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IMS Proschool CFP Ebook PDF
IMS Proschool CFP Ebook PDF
T he Indian youth never had it so good. On the consumption side, the choice of goods and services
available is unprecedented. And, as far as income is concerned, given the booming economy and its
ever improving prospects, opportunities have never been better! So the youth are earning a lot and
spending a lot as well. It is definitely a happy situation to be in.
In times like these, when everything seems to be going right for so many people, there is a tendency to
ignore that one great habit –saving money. The rationale is simple-since the future looks great from here,
why set aside money for the future needs and contingencies. But in our view, this is an ideal time to save
money as surplus monies are high. Rather than spending this money on a product that you don’t really
need, you would do well to invest in the future for some later date critical need.
In this book of financial planning, we discuss this and a lot more, including investment avenues available.
We also discuss the concept of spending wisely and creating wealth in a systematic way.
Happy Investing!
Financial decisions are critical decisions, which decide how comfortably we end up monetarily in life.
Poorly planned financial decisions can cause, at best, great anxiety and at worst lead to bankruptcy,
whereas well thought-out decisions can lead to a prosperous lifestyle.
The complexities of our financial circumstances are many and we need to take a careful well thought-out
solution to such problems. The concerns could be many. Some of them are:
Definition:
Financial Planning is the process of identifying a person’s financial goals, evaluating existing resources
and designing the financial strategies that help the person to achieve those goals.
The key basic steps toward reaching this end as a financial advisor are:
Taking Stock
T he first step in assessing your current wealth is determining your net worth. It is the starting point for
financial planning. It provides an indication of your capacity to achieve your financial goals. Your net
worth can be ascertained by drawing up a personal balance sheet, as shown in
Worksheet 2. 1. The process consists of three steps:
1. List the items of value that you own. These are your assets.
2. List the amounts that you owe to others. These form your liabilities.
3. Subtract your liabilities from your assets; the difference is your net worth.
This relationship is shown below:
Items of Value - Amounts Owed = Net Worth
Definition:
Your assets are the things that you own. You probably own assets that have many different forms,
including cash, investments, personal property, real estate etc.
Assets possess value. Value can be of different types. The most basic measure of value is cost i.e. the
amount of money you spent in acquiring the asset. However, usually cost is not a very accurate meaure
of value. This is because, over time, the market value of an asset changes significantly from its original
cost. For example, your house may have cost Rs. 10 Lakhs ten years back. But today it is likely to sell for
much more. In case of such assets, market value or the amount someone would be reasonably willing to
pay for it in today’s marketplace is a much more accurate estimate of the value. However, collector’s
items like art pieces and antiques have an emotional value which may be significantly different from their
market value or cost.
In the Balance Sheet or the Statement of Net Worth, the assets are arranged in order of liquidity. The
most liquid assets are listed at the top of the list and include cash, bank accounts, and money market
mutual funds.
Definition:
Liquidity is a measure of the ease with which an asset can be converted into cash or cash equivalents.
The easier an asset is to convert into cash, the more liquid it is. Cash is the most liquid asset.
The cash surrender values of your whole life insurance policies and annuities can be determined by
contacting your insurance company.
The value of cars can be obtained from agencies which buy and sell used cars.
Household furniture, clothing, and personal effects should be more conservatively valued so as not to
overstate their value. It should be remembered that in an actual sale of these items, you are likely to get
far less than the estimated values.
Note
There is another school of thought, which proposes that the value of a self-occupied house should not be
considered in the net worth statement because one cannot really sell the house to raise resources. This
approach is also worthy because it is the more conservative of the two.
Liabilities
Definition:
Your liabilities are amounts that you currently owe (i.e., your financial obligations). The sum of your
liabilities is what you must pay today to overcome debt.
Begin by listing your most current debts, such as utility bills, telephone bills, and others.
Next, list the balances outstanding on your credit card debts and loans. For most people, a home loan is
their largest single debt outstanding. The amount to include is not the original amount of the loan but the
current outstanding balance. The current outstanding balance of the loan can be obtained directly from
the lender.
Add up all the amounts owed to others and to get the total of your liabilities.
Net Worth
Definition:
Your net worth is the difference between the totals of your assets and liabilities. In other words, if you
sold all your assets for the values stated and paid off all your debts, the amount left over would be
your net worth. The net worth of a person is a measure of a person’s financial position as of the date
of the personal balance sheet.
Steps:
List all items of value starting with cash, investment assets, the current value of your house, and
possessions.
List and total all liabilities.
Subtract total liabilities from total assets.
Notes:
Assets
Determining the value of your stocks, bonds, and mutual funds is easy. The prices can be found in
newspapers or on financial websites.
Appreciation of assets (for example, a rise in the value of stocks, bonds, mutual funds, and real
estate).
Reducing liabilities.
Increasing income, such as through salary and wage increases as well as growth in investment
income.
Reducing the amount spent on living expenses.
The importance of increasing net worth is obvious. It is important to remember that addition of assets
may not always increase your net worth. This is especially true for depreciating assets, such as cars,
computers, electronic equipments etc.
Investment assets like shares could also lose substantial part of their value.
Creating a personal balance sheet will assist you in tracking your personal wealth over time and enable
you to see relationships among the balance sheet items. The relationship between liquid current assets
and current liabilities indicates the relative ease or difficulty in paying upcoming debts. This evaluation
ratio is the current ratio and is determined as follows:
Current Ratio = Current Assets ÷ Current Liabilities
For example, if a person has Rs. 10 Lakhs in liquid current assets and Rs. 5 Lakhs in current liabilities,
the current ratio is 2. This means that for every Rs. 1 in current debts, there is Rs. 2 in liquid assets.
Generally, most current debts are repaid from liquid current assets such as cash, savings accounts etc.
In the event of unemployment or insufficient liquid current assets to cover current debt, longer-term
investment assets would need to be liquidated to pay off the debt.
The other significant relationship between balance sheet items is the debt ratio, which is total liabilities
divided by net worth:
Debt Ratio = Total Liabilities ÷ Net Worth
For example, if a person has Rs. 1 Lakh as total liabilities and a net worth of Rs. 2,00,000, the debt ratio
is 0.5.
We need to make the Cashflow statement and the Income and Expenditure Statement, to assess changes
in networth.
1. Mukesh bought a flat for 12 Lakhs, worth 20 Lakhs today. He has no loan repayments i.e. EMIs due
on his flat. He has FDs worth Rs. 2 Lakhs and cash of 30,000 in his account, jointly held with his
wife. He has mutual funds worth 1.5 Lakhs and stocks worth 1.5 Lakhs. Ritesh, an old colleague of
his, has taken a loan from him for Rs. 50,000, for which he pays him 10,000 every month. His wife,
Geeta is fond of diamond jewellery and owns up to 3 Lakhs of diamond jewels.
Mukesh bought a car for 4 Lakhs, 3 years ago. He has a tax liability of Rs. 35k per year. He has no
other outstanding bills pending, except for telephone and electricity bills to the tune of Rs. 5,000 .
A] What is his net worth?
B] Can you think of ways of increasing his net worth?
C] What is his current ratio and debt ratio?
Chapter Review
Y our Income and Expense Statement reports income earned and spent during a specified period,
while the Cashflow Statement presents a record of all the cash inflows and outflows during a particular
time period.
The difference between the two is that the cashflow statement records only the actual cash inflows and
outflows. It does not include amounts spent or earned on credit. On the other hand the income and
expense statement records all types of income and expenses.
These statements make it easy to see where your money is being spent. Many people complain that
they earn large sums of money, but they never have anything left over. Recording their expenditures is
a first step to taking control of their financial affairs. Because earnings and living expenses also influence
net worth, these statements also show that change.
The income statement shows actual income and expenditures over a period of time, whereas a balance
sheet or Statement of Net Worth shows financial position at a single point in time.
There are three steps to creating an income statement, as shown in Worksheet 3.1.
Note:
Cash surplus increases net worth while a deficit decreases it.
1. Anil lives in a flat, which he purchased 10 years ago for Rs. 10 Lakhs. There is a loan outstanding
for Rs. 3 Lakhs left. The monthly EMIs, which Anil pays towards the loan, is Rs. 4000 pm. His wife
has jewellery worth Rs. 2 Lakhs.He has a car, which he purchased for 3 Lakhs, four years ago. He
pays a monthly EMI of Rs. 2000 for his car loan. His life insurance and pension funds cost him Rs.
4000 pm. He earns Rs. 40000 pm. His car requires petrol worth Rs. 3000 pm. The grocery bill adds
up to Rs. 8000 pm. His wife, Mina likes to eat out. They spend Rs. 2000 on entertainment every
month. His mobile bill and utilities come to Rs. 6000 pm. His credit card bill is Rs. 2000 pm.Anil
earns interest income up to Rs. 400 pm.He has no other source of income.
Prepare his income and expense statement. Is there a surplus or a deficit? State the discretionary
and non-discretionary income. What is the percentage of discretionary and non-discretionary expenses
to the income?
2. Mukesh, a student had withdrawn Rs.3000 on 1st May’07. By the 10th of May, he had only Rs. 100
in his wallet. Intrigued as to where he spent all his money, he decided that for the following month,
he would maintain a note of all his cash outflows and inflows.
One June 1’07, Mukesh withdrew Rs. 3000 from ICICI Bank. On the 1st, he had travel and eating
expenses of Rs. 150. On the 2nd, he bought some fruits worth Rs. 45 and had conveyance of Rs.
50. On the 4th and the 5th, he had miscellaneous expenses of Rs. 500. On the 7th of June, he realized
that the rains will start soon and that he needed both a pair of rainy shoe and a bag. He purchased
the office bag at Rs. 700 and the shoes cost him Rs.900. He hunted out his old umbrella that had
served him well for the last 2 rainy seasons.
How does Mukesh’s cash inflow-outflow statement look like? Does Mukesh have a surplus or a
deficit? Is he better off in June than in May?
Chapter Review
What is budgeting?
Budgeting is a process for tracking, planning, and controlling the inflow and outflow of income.
Estimate your future net income for the period of the budget.
Determine your expected expenditures during the period of the budget.
Bonuses
Business upturn/downturn
Commissions and royalties
Cost-of-living adjustments
Disability
Dividends
Gifts
Health condition
Inheritance
Interest rate changes
Investment gains/losses
Job promotion
Personal property sale
Salary increase/decrease
Change in tax bracket
Tax refunds
Remember
When estimating income that is highly variable, the estimate should be conservative. Being surprised by
an income surplus is far more pleasant than having an unexpected income shortfall. In fact, the latter can
cost even more if you need to rely on credit to cover the shortage. Being conservative by underestimating
budgeted income is prudent so as to avoid overspending.Use the reasonableness test to avoid unrealistic
estimates.
Review prior period expenses and determine which will recur in the forthcoming period
Determine what new expense items are anticipated
Estimate the amount of each expense for the period
Add individual estimated expenses to obtain total estimated expenses
Whether estimating expenses or income, you should always estimate conservatively. Being surprised by
lower than expected expenses is far more pleasant than experiencing a spending deficit. If you need to
borrow funds to cover a spending deficit, you’ll be spending even more. Use the reasonableness test to
avoid unrealistic estimates.
Expenses can come from many directions, so be careful not to overlook any that could be significant.
Expenses that are uncommon and nonrecurring are the most difficult to predict, yet are frequently the
cause of budget chaos.
Certain expenditures such as rent, mortgage, and car loan payments are fixed in amount and do not vary
from month to month, whereas other expenditures such as food, clothing, and utilities vary in amount
from month to month. Anticipating these variable expenditures with accuracy may be difficult. The purpose
of budgeting is not to bind you so much that you cannot maneuver. On the contrary, its purpose is to
provide you with flexibility in your financial planning so you can achieve your financial goals.
1. Column 2 shows the estimated amount of money needed to fund each goal.
2. Column 3 lists each goal’s priority. For example, buying new furniture is the lowest of the family’s
priorities.
3. Column 4 shows when the expenditures will be needed. For example, a new car to be purchased in
12 months; fund children’s education in 15 years (180 months); retirement in 24 years (288 months);
and new furniture to be bought in six months.
4. Column 5 shows the amount that will be needed every month to finance each goal. It is calculated as
follows:
Monthly Amount = Estimated Cost ÷ Time Needed
For example: Monthly amount required for a new car = 600000 ÷12 = 50000
Since setting appropriate financial goals forms the foundation of any budget, we will look at the process
of setting budget goals in detail in the next chapter.
Step 5: Record Actual Income and Expenditures for the Period Budgeted
Actual amounts earned and spent are not always the same as those projected. By recording the actual
amounts and comparing them with the budgeted amounts, you can immediately see the differences,
called variances. Spending more than a budgeted amount for one item can be offset by spending less
than the budgeted amount for another item.
