
w ith thesizeand scopeofthebusinessoperation.W hileIagreein general,thew rong
reporting relationship can certainly underm inetheRM departm entseffectiveness.In
sm allerorganizations,theRM m ay need to reportto thepresidentorow ner,because
as w as said, every silo of an organization is touched by risk m anagem ent and
therefore there exists the potentialforspecialinterests and conflicts by individual
departm ents. Risk m anagem ent affects the overall business operations, therefore
having itreportthrough H R,treasury,finance,orthegeneralcounselisin m ostcases
aform ulaforfailure.
Risk m anagerm ust,above all,be a tough-m inded individualable to com m unicate
because the task athand is,in large part,selling the conceptofrisk m anagem entto
V P-levelpeers.The V Psare paid to grow revenue,w hile the risk m anagerispaid to
prevent/lim it loss.There is a healthy tension here w hich,in the end,serves the
organization best.Ifthe risk m anagerisnotgetting results,then find a risk m anager
tough enough forthejob.Investing m oreauthority in an essentially w eak playerw ill
only fosterthew rong kind ofstressw ithin theorganization,and m akelifeeven m ore
difficultfortherisk m anager.
Businessenterprisesface a num beroftypesofrisks-som e called pure riskssuch as
property and liability risksand som eotherrisksthatarecalled financialriskssuch as
interestraterisk,foreign exchangerisk and com m odity pricerisk.Theform erthatis
pure risksare often insurable and are characterized by only a dow nside potential,
i.e. chance of loss. Insurable risks can be m anaged by insuring them . The
com partm entalization ofrisk m anagem entactivitiesw ithin afirm m ay beillustrated:
pure orhazard risk ism anaged by the traditionalrisk m anager;creditand m onetary
risk is handled by the corporate treasurer; m arketing and public relationship
personnelfocuson reputationalrisks;Forhandling operationaland com m odity risk,
strategic business units develop appropriate controls. N ew financial products
futures, options, sw aps and other derivative contracts are used for m anaging
financialrisks,such asinterestrate risk,com m odity price risk and foreign exchange
risk.
D uring the lastdecade or so,there is a proliferation of a num ber of tools of risk
transfer,(asan alternative to insurance).Itistrue thatthey have notbecom e w idely
used.They include creation ofcaptive insurance com panies,finite risk orfinancial
insurance,m ulti-line/m ulti-year insurance,m ulti-trigger policies and securitization
techniques.
A m ong the risk m anagem entinstrum ents com m only used by enterprises,hedging
tools orinsurance are the m ostim portant.These devices perm itthe party holding
som erisky assetto transferthatrisk to another,called counter-party.Theassetvalue
can be separate from risk and the lattersold separately fora price.Risk is a traded
com m odity and issold in them arketforrisk.
III-53
M O D U LE-III:RISK M A N A G EM EN T A N D REIN SU RA N CE

C hapter8
R einsuranceTheory

SEC TIO N -A

1. Theagreem entbetw een theprim ary insurerand reinsurerisknow n as:


a. Coinsurance
b. U nderInsurance
c. O verInsurance
d. Reinsurance
e. N oneoftheabove.
2. Theothernam esforprim ary insurer;
a. Insured
b. Ceder
c. Cedent
d. Proposer
e. N oneoftheabove.
3. R einsuranceisa contractof
a. Indem nity
b. Securitisation
c. A elatory contract
d. BothA & B
e. BothA & C
4. A n insurersability to providea high lim itofinsuranceon a singlelossexposure,
iscalled:
a. Solvencysyndrom e.
b. ExposureBarrier
c. Large-lineCapacity
d. O verCapacity
e. N oneoftheabove.
5. W hich one the follow ing can be classified as one of the prim ary functions of
reinsurance?
III-54
M O D U LE-III:RISK M A N A G EM EN T A N D REIN SU RA N CE

a. Stabilizing oflossexperience.
b. M inim izing theeffectsofcatastrophe.
c. Increasing thecapacity.
d. A lloftheabove
e. N oneoftheabove.
6. The process of reinsuring all losses for an entire class,territory or book of
businessisknow n as
a. CatastropheReinsurance
b. D isasterinsurance
c. Portfolio Reinsurance
d. Large-linecapacity
e. N oneoftheabove.
7. A tlaw,the policy holdersdo nothave directaccessto the reinsurers.H ow ever,
thereisan exception and itis
a. Provision ofSubrogation
b. Cut-through Endorsem ent
c. Pre-em ptiveClause
d. A lloftheabove
e. N oneoftheabove.
8. R einsurance contractunder w hich the ceding com pany has the option to cede
and reinsurer has the option to accept a risk of a specific business line is
called .
a. FacultativeReinsurance
b. Treaty Reinsurance
c. ProporionalReinsurance
d. O ptionalReinsurance
e. N oneoftheabove.
9. W hatdoesthew ord " treaty" m ean in Treaty R einsurance
a. A n agreem entbetw een tw o parties
b. Bulk Insurancepolicy
c. SingleInsurancepolicy
d. Ceding
e. N oneoftheabove
10. U nderthistheprim ary insurercedesa fixed,predeterm ined percentageofevery
risk to thereinsurerw ithin theclassorclassessubjectto thetreaty.
a. SurplusShareTreaty
b. ExcessofLossTreaty
III-55
M O D U LE-III:RISK M A N A G EM EN T A N D REIN SU RA N CE

c. Q uotaShareTreaty
d. Stop LossTreaty
e. N oneoftheabove.
11. In surplusreinsurance,theretained businessiscalled
a. M argin
b. Line
c. Treaty
d. LossRatio
e. N oneoftheabove
12. The form ofexcessoflossreinsurance w hich indem nifiesthe reinsured against
the am ount by w hich the reinsured losses incurred during a specific period
exceed eitheran agreed am ountoragreed percentageiscalled
a. Stop-LossReinsurance
b. ExcessofLossreinsurance
c. Q uotaShareReinsurance
d. ProportionalReinsurance
e. N oneoftheabove.
13. Thisisthesim ilarity betw een insuranceand reinsurance
a. Liability ofreinsurersisseveraland notjoint
b. Principleofutm ostgood faith
c. PrincipleofIndem nity
d. Both B & C
e. BothA & B
14. The sum ofallindividuallossesdirectly occasioned by any one disaster,accident
orlossorseriesofdisastersarisingoutofoneevent,w hich occursw ithin oneState.
a. CatastropheLoss
b. D isastersyndrom e
c. LossO ccurrence
d. H urricaneclause
e. N oneoftheabove.
15. Theprim ary insurersendsa reportofreinsured businessevery m onth /quarter
know n asbordereauxto reinsurer.Such bordereauxcontains
a. Prem ium details.
b. D etailsofpolicies
c. D etailsofclaim s
d. A & B
e. A ,B & C.
III-56
M O D U LE-III:RISK M A N A G EM EN T A N D REIN SU RA N CE

SEC TIO N -A A N SW ER S
1. d 2. c 3. e 4. c 5. d. 6. c
7. b 8. a 9. a 10.c 11.b. 12.a
13.d 14.c 15.d

SEC TIO N -B

1. D oyou agreethatreinsurancecontractsareaelatoryin nature? Ifso,explain how.


A ns.A llthe legalprinciples thatgovern an insurance contractw illbe applicable to a
reinsurance contractasw elllike insurerand reinsurershould have the legalcapacity
to contractsand there m ustbe consideration forthe contract.Reinsurance contracts
are aelatory in the sense that prem ium share to the reinsurer w ill be sm all as
com pared to thereinsurancepaym entsthatw illbem adeby thereinsurerin theevent
ofaclaim .
2. W hatarethefunctionsofreinsurance?
A ns.Therearesix differentfunctionsofreinsurancethathavebeen broadly recognized:
Stabilisation oflossexperience.
Large-linecapacity
Financing (Surplusrelief)
CatastropheProtection
U nderw ritingA ssistance
W ithdraw alfrom aterritory orclassofbusiness.
3. Explain FacultativeR einsuranceand Treaty R einsurance.
A ns.Facultative isoptional-notcom pulsory.The prim ary insurerneed notinsure every
business.H e need only reinsure w hen there islack ofcapacity regarding a particular
class of insurance, e.g aviation insurance. Facultative reinsurance is defined as
reinsurance contract under w hich ceding com pany has the option to cede and
reinsurerhastheoption to acceptarisk ofaspecificbusinessline.
Facultative can be eitherproportionalornon-proportional.Itplaysa very im portant
rolein Aviation H ull,O iland Spaceindustry.
W hereas underTreaty Reinsurance the prim ary insureris obliged to cede and the
reinsureris obliged to acceptpartorallofthe classes ofbusiness covered by the
treaty.The treaty can be either proportionalor non-proportionalbasis.The treaty
doesnotrequire the ceding com pany to provide the detailsofthe risksindividually
butsom etim esabordereaux isprovided.
4. W hatisproportionaland non-proportionalreinsurance?
A ns.In proportionalreinsurance,thecession accepted by thereinsurerhasacertain fixed or
agreed proportion to theretention oftheprim ary insurer.Sim ilarly,w hen claim occurs,

III-57
M O D U LE-III:RISK M A N A G EM EN T A N D REIN SU RA N CE

thelossissettled betw een theprim ary insurerand thereinsurerin thesam eproportion


as theiracceptance ofsum insured.Proportionalcontracts can be facultative,quota-
sharetreaty,surplustreaty,facultativeobligatory treaty,open coverand pools.Itisalso
know n asParticipating ReinsuranceorPro ratareinsurance.
U ndernon-proportionalreinsurance,the distribution ofliability betw een the cedent
and the reinsurer is based on loss and not on the am ount insured. There is no
proportionate sharing of loss butan am ountis decided and any loss beyond that
am ountispaid by the reinsurer.Som e ofthe non-proportionate contractsare excess
oflosstreaty and stop-losstreaty.
5. Explain theExcessofLossR einsurance.
A ns.In thistypeofreinsurance,no insuranceam ountisceded underexcessoflosstreaties,
butonly lossesand prem ium s.Thereinsuranceprem ium isnegotiated by lineand by
insurer.There are no ceding com m issions under excess of loss treaty.The excess
reinsureris only responsible forlosses thatexceed the retention and fallw ithin the
coverageprovided by thereinsurancecontract.
The excess ofloss covers are tw o types:(a)perrisk cover(b)Pereventcovers /
Catastrophecovers.
The purpose of per risk cover is to reduce or replace the norm al proportional
reinsurance.These treaties are referred to as underw riting orw orking covers.The
reinsurerhasto pay any losson an individualrisk in excessofthe ceding com panys
retention.Thereinsurerisliableforallorpartoflossto any oneexposurein excessof
theretention and up to theagreed reinsurancelim it.
Catastrophecovers/PerEventcovers:thiscoverindem nifiesthereinsured com pany
fortheam ountoflossin excessofaspecified retention w ith respectto accum ulation
oflossesresulting from acatastrophiceventoraseriesofevents.

SEC TIO N -C
(C A SE STU D IES)
1. N ew Starinsurance com pany has purchased from M um Re Reinsurance com pany a
Q uota Share Treaty w ith a Rs 250,000 lim itand a retention of 25 percentand a
cessionof75percent.N ew Starhasw rittenthreepolicies.PolicyA insuresbuildingA
forRs10,000 foraprem ium ofRs100,w ith onelossofRs8000.
Policy B insuresbuilding B forRs100,000 foraprem ium ofRs.1000,w ith oneloss
ofRs10,000.Policy C insuresbuilding C forRs150,000 foraprem ium ofRs1500,
w ith onelossofRs60,000.
RahulK hanna,the new Reinsurance M anager,feels thatSurplus Share Treaty is
betterthan Q uota Share Treaty asitw illbe lim iting the claim exposure ofN ew Star
Insuranceand thereism oreliability in thecourtofM um Re.A ssum ing thatN ew Star
haspurchased aSurplusShareTreaty w ith aretention ofRs25,000 and alim itofRs
250,000 (a ten-line surplus treaty),show your calculations under tw o reinsurance
arrangem ents.
III-58
M O D U LE-III:RISK M A N A G EM EN T A N D REIN SU RA N CE

SO LU TIO N :
Q U O TA SH A R E TR EATY
D ivision ofInsurance,Prem ium and Losses
New Star M um Re Total
Rs Insurance(25% ) (75% )
PolicyA
Insurance 2500 7500 10,000
Prem ium 25 75 100
Loss 2000 6000 8,000
PolicyB
Insurance 25,000 75,000 100,000
Prem ium 250 750 1000
Loss2500 7500 10,000
PolicyC
Insurance 37,500 112,500 150,000
Prem ium 375 1125 1500
Loss 15000 45000 60,000

SU R PLU S SH A R E TR EATY
D ivision ofInsurance,Prem ium and LossesR etention
R s.25,000 and Lim itR s.250,000
New Star M um Re Total
Rs Insurance(% ) (% )
PolicyA
Insurance 10,000(100% ) 0 (0% ) 10,000
Prem ium 100 0 100
Loss 8000 0 8,000
PolicyB
Insurance 25,000 (25% ) 75,000(75% ) 100,000
Prem ium 250 750 1000
Loss 2500 7500 10,000
PolicyC
Insurance 25,000(16.67% ) 125,000(83.33% ) 150,000
Prem ium 250 1250 1500
Loss 10,000 50,000 60,000

ThusunderSurplusShareTreaty N ew Starinsurancecom pany can lim itthepaym ent


ofprem ium and also reducelossexposure.

III-59
M O D U LE-III:RISK M A N A G EM EN T A N D REIN SU RA N CE

C hapter9
M ethodsofR einsurance

SEC TIO N -A

1. O neofthefollow ing isnota benefitofTreaty R einsurance:


a. N o need to offereach and every risk to Reinsurer.
b. A utom aticprotection forinsurer.
c. A dm inistrativeconvenience.
d. Prem ium concession
e. N oneoftheabove.
2. Thekind oftreaty w herethecedentcom pany retainstheriskstilla certain lim it
and reinsuresonly thepartthatisaboveitsnetretention is
a. ExcessofLossTreaty
b. Stop LossTreaty
c. Q uotaShareTreaty
d. SurplusTreaty
e. N oneoftheabove.
3. Itis an agreem entunder w hich the reinsured and the reinsurer are obliged to
cedeand accepta certain percentageoftherisks.
a. ExcessofLossTreaty
b. Stop LossTreaty
c. Q uotaShareTreaty
d. SurplusTreaty
e. N oneoftheabove.
4. U nderthisagreem entthereinsured lim itstheam ountthatitisready to lose.The
reinsured relievestheexcessam ountw hich isin excessofitslossretention.
a. ExcessofLossTreaty
b. Stop LossTreaty
c. Q uotaShareTreaty
d. SurplusTreaty
e. N oneoftheabove.
III-60
M O D U LE-III:RISK M A N A G EM EN T A N D REIN SU RA N CE

5. U nder this agreem ent the reinsurer indem nifies the reinsured against the
am ountby w hich thereinsured lossincurred during a particularperiod exceeds
eitheran agreed am ountoran agreed percentageorsom eotherpercentage.
a. ExcessofLossTreaty
b. Stop LossReinsurance
c. Q uotaShareTreaty
d. SurplusTreaty
e. N oneoftheabove.
6. The reinsurance in w hich the reinsurance lim it and the reinsurers loss lim it
apply perriskiscalled
a. Peroccurrencereinsurance
b. Perrisk reinsurance
c. Catastrophereinsurance
d. A ggregatereinsurance
e. N oneoftheabove.
7. O neofthefollow ing isnota characteristicofQ uota ShareTreaty
a. Sharing ofpercentageisfixed.
b. N o individualcessions
c. Prem ium sand lossesaresettled by account.
d. Individualcessions
e. N oneoftheabove.
8. O neofthefollow ing isnota characteristicofPro-rata reinsurance.
a. Liability isbased on predeterm ined percentage
b. Itisproportionaltreaty
c. Thereissharing ofrisks.
d. Itisnon-proportionaltreaty
e. N oneoftheabove.
9. It offers the insurer protection against the accum ulations resulting from
num erouslossescaused by thesam eevent(cyclone,earthquake)
a. Pro ratareinsurance
b. Perilreinsurance
c. Coverperevent
d. BothA & B
e. N oneoftheabove.
10. A line isequalto theceding com panysretention.W here,a ceding insurerhasa
ten line surplus treaty on the basis of a m axim um retention of R s 5000,the
III-61
M O D U LE-III:RISK M A N A G EM EN T A N D REIN SU RA N CE

capacity ofthetreaty to absorb liability overand aboveretention w ould be


a. Rs50,000
b. Rs55,000
c. Rs5,000
d. Rs1,00,000
e. N oneoftheabove.

SEC TIO N -A A N SW ER S
1. d 2. d 3. c 4. a 5. b 6. b
7. d 8. d 9. c 10.a

SEC TIO N -B

1. Explain Q uota ShareTreaty.


A ns.In Q uotasharecontractsthecedantbindsitselfto retain and cedefixed proportionsof
allthebusinessitunderw ritesup to afixed am ount.
Forexam ple,iftheCeding Com pany shallretain forow n account40% ofallburglary
business,w ith an underw riting lim itof50,000 perrisk.The Cedantshallreinsure
w ith theReinsurer,w ho agreesto accepta60% shareofallburglary business.
Theadvantagesofthesystem isparticularly appropriatein thefollow ing cases:
1. W hen a com pany com m ences business in a line of business for w hich no
statistics exist; here the Reinsurer participates in the underw riting of each
policy,largeand sm all,and paysin thesam eproportion itsshareofthelosses.
2. In orderto sim plify adm inistrativew ork and reducecost.
3. If the loss ratio has gotoutof the Cedants controland cannotbe corrected
im m ediately w ithout endangering the relationship w ith the clientele.U nder
these circum stancesCedantw ould conclude quota share reinsurance asa relief
foralim ited period oftim e.
2. D ifferentiatebetw een Proportionaland N on proportionaltreaties.
A ns.N on-proportionalreinsurance arrangem ents are characterized by a distribution of
liability betw een theCedantand thereinsureron thebasisoflossesratherthan Sum s
Insured,asin caseofproportionalarrangem ents.
A s com pensation forthe covergranted,the Reinsurerreceives partofthe original
prem ium sand notthe partofthe prem ium corresponding to the sum reinsured asin
proportionalreinsurance.
Thefollow ing com m on characteristicsdifferentiatethem from proportionaltreaties.
1. Thesizeofcession isnotdeterm ined caseby case.
2. A dm inistrativecostsaresubstantially reduced.
3. U sually thereisno profitcom m ission.
III-62
M O D U LE-III:RISK M A N A G EM EN T A N D REIN SU RA N CE

4. Reinsurance prem ium is w orked outon the basis of exposure and pastloss
experience.
3. D ifferentiatebetw een SurplusShareTreaty and Q uota ShareTreaty
A ns.
Surplussharetreaty Q uota sharetreaty
1. O ften property only. 1. Both property and casualty.
2. Sharing ofpercentageisvariable. 2. Sharing ofpercentageisfixed.
3. Individualcessions. 3. N o individualcessions.
4. Reinsurersprem ium isthepercentage 4. Reinsurersprem ium isthe
oftheoriginalprem ium lessa percentageoftheoriginal
negotiated ceding com m ission. prem ium lessanegotiated
ceding com m ission.
5. Prem ium sand lossesaresettled by 5. Prem ium sand lossesaresettled
account. by account.

4. D ifferentiatebetw een Pro-rata and ExcessofLossR einsurance.


A ns.
Pro-rata Excessofloss
1. Liability isbased on predeterm ined 1. Liability in excessofthe
percentage Cedantsretention.
2. Itisaproportionaltreaty. 2. Itisanon-proportionaltreaty.
3. Thereissharing ofrisks. 3. Risksthatareaboveretention
arenotshared.
4. Thistreaty focuseson thesizeof 4. Thistreaty focuseson thesize
therisk. oftheloss.
5. Rateiscalculated asthepercentof 5. Thereisaseparaterate,w ith
theoriginalprem ium lesstheceding com m ission orw ithout
com m ission. com m ission.
6. Prem ium sand lossesaresettled by 6. Settlem entofprem ium s
accountorbordereau. accountand thesettlem entof
lossesindividually.

5. O utlinethecharacteristicsofN on-proportionaltreaties.

III-63
M O D U LE-III:RISK M A N A G EM EN T A N D REIN SU RA N CE

A ns.
Perrisk PerO ccurrence Aggregate(stop loss)
1. Itisnegotiated on rate 1. Itisnegotiated on rate 1. Itisnegotiated on rate
exposurebasisand there exposurebasisand there exposurebasisand
isno com m ission. isno com m ission. thereisno com m ission.
2. Prem ium saresettled by 2. Prem ium saresettled by 2. Prem ium saresettled by
annualadjustm entof annualadjustm entof annualadjustm entof
depositprem ium . depositprem ium . depositprem ium .
3. Prem ium ism inim um . 3. Prem ium ism inim um . 3. Prem ium ism inim um .
4. Lossesaresettled 4. Lossessettled by 4. Lossesaresettled
individually. catastropheorevent. annually
5. Retention isforeach 5. Retention isusually 5. Retention and thelim it
risk orbuilding or aboveam inim um of stated asalossratio.
location. tw o full-losses.
6. Ithasperoccurrence 6. Ithasaco-insurance 6. Ithasaco-insurance
lim itation. provision w hen the provision w hen the
reinsured sharestheloss reinsured sharesthe
above retention. lossaboveretention.

