Combinepdf PDF

Chapter-12 Fraud Management
Certificate in Insurance Operations
Page 1 of 18
Confidentiality Statement
This document should not be carried outside the physical and virtual boundaries of TCS and
its client work locations. The sharing of this document with any person other than TCSer
would tantamount to violation of confidentiality agreement signed by you while joining
TCS.
Notice
The information given in this course material is merely for reference. Certain third party
terminologies or matter that may be appearing in the course are used only for contextual
identification and explanation, without an intention to infringe.
Certificate in Insurance Operations TCS Business Domain Academy
Contents
Chapter – 12 Fraud Management ....................................................................................4
12.1 What is Fraud? ........................................................................................................... 5
12.2 Costs of Fraud ............................................................................................................6
12.3 Risk Management Framework ................................................................................... 7
Summary ........................................................................................................................ 15
Page 3 of 18
Chapter – 12 Fraud Management
Introduction
Insurance fraud is a major issue for insurance companies, policy holders and economy as a
whole. Insurance companies and the insured must take appropriate steps to tackle this
menace. This chapter details what is fraud, its different types and steps taken for fraud
management in insurance organizations.
Learning Objective
After reading this chapter you will:
Understand what fraud is and its different types
Know the costs of fraud
Know about the risk management framework
Page 4 of 18
12.1 What is Fraud?
Insurance fraud occurs when people deceive an insurance company or agent to collect
money to which they aren’t entitled. Similarly, insurers and agents also can defraud
consumers, or even each other. Insurance fraud can be "hard" or "soft."
Hard Fraud. Someone deliberately fakes an accident, injury, theft, arson or other loss to
collect money illegally from insurance companies. Crooks often act alone, but increasingly,
organized crime rings stage large schemes that steal millions of dollars.
Soft Fraud. Normally honest people often tell "little white lies" to their insurance company.
Many people think it's just harmless fudging. But soft fraud is a crime, and raises everyone's
insurance costs. (Source: Coalition Against Fraud)
Fraud can be defined as an act or omission intended to gain dishonest or unlawful

advantage for the party committing fraud or for other related parties. In the case of
insurance fraud, this would usually involve an exaggeration of an otherwise legitimate
claim, premeditated fabrication of a claim and/or fraudulent misrepresentation of material
information.
Insurers rely greatly on the accuracy and completeness of information provided by

policyholders, claimants and intermediaries when underwriting risks and processing claims.
However, they face various constraints in verifying the legitimacy of the information
provided due to factors such as high volume of transactions (for some insurance products),
complexity of circumstances leading to a claim and asymmetric information.
Insurance fraud can pose serious risk to insurers and may result in significant costs to its
stakeholders. If prevalent and not mitigated, insurance fraud can potentially affect the
financial soundness of individual insurers and erode both consumers’ and shareholders’
confidence in these insurers as well as the insurance sector at large.
The broad categories of fraud would include:

• policyholder and claims fraud - fraud against the insurer by the policyholder and/or
other parties in the purchase and/or execution of an insurance product;
Page 5 of 18
• intermediary fraud - fraud by intermediaries1 against the insurer and/or

policyholders; and
• internal fraud – fraud against the insurer by its director or employee on his/her own
or in collusion with parties internal or external to the insurer.
12.2 Costs of Fraud
People lose their savings. Trusting citizens are bilked out of thousands of dollars, often
their entire life savings, by insurance investment schemes. The elderly are especially
vulnerable.
Health is endangered. People’s health and lives are endangered by swindlers who sell
nonexistent health policies or perform quack medical care to illegally inflate health
insurance claims.
Premiums stay high. Auto and homeowner insurance prices stay high because insurance
companies must pass the large costs of insurance fraud to policyholders.
Consumer goods cost more. Prices of goods at your department or grocery store keep
rising when businesses pass higher costs of their health and commercial insurance onto
customers.
Honest businesses lose money. Businesses lose millions in income annually because fraud
increases their costs for employee health coverage and business insurance.
Innocent people are killed and maimed. People die from insurance schemes such as
staged auto accidents and arson — including children and entire families. People and even
animals also are murdered for life insurance money.
Employees lose jobs. People lose jobs, careers and health coverage when insurance
companies go bankrupt after being looted by fraud thieves.
Insurance fraud steals $80 billion every year. With $80 billion, you could pay…
Salaries of 2.2 million American workers for a year.
Page 6 of 18
All personal income taxes for 7.4 million Americans for a year.
Tuition for nearly 15.6 million students at America’s four-year public universities for
a year.
Healthcare costs for nearly 2 of every three seniors aged 65 and over for a year.
Every CEO of America’s 500 largest companies for the next 16 years.
You could also…

Build 293,000 new homes.
Buy a new car for nearly 3 million licensed drivers.
Fund America’s entire space program for the next five years — or launch 62 space
shuttle missions.
Build 69 stealth bombers.
Fund all cancer research in America for the next 13 years.
Buy enough oil to power every car, SUV and light truck for 7 1/2 months.
If insurance crooks formed a company called Fraud, Inc., it would rank 17th among the
Fortune 500 in yearly income (for 2004).
Long walk: If you place 80 billion one-dollar bills end to end, they’ll stretch to the moon and
back — about 16 times.
(Source: Coalition against Fraud)
12.3 Risk Management Framework
Insurance has a key role to play in smoothing cash flow fluctuations. In the household arena,
life insurance can help cope with financial commitments when there is a fall in family
income in case of death of an insured person. After retirement, pension plans help address
retirement income needs. In the same way, businesses can prevent bankruptcy through the
use of risk management in general and insurance in particular.
Worldwide, savings are put into a number of financial institutions with a substantial
proportion going to banks. Capital markets are another key channel for investment. The
Page 7 of 18
Insurance is also a major area with investments going towards life insurance, pension plans,
health insurance and others.
12.3.1 Strategy
An insurer should have a sound strategy to manage fraud risk arising from its operations.
The fraud management strategy should form part of an insurer’s business strategy and be
consistent with its overall mission, business strategy and objectives. It should:
• include a clear mission statement to indicate the insurer’s level of tolerance to
fraud;
• facilitate the development of quantitative risk tolerance limits on fraud; and
• Provide direction to the overall fraud management plan.
A sound and prudent fraud management strategy must be compatible with the risk profile
of the insurer. In determining its risk profile as well as its vulnerability to fraud, insurers
should consider the following factors:
• size, composition and volatility of its business;
• organizational structure;
• complexity of its operations;
• products and services offered;
• remuneration and promotion policies;
• distribution modes; and
• market conditions.
To ensure its relevance and adequacy, the strategy should be reviewed regularly to ensure
that it continues to be effective, especially when there are material changes to the insurer’s
risk profile. The strategy should also be properly documented and effectively
communicated to all relevant staff. There should be a process to approve proposed
deviations from the approved strategy, and systems and controls to detect unauthorized
deviations.
12.3.2 Structure
An insurer should adopt a risk management structure that is commensurate with the size
and nature of its activities. The organizational structure should facilitate effective
Page 8 of 18
management oversight and execution of its fraud risk management and control processes.
The structure should facilitate communication between departments and to senior
management and/or the Board of Directors to ensure prompt responses to instances or
suspicions of fraud.
The Board is ultimately responsible for the sound and prudent management of fraud risk. It
should recognize and understand the risk of fraud and its potential impact on the
institution. The Board should approve the fraud management strategy and ensure that
adequate resources, expertise and support are provided for the effective implementation of
the insurer’s fraud management strategy, policies and procedures. Any deviation from the
approved strategy and policies should be subject to the Board’s review and approval.
An insurer should consider establishing a fraud management functions if warranted by its

risk assessment. This function would be primarily responsible for the compliance with the
insurer’s fraud management policies and procedures covering fraud identification, reporting
and investigations. In order to be effective, this function should have the requisite authority,
sufficient resources and be able to raise issues directly to the Board or relevant Board
Committee.
12.3.3 Policies and Procedures
An insurer should establish clear policies and procedures for the management of fraud risk.
These policies should be well-defined and consistent with the insurer’s fraud management
strategy, as well as adequate for the nature and complexity of its activities. These include:
• the roles and responsibilities of the fraud management function or staff assigned to
execute the insurer’s fraud management strategy, policies and procedures;
• measures to identify and mitigate the risk of fraud; measures to monitor and detect
instances or suspicion of fraud;
• reporting of suspicions of fraud to designated person(s) for review and
investigation;
• record keeping of suspicions of fraud and fraud cases; and
• Relevant initial and ongoing training on fraud matters for its directors, management
and staff.
Page 9 of 18
The insurer should retain records of all reported cases of suspicion/incident of fraud
together with internal findings and analysis done in relation to them. It should establish
standards relating to the turnaround time for the assessment of fraud, documentation of
analysis, and keeping of records on suspicions/incidents of fraud. The insurer should specify
in its policies and procedures in respect of record keeping the following:
• information and analysis to be recorded;
• retention period; and
• staff access to records based on their confidentiality classification
The insurer’s anti-fraud policies should be communicated throughout the organization. An

insurer should also review the effectiveness of its policies, taking into account changing
internal and external circumstances as well as identification of lessons from incidents of
fraud or suspicions of fraud to enhance its management of fraud risk. Policies and
procedures should be documented and set out in sufficient detail to provide operational
guidance to staff.
The insurer should have in place proper and effective reporting systems to satisfy the
requirements of the Board with respect to reporting frequency, level of detail, usefulness of
information and recommendations to address issues of concern. There should be clear
guidelines on the type of information to be reported to the Board on a regular basis as well
as when certain information or development ought to be communicated immediately to the
board.
12.3.4 Risk Identification, Control and Monitoring
Risk Identification and Measurement

An insurer should assess its activities and processes for any vulnerability to fraud and
determine the consequential impact of any potential fraud. In determining the potential
sources of fraud risk, the insurer should consider the following:
• adequacy of measures to verify customer information before accepting a
customer’s proposal taking into consideration the risk factors posed by different
distribution channels such as internet policy application without face-to-face
contact; and
• Fit and proper standards for its intermediaries.
Page 10 of 18
The insurer should also recognize that certain products or lines of business may be more
susceptible to particular types of fraud. For instance, for workman compensation insurance,
employers may misrepresent their employees’ payroll and job scope in order to pay lower
premiums. Similarly, motor insurance is susceptible to inflated claims as well as staging of
accidents so that policyholders and/or workshops can obtain more compensation from
insurers. The insurer should also identify fraud risk factors in product design during the early
stages of product development.
The insurer should establish appropriate indicators that when triggered, suggests a higher
risk of fraud. In the event that one or more indicators are triggered, the insurer should
ascertain the facts to determine whether a more in-depth investigation and follow up
actions are warranted.
There should be adequate documentation of the verification actions taken. The indicators
should be reviewed regularly for their continued relevance and effectiveness in detecting
fraud.
Common indicators that could be used in the identification of fraud risk may include:
• Policyholder and Claims Fraud

policyholder has been declined coverage by other insurers due to reasons
such as non-disclosure of material information;
claimant is willing to settle claims for an inexplicably low settlement
amount in exchange for a quick resolution; claimant provides inconsistent
statements or information to relevant parties such as the insurer or police;
and
claimant made several claims of similar nature within a relatively short
period of time;
• Intermediary Fraud
evidence of churning of policies either within the organization or across
several product providers;
large number of policies in the intermediary’s portfolio that have arrears in
premium payments, unusual product-client combinations such as instances
where the policyholder’s
Page 11 of 18
income is not likely to be able to support the premium he/she has to pay for
the product purchased and/or previous instances of fraud;
customer complaints against the intermediary, including allegation of
mishandling of monies and non-receipt of policy documents from the
intermediary when the documents have been issued by the insurer;
customers’ records are not in the insurer’s customer database even though
proposal documents and/or payment have been provided to the
intermediary some time ago; and
Indications that suggest that the intermediary is in financial distress.
Risk Control and Mitigation

Policyholder and Claims Fraud - An insurer should also establish an adequate client
acceptance policy, which should include the categorization of usual product-client
combinations. For example, insurers could categorize the customers based on expected
earning and other factors for certain products in order to identify any unusual product-client
combinations. For each combination, the insurer should set out clear conditions for the
acceptance of the client’s proposal and the appropriate measures to mitigate or detect
fraud. A typical client acceptance policy would also include one or more of the following:
• Customer Due Diligence (“CDD”) measures to be taken before business relationship
is established for various product types; and
• Measures to be taken for unusual product-client combinations including the request
for additional supporting documents. For instance, the insurer may request for
additional information to verify whether the policyholder has other sources of
wealth such as inheritance, when the latter's normal earning does not
commensurate with the proposed product purchased.
These measures should be designed in order to detect incorrect and/or incomplete

information provided by policyholders in their application for insurance cover as well as
incompatibility of the policyholder characteristics with the insured event and give due
consideration to policyholder fraud indicators.
The insurer should also incorporate in its claims assessment procedures, clear requirements
on what claims assessors should do to mitigate the risk of claims fraud, for example:
• checks against indicators for claims fraud;
Page 12 of 18
• checks against internal database or other sources for confirmed or potential

fraudsters; and
• Interviewing claimants and conducting special investigations for suspicious cases.
The insurer should ensure that it possesses the relevant expertise, for example, by enlisting
the services of fraud experts, when assessing claims. In addition, the authority limits
assigned to claims assessors should commensurate with their experience and competency.
The insurer should also consider the quality and reputation of any other third parties when
placing reliance on material information provided by these parties. For this purpose,
consideration should be given only to trusted or accredited third parties whose performance
and practices have been or could be verified by the insurer.
To deter fraud, an insurer should inform policyholders that certain actions, such as
knowingly providing false or misleading information to the insurer, submitting inflated or
fictitious claims, etc could tantamount to committing fraud against the insurer and this
could result in the loss of benefits or other consequences to the policyholders. It should also
highlight to policyholders their contractual duties to the insurer when a policy is purchased
or a claim is made.
Intermediary Fraud - An insurer should adopt adequate measures to ensure that the
intermediaries it deals with meet fit and proper standards. It should establish an internal
assessment framework for the appointment of its intermediaries.
In assessing the fit and proper standards of its agents, the insurer should conduct adequate
background checks on the agents including a search for any adverse records in reliable
database. In addition, the insurer should conduct industry reference checks with the agents’
previous employers using the standard reference check letter adopted by industry and
professional bodies in the financial services sector. The insurer should also develop a code
of conduct for its agents, with appropriate penalties for non-adherence to the code or other
misconduct by the agents.
An insurer which accepts business from financial advisory firms and insurance brokers
should also ensure that the appointed firms’ performances are reviewed periodically to
ensure compliance with the insurer’s fraud management controls.
Page 13 of 18
To minimize the risk of intermediary fraud, insurers should adopt the following measures
where appropriate:
• ensure that policyholders’ information such as mailing addresses are not altered
without proper authorization from or verification with the policyholders;
• Send policies and documents as well as payments directly to policyholders rather
than through intermediaries. If this is not possible, insurers should, at a minimum,
send a separate notification to the policyholders if policies and documents as well as
payments are dispatched via the intermediaries;
• prohibit intermediaries from accepting premium payments in cash (if this is
unavoidable, receipts should be issued by the intermediary);
• strongly encourage policyholders to make all cheques payable to the insurer only
and take additional precautionary measures such as indicating the policy number
(for renewal policies) or the proposed policyholder’s name on the back of the
cheques;
• enhance the monitoring of an intermediary’s own insurance policies and those of his
immediate family members when there are grounds for suspicion;
• Avoid issuing cheques in favor of parties other than beneficiaries of the insurance
policies. Should the insurer decide to accommodate a policyholder's request to
issue
• cheques made out in favour of a third party, the insurer should ensure that it has
exercised due care to authenticate the authorization given by the policyholder to
issue the third party cheque; and
• enhance monitoring of cheques received through an intermediary that are issued by
third parties who are unrelated to the intermediary to pay for policies owned by the
intermediary or his immediate family members when there are grounds for
suspicion.
12.3.5 Risk Monitoring and Review
An insurer should establish and maintain an incident database, which contains the names of
staff or their immediate family members, policyholders, claimants or other relevant parties
who have been convicted of fraud or have attempted to defraud the insurer.
Page 14 of 18
It should also monitor the performance and trend of business brought in by the
intermediaries in relation to the insurer’s products with a view to detecting any indication of
intermediary fraud. For example, should the actual level and pattern of business accepted
by the intermediary differ significantly from the intermediary’s track record and projections,
this may warrant verifying whether there are legitimate reasons for the disparity.
The insurer should also conduct regular checks to ensure compliance with its policies and
procedures in respect of its management of insurance fraud risk. For example, the checks
should include verification that whenever fraud risk indicators are triggered, they are
properly and consistently dealt with and adequately documented.
Senior management should ensure that proper and effective reporting systems are in place
to satisfy all requirements of the Board with respect to reporting frequency, level of detail,
usefulness of information and recommendations to address fraud risk. It is also the
responsibility of the senior management to alert the Board promptly in the event that they
become aware of or suspect that a fraud that may have a significant adverse impact on the
insurer has occurred.
Page 15 of 18
Summary
Insurance fraud occurs when people deceive an insurance company or agent to
collect money to which they aren’t entitled. Similarly, insurers and agents also can
defraud consumers, or even each other.
Insurance fraud can be "hard" or "soft."
Fraud can be defined as an act or omission intended to gain dishonest or unlawful
advantage for the party committing fraud or for other related parties.
In the case of insurance fraud, this would usually involve an exaggeration of an
otherwise legitimate claim, premeditated fabrication of a claim and/or fraudulent
misrepresentation of material information.
Insurance fraud can pose serious risk to insurers and may result in significant costs
to its stakeholders.
The broad categories of fraud would include: policyholder and claims fraud;
intermediary fraud and internal fraud
Insurance fraud steals $80 billion every year.
An insurer should have a sound strategy to manage fraud risk arising from its
operations.
The fraud management strategy should form part of an insurer’s business strategy
and be consistent with its overall mission, business strategy and objectives.
An insurer should adopt a risk management structure that is commensurate with
the size and nature of its activities.
The organizational structure should facilitate effective management oversight and
execution of its fraud risk management and control processes.
The Board is ultimately responsible for the sound and prudent management of
fraud risk.
An insurer should establish clear policies and procedures for the management of
fraud risk. These policies should be well-defined and consistent with the insurer’s
fraud management strategy, as well as adequate for the nature and complexity of
its activities.
The insurer should establish appropriate indicators that when triggered, suggests a
higher risk of fraud.
An insurer should also establish an adequate client acceptance policy, which should
include the categorization of usual product-client combinations.
Page 16 of 18
An insurer should adopt adequate measures to ensure that the intermediaries it

deals with meet fit and proper standards. It should establish an internal assessment
framework for the appointment of its intermediaries.
An insurer should establish and maintain an incident database, which contains the
names of staff or their immediate family members, policyholders, claimants or
other relevant parties who have been convicted of fraud or have attempted to
defraud the insurer.
The insurer should also conduct regular checks to ensure compliance with its
policies and procedures in respect of its management of insurance fraud risk.
Senior management should ensure that proper and effective reporting systems are
in place to satisfy all requirements of the Board with respect to reporting frequency,
level of detail, usefulness of information and recommendations to address fraud
risk.
Page 17 of 18
Page 18 of 18
Chapter-11 Distribution Management
Page 1 of 30
TCS.
Notice
Contents
Chapter - 11 Distribution Management ..............................................................................4
11.1 Distribution ................................................................................................................ 5
11.2 Insurance Distribution Models.................................................................................... 7
11.3 Channel Characteristics: .............................................................................................9
11.4 Agent ....................................................................................................................... 10
11.5 Broker ...................................................................................................................... 12
11.6 Agents Vs Brokers .................................................................................................... 14
11.7 Bancassurance ......................................................................................................... 14
11.8 Third Party Administrators....................................................................................... 15
11.9 e-Channel ................................................................................................................ 15
11.10 Personal Selling Distribution Systems .................................................................... 16
11.11 The Sales Procedure ............................................................................................... 17
11.12 Agency-Building Distribution Systems ................................................................... 17
11.13 Non-agency-Building Distribution Systems ............................................................ 21
11.14 Financial Institutions Systems ................................................................................22
11.15 Direct Marketing Systems ...................................................................................... 23
11.16 Distribution Channel Decisions...............................................................................24
11.17 The NASD............................................................................................................... 25
11.18 Some concepts .......................................................................................................26
Page 3 of 30
Chapter - 11 Distribution Management
Introduction
For any marketers, the distribution decision is principally alarmed with the supply chain’s
front-end or channels of distribution that are always well designed to move the product
(generally goods or services) from the hands of the producer or the company to the hands
of the end consumers or customer. All activities and organizations helping with the
exchange are part of the marketer’s channels of distribution.
Learning Objective
Understand how distribution is done and its importance
Know about the various channels and their characteristics
Know the different distribution systems
Page 4 of 30
11.1 Distribution
For any marketers, the distribution decision is principally aligned with the supply chain’s
front-end or channels of distribution that are always well designed to move the product
(generally goods or services) from the hands of the producer or the company into the hands
of the end consumers or customer. All activities and organizations helping with the
exchange are part of the marketer’s channels of distribution.
For example, in the developed markets producers (brokers and agents) form the major
channels of distribution, while the web as a complementary channel is catching up slowly.
According to a Forrester survey, 88% of the Life insurance executives responding identified
agents as the primary channel of distribution.
(Source: http://unpan1.un.org/intradoc/groups/public/documents/apcity/unpan023814.pdf)
Activities involved in the channel are extensive and mixed though the basic activities
revolve around these general tasks:
Ordering
Handling and shipping
Storage
Display
Promotion
Selling
Information feedback
Insurers need for a distributor is to
Increase awareness about insurance products and services
Harness untapped potential
Better market and business reach by insurers
Provide expert financial advice by mapping the clients and prospects need to
insurance products and services
Insurance companies reach their producers and customers through various channels. Some
examples of such channels are: Portals, Web sites, Mobile devices, Call centers, Face to face
etc. Most customers and producers prefer face to face interaction especially when it comes
to life insurance. Individual agents who sell life insurance need to obtain a license from
Page 5 of 30
IRDA. Insurance agencies are now focusing on developing distribution and channel
management strategies so as to perform better and increase their market share.
Initially captive agents were the only channels for insurance. But now-a-days insurance
products are available through – independent producers, institutional channels like banks,
broker-dealers, IFA’s and wire houses. It is important that the insurance companies attract
the distribution channels by:
Making it easy for the channels to do business with them
Providing good and quick underwriting supporting
Managing commissions in an efficient manner
Figure 1: The Insurance Back Office
Source: http://www.mastek.com/insurance/backoffice/uploaded_doc/channeling-the-future.pdf
Page 6 of 30
11.2 Insurance Distribution Models