Similarly, if actual income exceeds actual expenditures, there is a surplus, which means additional cash.
The opposite is a deficit, which means that cash will have to be withdrawn from cash savings or other
assets in order to pay for the deficit spending.
1. Priti is a 30-year-old young professional. Her net salary is Rs. 50,000 pm. She is expecting a bonus
of Rs. 30,000 in the next 6 months. Her car loan outflow is Rs. 6,000 pm. The rent is Rs.15,000 pm.
She spends on food and clothing Rs. 9,000 pm.She invests all her surplus funds in retirement
schemes, so far. She invests Rs.10,000 pm on pension annuity fund. She wants to save money to
enjoy a holiday with her parents and take them on a world tour. She will have to have Rs. 6 Lakhs
for this trip. She has monthly medical and miscellaneous expenses for her parents to the tune of
Rs. 5,000 pm. Her salary is expected to go up by Rs. 5,000 net of tax, in 2 months time.
Prepare a budget for Priti.
Should she invest in any other instruments as well? What could they be? Discuss.
2. Nitish is a 40year old, working with Elder Pharma Ltd. He lives with his wife, child and elderly
parent. In the year 2007-2008, he expects interest from his Fixed Deposits to amount to Rs. 20,000.
He has invested in mutual funds to the tune of Rs. 2 Lakhs, the value of which all together is Rs. 2.5
Lakhs. He has received tax-free dividends of Rs. 10,000, in the year. His agricultural income
comes from the land in his village. He received Rs. 1 Lakh this year as agricultural income. He is
quite generous with the people who look after his farm, and they are faithful farmers who have been
associated with his family for more than 40 years, now.
He lives in a self-occupied house, where the EMIs are Rs. 15,000 pm. His salary is Rs. 8 Lakh pa.
His monthly expenses to look after the house inclusive of groceries, utility bills, car maintenance,
and children’s education comes to Rs. 30,000 pm. Medicines and miscellaneous purchases come
to approximately Rs. 10,000 pm. His insurance payment is Rs. 5,000 pm. He wants to set up an
emergency corpus of Rs. 2 Lakhs and set aside Rs. 10,000 pm as retirement funds. There is an
anticipated expense to cover the leakage in the house to the tune of Rs. 50,000. This leak has to be
fixed before the monsoon begins, which is in another 2 months time.
Prepare a worksheet and analyze his expenditure pattern to determine if his future goals can be
achieved.
3. Naik, who is living in Mumbai decided to look into his finances one saturday afternoon. He had not
had a look at them in a long time for now. It was decided that it was high time that he took out some
time for stocktaking regularly. He and his wife Renu, sat down to discuss and enumerate all their
respective responsibilities and priorities. Renu said that she had a family wedding coming up and
there were some gifts to be purchased on an immediate basis. Her brother’s wedding was fixed up
and she wanted to buy a gift worth Rs. 8,000 for him.
Their son would require tuition fees to be paid to Aggrawal classes. Aggrawal Classes charged Rs.
20,000, a year which was due to be paid in 2 months time. Mr. Naik had a commitment to pay EMIs
for his home loan for which the monthly outflow was to the tune of Rs. 12,000 pm. Looking at their
long-term plan, they wanted to save Rs. 5 Lakhs for their child’s education, Rs.8 Lakhs for his
wedding and Rs. 50 Lakhs as a corpus for their retirement. Mr. Naik is due to retire in 5 years time.
He earns Rs. 60,000 pm, after taxes.
Identify the short term and the long-term goals, their priority and the time needed to fulfill the goals
and their monthly cost. Determine if there is a surplus or a deficit to fulfill these goals.
T hink of your budget goals as your financial wish list and your spending plan as a way to make those
wishes a reality. Without clear budget goals, your financial life may remain in disarray. Like any other
goals in life, your budget goals help you turn your wish list into an action plan.
Your budget goals also help you take the drudgery out of following the budget because now, when you
give up any immediate desire, you know that you are one step closer to something you really want. For
example, when you give up having dinner in a nice restaurant, you know that you are closer to being able
to buy a dream car next year. With clear goals in sight, you can chart your course of action and change
your direction when needed.
Step 5 : Calculate how much you need to set aside each period
Once you have some idea about the future cost of your goals, your next step is to determine how much
you should put aside each period to meet all your goals. Keep in mind that you may not need to assign
a separate savings or investment account for each goal as long as you have a method to keep a record
of your goals. You may want to have a separate investment strategy, however, for your short- and long-
term goals.
For your short-term goals, it is easy to estimate the cost, the amount you will need to set aside each
month, and your projected income during that time. Divide the cost by the number of months until you
need to meet your goal. You then know the amount of money you need to put aside each month for your
goal. For example, if you want to buy a music system in six months and it costs Rs. 30,000, you need to
put aside Rs. 5,000 a month for the next six months.
Example
If you are saving for your child’s college education and you will need that money in 10 years, you first find
out the amount of money you will need, taking into account the rate of inflation. Say, for example, you will
need Rs. 6,00,000 for the first year of college. Now, calculate the amount of money you will need to save
each month, taking into account the estimated rate of return on your savings or investments.
Once you have calculated this number for all of your goals, you get an amount that you will need to save
every month. Then you need to evaluate your goals in order of their priority so that you can channel your
savings in the right direction.
Goal Priority
Saving for Retirement 1
New Car 2
Saving for child’s education 1
Taking a vacation 2
Buying a music system 3
Buying a vacation home 3
Your first focus will be on the goals marked with a number one. Calculate the amount of money you will
need to put aside each month to meet these goals. Do the same for goals with priority number two,
followed by those for number three. You can then write your goal schedule.
This table will give you a picture of how much money you need to save every month to achieve all your
goals. The table will also give you an idea of your investment options, since your personal time line
affects your choice.
With the clear picture of your goals, their priority, the amount of money you need, and the amount of monthly
savings to attain those goals, you can move to the next step - developing a spending plan for your budget.
Chapter Review
Y our spending plan is your active strategy for getting where you want to go. Think of your spending
plan as a road map that helps you reach your goals. Your spending plan provides a sense of
direction and puts you in charge of how your money is spent on a weekly, monthly, and yearly basis.
Look at your records and see how your spending is distributed in terms of percentage of your income.
You can see how your own spending habits compare with the guidelines above. You may choose to
follow these guidelines closely, or you may decide to make changes so that the overall spending plan
reflects your lifestyle. For example, if you love to travel, your transportation budget may be larger than
the suggested average. To compensate for that extra spending, you will have to reduce some of your
other expense categories. Also, keep your goals and priorities in mind and adjust your spending plan
accordingly. For instance, if you are not saving any money right now but you want to save 10 percent of
your income for retirement, find out from which categories the money will come.
Be disciplined.
To get long-term benefits, your budget should become a way of life. Jot down all the expenses, item by
item, day by day, in your diary. If you are using your computer, make sure you enter all the expenses at
Keep it simple.
Keep monitoring simple. Divide your expenses into fixed, variable, and discretionary categories. Monitor
your variable and discretionary expenses, such as clothing money or eating out, once you have assigned
your fixed expenses.
Caution
If you’re going to use multiple credit cards to help track your expenses, make sure that you aren’t
paying high annual fees for each of these cards.
Be careful not to fall into the trap of using credit to pay for everyday expenses and not paying off your
outstanding balance each month. If you do this, it will seem like you are spending less, but your debt
will continue to increase.
Fine tune as you go.
Keep in mind that implementing a spending plan requires fine tuning of your estimates and your expenses
as you go along. You will get better as time progresses. Don’t give up too quickly if you feel it is not
working.
1. Nishant had joined TCS on the 1st of July’07. He had come to Bombay from Nagpur. In the first
month, he took a vehicle loan, so that his commute is faster and convenient. He had to allocate Rs.
6000pm for this outflow. Initially, during the first few days, he had to spend Rs. 15000 from his
pocket for stay and food expenses until he rented a place and made arrangements for food. He
made clothing purchases for Rs. 6000, just before he joined his organization. The petrol costs were
amounting to Rs.1000pm. His mobile monthly expense came to Rs.2000pm. He spent Rs. 2000
initially on gifts and entertainment. His monthly expenses for food and rent were up to Rs.12000pm.
He wanted to plan to save money for his sister’s college education, as soon as possible. His
monthly salary was Rs. 25000pm. The corpus required for education was Rs. 2 Lakhs.
Record Nishant’s expenses and develop a plan to save money for his goals.
Chapter Review
T he time value of money is one of the most important concepts in personal finance decision-making.
Money does not have the same value over time due to the fact that it earns interest. Consequently,
a rupee today is not the same as a rupee in the future.
Investing that rupee today yields an amount greater than the rupee in the future because of the interest or
return that the investment generates. The interest rate or the rate of return is the link between the present
and future value of money.
The impact of the time value of money is dependent on the following three factors:
Simple Interest
The most basic method of calculating interest is the simple interest method. The other, more common
method, of calculating interest is the compound interest method.
Definition:
Interest is the cost charged or payment made for the use of money.
The simple interest method calculates interest on the principal only, without any compounding. In other
words, the interest earned is not used to earn further interest.
The elements used to determine simple interest are the principal, the rate of interest, and the length of
time that the principal is invested or borrowed. The formula for simple interest is as follows:
Interest = Principal Amount ×Annual Interest Rate ×Time Period
or
I =P × R × T
If the amount is deposited for less than one year, then the time period is divided accordingly. For
example if Rs. 2,000 is deposited for a period of 9 months at an interest rate of 5%, then the amount of
interest is calculated as below:
Interest = Rs. 2,000 x 0.05 x (9/12)
= Rs. 75
Compound Interest
Compound interest differs from simple interest in that interest is paid not only on the principal but also on
the accumulated interest, assuming that the interest is left to accumulate. The greater the number of
periods for which interest is calculated, the greater is the accumulation of interest earned on interest plus
interest earned on the principal.
The formula for compound interest is expressed as follows:
Future Value = Principal (1 + Interest Rate)n
or
FV = P (1 + i)n
where
FV = Total future value (principal plus total compound interest)
P = Principal (amount invested)
i = Interest rate per year or annual percentage rate
n = The number of periods at the interest rate
Example:
To illustrate the difference between simple and compound interest, assume that Rs. 100 is invested at
an interest rate of 5 percent per year for five years and the interest is not withdrawn. If compounded
annually, the compound interest earned would be Rs. 27.63, while the simple interest earned would be
Rs. 25, as shown in the figure.
Impact of Inflation
Definition
Inflation is the tendency of prices to rise over time.
Learnings
Through this example, you will see that as time goes by, the expenses will only increase, by the order of
inflation. It is safer to ensure that you are geared up for it today.
Inflation erodes the value of your financial assets. For example, suppose you are able to fulfil all your
household needs for Rs. 10,000 currently. If the rate inflation is 4% p.a., it means that the same household
goods will cost Rs. 10,400 next year. As we have seen the impact of compound interest, this would
mean that in about 18 years the cost of all goods will be twice their current cost.
What this means is that a rupee today is more valuable than a rupee in the future. Also it implies that all
investments that you make should earn you a return that is in excess of the rate of inflation.
Chapter Review
A s a financial planner, you will be doing a lot of mathematical calculations for your clients. Doing
these calculations for a large number of years is very tricky and difficult if you do not use the correct
tools. It is recommended that you use either computer spreadsheet software like MS Excel or a financial
calculator to do these calculations.
Simple Interest
This is when interest is calculated on the principal amount only.
SI = PV x R x T
Where,
SI = Simple Interest
R = Rate of Interest
T = Time period
MS Excel
The Excel FV function can be used to find out the future value of a single cash flow. The FV function is:
= FV(RATE,NPER,PMT,PV,TYPE)
Where,
RATE is the interest rate for the period;
NPER is the number of periods;
PMT is the equal payment or annuity each period;
PV is the present value of the initial payment; and
TYPE indicates the timing of the cash flow, occuring either in the beginning or at the end of the period.