SEC TIO N -C
(C A SE STU D IES)
1. M unich insurance com pany entered into tw o surplus treaty contracts w ith the
reinsurers.Thefirstsurplustreaty consisted 10 linesw ith am axim um liability ofRs.
30,00,000.Thesecond surplustreaty consistsof20 linesw ith am axim um liability of
50,00,000.Theclaim sfiled areasunder:Show calculationsofprem ium aspersurplus
treaty.
Risk G rosssum insured Retention applicable

1 Rs.2,00,000 Rs.2,00,000
2 Rs.3,00,000 Rs.1,00,000
3 Rs.12,00,000 Rs.2,00,000
4 Rs.30,00,000 Rs.4,00,000
5 Rs.65,00,000 Rs.2,00,000

SO LU TIO N :
Risk G rosssum Retention [Rs] Cessionsto 1st Cessionsto 2nd
insured [Rs] surplustreaty surplustreaty
1 Rs.2,00,000 Rs.2,00,000 N il
2 Rs.3,00,000 Rs.1,00,000 Rs.2 ,00,000 N il
3 Rs.12,00,000 Rs.2,00,000 Rs.10,00,000 N il
4 Rs.30,00,000 Rs.4,00,000 Rs.26,00,000 N il
5 Rs.65,00,000 Rs.2,00,000 Rs.20,00,000 Rs.40,00,000
Balance3,00,000 hasto bearranged facultatively.
III-64
M O D U LE-III:RISK M A N A G EM EN T A N D REIN SU RA N CE

2. Rakshak Insurance w as prepared to bear any claim up to Rs 3,00,000. It


estim ated the m axim um exposure per event to be Rs 12,00,000. Rakshak
Insuranceentered an excessoflossreinsurancecontractw ith TakatReinsurance
to m eetthe balance of any claim up to further Rs 9,00,000 in excess of Rs
3,00,000 perrisk.
O n accountofa cyclone the tow n suffered heavy dam agesand severalhouses
w erebadly hit.60 housesoftheinsured w eredam aged.
Subsequently 60 claim sofeach Rs3,60,000 w erefiled w ith Rakshak.
Show thecalculationsrelating to (a)retention am ountby theinsured
(b)recoverableam ountfrom theexcessofloss
reinsurance.
SO LU TIO N :
N um berofhouses 1 (Rs) 60 (Rs)
Paym entto prim ary insured 3,60,000 2,16,00,000
Retained by Rakshak 3,00,000 1,80,00,000
Recovery from TakatRe 60,000 36,00,000

III-65
M O D U LE-III:RISK M A N A G EM EN T A N D REIN SU RA N CE

C hapter10
Treaty W ordings

SEC TIO N -A

1. O neofthefollow ing isnottrue:


a. There m ust be identity of view s betw een the contracting parties in case of
reinsurancecontracts.
b. Thepartiesto thecontractshould nothaveany legaldisabilities.
c. Therem ustbeconsideration forthecontract.
d. W ordingsofthe reinsurance agreem entare agreed betw een the cedentand the
reinsurerbeforehand.
e. N oneoftheabove
2. O neofthefollow ing isnottrue:
a. O ther than facultative reinsurance,allother agreem ents betw een the ceding
prim ary insurerand thereinsurerarew ritten.
b. Treaty w ordings have com e to occupy an im portant place in the study of
reinsurance.
c. Treaty w ordingsarestandardized throughoutthew orld.
d. They includeagreem entson thefollow up ofaccounting procedures.
e. N oneoftheabove.
3. Theliability oftheR einsurerin respectofreinsuranceallotted hereundershall
com m ence sim ultaneously w ith thatofthe com pany assoon asthe retention of
the com pany on any one risk as defined by its lim its, records, practice or
instructionsisexceeded .Thisclauseisknow n as:
a. O perativeclause
b. A ttachm entofCessionsclause
c. Exclusionsclause
d. Reservesclause
e. N oneoftheabove.
4. A ll acceptances hereunder shall be at the sam e gross rates, term s and
conditions as and to follow the settlem entofthe com pany,and the R einsurer
shallfollow the fortunesofthe com pany in regard to the cessionsin w hich the
III-66
M O D U LE-III:RISK M A N A G EM EN T A N D REIN SU RA N CE

reinsurerby virtueofthisagreem enttakespart .W hatclauseisthis?


a. O perativeclause
b. Follow theFortunesclause
c. Exclusionsclause
d. Reservesclause
e. N oneoftheabove.
5. In no eventshallthisagreem entprotectthe com pany in respectof:w ar and
civilw arobligatory reinsurances.A ny lossorliability accruing to thecom pany,
directly or indirectly and w hether as insurer or reinsurer,from any poolof
insurers or reinsurers form ed for the purpose of covering atom ic or nuclear
energy risks. Thisclauseisknow n as:
a. O perativeclause
b. A ttachm entofCessionsclause
c. Exclusionsclause
d. Reservesclause
e. N oneoftheabove.
6. W hich ofthe follow ing clauses ensures thatthe reinsured does notchange its
underw riting practicesw ith regard to thebusinesscovered by thetreaty?
a. Changeoflaw clause
b. Costsclause
c. Currency clause
d. Changeofunderw riting policy clause
e. N oneoftheabove.
7. W hich ofthe follow ing clausesallow sthe reinsured to effectother reinsurances
in priority?
a. Recitalclause.
b. Recordsclause.
c. O perativeclause.
d. N etretained linesclause.
e. N oneoftheabove.
8. The reinsurers hereby agree to indem nify the com pany for that part of the
ultim ate netlossw hich exceedsthe am ountstated in item ofthe schedule on
accountofeach and every lossoccurrence and the sum recoverable under this
agreem entshallbe up to butnotexceeding the am ountstated in item ofthe
schedule,ultim atenetlosson accountofeach and every lossoccurrence
a. O perativeclause
b. Insuring clause
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M O D U LE-III:RISK M A N A G EM EN T A N D REIN SU RA N CE

c. Exclusionsclause
d. Reservesclause
e. N oneoftheabove.
9. Ifduring the currency ofthisagreem entany balancesunder any other treaty
ortreatiesbetw een thecom pany and thereinsurerrem ain unpaid by oneparty,
the other shall be entitled to: retain the balance due hereunder until full
paym ent has been m ade under the other treaty or treaties: or adjust such
balanceagainsttheam ountduefrom theotherparty.
a. ReservesClause
b. A djustm entClause
c. Set-offClause
d. A lterationsClause
e. N oneoftheabove.
10. A rbitration clausefordisputesprovidesforappointm entofarbitrator/s.
a. 1
b. 2
c. 3
d. 4
e. 5

SEC TIO N -A A N SW ER S
1. e 2. c 3. b 4. b 5. c 6. d
7. d 8. b 9. c 10.b

SEC TIO N -B
1. U nderw hatcircum stancesw illthereinsuranceagreem entgetterm inated?
Eitherparty shallbeatliberty to term inateitasat31stD ecem berin any yearby
giving notless than 90 days previous notice in w riting.U nless the parties
otherw ise agree,the Reinsurers w illrem ain liable for allreinsurances ceded
underthisagreem entuntiltheirnaturalexpiry.
In the eventof W ar (w hether declared or not) arising betw een India and the
country in w hich theReinsurersresideorcarry on businessorareincorporated,
thisagreem entshallbeautom atically term inated forthw ith.
If during the period of this agreem ent, postal and/or telegraphic
com m unications should be rendered im possible as a consequence of W ar,
w arlike operations,blockade,revolution,civilw arorothersim ilareventfora
period exceeding thirty (30)days,the com pany shallbe entitled to term inate
thisagreem entforthw ith w ithoutgiving notice.
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M O D U LE-III:RISK M A N A G EM EN T A N D REIN SU RA N CE

Eitherparty shallhave the rightto term inate this A greem entim m ediately by
giving theotherparty notice:
Ifthe perform ance ofthe w hole orany partofthisA greem entbe prohibited or
rendered im possible de jure orde facto in particularand w ithoutprejudice to
the generality ofthe preceding w ordsin consequence ofany law orregulation
w hich is or shall be in force in any country or territory or if any law or
regulation shallpreventdirectly orindirectly therem ittanceofany orallorany
partofthebalanceorpaym entsdueto orfrom eitherparty.
Iftheotherparty hasbecom einsolventorunableto pay itsdebtsorhaslostthe
w hole orany partofitspaid up capitalorhashad any authority to transactany
classofinsurancew ithdraw n orcanceled orsuspended orm adeconditional.
Ifthereisany m aterialchangein theow nership orcontroloftheotherparty.
Ifthecountry ortheterritory in w hich theotherparty resideshasitshead officeor
is incorporated shallbe involved in arm ed hostilities w ith any other country
w hetherw arbedeclared ornotorispartly orw holly occupied by anotherpow er.
If the other party shall have failed to com ply w ith any of the term s and
conditionsofthisagreem ent.
2. Explain theA ccounting ofLosses:
A ns.Prelim inary lossadvicesshallbe sentby the Com pany to the Reinsurerin respectof
alllossesw heretheproportion ofthereinsurerssharing in theagreem entisestim ated
to exceed theam ountstated in theSchedule.Furtherm ore,theCom pany shallfurnish
theReinsureran estim ateofoutstanding lossesasat31stD ecem berofeach year.
W hen theproportion ofalossand orexpensesfalling upon allthereinsurerssharing
in thisA greem entam ountsto orexceedsthe am ountspecified in the Schedule,the
reinsurers shall be liable to pay its proportion w ithin 21 days of dem and. The
Com pany shalldebitallother losses and/or loss expenses in the accounts of the
quartersin w hich thelossesand/orlossexpensesaresettled.
A ny loss or claim or com prom ise thereof and all expenses including fire
extinguishing expenses shallbe settled by the Com pany w ithoutreference to the
reinsurer and such settlem ents including ex gratia paym ents shallin allcases be
unconditionally binding upon the reinsurer.The Com pany atitssole discretion m ay
com m ence,continue,defend,com prom ise,settleorw ithdraw from any actions,suits
and prosecutionsand generally do allsuch m attersrelating to any lossorclaim w hich
in itsjudgm entm ay beadvantageousand thepaym entofallexpensesand allow ances
in connection therew ith shall be shared by the reinsurer in proportion to its
participation.
TheReinsurershallsharein proportion to itsparticipation in allam ountsw hich m ay
berecovered by theCom pany in respectofany lossorclaim .
3. W hatdo you understand by Insuring clause?
A ns. TheReinsurershereby agreeto indem nify theCom pany forthatpartoftheultim ate
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M O D U LE-III:RISK M A N A G EM EN T A N D REIN SU RA N CE

netlossw hich exceedsthe am ountstated in item ofthe Schedule on accountof


each and every lossoccurrence and the sum recoverable underthisA greem entshall
beup to butnotexceeding theam ountstated in item oftheSchedule,ultim atenet
losson accountofeach and every lossoccurrence.
The underlying loss stated in item ofthe Schedule shallbe retained netby the
Reinsured subjectonly to underlying excesscatastrophe reinsurancesasspecified in
item oftheSchedule.
4. Explain theim portanceofTreaty w ordings.
A ns. W ritten agreem ents are m ore easily enforceable than verbal ones and so every
insurancecontractisw ritten,satisfying allthelegalprincipleson w hich insuranceis
founded and thepointsoflaw to satisfy thedefinition ofalegalcontract.
Reinsurance is sim ilar to an insurance contractand hence itis im portantthatthe
w ordings of the reinsurance agreem ent are agreed betw een the cedant and the
reinsurerbeforehand.
O therthan facultativereinsurances,allotheragreem entsbetw een theceding prim ary
insurerand the reinsurerare by m eans ofw ritten and agreed treaties and therefore,
the treaty w ordings have com e to occupy an im portant place in the study of
reinsurance.H ow ever,itisrecognized thatthe treaty w ordingsare notstandardized
and the differentcountries and reinsurers have adopted theirow n typicalw ordings
fortreaties.A tthesam etim e,thegeneralconditionsarefairly uniform foralltreaties
butthe specialconditionsare distinctexercisesdepending on particularneedsofthe
contracting parties and also the individual classes of insurance. A gain, the
proportionaland non-proportionaltreaties have separate distinctw ordings,w hich
have som e specialfeaturescharacteristic ofthe type oftreaty.O ne otherinteresting
feature of all treaty w ordings is that they include agreem ents on the follow -up
accounting procedures, w hich actually m ake im plem entation of the treaty m uch
easier.
5. W hatisdisputeresolution m echanism availableforcom pany and reinsurer?
A ns. Incase of any disputes betw een the com pany and the reinsurers regarding the
interpretation ofthe agreem entorthe rightsw ith respectto any transaction involved
eitherbefore orafterthe term ination,disputesassuch shallbe dealtw ith the single
arbitratorappointed in w riting by both the parties.Ifin case ofany failure to agree
upon the single arbitrator it can be referred to tw o arbitrators of w hich one is
appointed in w riting by each ofthe parties.In case ofany disagreem entbetw een the
tw o arbitratorsan um pireisappointed by thearbitrators.
These arbitratorsorthe um pire are required to be appointed in 30 daysaftersuch a
requisition ofarbitratorsm ade by the parties.These are appointed in w riting by the
chairm an oftheBom bay RegionalCom m itteeofthetariffadvisory com m ittee.Such
appointed arbitrators or um pires are required to interpret their agreem ent as a
honourableengagem entand m aketheiraw ard and servethepurpose.

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M O D U LE-III:RISK M A N A G EM EN T A N D REIN SU RA N CE

The decision ofthese arbitratorsorthe um piresisthe finaland binding asthe case


m ay beinclusiveofallocation ofcostson both theparties.

SEC TIO N -C
(C A SE STU D IES)
D unhill,a subsidiary ofa bank,em ployed a consultancy firm to advise investors about
sw itching from corporateto pension plans.D unhillw asinsured underabankerscom posite
insurancepolicy issued by thedefendantinsurers.U nderthispolicy,theinsurersagreed to
indem nify the com pany in respectofitslegalliability from any third party claim .O vera
period ofyears,therew eresubstantialclaim sby investorsw ho had changed theirpensions
and w ho had suffered losses as a result.Itw as alleged thatthe consultancy firm had
provided incorrectadvice.Forthe purpose ofa claim on insurers,the com pany subm itted
thatthe claim s by investors w ere a series of claim s thatresulted from a single actor
om ission,nam ely,a failure on the partof their ow n m anagem entto train properly the
consultancy firm so asto be able to give investorsbestadvice.Insurersargued thatitw as
the failure on the partofthe consultancy firm in each case to give properadvice to the
investor,ratherthan thefailureon thepartofm anagem entto providepropertraining to the
consultancy firm .D iscuss.
SO LU TIO N :
The aggregation clause requires one to ask a m atterofcom m on sense w hetherthe
seriesofclaim sand questionsw ere the resultofan actorom ission ofthatkind.In
com m on senseterm s,allofthethird party claim sresulted from afailureon thepartof
m anagem entto provide the training required to enable the consultancy firm to give
proper advice to investors.The proper course w ould be to identify the dom inant,
efficient,orrealcause ofthe loss.In the absence ofagreem entto the contrary,the
presum ption w ould bethatthepolicy w asintended to providecoverw herean insured
perilw asthedom inant,efficient,orrealcauseoftheloss,butnototherw ise.
H ere, the policy provided cover against losses caused by a range of acts and
om issionscom m itted by officersand em ployeesoftheinsured.Itw asnotdifficultto
envisagecircum stancesin w hich asingleactorom ission on thepartofoneofficeror
em ployeem ightgiveriseto claim sofasufficientsizeto exceed thedeductiblew hen
aggregated.W hetherthatfailureshould beregarded asasingleactorom ission on the
partoftheinsured orasarelated seriesofactsorom issionsdoesnotm atter.In either
case,theinsured isentitled to theclaim s.
2. Carona Insurance entered into a reinsurance contract w ith Law son reinsurance
com pany.The definition of loss in the treaties provide that a disaster and / or
casualty included allloss resulting from aseriesofaccidents,occurrencesand /or
causative incidents having a com m on origin and /or being traceable to the sam e
act .. shall be considered as having resulted from a single accident... Carona
insurance settled claim s, w hich covered m ultiple sites in m ultiple geographic
jurisdictions,by allocating the sites as separate occurrences under its underlying
III-71
M O D U LE-III:RISK M A N A G EM EN T A N D REIN SU RA N CE

insurance policies.LaterCarona soughtrecovery from Law son.Carona treated each


settlem entforeach insured asa single disasterand/orcasualty underthe term sof
theapplicableexcessoflossreinsurancetreaties.
Law son Reinsurance did not accept Caronas allocation. W as Law son right in
rejecting Caronasallocation?
SO LU TIO N :
Carona s allocation of settlem ents did notfallw ithin the disaster and/or casualty
languageofthereinsurancetreaties.
Carona sinterpretation ofthe com m on origin languagein thetreatiesw asnotvalid
asthe w ords seriesof m odify com m on origin . A ggregation w asproperonly if
theoccurrenceshad acom m on origin.H ere,theclaim scould notbeaggregated since
they did nothaveacom m on origin.Thus,Law son Reinsurancew asrightin rejecting
Caronasallocation.

III-72
M O D U LE-III:RISK M A N A G EM EN T A N D REIN SU RA N CE

C hapter11
R einsuranceA ccountsand
A dm inistration

SEC TIO N -A

1 O neofthefollow ing isnottrue.


a. Forthe successofreinsurance both the prim ary insurerand the reinsurerm ust
m akejointefforts.
b. They both havedutiesasw ellasrightsunderthetreaties.
c. Theprim ary insurerm ustconducthisunderw riting operationssatisfactorily.
d. BothA & B.
e. A ,B & C.*
2. In caseoflargelossesinvestigationsareconducted by;
a. Prim ary Insurer
b. Reinsurer
c. Police
d. A & B*
e. N oneoftheabove.
3. Follow theFortunes m eans:
a. Takeasm uch reinsuranceaspossible
b. The reinsurer is norm ally bound by the prim ary insurers actions in the
underw riting and claim sm atters.*
c. The reinsurer need to follow the reinsurance rules and notprim ary insurers
actions.
d. A & B
e. N oneoftheabove.
4. Thereinsurerw illbeableto controllossesonly underfollow ing circum stances:
a. Prim ary insurerhasprofessionalstaff.
b. Thereisw elldesigned inform ation system w ith prim ary insurer*
c. Thereisgood com m unication system .

III-73
M O D U LE-III:RISK M A N A G EM EN T A N D REIN SU RA N CE

d. A& B
e. N oneoftheabove.
5. O neofthefollow ing isnottrue:
a. D irect prem ium data to calculate the reinsurance prem ium payable to the
reinsurer.
b. D ataforindividuallossesneeded to apply treaty lim itsand excessretentions;
c. Codesforidentifying occurrencesundercasualty clashcoverage;
d. Inform ation on risks included in the treaty but not ceded for preserving
profitability ofthetreaty.
e. N oneoftheabove.*
6. N ow adaystheprim ary insurersaresending inform ation through thisstatem ent
to reinsurersinstead ofbordereaux.
a. Statem entofStatistics
b. CurrentA ccountStatem ent
c. Ceding statem ent
d. Scrip
e. N oneoftheabove.
7. D isputesbetw een prim ary insurerand reinsurerarenorm ally settled through
a. D irectnegotiations
b. A rbitration
c. Courts
d. A lloftheabove*
e. N oneoftheabove
8. O neofthefollow ing isnottrue:
a. Reinsurershavevery littleto do exceptcollecting reinsuranceprem ium ;*
b. Som e reinsurers m inim ize their w ork by preferring large retentions w ith the
possibility ofno claim sbeing presented atall.
c. Reinsurersm ay beengaged in auditing theunderw riting and claim spracticesof
theprim ary insurers.
d. A & B
e. N oneoftheabove.
9. W hat is the purpose of collecting and analyzing a large am ount of data by
reinsurers?
a. O btain betterterm s
b. Balancecessions.
c. Solidify relationship.
III-74
M O D U LE-III:RISK M A N A G EM EN T A N D REIN SU RA N CE

d. A& B
e. A lloftheabove*
10. ProbableM axim um Loss isan assessm entby
a. Thecedent
b. The reinsurer
c. Thesurveyor*
d. Thebroker
e. N oneoftheabove.

SEC TIO N -A A N SW ER S
1. e 2. d 3. b 4. b 5. e 6. b
7. d 8. a 9. e 10.c

SEC TIO N -B
1. O utlinetheroleofPrim ary Insurerin reinsuranceadm inistration.
A ns.The prim ary insurerm ustconducthis underw riting operations satisfactorily w ithin
the guidelines and expectations ofthe treaty so thatthe reinsurerhas no surprises
com ing in theform oflargelosses.M ore,theprim ary insurerm ustnotify prom ptly all
large losses and the reinsurer m ust be given the opportunity to participate in
investigation ofsuch losses.
The prim ary insurer has the freedom to underw rite individual risks and adjust
individual claim s once clear-cut underw riting policies are contem plated under a
treaty.W e conventionally use a phrase "FO LLO W TH E FO RTU N ES".Itm eansthe
reinsurerisnorm ally bound by the prim ary insurersactionsin the underw riting and
claim sm atters.
Theprim ary insurerm usthaveagood orw elldesigned inform ation system to beable
to furnish allnecessary inform ation in tim e forthe reinsurerto be able to control
losses w herever possible and to discharge their obligations under the treaty
professionally.
2. Them oreim portantdata thatshould becapableofbeing m adeavailablefrom a
good inform ation system used by the prim ary insurer should include certain
elem ents.H ighlightthem .
A ns.a. D irect prem ium data to calculate the reinsurance prem ium payable to the
reinsurers;
b. D ataforindividuallossesneeded to apply treaty lim itsand excessretentions;
c. Theabovedataforaccounting purposes;
d. Codesgenerated forcatastrophelosses;
e. Codesforidentifying occurrencesundercasualty clashcoverage;
III-75
M O D U LE-III:RISK M A N A G EM EN T A N D REIN SU RA N CE

f. D ata to determ ine the portion of policy/ies ceded to each surplus share
reinsurer;
g. Separate data on retention,lim its,rates,and the reinsurer involved for each
facultativeplacem ent;
h. Inform ation on risks included in the treaty but not ceded for preserving
profitability ofthetreaty;
i. D ataon risksexcluded underthetreaty butunderw ritten by theprim ary insurer
so asnotto includethesam ein thereinsurancebordereau;
A n accurate and efficient inform ation system helps the credibility of the
prim ary insurer and helps the renew alof treaties.The prim ary insurer m ust
m akeavailablehisbooksofaccountforinspection by thereinsurer.
3. O utlinetheroleofreinsurerin thecontextofreinsuranceadm inistration.
A ns.O ne w ould think that the reinsurers have very little to do except collecting
reinsurance prem ium ,and paying claim s and brokerage com m ission to brokers and
cedingcom m issiontotheprim aryinsurer.M aybethisisso w hen thetreaty relationship
issm ooth.In fact,som e reinsurersm inim ize theirw ork by preferring large retentions
w ith thepossibility ofno claim sbeing presented atall.
O n thecontrary,thereinsurersm ay beengaged in auditing theunderw riting and claim s
practicesoftheprim ary insurerso asto ensurethatthesearedonesatisfactorily and as
expected.A gain,w heneverthelossesarelarge,thereinsurersm ay liketo participatein
theinvestigation ofthesam e,both to seethatproperproceduresarein placeand to find
out the underw riting im plications. M any a tim e, the prim ary insurers, both on
underw riting and claim sissues,openly consultthereinsurers.
Thereinsurersnotonly help in stabilizing lossexposuresbutalso positively assistthe
prim ary underw riters in underw riting on accountof their superior experience and
expertise.
4. Explain how claim saresettled underdifferentm ethodsofreinsurance.
A ns.Theprocedurediffersfrom treaty to treaty based on individualagreem ents.
If it is a pro rata treaty,the prim ary insurer sends a m onthly bordereaux to the
reinsurer, detailing the prem ium s due to the reinsurer and claim s due from the
reinsurer.The prim ary insurer w illrem itthe difference to the reinsurer w hen the
prem ium s exceed the losses and if the losses exceed the prem ium s,the reinsurer
rem its the difference to the prim ary insurer. If at any tim e, there are som e
exceptionally large losses,then itis the convention for the reinsurer to rem itthe
lossesto theprim ary insurerbeforetheend ofthereporting period.
In thecaseofexcesstreaties,assoon aslossesexceed theretention,intim ation isgiven
and thereinsurerpayson being given proofofsettlem ent,w hich issim ply astatem ent
oflossespaid by theprim ary insurer,togetherw ith estim atesofcurrentreserves.
In the case of aggregate excess treaties,the reinsurers are know n to m ake initial
paym ents say sixty days afterthe end ofthe accounting year.Ifitis clearthatthe
III-76
M O D U LE-III:RISK M A N A G EM EN T A N D REIN SU RA N CE

losses w illexceed the retention,then paym ents m ay be m ade before the end ofthe
year.
5. Explain C losing ofA ccountsin caseofa reinsurancecom pany.
A ns.Every insurance com pany w hile closing its annualaccounts atthe end ofthe year,
exam inesallclaim soutstanding w ith respectto inw ard treatiesin the booksin order
to m ake a reasonable estim ate forprovisionsto be m ade in the revenue accounts,so
thatitcan presentasaccurate a picture aspossible.Based on the estim atesm ade for
grossclaim s,thecom pany w illw ork outtheoutstanding claim sposition in respectof
itsvariousoutgoing treaties,w hich w illbeincluded in theannualaccountsasw ellas
adviceto therespectivereinsurers.
Profitand lossaccountasw ellasBalance SheetisasperInsurance A ctand IRD A
regulations.