The most common insurance distribution models are:
Direct selling: Insurance companies directly sell insurance through Internet selling,
walk in customer
Captive/tied agents: Agents who sell policies of only one insurance company who
hires them.
Independent agents: Independent agents access client needs and recommend
suitable products offered by insurance companies based on product and company
features. They are also called as independent financial advisors
Corporate agents: These are firms that sell the insurance policies of various
companies. They include:
Corporate societies
Villages panchayats
Post offices
Financial institutes
Mutual funds
Hospitals
Banks: Banc assurance in its simplest form is the distribution of insurance products
through a bank's distribution channel
Affinity marketing: In this model an insurance company ties up with another peer
to mutually promote their products
Work site marketing: Selling of voluntary( employee-paid) insurance and financial
products at the work site
The four most important distribution models are depicted in the figure below:
Page 7 of 30
Figure 2: Insurance Channels

Source: IRDA
Page 8 of 30
11.3 Channel Characteristics:
Agents - Insurance agents serve as an intermediary between the insurance company and
the customer. They give the information about the insurance products/services of the
insurance company to the customers. The agents perform the administrative work which
includes processing of forms, premiums and paperwork.
The companies provide necessary training to the insurance agents. IRDA mandates training
of these agents before they are given the license to operate as insurance agents. The
insurance companies recruit the individual agents and more often than not sponsor their
training. A lot of training is themselves provided by the company to the agents. This
includes training on product knowledge, soft skills and competition analysis. The training is
usually conducted across multiple locations. The insurance companies put in a lot of effort
to manage and train these agents since the attrition rate of the agents is as high as 70%.
Full time and commission based: Agents can be full time or a can be hired by the
insurers on a commission basis. That is the insurance agents can be either captive or
independent. Captive agents work for only one insurance company and
independent agents are those who work as on agents for a variety of insurers
Financial advisors or certified financial planners: These days insurance agents are
doubling up as financial advisors. This is because the agents provide information to
the customers which include comprehensive planning services.
Non-exclusive: This means that an agent need not be exclusive to only one
insurance company, he provides his services to more than one company.
Agency contract: The agent is bound by the terms and conditions in the agency
contract. The key feature of this channel is that it is productive and cost effective
and results in high customer service renewals:
Banks: Some insurance companies use banks as partners for distribution of their products.
The key features of the channel are:
Separate Unit
Page 9 of 30
Readily available customer base:

Big houses: high turnover
Cost effective
Personalized
Brand equity
Brokers: Insurance brokers offer services like risk management, financing, investment and
consulting services. Brokers can also be called as super independent agents. Brokers need
to have a broker’s license and they have to have more education or experience compared to
an agent. Brokers are employed by businesses, they have to analyze a business and secure
correct and adequate coverage for the business. They usually charge higher premium. The
key characteristics are:
Licensed and independent
Represent clients
Professional expertise:
Multiple options
All kinds of products
11.4 Agent
In insurance parlance, an Agent is the representative of insurance company. The key

responsibilities of an Agent could include:
Selling insurance products
Identifying prospective customers
Determining the insurance needs of each customer
Assisting the customer in arriving at the right decision
Collecting initial premiums if authorized by the company
Delivering policy
Providing pre-sales and post-sales service to policy-holder
Legally, an agent is a person employed to do any act for another in dealing with a third
person/party. The person whom the Agent represents is called the Principal. The
appointment of agent is a “contract for service” and hence the principal cannot closely
supervise the agent. Rather the principal is concerned with the end result. Hence, agent
appointments are subject to the provisions of Indian Contract Act, 1872. Even if the
Page 10 of 30
principal is getting work done through the agent, in the eyes of law, it is as good as doing
the work himself/herself … hence, the principal is bound by acts of agent, but the agent is
not!
As per the Indian Insurance Act 1938, an agent is a person who receives payments of
commission or other remuneration in consideration for his soliciting or procuring insurance
business, including business relating to continuance, renewal or revival of policies
11.4.1 The Professional Agent
The professional agent has been the strongest link between the insurer and the customer.
Training institutes have developed all over the country inculcating professional skills.
Perhaps only 20% of agents recruited, do develop as professional career agents. In general
insurance the retail agent markets mainly the personal lines of Fire, Motor, Burglary,
Household Insurance, Travel Insurance and Health Insurance. Due to the low ticket size, the
number of agents has not increased astronomically as in life insurance.
11.4.2 Group Representative
This is a specially designed group and known as group representatives. They are generally
salaried insurance company employees and are specifically trained with the skills of
marketing and servicing group insurance products. A group representative does the
following jobs:
Requests for commerce from producers and benefits consultants
Locates prospects for group insurance and annuity
Devises group annuities and insurance plans proposals
Establishes group insurance and annuity contracts
Re-bargain renewal contracts
11.4.3 Corporate Agent
A corporate agent is a company or co-operative society acting as an insurance agent. As per

IRDA, a corporate agent could be:
A company formed under the Companies Act 1956
A banking company defined under the Banking Companies Act 1949
Page 11 of 30
A regional rural bank set up under Regional Rural Banks Act 1976
A co-operative society/bank registered under corresponding act like Co-operative
Societies Act 1912
A panchayat or local authority
An NGO or micro-lending finance organization covered under the Co-operative
Societies Act 1912
An NBFC registered with RBI
Any other organization approved by IRDA
In these organizations, someone is vested with responsibility to act as agent in solicitation

of business and service matters. IRDA has envisaged a “Corporate Insurance Executive” who
should be the company’s director or partner and meets all eligibility criteria. Similarly,
“Specified Person” is designated by the corporate agent.
11.5 Broker
A broker acts as an intermediary between the customer and the insurer. But the role of
activities is wider than those of an agent. While an agent represents a single insurance
company, a broker may represent more than one (regulations stipulate at least 3). An
insurance broker cannot act as an insurance agent for any other company. To meet client
requirements, the broker needs to:
Be a member of the Insurance Brokers Association of India
Get quotes from various insures and advise on right product/mix
To meet these objectives, the broker is required to:
Interact with various insurers and identify products best serving the client
Identify and evaluate the risk scenario in client business and advise client in
risk control and transfer
Adopt globally accepted best business practices
Create lifetime value for customers
India has about 397 brokers
Page 12 of 30
Figure 3: Insurance Brokerage Firm

IRDA classifies brokers as following: Direct General Insurance Broker/ Direct Life
Insurance Broker, Re-insurance Broker and Composite Broker
Direct broker – A broker who is considered for general or life insurance, but does
not include broking of reinsurance
Page 13 of 30
Reinsurance broker – A broker who arranges for reinsurance for client insurers with
insurance and reinsurance companies
Composite broker – One who arranges insurance for clients with insurance
companies and reinsurance for client reinsurers
11.6 Agents Vs Brokers
Brokers operate in a manner similar to local agents, although legally they represent the
consumer, not the insurer. Thus, if the consumer asks a broker to obtain insurance, the
broker must make contact with the insurer before coverage is binding.
Agents may bind coverage immediately, because they are the legal representatives of the
insurer.
Of course, many brokers also hold agency contracts with insurers and may bind coverage
immediately because of this status. An agent is someone who legally represents the
principal and has the authority to act on the principal's behalf. A property and casualty
agent has the power to bind the insurer. A binder provides temporary insurance until the
policy is actually written. A life insurance agent normally does not have the authority to bind
the insurer. The applicant for life insurance must be approved by the insurer before the
insurance becomes effective
A broker is someone who legally represents the insured, and solicits applications and
attempts to place coverage with an appropriate insurer. He/ She is paid a commission from
the insurers where the business is placed and does not have the authority to bind the insurer
11.7 Bancassurance
Banc assurance is developing as an important channel in India. This is due to the large reach
and customer base of banks in both urban and rural areas in India. The persistency rate in
Banc assurance, due to the continuous contact with the client is better than in other
channels. The ease of payment of premium and the facility of maturity/claim payments
through the bank account make it a customer friendly channel.
Page 14 of 30
It is to be noted that Banc assurance models vary widely both in India and globally. The
differences could be in ownership, point of sale, specially designed products, sharing of the
client database and in the administration and servicing.
Banc assurance regulations were made clear by mid 2002. It was then clear that banks could
enter into any one of the two relationships with one life and one non life partner for
distributing the insurance products purely on a “Non –Risk Participating basis”. The two
relationships that the banks could enter are:
Corporate Agency Arrangement: In this arrangement the bank employees would
be identified, they would undergo the IRDA mandatory training program, pass the
IRDA exam and then get licensed. Only on completion of the same they would be
authorized to sell the products of the insurance companies to their customers. The
relationship here in this arrangement would be that of the bank being a pure
distributor while that of the insurer being a pure manufacturer of the insurance
products. The bank would get a ‘commission’ on the sale of the business.
Referral arrangement: In this arrangement the bank would provide the insurer all
the infrastructural support and “refer” the customers who are interested in buying
insurance plans to the representative of the insurance company, placed in the bank
premises, who would then sell the required plan to the customer. For referring the
customer of the bank to the insurance company, the bank would be paid a ‘Referral
Fee’ on the business actually booked
11.8 Third Party Administrators
Third party administrators were introduced through notification of TPA-Health Services

Regulations, 2001 IRDA. Their basic role is to function as an intermediary between the
insurer and insured and enable cash less insurance service. The main or primary object of
the company shall be to carry on business in India as a TPA in the health services. They are
paid a fixed percent of the insurance premium as commission. This is currently fixed at 5.6%
of premium amount.
11.9 e-Channel
Insurers use the e-channel or the Internet for the following types of activities:
Page 15 of 30
Brochure ware- Information about company, its offerings and services are offered
to prospects over the web
Enquiry over web- This would score higher in terms of interactivity than brochure
ware and could include policy and claim enquiry facility for the customers and
answer to the queries from prospects. Linkage to dedicated call centre could be
possible over the web
Transaction using dedicated lines- This has been the most widely exploited part of
IT where field staff and agents of insurers solicit business and transfer data to the
insurance company over the public or private network for further processing.
Sale of product over the web- This would include facility to place order and buy
insurance over the web.
Sale of customized product over the web- Taking user empowerment a step
further, this could encourage buyers to configure the products through mix and
match
11.10 Personal Selling Distribution Systems
Personal selling distribution system can be defined as one of the many types of distribution
channels in which commissioned or hired salespeople from the companies sell products all
the way through oral and written presentations made to potential customers. The two main
types of such systems are as follows:
1. Agency-building distribution system is one of the types where the insurer or the
insurance company recruits and trains all his producers and then provides them with
monetary support and other office facilities
2. Non-agency-building distribution system is the other type where the insurer

recruits those producers who require very little training, and are already
economically self-supporting, and who generally work out of independent offices
An agency relationship is considered as a legal relationship where one party generally

known as the principal or may be called as the insurer, authorizes the other party known as
the agent to act on the principal’s or insurer’s behalf.
Page 16 of 30
The agent’s authorities that are hired to act for an insurer or an insurance company are
usually specified in a special contract known as the agency contract.
The contracts have the following specialties:
The contract is defined as an agreement between an insurer/ insurance company

and an agent that clearly defines an agent’s role and his/her responsibilities.
The contract also describes the agent’s compensation, and
A contract very specifically defines what the agent can and cannot do on behalf of
the insurer
11.11 The Sales Procedure
The sales process is one of the most important parts of the distribution channel as this is the
part which provides with the sales quantity. To sell a life insurance and the annuities, all
producers normally pursue a general trend or process that comprises of nearly six key farm
duties:
Locating a prospect
Recognizing the prospect’s monetary needs
Building up a proposal
Sales presentation
Closing the sale
Executing the defined proposal
11.12 Agency-Building Distribution Systems
This can be defined as a type of insurance sales distribution system in which companies
recruit and train their salesperson, and also grant them with monetary support and office
facilities. There are four general types of agency-building distribution systems:
Figure 4: Agency Building Distribution Systems
Page 17 of 30
11.12.1 General/Ordinary Agency System
A general agency office is recognized, sustained, and financed by general agents and also
known as a field office. A general agent (GA) is one who is independent businessperson and
who supervises an agency office and is under contract to an insurer, rather than acting as an
employee of, the insurance company. An insurer rewards a GA principally with overriding
commissions based on the amount of all of the agency office’s sales. The GA pays the
salaries of the support staff.
11.12.2 Multiple-Line Agency (MLA) System
This is a special agency system known as the multiple-line agency (MLA) distribution
system where an agency-building distribution system uses their career agents to distribute
or supply products as life insurance, annuities, health insurance, and property/casualty
insurance for a group of financially consistent or commonly managed insurance companies.
Basic concepts in this MLA system:

Career agents are required to maintain their own offices and also hire their own
support staff.
Page 18 of 30
The producers are also required to slot in some cross-selling, where the process is to
recognize a customer’s need for additional products at the time of selling a key
product.
Cross-selling by the producers is always believed to improve the retention of in-
force insurance or annuity policies.
11.12.3 Salaried Sales Distribution System
The various important concepts regarding the salaried sales distribution system can be
noted down in the following way:
All the salaried sales representatives have the task of selling and providing services
to the insurance products on behalf of the insurer.
All the salaried sales representatives in this system are company employees.
In such system it is often seen that all the salaried sales representatives sell group
insurance products too.
11.12.4 Location-Selling Distribution System
The various important concepts regarding the location selling distribution system can be
noted down in the following way:
The whole location selling distribution system is planned to generate consumer-
initiated sales at an insurance office or information kiosk located in a store,
shopping mall, or other business establishment.
The facilities in such location selling distribution system are staffed with
commissioned or salaried sales personnel.
Contrast with non-agency building distribution system. Agency-building distribution

systems sometimes also include:
1. Career agency systems
2. Home service systems
3. Worksite marketing systems
Page 19 of 30
11.12.5 Career Agency System
The career agency distribution systems generally rely on company-associated insurance

producers (as a group known as the insurer’s “field force”) to sell and provide service life
insurance and annuity products. A career agent who has a contract with the insurer is
generally a full-time commissioned salesperson. He/she has the agency contract with at
least one insurance company. There are generally two types of career agents:
1. Exclusive agents are those career agents who are under contract to only one insurer
and who are usually not permitted to sell the products of other insurers. That means
they have a contract exclusively for sales of products on behalf on one insurer
2. Agent-brokers are those career agents who can start business with a principal
insurance company and also can work with other insurance companies. They are
not exclusive to any particular life insurance company.
The form of compensation for all those agents is nothing but the commission paid to them
by the insurer or the insurance company. Thus insurers typically pay compensation agents
by paying a commission (commission defined as the amount of money that an insurer pays
to an insurance producer for selling and servicing an insurance or annuity policy). The paid
commissions for insurance producers are always based on a predefined percentage of the
total premiums paid on each policy the producer sells.
11.12.6 Branch/Agency Office System
In this system, an insurer or the insurance company tries to create and maintain field offices
(branch offices) in all the key locations throughout its marketing territory. The head of a
branch office is a branch manager, who is a permanent employee of the insurance
company. Generally, all insurance company or insurers tries to compensate their branch
managers with a foundation salary along with overriding commissions. (An overriding
commission can be defined as a sales reward that is normally paid to an agency manager on
the business generated by a particular field officer or group of producers under the
supervision of the manager).
Page 20 of 30
11.12.7 Home Service Distribution System
In such type of system the exclusive agents sell specified insurance products and provide
policy owner service within a specified geographic area or territory. The system primarily
targets lower-income households. One of the important things to be noted here is that
annuities are not typically sold through this system. In this agents collect initial and renewal
premiums.
11.12.8 Worksite Marketing Distribution System
In such type of system an individual or group insurance products are distributed to people at
their place of work on a voluntary, payroll-deduction basis. Here the employees retain
ownership of a product purchased through this system even if they are no longer employed
by the employer who sponsored the plan.
11.13 Non-agency-Building Distribution Systems
Non-agency-building distribution system is a totally different kind of agency system and

includes:
11.13.1 The Brokerage Distribution System
The brokerage distribution system is a non-agency-building system where insurance

brokers are asked or required to distribute an insurer’s products. Some of the points to be
noted here are:
An individual is said to be a “broker” who is independent as an insurance
producer who offers products from a variety of insurers not for any
particular insurance company.
A “licensed broker” is not under an agency contract with any insurance
company but acts as a salesperson who is licensed to sell insurance
products.
A “brokerage company” is an insurance company that uses the brokerage
system exclusively and does not establish a career agency force.
Brokers sometime join a producer group (an organization of independent
producers) that bargains compensation, product, and service arrangements
with insurance companies.
Page 21 of 30
11.13.2 The Personal-Producing General Agency System
The personal-producing general agency system uses personal-producing general agents to

sell and service insurance products. Here there are no brokers involved. In a personal
producing general agent (PPGA) some of the important points to be noted are:
A personal producing general agent is a commissioned salesperson who
generally works independently. He/she is not addressed in an insurer’s field
offices, and also he/she is made to engage primarily in personal production
that is, sales of new policies.
A personal producing general agent normally holds agency contracts with
more than a few insurers
A personal producing general agent spends most of his time selling
insurance and annuities. They are not concerned about the building and
managing of an agency
A personal producing general agent can employ a subagent, who is a full-
time soliciting insurance producer.
11.13.3 Financial Planners
A financial planner is one who analyzes a client’s private monetary circumstances and goals
and prepares a program, typically in writing, to meet the client’s financial goals. Most of the
financial planners are career agents. A financial planner helps the clients with:
insurance planning,
investment management,
asset accumulation,
estate planning,
tax planning, and
retirement planning
11.14 Financial Institutions Systems
The distribution systems of financial institutions mostly include insurance companies,

banks, and broker/dealers. Insurance companies can also perform as a distribution channel
by selling those “nonproprietary products”, which are generally manufactured by another
insurer. This type of distribution partnership always benefits both the companies, the
manufacturing company as well as the distributing company.
Page 22 of 30
For instance, an insurance Company “A” and another insurance Company “B” reach a
contract where “A” will distribute B’s life insurance product in few “A” markets.
Most of the banks usually use one or more of the following strategies for marketing their
insurance products:
An independent general agency known as Third-party marketer (TPM) sells
insurance products for one or more banks. The insurer’s association is with the TPM,
rather than with the bank.
Bank’s own employees known as Platform employees are trained and licensed to
sell insurance products.
By hiring and training employees, a bank can enjoy the option of buying an existing
insurance agency or establishing its own agency.
A bank can also come into a distribution agreement with an insurer under which the
bank can promote the insurer’s products to the bank’s customers and provides the
insurer with qualified sales leads.
In some of the countries, broker/dealers, banks, or both may serve as most important
distribution channels for insurance annuity products. Mostly all broker/dealer firms ensure
that people who sell securities meet definite requirements with respect to training,
experience, and character.
For example to market any variable insurance products in the United States, an insurer has
to take one of the following proceedings:
Registering the insurance company as a broker/dealer
Establishing a auxiliary company that registers as a broker/dealer
Marketing its products through a firm that is already registered broker/dealer
11.15 Direct Marketing Systems
In a direct response distribution system, the consumers or customers purchase products

straight way from the insurance company by directly responding to the company’s
advertisements. Media also plays an important role in direct marketing. The various types
of media used in direct or indirect marketing are:
Page 23 of 30
Direct mail generally a mail service to distribute a marketer’s sales offer or

advertising message
Print media (magazines or newspapers)
Broadcast media (radio and television)
Telemarketing (telephone to generate sales)
Internet sales (online or e-shopping)
Every time when the insurer’s use direct mail communication, the insurer’s marketing
branch generally devises a fulfillment kit (a package of materials designed to address or
“fulfill” the respondent’s request) to send to people who submit applications in response to
any communication made by the insurance company (advertisements or solicitations).
11.16 Distribution Channel Decisions
Every time an insurer decides what type of distribution channels are to be taken for the
distribution of the product, the insurer or the insurance company generally takes the
following considerations:
Products feature
Costs involved
The distinctiveness of the target market
Marketing environment
Degree of distribution control
Insurer characteristics
Performance Management is critical for managing channels. It has three components –