Financial Calculator
Use [] [] to select “Set:”, and then press [EXE]
Press [2] to select “End”
Use [] [] to select “n”, input 8, and then press [EXE]
Use [] [] to select “I%”, input 12, and then press [EXE]
Use [] [] to select “P/Y”, input 1, and then press [EXE]
Use [] [] to select “PV”, input –22,000, and then press [EXE]
Use [] [] to select “FV”
Press [SOLVE] to perform the calculation
MS Excel
We can find the present value of a single cash flow in Excel by using the built-in PV function:
= PV (RATE, NPER, PMT, FV, TYPE)
Financial Calculator
Use [] [] to select (1) “Set:”, and then press [EXE]
Press [2] to select “End”
Use [] [] to select (2) “n”, input 13, and then press [EXE]
Use [] [] to select (3) “I%”, input 9, and then press [EXE]
Use [] [] to select “P/Y”, input 1, and then press [EXE]
Use [] [] to select (6) “FV”, input 25,000, and then press [EXE]
Use [] [] to select “PV”
Press [SOLVE] to perform the calculation
Ordinary Annuity
Payments or receipts occur at the end of each period.
Where
FVA = Future Value of Annuity
A = Annual Payment Amount
i = interest
n = number of years
Financial Calculator
Use [] [] to select (1) “Set:”, and then press [EXE]
Press [2] to select “End”
Use [] [] to select (2) “n”, input 6, and then press [EXE]
Use [] [] to select (3) “I%”, input 3, and then press [EXE]
Use [] [] to select “P/Y”, input 1, and then press [EXE]
Where
Where
PVA = Present Value of Annuity
A = Annual Payment Amount
i = interest
MS Excel
The Excel PV function for an annuity is the same as for a single cash flow. Here we have to put in the
value for PMT instead of FV:
Perpetuity
A perpetuity is an infinite annuity. In a perpetuity, the annual cash flows continue forever. The present
value of a perpetuity is given by:
PV = a/r
Where
PV = Present Value
a = Annual Payment Amount
r = interest rate
The concept of perpetuity finds application in case of stock valuation. Stocks are valued at present value
of their expected earnings. For example, suppose a company is expected to earn Rs. 5 every year. If the
discount rate is 10% then the value of the stock would be:
Price of Stock = PV of earnings = 5/0.10 = Rs. 50
Growing Perpetuity
The present value of a perpetuity that grows at a constant rate of g% is given by:
PV = a/(r-g)
To illustrate, a company expects to earn Rs. 5 per share in this year and expects its earnings per share (eps)
to grow at a rate of 6% every year. If the discount rate is 10%, then the current price of the share would be:
Price = 5 / (10-6) = 5/0.04 = Rs. 125
This formula also enables us to understand the PE Ratio in terms of the growth rate of earnings.
PE Ratio = Price per share / Earnings per share
Or
Where
P0 = Current Stock Price
e0 = Current Earnings per share
g = earnings growth rate
r = discount rate
Exercise:
Let us see the effect of compounding at different periodicity:
Comparison of different compounding periods for Rs. 1000 invested for 2 Years at an annual interest rate
of 12%.
Annual FV2 = 1,000(1+ [.12/1])(1)(2 = 1,254.40
Semi FV2 = 1,000(1+ [.12/2])(2)(2) = 1,262.48
Qrtly FV2 = 1,000(1+ [.12/4])(4)(2) = 1,266.77
Monthly FV2 = 1,000(1+ [.12/12])(12)(2) = 1,269.73
Daily FV2 = 1,000(1+[.12/365])(365)(2) = 1,271.20
Therefore, you can see that although the stated rate of interest is 12% in each case, the results are
significantly different. The stated rate is also known as Annual Percentage Rate, APR. The Effective
Annual Rate, EAR, is the rate if there was compounding only once per period; it is true effective rate.
The relation between APR and EAR is given by:
If the compounding period is made infinitely small, it is known as continuous compounding. The EAR for
continuous compounding is given by:
MS Excel
Excel has built-in functions for calculating the yield or IRR of an annuity and uneven cash flows. The
Excel function to find the yield or IRR of an annuity is:
= RATE (NPER, PMT, PV, FV, TYPE, GUESS)
GUESS is a first guess rate. It is optional; you can specify your formula without it.
The Excel built-in function IRR calculates the yield or IRR of uneven cash flows:
IRR (VALUES, GUESS)
The values for the cash flows should be in a sequence, starting from the cash outflow.
GUESS is a first guess rate (arbitrary) and it is optional. In the worksheet, we have entered the cash
flows of an investment project. In column B4 we enter the formula: = IRR (B3:G3) to find yield (IRR).
Note that all cash flows in year 0 to year 5 have been created in that sequence. The yield (IRR) is
27.43 per cent.
You can also use the built-in function, NPV, in Excel to calculate the net present value of an investment
with uneven cash flows. Assume in the present example that the discount rate is 20
per cent. You can enter in column B5 the NPV formula: = NPV (0.20, C3:G3) +B3. The net present
value is Rs. 21,850. If you do not enter +B3 for the value of the initial cash outflow, you will get the
present value of cash inflows (from year 1 through year 5), and not the net present value.
Financial Calculator
Use [] [] to select (3) “I%”, input 20, and then press [EXE].
Use [] [] to select “Csh=D.Editor x”, and then press [EXE].
This displays the DataEditor. Only the x-column is used for calculation. Any values in the y-column and
FREQ-column are not used.
-40,000 [EXE] (CF0).
15,000 [EXE] (CF0).
25,000 [EXE] (CF0).
30,000 [EXE] (CF0).
17,000 [EXE] (CF0).
16,000 [EXE] (CF0).
Press [ESC] to return to the value input screen.
Use [á] [â] to select “NPV: Solve”.
Press [SOLVE] to perform the calculation.
Use [á] [â] to select “IRR: Solve”.
Press [SOLVE] to perform the calculation.
1. Naina is 22 years old. She has recently started her work. Naina is working with an educational
institute and she has been trained to counsel students. Day in and day out, she talks to young
people about the careers and goals and where they want to be in life. This set her thinking in terms
of her future.
Her aspiration levels increased and she herself wanted to study further. She knew her potential and she
was getting educated on the job market and her areas of interest. After doing the initial research, she
concluded that she wanted to study abroad. However, as is well known, a 22 year old doesn’t have a
lot of money in her kitty. Also she knew that her parents could not take the burden of such a loan. She
decided that she would need to plan for fulfilling this dream of hers. She calculated the amount to be
Rs. 15 Lakhs. She wanted to have saved up Rs. 15 Lakhs in 8 years time. The average market return
is about 10%pa. How much would she need to invest to get Rs. 15 Lakhs in 8 years?
Also, if Naina invests in yearly installments rather than a one time proposition, how much will she
have to invest each year, so that she will have Rs. 15 Lakhs corpus at the end of 8 years at a 10%
rate of return.
2. Let us assume that an investor invests Rs. 1000 at 12% for a period of one year. Let us assume
inflation to be 6% and the tax rate to be 30%. The real return that the investor gets is calculated as
below:
Therefore the formula for finding the real rate of return is:
Real Rate = I(1-T) – R
Where
I = interest rate received
T = tax rate
R = rate of inflation
O nce you have made an assessment of your current financial situation and decided on your financial
goals, it is time to develop and deploy strategies to achieve them.
Risk Mitigation
A business / financial proposition becomes risky, when one cannot predict the outcome of a decision.
However, by careful analysis and preparation the risk can be mitigated.
Protection
Asset protection or wealth protection essentially means safeguarding its financial value.
Let us see a corporate example to understand both sides of a coin :
Example
An IT company, primarily in software development has been affected by the strengthening of the rupee.
The earnings of the company has dipped. To protect itself from future fluctuations in exchange rate, it
quickly decides to diversify to closely related areas of business that it is already into. Besides doing
software development initiative, they have quickly spread their boundaries with a view to reducing their
risk and protecting their incomes.
Decrease outflow
This is a more passive conservative way by which wealth could be protected. Suppose you have Rs.
10,000 as your budget for the month. You can blow it up in a party by spending it once or twice or you
decide to spend not more than Rs. 300 a day and more importantly on the essentials first and
luxurious later.
Increase inflows
This is a more aggressive approach to wealth protection. A good example would be a B.Com student,
simultaneously studying for CA. During the student days, they build on their experience and earn minimally
to support their pocket money.
This way, they armor themselves with a thorough preparation for higher education and have learnt to
manage personal finances.
In the context of financial planning, we are concerned only with pure risks.
Personal Risks
Personal risks are those risks that directly affect an individual. They cause financial insecurity because
they usually result in reduction or stoppage of income, increase in expenses and depletion of financial
resources. Some of the major personal risks are:
Direct Loss
Indirect or Consequential Loss
Direct Loss
A direct loss results from physical damage, destruction or theft of property. For example, if your house
is damaged due to earthquake, the amount of loss is known as direct loss.
Liability Risks
Liability risks arise from the possibility of being held legally liable for the loss to another person. If a person
commits a mistake or because of negligence, causes bodily harm or injury to another person, a court of law
can order that individual to pay damages to the injured party. Liability risks can be categorized into:
Personal Liability
Personal liability arises when a person acts negligently or carelessly during the course of his personal life
and causes harm to another. For example, if you hit a pedestrian with your car due to jumping traffic
lights, you may be asked to bear the treatment expenses and pay damages to the victim.
Professional Liability
Professional liability arises when a person harms another while performing as a professional. For example,
a doctor who causes harm due to a wrong diagnosis can be held professionally liable to pay damages to
the patient.
Liability risks cause financial insecurity because they result in depletion of existing financial resources.
Let us consider, Keshav who is running an industrial unit at Vapi, near Surat. His company manufactures
heavy machinery to handle equipments that are used in construction activities. He has employed a full
time work force of 10 workers and part time contractual workers, another 10 in number. Contractual
workers balance out the cost as well as the requirement needs during peak season.
His work force risks the possibility of permanent or temporary disability while at work. What category of
risk does this fall under?
Solution : This is a professional liability.
Some of the equipment is old and doesn’t function properly. During peak season, to make up for the
capacity, Keshav has to hire additional machinery to cover for the productivity loss due to his old
equipment.
What kind of loss is this?
Solution : This is an Indirect loss.
Chapter Review
W hile risks cannot be eliminated, measures can be taken to reduce the probability and size of loss
caused by risks. This process is known as risk management.
Response to risk
The different methods used for management of risk can be broadly categorized into two categories:
Risk Control
Risk Financing
Risk Control
Risk Control methods are those that try to minimize the losses from risks. These can be of two types:
1. Risk Avoidance
Risk avoidance is accomplished by not engaging in the action that gives rise to risk. Avoiding risk is an
appropriate strategy for high frequency and high severity risks.
While the avoidance of risk is one method of dealing with risk, it has many negative consequences. for
example, you can avoid dying in an air crash by giving up air travel, but it also means giving up the huge
time savings and convenience that air travel offers.
2. Risk Reduction
Risk reduction is achieved through loss prevention and control. For example, the risk of fire can be
reduced by measures like installing fire extinguishing systems and sprinklers, using fire retardant materials
in construction. It is an appropriate strategy for high frequency and low severity risks.
Risk Financing
Risk financing methods are those that pay for losses that actually happen. These can be of two types:
1. Risk Retention
Risk retention is used when the risk is retained. The retention may be voluntary or involuntary. This is an
appropriate strategy for low frequency and low severity risks. For example, the risk of suffering from
common cold can be retained. As a general rule, risks that should be retained are those that lead to
relatively small certain losses. The reason for retention is because there is a cost attached to transfering,
reducing or avoiding risk. It may be more cost effective to retain the risk since its frequency as well as
impact is low.
2. Risk Transfer
Risk transfer is the transfer of risk from one individual to another who is more willing to bear the risk.
Insurance is the most widely used means for reducing risk by transfer. Risk transfer is appropriate for low
frequency and high severity risks.
Let us try to understand these for concepts better through some examples.
Examples
1] Vikram had a run of 7kms from home to his office. There are two routes he can take. One route is
faster, but highly dangerous. It is a main highway and has a record number of accidents. In other words,
the area is accident-prone. The second route typically takes him 15-20 mins more. Since it is an inner
city road, it has less of heavy traffic and this route is considerably safer. Which kind of risk would you
classify this as? What is the best way to deal with it?
Since his travel frequency in that route was twice a day, back and forth from home to office, in case of
any accident, the impact would be fatal, hence it can be classified as high frequency, high severity risk
and best way to deal with it is Risk avoidance.
2] Anand was earning well in his company. His friendliness was unfortunately taken as his vulnerability.
Whenever, any of his friends needed some money, they would invariably ask Anand. Anand could never
say no, and always felt that he should help someone in need. The loan was always given on a returnable
basis, but that never happened. What kind of a financial risk does it entail? How should it be handled?
This can be classified as high frequency, low severity risk hence best way to handle it would be Risk
reduction.
C] Prem was to take an official trip to USA. His wife also wanted to join him, as a personal holiday trip. His
company gave Prem an insurace cover. Should his wife also take an insurance cover? What are the risks that
could arise incase the risk cover is not taken? What is the category of risk and how should it be handled?