SEC TIO N -C
(C A SE STU D IES)
1. U tkal Insurance com pany has reinsurance arrangem ents w ith G reat Eastern
reinsurance com pany,K olkata.The prem ium s to be paid by cedentto reinsureris
based on the rate specified in the contractand the rate w illbe applied to the ceding
insurerstotalnetprem ium afterceding to proportionalreinsurances.

M arketFirePool Rs.
Profitasat31/03/2004 207,161,000
Prem ium 767,898,000
PC Term s 15% PC on Profit
U p to 10% ofPrem ium
& 75% ofbalance
CalculateProfitCom m ission

SO LU TIO N :
15% PC up to 10% on Prem ium
10% on Prem ium 76,789,800
@ 15% on above 11,518,470(A )
75% ofBalance
Profit 207,161,000
Less10% Prem ium 76,789,800
Balance 130,371,200
@ 75% on Balance 97,778,400(B)
Com m ission (A +B) 109,296,870

III-77
M O D U LE-III:RISK M A N A G EM EN T A N D REIN SU RA N CE

2. TheJanapriyaInsurancecom pany issued itspolicy in thenam eofaconsum ergroup


and issued certificates of insurance covering group m em bers. The Surya Re -
reinsurerand itsw holly ow ned subsidiary,the Janapriya,entered into a reinsurance
contractw here the reinsurerreinsured 100% ofthe Janapriyasliability underallof
its policies. The reinsurance contract contained a custom ary no third party
beneficiaryclause,w hich provided thatonly the reinsurer,cedentand the consum er
group had rights underthe reinsurance contract.The reinsurerand the cedentalso
entered into an adm inistrative services agreem entthatrequired the reinsureratits
expense to provide all services of adm inistration for all of the cedents policies,
including actuarial, underw riting, com pliance, legal, accounting, issuance, etc,.
W hen the cedentdenied the certificate holdersclaim ,the certificate holdersued the
cedentand thereinsurer.Thereinsurerm oved forsum m ary judgm ent,dism issing the
action on the ground thatthere w as no contractualrelationship w ith the certificate
holderupon w hich liability could beestablished againstthereinsurer.
D iscusstheim plications.
SO LU TIO N :
Cedent-Janapriya -could notdelegate its duty to its insured and the reinsurance
agreem entsprovided thatthey do notbenefitthird partieslikethecertificateholders.
Itis im portantto note thatthe reinsureris really the certificate holders insurer.A
reasonable conclusion m ightbe draw n from the adm inistrative services agreem ent
thatthe cedentw as sim ply fronting forthe reinsurerin the provision ofhealth and
accident insurance by the reinsurer to the public. The agreem ent suggested,
realistically,thatallthatthe cedentw as doing w as providing insurance policy and
certificateform sbearing itsnam eand address,and perhapsasalesorganization,but
thatthe reinsurerw asresponsible forand did perform allotheraspectsofinsurance
undertaken in thecedentsnam e.H ence,thecertificateholdersclaim isjustified and
thereinsurersm otion forsum m ary judgm entshould bedenied.

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M O D U LE-III:RISK M A N A G EM EN T A N D REIN SU RA N CE

C hapter12
R einsurance R egulations

SEC TIO N -A

1. O neofthefollow ing isnottrue:


a. The D ept.of Trade,U K requires the prim ary insurers to annually reportthe
am ountofprem ium payableto each reinsurer.
b. In the U S,reinsurers have to keep solvency m argin alm ost along the lines
prescribed forprim ary insurers.
c. In U S,the reinsurers have to file financialstatem ents w ith State Regulatory
A uthoritiesquarterly.
d. Pricing isnotdirectly regulated.
e. N oneoftheabove*
2. O neofthefollow ing isnottrue:
a. Theregulation by m eansofan insolvency clauseprovidesthattheinsolvency of
theprim ary insurerw illnotaffecttheliability ofthereinsurer.
b. The reinsurer w ill m ake paym ent to the liquidator or the receiver of the
insolventprim ary insurerforthebenefitoftheircreditors.
c. Therisk ofinsolvency ofthereinsurancebrokerispassed on to thereinsurerso
any defaultby thereinsurancebrokerw illbem adegood by thereinsurer.
d. Reinsurancebrokerisan agentofprim ary insurer.*
e. N oneoftheabove.
3. Theinterm ediary m ustm akefullw ritten disclosureof:
a. A ny controloverthebrokerby areinsurer.
b. A ny controlofareinsurerby theinterm ediary.
c. A ny retrocessionsofthesubjectbusinessplaced by theinterm ediary
d. Com m issionsearned orto beearned on thebusiness;
e. N oneoftheabove*
4. R ecords of all transactions m ust be retained for at least------years after the
expiration ofallreinsurancecontracts.
a. 5
b. 7
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M O D U LE-III:RISK M A N A G EM EN T A N D REIN SU RA N CE

c. 10*
d. 12
e. N oneoftheabove
5. In India thefollow ing authority adm inistersregulationson insuranceindustry.
a. M inistry ofFinance,U nion G ovt.
b. RBI
c. IRD A *
d. PFRD A
e. SEBI
6. O neofthefollow ing isnotan objectiveofreinsuranceregulationsin India.
a. to m axim izetheretention w ithin thecountry.
b. D evelop adequatecapacity
c. Securethebestpossibleprotection forthereinsurancecostsincurred;
d. Sim plify theadm inistration ofbusiness
e. N oneoftheabove.*
7. R egulationsrelating to placem entofreinsurancebusinessoutsideIndia:
a. Those reinsurers w ho have a period ofthe past5 years enjoyed a rating ofat
leastBBB (w ith S& P)
b. Rating ofany internationalagency equivalentofS& P
c. Placem entcan bedonew ith reinsuranceagency in U SA .
d. Priorperm ission ofIRD A should beobtained.*
e. N oneoftheabove.
8. W hich ofthefollow ing A ctsarerelevantto reinsurancecases?
i. IndianContractA ct.
ii. IndianA rbitrationA ct.
iii. InsuranceA ct.
a. only (i)
b. only (ii)
c. Both (i)and (ii)
d. Both (ii)and (iii)
e. A lloftheabove.*
9. Every insurer shallcede such percentage ofthe sum insured on each policy for
differentclasses ofinsurance w ritten in India to the Indian reinsurer.W hatis
thatpercentage?
a. 15.
b. 20.*
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c. 30.
d. 40.
e. N oneoftheabove.
10. TheIndian reinsuranceagency is:
a. EX IM bank.
b. ECG C.
c. G IC.*
d. LIC.
e. IRD A .

SEC TIO N -A A N SW ER S
1. e 2. d 3. e 4. c 5. c 6. e
7. d 8. e 9. b 10.c

SEC TIO N -B
1. Exam inereinsuranceregulation scenario in U K and U SA briefly.
A ns.In theU .K .,theD epartm entofTraderequirestheprim ary insurersto annually report
on thefollow ing:
a. The nam es and addresses ofallreinsurers to w hom business has been ceded
during theyear;
b. A ny connection (other than the reported reinsurance) betw een the prim ary
insurerand any ofitsreinsurers;
c. Theam ountofprem ium payableto each reinsurer;and
d. A ny indebtednessofareinsurerto theprim ary insurerattheend oftheyear.
In theU nited States,reinsurersasw ellaslicensed alien reinsurershaveto keep
solvency m argin alm ostalong thelinesprescribed forprim ary insurersand m ust
follow reserves,investm ent,capitaland surplus requirem ents and annually or
som etim es every quarter file financial statem ents w ith State regulatory
authorities.
2. R einsuranceinterm ediariesactin a fiduciary capacity forallfundsreceived in
theirprofessionalcapacity and m ustnotm inglethem w ith otherfundsin U SA .
Explain theroleofinterm ediaries.
A ns.Reinsurance interm ediaries shallhave w ritten authorization from the insurers and
reinsurersthey represent,spelling outtheextentand lim itationsoftheirauthority;
The w ritten authority above m ust be m ade available to the prim ary insurers or
reinsurersw ith w hich theinterm ediary deals;
N o licensed interm ediary shall procure reinsurance from an unlicensed reinsurer
unlessthereinsurerhasappointed an agentfortheserviceofprocessin N ew York;
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Theinterm ediary m ustm akefullw ritten disclosureof


A ny controloverthebrokerby areinsurer,
A ny controlofareinsurerby theinterm ediary,
A ny retrocessionsofthesubjectbusinessplaced by theinterm ediary,and
Com m issionsearned orto beearned on thebusiness;
3. Briefly explain reinsuranceregulationsin India.
A ns.In India, the Insurance Regulatory and D evelopm ent A uthority has prescribed
regulationsforthereinsurancesectorforgeneralasw ellaslifeinsurance.
TheIRD A (G eneralInsurance-Reinsurance)Regulations,2000 areasfollow s.
The firstchapterdefinessuch specialterm sascession,facultative,Indian reinsurer,
pool,retrocession,retention,and treaty.
The second chapter describes the procedure to be follow ed for reinsurance
arrangem entsClause3-1 statestheobjectivesofareinsuranceprogram m eas
To m axim izeretention w ithin thecountry;
D evelop adequatecapacity;
Securethebestpossibleprotection forthereinsurancecostsincurred;
Sim plify theadm inistration ofbusiness.
4. Stateim portantprovisionsofC lause3 -IR D A R egulationson reinsurance.
A ns.Clause 3-2:Every insurer shall m aintain the m axim um possible retention
com m ensuratew ith itsfinancialstrength and volum eofbusiness.
Clause 3-3:Every insurer shallcede such percentage of the sum insured on each
policy fordifferentclassesofinsurancew ritten in Indiato theIndian reinsurer.
Clause 3-4:The reinsurance program m e ofevery insurershallcom m ence from the
beginning ofevery financialyearand every insurershallsubm itto theA uthority,his
reinsuranceprogram m esfortheforthcom ing year.
Clause3-5:W ithin 30 daysofthecom m encem entofthefinancialyear,every insurer
shallfilew ith theA uthority aphotocopy ofevery reinsurancetreaty slip.
Clause3-6:TheA uthority m ay callforfurtherinform ation orexplanationsin respect
ofthereinsuranceprogram m eofan insurerand m ay issuenecessary directions.
Clause 3-7:Insurers shallplace their reinsurance business outside India w ith only
thosereinsurersw ho haveoveraperiod ofthepastfiveyearscounting from theyear
preceding forw hich the businesshasto be placed,enjoyed a rating ofatleastBBB
(w ith Standard & Poor)orequivalentrating ofany otherinternationalrating agency.
Placem entsw ith otherreinsurersshallrequiretheapprovaloftheA uthority.
Clause 3-8:The Indian reinsurer shall organize dom estic pools for reinsurance
surpluses in fire,m arine hulland otherclasses in consultation w ith allinsurers on
basis,lim its,and term sw hich arefairto allinsurers.;
Clause 3-10:Every insurer shall offer an opportunity to other Indian insurers

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including the Indian reinsurer to participate in its facultative and treaty surpluses
beforeplacem entofsuch cessionsoutsideIndia.

SEC TIO N -C
(C A SE STU D IES)
1. G eneralInsuranceCorporation ofIndiahasbeen w elladapting itselfto thechanging
reform s scenario. To focus itself on the reinsurance m arket both dom estic and
international,ithastaken variousdecisionsto supportitsnew corporatevision.In Jan
2004,G IC hasdecided to exititsm utualfund arm ,G IC M utualFund,so asto focus
on core reinsurance operations.The fund had been constantly underperform ing for
thelastfew years.In 2002-03 therehasbeen w hopping increasein theforeign inw ard
reinsurance prem ia atRs600 crores.Thisincrease haspushed the totalreinsurance
prem ium to overRs3800 crores.The Indian reinsurer,isw illing to w rite m ore risks
in the dom estic m arket.The underw riting losses fellbelow the Rs 500 core-m ark.
Though the severe drought,took its toll on G ICs underw riting w ith agricultural
losseszoom ing to Rs400 croresin 2002-03.theclaim sratio reduced during theyear
from 94 to 86% .Though the quantum offoreign inw ard prem ium islow in the total
prem ium incom e,the increase in its share over the lastone year is significant.In
2002-3,the share offoreign prem ium hasbeen over15% ascom pared to just6% in
thepreviousyear.
InternationalCreditrating agency,A M Best,hasgiven A (Excellent) rating to the
corporation indicating its financial strength. The rating reflects not only the
Corporationsexcellentfinancialposition and conservative investm entportfolio but
also recognizesitsleading position in theglobalm arket.
D iscuss the grow th opportunities and business ofG IC in the lightoflatestglobal
changes.
SO LU TIO N :
Today,India stands as a country w hose econom y is getting increasingly integrated
w ith the w orld econom y.The large and grow ing m arket,developing infrastructure,
sophisticated financialsector,stable polity and strong econom ic outlook m ake India
an attractivedestination,both,forbusinesstravellersand tourists.
G IC of India (G IC),the Indian Reinsurer caters to the reinsurance needs of the
country and also underw ritesrisksglobally.G ICssupportto theIndian m arketcom es
in the form ofobligatory cessions,com pany surplustreaties,m arketsurplustreaties,
Excess of Loss (X O L) protection to direct w riting com panies and facultative
acceptances. G IC is one of the reputed underw riters for treaty and facultative
reinsurancein theA fro-A sian region.
A sa sole reinsurerin the dom estic reinsurance m arket,G IC providesreinsurance to
the directgeneralinsurance com paniesin the Indian m arket.G IC receivesstatutory
cession of20% on each and every policy subjectto certain lim its.Itleadsm any of

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M O D U LE-III:RISK M A N A G EM EN T A N D REIN SU RA N CE

dom estic com paniestreaty program m esand facultative placem ents.G ICscapacity
foreach class ofbusiness on Treaty and Facultative basis fordom estic business is
given in thefollow ing table.

C lass
C apacity
Property
IN R 15000 m ln.A ny onerisk
M arine
H ull-IN R 2000 m ln.any onevessel
Cargo IN R 2500 m ln.A ny onepolicy/sending
CrudeO ilIN R 3500 m ln.any onepolicy/sending
Engineering
IN R 15000 m ln.Sum Insured
M iscellaneous
IN R 3500 m ln.Sum Insured
M otor
U nlim ited
C lass
C apacity
Aviation-H ull/Spares RotorW ing
IN R 20.50 m ln.peraircraft
Aviation-H ull/Spares Fixed W ing
IN R 50 m ln.peraircraft
Liability
IN R 100 m ln.peroccurrence
Aviation Treaty H ull
IN R 500 m ln.
Spares
IN R 250 m ln.
Liability
IN R 1000 m ln.
G IC declared a bonusin the ratio of1:1 and the equity capitalhasgrow n to Rs.430
crores.D ividend @ 15% am ounting to Rs.64.50 croresw asdeclared on theenhanced
capital.The incom e from investm ents am ounted to Rs.1398.61 crores in 2004-05.

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M O D U LE-III:RISK M A N A G EM EN T A N D REIN SU RA N CE

G IC booked aprofitbeforetax ofRs.800.08 croresand profitaftertax ofRs.200.02


crores.
The N et Prem ium Incom e during 2004-05 am ounted to Rs. 4613.87 crores
representing a grow th of10.83% .K eeping in line w ith the philosophy ofutilizing
Indian capacity optim ally and m axim izing retentions,the netretention ratio stood
higherat90.09% in 2004-05 as against89.7% in 2003-04.N etIncurred claim s in
2004-05 w ereto thetuneofRs.3702.80 crores.
TotalInvestm ents as on 31.03.2005 am ounted to Rs.15434.31 crores,TotalA ssets
increased to Rs.19551.84 crores and TotalFunds as on 31.03.2005 stood atRs.
11767.69 crores.O n the strength of Indian business and w ith focused m arketing
effortsin A fro-A sian region,G IC aim satpositioning itselfw ithin the top 20 G lobal
Reinsurancein theyearsto com e.
The ratings of G IC reflect its leading business profile in the Indian reinsurance
m arket and an expected im provem ent in underw riting perform ance. A .M . Best
believes G IC w illretain its leading position w ithin its dom estic m arketdespite an
expected decline in dom estic prem ium over the m edium term w ith the likely
cessation ofcom pulsory cessionsfrom w hich itcurrently benefitsasIndiasnational
reinsurer(currently 20% cession from dom estic insurers).Furtherm ore,A .M .Best
expects G IC to increase its acceptance of internationalem erging m arketbusiness
through itsrepresentativeofficesin London,M oscow and D ubai.

III-85
M O D U LE-III:RISK M A N A G EM EN T A N D REIN SU RA N CE

C hapter13
R einsurance M arkets

SEC TIO N -A
1. It is an association of reinsurers banded together to underw rite reinsurance
jointly.
a. LloydsClub.
b. ReinsurancePool
c. Society ofReinsurers
d. W orld ReFederation.
e. N oneoftheabove.
2. O neofthefollow ing isnottrue;
a. Som ereinsurancepoolsw ritereinsuranceforonly m em bers.
b. Industrialinsurersm ay form apoolto w ritespecificrisks.
c. Specialized poolsarealso form ed forenergy insurance.
d. A & B
e. N oneoftheabove
3. Lloydsw asoriginally developed as
a. CenterforM arineinsurance.
b. CenterforAviation insurance.
c. CenterforG eneralinsurance.
d. CenterforLifeinsurance.
e. N oneoftheabove.
4. Thisisthelargestreinsurancecom pany ofthew orld.
a. M unich Re
b. Sw issRe
c. Em ployersRe
d. A m erican Re
e. N oneoftheabove.
5. M ostofthetop reinsurersarelocated in;
a. Sw itzerland
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M O D U LE-III:RISK M A N A G EM EN T A N D REIN SU RA N CE

b. G erm any
c. U nited StatesofA m erica
d. Britain
e. Japan.
6. O neofthefollow ing isnottrue:
a. In them odern daysreciprocalreinsuranceisnotw idely practised
b. Thereinsurancem arketin London isconstituted ofLloyds.
c. Thepercentagecom m ission paid by thereinsurersto thereinsurancebrokersis
relatively high.
d. B& C
e. N oneoftheabove.
7. A X A R eisassociated w ith w hich country?
a. N etherlands.
b. G erm any
c. U SA .
d. France.
e. Japan
8. G enerally reinsurancebrokerspreferthism ethod ofreinsurance.
a. Facultativereinsurance
b. ExcessofLossReinsurance.
c. Treaty Reinsurance
d. Q uotasharecover.
e. N oneoftheabove.
9. Identify the factor w hich is not contributing to the success of reinsurance
m arket:
a. Availability ofknow ledgecapital.
b. M atured financialm arkets.
c. Infrastructurefacilities.
d. D om esticm arkets.
e. Interestrates.
10. A fter nationalization ofthe insurance industry,five com panieshave taken care
ofgeneralinsuranceneeds.Identify theodd m an out.
a. G eneralInsuranceCorporation ofIndia.
b. LifeInsuranceCorporation ofIndia
c. O rientalInsuranceCom pany.