Appointment, Training and Development and Performance Review
Appointment: Regulated in respective countries and individual licenses are issued by the
regulator, who also caps their remuneration
Licenses are renewable periodically
Appointments are based on :
Educational Qualifications
Personal Interview
Pre-recruitment tests
Marketing skills
Awareness about products and services through:
Page 24 of 30
Previous experience
Pre-recruitment training
Training and Development – Mainly focuses on Pre-recruitment training and is conducted
by authorized training institutes, handled by experienced professionals in Insurance
Industry. It is sometimes mandated by regulator so as to impart awareness about Industry,
products & services. The key types of trainings are:
Induction Training
Continuous Professional Development
Market / Environment specific training
Performance Review – The main step in Goal Setting is setting sales and service level
targets, and creating a framework to achieve targets. The key issues to be addressed here
are:
Intermediary Remuneration
In general, intermediaries DO NOT earn any salary
Remuneration types are :
Commission paid at regular intervals
Bonus and Overriding commission on the New Business
completed and/or volume of business exceeding the target
Remuneration are settled on the basis of :
Premium Income received
Amount of existing business retained
Number of leads generated
Number of client contacts
Remuneration – Computation Methods
A percentage of premiums received
Based on the no. of years of experience of the intermediary as a percentage
of premium
Volume of business exceeding the target specified
11.17 The NASD
National Association of Securities Dealers (NASD) is known as a nonprofit, self-regulatory

organization of securities, broker/dealers that is accountable for regulating certain types of
securities sales, including the sale of variable insurance products. For distributing variable
products through a registered representative a person should:
Page 25 of 30
Be a NASD business associate

Employ in the securities business on behalf of a member by requesting the sale of
securities or training securities salesperson
Clear a particular examination administered by the NASDBoth the public and new private
sector companies have their own perspective of customer perception management
Public Sector Companies Private Sector Companies

Identity is well established, but Have to build their identity in a
the perception of " poor service market where the public does not
providers" is a stigma. distinguish them.
Products are not attractive and Remove the perception that
flexible enough but expensive. anything that looks good is
expensive
To retain their creamy layer Work against the people's
clientele who are the most likely mindset that they are not here for
to be wooed by the new the long term
companies
Retain and attract good Attract intermediaries especially
intermediaries agents with the requisite
qualifications and attributes who can
market the company and the product.
Match the aura created by the Run the risk of tapping an
new companies in the urban already insured market for repeat
market insurance instead of tapping new
virgin pockets in the market
11.18 Some concepts
Cold Calling - Cold calling can be defined as the process of telephoning or visiting the
prospects with whom, the producer has no prior contact. This type of selling is generally
suitable for newer producer in the individual insurance market. And they might need to rely
Page 26 of 30
heavily on cold calling as they don’t have many prior contacts. After spotting a prospect and
making a safe interview, the producer meets with the prospect and finally talks about the
prospect’s monetary needs.
At some stage in that first meeting, the producer performs a needs analysis. Need analysis
is the process of developing a comprehensive personal and financial picture of a prospect to
evaluate the prospect’s financial needs so that the selling of the product can be done in a
smother way. More than all stages in the selling process, cold call enables the sales person
to interpret, define and command the situation.
Marketing Territory - In simple terms the marketing territory can be defined as the
geographic area in which an insurer distributes its products. Throughout this marketing
territory are an insurance company has got sales offices generally known as field offices. All
the career agents normally work out of a field office, and a field office is generally
considered to be either a branch office or an agency office.
Page 27 of 30
Summary
Insurance companies reach their producers and customers through various

channels. Some examples of such channels are: Portals, Web sites, Mobile devices,
Call centers, Face to face.
The most common insurance distribution models are: direct selling, captive/tied
agents, independent agents, corporate agents, banks, affinity marketing and work
site marketing.
Insurance agents serve as an intermediary between the insurance company and the
customer.
Agents can be full time or a can be hired by the insurers on a commission basis.
These days insurance agents are doubling up as financial advisors
Insurance brokers offer services like risk management, financing, investment and
consulting services. Brokers can also be called as super independent agents.
A broker acts as an intermediary between the customer and the insurer. But the role
of activities is wider than those of an agent.
It is to be noted that Banc assurance models vary widely both in India and globally.
The differences could be in ownership, point of sale, specially designed products,
sharing of the client database and in the administration and servicing.
Personal selling distribution system can be defined as one of the many types of
distribution channels in which commissioned or hired salespeople from the
companies sell products all the way through oral and written presentations made to
potential customers.
The contracts have the following specialties:
The contract is defined as an agreement between an insurer/ insurance
company and an agent that clearly defines an agent’s role and his/her
responsibilities.
The contract also describes the agent’s compensation, and
A contract very specifically defines what the agent can and cannot do on
behalf of the insurer
To sell a life insurance and the annuities, all producers normally pursue a general
trend or process that comprises of nearly six key farm duties:
Locating a prospect
Recognizing the prospect’s monetary needs
Building up a proposal
Page 28 of 30
Sales presentation
Closing the sale
Executing the defined proposal
There are generally two types of career agents:
Exclusive agents are those career agents who are under contract to only one
insurer and who are usually not permitted to sell the products of other
insurers. That means they have a contract exclusively for sales of products
on behalf on one insurer
Agent-brokers are those career agents who can start business with a
principal insurance company and also can work with other insurance
companies. They are not exclusive to any particular life insurance company.
A group representative does the following job:
Requests for commerce from producers and benefits consultants
Locates prospects for group insurance and annuity
Devises group annuities and insurance plans proposals
Establishes group insurance and annuity contracts
Re-bargain renewal contracts
A financial planner helps the clients with:
insurance planning,
investment management,
asset accumulation,
estate planning,
tax planning, and
retirement planning
Page 29 of 30
Page 30 of 30
Chapter-10 Insurance Pricing
Program in Insurance Operations
Page 1 of 21
TCS.
Notice
Contents
Chapter – 10 Insurance Pricing ..............................................................................................4
10.1 Pricing........................................................................................................................ 5
10.2 Basic Components of Effective Pricing.......................................................................6
10.3 Pricing of a Product .................................................................................................... 7
10.4 Determining a Product Price .................................................................................... 10
10.5 Determining a Service Price ..................................................................................... 12
10.6 Pricing Strategies for Life Insurance Premiums........................................................ 14
10.7 Insurance Product Expenses..................................................................................... 18
10.8 Bundled and Unbundled Pricing............................................................................... 18
Summary: ....................................................................................................................... 19
Page 3 of 21
Chapter – 10 Insurance Pricing
Introduction
Whatever may be the type of product we sell, the success of the business lies in the price
companies charge from our customers or clients. Speaking in real terms pricing strategies
are complex in nature. The ideology is that before setting a price for the product, one has to
identify the expenses of running a business. The price for the product or service should
cover costs, else the cash flow will be cumulatively negative, and there would be exhaustion
of financial resources, and ultimately business will fail.
Learning Objectives
Understand what pricing is
Know pricing types
Know how to determine price of product and service
Page 4 of 21
10.1 Pricing
Pricing is one of the four p's of the marketing mix which includes product, promotion,
pricing and place. Pricing is considered as the key variable in microeconomic “price
allocation theory”. Amongst the 4ps, price is the only revenue producing element and the
rest are cost hubs. Pricing is the practice of applying prices to purchase and sales orders,
based on factors such as: a fixed amount, quantity break, promotion or sales campaign,
specific vendor quote, price prevailing on entry, shipment or invoice date, combination of
multiple orders or lines, and many others.
Whatever may be the type of product sold, the success of the business lies in the price
charged from our customers or clients. Speaking in real terms pricing strategies are
complex in nature, but there are some basic rules of pricing followed by most of the
managers:
The price must cover costs and profits.
Lower costs will lead to effective lower pricing.
Price of a product must reflect the dynamics of cost, market demand, response to
the competition, and profit objectives.
Key motive behind prices is to promise sales.
The ideology is that before setting a price for the product, one has to identify the expenses
of running a business. The price for the product or service should cover costs, else the cash
flow will be cumulatively negative, and there would be exhaustion of financial resources,
and ultimately business will fail.
The costs to run the business is determined by including property and/or equipment leases,
loan repayments, inventory, utilities, financing costs, and salaries/wages/commissions etc.
Also the costs of markdowns, shortages, damaged merchandise, employee discounts, cost
of goods sold, and desired profits are also taken into account in the list of operating
expenses.
Generally at what time there is a need to do the pricing?

Introduction of a new product or product line;
Change of costs involved;
Exploring new market;
Page 5 of 21
Change in competitors prices;

Change in economy (inflation or recession);
Change in sales strategy
Customers’ derived value is more than expectations
10.2 Basic Components of Effective Pricing
Four basic components are considered for an effective pricing:
Cost: Cost is the most important factor in deciding the price of the product. Lower
the cost more effective is the pricing.
Price Sensitivity: The pricing strategy must move in accordance with the price
sensitivities of buyers.
Competition: Competition- the term itself ignites spark on the minds of the
managers and pricing is also done sometimes on the basis of pricing trends in the
market or that of the competitors’ price as a bench mark.
Product Lifecycle: Depending on the position where the product lies in the product
life cycle, the product pricing is done. This has a great influence on the pricing of the
product as pricing strategy changes as we move through the product lifecycle.
A perfect price for a product must:

Accomplish the financial objectives of the business (profitability)
Match the practicality of the market scenario (are people ready to buy at that
price?)
Support a product's positioning and be consistent with the other variables in the
marketing mix
Pricing usually involves

Selecting product pricing objectives and strategy,
Profit-testing actuarial assumptions, and
Organizing pricing results
Pricing objective is a goal that specifies what a company wants to achieve with a product’s
pricing in terms of desired profits, sales, and market share. Product strategy is a general
guideline for using a product’s financial features as a variable in the marketing mix.
Page 6 of 21
10.3 Pricing of a Product
Financial and insurance markets and the pricing of various products differ in many ways. On
the market side, the main difference can be stated as warehousing of risk (insurance) versus
intermediation of risk (finance). On the other hand Insurance pricing is in general based on
classical risk theory while finance relies on non-arbitrage pricing. Establishing comparable
pricing principles is, important when it comes to transferring insurance risk to financial
markets and vice versa. Incompatibilities blur business opportunities or open up the
possibility to arbitrage.
Non-arbitrage pricing relies on liquidity and efficiency of markets. Clearly, most of the
insurance market is neither liquid nor efficient. Nevertheless, there are situations where in
addition to pricing based on classical risk theory the corresponding non-arbitrage value of
an insurance contract is of interest, e.g. when part of the risk is transferred to the financial
markets or insurance risk is traded. With a growing interconnection of financial and
insurance markets this situation becomes more frequent.
Pricing of insurance contracts is commonly based on real probabilities P, i.e. probabilities

reflecting the actual likelihood of loss events. In the simplest one period case, the premium
for an insurance contract covering losses X according to the equivalence principle is
where EP[X] is the loss expectation calculated under the real probability measure P,
discounted with a risk-discount rate r t chosen according to actuarial judgment. S[X] is the
safety loading or risk premium. A particular choice of r t and S[X] should reflect the overall
risk related to the contract, the risk-free interest rate, the cost of capital, the expected
investment return, market conditions etc. For complex contracts this is usually not an easy
task.
(Source: www.casact.org/pubs/forum/03wforum/03wf317.pdf)
10.3.1 Cost-Plus Pricing
The general tendency of all manufacturers or service providers during the time of pricing is
to use cost-plus pricing. The key trick here is the “plus” figure in the pricing of the product.
Page 7 of 21
So to be unbeaten with this technique it is very important to deal with the “plus” factor or
figure very sensitively. The “plus” figure should try to cover all overhead expenses along
with generating the desired percentage of profit for the business. So incase the overhead
expenses figure is not exactly determinable, the risk profits may go too low. An example of
such a technique will make it much clearer:
Cost of materials $80.00

Cost of labor $15.00
Overhead $25.00
Total cost = $120.00 = Cost of materials ($80.00) + Cost of labor ($15.00) + Overhead
($25.00)
Now the desired profit percentage is (25% on sales) = $40.00
Required sale price = $160.00 = (Total cost + Desired profit)
10.3.2 Demand Price
The most favorable amalgamation of volume and profit determines the demand pricing.
Products are generally sold through diverse sources at dissimilar prices:
Retailers,
Discount chains,
Wholesalers, or
Direct mail marketers
These all are examples of places where price is determined by demand. A wholesaler
generally buys larger quantities than a retailer, which helps the wholesaler in purchasing the
same product at a lower unit price than that paid by the retailer. The wholesaler takes his
earnings from a larger quantity of sales of the product that was priced much lower him
lower than that of the retailer. The retailer usually pays more per unit than what is paid by
the wholesaler because he or she cannot purchase, store, or sell the quantity of product
what a wholesaler does. And for this reason retailers generally charge higher prices to
customers than what a wholesaler can charge. Demand pricing is always tricky to master
Page 8 of 21
because one should appropriately calculate in advance what price will generate the best
possible relation of profit to volume.
10.3.3 Competitive Pricing
Competitive pricing is usually used when there is already a conventional market price for a
particular product or service. For example if most the competitors are charging $300 for a
replacement windshield, then in this type of pricing strategy $300 should also be charged by
any new entrant during the pricing of a similar product. This competitive pricing is generally
used within markets with commodity products that are not easy to distinguish from one
another. There may be case where a company may prefer to set a price referred to as the
market leader, if there's a major market player in the market. Generally it’s seen that,
smaller companies within that same market are forced to follow the price set by the leader.
One of the ways to use competitive pricing effectively is to know the prices established by
each competitor. Then it’s important to figure out the best possible price, based on direct
comparison, whether the price mentioned or decided can be defended. One may wish to
charge more than his competitors, if he/she thinks that he/she can provide or is providing a
superior customer service or warranty policy than what the competitors are providing.
10.3.4 Average cost Pricing
This strategy is imposed often by the regulators on certain businesses to limit the price they
are able to charge to the consumers for their products and services. Generally, this price is
limited to the costs necessary to create those products and services.
This implies that the businesses will set the unit price of a product relatively close to the
average cost needed to produce it.
10.3.5 Marginal Pricing
Under marginal pricing, the direct or variable costs of the product/service are covered but
not the fixed costs. To adopt marginal pricing, a business must be sure about the stability of
existing business and that business won at marginal pricing is in addition to existing
volumes at the higher normal price.
Page 9 of 21
There is however a risk that if the existing business converts to the marginal pricing rate (a
lower unit price), fixed costs may not be covered and profit could reduce or even losses may
occur.
10.3.4 Markup Pricing
There is a need to calculate a mark up on the price to be charged for goods and services in
order to make a profit. This type of pricing is generally used by manufacturers, wholesalers,
and retailers. A markup is simply calculated by adding a set amount to the cost of the
product, and the final value is the price charged to the customer.
For instance, if the cost of the product is $200 and your selling price of the product is $240,
the markup would be $40. Now to find out the percentage of markup on cost, we need to
divide the amount of markup by the amount of product cost
(Amount of markup / Amount of product cost)

= ($40 / $200) = 20%
Percentage of markup on cost = 20%
This pricing method often generates misunderstanding among the first-time small-business
owners because markup (generally expressed as a percentage of cost) is habitually confused
with gross margin (generally expressed as a percentage of selling price).
10.4 Determining a Product Price
A single pricing formula does not work efficiently for all businesses, nor is there a single
formula that can promise maximum profits in every situation. So every business must move
towards the problem independently.
Several formulas are listed below for determining price. Each formula adds an additional
item to consider in determining a selling price. There may be a situation wherein after using
the formula’s, one may find that the selling price is clearly higher than that of the
competitors. In such a case one may need to search for ways to minimize the production
costs, reduce overhead costs or accept less profits (a rare case), and become more efficient
without affecting the quality of product.
Page 10 of 21
To compare the pricing formulas, let’s assume a firm has determined that a market exists
for guinea pig cages. The cost of materials per cage is $4. It takes one hour of labor to
construct the cage and the labor rate is $5 per hour. Overhead costs are $2 per cage.
Formula A
Materials + labor (which is production time x hourly wage) divided by number of units =
selling price per unit.
Selling Price Per Unit = (Materials + Labor) / No. of Units
Example: $4.00 + $5.00 divided by 1 cage = $9.00 selling price
This approach is often used by beginners because it provides a reasonable wage. You must
determine material cost and give yourself a labor rate. There should be a value placed on
your time. There is no allowance for overhead costs, inflation or profit.
Formula B
(Materials + overhead + labor) divided by number of units = selling price per unit.
Example: $4.00 + $2.00 + $5.00 divided by 1 cage = $11.00 per cage
Overhead costs have been added in this formula.
Formula C
Materials + overhead + labor + profit divided by 1 cage = selling price per unit
Example: $4.00 + $2.00 + $5.00 + $2.50 divided by 1 cage = $13.50
This is the most individualized approach because a conscious decision is made about the
profit you want from your business. You decide on a satisfactory wage and the amount of
time you spend earning it. Profit and your labor rate are not the same.
Formula D
Wholesale price (Formula C) X 2 = retail selling price per unit.
Example: $13.50 x 2 = $27.00
Page 11 of 21
This is a general distributor or retail pricing formula.
It assumes efficiency in production and a steady demand. When you decide to wholesale
you must understand that the buyer will mark up your item a certain percentage. If you sell
directly anywhere in the vicinity of the retailer, you must not under-cut the shop that is
handling your work.
10.5 Determining a Service Price
A service-oriented business needs to figure out the operating or fixed costs and the variable
costs simply to keep the business going. These costs are the same as for the product-
oriented business. In a service-oriented business the price should include:
Variable costs
Fixed (operating expenses) costs
Profit
Labor is usually the major portion of the service-oriented business expense. You must figure
out what your time per hour is worth for each service job you do and include it in your price.
You may decide to change the hourly minimum wage for yourself. If the service you provide
is complicated and/or requires special expertise not readily available, you may want to
charge a higher amount for your labor. Keep in mind this will create a higher price and some
customers will either be unwilling or unable to buy your service. Some entrepreneurs are
willing to charge less than minimum wage for their labor until they have established their
business reputation.
Profit should also be included in the price. A business cannot continue to operate if it does
not make a profit. You will want to find out the profit percentage made by other similar
service- oriented businesses and include a comparable amount in your price. Use the
following formula to determine a price to charge for your services.
First, you must decide on the amount to charge per hour for your labor.
Second, determine the amount of overhead and variable expenses you incur to
deliver your service.
Third, decide what you think is a fair and competitive amount of profit.
Page 12 of 21
Formula A-Price per Hour of Service
Labor expenses per hour + overhead and variable expenses + profit = price per hour
charged.
Formula B-Price per Job
In lieu of charging an hourly rate for your service, you may wish to have a per job charge. To
figure out this price, determine the total hours to do the job, and then add this figure to this
formula.
Labor expenses per hour x hours needed to do job + overhead and variable expenses + profit
= price charged per job.
Remember, the key to setting prices for your product or service is to set them high enough
to cover all your costs and low enough to encourage people to buy. Learning to set prices
takes some business experience.
10.5.1 Consumer Psychology towards Price
Whether they know it or not, most consumers develop mental attitudes about the price
they are willing to pay for a product or service. There is considerable evidence that the
importance of price in the decision to purchase varies from product to product and person
to person.
There are numerous price strategies used by businesses to take advantage of customer
pricing psychology. Three of the more common are listed below.
10.5.2 Multiple Unit Pricings
Simply put, this is a strategy where the customer perceives quantity buying as involving
greater savings. An example is an item that normally sells for 49 cents. Multiple pricing
would change this situation to a two for 89 cents or perhaps three for $1.39 price. In general,
multiple unit pricings are usually effective in increasing immediate sales. However, this
pricing technique may not increase the rate of consumption of the product. People will buy
extra units of the product and use them as needed.
Page 13 of 21
Several factors ought to be considered when using multiple unit pricings. First, the multiple-
unit price has to be easy to understand. Eight for 79 cents is usually less effective than
simple multiples of two for 19 cents. Second, the bargain concept of multiple pricing is not
usually effective over the $10 range. It is, however, very effective for items within the $1
range.
10.5.3 Odd Number Pricing
Odd number pricing refers to setting a price just below the psychological breaks in the
dollar, such as a price is set at 49 cents or 99 cents rather than 50 cents or $1. Prices may be
set at 19 cents or 49 cents or $19.95. This gives the psychological impression to the
customer that the price is not 20 cents or 50 cents or $20, but less. Odd number pricing is
often avoided in prestige stores or with higher priced items. An expensive dress could be
priced at $150, not $149.95.
10.5.4 Prestige Pricing
Prestige pricing refers to high markups and/or pricing above the market. Many consumers
are willing to pay more for a product or service because it is felt the product or service is of
higher quality or possesses brand or manufacturer prestige. Usually above-market pricing
can be done only when the product is unique or distinctive, or when the seller or
manufacturer has acquired prestige in the field.
(Source: Pricing-CDFS-1326-95-Small Business Series by Gregory R. Passewitz)
10.6 Pricing Strategies for Life Insurance Premiums
Cost-driven pricing: This type of strategy generally sets the premiums at a level
that will cover the company’s costs to create, offer, and administer the product, and
also allow an optimum profit for the company.
Competition-driven pricing: This type of strategy generally sets premiums in
reference to those set by competitors for similar products.
Customer-driven pricing: This type of strategy generally sets premiums that a
company’s customers will accept, that means the pricing is done depending on the
acceptance power of targeted customers.
Page 14 of 21
10.6.1 Actuarial Assumptions
Mathematical models are extensively used by insurance companies in relation to