Death
Disability
Major surgery or hospitalization
Illness
Liability for injuries to others
Burglary of home
Destruction of house and contents
Car accident – major or minor damage to car
Professional Liability, etc.
Step 3 : Rate each event for probability or frequency of occurrence. Frequency of occurrence can be
categorized into:
a. Extremely Probable/Frequent – an event that is almost certain to happen, or that happens very
frequently.
b. Very Probable/Frequent – an event that is quite likely to happen, or that happens often.
c. Moderately Probable/Frequent – an event that could happen, or that happens infrequently.
d. Not Probable/Infrequent – an event that is unlikely to happen, or that almost never happens.
Step 5 : Compare the recommended methods of handling risks with the ways they are currently handled,
to identify gaps or mismatches in the current risk management strategies.
Create an action plan to plug the identified gaps. Keep in mind that:
Step 6 : The topmost priority must be given to risks that should be avoided or transferred but are being
borne. These risks can completely wreck the financial affairs of a person. Accordingly, they need to be
handled foremost. Next priority should be given to risks that should be reduced but are being currently
borne. These risks should be immediately managed by making lifestyle changes and by putting appropriate
loss control mechanisms in place. If risks that should be borne have been transferred through insurance,
the amount of insurance may be reduced or completely eliminated. The resultant cost savings should be
employed into addressing the other gaps. The most common method of risk transfer is insurance. In the
next chapter, we will discuss the relationship between risk and insurance.
Chapter Review
I nsurance is the most common method used for transferring risks. It transfers the risk from an individual
to a group. It also provides a means for paying for losses. Insurance provides an important means of
preventing risk from interfering with a client’s achieving financial objectives.
Some people might not agree to be part of such an agreement, making it difficult to reach the large
numbers of participants necessary for the scheme to work.
Some people might not pay their share, even though they were part of the agreement.
Someone would need to perform the task of collecting money from the people and providing it to the
affected family.
In the real world, insurance companies act as facilitators and remove the obstacles to risk transfer and
risk sharing. They perform the functions of making agreements, collecting money, calculating losses
and providing payments to affected persons.
In the larger perspective, let us hear what an insider has to say from an expert view point.
Expert View
In an interview Mr.K R Subramanian, COO, ING Vysya Life mentions that in a fiercely competitive
market like life insurance, all players deal in similar products. They use the same Indian mortality
assumptions and pricing. “The only differentiating factor is cost leadership and efficient service. We
have to issue policies faster and make sure that normal insurance applications are processed quickly.”
Subramanian feels that there is a need to build awareness about risk management so that people adopt
good risk minimisation methodology. Insurance is a crucial element of transferring risk. Today’s well-
informed customers want to spend an allotted amount intelligently.
“Insurance has developed to such an extent that it can shift risk from insurance to the capital market by
means of a methodology called alternate risk transfer (ART). This includes catastrophe bonds, for instance
you get a particular return if earthquake hits Japan or you get another value as return if an earthquake
does not hit Japan,” says Subramanian. These are high end investment instruments targeted at very
specific well informed clientele.
Pooling of Risks
To perform the function of insurance and to carry out their own activities, insurance companies need to
collect contributions from individuals. But since losses are unpredictable, how does the insurance company
decide how much to collect from each individual?
The theory of probability deals with random events and postulates that while some events appear to be
a matter of chance, they actually occur with regularity over a large number of trials revealing a measurable
pattern.
To draw an analogy – it is difficult to state with confidence whether the daytime temperature will cross 40° C
on a particular day in Delhi, but if data for the past 15 years is collected, it can be seen that in Delhi, the
daytime temperature exceeds 40° C on most days in May and June. Study of historical data is an important
means to understand probability of occurance. Statistical tools are also employed to this effect.
Definition:
The law of large Numbers implies that the frequency with which an event happens, reflects the actual
probability of the event occurring more closely if the number of cases involved is larger.
The law of large numbers finds many applications in the field of insurance. The most important of them
is that if the risks faced by a large number of individuals are pooled together, then the probability of the
adverse events actually occurring can be predicted quite accurately. This enables the insurance companies
to predict the losses that will actually occur over a period of time and thereby fix the contributions
payable by each individual.
Insurance companies also employ other statistical techniques like regression analysis, loss distributions,
mortality tables to arrive at the probability of occurrence of a particular event which, in turn, is used to fix
the level of premium contributions.
The risk must be a part of a large number of homogeneous units; otherwise the law of large
numbers will not apply – making it difficult to estimate the probability of losses.
The loss due to the risk must be definite and measurable. The insurer must be able to determine
that a loss has occurred and to accurately measure the economic impact of the loss. This is because
insurers can only provide re-imbursement of the financial loss occurred. They cannot always undo
the damage done. For example, a rare painting of say, Picasso, if destroyed, can’t be reconstructed.
The damage or loss due to the risk must be fortuitous or accidental. Insurers cannot be held
responsible to pay for certain (intentionally caused) losses.
Indemnification of loss
Insurance restores individuals to their former financial condition after a loss. As a result, it reduces the
amount of disruption that such losses would otherwise cause. Insurance contributes immensely to family
and business stability in the society.
Reduction of anxiety
Insurance reduces the level of anxiety and stress in the society because the insured individuals do not
have to worry about financial insecurity in case of adverse events. Even if such events occur, insurance
reduces worry because the insured know that the insurance they have will pay for the loss.
Loss prevention
Since insurance companies benefit if incidence of loss causing events goes down, they actively promote
best practices for loss prevention amongst insured. Insurance companies employ a wide variety of
personnel who specialize in loss-prevention such as safety engineers and fire prevention experts. Better
safety measures adopted by individuals because of the insurance companies’ activities go a long way in
reducing the losses that would otherwise occur.
Enhancement of credit
Insurance makes a borrower a better credit risk because it acts as collateral to the lender. The lender
knows that in case of any adverse event which causes financial losses or affects the income potential of
the borrower, the insurer will restore the borrower to his former financial position.
Fradulent Claims
Dishonest policyholders submit fraudulent claims to insurance companies by faking losses. The payment
of such claims increases the cost of insurance for all insureds.
Inflated Claims
Another related cost of insurance is submission of inflated claims by policyholders. While the loss is
actual and accidental, many policyholders inflate the severity of loss so as to profit from insurance. This
again results in higher premiums for all insureds.
Chapter Review
Definition:
Utmost Good Faith is defined as a positive duty voluntarily to disclose, accurately and fully, all facts
material to the risk being proposed, whether requested or not.
Definition:
A Material Fact is any fact which would influence the insurer in accepting or declining a risk or in fixing
the premium or terms and conditions of the contract.
1. Misrepresentation
2. Non-disclosure
Misrepresentation happens when the proposer does not report the facts accurately.
Non-disclosure happens when the proposer omits to report material facts. If the proposer deliberately
hides facts that he knows to be material it is called “Concealment”
Definition:
Insurable interest is the financial interest of the proposer
in such a manner that the proposer stands benefited by
the safety or continuous existence of an asset and
absence of liability and prejudiced by the destruction or
damage of assets or existence of liability.
Example
Suppose a person uses his car to travel to work. Then he is benefited by its safety as it adds convenience
to his life. But if the car meets with an accident then the person would need to get his car repaired, if he
wishes to continue enjoying the comfort of traveling by car.
1. By Common Law: When the element of insurable interest is automatically present, it is said to have
arisen through common law. For example, if a person owns a house, he is entitled to insure it.
2. By Contract: In this case, insurable interest arises by virtue of a contract entered into. For example,
normally the landlord is responsible for maintenance of the property but a lease may make a tenant
responsible for maintenance and repairs in the building. Such a contract gives rise to an insurable
interest of the tenant in the building.
3. By Statute: An act of parliament may create an insurable interest by granting some benefit to a
person or imposing some duty.
In Life Insurance
Every person has an unlimited insurable interest in his own life. His ability to get himself insured is
restricted only by his ability to pay the applicable premium.
A person also has an automatic insurable interest in the life of his/her spouse.
A person has insurable interest in the life of debtor, but only to the extent of loan outstanding.
In Property Insurance
The absolute owner has insurable interest in the property owned by him/her.
Any person who has partial or joint interest in some property is entitled to insure to the extent of the
full value of the property, rather than just the extent of actual interest. In such cases, he will be
deemed an agent for the balance.
Mortgagees and Mortgagors both have insurable interest. Here, the purchaser’s (or mortgagee) interest
arises because of ownership whereas the mortgagor’s interest arises as a creditor which is limited to
the extent of the amount of loan.
Trustees/ executors/ administrators are legally responsible for the property in their charge. So, they
have insurable interest.
A bailee is a person who legally holds the goods of another e.g. workshops, drycleaners etc. They
have insurable interest as they have the responsibility to take reasonable care of the goods.
Spouses have insurable interest in each other’s property.
In Liability Insurance
A person has insurable interest to the extent of any potential liability which may be incurred by way
of damages or costs. For example, a drug manufacturing company may incur a liability due to ill
effects of a new drug.
In liability insurance, it is not possible to predetermine the extent of interest because there is no way of
knowing how and when one may incur liability and what would be the monetary value of the liability.
In practice, a realistic judgment is made by the insured about the maximum liability that may be
incurred and insurance procured for that amount,unless any relevant statute has fixed some limits.
Assignment
Assignment refers to transfer of title of the policy from one insured to another.
For example, if A sells his car to B, then A ceases to have insurable interest in the car. At the same time,
insurable interest is created for B with the ownership of the car. In such a case, A can transfer the
insurance policy in the favour of B.
Nomination
A life policy holder may appoint a nominee to receive the policy proceeds becoming payable in the event
of his/ her death during the term of the policy.
Unlike an assignee, nominee does not have any right to sue the insurer, except to receive the policy
proceeds payable to him from the insurer.
The policy holder may change nominee at any point of time without consulting the insurer or the nominee.
In the absence of nomination, the legal heirs of the deceased policy holder need to submit the relevant
documents as a proof of the right to claim under the policy.
Nomination is nothing but a form of assignment of proceeds of the insurance policy.
Property Insurance
In this case, the amount of indemnity is determined not by the cost of the property but by the value at the
date of the loss and at the place of the loss.
If the value has increased during the currency of the policy, the insured
is entitled to an indemnity on the basis of the increased value. This
rule is, however, subject to policy conditions such as the total sum
insured etc.
In assessing the amount of indemnity, the following are not considered:
Indemnity only
New for old
“Indemnity only” policies operate in the same way as other property insurances. The cost of replacement
is paid with deductions for wear and tear.
In the “new for old” type of policies, there is no deduction for wear and tear. Indemnity is calculated at
replacement at current market price. Accordingly, the premium payable in this type of policies is higher
than that in “indemnity only” policies.
Liability Insurance
Amount of indemnity is the amount of any court award or negotiated “out-of-court” settlement plus costs
and expenses arising in connection with the claim.
Sum insured
The total sum insured is the limit of maximum amount recoverable under the policy even if the calculated
amount of indemnity is higher. Indemnity can exceed the sum insured if the policy is not updated for a
long time and in that duration, the value of the property increases.
Exceptions
At times, in marine insurance policies, some loss minimization expenses are paid even in excess of sum
insured.
Depreciation
The value of an asset decreases over time due to constant use. So the amount towards depreciation due
to wear and tear is generally deducted.
Salvage
In case of partial loss, the property may remain in a deteriorated or damaged condition. If the insurance
company has agreed to pay the loss in full, it is entitled to any materials left. If the left over parts are not
deposited with the insurance company, the amount payable is reduced by the value of salvage. This is
common practice in motor insurance policies.
Sum Insured
Loss = Amount of Recovery
Total Value
Therefore, when the average clause operates to reduce the amount payable, the insured is receiving less
than an indemnity. This is because, he is considered his own insurer for a proportion of risk and in that
sense is supposed to “indemnify himself” for the balance.
Excess
An excess is the initial amount of each and every claim that is supposed to be borne by the insured
himself. The objective is to eliminate the small losses which may involve comparatively high administrative
cost for the insurer. Excess is of two types – Voluntary and Compulsory. Voluntary excess is voluntarily
opted for the insured and results in reduction of premium whereas compulsory excess does not result in
any reduction.
Limits
Many policies limit the amounts to be paid for certain events by the wording of the policy itself. For
example, universal health insurance policies often specify a limit of Rs. 15,000 per claim.
Corollaries of Indemnity
There are two corollaries to the principle of indemnity – Subrogation and Contribution.
Subrogation
Definition:
Subrogation is the right of one person (insurer), having indemnified another (insured) under a legal
obligation to do so, to stand in the place of that other (insured) and avail himself (insurer) of all the
rights and remedies of that other, whether already enforced or not.