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M O D U LE-III:RISK M A N A G EM EN T A N D REIN SU RA N CE

d. U nited IndiaInsuranceCom pany.


e. N ationalInsuranceCom pany.
11. The setting up of a R egional R einsurance C orporation depends on certain
com m on features.O neofthefollow ing isnottrue:
a. Countriesm usthavecom m on physicalboundaries.
b. Countries m ust have w ell-developed com m unication betw een m em ber
countries.
c. Countriesm usthavecom m on currency.
d. M ustsharecom m on custom s,ethnicidentity and language.
e. N oneoftheabove.
12. The insurance com panies form ed by large com m ercial or industrial
establishm ents,essentially to takecareoftheirow n insuranceneeds:
a. In-houseInsurance.
b. Self-Insurance.
c. Captives
d. PrivateA gencies.
e. N oneoftheabove.
13. Tax concessionsby thelocalgovernm entsarea m ajorattraction to:
a. In-houseInsurance.
b. Self-Insurance.
c. Captives
d. PrivateA gencies.
e. N oneoftheabove.
14. Thisprovidescoverageto thesingleow nersw ho hold thecom pany.
a. PureCaptives.
b. A ssociateCaptives.
c. Beneficiary Captives.
d. In-houseEnterprises.
e. N oneoftheabove.
15. O neofthefollow ing isnota benefitofcaptives:
a. O perating costsarereduced.
b. Thereisim proved cash flow.
c. Thereisadirectreach to w holesalereinsurancem arkets.
d. Thereisgreatercontroloverclaim s.
e. N oneoftheabove

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M O D U LE-III:RISK M A N A G EM EN T A N D REIN SU RA N CE

SEC TIO N -A A N SW ER S
1. b 2. e 3. a. 4. a 5. c 6. c
7. d 8. c. 9. e 10.b 11.c 12.c
13.c 14.a 15.e

SEC TIO N B

1. M ention any top ten reinsurancebrokersin thew orld.


A ns.
Com pany CountryofD om icile
M unich Re G erm any
Sw issRe Sw itzerland
Em ployersRe U nited States
G eneralre/CologneReG roup U nited States
A ssicurazioniG eneraliS.p.A . Italy
H anoverReG roup G erm any
Lincoln N ationalRe U nited States
G erling G lobalReG roup G erm any
SCO R G roup France
Tokio M arine& FireIns.G roup Japan

2. Explain theroleofreinsurancebrokers.
A ns.Justasthere m ay be brokersforprim ary insurersw ho actasinterm ediariesbetw een
the insured and the insurer,there are reinsurance brokers w ho are go-betw eens to
prim ary and reinsurers.The percentage com m ission paid by the reinsurers to the
reinsurance brokers is relatively sm all,as com pared to the com m ission paid to the
insurance brokers and is som etim es as low as one percent of the reinsurance
prem ium .
W hen there are reinsurance brokers,the prem ium paym ents and loss paym ents as
w ellas prem ium refunds pass through them .W hen prim ary insurers do nothave
expertise to place reinsurance directly,they need the services of the reinsurance
brokers. Large reinsurers also use reinsurance brokers as a m atter of course.
H ow ever,ifprim ary insurersgo directto reinsurers,they m ay be able to reduce the
reinsurancecostto som eextent.
A lthough reinsurancebrokersobtain theircom m ission from thereinsurers,they have
aduty to observetheprincipleofutm ostgood faith,w hich m eansthey m ustrevealto
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M O D U LE-III:RISK M A N A G EM EN T A N D REIN SU RA N CE

the reinsurers allm aterialfacts concerning the risks,w hich they obtained from the
prim ary insurers.Them arketshareofthereinsurerscom bined in theU nited Statesis
estim ated at75% ,w hich show sthe predom inance ofthe reinsurance brokersin the
reinsurance m arket. G enerally, reinsurance brokers handle treaty reinsurances in
preferenceto facultativereinsurance.
3. O utlinethefeaturesofa successfulreinsurancem arket:
A ns.Thefeaturesthatexem plify thereinsurancem arketareasfollow s:
1. Stability factor.
2. Availability ofK now ledgeCapital.
3. M atured FinancialM arkets.
4. TheRoleofEconom y.
5. TheA rbitration Factor.
6. Infrastructure Facilities.
7. D om esticM arkets.
8. TheLocation A dvantage.
9. TheRoleofForeign Reinsurers.
4. W hatistheR egionalR einsuranceC orporation? O utlinetheirrole.
A ns.G enerally,a regionalreinsurance corporation caters to the needs arising am ong a
group ofneighboring countries.Thesecorporationsw ereproposed to besetup across
thedifferentdeveloping nationsofthew orld.
The setting up ofregionalreinsurance m ainly dependson certain com m on features,
w hich the m em bercountriesare bound to have due to the binding proxim ity w ith or
to each other.
The regionalreinsurance corporations have the liberty to choose theirow n m arket
place to locate theirheadquarters.The headquartersm ay be setup depending on the
factorssuch asw ell-developed accessibility,excellentcom m unication facility,w ell-
established com m ercialbackup,etc.Thebacking ofgood banking system w illenable
thecorporation to haveasm ooth functioning.
The regional reinsurance corporations end up w ith a good business in hand by
involving com pulsory cessions from its m em bers. The corporation can also get
exposed to the risks arising from the m em ber nations. In order to avoid such
happeningsthey getprotection through retrocession coversfrom otherm arkets.The
regional reinsurance corporations m anage their portfolio, w hich is spread over
differentcountriesthrough variousretrocession coversthey are:
Proportionalcovers
N on-proportionalcovers
By trading outw ard coversthrough tradersand generating inw ard covers.
N on-reciprocalinw ard reinsuranceaccounts,apartofw hich m ay beretroceded
back to them em bernations.
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M O D U LE-III:RISK M A N A G EM EN T A N D REIN SU RA N CE

5. W hatisC aptive? Explain varioustypesofC aptives.


A ns.The insurance com paniesform ed by large com m ercialorindustrialestablishm ents,
essentially to take care of their ow n insurance needs,are called captives.These
captivesplay a m ajorrole in fulfilling the insurance needsofthe parentcom panies
and help them oney flow insidetheperiphery ofthebusinessgroup.
Thevariouskindsofcaptivescan bebranched outasfollow s:
SingleParentC aptives:
Singleparentcaptivesarealso called aspurecaptives.Thisprovidescoverageto the
singleow nersw ho hold thecom pany.A risk m anagerorfinancialofficerattheparent
com pany m onitorsthem .
A ssociation captives:
A n established association generally form sthiscaptive.The coverage isprovided to
its m em bers. In this the ow nership vests w ith the association or the individual
m em bers.Thefinancialexpertattheassociation levellooksaftertheoperation orthis
responsibility isoutsourced to am anagem entcom pany,consultantorabroker.
Industry captives:
Theindustry captiveisow ned by industriesw ith sim ilarspecificinsuranceproblem .
A board ofdirectorisappointed by theshareholdersto w hom thecom pany isrequired
to report.
A gency captives:
A n agentorgroup ofagents ow ns this particularcom pany.These are form ed such
thattheirclientscan participatein theprogram m es.
R ent-A -C aptives:
The risks of the m em bers are insured.The investm ent incom e and underw riting
profitsarereturned back to theinsureds.U nderthisthesurplusofcertain com panies
are given on rentin orderto establish a self-insurance program m e and nottheirow n
captive.
Protected cellcom panies:
Thesearespecialcategory ofrent-a-captivesincethey shield theircapitaland surplus
from otherrentersin thecaptiveuntiltherent-a-captivesow nerrem ainssolvent.
6. W hatarebenefitsofC aptives?
The corporationsand groupsw ho w antto take a financialcontroland m anage risks
by underw riting theirow n insurance than preferring to pay prem ium s to the third-
party insurerscan optforcaptives.Captiveisnothing butatoolto such organizations.
Thebenefitsofcaptivesareasfollow s:
Provides insurance for certain exposures,w hich other insurance com panies

III-91
M O D U LE-III:RISK M A N A G EM EN T A N D REIN SU RA N CE

m ightnotprovide.
Enablesto retain theprem ium sw ithin thegroup by theparentcom pany.
O perating costsarereduced.
Thereisan im proved cash flow.
Thereisan increasein coverageand capacity.
Betterinvestm entasw ellasinvestm entincom e.
Thereisadirectreach to w holesalereinsurancem arkets.
Thereisflexibility in underw riting and funding.
Thereisagreatercontroloverclaim s.
Availability ofsm allerdeductiblesforoperating units.
Thereisan additionalnegotiating leveragew ith underw riters.
Availability ofincentivesforlosscontrol.

SEC TIO N -C
(C A SE STU D IES)
1. The w eatherhas a substantialinfluence on the econom y from the risk ofa rainy
sum m er for beer garden proprietors to the dependency of energy suppliers on the
w eather.W eather derivatives offer a range of tools for these industries to hedge
againstpreviously uninsurablew eatherrisks.
H edging againsta cold sum m er
W hen thetem peraturein Britain risesby 3 C,daily beerconsum ption increasesby
10% ,saysthe U K M etO ffice in a study a very telling exam ple thatshow show
m uch aparticularindustrysturnovercan beaffected by thew eather.
M eteorological research institutes estim ate that m ore than 80% of all econom ic
activities are w eather-dependent.In other w ords,a huge variety of industries are
involved fashion com panies,brew eries,construction firm s,ice-cream producers
and especially energy suppliers.
W hen nationalutility m onopolies in the U SA w ere turned into independentenergy
com panies, dem and increased for protection against the im pact of the w eather.
Instrum entsforhedging w eatherrisksw eresought,and w hatm oreobviousideathan
to use the tools ofthe capitalm arket? Explain how M unich Re is offering w eather
derivatives.
SO LU TIO N :
O bjectiveofw eatherderivatives
A w eatherderivative differs from a custom ary derivative in thatitis notbased on
tradable reference item ssuch asshares,share price indices,bondsorexchange rates
buton predeterm ined index data,such asthetem perature.Itfollow sthatthepurpose
ofaw eatherderivativeisto hedgevolum erisksratherthan pricerisks,sincearising
III-92
M O D U LE-III:RISK M A N A G EM EN T A N D REIN SU RA N CE

orfalling turnoverneed notaffecttheprice.


In a cold sum m er,forinstance,itisnotusualforthe price ofice-cream to suddenly
fall-the ice-cream industrysdecrease in turnoverisdue to the low ersalesvolum e,
then,notto a price reduction.In these cases,w eather derivatives provide volum e
com pensation.
A sim ilarsituation existsin future-oriented fieldslikerenew ableenergy:particularly
in thefirstfew years,w hen high investm entcostshaveto berecouped,alack ofw ind
ortoo littlesolarirradiation m ightreducethevolum eofelectricity generated to such
an extentthatthe financing ofthe venture is jeopardised.W eatherderivatives can
then provideim portantbalance-sheetprotection.
From singletriggerto m ultipletrigger
O fcourse,therearealso m any industriesw herethew eatherhasan im pacton both the
volum e and the price,such as the oilindustry.Ifa w interis w arm erthan average,
peopleheatless-thereisafallin thesalesvolum eand thepriceoffueloil.
In such cases,"cross-hedging"isrecom m ended,am ixtureofw eatherderivativeand
classic com m odity derivative,w hich also hedgesagainsta decrease in turnoverasa
resultofpricereductions.
W ithin the fram ew ork ofintegrated risk m anagem ent,M unich Re offers m ultiple-
triggerm odelsthatcoverseveralriskssim ultaneously.
W hatconstitutesbad w eather?
The m ost w idespread trigger used for w eather derivatives is the tem perature.
H ow ever,othertriggersareagreed on som etim esasw ell,such ascertain am ountsof
precipitation,w ind,sunshineorsnow fall.
W eatherderivativesare usually concluded forone season only,butw ealso offerour
clientscontractsthatarevalid forashorterorlongerperiod.
M unich R esknow -how
O ptim ally designing and deploying w eather derivatives for clients requires
geoscientific expertise com bined w ith know -how in statistical m ethodology and
know ledgeofthecapitalm arkets.
M unich Rehasbeen offering extensivew eatherand clim ateconsultancy servicesfor
over30 years and assess over500 w eatherrisks a year.Besides this,they have a
sufficiently diversified portfolio w hich they actively m anage,thus m eeting allthe
requirem entsforsuccessfulbusinessw ith w eatherderivatives.
2. The insurance industry hasa num berofcriticalcogsthatallow itto w ork properly.
O neofthem ostim portantcogsin them echanism isthereinsurancem arket.A nd like
theprim ary insurancem arket,thelastfew yearshaveproven to bequitechallenging
forreinsurers.A long listofissueshasshaped the currentreinsurance m arketplace.
A m ong the m ore significant contributing factors w ere: 9/11, a prolonged soft
insurancem arket,low returnson investm entincom eand theneed forgeneralreserve

III-93
M O D U LE-III:RISK M A N A G EM EN T A N D REIN SU RA N CE

strengthening.
C urrentstateofthem arket
Financial results for the reinsurance m arket are sim ilar to those of the general
insurance m arket.Forexam ple,financialresultsforthe firstquarterof2004 show a
m arked im provem entin profitability.Thecom bined ratio forthereinsuranceindustry
asreported by the Reinsurance A ssociation ofA m erica is94,betterthan lastyears
healthy 96.4.Thiscontinuesa trend ofsteadily im proving resultsoverthe pastfew
years.D espitethisrosy present,m any expertsarestillconcerned aboutthelong-term
prospectsforthereinsuranceindustry.
Standard & Poors is one of the m ore vocalcritics of reinsurersfuture financial
conditions.Itcontinuesto reportthattheoutlook forthereinsuranceindustry rem ains
negative. This basically m eans that ratings dow ngrades for U .S. reinsurers are
expected to exceed upgradesin thecurrentyear.D iscuss.
SO LU TIO N :
Poorfinancialresultsoverthe pastfew yearshave required a num berofchangesin
thew ay reinsurersapproach theircorebusiness,asw ellasoperationalaspectsin their
underw riting.Follow ing isareview ofsom eofthem oreinteresting changes,asw ell
asa reporton severalkey trendsthatw illhave a profound im pacton the industry in
thefuture.
R isk securitization
Itisobviousthatthereinsurancem arketisundergoing rapid changesin thenatureof
itscorebusinesspractices.Forthem ostpart,thishasbeen caused by theconvergence
of the financial m arkets. Leading the change in core business practices is the
securitization ofrisk.
A recentstudy by G uy Carpenterfound thatin 2003 thecatastrophebond (CAT bond)
m arkethad significantgrow th.The prim ary purpose ofCAT bonds is to provide a
m echanism forreinsurersto raise capitalto covercatastrophic claim s.A n additional
purpose, how ever, is to offer a portfolio diversification strategy to institutional
investors. U p to this point, the m ost popular CAT bonds w ere associated w ith
property risk such asw indstorm and earthquake exposuresin the U nited States,but
now there is grow ing interestin other types of applications.Currentpossibilities
include such diverse areasassecuritizing life insurance portfoliosand non-property
exposuressuchasw orkerscom pensationandterrorism .A num berofotherinnovative
applicationsarealso being review ed forfinancialviability.
W hile m any in the insurance com m unity see the value ofthe CAT bond approach,
m uch ofthe currentm ovem entisbeing driven by investorslooking forhigheryield
investm entvehicles.A m ong otherreasonsfortheincreasing attention are:
* Investorsarebecom ing m orecom fortablew ith thesecuritization approach.
* Thestructureofsecuritizationsisbecom ing m orestandardized.
* Tim e and cost involved in com pleting a securitization have been greatly
III-94
M O D U LE-III:RISK M A N A G EM EN T A N D REIN SU RA N CE

reduced.
Both G uy Carpenterand Sw issRe predictsignificantgrow th in securitizationsnear
term .A sinnovation and consum eracceptancecontinuesin thism arketsegm ent,one
w ould expect to see this trend of the gradual blending of the financial service
productsto accelerate.
A tthis point,m ostindustry experts and rating agencies are painfully aw are ofthe
potentialproblem associated w ith questionable recoverables and are im plem enting
reductions in theirlistings offuture recoverables.A s a result,som e com panies are
taking m ore ofthe risk internally,w hile seeking to place businessw ith higherrated
reinsurancecom paniesw hen they do chooseto usethatm arket.A n additionalfailsafe
m echanism isaN ationalA ssociation ofInsuranceCom m issioners(N A IC)-U SA rule
thatrequires insurers to reduce reinsurance recoverables by 20% forthose thatare
overdueby m orethan 90 days.A ccordingly,therehasbeen an overalltrend to m ove
the reinsurance business to m ore highly rated reinsurers.This,of course,has the
predictable effectofplacing prem ium pricing on financially sound reinsurers.Itis
expected thatthistrend w illpersistoverthenextfew yearsastheindustry continues
to strugglew ith adequateam ountsofcapital.

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M O D U LE-III:RISK M A N A G EM EN T A N D REIN SU RA N CE

C hapter14
Inw ard R einsurance

SEC TIO N -A
1. O neofthefollow ing isnottrue:
a. Reinsurancebusinessaccepted by an insurerisinw ard reinsurancebusiness
b. Reinsurancebusinessaccepted by areinsurer,isinw ard reinsurancebusiness
c. Itisopposed to insurancebusinessceded to anotherinsurer.
d. A & B
e. N oneoftheabove.
2. W hy com paniesgo forinw ard reinsurancebusiness?
a. To increasethegrossprem ium and netretained prem ium
b. To achieve a low er expense ratio by m aintaining the volum e of prem ium
incom easceding reducestheprem ium incom e.
c. To obtain abetterand w iderspread ofbusiness
d. A lloftheabove.
e. N oneoftheabove.
3. O neofthefollow ing isnottrue:
a. A com pany hasto deviseitscorporatestrategy foritsunderw riting policy.
b. Itcan w ritelinesforitsnetaccount.
c. Itcan w ritelargershares.
d. Itcan createaretrocession treaty to takecareofsurplusoveritsnetretention.
e. N oneoftheabove.
4. Thisconsideration need notbekeptin m ind w hilefinalizing inw ard reinsurance;
a. Treaty orFacultativereinsurance
b. Territorialscope.
c. D irectorBrokers.
d. Classofbusiness
e. N oneoftheabove
5. O neofthefollow ing isnottrue:
a. Facultativereinsuranceinvolvesm oreadm inistrativew ork.
III-96
M O D U LE-III:RISK M A N A G EM EN T A N D REIN SU RA N CE

b. Treaty islessexpensivebutrequiresthorough know ledgeofthem arket.


c. Ifthe com pany w ants a greatergeographicalspread then itshould underw rite
foreign business.
d. Ifthecom pany hasexperienced staffdirectbusinesscan besolicited.
e. N oneoftheabove.

SEC TIO N -A A N SW ER S
1. e 2. d 3. e 4. e 5. e

SEC TIO N -B

1. W hy do com paniesgo forinw ard reinsurance?


A ns.Som eofthereasonsw hy com paniesgo forinw ard reinsuranceareasfollow s:
to increasethegrossprem ium and netretained prem ium
to achievealow erexpenseratio by m aintaining thevolum eofprem ium incom e
asceding reducestheprem ium incom e
to obtain abetterand w iderspread ofbusiness
to counteractthedrain offoreign exchangecaused by ceding ofprem ium
to earn an investm entincom ew hich m ay bederived from thecash flow.
2. W hataretheconsiderationsa com pany should keep in m ind w hilefinalizing its
inw ard program m eofreinsurance?
A ns.Som e considerations the com pany should keep in m ind w hile finalizing its inw ard
program m efortheyearareasfollow s
Treaty orfacultative facultative involves m ore adm inistrative w ork as each
offer w illbe scrutinized.Treaty is less expensive butitrequires a thorough
know ledgeofthem arketand treaty clauses.
Territorialscope ifthe com pany w ants a greatergeographicalspread then it
should underw rite foreign businesskeeping in view the politicaland econom ic
conditionsofthecountry.
D irectorbrokers ifthe com pany hasexperienced staffdirectbusinesscan be
solicited.H ow ever this w illinvolve travelexpenses to procure business.So
initially itisbetterto placebusinessthrough abroker.
Classofbusiness the com pany should decide w hetheritw antsto underw rite
property business,w hich ison annualbasisorcasualty business.
A cceptance lim its keeping in m ind the financial standing and prem ium
incom e ofthe com pany the acceptance lim itshould be large enough to m ake it
attractiveforthebrokersand ceding com paniesto offerbusiness.

III-97
M O D U LE-III:RISK M A N A G EM EN T A N D REIN SU RA N CE

C hapter15
R einsurance Practice

SEC TIO N -A
1. W hich ofthefollow ing statem entsistrue?
a. A good reinsurance program m e can be executed w ith assistance from
reinsurers,brokersand consultants.
b. A reinsuranceplan m usttakeinto accounttheprim ary insurersneeds.
c. Theprim ary insurersm ustcontinueto besolvent.
d. A & B
e. A ,B & C.
2. O neofthefollow ing isnota factordeterm ining thereinsuranceneeds.
a. K indsofinsurancew ritten
b. Volum eofinsurancew ritten
c. Availablefinancialresources.
d. Businessvolum eofclient
e. N oneoftheabove
3. Law oflargenum bersisnotapplicablein oneofthefollow ing cases.
a. M otorreinsurance
b. Catastrophes
c. M arineinsurance
d. Lifeinsurance
e. N oneoftheabove.
4. Theim portantfactorin setting oftheretention
a. Stability
b. Liquidity ofinvestm ent
c. A m ountofreliefneeded
d. G row th plans.
e. N oneoftheabove.
5. Theprincipalpurposeofan excessoflosstreaty is
a. stabilizelossexposures
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M O D U LE-III:RISK M A N A G EM EN T A N D REIN SU RA N CE

b. providing largelinecapacity
c. stabilizeearnings
d. A& B
e. A ,B& C
6. Setting reinsurancelim itsdependson
a. Com pany considerations
b. Costconsiderations
c. Financialstrength ofthereinsurer
d. Financialstrength oftheclient
e. N oneoftheabove.
7. W hilesetting thereinsurancelim itsthisfactorisnotconsidered
a. Volum eoftheprem ium
b. Prem ium loading
c. Reinsurancecost
d. A lltheabove.
e. N oneoftheabove
8. O neofthefollow ing ism orevulnerableto lossratio fluctuation.
a. N ationallevelprim ary insurer
b. Regionalinsurer
c. M arineinsurer
d. LifeInsurer
e. N oneoftheabove.
9. Thereinsurancecostincludes
a. O perating expenses
b. Prem ium paid to reinsurer
c. Lossesrecovered /to berecovered
d. A & B
e. B& C
10. O neofthefollow ing isnottrue:
a. Transferofassetsresultsin lossofinvestm entincom eto theprim ary insurer.
b. Such alossofinvestm entincom em ay begreaterunderpro-ratatreaty.
c. Reinsuranceprem ium forapro-ratatreaty isusually low er.
d. Lossofinvestm entincom em ay also becom ean additionalcostofreinsurance.
e. N oneoftheabove.