profitability standards. Actuarial assumptions (assumed values) are made for the key pricing
components of a product. These include:
Investment earnings (often shown in terms of interest rate)
Cost of benefits
Loading
10.6.2 Investment Earnings and Interest Rates
For investment earnings and interest rates the following concepts are important to deal
with:
Time value of money: This concept states that the value of a sum of money will
change over time due to the effect of interest specified for that year.
Net investment income: This concept states the excess of investment income over
investment expenses, including management fees, transactions fees, and
administrative expenses
While all other factors are considered as constant, then if the:
Interest rate increases, then the value of the money invested will increase;
that means if the interest rate increases from 7% to 9% then the value of
the money invested will also increase.
Interest rate decreases, then the value of the money invested will decrease;
that means if the interest rate decreases from 7% to 5% then the value of
the money invested will also decrease.
Growth time period lengthens, and then the value of the money invested
will increase; that means if the time period increases from 7 years to 9 years
then the value of the money invested will also increase.
Growth time period shortens, and then the value of the money invested will
decrease: that means if the time period decreases from 7 years to 5 years
then the value of the money invested will also decrease.
10.6.3 Cost of Benefits and the Mortality Factor
Mortality rate: Mortality rate can be defined as the rate at which death occurs among a
group of people during a specified period generally one year
Page 15 of 21
Cost of Benefits - Cost of benefits means the cost of insurance. For life insurance it is
computed as:
Cost of benefit = (Death Benefit * Mortality Rate)
Generally, the higher the mortality rate, the higher the benefit cost and the higher the
premiums for life insurance.
Cost of benefits for an annuity is affected by the type of annuity and the payout option
selected.
During the payout period, the

Cost of annuity benefits for the year = (Annual income payment × Probability of annuitant’s
survival to the next year)
Higher mortality rates generally are associated with shorter life spans. The higher the
mortality rate for a group of life annuitants, the lower the benefit cost.
Loading - Loading refers to a pricing component structured to account for insurer’s

operating costs, and others (if specified). Loading charge offers several benefits to the
insurance company:
Provides a buffer to the insurer’s operating expenses
Makes up for loss of premium income due to defaults or policy lapses
Offers a financial cushion against unforeseen circumstances
Provides a margin that protects against departures from actuarial assumptions
Offers resources for policy dividends
Operating Expenses of Insurers - Operating expenses refer to those costs that are incurred
when the insurance company conducts its business. This excludes the benefit costs. The key
heads of operational expenses are:
Development expenses relating to planning and developing insurance products
Acquisition expenses involved in getting and issuing new business (policies)
Maintenance expenses which are incurred for keeping the policies active
Overhead expenses are incurred in performing routine operations, but are not
linked directly to any product/service. For instance, electricity and telephone bills.
Page 16 of 21
10.6.4 Mortality Table Calculations
Generally all actuaries collect and preserve mortality statistics from various sources,
including the insurer’s mortality experience that defines the number or rate of deaths that
actually occurred in a given group of people generally taken for a year
An example: Mortality Table Calculations

BASIC MORTALITY TABLE
1 2 3 4
Age Mortality per 1000 Number living Number dying
80 11 1,00,000 1,000
81 12 99,000 1,100
82 13 97,900 950
Number living, age 81

= (Number living, age 80 – Number dying, age 80)
= (1, 00,000 – 1,000) = 99,000
Mortality rate = (Number dying, age 81/ Number living, age 81)
= 1100/99000
= 0.012
The mortality rate is 12 per 1,000 lives.
10.6.5 Mortality Tables and Data
Common types of mortality tables include:

Annuity mortality table: lower mortality rates than life insurance mortality table
Life insurance mortality table: higher mortality rates than annuity mortality table
Basic mortality table: no safety margin; used for pricing
Valuation mortality table: safety margin; used for reserves
Sex-distinct mortality table: women live longer than men
Unisex mortality table: required in a few jurisdictions
Page 17 of 21
10.7 Insurance Product Expenses
The loading charge in insurance products:

Defrays the insurer’s operating expenses
Compensates the insurer for loss of premium income from policy lapses
Provides a financial safety margin against unexpected outcomes from actuarial

assumption
Provides a safety margin that can fund policy dividends for participating products
Operating expenses are costs, other than benefit costs, that arise in the normal course of
insurance company operations. These include the following:
Development expenses: associated with planning and creating insurance products
Acquisition expenses: related to obtaining and issuing new business
Maintenance expenses: associated with keeping policies in force
Overhead expenses: incurred during normal business operations, but not directly
connected to a specific product or service (e.g., electricity cost)
10.8 Bundled and Unbundled Pricing
Both life insurance and annuity products may have a bundled or unbundled pricing
structure. Bundled pricing is common for older product types such as whole life insurance
and fixed annuities.
Bundled pricing: the insurer presents the product as a package of benefits to customers in
exchange for a specified monetary amount
Unbundled pricing: the insurer explicitly discloses to customers the breakdown of various
benefits and loading charges and the investment return rate being credited
Page 18 of 21
Summary:
There are some basic rules of pricing followed by most of the managers:
a. The price must cover costs and profits.
b. Lower costs will lead to effective lower pricing.
c. Price of a product must reflect the dynamics of cost, market demand,
response to the competition, and profit objectives.
d. Key motive behind prices is to promise sales.
Generally at what time there is a need to do the pricing?

a. Introduction of a new product or product line;
b. Change of costs involved;
c. Exploring new market;
d. Change in competitors prices;
e. Change in economy (inflation or recession);
f. Change in sales strategy
g. Customers’ derived value is more than expectations
Four basic components are considered for an effective pricing: Costs, Price
Sensitivity, Competition, Product Life cycle
A perfect price for a product must:

a. Accomplish the financial objectives of the business (profitability)
b. Match the practicality of the market scenario (are people ready to buy at
that price?)
c. Support a product's positioning and be consistent with the other variables
in the marketing mix
Pricing of a product generally follows one of the basic rules: Cost-Plus Pricing,
Demand Price, Competitive Pricing, Markup Pricing
a. In a service-oriented business the price should include:
b. Variable costs
c. Fixed (operating expenses) costs
d. Profit
Pricing strategies for life insurance premiums: Cost-driven pricing, Competition-
driven pricing, Customer-driven pricing
Page 19 of 21
Mortality rate: Mortality rate can be defined as the rate at which death occurs
among a group of people during a specified period generally one year
Cost of Benefits - Cost of benefits means the cost of insurance. For life insurance it
is computed as:
Cost of benefit = (Death Benefit * Mortality Rate)
During the payout period, the
Cost of annuity benefits for the year = (Annual income payment × Probability of
annuitant’s survival to the next year)
Loading - Loading refers to a pricing component structured to account for insurer’s
operating costs, and others (if specified)
Bundled pricing: the insurer presents the product as a package of benefits to

customers in exchange for a specified monetary amount
Unbundled pricing: the insurer explicitly discloses to customers the breakdown of
various benefits and loading charges and the investment return rate being credited
Page 20 of 21
Page 21 of 21
Chapter-9 Product Development
Page 1 of 18
Notice
Contents
.....................................................................................4
!" .......................................................................................... 5
# ......................................................................................6
$ ................................................................................6
% .......................................................................................................... 7
& ' ( ...............................................................................9
) ...................................................................................................... 12
* ....................................................................................................... 12
+ , ............................................................................................. 13
- .............................................................................................................. 13
!. / ................................................................................. 13
!! , ................................................................................................ 14
!# 0 ............................................................................................ 14
!$ , ................................................................................................ 14
!% / ...................................................................................................... 15
!& 1 ............................................................ 15
......................................................................................................................... 16
Page 3 of 18
" 2" 34 4
" (
( 6
7 "
8
8 ' ( 4 4 4 4
4
Page 4 of 18
! "
" 2" 34 4
" 6
6 4 4 9
6
/
5
;, <
;
;,
;, =
9 >
? , 4
2 < > 34 2 < ,>

( 34 2 < , @
3 ? 4
<
> -
Page 5 of 18
A <
"
' >
(
# $$
0
6
$$ $
;/
;
;0
5
% $
% $ &B 5
6
8
1
( 5 C
A
B 5 C
Page 6 of 18
/ <
B 4
1 5
>
%# ' & ( 5
6
4
0< 4
2 4
4 4 4
3
(
6
4
' 4
/ 2 4 4 3
(
> >
0
(
?
4
= 4
4
Page 7 of 18
2 6 6DD D $ 3
'
4 - 4
4
"
C D
Page 8 of 18
B
' D
,
5
=
4
4 <
) $ * $ $$ + $$
(
4
' , $ $6 (
=
- $ $ $6 (
C <
' , 6(
<
4 < 4 4 4
Page 9 of 18
$ $6
C 4 4
4
- $ . $ - /0
C = 4 4 4 4
9.5.1 Responsibilities in Comprehensive Business Analysis
' , $ $ $ $
(
6
4 4
(
C 4 4
C >
0
+ $$ $ $ $
4 4
+ $ $ $ $
4 4
4 4 4
1 " $ $ $ $
Page 10 of 18
$ $$ $ $ $
=
<
$ $ $ $ $
<
=
C
. 2/ $ $ $ $
$ $ $ $ $ $
=
=
+ $ $ $ $
3 $ $ $ $
Page 11 of 18
4 $ $
( C D
4 4 4 4
=
, 4
4
>
6 5 3 678 73 6797 2
4 4
4 <
23 2 4
4 39
:2 $
EF >
4
4 4
4 4 4 4
Page 12 of 18
,
, 2, 3
A D(
5 6
( = =
( C 5 5
4
=
, 7 4
0< 2 0 3
< $' $
, 4
6
"
>
Page 13 of 18
, 7 4 "(, A , , / 1
4
4 =
/ 1
" 4 4 4 4
$ $
, 4,
>
, 4 4 = 9
4 4
#7 2
( 4
C
=
4
4
C 4 =
-
6
,
B
4 4
Page 14 of 18
( $'
< 4
6
1 D
/ C
1 > >
,
, C 4
)6 " $$
C
C
,
=
Page 15 of 18
" 6
6 4 4 9
6
6
/
A <
"
' >
(
0
6
6
$ '
6
4
' 4
/ 2 4 4 3
/ 6 (
=
Page 16 of 18
- 2 - 36
C = 4 4 4 4
6
23 2 4
4 39
6
/
,
, 2, 3
A D(
, 4
6
"
>
Page 17 of 18
Page 18 of 18
Chapter-8 Captive Insurance
Page 1 of 21
TCS.
Notice
Contents
Chapter – 8 Captive Insurance ...............................................................................................4
8.1 Introduction ................................................................................................................. 5
8.2 History.........................................................................................................................6
8.3 Captive Offshore Locations .........................................................................................6
8.3 Types of Captives.........................................................................................................8
8.4 Setting of Premiums.................................................................................................. 10
8.5 Advantages of Captives ............................................................................................. 10
8.5 Structure of Captives ................................................................................................. 13
8.6 Captive Operations.................................................................................................... 14
8.7 Challenges ................................................................................................................. 16
8.7.1 “Numbers” Challenge.............................................................................................. 16
8.7.2. Tax Challenges....................................................................................................... 16
8.7.3. Ratios and Regulations........................................................................................... 17
Summary ........................................................................................................................ 19
Page 3 of 21
Chapter – 8 Captive Insurance

Introduction
Large insurance companies carry a lot of risk and they often create vehicles to finance these
risks. Here is where captive insurance companies step in. Captive insurance companies
finance risks arising from parent insurance company operations. They thus act as in-house
self insurance companies. This chapter describes the fundamentals of captive insurance and
how it operates.
Learning Objective
After reading this chapter you will understand:
What captive insurance is and its purpose
Various types of captives
Captive benefits and challenges
Operations and structure of a captive
Page 4 of 21
8.1 Introduction
Captive insurance aims to “captivate” risk!!

“A captive insurance company is generally defined as a company that insures risks of its
parent firm, particularly those risks which are complex and are not often insured in
traditional scope of insurance operations.”
Large insurance companies carry a lot of risk and they often create vehicles to finance these
risks. Here is where captive insurance companies step in. Captive insurance companies
finance risks arising from parent insurance company operations. In essence, they insure risk
of their “super” companies, thus acting as in-house self insurance companies.
Insurance companies prefer setting up captives, as they benefit from commercial, economic
and tax concessions. This in turn helps reduce costs, simplify insurance risk management
and increase cash flow flexibility. Plus, the greatest benefit is captives cover risks which are
often not available under traditional insurance market. It also facilitates easier access to
reinsurance. Captives are often located offshore and administered by special “captive
managers”
The main kinds of insurance underwritten by captives include property damage, public and
products liability, professional indemnity, employee benefits, employer’s liability, motor
and medical aid expenses.
There are a number of factors fueling the growth of captives, with the primary ones being:
1: High costs of premiums in traditional insurance
2: Reluctance of insurers in covering some risk types
3: Lack of uniformity of insurance coverage in different regions of the world
4: Flawed credit rating policies which are dictated by market rather than individual
losses
With growing economies, liberalisation and globalisation, the exposures of companies are
also on the rise. Particularly in the past three decades, captives have been increasing in
number and business. Currently, there are over 4,000 captive firms globally, with more than
$20 billion in underwriting premiums. Capital and surplus of these firms is well over $50
billion.
Page 5 of 21
Captive insurance originated in 1920s with the setting up of mutual funds and insurance
firms. Rapid growth of captives could however be seen in 1950s, with companies
establishing captives offshore.
Captives often function as reinsurers i.e., they accept risk of their parent firm indirectly. The
parent firm takes insurance from a licensed insurer, who then cedes this risk to the captive.
This licensed insurer is termed as a “fronting company”, and it may seek a guarantee
towards captive’s claims repayment capability by a letter of credit.
8.2 History
Captives are by no means new – they have been around in some way or the other since the
late 19th century when there were Protection and Indemnity clubs. But, the growth of such
groups or clubs was slow. The origin of captive insurance industry is a result of formation of
mutual and co-insurance companies in the 1920’s and 1930’s. By 1950s, there were not more
than 100 captives. Developments in Bermuda in the 1960s helped accelerate the growth.
The term “captive” was coined by Fred Reiss, who created a management firm in 1962 in
Bermuda and got many of his clients to set up captives. The insurance sector hardened in
the 1970s and 1980s, pressurizing several companies to establish captives, which further
contributed to the growth. Today, captives are all pervasive – in fact over 40% of large US
companies and several multinationals own at least one captive. Thus it can be seen that
there has been a phenomenal growth in the number of captives companies in past 2 to 3
decades. The result of this growth led to over 4000 captives worldwide.
8.3 Captive Offshore Locations
Captives are generally established in offshore locations (“domiciles”) to take advantage of

lower costs, tax and regulatory advantages. Worldwide, there are some countries that have
emerged as captive havens including Bermuda, Vermont, British Virgin Islands, etc.
Domicile Captive Number Percentage
Bermuda 879 20.0%
Cayman Islands 693 15.8%
Page 6 of 21
Vermont 524 11.9%
Guernsey 379 8.6%
British Virgin Islands 346 7.9%
Luxembourg 262 6.0%
Barbados 224 5.1%
Ireland 224 5.1%
Hawaii 147 3.3%
Isle of Man 130 3.0%
South Carolina 114 2.6%
Turks & Caicos 71 1.6%
Arizona 59 1.3%
Singapore 57 1.3%
Sweden 41 0.9%
Switzerland 41 0.9%
District of Columbia 40 0.9%
Utah 40 0.9%
Nevada 38 0.9%
Page 7 of 21
New York 27 0.6%
Netherlands 26 0.6%
Labuan 25 0.6%
Vanuatu 25 0.6%
Bahamas 23 0.5%
Total 4,435 100.0%
Table 8.1: Captive Locations
Source: www.wikipedia.org
8.3 Types of Captives
There are various types of captive insurance companies. The important ones include the
following:
Single Parent Captive -This can be an insurance or reinsurance company for a
“non-insurance” company. This captive is formed to take on risks arising from a
parent company or affiliate which is not engaged in insurance. Here capital is
provided by the parent of the captive insurance company. There is an initial set
up cost and long term commitment is required to be fully effective.
Association Captive - This is a captive created by an industry/trade
association/service group with the intent to insure risk of its members. Liability
risks such as medical malpractice are often insured in this manner.
Page 8 of 21
Figure 8.1: Single Parent Captive
(Source: www.riskmgmtadvisors.com)
Group Captive - A group of companies often create these captives, to address a

common insurance requirement.
Agency Captive - An insurance broker or agency establishes this captive for
reinsurance of their customer’s risk. Also known as Program Business captive or
producer-owned reinsurance companies (PORC).
Rent-a-Captive - This is a captive that offers facilities to smaller insurance