This principle is corollary to the principle of indemnity in the sense that it prevents the insured to be
benefited by loss after receiving the loss from the insurer as well as the responsible third party. The
insured may recover the loss from another source after receiving the claim from the insurers but that
additional money must be given to the insurers.
Subrogation applies only when there is a contract of indemnity. It is not applicable in life insurance,
personal accident insurance as these are not subject to the principle of strict indemnity.
Basis of Contribution
Contribution is usually calculated on the basis of ‘Rateable Proportion’. This means that each insurer
contributes towards paying the loss in proportion to the sums insured on the policies.
The amounts payable by each insurer are calculated as per the following formula:
To illustrate: Let us assume that a businessman has insured his warehouse against the peril of fire with
three different insurers for Rs 5 Lakh, Rs 3 Lakh and Rs 2 Lakh. Suppose the warehouse is partly
destroyed due to fire and the amount of loss is assessed at Rs. 2,00,000. Then the amounts payable by
each insurer would be calculated as per the following formula:
Note
Even if the property is underinsured, the insured is considered to be his own insurer for the uninsured
amount. Thus, as per the concept of rateable proportion, the insured is supposed to contribute towards
bearing the loss with respect to the uninsured amount.
Definition:
Proximate Cause is the active efficient cause that sets in motion a train of events which bring about
a result, without the intervention of any force started and working independently from a new source.
Therefore, the more proximate cause of damage in terms of time was water. However, as per the doctrine
of proximate cause, the time that elapses between cause and result does not matter. We know for sure
that damage by the use of water was caused because of the fire that started in the first place.
Types of Perils
Once the proximate cause is identified, the next step is to determine if the causative peril is covered by
the insurance policy or not.
Insured Perils
These are perils that are covered by the policy as insured. For example, – fire, lightening, theft etc.
Application in Practice
In practice, losses caused only by insured perils are payable under the policy. Losses where the proximate
cause is an excluded or uninsured peril are not payable.
To entitle an insured to recover, the train of events leading from the insured
peril to the actual financial loss suffered by the insured, must be unbroken.
If the sequence of events from an insured event is broken by a train of
events from an excepted or uninsured peril, then only the loss upto the
break is covered.
Let us look at an example to understand this concept in depth:
Suppose a fire breaks out in a building which is insured against fire but not
against earthquake. About 50% of the building is destroyed in the fire.
Further suppose, that there is an earthquake later in the day and the entire
building is reduced to rubble.
In such a case, only 50% of the building value is payable, since the rest
of the damage was caused by an uninsured peril i.e. earthquake. It is also important to note that the
latter cause (earthquake) of the damage was completely independent of the former cause (fire).
Chapter Review
I nsurance policies are based on the law of contracts. Each insurance contract must meet the following
essential requirements
Consideration
‘Consideration’ is the value that each party to the contract provides to the other. Without consideration,
there cannot be any contract. In case of insurance contracts, the consideration for the insured is the
premium payments and the agreement to abide by the terms of the policy. For the insurer, the consideration
is the promise to make payment of the sum insured on occurrence of a specified event.
Competent Parties
Each party to the insurance contract must be legally competent to enter into contract. For the insured,
this means that the proposer should be an adult of sound mind. For the insurer, this means that the
insurer must have a valid license to do insurance business.
Common Intention
Parties to a contract are said to have common intention when they understand the same thing in the
same manner at the same time.
For example, if the proposer intends to take a policy for theft then it should not be misunderstood with
burglary. Burglary entails forced entry into the premises, but that is not the same in case of theft.
Legality of Purpose
The purpose of the insurance contract should be legal. A terrorist cannot insure his weapons against
theft because the object of the contract is not legal and is contrary to the greater public interest.
Aleatory Contracts
Aleatory contracts are those where the value exchanged is not equal but depends on an uncertain event.
Depending on the occurrence of a chance event, one party to the contract may receive a value out of
proportion to the value that is given. For example, in case of a motor vehicle insurance contract, an
individual may pay Rs. 5,000 as premium, but collect Rs. 5,00,000 if the car is stolen or destroyed during
the insurance period. Similarly, there may be cases where the insured pays premium but gets absolutely
nothing in return if no event causing any loss occurs.
Unilateral Contracts
Unilateral contracts are those in which only one party makes a legally enforceable promise. In the case
of insurance contracts, only the insurer makes that promise. If the insured does not pay further premiums
after the payment of the first premium, he cannot be legally forced to pay the balance premiums. The
insurer can withhold payment of claims if premiums are not paid but cannot force the insured to pay the
premiums.
On the other hand, if the insured pays the premium, the insurer is under obligation to provide the insurance
promised under the contract. In general contracts, if one party fails to perform, the other party can insist
on performance or sue for damages because of breach of contract.
Conditional Contracts
Conditional contracts are those which place certain restrictions or limitations on one or both parties. In
insurance contracts, the insured must comply with policy conditions if he wants to collect payment for
his claims. In case of non-compliance of the policy conditions, the insurer can refuse payment.
Personal Contracts
An insurance contract is a personal contract. This means that the policy is personal to the insured. With
the exception of life insurance, it may not be assigned to anyone else without the approval of the insurer.
Contract of adhesion
Contracts of adhesion are those that must be accepted in total, with all their terms and conditions. In
insurance contracts, this means that the insured must accept the policy issued by the insurer as it is.
The insured cannot insist on any changes or modifications to the contract.
Meaning of “Insured”
All insurance contracts invariably contain the precise meaning of the word “insured” in the
Definitions section. The contract generally indicates the insured person by name. In some insurance
contracts other parties are also covered even though they may not be named in the policy.
For example, a person may take a motor vehicle policy for the driver and the passengers of the car. This
would mean that any person driving the car and any passenger traveling in the car would be covered
under the insurance policy. It goes without saying that the driver must hold a valid driving license and
Co-Insurance
The same property can be insured with multiple insurers. In such a case whenever a loss occurs, it is
paid by all insurers in the proportion of their respective insurance amounts.
When a person chooses to insure a property for less than its full value, he is considered to be insurer for
self for the uninsured part. Accordingly in case of a loss, the insured has to bear the loss in the same
proportion as the uninsured part bears to the value of the property.
For example, if a property worth Rs. 5 lakhs is insured for only Rs. 4 lakhs, then the insured is considered
to be the insurer for self to the extent of Rs. 1 lakh. In case of a loss causing event where the property
suffers damages to the tune of say Rs. 3 lakhs, the amount payable by the insurance company would be
calculated as below:
or
Rs. 4,00,000
Rs. 3,00,000 = Rs. 2,40,000
Rs. 5,00,000
Purpose
The purpose of co-insurance is to achieve equity in charging premiums. For example, consider two
adjoining properties valued at Rs. 5 Lakhs each. Suppose the owner of the first property – Mr. A – insures
his property for Rs. 4 Lakhs only while the owner of the second – Mr. B – insures his property for the full
value of Rs. 5 Lakhs. If the premium rate is Rs. 1 per thousand ,then Mr. A pays a premium of Rs. 400
while Mr. B pays a premium of Rs. 500.
Further, suppose both properties suffer damages of Rs. 3 Lakhs. If the principle of co-insurance is not
applied both Mr. A and Mr. B will receive Rs. 3 Lakhs from the insurer. But Mr. B will be paying more
premium to get the same amount as Mr. A. This would be inequitable and implies penalizing individuals
who insure their assets for their true value!
Hence Mr. A shall get i.e. 80% of the loss which works out Rs 2.40 lakhs only.
M edical insurance is a type of insurance where the insurer pays the medical costs of the insured if
the insured becomes sick due to covered causes, or due to accidents
Example
Suppose “A” is driving back to his home after work on his two-wheeler. He gets hit by a speeding car from
behind and suffers intensive brain injuries. He has to now undergo immediate surgery. He has to bear all
those expenses out of his pocket in case he has not taken any medical insurance.
Indemnity Plan
Managed Care Plan
Reimbursement of actual charges : Where the actual cost of medical expenses is reimbursed.
Reimbursement of a percentage of actual charges: Where only a set percentage of the actual
charges is reimbursed. The rest has to be borne by the consumer.
Indemnity: Where a specified amount per day for a predetermined number of days is paid regardless
of the actual cost of care. The reimbursements however, will never be more than the actual expenses.
Example
A person enrols for a Medical Insurance Plan. He opts for coverage of up to 1 lakh rupees. Suppose, he falls
sick and incurs an expense of Rs 10,000 over a period of 5 days. If the insurance company reimburses the full
10,000 rupees to him, this will be an example of indemnity plan with reimbursement of actual charges.
In case the medical insurance company pays him @ Rs 1000 per day, i.e. Rs 5000 in total (since he was
ill for 5 days only) then this would be an example of indemnity plan with indemnity.
In case the medical insurance firm reimburses 80% of his total expenses, i.e. to say Rs 8000, then this
would be an example of indemnity plan with reimbursement of a percentage of actual charges.
What are the factors that need to be considered while determining the coverage?
The determination of an appropriate coverage will depend on a number of factors. A few of them are
as follows:
Age
Health history and Present health condition
Profession
Income and Prior Financial Commitments
Options of floater cover
Example of age as a factor
A 23 year old will be less susceptible to disease than a 45 year old, who might run a risk of heart attack,
diabetes or blood pressure.
Example
Person A is earning Rs 1 Lakh per annum. Person B is earning Rs 3 Lakh per annum. Both will have
different capacity to pay premium and hence, would take different coverage
Person A earns Rs 1 Lakh per annum but has no prior financial commitments. Person B earns Rs 2
Lakh per annum, but has an education loans worth Rs 1.5 Lakh. This prior commitment would reduce
person B capacity to pay premium and thus, he would take a lower coverage.
Options of floater covers
A person might decide on the amount of coverage based on the concept of floater covers. Floater cover
policy is a policy under which the policy is purchased by a group of members, mostly belonging to the
same family. This policy allocates a total amount for the family rather than for individuals; giving the
advantage of a large cover for the family. This policy is based on the assumption that at any point in
time, all the members of the group would not require the complete amount of cover.
Example
Suppose 3 members of a family purchase Rs. 1 Lakh worth of cover individually. However person A of
the family uses only Rs. 50 thousand of the entire cover, person B doesn’t use the entire 1 Lakh while
person C requires Rs. 1.5 Lakh for his treatment and has to provide the 50 thousand rupees from his
side. This family can take a floater cover policy of a total of Rs. 2 Lakh which is available for all the three
members. As the total sum insured is less than the individual cover, the premium on this policy is lower
and thus the cash outflow is lower.
Benefits
This policy offers compensation in case of death or bodily injury to the insured person, solely as a
result of an accident, by external, visible and violent means.
The different variations have different coverages ranging from death to comprehensive covers including
death, permanent disablements and temporary total disablements.
An Indian adult up to the age of 70 can cover himself / herself and dependent family members
between the age of 5 and 70 years.
This policy also provides a daily allowance for the tenure of hospitalization.
Some policies of this category also provide for the education of 2 dependent children of the insured
person and a bonus on the total sum insured in case of permanent disability.
Chapter Review
A part from risks to life and health, a person is also exposed to risks that may cause damage to his/
her property. These risks can be covered by opting for Personal Property insurance.
Let us look at some of the major property insurance types in more detail.
Householder’s Insurance
A comprehensive householder’s insurance policy covers most of the risks faced by any household. It
protects against natural calamities like flood and earthquake and also man-made disasters like theft and
burglary.
Instead of opting for separate policies for the building and for the contents of the house, the householder
can take up one package policy.
Private cars: This category includes cars, station wagons, motor vehicles used for social, domestic,
business or professional purposes (excluding those used for the carriage of goods other than samples)
Motor Cycles: This includes motorcycles with or without sidecars, pedal cycles, mechanically assisted
pedal cycles and motor scooters with or without sidecars.
Commercial Vehicles: All vehicles excluding private cars, motor cycles and vehicles running on rails
come under this category.
Determining the value of the vehicle
The value of the vehicle is calculated on the basis of the current showroom price of the vehicle multiplied
by the depreciation rate that is set by the Tariff Advisory Committee at the commencement of each
policy period. This is called IDV (Insured’s Declared Value).
Type of Vehicle
Age of the vehicle
City of registration
Use of the vehicle
Bonus / Malus System
In case of an accident occurring in a year for which the insured makes a claim, in the very next year the
insurance company increases the premium by way of charging a malus i.e an extra percentage. On the
other hand, when there is no claim lodged during the year, the insurance company grants a discount in
the premium by way of bonus.