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M O D U LE-III:RISK M A N A G EM EN T A N D REIN SU RA N CE

11. N egotiationsfor reinsurance depend on severalfactors.O ne ofthe follow ing is


notoneam ong them .
a. Thenatureoftheprim ary insurer
b. The reinsurer
c. K ind ofreinsurancetransacted
d. Interestrates
e. N oneoftheabove.
12. In facultativereinsurancenegotiations,oneofthefollow ing isim portant
a. thereinsurer
b. theprim ary insurer
c. detailsofindividuallossexposures
d. underw riting operations.
e. N oneoftheabove.
13. O neofthefollow ing isnottruein assessing theunderw riting policy ofa prim ary
insurer.
a. Theclassesofbusinesstheprim ary insurerisw riting.
b. H ow satisfactory aretheprim ary insurersunderw riting guidelines?
c. A re their gross line lim its and netline lim its in keeping w ith their financial
strength?
d. The prim ary insurersrates are notadequate for the risks covered under the
treaty.
e. N oneoftheabove.
14. Thesearethecom m issionsinvolved in thereinsurancetransaction.
a. CedingCom m ission
b. BrokerageCom m ission
c. Settlem entCom m ission
d. A ,B& C
e. A & B
15. Theprem ium registered in thebooksofan insureratthetim ea policy isissued,
iscalled;
a. Earned prem ium
b. U nearned prem ium
c. W ritten prem ium
d. Registered prem ium
e. N oneoftheabove

III-100
M O D U LE-III:RISK M A N A G EM EN T A N D REIN SU RA N CE

SEC TIO N -A A N SW ER S
1. e 2. d 3. b 4. c 5. d 6. b
7. b 8. b 9. e 10.c 11.d 12.c
13.d 14.e 15.c

SEC TIO N -B

1. W hatarethefactorsdeterm ining thereinsuranceneedsofa prim ary insurer?


A ns. Theim portantfactorsare:
K indsofinsurancew ritten
Exposuressubjectto catastrophicloss
Volum eofinsurancew ritten
Availablefinancialresources
Stability and liquidity ofinvestm entportfolio,and
G row th plans.
2. Explain theconceptofSetting R etentions.
A ns.The choice ofretention dependson the type oftreaty,w hich in turn dependson the
needsoftheprim ary insurer.Thesetting ofretention variesdepending on thetypeof
treaty.In otherw ordsthebasicreason forchoosing onetypeoftreaty in preferenceto
anotherissupported by the follow ing exam ple.Forexam ple,ifthe prim ary insurer
prefersapro-ratatreaty w hen com pared to an excesstreaty thereason could bethata
pro-ratatreaty providessurplusrelief.Therefore,theim portantfactorin thesetting of
retention m ustbe the am ountofreliefneeded.The am ountofsurplusreliefreceived
w illbe a function ofthe percentage ofprem ium s ceded and the percentage ceding
com m ission received.
3. Explain theprocessofsetting reinsurancelim its.
A ns.Setting the reinsurance lim its depends on costconsiderations since reinsurance costs
increase in direct proportion to reinsurance lim its,keeping the retention constant.
H ow ever,thetreaty reinsurancecostsm ustbew eighed againstotherrecurring costsin
facultativeplacem entssuch astheprem ium ,adm inistrativeexpenseand inconvenience
and uncertainty associated w ith facultative reinsurance.H ow ever,w hile setting the
reinsurancelim itsonly thevolum eoftheprem ium isconsidered and nottheprem ium
loading.Lim itSetting fora Catastrophe treaty iseven m ore difficultin practice since
one cannot predict a large loss m erely based on historical records. Therefore, in
reinsuring catastrophes,concentration oflossexposuresm ustbecarefully analyzed.
In the exercise ofsetting the reinsurance lim it,the term softhe severaltreatiesm ust
be com pared and the lim its can be kept flexible. For exam ple, the lim it for an
aggregateexcesstreaty can below ered ifadequatecatastrophereinsuranceiscarried.
A gain the lim itofa catastrophe can be low erifitappliesonly to the retention ofthe
III-101
M O D U LE-III:RISK M A N A G EM EN T A N D REIN SU RA N CE

prim ary insurerafterrecoveries from pro-rata reinsurance,ratherthan to the direct


losses.
4. C ost of R einsurance is an im portant elem ent in finalizing reinsurance deal.
Explain thecostofreinsurance.
A ns.The reinsurance cost includes the prem ium paid to the reinsurer and the losses
recovered or to be recovered under the reinsurance agreem ent.A prim ary insurer
should pay itsow n lossesand the reinsurersexpensesand profitunderany treaty,if
the treaty iscontinued overa fairly long period.Thatisw hy the am ountincluded in
theprem ium forthereinsurersexpensesand profitisan im portantfactorin assessing
thereinsurancecost.
Loss of investm entincom e m ay be greater under a pro-rata treaty than under the
excess treaty since the reinsurance prem ium fora pro-rata treaty is usually greater.
Thus, the loss of investm ent incom e m ay also becom e an additional cost of
reinsurance.The costofadm inistering the reinsurance program m e variesdepending
upon the type of reinsurance. For instance, since facultative placem ents are
individualand separate,thecostofadm inistration in thesecasesisgreaterthan in the
case of treaties. Sim ilarly pro-rata treaties cost m ore to adm inister than excess
treaties.Finally,theprofitorlosson insuranceassum ed underreciprocalarrangem ent
m ustalso form partofthereinsurancecost.
5. W hatare the typicalquestions to be considered in assessing the underw riting
policy ofa prim ary insurer?
A ns.Theclassesofbusinesstheprim ary insurerisw riting;
Ifthey areprim arily concentrating on personallines,com m ercial,industrialorothers;
Theirgeographicareaofoperation;
H ow satisfactory aretheprim ary insurersunderw riting guidelines?
A retheirgrosslinelim itsand netlinelim itsin keeping w ith theirfinancialstrength?
A re the prim ary insurerslosscontroland lossadjustm entpracticesadequate forthe
classesofbusinessw ritten?
H avetheprim ary insurersunderw riting resultsbeen satisfactory in thelinescovered
by theproposed reinsurancetreaty?
D oes the prim ary insurer anticipate any substantial changes in its m anagem ent,
m arketing orunderw riting practices?
A retheprim ary insurersratesadequatefortheriskscovered underthetreaty?

SEC TIO N -C
(C A SE STU D IES)
H im alayan Insurance com pany is a large insurance com pany.Itspecializes in personal
lines insurance, m otor insurance and m ortgage insurance. Its annual direct prem ium
volum eisRs2000 crores.Itsbusinessisspread alloverthecountry,w ith theproportion of
III-102
M O D U LE-III:RISK M A N A G EM EN T A N D REIN SU RA N CE

itsbusinessin any one state being approxim ately the sam e asthatstatesproportion ofthe
nations population.Its policy holders surplus is Rs 1200 crores.Its investm entportfolio
consists m ostly of G overnm entBonds and high-grade industrialand utility bonds.The
insurance com pany norm ally holds about Rs 500 crores in treasury bills, high rated
Com m ercialPaperand othershortterm assets.Investm entin equity stocks accountfor
only 5 percentofitsinvested assetsand lessthan 10 percentofpolicy holderssurplus.The
insurance com pany hasshow n an operating profitevery yearforthe lastone decade.A n
analysisofthe geographic spread ofitsbusinessexposuresindicatesthatlossesin excess
ofRs500 croresin any onecatastrophearevery unlikely.
Exam inethereinsuranceplanning processofH im alayan InsuranceCom pany.
SO LU TIO N :
A fterreview ing alloftheavailabledata,itissuggested thattheH im alayan Insurance
Com pany does notrequire any reinsurance.Its large prem ium volum e,w idespread
sm allindividualrisks,strong surplusposition and stable,liquid investm entportfolio
w ould enable itto cope w ith any loss ratio variation itm ightreasonably expectto
occur,including catastrophes.
2. D harm aInsurancecom pany hasannualdirectw ritten prem ium sofRs100 croresand
policy holderssurplusofRs50 crores.Ithasaveraged 10 percentannualgrow th over
thepastdecadeand expectsto continueto grow ataboutthesam erate.Itscom bined
ratio hasexceeded 100 percenteach yearforthe lastdecade,averaging 102 percent
fortheperiod.Ithasreported an operating profiteach yearforthelastdecade,butthe
profithasbeen sm allin som e years.A high rated portfolio ofbondsand otherfixed-
incom e securitiesaccountsforabout95 percentofitsinvested assets.The balance
consistsofcarefully selected preferred and equity stocks.
D harm a w ritescom m ercialm otorinsurance,generalliability,fire and allied linesof
insurance.Itw ritessm allto m edium -sized com m ercialand industrialrisks.A survey
ofits outstanding policies show ed thatabout95 percentofits liability policies had
occurrence lim its of Rs1.0 crore and less,and about95 percentof other policies
proved coverage ofRs 1.5 crore orless.M anagem enthas decided to setits treaty
lim its to cover those am ounts and to depend on facultative reinsurance for the
policiesw ith greaterlim its.D harm a doesnotneed surplusrelief,and so no pro rata
reinsurancew illbepurchased.D iscuss.
SO LU TIO N :
Perrisk orperpolicy excesstreatiesw illbepurchased forboth liability and property
insurance.M anagem entm ay decide thatthe insurercan afford to assum e individual
lossesupto 0.5 percentofdirectw ritten prem ium ,or1.0 percentofpolicy holders
surplus.Consequently,theretention underboth theliability and othertreatiesw illbe
setatRs50 lacsperloss.Treaty lim itsw illbeRs50 lacsforliability and Rs1.0 crore
form ortgage losses.Thus,the prim ary insurers retention and the treaty lim its w ill
fully coverabout95 percentofallpoliciesissued.

III-103
M O D U LE-III:RISK M A N A G EM EN T A N D REIN SU RA N CE

The propertiesinsured by the prim ary insurerare spread w idely acrossthe country,
butseveralareas have high concentrations ofvalues subjectto catastrophe losses.
Thew orsttragedycanoccurincoastalareasw herelossescouldgouptoRs5crore.A
catastrophe treaty w ith a lim itofRs 5 crore and a retention ofRs 50 lacs w illbe
purchased to covertheexposure.

III-104
DIRM
MODULE IV

BUSINESS STRATEGIC
PLANNING & INFORMATION
TECHNOLOGY
MODULE IV
BUSINESS STRATEGIC PLANNING &
INFORMATION TECHNOLOGY

Chapter 1
Management of Insurance Companies ...................................................................IV-1
Chapter 2
BPO and Insurance ...............................................................................................IV-11
Chapter 3
Exchange Control and Taxation ...........................................................................IV-19
Chapter 4
System Development Process ..............................................................................IV-24
Chapter 5
System Analysis ...................................................................................................IV-35
Chapter 6
System Design ......................................................................................................IV-40
Chapter 7
System Implementation and Operation ............................................................... IV-48
Chapter 8
Computer Software and Configuration ................................................................IV-57
Chapter 9
Data Storage and Processing Methods......................................IV-71
Chapter 10
Information System Controls ...............................................................................IV-84
Chapter 11
Data Security and Integrity ................................................................................IV-100
Chapter 12
Information Technology and Insurance .............................................................IV-116
Chapter 13
Pricing and Marketing of Insurance ...................................................................IV-121
Chapter 14
Case Studies... IV-139
C hapter 1
M anagem entof
Insurance C om panies

SEC TIO N -A :O BJEC TIV E TY PE Q U ESTIO N S

1. Follow ing yardsticksareused to classify insuranceEX C EPT:


(a) Tim ePeriod
(b) N atureofRisk coverage
(c) N atureofsubjectm atter
(d) Price
2. Personalinsurancecoversallofthefollow ing EX C EPT:
(a) D eath
(b) A ccident/Sickness
(c) H om e
(d) O ld age
3. ______________ insurance covers perils that m ay prevent one from earning
m oney w ith w hich to accum ulate property in the future, w hereas
_______________ insurancecoversbelongingsthatarealready accum ulated.
(a) Personal,Property
(b) Property,Personal
(c) Property,Property
(d) Personal,Personal
4. Third party insurancecoversdam ageto a third party dueto theoperation ofthe
______________ ofthefirstparty.
(a) Profits
(b) Property
(c) Senses
(d) Losses
5. The functions perform ed by any insurer necessarily depend on the follow ing
EX C EPT:

IV-1
M O D U LE-IV :BU SIN ESS STRA TEG IC PLA N N IN G

(a) typeofbusinessitw rites


(b) thefinancialresourcesavailable
(c) thesizeand natureoftheinsurer
(d) com petition
6. W hatisalso called asProduction in insurance?
(a) Ratem aking
(b) Investing
(c) Sales
(d) U nderw riting
7. Theobjectiveof_____________isto ensurethattheproposerdoesnotsuffera
lossthatism uch greater than w hatw asassum ed atthe tim e the prem ium sare
fixed.
(a) U nderw riting
(b) Ratem aking
(c) Record keeping
(d) M arketing
8. Theprem ium charged by an insurancecom pany istheam ountof
(a) anticipated loss+ costofdoing business
(b) anticipated profit+ costofdoing business
(c) anticipated profit+ businesscapital
(d) unanticipated loss+ costofdoing business
9. W hich ofthe follow ing isnota w ay in w hich m ultinationalfirm scan structure
theirglobalinsuranceprogram m e?
(a) They can buy insurancein onecountry and arrangeforcoveragew hereverthey
do business.
(b) A llow localm anagem entin each country to purchaseinsurance
(c) H avetheirow n insurancecom panies
(d) By using a m asterprogram m e thatis globally controlled and coordinated by
globalinsurerthrough subsidiaries,associatesorpartners.
10. Identify therightsetofsom eprinciplesofBPR .
(i) O rganisearound outcom es,nottasks
(ii) H avethosew ho do notneed theresultsofaprocessperform theprocess.
(iii) Integrate the processing ofinform ation into the w ork processthatproducesthe
inform ation
(iv) Treatgeographically dispersed resourcesasdecentralized.
(v) Lineparallelactivitiesinstead ofintegrating theirresults.
IV-2
M O D U LE-IV :BU SIN ESS STRA TEG IC PLA N N IN G

(vi) Capturetheinform ation atvariousintervalsand sources.


(a) i,ii,iii
(b) ii,iii,iv
(c) iii,v,vi
(d) i,iii,v

11. W ho iscredited w ith firstusing theterm reengineering ?


(a) M ichaelH am m er
(b) H arvard BusinessSchool
(c) W harton School
(d) M ichaelW erner

12. Insurance m arkets in the industrial countries do not offer the sam e
opportunitiesfor grow th in thenext10 yearsastheem erging econom ies. This
trend hascontributed tow ards
(a) D e-tariffing
(b) G lobalisation
(c) Increasein tradebarriers
(d) Entry ofM N C (insurers)into developing econom ies

SEC TIO N -A :A N SW ER S
1. d 2. c 3. a 4. b 5. d 6. c
7. a 8. a 9. c 10.d 11.a 12.d

SEC TIO N -B :Q U ESTIO N S

1. W hatarethedifferentbasesofclassification ofinsurance?
A ns:D ifferentyardsticks like tim e period of insurance policy,nature of risk coverage,
nature ofsubjectm atterorinsurable interest,purpose ofinsurance can be applied to
classify insurancein India.Som eofthepopularbasesofclassification include:
Personal,Property and Liability Insurance
G overnm ent(orsocial)and PrivateInsurance
V oluntary and Involuntary Insurance
Long-term and Short-term Insurance
Lifeand G eneralInsurance
Firstand Third Party Insurance
Itm ay benoted thattheseareoverlapping classifications.Forexam ple,lifeinsurance
isform ofpersonalinsurancew hich isusually long-term in nature.

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M O D U LE-IV :BU SIN ESS STRA TEG IC PLA N N IN G

2. D istinguish betw een thefollow ing:


(a) PersonalInsuranceand Property insurance
PersonalInsurance isrelated directly to the individual;the risk itcoversisthe
possibility thatsom e perilm ay harm the individuals incom e.There are four
such perils:
(i)death (ii)accidents(iii)sickness,unem ploym ent(iv)old age.
Insurance is w ritten on each. Private insurance com panies are active in
providing insurance fordeath,accidents and sickness,and old age (pension).
The governm entusually provides for unem ploym entbenefits,particularly in
developed countries.Lifeinsuranceisalso aform ofpersonalinsurance.
Property Insurance is directed against perils that m ay destroy property.
Property insurance is distinguished from personalinsurance in thatpersonal
insurancecoversperilsthatm ay preventonefrom earning m oney w ith w hich to
accum ulate property in the future,w hereasproperty insurance coversproperty
thatisalready accum ulated.Property insurance includesfire,m arine,liability,
casualty,and surety insurance.Property insurance isalso referred to asgeneral
insurance.
(b) Lifeinsuranceand G eneralinsurance
Life insurance covers perils againstthe life ofa person.A s perthe Insurance
A ct,1938 therearetw o typesofinsurancebusinesses,lifeand general.
G eneralInsurance(aspertheInsuranceA ct,1938)coverseverything otherthan
life insurance.
(c) Firstparty insuranceand Third party insurance
FirstParty Insurancecoverstheproperty oftheinsured and in caseofdam ageto
theproperty,theclaim ispaid to theinsured and thereisno third party involved.
Third Party Insurancecoversdam ageto athird party dueto theoperation ofthe
property ofthefirstparty.In thiscasetheprem ium ispaid by theinsured butthe
property belongsto athird party and theclaim isalso payableto thethird party.
The party becom esinvolved only on the happening ofan event.Itisa form of
socialsecurity to protectthethird party from theactionsofothers.A n ow nerof
a m otor vehicle is usually required by law (i.e. com pulsorily) to purchase
insuranceto coverdam agesto third party.

3. Listoutthevariousfunctionsofinsurers.
Thefunctionsperform ed by any insurernecessarily depend on thetypeofbusinessit
w rites,thedegreeto w hich ithasoutsourced certain functions,thefinancialresources
available,the size and nature ofthe insurerand a hostofotherfactors.H ow ever,a
broad rangeoffunctionsarecom m on to alm ostallinsurers.Thesefunctionsare:
1. Production (Selling and M arketing)
2. U nderw riting
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M O D U LE-IV :BU SIN ESS STRA TEG IC PLA N N IN G

3. RateM aking
4. Claim sM anagem ent
5. Investing and Financing
6. Record keeping and A ccounting
7. M iscellaneousfunctions
4. W hatisProduction in insuranceand briefly discussitsuniquecharacteristics.
Insurance is an intangible item and thus does notexistuntila policy is sold.In the
insurance industry,therefore,the actofselling isproduction in the truestsense and
the function thatcorresponds to selling orm arketing in otherbusinesses is usually
referred to asproduction in theinsuranceindustry.
The production (or sales) m anagem ent team coordinates and m anages the
relationships w ith agents in the field.W here an insurance com pany has exclusive
agents,ithasto m aintain ahigh degreeofcontrolovertheactivitiesoftheagent.The
function encom passes the recruitm ent,training and supervision of such agents.In
India,the IRD A (Insurance Regulatory and D evelopm entA uthority)haslaid dow n
the qualification and training necessary forsuch agents.Som e insurance com panies
havedesignated theiragentsas Certified FinancialPlanner .Them ain task ofthese
agentsisto reach outto custom ersand sellthepolicy.They areoften thepublicface
of the insurance com pany.A n insurance com pany needs a sufficient num ber of
applicants(policyholders)foritto beaviableentity.
5. Selection and classification of risks is a very vital function in insurance
business. D iscuss.
U nderw riting is the process ofselection ofrisks.The insurance com panies need to
selecttherisksto insurein accordancew ith thecom panies policies.Theobjectiveof
underw riting isto ensure thatthe applicantw illnotsuffera lossthatism uch greater
than w hatw asassum ed atthe tim e the prem ium sare fixed.The insurance com pany
establishes certain standards ofselection,w hen the prem ium rates are form ulated,
keeping in m ind the physicaland m oralhazards.For exam ple,the com pany m ay
decidethatitw illnotinsureagainsttheftand burglary,ifthenearestpolicestation is
m orethan 16 km aw ay.A lifeinsurancecom pany m ay sim ilarly decidenotto insure
the life ofsom eone w ho w orks in a hazardous environm ent,say,a stuntm an in the
film industry.
W hen considering an application fortheftand burglary insuranceofapieceofproperty
w herethenearestpolicestation is17 km aw ay orw hileconsidering an application for
lifeinsuranceofafilm stuntm an,theunderw riterneedtoconsiderw hetherhecanm ake
an exception to the com pany policy.The underw riterneeds to evaluate w hatw ould
happen ifa large num berofsuch policiesw ere w ritten and ifa significantnum berof
claim sarose.U nderw ritershaveto strikeabalancew ith RateM aking.RateM aking is
an extrem e balancing actbetw een being very liberaland taking m ore risk than is
w arranted and being very strictand losing too m any custom ers.
IV-5
M O D U LE-IV :BU SIN ESS STRA TEG IC PLA N N IN G

The field agentis also expected to do som e prelim inary screening ofthe applicant
before forw arding it to the insurance com pany s underw riter. In m any fields of
insurance,the agentcan m ake binding decision on behalfofthe insurance com pany,
butthesedecisionsaresubjectto postunderw riting by theinsurancecom pany and the
contractiscancelableon giving duenoticeto theinsured.
There are som e functions that are allied to underw riting or provide support to
underw riters.In lifeinsurance,forexam ple,aphysician m ay providem edicalreports
on prospective applicants. The physicians m ay be appointed or licensed by the
insurance com pany. Sim ilarly in property and m arine insurance, inspectors w ho
inspectvalue and assess the risks involved in insuring the property m ay assistthe
underw riter.
A notherfunction oftheunderw riting departm entispolicy w riting.In m ostcases,the
agentissuesthepolicies,buttheunderw riterhasto check w hethertherateshavebeen
accurately charged,w hetherornotthe agenthastaken a prohibited risk and w hether
theapplicanthasfollow ed alltheterm sand conditions.
6. W hatisratem aking? Stateitssignificance.
RateM aking isan extrem ely technicalfunction,w hich involvesselection ofclassesof
insurableunitson w hich statisticsiscollected regarding probability ofloss.In thecase
oflife insurance,itusually involvesestim ating m ortality ratesaccording to age,sex,
occupation and otherfactors including lifestyle habits and choices such as sm oking/
drinking,etc.In otherfields,like property and liability insurance,ratem aking is an
extrem ely com plicated and a large num berofvariablesneedsto be factored in before
ratesarefixed.Ratem aking isaspecialised field thatisusually overseen by actuaries.
A ccurate rate m aking requires huge am ounts of inform ation collected over long
periods oftim e in orderto predictthe potentialloss from each class ofassets.The
prem ium charged by an insurance com pany isthe am ountofanticipated loss(called
pureprem ium )plusthecostofdoing business(called loading).
Forexam ple,ifan insurance com pany expects to pay Rs.600,000 by w ay ofm otor
vehicle insurance claim s fora particularclass ofinsured (say truck operators)and
there are a totalof1000 trucks am ong the insured,the pure prem ium w orks outto
Rs.600 pertruck.Thispureprem ium hasto beincreased by thecostofdoing business
w hich includes expenses such as agents com m issions,generalcom pany expenses,
prem ium s,taxes and fees,and the profitm argin.The sum of pure prem ium and
loading is w hatthe custom eractually pays the insurance com pany and this sum is
called grossprem ium .G uidelinesforratem aking arefixed by theIRD A .
7. C laim s m anagem ent is crucial to the success of an insurance com pany.
D iscuss.
Settling claim s under insurance contracts is the function of claim s m anagem ent,
w hich is often perform ed or supervised by risk m anagers. This activity usually
requires field w ork,and use ofoutside expertise in the form ofloss assessors and

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M O D U LE-IV :BU SIN ESS STRA TEG IC PLA N N IN G

insuranceadjusters.A certain am ountoflegalexpertiseisalso required forthistask.