companies for a fee. The risk that is thus borne is often mitigated through other risk
management programs. The customer needs to offer some collateral to prevent
losses to the captive arising from the customer’s underwriting losses.
Diversified Captive - This not only addresses risks of parent/affiliate, but also of
unrelated companies.
In the recent years, two unique insurance programs have come into play. These include
special purpose vehicles (SPV) and segregated portfolio companies (SPC). SPV has
commonly been used traditionally for financing arrangement, but lately it is being used
in reinsurance and catastrophe bonds. SPVs function through securitisation i.e., they
Page 9 of 21
offer reinsurance to their parent firms and then convert the risk borne into securities
that can be traded in capital markets. SPCs are being created as rent-a-captives.
8.4 Setting of Premiums
Premiums are paid to captives to generate a valid business deduction. The terms of the
policy as well as the premium amount must be reasonable.
The premium amount cannot be set arbitrarily by the captive to generate a deduction for
the parent. A US taxpayer gets no deduction for premiums paid to the captives that are
wholly-owned. On a consolidated basis and for tax purposes; a non-insurance parent
company can deduct amounts actuarially accrued as loss reserves, on a discounted basis
and for others an undiscounted basis for US GAAP earnings is helpful. Other corporations
may not accrue or expense any general provisions for loss, insurance-related or otherwise
until the amount is actually identifiable, measurable and owed. These types of losses are
accepted in the form of Incurred-but-not-reported (IBNR) for insurance and reinsurance
entities.
8.5 Advantages of Captives
The underlying rationale with captives is that risk must be kept with a captive, otherwise it
will end up being with the owner. Hence it is an essential tool of risk management in the
insurance sector. In addition, there are several important advantages to captives as outlined
below:
Cost - External insurers charge premiums so that they account for profit margins
and overheads. Premiums thus can be on the higher side as overheads tend to be
higher for large insurers due to their huge corporate structures. Thus owing a
captive does make for business sense.
Thanks to a captive, a company can stabilise costs as it is not subject to insurance

market swings. Cost savings also come from lack of profit element, absence of
broker commissions, and reduced administrative costs. The parent also gets to
share profits by way of shareholder or policyholder dividends. Another major cost
saving is that expensive insurance regulations maybe avoided, specially those
pertaining to making payments to residual market pools and premium taxes. Often
Page 10 of 21
all of these savings amount to more than the cost of establishing and running a
captive.
Stability - Captives reinsure their risks when insurance rates are low in soft market
conditions. The low cost helps captive create a buffer or an “extra” cushion for its
operations. So, the captive can continue to insure risk for parent company, even
when the market hardens or insurance becomes pricey.
Claims management - Claims management is easier and takes less time as the
captive is an in-house vehicle. Thus it helps eliminate bureaucracy and delays that
are typical of a traditional insurance company.
Claims experience benefits - Captives keep some risk and reinsure the rest. Hence,
when the claims experience (the actual claims made against a risk insured) is better
than anticipated (i.e., there are lesser claims), then the surplus of premiums is
retained by the captive. Hence, reinsurance is made tailored to the group’s
exposure.
The common perception is that tax benefit is the primary benefit from a captive.
However, in reality, the motivating factors for captive insurance are risk management
and risk financing.
Lower insurance costs - In fact, premiums account for 30-40% of the whole pricing.
By setting up a captive, the parent company retains the profit and prevents it from
going to an outside firm. In addition, the captive is in a better position to determine
a premium which is more appropriate to the parent’s loss experience.
Cash flow - Insurers profit not only from underwriting premiums but also from
investment income. This is because insurers get premiums in advance and pay
claims in future. Until such claims are paid, premiums can be invested – thus the
insurer has free resources. If a captive is there, the parent company gets to retain
premiums as well as investment income. And if the captive is located offshore,
there may be no taxes on investment income. In addition, the parent firm may get
the benefit of a flexible premium payment plans resulting in cash flow benefits.
Risk management - The parent firm’s risk management and financing activities can
be the core focus for a captive. In turn, for the captive, risk management can be
profitable and not a cost element.
Page 11 of 21
Access to reinsurance - Reinsurers can be viewed as wholesalers, whose

operational costs are lower than traditional insurers. Hence they can offer services
at better prices. A captive can easily access reinsurance markets and decide the
appropriate risk retention and accordingly create insurance plan for the parent.
Unrelated risk - A captive also has the option to underwrite unrelated risks i.e.,
offer services to third parties. Specifically, a company may wish to offer insurance
to existing clients. For example, a bank may want to give insurance to its deposit
holders. Generally, claim experience of such operations is predictable, and can
generate additional income to the company.
Increased capacity - On their own, captives maybe unable to provide a
comprehensive range of insurance. However, they are able to access reinsurance
and thus provide greater coverage limits than could be obtained in the retail
market. In addition, a captive can insure subsidiaries and members who cannot be
insured traditionally. Such liabilities include professional liability, business risks and
punitive damages.
Better control - Captives allow companies to control various aspects of insurance
which otherwise are subject to several changes. These include claims, settlements,
underwriting, investments, premium rates and forms. If the captive is involved
directly in writing, then they can offer “tailored” wordings that the reinsurers can
follow.
Benefit from insurance accounting - Special tax benefits are accorded to insurers –
tax deductible reserves can be accrued for unpaid claims. If there are life insurance
reserves, they need not pay taxes on inside build-up of interest income. In addition,
for non-insurance parents with captive insurers, tax accounting hinges on a similar
treatment.
Tax Deductibility - There are several tax benefits to be harnessed through captives,
particularly those with multiple owners or insured parties and/or where the
shareholders are distinct from the insureds. The two main advantages are premium
deductibility and deferred taxation of insurance income.
Formalized services - Captives offer the security of “formalized services” – books
and records of captives are audited. Their claims reserves are audited by actuaries,
accounts maintained by independent personnel, and investments are handled by
professionals. Thanks to these processes, the risk financing process is formalized,
which are considered better than “unformalised” internal services.
Page 12 of 21
Benefit from favorable regulations - A majority of captives are domiciled offshore

to avoid insurance solvency regulations. Solvency regulations aim to protect policy
holders.
Data efficiency - A captive has a key role to play in data collection and
management efforts. Warehouse data: A captive functions as a tool for data
collection that supports the company in cost containment initiatives. As an
illustration, a captive can be a central location for information pertaining to
professional liability insurance.
Figure 8.2: Comparison of Various Insurance Structures
8.5 Structure of Captives
There are three components of any captive – finance, operations and people.
Financial resources – These comprise capital, premiums and investment income.

Together these financial resources must be able to cover
Operational expenses of the captive
Page 13 of 21
Legal obligations involved in insurance/reinsurance agreements

Ability to finance during some adverse business development
Owners/Insured Captive Investment

Portfolio
Owners/insured give capital and premiums to the captive

The captive in turn makes claims and dividend payments to owners/insured
The captive also holds a portfolio of investments, from which it derives
investment income
Figure 8.3: Sources and Uses of Funds of a Captive
8.6 Captive Operations

Captive operations resemble those of a commercial insurance company. The captive either
offers insurance policies directly to the insured or reinsures a “fronting firm” which insures
the parent. The captive gets premiums from insured and makes claim payments. And as any
financial firm, retains some reserves to meet its obligations and expenses. Another major
activity is investing and getting income from this. Captive insurance companies are also
responsible for issuing dividends to insured’s and owners.
There are three core entities involved in operating a captive –

Captive’s executives
Board of Directors
External service providers
Some captive also employ “own” people. The Board of Directors sets up committees in
various areas such as claim, audit, finance, underwriting, etc., who help set policy.
Execution of the policy is delegated to various executives of the Captive.
Generally captives conduct everyday operations, maintain requisite books and records, and
liaise with regulators and the board of directors. In addition, they also work with special
service providers such as lawyers, actuaries and accountants, legal counsel, claim managers,
who are accountable to the Board of Directors.
Page 14 of 21
Owner/Insured
Captive Board of
Directors
Committees of Executives/Officers Service Providers

Board President Legal
Claims Treasurer Actuary
Finance Secretary Management
Premium Finance Officer, Audit, etc.
Audit, etc. etc.
Figure 8.4: Organizational Structure of a Captive
If the captives do not have their own employees, then captive management company takes
care of day to day operations of the captive. The captive management company is also
responsible for keeping accurate books and financial records and also for working with
special service providers. Generally these management companies assemble a service team
which helps the captive owners to enter in the captive insurance market.
Page 15 of 21
Figure 8.5: Relationship of a Captive Management Firm

8.7 Challenges
The key challenges for a captive can be summarized under four heads – numbers, taxes,
regulations and financial ratios.
8.7.1 “Numbers” Challenge

Actuarial projections - In several locations where captives are domiciled, actuarial analysis
is a must as a component of feasibility study. This analysis forms the base for premium and
loss estimations. Such an analysis will also give a positive impression to regulators, tax
advisors and reinsurers. Most times, ongoing actuarial analysis maybe needed – this is
particularly true when a third party experts’ views about the captive’s reserve position are
required.
Expenses - In order to offer the host of benefits listed above, operations of a captive must
be more efficient than those of a traditional insurer. Captive expenses need to be less than
20% of the premium (except in certain unavoidable circumstances).
Investment results - Premiums are a reflection of time value of money. The underlying
assumption is that investment income will make up for the decreasing relative value of
premiums over a time period (i.e., the same premium amount amortises).
8.7.2. Tax Challenges

Taxes are constantly in a state of flux, which is a key area of concern to captives. Primarily,
captives are subject to three main kinds of taxation – domicile premium tax, government
excise tax (Federal in the US), and income tax. Further, in the US, captives are subject to the
953(d) election.
Premium taxes- These apply when insured pays premiums. The tax ranges between
3-4% of the premiums.
Excise taxes - When there is a deal with offshore captive, it is treated as import of a
service and hence is subject to federal excise tax (FET) in the US. Tax rate is lower for
reinsurance when compared to insurance.
Income tax - Not all premiums made to captives are tax deductible. In US, tax
deductibility is subject to one or all of the following factors:
It’s a genuine insurance transaction, with some risk being taken on by the
captive
Page 16 of 21
The parent is so structured that subsidiaries make premium payments (not

the parent itself)
The captive also significantly (around 20-30%) insures third party risk writes
a substantial amount of unrelated business.
The captive is so organised that shareholders are distinct from the insured
One advantage is that premiums to group captives are tax deductible.
Income tax for a captive differs based on the domicile. In case it’s located offshore,
generally in such locations, income tax is zero. However, the country in which the parent
company is based may tax the profits earned by the captive even though it’s domiciled
elsewhere. In the US, the profit amount must be filed through Subpart F of the IRS tax code.
As per Section 953(d) of US Internal Revenue Code, select foreign insurers such as captives
are considered domestic for tax purposes. They are subject to income tax directly, rather
than through subpart F (i.e. income earned by shareholders). There are some key benefits
to this “election” including exemptions on federal excise tax and branch profits tax.
However, there are some disadvantages also – primarily the election cannot be revoked.
8.7.3. Ratios and Regulations

Captive insurance firms are often regulated on the basis of certain leverage ratios (some key
financial ratios). Some these are:
Risk gap:
Risk Gap = Net retained limit of captive – (premiums + capital of captive)
Captives need to have enough reinsurance to cover the risk gap. Alternatively, they must
guarantee more premium or capital.
Solvency ratio - This refers to the maximum amount of premiums a captive can write vis-à-
vis its capital and surplus position. For example, the limit in Bermuda is 5:1 for premiums up
to $6 million and 10:1 for higher premium. In some other domiciles its 3:1. For a majority of
captives, the solvency ratio makes no sense as their risk profile is separate from that of
Page 17 of 21
traditional insurers (based on whom the ratio was designed in the first place). As a matter of
fact, majority of captives follow a ratio of less than 1:1.
Loss Reserve ratio - This compares loss reserves with capital and surplus. The loss reserves
to capital and surplus ratio is important from regulatory point of view if they feel that
reserves are understated. Generally for P&C captives, the proportion of 4:1 is accepted,
though in Bermuda it can go up to 10:1.
Retention ratio - This means the amount of risk retained in net by a captive per occurrence
(per event) compared with its capital and surplus. Often 10-25% of capital and surplus is
exposed per occurrence. This is more than what the traditional insurers are subject to
(which can’t be more than 10%). In fact, some captives have ratios of 50-100%!
Page 18 of 21
Summary
Captive insurance aims to “captivate” risk!!
Captive insurance companies finance risks arising from parent insurance company
operations. In essence, they insure risk of their “super” companies, thus acting as in-
house self insurance companies.
The main kinds of insurance underwritten by captives include property damage,
public and products liability, professional indemnity, employee benefits, employer’s
liability, motor and medical aid expenses.
Currently, there are over 4,000 captive firms globally, with more than $20 billion in
underwriting premiums
Captives are generally established in offshore locations (“domiciles”) to take
advantage of lower costs, tax and regulatory advantages
There are various types of captive insurance companies. The important ones include
the following: Single Parent Captive, Association Captive, Group Captive, Agency
Captive, Rent-a-captive, Diversified Captive
There are three components of any captive – finance, operations and people
The captive either offers insurance policies directly to the insured or reinsures a
“fronting firm” which insures the parent.
The key challenges for a captive can be summarized under four heads – numbers,
taxes, regulations and financial ratios.
Page 19 of 21
Page 20 of 21
Page 21 of 21
Chapter-7 Investment Management
Page 1 of 20
Confidentiality statement
TCS.
Notice
Contents
Chapter – 7 Investment Management ...................................................................................4
7.1 Investment Concepts ................................................................................................... 5
7.2 Types of Risk ................................................................................................................6
7.3 Risk-Return Tradeoff and Diversification ..................................................................... 7
7.4 Asset/Liability Manager ............................................................................................... 7
7.5 Investment Operations ................................................................................................8
7.6 Investment Policy ........................................................................................................9
7.7 Regulation.................................................................................................................. 10
7.8 Debt Assets and Equity Assets ................................................................................... 10
7.9 Bonds ........................................................................................................................ 11
7.10 Mortgages................................................................................................................ 13
7.11 Amortization ............................................................................................................ 14
7.12 Securitization ........................................................................................................... 14
7.13 Concepts in Real Estate ............................................................................................ 15
7.14 Policy Loans ............................................................................................................. 15
7.15 Investment Strategies .............................................................................................. 16
Summary: ....................................................................................................................... 18
Page 3 of 20
Ch7: Investment Management V1.0 TCS Business Domain Academy
Chapter – 7 Investment Management
Introduction
Investment or investing can be explained as use of resources intended to generate a return;
an asset in which an investor places money to earn a financial return. The basic meaning of
the term being an asset held to have some recurring or capital gains. It is an asset that is
expected to give returns without any work on the asset.
Learning Objective
Understand what Investment is and its importance and various concepts
Know about Investment Operations, Investment Policy and Investment Department
Activities
Know the purpose of investment and the investment strategies
Importance of insurance for investments
Page 4 of 20
7.1 Investment Concepts
7.1.1 Investment
Investment or investing is a term with several closely-related meanings in business

management, finance and economics, related to saving or deferring consumption. An asset
is usually purchased, or equivalently a deposit is made in a bank, in the hope of getting a
future return or interest from it. The word originates in the Latin “vestis”, meaning garment,
and refers to the act of putting things (money or other claims to resources) into others’
pockets. The basic meaning of the term being an asset held to have some recurring or
capital gains. It is an asset that is expected to give returns without any work on the asset.
In simple terms this can be explained as the use of resources intended to generate a return;
an asset in which an investor places money to earn a financial return.
7.1.2 Investment Risk
On the basis of assurance of the return, there are two kinds of Investments – Risk-less and
Risky. “Risk-less” investments are guaranteed, but since the value of a guarantee is only as
good as the guarantor, those backed by the full faith and confidence of a large stable
government are the only ones considered “risk-less.” Even in that case the risk of
devaluation of the currency (inflation) is a form of risk appropriately called “inflation risk.”
Therefore no venture can be said to be by definition “risk free” - merely very close to it
where the guarantor is a stable government.
7.1.3 Portfolio
Portfolio is defined as a collection of assets brought together to meet a defined set of

financial goals. A portfolio can also be defined as a suitable mix of or collection of
investments held by an institution/ company or a private individual. In construction of an
investment portfolio a financial organization will usually carry out its own investment
analysis, whilst a private individual may make use of the services of a financial advisor or a
financial institution which offers portfolio management services or can decide on his/her
investment portfolio. Holding a portfolio is part of an investment and risk-limiting strategy
called diversification. By owning more than a few assets, certain types of risk (especially
specific risk) can be reduced. The assets in the portfolio may include stocks, bonds, options,
Page 5 of 20
warrants, gold certificates, real estate, futures contracts, production facilities, or any other
item that is expected to retain its value.
7.2 Types of Risk
Depending on the nature of the investment, the type of investment risk will vary.
Capital risk: A general apprehension with any investment is that one may lose the money
he/she invested, that is the capital owned by that individual. Such risk is therefore often
referred to as “capital risk.”
Currency risk: If the assets invested by an individual are held in another currency there is
always a risk that currency rate fluctuations alone may affect the value of those currencies.
This is defined as “currency risk.”
Liquidity risk: All the forms of investment may not be willingly saleable on the open market
(for instance commercial property) or the market may have a small capability and may
therefore take a little more time to sell. Therefore such types of risk are termed as “liquidity
risk.” Assets that can be easily sold are termed liquid.
Financial risk: The risk where there may be a disturbance in the internal financial affairs of
the investment, thereby causing a loss of value, is called “financial risk.” A perfect example
of that form of risk was experienced by the investors in Enron, where one of the “dot-com”
stocks really never did have a profitable financial footing. Many of the employees of Enron
experienced both liquidity and financial risk as the price decline in the stock of that
company occurred just as there was a “freeze” on stock liquidation in their retirement plans.
Market risk: This is the most familiar form of investment risk “market risk.” In a highly liquid
market like the collective stock exchanges in the United States and across the developed
world, the price of securities is set by the forces of supply and demand. If there is a high
demand for a given issue of stock, or a given bond, the price will rise as each purchaser is
willing to pay more for the security than the last one. The reverse of that occurs when the
sellers want to rid themselves of an issue more than the buyers want to buy it. Each seller is
willing to receive less than the last one and the market price, or valuation, declines
This “market risk” can be simply defined as the possibility that the investor will fail to earn a
return or will lose all or part of the principal, the amount initially invested in the stocks.
Page 6 of 20
7.3 Risk-Return Tradeoff and Diversification
Interest can be defined as a fee paid for the use of someone else’s money. Two type of
interest are there for calculation purpose:
1. Simple interest can be defined as interest paid on the original principal only
2. Compound interest can be defined as interest paid on both the original principal and
any previously accumulated interest
Capital gain can be defined as the amount by which an asset’s selling price exceeds its
purchase price where as capital loss can be defined as the amount by which an asset’s
purchase price exceeds its selling price.
Risk-return tradeoff - This can be defined as the relationship between risk and return which
is considered as a factor in every financial or investment decision that an insurer makes.
Inflation can be defined as a prolonged rise in the average level of prices in an economy
where as deflation can be defined as a prolonged decrease in the average level of prices in
an economy.
Diversification can be defined as a technique for spreading risk by investing in different
assets with different risk levels.
7.4 Asset/Liability Manager
Asset liability management is the practice of managing risks that arise due to mismatches
between the assets and liabilities (debts and assets) of the bank.
Banks face several risks such as the liquidity risk, interest rate risk, credit risk and
operational risk. Asset liability management (ALM) is a strategic management tool to
manage interest rate risk and liquidity risk faced by banks, other financial services
companies and corporations.
Banks manage the risks of Asset liability mismatch by matching the assets and liabilities
according to the maturity pattern or the matching the duration, by hedging and by
securitization.
Asset liability managers monitor the investment-related cash inflows and outflows for a
specific line of the insurer’s business and ensure that sufficient funds are available when
needed to support that line.
Page 7 of 20
7.5 Investment Operations
Typical Employees in Investment Function include:

Chief investment officer
Asset/liability managers
Portfolio managers
Investment analysts
Economists
Traders
Investment department organizational structures vary greatly among life insurance

companies, according to which activities are outsourced and which are performed in house.
When evaluating investments, analysts and portfolio managers consider:
Cash flow patterns
Risk characteristics
Liquidity
General economic conditions
Investment constraints from regulatory requirements
Insurance Industry investment asset allocation
Page 8 of 20
Life insurance companies made a growth of 4% in the first three quarters of financial year
2012-13. The total premium collection from the individual segment by 24 life insurers stand
at Rs 40,688 crore in April-December 2012 as against Rs 39,131 crore in the last year.
Public sector insurer Life Insurance Corporation of India (LIC) made 11.3 per cent growth in
retail segment, with Rs 28,017 crore during April-December 2012 while private sector
insurers' has collected Rs 12,671 crore from individual segment. As per IRDA reports
insurance density came out be US$ 49 while insurance penetration stood at 4.1 per cent in
2011.
The level of growth of insurance sector in a country depends on the measure of insurance
penetration and density. Insurance penetration is measured as the percentage of insurance
premium to the gross domestic product (GDP), insurance density is calculated as the ratio
of premium to population (per capita premium).
(Source: www.ibef.org)
7.6 Investment Policy
An investment policy is any government regulation or law that encourages or discourages

foreign investment in the local economy, e.g. currency exchange limits. The economies of
neighboring and of trading states, are typically forced to trade off such rules as part of a
common tax, tariff and trade regime, e.g. as defined by a free trade pact. Investment policy
favoring local investors over global ones is typically discouraged in such pacts, and the idea
of a separate investment policy rapidly becomes a fiction or fantasy, as real decisions reflect
the real need for nations to compete for investment, even from their own local investors.
Investment policy in many nations is tied to immigration policy, either due to a desire to
prevent human capital flight by forcing investors to keep local assets in local investments,
or by a desire to attract immigrants by offering passports in a safe haven nation, e.g.
Canada, in exchange for a substantial investment in a business that will create jobs there.
Sample Issues Addressed in Investment Policy