No Claim Bonus (NCB) clause is applicable to holders of comprehensive insurance policy. The minimum
bonus is 20 percent and the maximum is 65 percent.
Misleading statements
Errors and inaccuracy in financial statement and annual accounts
Lack of judgment and good faith
Unfair allotment of shares
Mis-statement in prospectus
Unauthorized loans or investments
Unfair dismissal of an employee
Unwarranted dividend payment, salaries, or compensation
Failure to obtain competitive bids
Using inside information
Misrepresentation in acquisition agreement for the purchase of another company
Exclusions
The policy does not pay for:
Prior and pending litigation and claims submitted under previous policies
Bodily injury, sickness, disease, emotional distress, death, damage, or destruction of tangible property
including loss
Criminal wrongs
Deliberate, dishonest, or fraudulent acts
Pollution and/ or contamination
Professional Indemnity Policy / Professional liability Insurance
This policy is meant for professionals like doctors to cover liability falling on them due to mistakes and
omissions committed by them while rendering professional service. Though doctors are supposed to be
immaculate in their profession, they are human beings and are prone to errors. As a result, they are
exposed to the risk of claims from clients who have suffered loss due to negligence.
Any liability arising out of or in connection with any criminal act or act committed in violation of any
law
Acts committed under the influence of drugs
Weight reduction
Plastic surgery
HIV Aids
Radioactivity
Blood Banks
Non-compliance with statutory provisions
Accidental death
Bodily injury or disease
Loss or damage to property
Exclusions
The policy does not cover any liability for:
Product recall
Product guarantee
Exclusions
The policy does not cover liability or costs, which arise out of the following factors:
Earthquake, volcanic eruption, flood, storm, hurricane, tornado, or similar weather conditions
Deliberate or willful non-compliance of statutory warnings
Fines, penalties, and damages
War, invasion, hostilities
Loss of goodwill in the market
Ionizing radiation or contamination by radioactivity from any nuclear fuel or from any nuclear waste
from the combustion of nuclear fuel
Any injury that does not result in a fatality or disability for 3 days subsequent to the accident
Any injury caused due to:
War or nuclear perils
Exercise
Ravi had joined Numark recently as the Director-Marketing. He was given a car and a driver by this
company. The company had taken insurance, which will give compensation for other vehicles’ driver and
pedestrians in case of any untoward accident involving the company car. It is mandatory for all vehicles
to take this policy. The HR manager asked that instead of taking only this cover; why not take a more
complete one. It would also cover the car in case of any loss due to theft of the car. What are the two
types of insurance that is being talked about?
Solution : The two types of insurance are third party insurance, comprehensive motor insurance.
Ravi will be the spokesperson of the company. He is the key person, who works as a representative of the
company. It is important that the company takes a (Directors and Officers Liability) insurance policy.
Does it cover dishonest, deliberate or fraudulent acts?
Solution : The insurance policy does not cover dishonest, deliberate or fraudulent act.
Numark is a pharmaceutical company. They manufacture generic drugs for diabetes and hypertension.
There are reputed players in the market and well known for quality products. However, they had started
their distribution in South East Asian countries and wanted to expand business. There is one insurance
policy that is definitely recommended. What do you think it is?
Solution : Products liability insurance is recommended.
Numark also runs a chain of clinics across the rural areas. The brothers in partnership thought that this
would be a good way to give back to the community. They started this business about 10 years back and
it has been very successful in treating a lot of patients who would otherwise find it difficult to access
bigger cities where all the facilities are already available.More than it being a business proposition, it
started out being a part of the corporate social responsibility.Since it was managed well, this new associate
venture grew in size and geography.The philosophy was to help all the poor and needy free of cost.The
hospital became well known for its treatment and quality of service. Many people started queing up to get
treated who were not necessarily poor but came from the middle class backgrounds. This low revenue
earning model, an associate of the main business was doing contributing up to 7% profits of the company.
The company hires a lot of doctors, who have just completed their education and want to train under
diverse conditions. The company want their costs to be optimized, yet give quality care. To hire young
doctors who are yet gaining a wider range of experience was one of their ways of doing it. The management
decided that it made legal sense to take up another policy. What policy to do think that would be?
Solution : Numark should take up Professional Indemnity Policy.
P ersonal financial planning for the business owner requires that the risks affecting his business
should also be covered. No matter how diligent an entrepreneur is, a single crisis can annihilate all
profits and can even ruin the business. Protecting the business with insurance is the key to cover all
financial risks. It ensures that the money invested in the business does not disappear whenever a
catastrophe strikes.
It is the job of the financial planner to study the nature of the business run by his client and spot the
potential exposure to risk. Whereever the financial planner feels the need, he/she should not hesitate to
consult an expert in this area.
Crime insurance
This protects the business in case of theft.
Reduction in profit
Loss of significant clientele
Loss of time, money and efforts in recruiting a replacement
Loss of business ideas, projects and ventures
How much key person insurance is enough?
There is fixed formula that determines the value of a key employee. Expected profits, replacement costs
and a compensation-multiple formula are the usual techniques of determining a loss. The following
factors are also taken into consideration to determine the amount of coverage:
Projects that would be lost with the loss of the key employee
Sales generated by the employee
Age of the person
Physical condition of the person
Cost of replacing the individual
Important:
Partnership and proprietorships tend to be much more dependent on one or two key employees as
compared to companies. Therefore, key employee insurance is much more relevant for them.
A ll across the world, insurance is a highly regulated industry. The reason for this is that for the
insurance industry to run smoothly, it is essential that the insuring public has complete faith in the
capabilities of the insurers.
This faith is essential because the insuring public pays premiums much in advance and the claims occur
far into the future. If during this period some insurer goes bankrupt and is not able to pay claims of the
insured when they arise, then the entire purpose of insurance would be defeated. Also, if because of
some unscrupulous insurers the faith of the public gets shaken, then the entire insurance industry would
collapse. People would stop buying insurance out of fear. This would lead to dwindling sales and the law
of large numbers would cease to be applicable as insurance companies will be unable to get a large
number of homogenous risks to cover. This in turn would increase the unpredictability and make it
difficult for insurers to charge the correct premia.
If the insurers charge excess premia, then they would reduce the market size even more and if they
charge less, then they themselves may go bankrupt.
As a result, insurers are regulated to:
Types of Agents
Broadly, agents are classified into two categories as follows:
General Agent - One who is authorized to act for his principal in all matters in a specified sphere.
Special Agent - One who is authorized to transact a special business, e.g. to buy or sell a particular
product.
Insurance Agent
Insurance agents are a kind of special agents who are authorized to transact insurance business. They
are further subdivided into two categories namely:
Direct Agent
Corporate Agent
Direct Agents
Under direct agents, there are three types of agents:
Life Insurance Agent - One who is licensed to transact life insurance business only.
General Insurance Agent - One who is licensed to transact general insurance business only.
Composite Insurance Agent - One who is licensed to transact both life and non-life insurance business.
Corporate Agent
A corporate agent can be a firm, a company under the Companies Act, a banking company, a regional
rural bank, a cooperative society, a panchayat, a local authority, a non-government organization, a
micro-lending finance organization, or any other organization approved by IRDA.
Training
The applicant has to complete at least one hundred hours practical training from an approved institute in
life or general insurance business as the case may be.
Pre-recruitment Test
The applicant has to pass the pre-recruitment examination in life or general insurance business or both,
as the case may be, conducted by the Insurance Institute of India or any other examination body recognized
by the Authority.
Issuance of License
The designated person on being satisfied with the formalities of the application, grant the license along
with the identity card.
In case of a composite agent, separate identity card should be issued by life and non-life insurance
company.
Authority of an Agent
An agent can act only to the extent of authority granted to him by the principal.
Details of various plans of insurance like covers, premiums, exclusions, conditions, warranties.
The office procedures for various matters including the forms and documents considered necessary.
Disclose all the material facts accurately to help the underwriter make his decision with regard to
acceptance of the proposal, as made.
Commission
Commission is the remuneration which the Agent gets in lieu of his services towards the Insured and the
Insurance company. This is paid by the Insurance company and not the Insured.
Commission should not exceed 15% of the premium.
The terms of appointment of the agent include rates of commission, which may be:
Training – The Agent has to complete 25 hours practical training in life or general insurance business,
as the case may be, or at least 50 hours practical training in life and general insurance business, in
the case of a composite insurance agent.
Fees – Rs.100/- . However, an additional fee of Rs. 100 is charged in case of late applications, even
if it is made before the date of expiry.
Termination of Agency
An Agency can be terminated in the following circumstances:
Code of Conduct
Every insurance broker needs to follow recognized standards of professional conduct and discharge his
functions in the interest of the policyholders.
Remuneration
On Direct General Insurance Business:
No insurance broker can be paid or contracted to be paid by way of remuneration (including royalty or
license fees or administration charges or such other compensation) an amount exceeding:
On tariff products:
10% of the premium on that part of the business, which is compulsorily under any statute
or any law in force.
12.5% of the premium on others.
On non-tariff products:
17.5% of the premium on direct business.
Premium from a single client:
The premium shall not exceed 50% of the total premium of a broker in the first year of business, 40%
of in the second year of business, and 30% from the third year of business.
News-bytes
T here are some interesting facts from the insurance company point of view relating to the worst floods
which took place in the history of Mumbai in the last 100 years on 26/7.
Let me share with you what happened in the 26/7/05 rain disaster at Mumbai. All insurance companies
had to take care of their claims during such a tragedy. It was definitely a better situation for all those
people who had taken insurance covers than those who hadn’t. Some newspaper reported that though
the damages were inflated, the insurers were forced to pay because of their commitment.
Generally, with a flood like situation, there are insurance claims made each year, but their surveyors are
more stringent than they were at the time of the major flood disaster like 26/7. Largely, 50% of the claims
come from the retailers and the shopkeepers, and about 40% from the wholesale stockists. The remaining
comes from owners of ground floor flats in low-lying areas. On normal flood days, there are claims from
car owners whose cars get damaged, as well. Typically, the average repair costs are claimed for falls
between Rs. 3000 to Rs. 10000, as quoted by Mahendra Dhruva, president of the Institute of Surveyors,
Valuers and Adjusters.
But, if the cars get submerged in water, then the claims become much heftier. When water seeps in, the
power steering gets damaged which costs Rs. 30000.Damaged upholstery cost anywhere between Rs
5000 to Rs. 20000. So, when deep flooding happens, the car damage claims go up by an average of four
times the normal flooding damages’ amount. The insurer also says that if the damages are below Rs.
3000, then it is better to avoid asking for the claim, since one loses out on valuable bonus points and the
premium amount could rise. Insurance had to shell out monies to the tune of Rs. 5000 crores in damaged
property claims. A senior official from the public sector insurance company mentioned in leading papers
that the company was still recovering, after almost 2 years, from such a huge outflow of funds, due to
indemnity provided during disasters of such a large magnitude.
The above-discussed article drives home two important points. Risk assessment is a major function of
an insurance company and the underwriter identifies this risk and calculates the premium to be paid.
Each situation carries a different risk, which needs to be considered and studied very carefully while
undertaking a policy. The second major point discussed is that insurance companies also need to cover
their risk with a reinsurer to tide over major fall-outs like the New York bombing by Al Qaeda. If this
weren’t the case, a lot of insurance companies would have been wiped out because of the claims that
opened due to 9/11 disaster.
Insurance companies (insurers) act as facilitators between groups of people who share similar risks. In
its simplest form, an insurance company collects premiums from policyholders (insureds), invests those
premiums, compensates for losses and shares some of the surplus with policyholders. Eventually,
insurers give policyholders some sort of a financial reimbursement, either upon the policyholder’s death
or when a policy matures.
Life Insurance Companies: These companies provide insurance for human life. They guarantee a
specific sum of money:
to a designated beneficiary upon the death of the insured, or
to the insured if he/ she lives beyond a certain age
General Insurance or Non-life Insurance Companies: These companies provide insurance for
property and profession/ business related liabilities.
No company can deal in both life and general insurance through a single entity.
Rate making
Underwriting
Production
Claims settlement
Reinsurance
Investments
Insurers also engage in other operations like customer service, to handle client queries and transactions;
and other internal departments such as human resources, accounts and administration.
Let us look at the major operations in more detail.
Rate Making
Rate making refers to the pricing of insurance. Insurance pricing differs significantly from the pricing of
other products in the sense that at the time of the sale of the insurance policy, the insurance company
does not know what the actual costs are going to be to service that policy. It is only after the period of
insurance has passed that the insurance company can determine the actual cost.