The claim s departm ent of an insurance com pany has to ascertain the validity of
w ritten proofs ofloss,investigate the scene ofthe loss,estim ate the am ountofthe
loss,interpretand apply the term s of the policy in the loss situation,and finally
approvepaym entoftheclaim .
Claim s m anagem entis crucialto the success of an insurance com pany.The public
im age ofthe com pany is dependenton the speed and fairness w ith w hich itsettles
claim s. Since in m any cases, the agent is responsible for selling the policy and
collecting prem ium s,itisoften only w hen a claim ism ade thatthe insured com e into
direct contact w ith the insurance com pany. If the insured is dissatisfied w ith the
handling ofhis case,itm ay resultin loss ofbusiness,punitive action by regulatory
bodies/courts.
8. Illustrate the influence of globalisation on insurance and risk m anagem ent
business.
The m ain force driving the international focus of the insurance business is the
globalization ofthefirm sthatbuy insuranceand purchaserisk m anagem entservices
from insurers.A lso the m ultinationalfirm sare becom ing increasingly sophisticated
regarding risk m anagem entpractices,and they require the ability to com bine and
integrate their risk m anagem entprogram m es on a globalbasis and dem and high-
quality risk m anagem entservices,such asclaim sm anagem entand losscontrol.
Insurance m arketsin the industrialcountriesdo notofferthe sam e opportunitiesfor
grow th in the nextten yearsasthe em erging econom iesin the countriesofEastern
Europe,Latin A m ericaand A sia.
A notherfactorfacilitating theglobalization processisthetechnologicaladvancem ents
in thefield ofcom m unication and transportation,and reduction in tradebarriers.
There are tw o w ays in w hich globalization has affected risk m anagem ent and
insurance.Insurers w ho operate internationally in different counties face different
kindsofrisksorperilsand the m ethodsofrisk m anagem entthatare effective in one
countryor regionm aynotbeeffectiveinanothercountryorregion.Secondly,different
regionsofthe w orld have differentgrow th potentialand insurersw ho find theirhom e
m arketssaturated find itadvantageousto expand to otherdeveloping m arkets.
G lobalfirm salso faceanum berofrisksthatarisedirectly from operating in m ultiple
countries.These risksinclude politicalinstability,legaland proceduraldifferences,
currency fluctuations, export/im port restrictions, poorly developed infrastructure,
lack oftechnicalskill,w eaknessin capitaland financialm arkets.Further,assessing
risk in developing countriescan beachallengedueto paucity ofdata.
A partfrom allthe above risks,extentofthe insurance m arketcan also vary from
country to country.Taxation ofinsurance variesfrom country to country.In certain
countriesinsuranceism andatory forcertain activities,likew orkm en scom pensation
forindustrialestablishm ents and forpractising certain professions one m ay require
professional indem nity insurance. In som e countries and com m unities, religious
IV-7
M O D U LE-IV :BU SIN ESS STRA TEG IC PLA N N IN G

beliefs preclude paym entofinterest.In othercountries,governm entfunded social


insurance program m es are so extensive thatthe dem and forprivate life and health
insuranceislim ited.
9. H ow do you think m ultinationalcom paniescan structuretheirglobalinsurance
program m es?
There are three w ays in w hich m ultinational firm s can structure their global
insurance program m e.
(a) They can buy insurance in one country (usually the hom e country)and arrange
forcoveragew hereverthey do business.Theadvantageofthisapproach isthat
itiseasy to adm inisterand itleavesthe decision-m aking in the hom e country.
H ow ever,thism ightbe illegalin som e countries,and in som e othercountries
the prem ium m ay not be tax deductible unless the prem ium is paid to a
dom estic insurer.A lso the insured does nothave a localinsurer to provide
claim sand otherservices.
(b) The second w ay m ultinational firm s can structure their global insurance
program m e isto allow the localm anagem entin each country,in w hich itdoes
business,to purchase insurance.Thisw illensure thatlocallaw sare com plied
w ith,and ensurethatany tax benefitsaretaken advantageof.Thedisadvantage
isinefficiency and additionalcosts.Theseinefficienciesand costaredueto the
overheads involved in dealing w ith diverse insurance com panies.Furtherthe
policies them selves are not likely to be uniform w ith different term s and
conditionsand providedifferentcoveragelim itsand even leaveim portantareas
uncovered and uninsured.
(c) Thethird w ay in w hich m ultinationalfirm scan structuretheirglobalinsurance
program m e is to have a m aster program m e that is globally controlled and
coordinated.H ere a globalinsurerw orksthrough itssubsidiaries,associatesor
partnersin each ofthe countriesin w hich the m ultinationalfirm doesbusiness
to provide relatively uniform coverage.The globalcontroland co-ordination
ensuresthatinsurance coveriscost-effective and consistent.The involvem ent
of subsidiaries,associates or partners ensures thatthe com pliance w ith local
law sand associated tax benefitsare taken advantage of.A lso the subsidiaries,
associates or partners can provide local expertise in m anaging claim s and
assessing risk.
10. W hatisBusinessProcessR eengineering? D iscussitsprinciples.
Business process reengineering is an activity larger in scope than system s
developm ent,as itaddresses allofthe processes in the organization,including the
inform ation system sprocesses.
Com panies are being asked som etim es being forced in orderto ensure theirvery
survival to abandon long-held businessbeliefsand assum ptionsand to rethink w hat
they areattem pting to accom plish and how they aretrying to accom plish it.Business

IV-8
M O D U LE-IV :BU SIN ESS STRA TEG IC PLA N N IN G

process reengineering (BPR) has been likened to presenting an organization s


m anagem entw ith ablank pieceofpaperand asking them to reinventtheorganization
from scratch.
TheprinciplesofsuccessfulBPR areasfollow s:
1. O rganizearound outcom es,nottasks.Thisprinciplearguesthatan organisation
should haveoneperson perform allthestepsin aprocess;design thejob around
an objectiveoroutcom eratherthan asingletask.Forexam ple,atan electronics
com pany a custom erservicerepresentative takesacustom erorder,translates
the orderinto internalcodes forthe ordered item s com ponents,requisitions,
receives,and assem blestheitem ,and deliversand installstheitem .A saresult,
oneperson isresponsibleforgetting theitem to thecustom erand foransw ering
custom er questions during the process. This elim inates m any handoffs,
num erous errors, delays, and m isunderstandings, and it also elim inates the
traditionalsegregation ofdutiesthatorganisationsnorm ally associate w ith the
orderfulfilm entprocess.Program m ed controls,integrated into the inform ation
process,m ustcom pensateforthelossofm anualcontrols.Tw o com plem entary
m eansby w hich outcom esareim proved are:
D eterm ine w hatactivitiesortasksare needed to achieve the outcom e and
to elim inatenon-value-added activities.
Create parallelactivities w hereverpossible.Forexam ple,the insurance
and loan application processes often involve activities and decisions by
m ultiplefunctions.By m aking useofshared databases,im ageprocessing,
and intelligentw orkflow ,softw are,m any activitiescan be accom plished
sim ultaneously,thusim proving outputtim eliness.
2. D o thosew ho need theresultsofaprocessperform theprocess?D epartm entsin
organizations are organized around specialized functions perform ed for
custom ers forthe outputofotherunits.In som e situations,reengineering can
provide custom ers w ith m ore tim ely service and reduce the overhead needed
to coordinatetheactivitiesoftheseunitsby having custom ersprovidetheirow n
service.Forinstance,in exchange forthe prom ise ofm ore tim ely repairs,an
electronic equipm ent m anufacturer asks its large num ber of custom ers to
perform som eoftheirow n routinerepairsand to carry thesparepartsinventory
required for their ow n m achines.N ow ,custom ers m ake som e repairs them -
selves using spare parts stored on site.The field service representatives,w ho
had been m aking all repairs, answ er custom er calls and guide custom ers
through arepairprocessusing adiagnosissupportsystem (an expertsystem ).A
com puterized inventory m anagem ent system m onitors the spare parts
inventories. Field service representatives are dispatched only for com plex
problem s.The electronics m anufacturerachieved bettercustom erservice and
low erinventory carrying costs.
3. Integrate the processing ofinform ation into the w ork processthatproducesthe
inform ation.Forexam ple atFord M otorCom pany,the receiving departm ent
and the receiving system produced and processed inform ation aboutthe goods

IV-9
M O D U LE-IV :BU SIN ESS STRA TEG IC PLA N N IN G

received instead of sending it to accounts payable. The receiving system


com pared the goodsreceived w ith the orderand took appropriate action (send
thegoodsback orcreateapayable).
H ere one can notice again,the relaxing ofsegregation ofduties.M anagem ent
m ustevaluateand accepttherisksassociated w ith theincreased opportunity for
unauthorized orinaccuratetransaction.
4. Treat geographically dispersed resources as though they w ere centralized.
D ecentralized resources typically provide betterservice to theircustom ers at
the expense of creating redundant operations and lost econom ies of scale.
A tH ew lett-Packard (H P),a m ajorcom puterand peripheralsm anufacturer,50
decentralized purchasing factions provided excellent responsiveness and
serviceto theplants,butprevented H P from benefiting from quantity discounts.
A fterreengineering,H P hasa centralized purchasing function thatcreatesand
m aintains a centralized database ofvendors w ith w hom they have negotiated
contracts.D ecentralized units can access the database to execute their ow n
purchaseorders.
5. Line parallelactivities instead ofintegrating theirresults.Ifparallelactivities
have been created, use com m unications netw orks, shared databases, and
teleconferencing to coordinate activities thatm usteventually com e together.
Forexam ple,in theloan application process,decisionsby onefunction thatw ill
affecttheloan decision m ustbeim m ediately com m unicated to otherfunctions.
6. Putthe decision pointw here the w ork isperform ed,and build controlsinto the
process.O rganisationsoften distinguish thosew ho do thew ork from thosew ho
m onitorand m akedecisionsaboutthew ork.Thisisdoneundertheassum ption
thatthose w ho do the w ork do nothave the tim e,inclination,know ledge,or
responsibility form onitoring and controlling w hatthey do.O rganisations can
reduce non-value-added m anagem entand flatten the organization structure if
the organisations use inform ation technology to capture and store data,and
expert system s to supply know ledge, to enable people to m ake their ow n
decisions.Thischangesthe role ofm anagerfrom controllerand supervisorto
supporterand facilitator.A nd,as organisations flatten,they can elim inate the
m iddle m anagers w ho had been sum m arizing and reporting inform ation to
upper m anagem ent. To com pensate, executives m ust be directly lined to
databasesusing executiveinform ation system s.
7. Capture inform ation once and atthe source.Collectand store data in online
data-basesforallthosew ho need it.Thisprincipleisfacilitated by inform ation
technology, such as telecom m unications, netw orking, client/server
architecture,ED I,im age processing,relationaldatabase system ,bare coding,
and intelligentw orkflow softw are.

IV-10
C hapter 2
BPO and Insurance

SEC TIO N -A :O BJEC TIV E TY PE Q U ESTIO N S

1. A strategy by w hich an organisation contractsoutm ajorfunctionsto specialized


and efficientserviceproviders,w ho becom evalued businesspartnersiscalled:
(a) Reengineering
(b) Businessventures
(c) O utsourcing
(d) JointV entures
2. W hich ofthefollow ing isnota typeofoutsourcing arrangem ent?
(a) Conventional
(b) Transform ational
(c) Regional
(d) Collaborative
3. Identify therightsetofsom eadvantagesofoutsourcing
(i) M arginalincreasein operating costs
(ii) Im provem entin com pany focus
(iii) Inaccessibility to w orld classcapabilities
(iv) A vailability ofcapitalfunds
(v) M ultiplication ofrisk
(vi) A ccelerateReengineering benefits
(a) i,ii,iii
(b) ii,iii,iv
(c) iii,iv,v
(d) ii,iv,vi
4. W hataretheareasin w hich outsourcing cannotbearranged in insurance?
(a) Field based services
(b) Financialrecoveries
(c) D atam anagem entand analysis
(d) Financialunderw riting
IV-11
M O D U LE-IV :BU SIN ESS STRA TEG IC PLA N N IN G

5. Identify theincorrectstep in them ethodology ofoutsourcing.


(a) D eterm inetheactivity and evaluatethefinancialim pactofoutsourcing
(b) A ssessthenon financialcostsand advantagesofoutsourcing
(c) Choosean outsourcing partnerand contracttherelationship
(d) D eterm inethelocation ofoffice
6. The key docum entin outsourcing agreem entsw hich helpsto m anage strategic
relationship betw een the outsourcing com pany and the supplier and includes
theidentification ofresponsibilitiesand resultsiscalled:
(a) ServiceLevelA greem ent
(b) StrategicLevelA greem ent
(c) M em orandum ofU nderstanding
(d) M utualConsentLetter
7. W hich ofthe follow ing is ofprim ary im portance in initiating a successfulout-
sourcing arrangem ent?
(a) Seniorm anagem entcooperation
(b) M iddlem anagem entcooperation
(c) Low erm anagem entsupport
(d) O perationalsupport
8. __________________ isa very criticalfactor influencing successfuloutsourcing
w hich helpsin assessing stakeholderrequirem entsand establishing freeflow of
inform ation am ong allthoseinvolved in theprocess.
(a) O pen com m unication
(b) Closed com m unication
(c) Inform alcom m unication
(d) Form alcom m unication
9. W hatarethefactorsto beconsidered w hilechoosing an outsourcing partner?
(a) Q ualified w ith dem onstrated effectiveness
(b) A bility to w ork collaboratively.
(c) Clearly established perform anceguidelinesand m easures
(d) A lltheabove.

SEC TIO N -A :A N SW ER S
1 c 2 c 3 d 4 d 5 d 6 a
7 a 8 a 9 d

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M O D U LE-IV :BU SIN ESS STRA TEG IC PLA N N IN G

SEC TIO N -B :Q U ESTIO N S


1. D efineoutsourcing and briefly discussthetypesofoutsourcing arrangem ents.
O utsourcing can be defined as the strategic use of outside resources to perform
activities traditionally handled by internal staff and resources. O utsourcing is a
strategy by w hich an organisation contracts outm ajorfunctions to specialised and
efficientserviceproviders,w ho becom evalued businesspartners.
O utsourcing involvessubstantialrestructuring ofparticularbusinessactivitiesw hich
m ay include the transfer of staff from the host com pany to a specialist,usually
sm aller,com pany w ith therequired corecom petencies.
TypesofO utsourcing Arrangem ents
The current trend is to classify different kinds of outsourcing arrangem ent as
traditional,cooperativeand transform ationalorstrategic.
TraditionalorConventionalO utsourcing
Thisentailsusing a niche providerto provide a narrow scope ofservicesthrough a
contractualrelationship.M ostfrequently com paniesuse the provider sprocessesto
m inim izecosts.They usually do nottransferpeopleand assetsto theprovider.
CooperativeorCollaborativeO utsourcing
Collaborative outsourcing involves a cooperative, flexible relationship w ith the
outsourcing provideroffering a broaderscope ofservices.The firm and its partner
frequently definetheseservicesjointly.Thefirm m ay orm ay nottransferpeopleand
assetsto theprovider.
Transform ationalorStrategicO utsourcing
This high risk/high payoff outsourcing initiative involves a deep com m itm ent
betw een the firm and its outsourcing partner to radically transform the firm s
enterprise-level outcom es. The tw o com panies jointly define a broad range of
processesthey w illuseand m ay also sharein ajointventurethatm anagesassetsand
em ployeesthatboth contribute.
2. D iscusshow organizationscan benefitby outsourcing arrangem ents.
Therearem any reasonsw hy com paniesseek to outsourcetheirprocesses.Follow ing
are som e ofthe com petitive advantages thataccrue from a successfuloutsourcing
project.
Reduction in O perating Costs
Com panies thattry to do everything them selves often incurvastly higherresearch,
developm ent,m arketing and deploym entexpenses,allofw hich are passed on to the
finalcustom er.A n outsideprovider slow ercoststructure,w hich m ay betheresultof
a greater econom y of scale or other advantage based on specialization,reduces a
com pany soperating costsand increasesitscom petitiveadvantage.

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M O D U LE-IV :BU SIN ESS STRA TEG IC PLA N N IN G

Im provem entin Com panyFocus


O utsourcing lets a com pany focus on its core business by having operational
functions assum ed by an outside expert.Freed from devoting tim e and energy to
areasthatarenotin itsexpertise,thecom pany can focusitsresourceson m eeting its
custom ers needs.
G ain Accessto W orld classCapabilities
W orld classprovidersm akeextensiveinvestm entin technology,m ethodologies,and
people.They gain expertiseby w orking w ith m any clientsfacing sim ilarchallenges.
This com bination of specialization and expertise gives custom ers a com petitive
advantage and helps them avoid the cost of chasing technology and training.In
addition,there m ay be better career opportunities for personnelw ho m ove to the
outsourcing provider.
Freeinternalresourcesforotherpurposes
Every organization haslim itson theresourcesavailableto it.O utsourcing perm itsan
organization to redirectits resources,m ostoften people,from non-core activities
tow ards activities w hich serve the custom er.The organization can redirect these
people onto greater value adding activities.People w hose energies are currently
focussed internally can now befocused externally on thecustom er.
Required resourcesnotavailableinternally
Com panies outsource because they do not have access to the required resources
w ithin the com pany. O utsourcing is a viable alternative to building the needed
capability from the ground.N ew organizations,spin-offs,orcom panies expanding
into new geography ornew technology should considerthe benefits ofoutsourcing
from thevery start.
AccelerateReengineering Benefits
Reengineering aim s atdram atic im provem ents in criticalm easures ofperform ance
such ascost,quality,serviceand speed.Buttheneed to increaseefficiency can com e
into directconflictw ith the need to investin core business.A s non-core internal
functionsare continually puton the back burner,system sbecom e lessefficientand
less productive.By outsourcing non-core functions to a w orld-class provider,the
organization can begin to seethebenefitsofreengineering.
Functionsthataredifficultto m anage
O utsourcing isone option foraddressing thisproblem .Itiscriticalto rem em berthat
outsourcing doesnotm ean abdication ofm anagem entresponsibility nordoesitw ork
w ellas a knee jerk reaction by a com pany in trouble.W hen a function is view ed as
difficultto m anageoroutofcontrol,theorganization needsto exam inetheunderlying
causes. If the requirem ents, expectations or needed resources are not clearly
understood,then outsourcing w illnotim provethesituation;itm ay in factw orsen it.If

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M O D U LE-IV :BU SIN ESS STRA TEG IC PLA N N IN G

the organization does not understand its ow n requirem ents,it w ill not be able to
com m unicate them to an outside provider.H ow ever,ifthe organization understands
thereasonsthatm akeaparticularnon-corefunction difficultto m anage,then itm ay be
in aposition to evaluatew hetheroutsourcing m ay beabetteralternative.
M akecapitalfundsavailable
There is trem endous com petition w ithin m ost organizations for capital funds.
D eciding w here to investthese funds is one of the m ostim portantdecisions that
seniorm anagem entm akes.Itisoften hard to justify non-corecapitalinvestm entsw hen
areasm ore directly related to producing a productorproviding a service com pete for
the sam e m oney.O utsourcing can reduce the need to investcapitalfundsin non-core
business functions.Instead of acquiring the resources through capitalexpenditures,
they arecontracted foron an asused operationalexpensebasis.O utsourcing can also
im prove certain financialm easurem ents ofthe firm by elim inating the need to show
return on equity from capitalinvestm entsin non-coreareas.
ShareRisk
Trem endousrisksareassociated w ith theinvestm entsan organization m akes.M arkets,
com petition,governm entregulations,financialconditionsand technologiesallchange
extrem ely quickly.K eeping up w ith these changes,especially those in w hich the next
generation requiresasignificantinvestm ent,isvery risky.O utsourcing providersm ake
investm ents on behalfofm any clients,notjustone.Shared investm entspreads risk,
and significantly reducestherisk borneby asinglecom pany.
Cash Infusion
O utsourcing often involvesthe transferofassetsfrom the custom erto the provider.
Equipm ent,facilities,vehiclesand licensesused in thecurrentoperationshavevalue
and aresold to thevendor.Thevendorthen usestheseassetsto provideservicesback
to the client.D epending on the value ofthe assetsinvolved,thissale m ay resultin a
significantcash paym entto the custom er.W hen these assetsare sold to the vendor,
they are typically sold atbook value.The book value can be higherthan the m arket
value.In these cases,the difference betw een the tw o actually representsa loan from
thevendorto theclient,w hich m ay berepaid by thepriceoftheservicesoverthelife
ofthecontract.
3. Identify theareasin w hich outsourcing isfeasiblein insurancecom panies.
Traditionally,com panies have outsourced supportfunctions thatallow ed them to
concentrate their focus on activities that contribute to grow th. The scope of
outsourcing hasdram atically increased.Presently,thefollow ing classesofprocesses
arebeing outsourced:
Field-based Services
Services perform ed over a large geographicalarea,including loss prevention and
prem ium auditing.
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M O D U LE-IV :BU SIN ESS STRA TEG IC PLA N N IN G