Cash-flow properties of the portfolio
Strategy to meet policy owner obligations
Contributions to earnings and surplus
Spread is defined as the difference between the rate of return earned on
investments and the interest rate credited on policies
Page 9 of 20
Rate of return can be defined as the return earned on an investment during a given
time period, expressed as a percentage of the purchase price
Investment department operational guidelines
7.7 Regulation
Regulation can be well thought-out as legal boundaries or margins propagated by

government authority. One can think about at least two levels in democracies; one as
legislative acts, and other as implementing specifications of conduct imposed fine. This
administrative law or implementing regulatory law is in contrast to statutory or case law.
Regulation mandated by a state efforts to produce results which might not otherwise occur,
produce or may prevent outcomes in different places to what might otherwise occur, or
produce or prevent outcomes in different timescales than would otherwise occur.
Regulators aim to protect consumers from the threat of insurer insolvency by adequate
diversification. Regulatory requirements apply to the insurer’s general account.
General accounts are defined as assets that support a life insurer’s contractual obligations
for guaranteed products, such as traditional whole life insurance and fixed annuities.
Whereas separate accounts are described as assets that support the liabilities associated
with variable products, such as variable life insurance and variable annuities
7.8 Debt Assets and Equity Assets
Debt assets represent the investor’s loan of funds to the debt issuer in exchange for the
promised repayment of the principal and payment of interest. This can also be defined as a
metric generally used to calculate company's financial risk. This is done by measuring how
much of the company's assets have been financed by debt.
This is done by adding short-term and long-term debt, and then dividing the total by the
company's total assets.
Bonds
Mortgage loans
Bank deposits
Equity asset represents the investor’s ownership or share of ownership in an asset generally
a business or a piece of property
Common stock
Page 10 of 20
Real estate
New and Previously Issued Securities
Public offering can be defined as the security where an issuer makes a new or fresh
security available for sale to the public
Private placement can be defined as the new security sold directly from the issuer to
a limited number of investors, typically institutional investors such as insurers, and
mostly they are into public
Some concepts:
Securities exchange can be defined as location where buyers and sellers meet to
buy and sell their existing securities. In simple terms it is defined as a place to buy
and sell securities.
Over-the-counter (OTC) market can be defined where dealers at different locations
who have an inventory of existing securities stand ready to buy and sell securities
7.9 Bonds
This can be defined as a security that represents a debt that the issuer of the bond owes to
the bondholder and to the investor who owns the bond. The various concepts linked to a
bond are:
Maturity date can be defined as the specified date on which the business or government
that issues a bond is legally obligated to pay the bondholder the bond’s face value (defined
as the amount owed on the maturity date)
Coupon rate can be defined as the interest rate specified on a bond and applied to the
bond’s face value to determine the amount of the periodic interest payments made to the
bondholder
7.9.1 Types of Bonds
The key types of bonds are:

Corporate bonds: These are the bonds that are issued by corporations only.
Government bonds: These are the bonds that are issued by national, state, provincial, or
city governments. Under government bonds there are other types of bonds, they are:
1. Federal government bonds: These are the bond that act as funds for government
expenditures and to finance the national debt
Page 11 of 20
2. Agency bonds: These are the bond that raise fund to buy or originate loans (for
instance home mortgages, farm loans)
3. Municipal bonds: These are the bond that help in financing local projects (schools,
road construction); and are exempted from U.S. federal income tax
general obligation bonds backed by credit and taxing authority
revenue bonds backed by revenue from a specific project
7.9.2 Stock
Stock typically takes the form of shares of common stock (or sometimes called as voting
shares). As a unit of ownership, common stock usually carries voting rights that can be
exercised in corporate decisions. Preferred stock differs from common stock in that it
typically does not carry voting rights but is legally entitled to receive a certain level of
dividend payments before any dividends can be issued to other shareholders. Stockholders
generally earn returns from stock through:
Capital gains upon sale of the stock and
Income in the form of cash dividends
Insurance regulations place limits on the amount of general account assets insurers can
invest in stocks.
Stocks vs. Bonds:

Stocks have less predictable cash-flow characteristics than do bonds.
Stock prices fluctuate more than bond prices.
Stockholders have a lower priority claim than do bondholders on the company’s
assets if the company goes out of business.
7.9.3 Bond Risk and Return Characteristics
Term to maturity is defined as the length of time until the bond matures. The longer the
term the more is the interest rate risk.
Default risk is defined as the risk where the bond issuer will be unable to make interest
payments when the payments are due or to pay the face value of a bond when the bond
matures
Page 12 of 20
Bond rating is defined as a “letter grade” that a bond rating agency assigns to indicate the
credit quality of a bond issue. The higher the bond rating the lower is the default risks.
Two of the best-known bonds rating agencies are

Moody’s and
Standard & Poor’s
Bond ratings are based on a variety of factors, they include:

Earnings record and financial strength of issuer
Total amount of issuer’s bond indebtedness
Property (if any) pledged to back up the bonds
Investment-grade bonds are those bonds that are rated as highest categories (at least
Moody’s Baa or Standard & Poor’s BBB) and have got lowest default risk.
Convertible bond are those a bond that can be exchanged for shares of the issuing
company’s common stock at the option of the bondholder; lower risk than other bonds, so
lower coupon rates.
Call provision: This is defined as a provision which states the conditions under which the
bond issuer has the right to require the bondholder to sell the bond back to the issuer earlier
than the maturity date; callable bonds represent higher risk to bond holder
Collateral: These are assets pledged as security for a loan until the debt obligation is
satisfied
Secured bonds: collateral pledged
Unsecured bonds (debentures): no collateral pledged; higher risk, so higher coupon
rates
7.10 Mortgages
A mortgage is the pledging of a property to a lender as a security for a mortgage loan. While
a mortgage in itself is not a debt, it is evidence of a debt. It is a transfer of an interest in land,
from the owner to the mortgage lender, on the condition that this interest will be returned
to the owner of the real estate when the terms of the mortgage have been satisfied or
Page 13 of 20
performed. In other words, the mortgage is a security for the loan that the lender makes to
the borrower. In simple terms this can be defined as a loan, typically long-term, secured by
a pledge of specified real estate.
7.11 Amortization
Amortization or amortization is the process of decreasing or accounting for an amount over

a period of time. The word comes from Middle English amortisen to kill, alienate in
mortmain, from Anglo-French amorteser, alteration of amortir, from Vulgar Latin
admortire to kill. In simple terms this can be defined as the process by which a borrower
reduces a debt by regular payments of principal and interest that result in full payment of
the debt by the maturity date.
Life insurers hold mostly commercial mortgages, which finance retail stores, shopping
centers, office and apartment buildings, factories, and hospitals.
Mortgages vs. Bonds:
Mortgages have less liquidity and marketability.
Mortgages with fixed interest rates are subject to significant interest rate risk,
especially when a borrower refinances and the expected income stream is lost.
There are no mortgage rating agencies, so it is more difficult to evaluate the risk
that a mortgage presents.
Collateralized mortgage obligations (CMOs) are defined as bonds secured by a pool of
residential mortgage loans; insurers like CMOs because CMOs can be bought and sold like
bonds.
7.12 Securitization
The concept of “insurance securitization” was first coined by the financial markets, and it
was later in the 1970s that non-insurance securitized products -- in the form of asset-backed
(specifically, mortgage-backed) securities -- began to be traded.
“Insurance securitization” can be defined as the transferring of underwriting risks to the
capital markets through the creation and issuance of financial securities. Securitization
process involves the following two elements:
The transformation of underwriting cash flows into tradable financial securities.
The transfer of underwriting risks to the capital markets through the trading of
those securities.
The first element might be identified as “financial engineering,” which is essentially the
bundling and/or unbundling of cash flows into new and different financial securities. This is
Page 14 of 20
a common practice in the financial markets -- examples include Treasury strips or “zero-
coupon bonds” and collateralized mortgage obligations (involving the unbundling and re-
bundling of cash flows on mortgages).
The second element of insurance securitization involves the ultimate recipient of the traded
risks. Instead of an insurance company transferring its underwriting risk to a reinsurer within
the insurance industry, the risk is transferred to the broader capital markets. This is typically
accomplished by the buying and selling of financial instruments whose cash flows (payoffs)
are contingent upon underwriting experience.
For example, with exchange-traded catastrophe options, the payoff on the option depends
upon a sufficient amount of catastrophe losses being incurred by the insurance industry
during a specified time period.
7.13 Concepts in Real Estate
Sale-and-leaseback transaction are defined where the owner of a building sells the building
to an investor, such as an insurer, but immediately leases back the building from the
investor. The two important terms in such concept are:
Lessee: An individual or organization that leases a building from the building’s owner;
responsible for the maintenance and operation of the building. In simple terms lessee is one
who takes the asset for his use.
Lessor: An individual for example a building owner who leases the building to another
individual or organization. He/ she receive regular income in the form of lease payments. In
simple terms a lessor is one who lends the assets to others for their use.
7.14 Policy Loans
Policy loans are a relatively small portion of life insurance company assets. A higher-than-
expected level of policy loans may deprive an insurer of the opportunity to invest elsewhere
for a higher return. Policy loan cash flows are unpredictable because:
The policy owner, not the insurer, controls the timing of a policy loan
No systematic repayment plan is required
Policy owners need not pay back the loan
Page 15 of 20
7.15 Investment Strategies
Life insurers develop investment strategies that correspond to their solvency and
profitability goals and their asset/liability management practices. Within the confines of
regulatory limitations on general account investments, life insurers choose whether to
pursue an aggressive strategy, a conservative strategy, or a strategy somewhere in
between.
Aggressive investment strategy: insurer takes more investment risks to earn

potentially higher returns
Conservative investment strategy: focus is on safeguarding capital rather than
earning high returns
With regard to debt assets, the two extremes are a buy-and-hold strategy and an active
management strategy.
Buy-and-hold strategy: This is a type of strategy where investment department staff

carefully selects debt securities and expect to hold them until maturity.
Active management strategy: This is a type of strategy where investment department

staffs view every portfolio investment as potentially tradable, if trading the investment
would improve the portfolio’s performance.
Importance of insurance for Investment

The risks facing investment professionals today are enormous. In a volatile stock market
with high profile economic failures, investment advice is under scrutiny. This leaves the
clients exposed to high risk litigation.
Insurance for Investment offers clients protection against professional liability and
management liability claims. The policy can be customized to meet clients’ needs by
combining a variety of coverage’s. It includes expansive protection for claims arising from
actual or alleged "wrongful acts committed in the rendering of professional services.
Coverage can include:

Investment Advisor Professional Liability and Corporate Reimbursement Insurance
Page 16 of 20
Mutual Fund Professional Liability and Directors & Officers Liability and Corporate
Reimbursement Insurance
Directors & Officers Liability and Corporate Reimbursement Insurance
Distributor Professional Liability and Corporate Reimbursement Insurance
And any of the following coverage’s, which may be added by an endorsement or on
a separate policy:
Employment Practices Liability Insurance
Employee Benefit Plan Fiduciary Liability Insurance
Financial Institutions Bonds (on a separate policy)
Actions can be taken against

Misstatement of financial results
Misleading sales practices
Violations of management contracts
Non-fraudulent misrepresentations
Breach of fiduciary duties
Violation of federal regulations
Mismanagement of customer accounts
Page 17 of 20
Summary:
Portfolio is defined as a collection of assets brought together to meet a defined set
of financial goals.
Depending on the nature of the investment, the type of investment risk will vary.
The different types of risk are: Capital risk, Currency risk, Liquidity risk, Financial
risk and Market risk
Risk-return tradeoff can be defined as a the relationship between risk and return
which is considered as a factor in every financial or investment decision that an
insurer makes
Typical Employees in Investment Function: Chief investment officer,

Asset/liability managers, Portfolio managers, Investment analysts, Economists,
Traders
When evaluating investments, analysts and portfolio managers consider:

Cash flow patterns
Risk characteristics
Liquidity
General economic conditions
Investment constraints from regulatory requirements
Bonds can be defined as a security that represents a debt that the issuer of the
bond owes to the bondholder and to the investor who owns the bond.
Stock typically takes the form of shares of common stock (or sometimes called as
voting shares). As a unit of ownership, common stock usually carries voting rights
that can be exercised in corporate decisions.
Bond ratings are based on a variety of factors, they include:

Earnings record and financial strength of issuer
Total amount of issuer’s bond indebtedness
Property (if any) pledged to back up the bonds
Page 18 of 20
Call provision: This is defined as a provision which states the conditions under
which the bond issuer has the right to require the bondholder to sell the bond back
to the issuer earlier than the maturity date; callable bonds represent higher risk to
bond holder
Collateral: These are assets pledged as security for a loan until the debt obligation
is satisfied
Secured bonds: collateral pledged
Unsecured bonds (debentures): no collateral pledged; higher risk, so higher
coupon rates
Buy-and-hold strategy: This is a type of strategy where investment department

staff carefully selects debt securities and expect to hold them until maturity.
Active management strategy: This is a type of strategy where investment

department staffs view every portfolio investment as potentially tradable, if trading
the investment would improve the portfolio’s performance.
Page 19 of 20
Page 20 of 20
Chapter-6 Financial Management

TCS.
Notice
Page 2 of 21
Contents
Chapter – 6 Financial Management .......................................................................................4
6.1 Financial Management ................................................................................................ 5
6.2 Basic Accounting Documents ...................................................................................... 5
6.3 Basic Accounting Equation ..........................................................................................6
6.4 Balance Sheet and Income Statement.........................................................................6
6.5 Revenues and Expenses ............................................................................................... 7
6.6 Profits and Losses........................................................................................................ 7
6.7 Profitability ..................................................................................................................8
6.8 Solvency ......................................................................................................................9
6.9 Risk-Based Capital (RBC) Ratio Requirements ........................................................... 11
6.10 Capital and Surplus .................................................................................................. 12
6.11 Cash Flows & Cash-Flow Testing .............................................................................. 12
6.12 Asset/Liability Management (ALM) ......................................................................... 13
6.13 Policy Reserves ........................................................................................................ 13
6.14 Some other Reserves ............................................................................................... 13
Summary ........................................................................................................................ 19
Page 3 of 21
Chapter – 6 Financial Management

Introduction
This is one of the most important chapters where basics of financial management are being
dealt with. Financial Management defines the efficient use of economic resources
specifically capital funds. According to Phillippatus, “Financial management is concerned
with the managerial decisions that result in the acquisition and financing of short term and
long term credits for the firm”. All the basic concepts of financial management that are
concerned with insurance have been discussed in the chapter.
Learning Objectives
Understand what finance management is and its importance
Know the concept of policy reserves
Basic concepts of financial management (revenues, expenses, losses, profit,
solvency, capital, surplus, asset)
Page 4 of 21
6.1 Financial Management
Financial Management can be defined as the process of managing an insurer’s financial

resources to meet its solvency and profitability goals. Financial Management concentrates
on the efficient use of economic resources specifically capital funds. According to
Phillippatus, “Financial management is concerned with the managerial decisions that result
in the acquisition and financing of short term and long term credits for the firm”. It deals
with the situations that require selection of specific assets (or combination of assets), the
selection of specific problem of size and growth of an enterprise. In this case the analysis
deals with the expected inflows and outflows of funds and their effect on managerial
objectives.
So the analysis simply states two main aspects of financial management like procurement
of funds and an effective use of funds to achieve business objectives.
Specific responsibilities of financial management include:

Planning company’s financial strategy
Supervision of capital and surplus
Improve the allocation of working capital management
Review capital budgeting and revenue and cost forecasting Using techniques for
project, portfolios and asset valuation
Interpret income statement, P&L account, balance sheet and Cash Flows.
Organizing investments
Drafting company’s financial results
Other accounting duties
Conducting financial audits and internal controls
Performing financial analysis
6.2 Basic Accounting Documents
There are two basic accounting documents – the financial statement and the balance sheet.
Financial statement is a special report that summarizes a company’s financial situation or
major monetary events and transactions.
The Balance Sheet can be defined as a financial document that lists the values of a
company’s assets, liabilities, and capital and surplus as of a specific date.
Page 5 of 21
6.3 Basic Accounting Equation
The balance sheet is based on the basic accounting equation which is stated as:
Assets = (Liabilities + Capital and Surplus)
At all times, the amount of the insurer’s assets equals the sum of its liabilities and its capital
and surplus. The total of the left side always equals the total of the right side.
6.4 Balance Sheet and Income Statement
Income statement can be defined as a financial document that reports on an insurer’s net
income or net loss for a given period by summarizing the company’s revenues and expenses
during that period
There is a link between income statement and the balance sheet through the capital and
surplus account on the balance sheet.
At the end of each accounting period, the net income amount shown on the income
statement is added to the amount of capital and surplus on the balance sheet. If the income
statement shows a net loss, that amount is subtracted from the capital and surplus account
on the balance sheet.
An example: Let’s say at the beginning of one accounting period, the balance sheet shows
like this:
Assets $25,000,000
Liabilities $15,000,000
Capital and surplus $10,000,000
Net income $500,000
As at the end of the accounting period, the insurer’s income statement shows net income of
$500,000. So at the end of the accounting period, the balance sheet will show an increase in
capital and surplus of $500,000, for a total of $10,500,000 in the capital and surplus account.
Page 6 of 21
6.5 Revenues and Expenses
Revenue or revenues (known as turnover in Europe) is nothing but the income that a
company receives from its normal business activities, usually from the sale of goods and
services to customers. Some companies also receive revenue from interest, dividends or
royalties paid to them by other companies. Revenue may refer to business income in
general, or it may refer to the amount, in a monetary unit, received during a period of time,
as in “Last year, Company X had revenue of $440 million.” In simple terms the income that a
company generates from its core business operations is called revenue.
A life insurer’s two main sources of revenue are:
Insurance and annuity premiums
Earnings from its investments
In common usage, an expense or expenditure is an outflow of money to another person or

group to pay for an item or service, or for a category of costs. For a tenant, rent is an
expense. For students or parents, tuition is an expense. Buying food, clothing, furniture or
an automobile is often referred to as an expense. An expense is a cost that is “paid” or
“remitted”, usually in exchange for something of value. Something that seems to cost a
great deal is “expensive”. Something that seems to cost little is “inexpensive”.
So in simple terms, expense can be defined as the amount of money that a company spends
to support its business operations
Insurer expenses generally include