As a result, insurance companies have to determine their premiums on the basis of probabilistic and
statistical analyses. The person who determines rates and premiums for the insurer is known as the
actuary. Actuaries study past data to arrive at probabilistic figures for loss causing events and determine
the premium to be charged from persons seeking insurance.
Underwriting
An insurance company’s main business is that of underwriting or writing insurance policies. The insurer’s
underwriters identify and calculate the risk of loss from policyholders; establish appropriate premium
rates; and write policies that cover this risk. An insurance company may lose business to competitors if
the underwriter appraises risks too conservatively, or it may have to pay excessive claims if the underwriting
actions are too liberal.
Each insurance company uses its own set of underwriting guidelines in order to determine whether or not
the company should accept a proposal. In life insurance, this decision process sometimes requires that
applicants provide further medical evidence. Applications often are supplemented with medical reports
and reports from actuarial studies.
1. Age
2. Gender
3. Height and weight
4. Health history (and often family health history)
5. The purpose of the insurance (such as for estate planning, or business or for family protection)
6. Marital status and number of children
7. The amount of insurance the applicant already has, and any additional insurance he/she proposes to
buy (as people with far more life insurance than they need tend to be poor insurance risks)
8. Occupation (some are hazardous, and increase the risk of death)
9. Income (to help determine suitability)
10. Smoking or tobacco use (this is an important factor, as smokers have shorter lives)
11. Alcohol (excessive drinking seriously hurts life expectancy)
12. Certain hobbies (such as race car driving, hang-gliding, piloting non-commercial aircraft)
13. Foreign travel (certain foreign travel is risky)
Underwriters then must decide whether to issue the policy and, if so, the appropriate premium to charge.
In making this decision, underwriters serve as the main link between the insurance company and the
insurance agent.
The underwriters can decide to make a counteroffer in which the premiums have been increased, or in
which various exclusions have been stipulated, which restrict the circumstances under which a claim
would be paid. Some companies use automated underwriting systems to encode these rules, and reduce
the amount of manual work in processing proposals.
Life insurance companies each have their own extensive policies and procedure manuals they are supposed
to follow in determining whether or not, to issue an individual, a life insurance policy, and in pricing that
policy.
Most underwriters specialize in one of the three major categories of insurance: life, health, and property
and casualty. Life and health insurance underwriters may further specialize in group or individual policies.
Property and casualty underwriters usually specialize in either commercial or personal insurance and
then by the type of risk insured, as in fire, homeowners’, automobile, marine, or liability insurance, or
workers’ compensation.
Production
In case of insurance companies, the term ‘production’ refers to sales and marketing activities. Life
insurance products are distributed primarily through a direct-selling system or through an agency system.
Direct-selling
In a direct-selling distribution system, the insurer deals individually with customers, through its own
employees. A number of marketing techniques are used including direct response and sales through
company-run agencies.
Claims settlement
The claims division of an insurance company performs the verification of a covered loss, ensures fair
and prompt payment of claims and provides assistance to the insured. The claims process is as below:
Intimation of the claim event, in writing and in the company’s specified format, signed by the claimant
(beneficiary/ nominee/ assignee/ legal heir). This intimation needs to mention the following:
A statement that the claim event (death/ accidental death/ permanent disability/ critical illness) has
occurred
Details of the policy under which the insured is covered
Date of the claim event
Place of occurrence of the claim event (hospital/ residence etc) and the address of such place
Cause of the claim event with supporting documents
Proof of the claim event with supporting documents (e.g., original death certificate in case of death
claim / hospital reports in case of critical illness claim etc)
Original policy document
Proof of age of the insured, if this has not been previously admitted by the company
Step 2: Receipt of Claims by the Company
The claimant would contact the insurance company’s claims department with the completed form. The
company would acknowledge receipt of the claim form.
If the claim cannot be settled quickly, the insurance company would provide an indicative time to the
claimant.
If it appears that the claim is not covered by the insurance policy, the company sends a notification as
soon as possible to the claimant, explaining why it is not covered.
Denial of claim
Offering an amount different from the amount claimed
Step 5: Complaints and Dispute Settlement
When the claimant files a complaint in case of a disagreement on settlement amount or non-fulfillment of
the claim by the insurer:
If the claimant is dissatisfied with the final response that he/ she has been sent by the company, he/ she
can activate an internal appeals process.
The claimant can also appeal to the dispute settlement procedures available outside the company (for
example, the handling of complaints by the supervisory authorities). In case of a dispute, the claimant
should be informed by the company of the existence of these appeal procedures. In some instances, a
claims dispute can result in litigation and is then settled in civil courts.
Reinsurance
Reinsurance is the means by which an insurance company (called the reinsured, ceding company or
cedant) shares the risk of loss with another insurance company (called the reinsurer). The reinsurer is not
directly involved in issuing insurance policies but only assumes a portion of the risk of many insurers.
There are many reasons an insurance company will choose to buy reinsurance. Some of these include:
Risk transfer: The main use of reinsurance is to allow the ceding company to assume risks greater
than its size would otherwise allow, and to protect itself against catastrophic losses. For instance, if
an insurance company can write policies with a maximum coverage of only Rs. 10 million, it can
reinsure (or cede) the amount in excess of Rs. 10 million to reinsurers.
Reinsurance is also particularly useful for an insurance company to protect itself against large catastrophic
losses, such as those arising out of hurricanes or other natural calamities or even terrorist activities.
Income smoothing: Reinsurance can help to make an insurance company’s results more predictable
by absorbing extraordinary losses.
Arbitrage: An insurance company may purchase reinsurance coverage at a rate lower than what it
believes is the true cost for the underlying risk. This is possible in a soft pricing scenario, when both
insurance and reinsurance pricing are relatively low.
Proportional
Under proportional reinsurance, the reinsurer assumes a stated percent share of each policy the insurer
writes and then shares in the premiums and losses in that same proportion. Premiums and losses are
shared on a pro rata basis
For instance, an insurance company might purchase a 50% proportional reinsurance; in this case they
would share half of all premiums and losses with the reinsurer.
The reinsurance company usually pays a commission on the premiums back to the insurer in order to
compensate them for costs incurred in sourcing and administering the business (usually 20-30%). This
is known as the ceding commission.
Investments
Insurers derive revenues from two main sources: premiums and investment income. Insurers collect
payments in the form of premiums from people who face similar risks. Earned premiums are typically an
insurer’s primary revenue source. At the time of issue of a policy, it is recorded on the insurer’s books as
a “written” premium. Then, over the life of the policy, the premium is “earned,” or recognized as revenue.
A part of the earned premiums are set aside to cover policyholder claims and are transferred to a loss reserve.
The second-largest component of insurer revenues is investment income. This is derived from investing the
funds set aside for loss reserves and from policyholders’ surplus or shareholders’ equity. An insurance
company invests this corpus in a number of investment vehicles such as equity, debt, corporate bonds etc.
Commission paid to the insurance broker, agent, or salesperson for selling a policy; this is usually
deducted immediately from the collected premium.
The largest expense facing a property-casualty insurer is losses, also referred to as policyholder
claims. Funds are also used to pay claims-related expenses, including insurance adjusters’ fees and
litigation expenses.
Insurers also face expenses related to the underwriting process, such as salaries for actuarial staff.
Like most other companies, insurers incur various other operating expenses and interest costs.
Broadly speaking,
Insurance company income = Underwriting Profit + Investment Income
The combined ratio is a measure of an insurance company’s overall underwriting profitability.
Loss Ratio = Losses due to policyholder claims
Expense Ratio = Salaries of actuarial staff and other underwriting expenses
Example:
Let’s assume the following details for an insurance company
Losses due to policyholder claims = Rs. 1 crore
Expenses = Rs. 50 Lakhs
Net premium written = Rs. 1.5 crore
Combined ratio = (1 + 0.5) / 1.5 * 100 = 100%
L et me draw out an important and a relevant scenario for you. Read on as we discuss an important
issue. Most of us who have bought a house, should consider ourselves lucky. Why?
The double whammy of rising real estate prices and increasing interest rates is threatening to put homes
out of reach of most first time buyers. Here’s the worrying statistic, brought out by HDFC- in 2004, the
average home owner could buy a house at a price that was equal to 4.4 years of his annual income.
Today that figure has been pushed to 5.1 times, meaning that he will need more than five year’s income
to buy the same house despite an increase in his own income during the intervening period.
EMIs
Even worse, the equated monthly installment (EMI) that he’s required to pay has shot up from 42% of the
monthly income to more than 67%. More than the rising prices, it is the hike in EMI’s that could end up
making homes unaffordable. In 1995, almost 35% of the home loan applicants to HDFC had an annual
income of around Rs. 1.2 Lakhs. Since most of the people who came from that bracket, that’s the figure
that was assumed to be the homebuyer’s income. Coming to the 2000s, the average salary increase
from 1995 to 2007 amounted to 13.2% annually based on data across a cross section of industries.
Infact the year 2004, was the best year to buy a house, since the price to income multiple touched a
lowest of 4.4 and EMI as a percentage of the income, touched a record low of 42%.
Then the tide began to change. Home prices rose faster than incomes and the interest rates have shot up
faster. The latter is worrying since the banks usually ensure that the EMIs does not exceed 40% of the
borrower’s monthly income. Under exceptional cases, it can go up to 50%.
In a scenario today, where the EMIs have gone up to 67% of the monthly income, the banks will simply
not loan enough money to make the purchase. To make the EMIs more reasonable, the prospective
buyer will have to pay more than 30% of the cost of the house on his own. But bankers also mention that
young people don’t have that kind of money saved up.
So we notice that the gap is widening.
Speaking of asset classes, real estate in terms of buying a home for occupancy is the single most
important agenda in a person’s lifetime. It is not for nothing that they say that buying a house and
marrying off a daughter well, are the two primemost concerns of a father. So plan ahead of time.
A house is only one asset class. There are many others. The wide range of investment options available
today also makes for a difficult, yet important investment decision. Terms like fixed deposits, bonds,
debentures, stocks, mutual funds etc, present a complicated puzzle, which a layman finds difficult to
understand. It is extremely difficult to identify a single investment that will perform well in a particular
year. Given this difficulty, investing in just one security—or one type of security— is risky. Therefore,
putting all your eggs (money) in just one basket (investment) may result in a large gain or a large loss.
Stocks
These are one of the riskier asset classes and represent an ownership or equity position in a corporation.
A stockholder can lay claim to a proportionate share in the corporation’s assets and profits and is
often paid dividends when the company makes money. Stock share prices will rise as the corporation
grows and there is greater demand for its stocks.
The idea is to buy stock when the company is still small, hold onto it for a number of years while the
company grows and becomes financially stronger. Then, sell it for a profit once the stock price has
risen as a result of new demand.
Bonds
A bond is a debt instrument issued for a period of one year or more.
This is a more conservative investment.
Bonds raise capital for the issuer by borrowing money from investors. With a bond note, the issuer is
basically promising to repay the principal along with interest on a specified date, also known as the
maturity date.
The government, states, cities, corporations and many other types of institutions sell bonds.
Mutual Funds
This is managed by an investment company that invests money belonging to a large number of
shareholders in various assets.
The primary advantage to investing in a mutual fund is that you automatically achieve a diversified
portfolio that is managed by professionals whose advice and expertise you might not otherwise be
able to afford.
Cash Equivalents
Cash equivalents are safe, short-term, very liquid investments that are, as the name suggests,
equivalents to cash.
Cash equivalents are excellent savings vehicles for short-term goals.
Real Estate
This may be defined as land and anything permanently fixed to it, including buildings, sheds, and other
items attached to the structure.
Unlike other investments, real estate is dramatically affected by the condition of the immediate area
where the property is located. With the exception of a global recession, real estate is affected
primarily by local factors.
The downside is that more time to sustain this investment is required. The maintenance and
management of the property will fall on the owner’s shoulders.
Commodities generally outperform other asset classes in an expansionary phase and deliver extra-
ordinary returns within short periods.
Commodities exhibit low correlation to equity and fixed income instruments and, therefore, provide a
natural hedge to the portfolio. Commodities, thus, provide a balancing and sobering effect on the
portfolio.
The outlook for commodities is positive given that the uptrend in the demand for a wide range of
commodities, driven by the high industrial growth in China and India, is likely to continue after having
spoken of different asset classes.
Comparison between two different asset classes
Let us consider the trend to see how the returns from sensex have performed against the various metals,
leading to a discussion on the importance of broadening of one’s portfolio.
Consider the last one and half years. If you compare the rally between the period of 6th February, 2006
and 6th July, 2007, this period saw the benchmark sensex moving up from 10000 to 15000 mark. The
average return from an equity investment was around 50% while the return from the precious metals like
gold and silver was as little as 4.5% and close to 25% respectively.