FinancialRecoveries
Thisincludessubrogation and prem ium (and overdueprem ium )collection.
D ata M anagem entand Analysis
Insurance com paniesneed to have the ability to turn volum esofdata into actionable
inform ation.This data m ay pertain to theircustom ers,agents,claim s and policies,
and even com petitors.It is necessary for an insurance com pany to analyse their
custom er sneedsand tailorallthebusinessprocessesto effectively m eetcustom er s
requirem ents.H erebusinessintelligencetoolslikedataw arehousing and datam ining
can be of trem endous help. H ow ever, since these specialised skills m ay not be
availableto insurancecom panies,they often outsourceit.
4. D iscuss the m ethodology of outsourcing and also the factors influencing
successfuloutsourcing.
There are asm any m ethodologiesforoutsourcing asthere are consultants.A broad
m ethodology foran outsourcing agreem entw ould be:
D eterm inetheactivity to outsource.
Evaluatethefinancialim pactofoutsourcing.
A ssessthenon-financialcostsand advantagesofoutsourcing.
Choosean outsourcing partnerand contracttherelationship.
D eterm inewhatto outsource
O utsourcing initiativesm ustcom e from the top.U pperm anagem entm ustarticulate
the goals and objectives of the outsourcing initiative and com m unicate how the
process w ill benefit the organisation. In m ost cases, it is unw ise to outsource
som ething thatprovidesunique com petitive advantage.Thus,core com petenciesare
neveroutsourced.
Evaluatethefinancialim pactofoutsourcing
O utsourcing likely offerscostadvantagesifavendorcan realizeeconom iesofscale.
A com plete financialanalysisshould include the im pactofincreased flexibility and
productivity ordecreased tim eto m arket.
Assessthenon-financialcostsand advantages
O utsourcing m ay also bring expertise or innovation available only in a firm
specialized in itschosen field.Even ifan activity iskeptinhouse,the evaluation of
externalresourcesm ay im proveinternalperform ance.
Choosean outsourcing partner
Candidates should be qualified and selected according to both their dem onstrated
effectiveness and theirability to w ork collaboratively.The contractshould include
clearly established perform anceguidelinesand m easures.
The em phasisfrom the outsetshould notbe on w ho w insthe bestdeal,butratheron
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M O D U LE-IV :BU SIN ESS STRA TEG IC PLA N N IN G

negotiating a reasonable contractforboth parties.A seach aspectofthe outsourcing


relationship is governed by the contract,both the outsourcing com pany and the
supplierneed to reach com plete consensus.Both partiesneed to reach agreem enton
issueresolution.
FactorsInfluencing SuccessfulO utsourcing
(a) M anagem entSupport
Strategic objectives,such asoutsourcing initiatives,m ustcom e from the top echelons
of a com pany.Senior m anagem entm ustarticulate the goals and objectives of the
outsourcing initiativeand com m unicatehow theprocessw illbenefittheorganisation.
Today s m anagers are looking ahead and recognizing that the responsibility for
ensuring the successoftheirenterprise soutsourcing initiativesdoesnotstop w hen
the ink has dried on the contract. O ngoing m anagem ent of the relationship is
im portant.Seniorm anagem entm uststay involved during the im plem entation ofthe
contract.N otonly should there be a clearly defined escalation procedure,butsenior
m anagem entshould also m eetatappropriate intervals to discuss the outsourcing
relationship.M eetings should also be held atthe operationallevelto address the
w orkingsoftheoutsourcing contractin practice,to identify and resolveany problem s
thathavebeen encountered,and to agreeon changesto ensurecontinued satisfaction.
(b) ServiceLevelAgreem ents
Thekey docum entin outsourcing agreem entsistheServiceLevelA greem ent(SLA ).
Ithelps to m anage the strategic relationship betw een the outsourcing com pany and
the supplier and includes the identification of responsibilities, Successful
outsourcing relationships focus on results.To be m eaningful,these results m ustbe
objective,m easurable,quantifiable,and com parableagainstpre-established criteria.
(c) O pen Com m unication
W hatever m ay be the form of the outsourcing arrangem ent,m anaging change is
fundam entalto thesuccessoftheprogram m e.A ssessing stakeholderrequirem entsis
thefirstpartofthisprocess,and having open channelsofcom m unication during this
tim earevital.Everyoneconcerned should beinvolved in theprocess.
5. W hatare the likely developm ents in insurance industry in future in the back-
ground oftechnologicaladvancem ents?
W hile today the insurance industry s com m unications needs are principally served
via paper, tom orrow s com m unications w ould require additional distribution
m ethods such as CD RO M , em ail, and the Internet. H ere are just a few of the
applicationsthatthebusinesscom m unicationscom paniesshould support.
Policies
Traditionalpoliciesm ay be taken to the nextstep by consolidating inform ation into
attractive,easy-to-read form ats.Each policy should be unique and personalized to

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M O D U LE-IV :BU SIN ESS STRA TEG IC PLA N N IN G

theindividual,w ith theintegration ofcriticaldatain readablefriendly text,table,and


high im pactgraph (barand piechart)form ats.
Policyholdercom m unications
H ighly custom ized periodicinvoicesand statem ents,endorsem ents,and pending and
renew alnotices m ay be consolidated (integrating data from m ultiple inform ation
stream s into one docum ent)orcom bined (collating m ultiple docum ents going to a
single recipientinto one envelope) for optim alprocessing efficiencies and postal
savings.
Personalized bookletsand cards
Integrated docum ents thatare produced in a bookletform atand uniquely prepared
for each policyholder m ay contain program m e specifics, preprinted form s,
identification cards or even personalized locator inform ation for nearest service
providersw ithin aspecified radiusofthecustom er shom eaddress.
Cheques
U sing today shigh-speed M ICR printing technology,checkscan be custom ized and
printed on genericstock,elim inating thepreprinting,inventorying,and w arehousing
ofspecialstocks.
Reports
Policyholderdata can be com bined into concise reportskeyed to product,provider,
branch,and region orcorrespondentactivity.Printon dem and technology m akes it
possibleto turn thesereportsoutin days.
M arketing and correspondentm ailings
Flexibledocum entsform atshelp providersbettercom m unicatew ith theircustom ers,
including targeted m ailingsforup selling and crossselling.

IV-18
C hapter 3
ExchangeC ontroland Taxation

SEC TIO N -A :O BJEC TIV E TY PE Q U ESTIO N S

1. Follow ing institutions and/or regulations have dealt or deal w ith Foreign
Exchangem anagem entin India EX C EPT:
(a) ReserveBank ofIndia
(b) FERA ,1973
(c) IRD A
(d) FEM A ,1999
2. C urrently foreign insurerscan operatein India in oneofthefollow ing w ays:
(a) 26% directinvestm entorsetting up ofabranch office
(b) 26% directinvestm entand setting up abranch office
(c) 100% ow ned subsidiary
(d) N oneoftheabove
3. Insurance com panies registered w ith IR D A are perm itted to issue general
insurancepoliciesdenom inated in foreign currency only in caseofthefollow ing:
(i) M arine insurance for vessels ow ned by foreign shipping com panies and
chartered by Indian com panies
(ii) A viation insurance foraircraftsim ported from outside India on lease basisfor
thepurposeofairtaxioperations,etc.
(a) O nly i
(b) O nly ii
(c) Both i& ii
(d) N one
4. The incom e of a Life Insurance C om pany w ill not be com puted under the
______ heads,but w illbetaxed asa ________item .
(a) V arious Single
(b) Single V arious
(c) V arious D ouble
(d) D ouble V arious

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M O D U LE-IV :BU SIN ESS STRA TEG IC PLA N N IN G

5. The absence ofa policy duly stam ped does notaffectthe ___________ ofthe
contract, butan unstam ped policy cannotbeadm itted as___________.
(a) validity .evidence
(b) evidence .proof
(c) eitheroftheabove
(d) noneoftheabove

SEC TIO N -A :A N SW ER S
1. c 2. a 3. c 4. a 5. a

SEC TIO N -B :Q U ESTIO N S

1. Briefly discusstheregulatory aspectsofForeign D irectInvestm entin insurance


sectorin India and also thew aysin w hich itisallow ed.
The Exchange Control D epartm ent w ithin the Reserve Bank of India (RBI) is
responsible forthe regulation and enforcem entofexchange controls.Before 1999,
India had stringent exchange control regulations under the Foreign Exchange
Regulation A ct,1973 ( FERA ).The Foreign D irectInvestm ent(FD I) regim e in
India has been progressively liberalized in the nineties w ith the passage of the
Foreign Exchange M anagem entA ct,1999 (FEM A ),w hich replaced FERA .M ost
restrictionson foreign investm enthave been rem oved and the procedureshave been
sim plified.N on-residents can investdirectly in India,either w holly or as a joint
venture.Foreign investm entisallow ed in virtually allsectorsincluding the services
sector,subjectto governm entperm ission in certain cases.
D irectInvestm ent
The aggregate equity participation ofa foreign com pany (eitherby itselforthrough
itssubsidiary com paniesoritsnom inees)in an insurancecom pany cannotnotexceed
26 percentofthe paid up capitalofthe insurance com pany.The Insurance A ctand
the regulations there underprovide forthe m annerofcom putation ofsuch 26 per
cent.FD I is perm itted in India either under the autom atic route ,or w ith prior
governm entapproval.Ifthe investm entisnoteligible forthe autom atic route ,the
investorsw ould have to getapprovalfrom the Foreign Investm entProm otion Board
(FIPB). Indian com panies are generally perm itted to accept FD I w ithout prior
approval,subjectto certain sectoralpoliciesand investm entlim its.
Setting up ofa Branch office
Ifa foreign insurance com pany is notinterested in directly investing in an Indian
insurance com pany,ithas the option ofsetting up a branch office,afterobtaining
perm ission from the RBIand/orthe G overnm entofIndia.The liaison office w illbe
perm itted to carry on lim ited set of functions, like carrying out of research,
representing theparentcom pany,etc.
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M O D U LE-IV :BU SIN ESS STRA TEG IC PLA N N IN G

2. D iscuss the regulations regarding issue of insurance policies and claim


settlem entin foreign currency in India.
PoliciesD enom inated in Foreign Currency
Insurance com paniesthatare registered w ith the IRD A ,are perm itted to issue general
insurance policiesdenom inated in foreign currency and are also perm itted to receive
prem ium sin foreign currency w ithoutthe priorapprovalofthe RBI.H ow ever,thisis
perm itted only forcertain kindsofcasessuch asm arineinsuranceforvesselsow ned by
foreign shipping com paniesand chartered by Indian com panies,aviation insurancefor
aircrafts im ported from outside India on lease/hire basis for the purpose of air taxi
operations,etc.
Claim sin Foreign Currency
A uthorised dealersare also perm itted to settle claim sin foreign currency on general
insurancepoliciessubjectto certain conditionssuch asiftheclaim hasbeen m adefor
the loss occurred during the policy period,ifthe claim has been settled as perthe
surveyors report and other substantiating docum ents, claim s on account of
reinsurance are being lodged w ith the reinsurers and w illbe received as per the
reinsurance agreem ent,the rem ittance isbeing m ade to the non-residentbeneficiary
underthepolicy,etc.
H ow ever,in the case ofresidentbeneficiaries,the claim isrequired to be settled in
rupee equivalent of the foreign currency due and under no circum stances can
paym entbem adein foreign currency to aresidentbeneficiary.
Policyissued byan insureroutsideIndia
A spertheprovisionsoftheForeign ExchangeM anagem ent(Insurance)Regulations,
2000,no person residentin India is perm itted to take any generalorlife insurance
policy issued by an insurer outside India. H ow ever, the RBI m ay perm it, for
sufficientreasons,a residentin India to take any life insurance policy issued by an
insurer outside India.Further,an exem ption has been m ade for units located in
SpecialEconom ic Zones(SEZs)forgeneralinsurance policiestaken by such units.
Therefore,rem ittancestow ardsprem ium forgeneralinsurance policiestaken outby
units located in SEZs from insurers outside India are perm itted provided thatthe
prem ium sarepaid outoftheforeign exchangebalances.
A person resident in India but not perm anently resident therein is perm itted to
continueholding any insurancepolicy issued to him by an insureroutsideIndia,ifthe
prem ium on such policy ispaid outofforeign currency resourcesoutsideIndia. N ot
perm anently resident m eans a person resident in India for em ploym ent of a
specified duration (irrespective of the length thereof) or for a specific job or
assignm ent,theduration ofw hich doesnotexceed threeyears.
A person residentin India m ay take a generalinsurance policy issued by an insurer
outside India,provided that,before taking the policy he hasobtained a no objection
certificate from the CentralG overnm entofIndia.Further,a person residentin India
IV-21
M O D U LE-IV :BU SIN ESS STRA TEG IC PLA N N IN G

isalso perm itted to continueto hold any insurancepolicy issued by an insureroutside


India w hen such person w as residentoutside India,subjectto fulfilm entofcertain
conditions.
3. D iscusstaxation ofinsurance com paniesand also how itisdifferentfrom other
sectors.
Taxation ofInsuranceCom panies
Section 44 ofthe Incom e tax A ct,1961 (IT A ct)read w ith FirstSchedule ofthe IT
A ctdealsw ith taxation oflife insurance,w hich laysdow n the m ethod ofcom puting
theprofitsofthefollow ing kindsofinsurers:
Personsw ho areresidentin Indiaand carrying on lifeinsurancebusiness;
Personsw ho areresidentin Indiaand carrying on business
N on-residentpersons carrying on the insurance business in India through a
branch office.
ResidentsCarrying on LifeInsuranceBusiness
The m ethod ofcalculating the profitsofan insurance businessisunlike thatofany
otherbusiness.Thusthe profitsoflife insurance business,istaken to be the annual
average ofthe surplus.This surplus is arrived atby adjusting the surplus ordeficit
disclosed by theactuarialvaluation m adein respectofthelastinter-valuation period
ending before the com m encem entofthe assessm entyear.The m ethod ofcarrying
out the actuarial valuations is as specified in the Insurance A ct, 1938. These
provisions override the operation of other sections of the Incom e Tax A ct and
introducean indirectm ethod ofcom puting.Theincom eofalifeinsurancecom pany
w illnotbecom puted underthevariousheads,butw illbetaxed asasingleitem .
O ne contentious issue thatdeserves m ention is thatthe life insurance industry is
currently taxed on the valuation surplus thatem erges during the m ostrecentinter-
valuation period,and theinvestm entprofiton shareholders funds.A llothertypesof
com pany are taxed on share holders profits.The em erging valuation surplus is
distributed as bonuses to policyholders and profits to shareholders. Taxing the
em erging valuation surplus im poses tax on both shareholders and policyholders.
W hilstitiscorrectto tax thatpartofthesurplusthatrepresentsshareholders profits,
itcan be argued thatitis notreasonable to tax policyholders on the fullvalue of
bonusesdistributed to them ,sinceam ajorsourceofthesebonusesaretheprem ium s
paid by thepolicyholdersthem selves.Thenew entrantsto thelifeinsurancebusiness
are recom m ending thatem erging valuation surplus should be taxed only w hen itis
transferred ordistributed.
ResidentsCarrying on AnyO therKind ofInsuranceBusiness
The profits and loss of a person carrying on the business of insurance are to be
com puted separately from the profitsand gainsfrom any otherbusiness.The profits
and gains ofthe business ofinsurance,otherthan life insurance,is taken to be the

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M O D U LE-IV :BU SIN ESS STRA TEG IC PLA N N IN G

profits as disclosed in the annualaccounts as com puted under the Insurance A ct.
Though the profitsoflife insurance businessare to be com puted separately from the
profits ofnon-life insurance business orotherbusiness carried on by the assessee,
any lossincurred in life insurance businesscan be setoffagainstprofitsofnon-life
insurancebusinessorotherbusiness.
Non-ResidentInsurers
TheIncom eTax A ctlaysdow n provisionsw ith respectto theincom ereceived by an
assessee from the businessofinsurance,w hetherthe com pany w hich receivessuch
businessincom eisresidentin Indiaornot.In theabsenceofreliabledata,theprofits
and gainsofanon-residentinsureristaken to bethatproportion ofthew orld incom e
w hich correspondsto the proportion w hich the prem ium incom e derived from India
bearsto thetotalprem ium .
4. D iscuss how the provisions of the Indian Stam p A ct,1899 are applicable to
insurancecontracts.
Stam p D uty
W hen a contract of insurance is effected, it is necessary to get it stam ped in
accordance w ith the stam p duty prescribed foreach kind ofpolicy underthe Indian
Stam p A ct,1899 (Stam p A ct).The ratesofstam p duty on insurance policiesare the
sam e throughoutIndia.The absence of a policy duly stam ped does notaffectthe
validity ofthecontract,butan unstam ped policy cannotbeadm itted asevidence.
The insurance policy is an actionable claim and is therefore treated as im m ovable
property.TheprovisionsoftheStam p A ctapplicableto im m ovableproperty arealso
applicable to insurance policies. A n assignm ent executed on the reverse of an
insurance policy isnotrequired to be stam ped.H ow ever,an assignm entm ade on a
separate piece of paper does require stam ping.Issuing a policy that is not duly
stam ped is a punishable offence w ith a fine w hich m ay extend up to Rs. 200.
G enerally,the stam p duty on a life insurance policy orgroup insurance isborne by
theperson effecting theinsurance.In thecaseofafireinsurancepolicy,theinsureris
liableto bearthestam p duty.

IV-23
C hapter 4
System D evelopm entProcess
SEC TIO N -A :O BJEC TIV E TY PE Q U ESTIO N S

1. __________________________ refers to the structuring of hardw are and


softw areto achievetheeffectiveand efficientprocessing ofinform ation.
(a) System Integration
(b) System D evelopm ent
(c) System Im plem entation
(d) System O bjective
2. Im plicitin theSD LC processarethefollow ing system sdevelopm entobjectives:
(i) the system being developed m ustsatisfy an organisations inform ationaland
operationalneeds
(ii) thesystem developm entprocessm ustbeefficientand effective
(a)O nly i
(b)O nly ii
(c)Both i& ii
(d)N one
3. Som eofthem ostcom m on reasonsforsystem failuredo notinclude:
(a) Lack ofseniorm anagem entparticipation
(b) A cceptanceofchange
(c) N ew technologies
(d) Lack ofuserparticipation
4. Thequalitiesofa successfulsystem do notinclude:
(a) itshould producecorrectand tim ely inform ation
(b) itneed notbedeveloped w ithin areasonableam ountoftim e
(c) thesystem should m eettheorganisation sneedsforinform ation
(d) usersshould besatisfied w ith it.
5. TheresponsibilitiesoftheInform ation System Steering C om m itteeD O ES N O T
include:
(a) Review and approve for further study all projects requested by operating
departm entsortheIS departm ent.
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M O D U LE-IV :BU SIN ESS STRA TEG IC PLA N N IN G

(b) Review and approve the IS departm ents w ork program m e and determ ine
prioritiesforprojects.
(c) Review periodicprogressreportson activesystem sprojects.
(d) Review and rejectproposed plansforsystem im plem entation.
6. The various w ays in w hich different accountants can becom e involved in the
system developm entprocessareasfollow s:
(i) System specialist
(ii) Consultant
(iii) Staffaccountant
(iv) Internalauditor
(v) Independentauditor
(a) i,ii,iiionly
(b) ii,iii,iv only
(c) iii,iv,v only
(d) alloftheabove
7. C om ponentsoftheSystem D evelopm entLifeC ycleincludes:
(a) System planning
(b) System analysis& System D esign
(c) System im plem entation
(d) A lloftheabove
8. C A SE toolsstand for
(a) Com puterA ided Softw areEngineering
(b) Com puterA nd Softw areEngineering
(c) Com puterA ided System Engineering
(d) N oneoftheabove
9. _______________ isan iterative processthatavoidsthe structure and periodic
form al approval process of the traditional approaches. It relies on the
developm entofa w orking m odelofthenew system .
(a) Prototyping
(b) Photo typing
(c) X ero typing
(d) N oneoftheabove
10. O bjectoriented developm entisa m ethod for creating system sthatthink ofthe
w orld as a set of ________________ that are related to one another and that
com m unicatew ith oneanother.
(a) classes
(b) objects
IV-25
M O D U LE-IV :BU SIN ESS STRA TEG IC PLA N N IN G

(c) fam ilies


(d) noneoftheabove

SEC TIO N -A :A N SW ER S
1 b 2 c 3 b 4 b 5 d 6 d
7 d 8 a 9 a 10 b

SEC TIO N -B :Q U ESTIO N S


1. W hatistheobjectiveofSystem D evelopm ent?
U nlikesystem sthatoccurnaturally,inform ation system sm ustbecreated.Im plicitin
the System D evelopm entLifeCycleprocessarethefollow ing system sdevelopm ent
objectives:
1. The system being developed m ustsatisfy an organization s inform ationaland
operationalneeds.
2. Thesystem developm entprocessm ustbeefficientand effective.
2. Statethereasonsforthesystem sfailure.
Som eofthem ostcom m on reasonsforsystem sfailureare:
Lack of senior m anagem ent com m itm ent and involvem ent in system s
developm ent:D evelopersand usersofinform ation system stake theircue from
senior m anagem ent to determ ine w hich system s developm ent projects are
im portant. M anagem ent also has the responsibility to ensure that adequate
resources, as w ell as budgetary control over use of those resources, are
dedicated to theproject,com m ensuratew ith strategicobjectives.
Changing user needs: U ser requirem ents for inform ation technology are
constantly shifting. H ow ever, w hen users request a change during the
developm entprocess,the developm entteam m ay be faced w ith the difficult
challenge ofdeveloping system sw hose very purposeshave changed since the
developm entprocess began.M ostusers do notrealise thatw hen a change is
requested for,late in the developm entprocess,the entire process has to be
started afresh.
D evelopm ent of strategic system s: Strategic decision m aking is highly
unstructured and the requirem ents, specifications, and objectives for such
developm ent projects are difficult to define in advance. Thus determ ining
w hethertheprojectw as successful isitselfelusive.
N ew technologies:W hen an organization triesto gain a com petitive advantage
by using the latest inform ation technology,it generally finds that attaining
system s developm ent objectives is far m ore difficult because developm ent
personnelarenotfam iliarw ith thetechnology.
Lack of standard project m anagem ent and system s developm ent
m ethodologies:M any organizationsdo notform alizetheirprojectm anagem ent
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M O D U LE-IV :BU SIN ESS STRA TEG IC PLA N N IN G

and system sdevelopm entm ethodologies.Thism akesitdifficultto consistently


com pleteprojectson tim eorw ithin budget.
O verw orked orundertrained developm entstaff:In largeorganisations,thereis
usually abacklog ofsystem sdevelopm entw ork facing developm entstaff.Thus
the developersfind them selvesoverw orked.A lso there isa shortage ofskilled
and trained staff.Further,m any com panies pay little attention to training the
developm ent personnel and help them stay technically current. These
organizationsdo nothaveacom prehensivetraining plan;nordo they budgetfor
such activities.
Resistance to change: People have a natural tendency to resist change, and
inform ation system sdevelopm entprojectssignalchanges often radical in the
w orkplace.A Business process reengineering exercise is often the catalystfor
m ajor system s developm entproject.W hen personnelperceive thatthe project
w illresultin personnelcutbacks,threatened personnelw illdig in theirheels,and
thedevelopm entprojectisoften acasualty.Personnelcutbacksoften resultw hen
reengineering projectsarereally attem pting at dow nsizing or rightsizing .
Lack ofuserparticipation:U sersm ustparticipate in the developm enteffortto
define their requirem ents, feel ow nership for project success, and w ork to
resolve developm ent problem s. U ser participation also helps reduce user
resistanceto change.
Inadequate testing and user training: N ew system s m ust be tested before
installation to determ ine thatthey w illoperate correctly.U sersm ustbe trained
to effectively utilizethenew system ,in orderto utiliseitsfullpotential.
To overcom e these and other problem s,organizations m ust execute the system s
developm entprocessefficiently and effectively.
3. A system is successful if it achieves four goals or qualities. Identify and
discussthefourgoalsin detail.
TheQ ualitiesofa SuccessfulSystem
N o inform ation system is com pletely successful or totally unsuccessful. In this
context,successisarelativequality:A system issuccessfulifitachievesm ostofthe
goalssetoutforit.In general,an inform ation system issuccessfulifitachievesfour
goalsorqualities.
(i) itshould producecorrectand tim ely inform ation.
(ii) itshould bedeveloped w ithin areasonableam ountoftim e.
(iii) thesystem should m eettheorganization sneedsforinform ation.
(iv) usersshould besatisfied w ith it.

Correctand Tim elyInform ation


In an inform ation system , errors and fraud are the tw o sources of incorrect
inform ation.Forexam ple,the double entry system prevents ordetects m any ofthe

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errors thathum ans can m ake in m anually processing accounting data.Because of


this,doubleentry system sareim plem ented on com puterseven though com putersare
lesslikely to m ake these kindsoferrors.The use ofcom puters,how ever,createsthe
possibility of other errors and m akes it easier for a dishonest person to use the
inform ation system to concealfraud.
A successfulsystem has internalcontrols thatpreventand detecterrors and fraud.
A ccountants and auditors frequently participate in system developm entprocesses
because they,m ore than m ostother professionals w ho w ork w ith com puters,are
know ledgeable about internal control.A dequate internal control is necessary for
im plem enting asuccessfulinform ation system .
Inform ation is considered tim ely if it is available to its user w hen needed for
decision m aking.Forexam ple,suppose inventory issues and additions are posted
only on Fridays.A custom erasksasalesperson abouttheavailability ofaparticular
producton W ednesday.The salesperson can tellthe custom erthatgoods w ere in
stock on the previousFriday butcannotsay thatthe goodsare available w hen the
custom erw ants them .Such a system provides inform ation thatis untim ely.M ore
m odern processing m ethods avoid this shortcom ing. A dopting a transaction
processing m ethod that m eets the needs of the system user can provide tim ely
inform ation.
Tim eRequired forSystem D evelopm ent
A notherquality ofasuccessfulsystem isthatitsdevelopm entshould becom pleted in
areasonableperiod oftim e.M any largeorcriticalinform ation system srequirethree
orm oreyearsto com plete.Excessivetim efordevelopm entresultsin excessivecosts
thatm ay causethesystem scoststo exceed itsbenefits.
W hatcan be done to avoid thiskind ofsystem failure? First,system designerslearn
to lim itthescopeofany new system to sizethatcan bedeveloped w ithin areasonable
tim e.In the term inology ofsystem stheory,they define the boundariesofthe system
and lim it their efforts to those com ponents w ithin the boundaries. Even though
proceduresoutsidetheboundariesm ay need changing,theseneedsareaddressed ata
laterdate.Forexam ple,accountantsseldom attem ptto change an entire transaction
cycle.Instead,they identify the application system w ithin the cycle thatm ostneeds
to be im proved.Then they com plete a new version ofthatapplication system before
proceeding to anothersystem w ithin thecycle.
Second,system design team s learn to use projectm anagem enttechniques such as
budgets,G anttcharts,and PERT (Program Evaluation and Review Technique) or
CPM (CriticalPath M ethod) diagram s.These m ethods require thatthe designers
identify in advanceallactivitiesrequired by thedevelopm enteffortand theestim ated
tim es and costs for each activity.D esigners can m onitor actualelapsed tim e and
costs,com paring them to those expected.Then they can change eitherthe scope of
thesystem ortheresourcesassigned to theeffortbeforean excessiveam ountoftim e
elapses.
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SatisfytheO rganization sNeeds


A third quality ofa successfulsystem isthatitm eetsthe needsofthe organization
im plem enting it.Thesystem should provideinform ation thatisboth m eaningfuland
relevantto itsusers.Because developing inform ation system scan be expensive and
tim econsum ing,they should beusefulform any years.Thus,any new system should
satisfy notonly the currentneedsofthe com pany butalso anticipated future needs.
A n appropriate system design satisfies the organization s currentneeds;adequate
system planning helpsto identify futureneeds.
M ostorganizations have m anagem entcom m ittees thatprovide shortand m edium
range planning for new inform ation system s. Frequently called the Inform ation
System sSteering Com m ittee(ISSC),thisgroup considersand approvesnew system s
on aprojectby projectbasis.W hen approving thefinaldesign foranew system ,they
try to ensurethatcurrentinform ation needsw illbem et.
Toproducesuccessfulsystem s,organizationsshouldalsoengageinlongrangesystem s
planning.Thistype ofplanning exam inesinform ation requirem entsata broaderlevel
than a projectby projectanalysis allow s.Itm ay be accom plished by m em bers ofa
CorporateLong RangePlanning Staff orby a StrategicPlanning G roup w ithin an
IS (Inform ation System s) departm ent. This long range system s planning group
identifieslong rangeinform ation resourcerequirem entsand developsasystem m aster
plan (often called theStrategicInform ation Technology Plan )fornew system s.The
m asterplan is based on overallcorporate goals,on proposed new products,on new
m arketsthefirm w illenter,and on futurecriticaltasksw ithin thefirm soperations.
W hetherasystem isintended foratransaction processing application orforaiding in
m anagem ent decisions at a less structured level, adequate system planning is
necessary ifitisto beconsidered asuccess.
U serSatisfaction with theSystem
A system isusually considered to besuccessfulifitsusersaresatisfied.In fact,m any
system sprofessionalsconsiderusersatisfaction asthestrongestindicatorofsuccess.
The userm ay be a clerk inputting data into a com ponentofa transaction processing
system . H e or she m ay be an operating m anager review ing reports from a
responsibility accounting or budgeting system . In either case, user satisfaction
indicates thatthe system provides inform ation thatis correctand tim ely enough to
satisfy theuser sneeds.
Frequently,designers ofa new system conductan evaluation ofitm onths afterit
starts operation. M ajor objectives of this post im plem entation review are to
determ ineifintended usersarerelying on thesystem and to find outw hetherthey are
happy w ith its operations and out-puts.By using surveys and interview s,they can
determ ineifusersaresatisfied w ith thesystem .
G aining U serAcceptance
A system can betechnically sound,designed to beconsistentw ith theorganization s
needs,and producecorrectand tim ely inform ation.Y etem ployeesm ay preferto use
an oldersystem ,am anualsystem oran inform alone.
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U sersm ay resistanew system forseveralreasons.Som etim espersonnelm ay feelan


econom ic threatdue to the fearoflosing a job.In othercases,the threatissim ply to
the user sego orstatus.Forexam ple,in the pastm any m anagersw ere unw illing to
use com puterterm inals.U sing the keyboard requires typing,w hich,they believed,
w as a secretarialtask.Som etim es a new system changes an em ployee s job in an
undesirablew ay.Thejob m ay haveadded com plexity orbecom em orerigid dueto a
tim e schedule established forthe new system .O ccasionally a person m ay feelm ore
insecure because of the form ality introduced by using com puter-generated reports
ratherthan those hum ansproduce.Som e people sim ply oppose any change in their
w ork routines.
System designershave learned to anticipate these problem sand to take stepsduring
system developm entto gain users acceptance ofthe new system .The rightkind of
userinvolvem entin thedevelopm entprocessencouragesuseracceptance.
U serInputin Setting Policies
The Inform ation System s Steering Com m ittee should involve users.The steering
com m itteeshould haverepresentativesfrom top m anagem entand from allthem ajor
inform ation system s user departm ents: accounting, m arketing, production,
engineering,internalaudit,and others.Each representative should be a high ranking
m anagerw ithin adepartm entand m ay bethehead ofthedepartm ent.Them anagerin
charge of the IS (Inform ation System s) function (now adays called the chief
inform ation officerorCIO )should also serve on thiscom m ittee.Large corporations
m ay have severalsuch com m ittees one atthe top m anagem entlevelcom posed of
divisionalvice presidents,and others w ithin the com pany s operating divisions or
subsidiaries.
The steering com m ittee provides user inputinto the selection of new system s for
developm ent.Justasim portant,thecom m itteeestablishesprioritiesforthosesystem
projects thatare approved.Every m anagerthinks thathis orherpetprojectis the
m ostim portantone! O n the steering com m ittee,a m anager has to convince other
m anagersoftheim portanceoftheproject.
U serSupportforProjects
System designersm ustenlistusers supportfordevelopm entprojectsin progress.A ll
m anagersand supervisorsshould besold on theprojectsvalueto theirdepartm ents.
If the superiors openly support a new system , subordinates w ill have difficulty
resisting it after im plem entation.In developing a successful inform ation system ,
salesability and good interpersonalskillsareasim portantastechnicalskills.
ActiveU serParticipation in Projects
U sersnotonly should besold on thevalueofanew system projectbutshould also be
activeparticipantsin thedesign process.
A m ultidisciplinary projectteam handlesm ostprojects.M em bersofthe team com e

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from varied backgrounds,and each contributes unique skills to the design process.
A ccountants usually participate in the design of an accounting system ,and so do
personnelfrom the affected operating departm ents.Forexam ple,the design ofan
orderentry system requiressom eone from salesorm arketing.The design ofa cost
accounting system requires inputfrom production.Frequently these personnelare
tem porarily relieved oftheirnorm aldutiesand assigned full-tim eto theproject.A ny
projectteam also has people from the IS departm entw ho are experienced in the
design and developm ent process. These include system s analysts, program m ers,
docum entation specialists,and technicalconsultants.
4. D iscussthe role and responsibility ofInform ation System sSteering C om m ittee
in system developm ent.
Theauthority forapprovalofprojectisusually vested w ith an IS steering com m ittee
to ensurethat:
Existing IT resourcesareused efficiently and effectively.
O rganizationalobjectivesareachieved.
System s developm entresources are allocated consistently across allbusiness
functions.
TheresponsibilitiesoftheISSC include:
1. Review and approve for further study all projects requested by operating
departm entsortheIS departm ent.
2. Review and approve the IS departm ents w ork program m e and determ ine
prioritiesforprojects.
3. Review periodicprogressreportson activesystem sprojects.
4. Review and approveproposed plansforsystem im plem entation.
5. Review periodically theIS departm entsbudget.
The projectteam should provide userinputto the developm entprocessthroughout.
U serrepresentativesshould beinvolved notonly in developing specificationsforthe
system butalso in coordinating the project,in perform ing costbenefitanalyses,and
in planning thefinalim plem entation ofanew system .
5. C om bining the know ledge ofIT,business,accounting,auditing and internal
controlw illensurethatthenew system m eetstheneedsoftheuserand possesses
adequate internalcontrols. D iscuss how this is achieved and w ho can play a
uniquely qualified rolein thisprocess.
M ost accountants play a uniquely qualified role in the process of system s
developm entbecausethey:
M ay beam ong thefew peoplein an organization w ho can com bineknow ledge
of IT,business,accounting,and internal control,as w ell as behaviour and
com m unications,to ensure thatnew system s m eetthe needs of the user and
possessadequateinternalcontrols.

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H ave specialized skills such asaccounting and auditing thatcan be applied


to the developm ent project.For exam ple,an accountant m ight perform the
analysisofaproposed system scostsand benefits.
A s internal, inform ation technology (IT), and independent auditors, accountants
provideaunique and independent perspectivew ith w hich to evaluatethesystem s
developm entprocess and the system s being developed.O ne study suggested that
system auditors should help projectsponsors periodically evaluate a project from
an outsider s perspective to assess w hether the sponsor has becom e overly
com m itted to the project.This study also suggested thatthe system auditorshould
help institutionalize a projectearly w arning system to assess the risks thatprojects
can be technologically successfuland acceptable to users/custom ers.A notherstudy
found thatauditorparticipation in thesystem sdevelopm entprocessreduced softw are
m aintenance,an indicatorofthequality ofthedevelopm entprocess.
The variousw aysin w hich differentaccountantscan becom e involved in the system
developm entprocessareasfollow s.
System s Specialist: A s an em ployee of the organization possessing som e
system sspecially,such assystem sanalystthe accountantundertakesm any of
theactivitiesin asystem sdevelopm entproject.
C onsultant: H ired from outside the organization possibly from the
m anagem entconsulting division of a public accounting firm ,the accountant
m ay undertakem any oftheactivitiesin asystem sdevelopm entproject.
Staff A ccountant: A s an em ployee of the organization,an accountant can
becom e involved in system sdevelopm entasthe userofthe system and asthe
requestor of the system changes. The accountant m ight also join the
developm entteam .
Internal A uditor: Internal and system auditors review system s and m ake
recom m endationsthatlead to system changes.A lso,they review developm ent
projects to ensure thatsystem s are developed efficiently and effectively and
thatthe system sbeing developed w illhave sufficientinternalcontrolsand w ill
beauditable.
IndependentA uditor :A n independentauditorm ustreview the system sthat
producefinancialstatem ents;iftheauditorfindsinefficientsystem s,henotifies
m anagem ent in the m anagem ent letter; if he finds inadequate controls, he
notifies m anagem ent and m ay alter the audit. The m anagem ent letter
recom m endationsm ay lead to theinitiation ofsystem sdevelopm ent.
6. W hatisSD LC and thevariouscom ponentsofit?
Inform ation system s contribute to m anagem entdecisions atthe strategic planning,
m anagem entcontrol,and operationallevels.A s organizations change,m anagers at
all levels face new decisions and acquire new needs for inform ation. Thus,
inform ation system s m ustchange to m eetthese new needs.The evolution ofm ost
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accounting system s follow s a distinct cyclical pattern com m only called the
System D evelopm entLifeCycle(SD LC).
The System D evelopm ent Life Cycle describes how an inform ation system
progressesfrom itsconception asan idea,through thedevelopm entprocess,and into
routine operation.Typically,the cycle begins as a m anagerrecognizes a need that
existing inform ation system sdo notsatisfy.Thism anagerm ay proposeasolution or
m ay w anta problem studied by som eone else w ho can suggestpossible solutions.
M anagem entappointsastudy team to apply thesystem study processto theproblem .
The study team m ay increase in size and m ay im plem enta new inform ation system
asasolution to theproblem .Thissolution m ay beused form any yearsbeforeanother
m anagerrecognizessom eotherneed forinform ation thatthesystem doesnotsatisfy.
Then thecyclebeginsagain.
C om ponentsoftheSD LC
SD LC com ponentsinclude
System splanning,
System sanalysis,
System sdesign,
System sim plem entation,and
System soperation.
Three of the com ponents analysis, design, and im plem entation com pose the
system developm entprocessand m ay require a few m onthsto a few years.The fifth
com ponent,operation,m ay lastfordecades.Forexam ple,onem ajoroilcom pany has
used the sam e payrollsystem forover30 years.D eveloped in the m id 1970s,this
system required approxim ately tw o yearsto develop.
7. W hatisa system sdevelopm entm ethodology? D escribeitscharacteristics.
A system sdevelopm entm ethodology (also know n assystem sdevelopm entlifecycle
[SD LC] m ethodology) is a form alized,standardized,docum ented setof activities
used to m anage a system s developm ent project. It should be used w henever
inform ation system s are developed,acquired,or m aintained.The m ethodology is
characterized by thefollow ing:
Theprojectisdivided into anum berofidentifiableprocesses,and each process
has a starting point and an ending point. Each process com prises several
activities,one or m ore deliverables,and severalm anagem entcontrolpoints.
The division ofthe projectinto these sm all,m anageable steps facilitates both
projectplanning and projectcontrol.
Specific reports and other docum entation, called deliverables, m ust be
produced periodically during system s developm ent to m ake developm ent
personnelaccountable forfaithfulexecution ofsystem sdevelopm enttasks.A n
organization m onitors the developm entprocess by review ing the deliverables
thatare prepared atthe end ofeach key step.M any organizationsrely on this
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docum entation for training new em ployees; it also provides users w ith a
referencew hilethey areoperating thesystem .
U sers,m anagers,and auditorsare required to participate in the project.These
people generally provide approvals,often called signoffs,atpre-established
m anagem ent control points. Signoffs signify approval of the developm ent
processand thesystem being developed.
The system m ustbe tested thoroughly priorto im plem entation to ensure thatit
m eetsusers needs.
A training plan isdeveloped forthosew ho w illoperateand usethenew system
Form alprogram m e change controls are established to preclude unauthorized
changes to com puter program m es.Lack of controlover program m e changes
jeopardizes the security of the entire system . Program m e change controls
provideassurancethatallm odificationsto program m esStructured System sare
authorised, and ensure that changes are com pleted, tested and properly
im plem ented. Changes in program m e should be also be reflected in the
docum entation.
A postim plem entation review ofalldeveloped system sm ustbe perform ed to
assess the effectiveness and efficiency of the new system and of the
developm entprocess.
A n organization ssystem sdevelopm entm ethodology isusually docum ented in
theform ofasystem sdevelopm entstandardsm anual.A m ong otheritem s,such
m anualsoften indicate:
M ethodsofrequesting system sdevelopm ent.
Procedures to be follow ed,techniques to be used,and docum entation to be
prepared during system sdevelopm ent.
Review sto beperform ed and signoffsto beobtained.
Theseproceduresensurethatdevelopm enteffortsareefficientand consistently
lead to inform ation system sthatm eetorganization needs.

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C hapter 5
System A nalysis

SEC TIO N -A :O BJEC TIV E TY PE Q U ESTIO N S

1. System analysism ay begin forthefollow ing ____ reasons.


(i) to solveaproblem w ith an existing system
(ii) to satisfy anew requirem entforinform ation
(iii) to im plem entanew form oftechnology
(a) ionly
(b) iionly
(c) iiionly
(d) alltheabove
2. W hich ofthe follow ing isthe rightcom bination ofallobjectivesofprelim inary
survey?
(i) to acquirean understanding ofan existing application system
(ii) to develop good relationship w ith usersofthesystem
(iii) to collectdatathatispotentially usefulin system design
(iv) to analysethedifferencesw ith com petitor ssystem s
(v) to identify thenatureoftheproblem being investigated
(a) i,ii,iii,v
(b) ii,iii,iv
(c) i,iii,v
(d) ii,iii,iv,v
3. In conducting the survey, the system study team determ ines the follow ing
inform ation abouttheexisting system :
(i) D ataflow
(ii) Efficiency
(iii) Effectiveness
(iv) Internalcontrols
(a) O nly i
(b) O nly iii
(c) O nly iii
(d) A lloftheabove
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4. V arious system tools used during prelim inary survey include w hich of the
follow ing:
(i) D ocum entation review
(ii) U sing interview s
(iii) D atam odeling
(iv) W ork m easurem ent
(v) Procedurem odeling
(vi) A uditreports
(a) i,ii,iii,iv
(b) i,ii,iii,iv,vi
(c) ii,iii,iv,v,vi
(d) iii,iv,v,vi,
(e) i,iii,iv,v,vi
5.-8.In a data flow diagram ,m atch thefollow ing correctcom binations:
(W ritethecorrectalphabetin the[]box)
(i)Circles [] (a)Externaldestinationsfordata
(ii)Squares [] (b)Processes
(iii)Rectangles [ ] (c)D ataflow
(iv)A rrow s [] (d)D atastore
9. Processm odeling isused forw hich ofthefollow ing purposes?
(a) Sum m arising
(b) D ocum enting
(c) A nalysing
(d) A lloftheabove
10. Feasibility study includesw hich ofthefollow ing?
(i) TechnicalFeasibility
(ii) O perating Feasibility
(iii) Tim e Feasibility
(iv) Econom ic Feasibility
(a) i,iionly
(b) ii,iiionly
(c) iii,iv only
(d) alloftheabove
11. Follow ing could betheoutcom eofsystem analysis:
(a) D o nothing
(b) M odify existing system
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(c) D esign new system


(d) A ny oneoftheabove

SEC TIO N -A :A N SW ER S
1. d 2. a 3. d 4. b 5. b 6. a
7. d 8. c 9. d 10.d 11.d

SEC TIO N -B :Q U ESTIO N S


1. D efineSystem sA nalysisand stateitssignificance.
System sanalysisisthe processa exam ining an existing inform ation system and its
environm entto identify potentialim provem ents.The inform ation system steering
com m itteebeginssystem sanalysisin responseto arequestfrom am anagerorfrom a
long range system s planning group.System s analysis m ay begin forthree reasons:
(1)to solve a problem w ith an existing system :(2)to satisfy a new requirem entfor
inform ation:or(3)to im plem entanew form oftechnology.
In an inform ation system s departm ent, highly skilled em ployees called system s
analysts coordinate system s analysis activities. A good system s analyst has a
thorough know ledgeboth ofcom puterprocessing m ethodsand ofbusinessneedsfor
inform ation.A system s analystis also skilfulatapplying the system s approach to
problem solving.
The system s analysis phase ofthe SD LC represents an application ofthe system s
approach to an organizational problem from the perspective of the entire
organization.Thisprocessissom etim escalled astheprelim inary survey.D uring the
exam ination,the projectteam identifiespossible solutifonsto the problem thatm ay,
orm ay not,require the use ofa com puter.A s they explore these alternatives,they
m ay identify t