Bright prospects of the overall Indian growth story, coupled with comfortable liquidity flow make the
equity markets soar, while a lull in the demand of precious metals has given investors lesser returns in
other asset classes. Besides the rupee’s appreciation has also spoiled the party for gold investors in the
bullion market. Investors in both the metals have not realized the gain due to the rupee’s rise. Large and
small traders are equally shying away from piling up the stock, fearing further losses in case the strong
rupee rally continues.
In the international market, the investment inflows into gold have slowed down in the last 6 months. This
leads one to understand that a person should always invest in different asset classes and broaden the
portfolio, so that not all the eggs are put in one basket.
An investment in the real estate market, on an average in the equivalent time period, though it is too
short to make a judgment call on real estate investment for less than 10 year periods, have shown a
return of 20%.
To conclude the equity market has given the largest returns.
Comparison of returns between the different sectors in one asset class - STOCKS
We move to the next step of details. We are now getting into the analysis of equity returns sector wise.
The reason for bringing this discussion here is that this kind of analysis will become common everyday
parlance for a financial planner. This is also the language of money channel-CNBC. It will become
If you see the growth between early 2004 and mid-2006 was mainly because of re-rating of India as an
emerging market. This meant that there was a strong rally across all the sectors. Now the last one-year
has seen that the re-rating phenomenon has passed, and the growth is more specific to certain sectors.
Some of the sectors like the FMCG were undervalued at that time and thus returned 194% in this two-
year period. However, with the major correction in May-June’06, the sector has been lagging far behind.
IT, Oil and sun-rise sectors like media and telecom have performed better, while the rest have witnessed
poorer returns than the benchmark, and returned lesser than the May’06 levels.
Based on the above mentioned discussions, let us look at Neeraj’s example correlating it to the two
different tables shown above.
If Neeraj had invested in the metals sector in 2006 an amount of Rs. 50000, and stuck on to it, he would
be at a loss today, after 1.5 years, which comes to a negative of 13% on Rs. 50000 ie. Rs.6500. This is
called an aggressive approach to investing.
While if the same amount, Rs. 50000 had been invested in an fixed deposit, he would have earned an
interest of 12% cumulative, at 8% pa rate of return. Neeraj would have earned Rs.6000.This is a
conservative approach to investing
Ideally, if he had invested 50% of his total money, ie Rs. 25000 in Fixed Deposit (FDs) and the rest of the
25% into two different stocks in two different industries each, lets us see how his investment works out
for him.
Lets say, he had invested Rs. 12500 in technology stocks, and the other Rs. 12500 in metal stocks . The
overall portfolio of Rs 50000 would now be divided into 3 different investments. His FDs at 12% would
have given him, on Rs. 25000 ie. Rs. 3000. The 12500 in Aluminium based metal company would have
yielded of negative of 13%, which is a loss of Rs. 1625. The rest of the investment of Rs. 12500 in an IT
company would have yielded him at profit of 50%, ie 6250. So his overall income would have been Rs.
7625. This is definitely a better return than both a profit of Rs. 6000, or a loss of 6500.
Different types of assets carry different levels of risk and potential for return, and typically don’t
respond to market forces in the same way at the same time.
When the return of one asset type is declining, the return of another may be growing (though there
are no guarantees).
If you diversify by owning a variety of assets, a downturn in a single holding won’t necessarily spell
disaster for your entire portfolio.
Asset Allocation means Diversification of Risk
In the 1950s, Nobel Laureate Harry Markowitz revolutionized the financial markets by showing that
owning a diversified portfolio of stocks could lead to higher returns with less risk than owning any individual
stock. Since then, it has been a commonly accepted fact that Asset allocation is a way to control risk in
your portfolio. The risk is controlled because different asset classes in a well-balanced portfolio will react
differently to changes in market conditions such as inflation, rising or falling interest rates, market
sectors coming into or falling out of favor, a recession, etc. The following are the benefits diversification
of risk or asset allocation:
Diversification across asset classes balances investments with higher levels of safety with those
that have higher levels of growth.
Spreading a portfolio’s investment risk across several types of investments can help smooth out the
ups and downs of investing.
There are different asset classes like equities, bonds, real estate, cash and even foreign investments (to
a limited extent) available to Resident Indian investors now. It has been a well established fact that
Asset allocation has been primarily responsible for portfolio performance more than even stock selection
and timing issues. Asset allocation is the key to portfolio returns and hence, it is of paramount importance.
An asset allocation decision involves deciding the percentage of investable funds to be placed in stocks,
bonds and cash equivalents. It is the most important investment decision made by investors because it
is the basic determinant of the return and risk taken. This is a result of holding a well-diversified portfolio,
which we know is the primary lesson of portfolio management.
Thus, asset allocation serves the purpose of diversification among different asset classes and
diversification among different securities within an asset class.
The returns of a well-diversified portfolio within a given asset class are highly correlated with the returns
of the asset class itself. In other words, the returns on a stock portfolio will depend on the market returns
to a great extent. No stock is expected to give phenomenal returns when the market returns are low or
negative. Within an asset class, diversified portfolios will tend to produce similar returns over time.
However, different asset classes are likely to produce results that are quite dissimilar. Therefore, differences
in asset allocation will be the key factor, over time, causing differences in portfolio performance.
Example
Suppose Mr Sharma diversifies risk by owning 10 or even 50 different stocks. He really hasn’t done
anything to control risk in his portfolio if those stocks all come from only one or two different industries
in the same sector. Those stocks will often react to market conditions in a similar way—they will generally
all either go up or down after a given market event. This means buying 12 internet or tech stocks will not
give Mr. Sharma optimal diversification; instead he needs to buy stocks of different sizes and from
various sectors.
This flexibility adds a component of market timing to the portfolio, allowing you to participate in
economic conditions that are more favorable for one asset class than for others.
This strategy demands some discipline, as you must first be able to recognize when short-term
opportunities have run their course, and then rebalance the portfolio to the long-term asset position.
What factors have to be kept in mind during asset allocation?
There are all sorts of investment recommendations continually flowing from the financial press. The key
question is: Are they suitable for you? It’s important to be informed about asset allocation so as to avoid
the “one size fits all” approach that many investors end up accepting. Asset allocation is the cornerstone
of good investing. Each investment must be part of an overall asset allocation plan. And this plan must
not be generic (one-size-fits-all), but rather must be tailored to your specific needs.
Regardless of the approach you take, be sure that an asset allocation takes into account your financial
profile to the extent feasible. Asset allocation can be an active process in varying degrees or strictly
passive in nature. Whether an investor chooses a precise asset allocation strategy or a combination of
different strategies depends on that investor’s goals, age, investment time-frame and risk tolerance.
Investors should keep these considerations in mind:
Investors should arrive upon the most suitable Asset Allocation Plan.
Investors should not focus exclusively on “market value”.
Investors should not dwell upon comparisons of one’s own unique portfolio with Market Averages.
Investors should not expect “performance” during specific time intervals as this investment plan is
expected to perform over a long period of time.
1. Investor’s goals
To help you determine the mix of investment options that may be appropriate for your investment goals,
ask yourself the following questions:
An aggressive asset allocation is most suitable for investors with a long-term investment horizon (for
example, 10 years or longer), who tolerate risk well, and whose primary goal is growing their investments.
A moderate asset allocation is most suitable for investors with a medium-term investment horizon (for
example, 10 years or longer), who tolerate risk moderately well, and whose primary investment goal is a
moderate level of growth.
A conservative asset allocation is most suitable for investors with a short-term investment horizon (for
example, less than 10 years), whose risk tolerance is low, and whose primary investment goals are
generating income and protecting against inflation.
2. Age
Why does age play a crucial role in portfolio building?
3. Investment Timeframe
Your Investment Timeframe is how long you will be invested until you need to start pulling money out of
your investment portfolio. The longer you have, the more risk an investor can afford to take. A person
who needs access to his investment funds in 5 years will have a much different looking portfolio than a
person who is going to retire in 35 years.
4. Risk Tolerance
This can be defined as your comfort with the potential for investment loss in exchange for a potentially
greater return. Recent market volatility has made it more important than ever to consider the relationship
between risk and return when investing. Risk tolerance is a measure of your willingness to accept
investment risk in exchange for higher potential returns. Risk is the uncertainty of earning your investment
returns and is measured by the volatility of investment.
When you invest, the weight you give to each of these two desires is commonly known as your risk
tolerance. Knowing your risk tolerance will help you identify your investment profile and decide how to
allocate your assets.
For example, if you’re an aggressive investor, you’re likely willing to accept the risk of losing some of
your investment capital (that means a negative rate of return) in exchange for earning higher potential
returns. A conservative on the other hand, is less willing to accept risk, even for higher potential returns.
Capital is a top priority for conservative investors. As a result, they tend to favor conservative investments
such as certificate of deposit, money market accounts and government bonds.
Your risk tolerance depends on many things, including:
Your goals and time frames. You most likely have several goals—such as your children’s education,
a vacation home or an early retirement. You may be willing to take more risk with some goals than
with others, depending on your time horizon for each goal.
Personality. Some people are simply more predisposed to take lesser or greater risk.
Income and asset base. The larger your income and asset base, the more risk you may be willing to
take, again depending on your time frame. Some investors with a large asset base, however, may
choose a more conservative approach, knowing they don’t need to take on additional risk to meet
their goals.
Portfolio Rebalancing
Once an asset allocation plan is finalized, then securities are chosen for investments and the investment
process is completed. Thereafter, the portfolio of investments comprising of debt, equity, etc. should be
monitored on a periodic basis. The frequency of review could be once in six months or even once a year.
A higher frequency is generally not necessary for a long term investment plan but sometimes, some
economic developments may necessitate an urgent review.
One of the most important factors that will have a big influence of the performance of the portfolio is the
interest rate (which generally moves with inflation). Whenever large scale and protracted interest rate
movements are expected, then a rebalancing will become absolutely essential. In a rising interest rate
scenario, corporate profitabilites will suffer and consequently, stock prices will fall. Bond prices dip to
adjust to the current yields of the market. Reducing equity exposure of the portfolio may become necessary
What is Investment?
I nvestment refers to a commitment of funds to one or more assets that will be held over some future
time period. It is important to understand the difference between savings and investments. Anything
not consumed today and saved for future use can be considered as savings. Almost all of us save money. In
fact, we are a nation of savers where the domestic savings is a high percentage of Gross Domestic Product
– sometimes as high as 26-27%. It is important to channel these savings into productive investment avenues.
Almost all individuals have wealth of some kind, ranging from the value of their services in the workplace to
tangible assets to monetary assets. For our purposes, investment will mean a measurable asset retained in
order to increase one’s personal wealth. A financial asset is one that generates income and contributes to
accumulation and growth of wealth over a period of time. The two elements in investments are generation of
income on a periodic basis and/or growth in value over a period of time.
A Financial Planner
Some investors have failed to recognize that the less obvious, but potentially more damaging, is the risk
of diminished income staying completely invested in low yielding fixed income securities or bank
deposits.The financial planner should ensure that investors take a hard look at the fixed income components
of their portfolios and rethink this strategy in the context of a more comprehensive, long-term objective,
understanding where the clients come from, the priorities in their life and the challenges they face in a
Investment Fundamentals
Some of the fundamental rules of investments are:
Start Early
Invest Regularly
Ensure Higher Returns on Your Investments
Let us study the effects of good investing principals through two examples.
1. Prem started investing money to the tune of Rs. 6000 pm diligently. He began this discipline at the age
of 21 years of age. He was earning a rate of interest of 12% compounded each year. While his friend,
Poonam started investing money to the tune of Rs. 10000 pm. She was also doing this very religiously.
She also earned 12% compounded. She started the process of doing the investments month on month,
after the age of 30. What are the total sums adding up to at the age of 50 years of age?
2. A second example of starting early to fulfill your dreams is shown below.
According to the College Board, college costs for the 2006–2007 school year are roughly Rs145,000
for four years at a private school and Rs.71,000 at a public school.
Two couples need to save Rs.150,000 for college expenses, but begin investing at different times.
Priti and Subodh begin investing the year their daughter is born, making monthly investments of
Rs.311 to reach their goal. Nirvan and Juhi start investing when their son is eight years old, making
monthly investment of Rs.815 to reach their goal.
Assume an 8% return per year compounded monthly and that the child enters college at age 18. This
example does not represent any specific investment
As you can see from the table the cost of waiting for Nirvan and Juhi it’s Rs.30,624. Priti and Subodh
benefited from eight more years of compounded growth than Nirvan and Juhi, which means Priti and
Subodh put in less money to reach their goal.