Benefit payments to policy owners or beneficiaries
Producer commissions
Salaries and benefits
IT costs
Taxes
6.6 Profits and Losses
Profit generally is the gain in business activity for the benefit of business owners. The word
comes from Latin meaning “to make progress,” is defined in two different ways, one for
economics and one for accounting.
Page 7 of 21
Pure economic profit is the increase in wealth that an investor has from making an
investment, taking into consideration all costs associated with that investment including
the opportunity cost of capital. Accounting profit is the difference between price and the
costs of bringing to market whatever it is that is accounted as an enterprise (whether by
harvest, extraction, manufacture, or purchase) in terms of the component costs of delivered
goods and/or services and any operating or other expenses.
So in simple terms, profit is defined as the excess of revenues over expenses during a
defined period of time. Insurers generally refer to profit as net income.
If expenses exceed revenues during a defined period of time, the excess is known as a loss.
Insurers generally refer to loss as net loss.
6.7 Profitability
Profitability is defined as the degree of success a business/ company/ organization has in

generating returns to its owners that includes its ability to generate profit and increase the
value of the company/ business.
Profitability can also be defined as a technical analysis term used to comparing

performances of different trading systems or different investments within one system.
There are varying definitions for it, some as simple as the expected or average ratio of
revenue to cost for a particular investment or trading system or “ratio of the number of
winning trades or investments to the total number of trades or investments made, a
number ranging from zero to 1.”
A definition that was published in the journal Technical Analysis of Stocks & Commodities
Magazine is as follows:
Profitability = [n Profits / n Trades] – [1/ (1+ avg Profit/avg. Loss)]
This is computed for each investment and is compared over the same period (long enough
to include significant “ups” and “downs”). An example of such period can be something like
the last 5 to 20 years.
Page 8 of 21
Return can be simply defined as the reward, profit, or compensation that an investor
receives for taking a risk in his investments. An insurer must maintain a balance between his
profits and the risk associated with it.
6.8 Solvency
Solvency can be defined as the ability of an entity to pay its debts with available cash.
Solvency can also be described as the ability of a corporation to meet its long-term fixed
expenses and to accomplish long-term expansion and growth. The better a company’s
solvency, the better it is financially. When a company is insolvent, it means that it can no
longer operate and is undergoing bankruptcy.
Solvency is a different idea from profitability, which refers to the ability to earn a profit.
Statutory solvency can be defined as an insurer’s ability to maintain capital and surplus at or
above the minimum standard of capital and surplus required by law
6.8.1 Risks Affecting Solvency
Contingency risks: There are four areas of risk that the U.S. actuarial profession has
identified as potentially affecting an insurer’s solvency
1. Asset risk (C-1 risk): This is defined as the risk where the insurer will lose asset value
on his investments in assets such as stocks, bonds, mortgages, and real estate for a
reason other than a change in market interest rates. Some examples of it can be:
Stocks owned by insurer lose market value
Issuer of insurer’s bonds defaults and does not make scheduled bond
payments
2. Pricing risk (C-2 risk): This is defined as the risk where the insurer’s experience with
mortality or expenses will differ significantly from expectations, causing the insurer
to lose money on his owned products. Some examples of it can be:
Life expectancy for a group of life insured’s decreases or life expectancy for
a group of annuitants increases
Product-related expenses increase
Page 9 of 21
3. Interest-rate risk (C-3 risk): This is defined as the risk where market interest rates
might change, causing the insurer’s assets to lose value and/or its liabilities to gain
value. Some examples of it can be:
Insurer’s bonds lose value when interest rates rise
Insurer is unable to earn rate of return on investments that equals or

exceeds the interest rates guaranteed in its policies
Customers withdraw funds and place them with other financial
intermediaries
4. General management risk (C-4 risk): This is defined as the risk of loss resulting
from the insurer’s ineffective general business practices or environmental factors
beyond the company’s control. Some examples of it can be:
Inefficient management
Losses from fraud and litigation
Changes in insurance regulations or tax laws
6.8.2 Measuring Solvency
Ratio is defined as a comparison of two numeric values that results in a measurement

expressed as a percentage or a fraction. To measure risk, insurers usually use capital ratios
which can be defined as a ratio that expresses the relationship between an insurer’s capital
and surplus and its liabilities
Capital ratio = Capital and surplus / Liabilities
6.8.3 Insolvency
Insolvency is a financial condition experienced by a person or business entity when their

assets no longer exceed their liabilities, commonly referred to as ‘balance-sheet’ insolvency,
or when the person or entity can no longer meet its debt obligations when they come due,
commonly referred to as ‘cash-flow’ insolvency. In simple terms it can be defined as the
inability of an insurer to maintain the legally required minimum standard of capital and
surplus
Page 10 of 21
An insurer that holds more risky investments has a higher legal minimum standard of
capital and surplus than does a comparable insurer that holds less risky investments.
6.9 Risk-Based Capital (RBC) Ratio Requirements
This is defined as the measurement of the amount of capital (or can be said as assets minus
liabilities) an insurance company or the insurer has as a foundation of support for the degree
of risk linked with the company’s operations and investments. This ratio recognizes the
companies that are insufficiently capitalized by dividing the company’s capital by the
minimum amount of capital that the regulatory authorities feel is necessary to support the
insurance operations. A ratio with the value 1.00 or greater is considered to be satisfactory.
This ratio standard can be used to recognize inadequately capitalized life and health
companies, thereby enabling regulatory authorities to intervene before a company
becomes insolvent.
Or in a simple term this can be defined as a requirement that enables state regulators to
evaluate the adequacy of an insurer’s capital relative to the riskiness of its operations.
Regulators analyze RBC calculations and compare them with specified standards. If the
ratio results fall below a certain standard, state regulators take action against the insurer.
Rating agency can be defined as an organization, owned independently of any insurer or

government body, which evaluates the financial condition of insurers and provides
information to potential customers and investors in insurance companies
6.9.1 Measuring Profitability
Return on capital ratio (ROC) can be defined as the ratio that compares the measure of an
insurer’s earnings during a stated period to the measure of its capital and surplus.
This ratio is generally expressed as
Return on capital = (Net gain from operations / Beginning capital and surplus)
Page 11 of 21
6.10 Capital and Surplus
The following are the activities of an essential capital and surplus management:
Analyzing company’s capital and surplus needs
Measuring the expected return from use of capital and surplus
Comparing the expected return on capital with company’s hurdle rate (defined as
the minimum percentage rate of return on capital that a company must earn for a
given level of risk)
Determining the effect of the use of capital and surplus with abandoning
unprofitable investments and lines of business
Arranging money for any additional capital
Internal financing involves raising funds through the core business operations of the
company where as external financing involves raising funds from outside the company.
6.11 Cash Flows & Cash-Flow Testing
Cash flow is defined as any movement of cash into or out of an organization whereas cash
inflow is defined as the movement of cash into an organization and cash outflow can be
defined as the movement of cash out of an organization.
The various ways of an insurer’s cash inflows:

Revenues generated by product sales and investment income
Sales
External financing
The various ways of an insurer’s cash outflows:
Payment of policy benefits, cash surrenders, and withdrawals
Operating expenses
Purchases of assets
Cash-Flow Testing is defined as the process of estimating future period cash flows
associated with an insurer’s existing business and comparing the timing and amounts of
asset and liability cash flows as of a given date.
In the U.S. the NAIC’s Standard Valuation Law has been accepted by most of the states,
which requires insurers to test cash flows under several different interest-rate scenarios and
identify scenarios that might threaten an insurer’s financial position.
Page 12 of 21
6.12 Asset/Liability Management (ALM)
This is defined as the system that synchronizes the administration of an insurer’s

contractual commitments to customers with the administration of the insurer’s investment
portfolio so as to achieve the best possible financial effects. ALM and many other financial
management techniques make extensive use of forecasts and simulations.
6.13 Policy Reserves
Insurance laws generally require insurers or the insurance companies to maintain a certain
level of policy reserves. Therefore, there is a need for insurers to value their policy reserves.
Reserve valuation can be defined as the process of establishing a value for an insurer’s
required policy reserves. This is generally done by an actuary. An actuary is properly
appointed by an insurer’s board of directors to render an official actuarial judgment as to
the insurance company’s financial condition. In addition, the actuary is answerable for
certifying that the amount of the insurer’s policy reserves is sufficient to meet future
obligations.
In addition to policy reserves, other required reserves that insurers typically maintain
include
A reserve for policy dividends payable
A reserve for premiums paid in advance
A reserve for claims incurred but not yet paid
Asset fluctuation reserves designed to absorb gains and losses in the insurers’
investment portfolio. These represent a type of contingency reserve, which is a
reserve that consists of surplus held to protect against a specified risk faced by an
insurer.
6.14 Some other Reserves
Full preliminary term reserve plan – This is a technique for valuing a reserve under which a
life insurance policy combines one-year term insurance and a one-year deferred plan. Under
this, the net premium is adequate for paying only the first-year death claims.
For instance, let us say a 10-pay (i.e. a payment done in ten installments) life insurance
policy has been issued at age 30. Actuarially, for full preliminary term reserve plan purposes,
Page 13 of 21
this would be viewed as a one-year term insurance at age 30 plus a nine-pay policy issued at
age 30 but deferred to age 31. This implies that if there is any casualty after payment of the
first premium, then the insured is eligible for the claim as it follows actuarial procedure.
Prospective reserve – This reserve refers to the amount designated as a future liability for
life or health insurance. The reserve should be adequate to pay future claims and its
computation takes into account future premiums and interest on the same and any survivor
benefits payable under the policy
Retrospective method reserve computation - Accumulated value of assumed past net life
insurance premiums, minus the accumulated value of past benefits (claims paid).
Source: http://www.allbusiness.com/glossaries/policy-reserve/4954392-1.html
6.14.1 Reserves of domestic insurers transacting business in foreign countries only
A domestic insurer transacting insurance in foreign countries only, and not transacting
insurance in any state may calculate its reserves on insurance written in each foreign
jurisdiction in accordance with the reserve standards required by such jurisdiction; and
negotiation and issuance of insurance on subjects of insurance resident, located or to be
performed in such foreign jurisdiction, and changes in, communications concerning, and
collection of premiums on insurance so issued shall not be deemed to constitute the
transaction of insurance in any such state.
6.14.2 Unearned premium reserve
1. As to property, casualty and surety insurance the insurer shall maintain an unearned
premium reserve on all policies in force.
2. Generally, the unearned premium shall be equal to the unearned portion of gross
premiums in force (after deduction of applicable reinsurance in solvent insurers)
computed on an annual, monthly or more frequently pro rata basis.
Page 14 of 21
6.14.3 Unearned premium reserve for marine and transportation insurance
As to marine and transportation insurance, the entire amount of premiums on trip risks not
terminated shall be deemed unearned, and the Insurance Regulator may require the insurer
to carry a reserve equal to 100% of premiums on trip risks written during the month ended
as of the date of statement.
6.14.4 Health insurance policy reserves
1. Active Life Reserves –General

For all health insurance policies, the insurer shall maintain an active life reserve which shall
place a sound value on its liabilities under such policies. It must not be less than the reserve
according to appropriate standards set forth in regulations and, in no event, less in the
aggregate than the pro rata gross unearned premiums for such policies.
2. Types of individual health policy
Type A. Policies which are guaranteed renewable for life or to a specified age, such as
60 or 65, at guaranteed premium rates.
Type B. Policies which are guaranteed renewable for life or to a specified age, such as
60 or 65, but under which the insurer reserves the right to change the scale of
premiums.
Type C. Policies in which the insurer has reserved the right to cancel or refuse renewal
for one or more reasons, but has agreed implicitly or explicitly that, prior to a specified
time or age, it will not cancel or decline renewal solely because of deterioration of
health after issue; however, policies shall not be considered of this type if the insurer
has reserved the right to refuse renewal provided the right is to be exercised at the
same time for all policies in the same category, unless premiums are based on the level
premium principle.
Type D. All other individual policies.
Reserve Standards for Policies of Type A, B or C

(a) Interest. The maximum interest rate for reserves should be the greater of (i) the
maximum rate permitted by law in the valuation of currently issued life insurance or (ii)
Page 15 of 21
the maximum rate permitted by law in the value of life insurance issues on the same
date as the health insurance.
(b) Mortality. The mortality assumptions used for reserves should be according to the
table permitted by law in the valuation of life insurance issued on the same date as the
health insurance.
(c) Morbidity or other contingency. Minimum standards with respect to morbidity are
subject to revision from time to time with respect to dates of issue of contracts.
(d) Negative Reserves. Negative reserves on any benefit may be offset against positive
reserves for other benefits in the same policy, but the mean reserve on any policy
should never be taken as less than one-half the valuation net premium.
(e) Preliminary Term. The minimum reserves shall be on the basis of two-year
preliminary term.
(f) Reserve Method. Mean reserves diminished by appropriate credit for valuation net
deferred premiums. In no event, however, should the aggregate reserve for all policies
valued on the mean reserve basis, diminished by any credit for deferred premiums, be
less than the gross pro rata unearned premiums under such policies.
3. Claims Reserve
(a) Reserves are required for claims on all health insurance policies, whether of
Type A, B, C or D, providing benefits for continuing loss, such as loss of time for
hospitalization.
(b) Claim Reserve Standards for Total Disability due to Accident or Sickness
(i) Interest. The maximum interest rate for reserves should be the
maximum posted rate permitted by law in the valuation of life insurance
issued on the same date as the date the claim is incurred.
Page 16 of 21
(ii) Morbidity. Minimum standards are followed as stated in the reserve

standards for individual health insurance policies except that for the
reported claims and resisted claims. It can also be claimed at
the option of the insurer,
the claims with a duration of disablement of less than two years,
(iii) For policies with an elimination period i.e. the length of time
between when an injury or illness begins and receiving benefit payments
from an insurer. Also known as "waiting" or "qualifying" period. During this
period policyholders must in the interim pay for these services and can be
thought of as a deductible.
(iv) A new disability connected directly or indirectly with a previous

disability which had a duration of at least one year and termination within
six months of the new disability should be considered a continuation of the
previous disability.
(c) Reserve Standards for All Other Claim Reserves
(i) Interest. The maximum interest rate for reserves should be the maximum rate
permitted by law in the valuation of life insurance issued on the same date as the
date the claims is incurred.
(ii) Morbidity or other contingency. The reserve should be based on the individual
insurer’s experience or other assumptions designed to place a sound value on the
liabilities. The results should be verified by the development of each year’s claims
over a period of years
Source: http://www.ksinsurance.org/legal/regulations/Model_Laws/Ref%2040-4-21%20-
%20Reserve%20Standards.htm
6.14.5 Title insurance reserves
In addition to an adequate reserve as to outstanding losses as required, a title insurer shall

maintain a guaranty fund or unearned premium reserve. In the US, this is not less than an
amount computed as follows:
Page 17 of 21
1. Ten percent of the total amount of the risk portion of premiums written in the
calendar year for title insurance contracts shall be assigned originally to the reserve;
2. During each of the 20 years next following the year in which the title insurance
contract was issued, the reserve applicable to the contract may be reduced by 5% of
the original amount of such reserve.
6.14.6 Mortgage Guaranty Contingency Reserve
Casualty or surety insurers insuring real property mortgage lenders against loss by reason of
nonpayment of the mortgage indebtedness by the borrower shall maintain a contingency
reserve for the protection of policyholders against the effects of adverse economic cycles.
(Source: http://delcode.delaware.gov)
Page 18 of 21
Summary
Financial management can be defined as the process of managing an insurer’s

financial resources to meet its solvency and profitability goals. Financial
Management defines the efficient use of economic resources specifically capital
funds.
Specific responsibilities of financial management include:

Planning company’s financial strategy
Supervision of capital and surplus
Managing cash flows
Organizing investments
Drafting company’s financial results
Other accounting duties
Conducting financial audits and internal controls
Performing financial analysis
The balance sheet is based on the basic accounting equation which is stated as:
Assets = (Liabilities + Capital and Surplus)
A life insurer’s two main sources of revenue are:

Insurance and annuity premiums
Earnings from its investments
Insurer expenses generally include

Benefit payments to policy owners or beneficiaries
Producer commissions
Salaries and benefits
IT costs
Taxes
Solvency can be defined as the ability of an entity to pay its debts with available
cash. Solvency can also be described as the ability of a corporation to meet its long-
term fixed expenses and to accomplish long-term expansion and growth.
Page 19 of 21
Insolvency is a financial condition experienced by a person or business entity when

their assets no longer exceed their liabilities, commonly referred to as ‘balance-
sheet’ insolvency, or when the person or entity can no longer meet its debt
obligations when they come due, commonly referred to as ‘cash-flow’ insolvency.
Return on capital ratio (ROC) can be defined as the ratio that compares the measure
of an insurer’s earnings during a stated period to the measure of its capital and
surplus.
Cash flow is defined as any movement of cash into or out of an organization

whereas cash inflow is defined as the movement of cash into an organization and cash
outflow can be defined as the movement of cash out of an organization.
Reserve valuation can be defined as the process of establishing a value for an

insurer’s required policy reserves.
.
Page 20 of 21
Page 21 of 21
Chapter-5 Financial Accounting
Page 1 of 27
TCS.
Notice
Contents
Chapter – 5 Financial Accounting ..........................................................................................4
5.1 Accounting .................................................................................................................. 5
5.2 History of Accounting .................................................................................................. 5
5.3 Users of Accounting Information ................................................................................. 5
5.4 Financial Reporting and Accounting ............................................................................6
5.5 Management Accounting ............................................................................................ 7
5.6 Accounting Standards ................................................................................................. 7
5.7 Accounting in Insurance Sector ....................................................................................9
5.8 Life Insurance Accounting Principles ......................................................................... 12
5.9 Disclosures in Life Insurance ...................................................................................... 14
5.10 Ratio Analysis .......................................................................................................... 15
5.11 Financial Accounting Operations ............................................................................. 16
5.12 Financial Reporting .................................................................................................. 18
5.13 Budget .....................................................................................................................20
5.14 Auditing ................................................................................................................... 21
5.15 Financial Condition Examination..............................................................................24
Page 3 of 27
Chapter – 5 Financial Accounting
Introduction
Accounting is also defined as a service action. The various functions provided by accounting
are quantitative information (mostly financial in nature), economic entities, with the
intention of helping in making economic decisions, and in building reasoned preferences
among alternative courses of action. This chapter will give an overview of accounting and
the activities involved in the same.
Learning Objectives
After reading this chapter you will know the following:

What accounting is?
The final users of accounting and the accounting standards followed
Financial accounting operations and reporting
Budgeting and auditing
Page 4 of 27
Ch5: Financial AccountingV1.0 TCS Business Domain Academy
5.1 Accounting
Accounting (the methodology) or accountancy (the profession) is the measurement,

declaration or terms of guarantee about the financial information mostly used by the
managers, investors, tax authorities and other decision makers. They use this method
mostly for the purpose of resource allocation decisions within companies, associations, and
public organizations. In other way this is defined as a system or set of rules or methods for
assembling, recording, scrutinizing, summarizing, and reporting financial information. The
term is derived from the use of financial accounts.
Accounting is also defined as a service action. The various function provided by the
accounting are quantitative information (mostly financial in nature), economic entities, with
the intention of helping in making economic decisions, and in building reasoned
preferences among alternative courses of action
The various functions served by accounting are as follows:
Performance measurement in financial terms
Map solvency and profitability goals for insurer’s
Helping determine whether the company is meeting its stated goals
5.2 History of Accounting
Accountancy’s beginnings are as old as human agriculture and civilization, which required
maintenance of correct records about quantities and values of agricultural produce. This
was recorded with the Sumerians in Mesopotamia. Simple accounting also has a mention in
the Christian Bible (New Testament) in the Book of Matthew and the Islamic Quran.
Detailed accounting systems employed by Muslims in mid-seventh century has been
described in the book Hisba, written by the twelfth-century A.D. Arab writer Ibn Taymiyyah.
There was Roman and Persian influence on these accounting practices, as Muslims
interacted with them.
5.3 Users of Accounting Information
Accounting/accountancy attempts to create precise financial reports that will be useful to

managers, investors, regulators, and other stakeholders such as shareholders, creditors, or
owners. Bookkeeping is the term used for day-to-day record-keeping which is one of the
task involved in this process of accounting.
Page 5 of 27
5.3.1 Internal Users
Simply put, internal users are the users within the company. The following are considered as
internal users of accounting information:
Board of directors
Company managers
Employees
Company-affiliated sponsors
5.3.2 External Users
The following are considered as the external users of accounting information. External users
are generally those people outside an insurance company who have a need for information
contained in the company’s financial statements. The various external users are as follows:
Regulatory authorities
Rating agencies
Policy owners
Investors
Taxing authorities
Competitors of the insurer
Creditors
Other companies that distribute the insurer’s products
5.4 Financial Reporting and Accounting
This is the process of presenting financial data about a company’s financial position,
operating performance, and its flow of funds during a specific period. Financial accounting
is one branch of accounting and historically has involved processes by which financial
information about a business is recorded, classified, summarized, interpreted, and
communicated. For public companies, this information is generally publicly-accessible. By
contrast, mostly decision-makers can access confidential information. Financial accounting
focuses primarily on reporting a company’s financial information to meet the needs of the
company’s external information users. Financial accounting reports are prepared primarily
for external users, but they can provide internal users with valuable accounting information.
Page 6 of 27
5.5 Management Accounting
This is defined as the process of recognizing, measuring, examining, and communicating

financial information to all the internal and external users so that a company’s internal
managers can make a decision on how finest he can use the company’s resources for the
development of the company. Management accounting also helps to recognize areas that
are not functioning as planned out earlier and if any alternative is required.
Management accounting mostly focuses on the provisions provided to the internal users
(mainly managers) and use of all accounting information to managers to present them with
the platform to make intellectual business choices that will help them and their company to
be better prepared for management decisions. Management accounting information is
used only within an organization by the management, normally for decision-making
purpose.
In contrast to financial accounting information, management accounting information is:

typically confidential and used by management only, not for external user or public;
forward-looking / future forecasting;
sensibly figured, instead of complying with accounting standards
5.6 Accounting Standards
Accounting standards are defined as the policies issued by the government or any
institution so as to make harmonized result across globe.
5.6.1 Recognition
This is defined as the process of

categorizing things in a financial operation as assets, liabilities, capital and surplus,
revenue, or expenses and
noting down each transaction in the business/ company’s accounting records
Points to be noted:
Almost every country has their own or personal accounting standards and all
insurers of that country must comply with that.
For evaluating the monetary value of assets or liabilities there are some standards
and they vary according to countries. And the type of information used or the
standards used must be disclosed in their financial statements.
Page 7 of 27
5.6.2 GAAP
GAAP or Generally Accepted Accounting Practices are a set of financial accounting

standards, conventions, and rules that U.S. stock insurers follow when summarizing
transactions and preparing their financial statements. That means in simple terms it
includes the standards, conventions, and rules accountants follow in recording and
summarizing transactions, and in the preparation of financial statements.
One key aspect of GAAP is an emphasis of “general” as a conceptual realization of variables

in method. All accounting exercises employ the same method and generate the same
results, GAAP accommodates variation in applied accounting methods as long as the
methods generally adhere to this set of principles, which are more broad than specific.
Pursuant to the foregoing, not only therefore does this provide for variation in method, the
natural conclusion is GAAP creates an environment in which financial reporting results can
vary depending on purpose. One company in one fiscal year can produce different reports,
all completed within GAAP, for different audiences or different purposes, and all these
reports can be considered correct.
A company may report financial performance considered acceptable by the accounting firm
producing the review; yet upon closer investigation oddities may be revealed, requiring a
restatement of all or part of the report. Recently (2006 - 2007) well known corporations such
as Apple and Research In Motion had to restate certain aspects of their financial reports that
met with disagreement as to their adherence to certain “best practices.” The point that
should be noted here is that mutual and fraternal insurers in the United States must comply
with GAAP if they sell variable life insurance or variable annuities.
The underlying premise of financial statements prepared in accordance with GAAP is the
going-concern concept under which accounting processes are based on the assumption that
a company will continue to operate for an indefinite period of time.
5.6.3 Statutory Accounting in the United States
The Statutory Accounting Principles are those set of accounting regulations made for
insurance companies by the National Association of Insurance Commissioners (NAIC). The
main purpose of this is to help in preparing the statutory financial statements of an
Page 8 of 27
insurance company. With slight state-by-state disparities, they form the platform for state
directives of insurance company solvency all through the United States.
The rules or guidelines are generally issued as discussion drafts, and public comments are
asked for, before they are written down in the National Association of Insurance
Commissioners (NAIC) Accounting Practices and Procedures Manual.
In simple terms, this can be described as some accounting standards or guidelines that all
life insurers in the United States must follow when preparing the Annual Statement and
other specified financial reports that are submitted to state regulators. Statutory
accounting is generally perceived as a more conservative approach than the going-concern
concept used by GAAP.
5.6.4 Accounting conservatism
This is defined as a financial reporting technique that results in the projection of:
minor values for a company’s assets,
elevated values for its liabilities and expenses, and
lower level of net income
All these would be the case if the company uses a less conservative reporting method.
5.7 Accounting in Insurance Sector
The Financial Statements of Insurance Company consists of:

Revenue Account (Policyholders Account)
Profit and Loss account (Shareholders Account)
Balance Sheet
Receipts and Payments account (Cash Flow Statement)
The segmental reports relating to the funds (Revenue accounts and Balance Sheet)
5.7.1 Revenue Account (Policyholders’ Account – Technical Account)
The Revenue Account sets out all income and expenses relating to the insurance business.
Income
The income of the technical account comprises of
Premium after adjusting reinsurance ceded and reinsurance accepted
Income from investments which needs to be shown under different heads
like:
Page 9 of 27
Interest, Dividend and Rents

Profit on sale redemption of investments
Loss on sale redemption of investments
Transfer gain on revaluation of change in fair value
Amortization charge
Under the Income head, there will also be Other Income, Foreign exchange gain /
Loss and other items.
The transfer of funds from Shareholders’ Fund to Policyholders’ Account is shown
separately in the Revenue Account.
Expenses
Expenses include:
1. Commission
2. Operating Expenses
3. Benefits paid
4. Interim bonus paid and
5. Change in valuation of liability against life policies in force.
5.7.2 Profit and Loss Account (Shareholders’ Account – Non-Technical Account)
This Account represents all income and expenses relating to Shareholders’ Account (Those
not relating to insurance business). The income comprises mainly of investment or other
income created out of Shareholders’ Fund. The major components of expenses are:
Depreciation relating to assets held by shareholders’ fund, investment expenses,
Directors Fees etc.
Transfer of funds to Policyholders’ Fund and
Preliminary Expenses written off
The profit or loss as per the Account is carried to the Balance Sheet as usual.
5.7.3 Balance Sheet Items
The items in the Balance Sheet of a Life Insurance Company includes, other than the normal
items –
1. Shareholders’ Fund
2. Policy Holders Fund
Page 10 of 27
3. Investments related to Policyholders’ Fund, Shareholders’ Fund and Assets held

to cover linked liabilities
Shareholders’ Fund includes share capital less preliminary expenses, reserves and surplus
and fair value change account.
Policyholders’ Fund consists of Policy liabilities, Fair value change relating to policy fund
investments, insurance reserves, provision for linked liabilities, Funds for future
appropriations, Surplus allocated to shareholders etc.
The balance in the Funds for future appropriations represents funds, the allocation of which,
either to participating policyholders or to shareholders has not been determined at the
balance sheet date. Transfers to and from the fund reflect the excess or deficiency of
income over expenses and appropriations in each accounting period arising in the
Company’s policyholder fund.
The Policyholders Funds
The Policyholders Funds need to maintain adequate level of solvency at all times.
Separate Funds are maintained for different types of policies like participating
Fund, Pension Fund etc. The solvency level is also to be maintained for declaration
of bonuses to Participating Fund and Pension Fund.
As we all know, during the initial period, company starts with Shareholders Fund. In
order to meet with the above requirements of the Policyholders’ Fund, the
company needs to transfer funds from Shareholders’ Fund.
This transfer has been allowed by IRDA during the first five years.
Such transfers from Shareholders’ Fund to Policyholders’ A/c is irreversible in nature
and at no point of time, such amount can be recouped to the Shareholders’ Fund.
Transfer of such funds is shown in Revenue Account and it adds to the revenue of
the Technical Account.
The same amount is treated as expenditure in Profit & Loss account (Shareholders’
Account – Non Technical account).
Page 11 of 27
5.7.4 Receipts and Payments account (Cash Flow Statement)
The cash flow statement of the insurance company needs to be worked out as per Direct
Method as per the IRDA requirement. The statement depicts the receipts and payments
from various business activities. The major items are:
Operating Activities
Receipts and Payments from policyholders
Payments to Re insurers
Payments to Agents,
Employee expenses, investment income
Investing Activities
Purchase and sale of investments
Purchase of fixed assets
(Source: ICAI and IRDA Accounting Guidelines)
5.8 Life Insurance Accounting Principles
There are certain key principles that are universally accepted in life insurance. These can be
categorized in the following ways:
Premium:
Premium shall be recognized as income when due.
For linked business the due date for payment may be taken as the date when the
associated units are created.
Acquisition Cost:
Acquisition costs, if any, shall be expensed in the period in which they are incurred
Acquisition costs are those costs that vary with and are primarily related to the
acquisition of new and renewal insurance contracts. The most essential test is the
obligatory relationship between costs and the execution of insurance contracts (i.e.,
commencement of risk).
Claims Cost:
The ultimate cost of claims shall comprise the policy benefit amount and specific claims
settlement costs, wherever applicable.
Actuarial Valuation - Liability for Life Policies:
The estimation of liability against life policies shall be determined by the appointed
actuary of the insurer pursuant to his annual investigation of the life insurance business.
Actuarial assumptions are to be disclosed by way of notes to the account.
Page 12 of 27
The liability shall be so calculated that together with future premium payments and
investment income, the insurer can meet all future claims (including bonus entitlements
to policyholders) and expenses.
Value of investments - Real Estate
The value of investment property shall be determined at historical cost, subject to
revaluation at least once in every three years. The change in the carrying amount of the
investment property shall be taken to Revaluation Reserve.
The insurer shall assess at each balance sheet date whether any impairment of the
investment property has occurred.
Value of investments - Debt Securities
Debt securities, including government securities and redeemable preference shares, shall
be considered as “held to maturity” securities and shall be measured at historical cost
subject to amortization.
Value of investments - Equity Securities and Derivative
Listed equity securities and derivative instruments that are traded in active markets shall
be measured at fair value on the balance sheet date. For the purpose of calculation of fair
value, the lowest of the last quoted closing price at the stock exchanges where the
securities are listed shall be taken.
Loans
Loans shall be measured at historical cost subject to impairment provisions.
The insurer shall assess the quality of its loan assets and shall provide for impairment. The
impairment provision shall not be lower than the amounts derived on the basis of
guidelines prescribed from time to time by the Reserve Bank of India that apply to
companies and financial institutions.
Linked Business
The accounting principles used for valuation of investments are to be consistent with
principles enumerated above. A separate set of financial statements, for each segregated
fund of the linked businesses, shall be annexed.
Segregated funds represent funds maintained in accounts to meet specific investment
objectives of policyholders who bear the investment risk. Investment income/ gains and
losses generally accrue directly to the policyholders. The assets of each account are
segregated and are not subject to claims that arise out of any other business of the
insurer.
Page 13 of 27
Funds for Future Appropriation

The funds for future appropriation shall be presented separately.
The funds for future appropriation represent all funds, the allocation of which, either to
the policyholders or to the shareholders, has not been determined by the end of the
financial year.
5.9 Disclosures in Life Insurance
As any corporate entity, life insurers also need to make disclosures in their accounting
statements. These fall in the following categories
Contingent Liabilities:
Claims, other than those under policies, not acknowledged as debts
Guarantees given by or on behalf of the company
Partly-paid up investments
Statutory demands/liabilities in dispute, not provided for
Reinsurance Obligations to the extent not provided for in accounts
Others (to be specified).
Other items
Investments made in accordance with any statutory requirement should be disclosed
separately together with its amount, nature, security and any special rights in and outside
India;
Segregation into performing/ non performing investments for purpose of income
recognition as per the directions, if any, issued by the Authority;
Assets to the extent required to be deposited under local laws or otherwise encumbered
in or outside India
Percentage of business sector-wise;
A summary of financial statements for the last five years, in the manner as may be
prescribed by the Authority
Bases of allocation of investments and income thereon between Policyholders’ Account
and Shareholders’ Account
Accounting Ratios as may be prescribed by the Authority.
Page 14 of 27
5.10 Ratio Analysis
There are certain ratios that are predominantly used in the insurance industry in financial
accounting operations. These include the renewal expense ratio, yield on life insurance
fund, net lapse ratio.
Renewal Expense Ratio
The renewal expense ratio indicates efficiency of the insurer’s operations. The formula used
for calculating this ratio is:
Renewal Expense / Renewal Premium Income * 100
Yield on Life insurance Fund
This indicates the efficiency of Return on Investments. Yield on life insurance fund is
calculated as:
Yield Ratio = R/I * 100
Where,
R = Interest, Dividend and Rent
I = Average Life Assurance Fund = (O + C) / 2 (where Opening Life Assurance Fund - O
Closing Life Assurance Fund – C)
Net Lapse Ratio
This ratio shows quality of new business and life selection. The ratio of the number of life
insurance policies that lapsed within a given period to the number in force at the beginning
of that period.
Formulae
No of Policies Lapsed = L
Policies in force at the start of the year = O
Policies in force at the close of the year = C
Average Policies in force = A= (O+C) /2
Lapse Ratio = L/A * 100
Page 15 of 27
5.11 Financial Accounting Operations
The basic financial accounting operations in life insurance companies are classified into one
of the following class:
Premium accounting
Investment accounting
General accounting
Tax accounting
5.11.1 Premium Accounting
This is defined as the accounting operation that is generally responsible for maintaining
detailed accounting records of each and every financial transaction in relation to the policies
an insurer has issued, also including the accounting method for premiums, charges or
commissions, claim payments, policy loans, policy dividends etc.
Premium accounting systems guarantee for:

Properly billing of Policy owners
Properly accounted premium payments from policy owners
Recording of premiums incomes in appropriate categories so that the company can
use that data for computation of premium taxes, preparation of financial
statements, and preparation of management accounting reports
Page 16 of 27
5.11.2 Investment Accounting
This type of accounting method records each and every investment transaction and also
simultaneously monitors all connected custodian accounts. It is also responsible for all
activities in the pooled endowment and also for all independently or individually held
portfolios. The following amounts are monitored by the investments accounting:
Insurer’s cash inflows and outflows related with his investments
Investment valuations that would be used in the preparing the company’s financial
statements
Realized and unrealized capital gains and losses (if any) from investments
Note: Realized gain (loss) is defined as the gain (or loss) on an investment that occurs only
when the investment matures or is sold to someone
Unrealized gain (loss) is defined as the gain (or loss) that occurs when the value of a
currently held asset changes from the earlier one
5.11.3 General Accounting
All the Basic accounting operations that are performed by roughly all businesses, comprises
of
Payroll accounting: This type of accounting generally involves calculating
employees’ wages, preparing paychecks, maintaining payroll records, and
producing payroll reports for internal management and government agencies.
Disbursement accounting: This type of accounting generally involves providing a
permanent record of all cash disbursed, confirming that all cash disbursements are
properly authorized, and ensuring that all disbursements are charged to the proper
account.
5.11.4 Tax Accounting
A tax accountant is simply an individual who assists a taxpayer in preparing a tax return
(Hussey, 1999). For businesses, the accounting system must also provide data for use in the
completion of the company’s tax returns. This function is the concern of the tax accountant.
In some countries, financial accounting must obey rules laid down for tax accounting by
national tax laws and regulations, but no such requirement is imposed in the United States,
and tabulations prepared for tax purposes frequently differ from those submitted to
Page 17 of 27
shareholders and others. In this regard, “taxable income” should be viewed as a legal
concept rather than an accounting concept.
Tax laws almost always include incentives to encourage companies to do certain things and
discourage them from doing others. Accordingly, what is considered “income” or “capital”
to a tax agency may be far different from the accountant’s measures of these same
concepts (Shilling law, 2004).
This type of accounting area keeps records of all things related to the company’s taxes and
may also help in preparing tax returns and filings.
Points to be noted:
Taxes paid by insurers comprise of income taxes, unemployment taxes, property

taxes, and premium taxes.
Premium taxes are those taxes that are generally taken or calculated on the
premium income that an insurer earns within a particular jurisdiction
Premium taxes are always calculated as a percentage of premium income.
5.12 Financial Reporting
Financial reporting is simply the groundwork and writing of all required financial statements
that communicate the synopsis of a company’s numerous financial transactions for a
specific period of time.
Points to be noted:
Cash flow statement: This is defined as a financial statement that provides
information about a company’s cash receipts (inflows), cash disbursements
(outflows), and net change in cash during a specified period.
Statement of owner’s equity: This is defined as a financial statement that shows
the changes that occurred in an insurer’s stockholders’ or policy owners’ equity
during a specified period of time.
5.12.1 The Annual Declaration
An annual report is a special document that a company presents at their Annual General
Meeting (AGM) for approval by its shareholders. This special document can be produced by
Page 18 of 27
a charitable organization for its trustees also. The annual declaration report generally
consists of reports and financial statements, and the reports may include the following:
Chairman’s report
CEO’s report
Auditor’s report on corporate governance
Mission statement
Corporate governance statement of compliance
Statement of directors’ responsibilities
Invitation to the company’s AGM
And the Financial Statements include:
Auditor’s report on the financial statements
Balance sheet
Statement of retained earnings
Income statement
Cash flow statement
Notes to the financial statements
Accounting policies
All the details provided in the various reports are used by the investors specially to
understand the company’s current financial position and future direction where the
company is heading. The financial statements are generally compiled in fulfillment with
IFRSs and/or the home/state GAAP, as well as home legislation (for instance the SOX in the
U.S.).
In the U.S., it is mandatory to submit a more-detailed version of the report, known as Form
10-K, to the U.S. Securities and Exchange Commission. The main purpose of an annual
statement is to present information about an insurer’s operations and financial
performance, with an emphasis on demonstrating the insurer’s solvency. This Statement
also presents information about an insurer’s operations and financial performance, with an
emphasis on demonstrating the insurer’s solvency.
The Annual Statement normally includes:

Balance sheet (Assets, Liabilities, Surplus, and Other Funds page)
Income statement (a Summary of Operations page)
Page 19 of 27
Capital and Surplus account page

Cash Flow statement
Exhibits, Schedules, and Supplemental reports
5.12.2 The Annual Report
This is a GAAP-based pamphlet/document that a company’s management is required to

send to its owners and other interested parties on the company’s financial performance
during the past year. Annual report is a comprehensive report of company’s activities during
a year and is presented at the end of a financial year. The annual report conforms to GAAP
and is less conservative than the annual statement.
5.13 Budget
Budget normally refers to a list of all revenues and expenses. It can be defined as a financial
plan which is used to express all the actions in monetary terms that stretches over a
specified time period. Budget is a significant concept in microeconomics, which uses a
budget line to illustrate the trade-offs between two or more goods. In simple terms, a
budget is an organizational/ business plan stated in monetary terms.
It’s seen that during budgeting procedure, all company managers and others generally
make forecasts about the following values:
Policies sold/will sell during the budget period
Expected income during the budget period
Cost of the work that must be done to sell and administer the desired number of
products to conduct other company operations
Anticipated cost in capital expenditures
Benefit amounts expected to be paid
Budgeting is defined as a management accounting process that includes developing a
financial plan of action that an organization/ business/ company believes will help it in
achieving its goals. Budget line replicates all possible combinations of two goods that could
be purchased, given the prices and the consumer's budget
Operational Budgets
This is defined as a budget that covers some part or all of a company’s central business
operations.
Page 20 of 27
Types of operational budgets

1. Revenue budget is defined as a budget that signifies the amount of income from
operations (for instance policy sales and investments) that the company expects in
the coming budget period.
2. Expense budget is defined as a budget that provides the company/ business with a
schedule of expenses expected during a given period.
Cash Budgets and Capital Budgets

1. Cash budget is defined as a budget that estimates a company’s opening cash
balance, cash inflows, cash outflows, and ending cash balance for a particular
period. This type of budget is used by insurers to build up investment strategy and
to conduct effective asset/liability management
2. Capital budget is defined as a budget that shows a company’s plans for the financial
management of its long-term, high-cost investment proposals. These are generally
used by financial managers to analyze decisions about investing in long-term
projects, such as purchasing another company, launching a new product,
purchasing a new computer system, or purchasing new office space. This is also
used to monitor the financial status of the company’s capital investments
Cost Accounting and Budget Variance

Cost accounting is defined as a system for gathering and categorizing the expense data for
the purpose of effective cost control and precise projections of future costs, so as to use the
information in pricing of a company’s products.
Budget variance can be defined as the difference between actual results and budgeted
results. Budget variance can be used for the following reasons:
To segregate substandard performance or problem areas (for instance costs
exceeding budgets or revenues falling short of budgets)
Pointing out where performance exceeded expectations
5.14 Auditing
Auditing is an activity in which an Auditor (a person trained and qualified in applying

auditing; defined as “one who listens”, from the Latin word audire meaning “to hear” or
“listen”) listens and gives auditing commands to a “Pre-clear,” (“PC”) or person not yet Clear
Page 21 of 27
who is finding out about herself or himself and life through auditing. Critics of the process of
auditing have suggested that it shares similarities with cult style programming and some
behavior modification techniques which rely upon psychological manipulation of the
subject.
Auditing involves the use of “processes,” which are exact sets of questions asked or
directions given by an auditor. There are many different auditing processes. When the
specific objective of any one process is attained, the process is ended and another can then
be used.
In simple terms auditing can be defined as the process of examining and evaluating
company records and procedures. Auditing is generally done to ensure that:
Accounting records and financial statements are presented fairly and reasonably
Quality guarantee is maintained
Operational actions and policies are effective
Financial audit
A financial audit, or more accurately, an audit of financial statements, is the examination by
an independent third party of the financial statements of a company or any other legal
entity (including governments), resulting in the publication of an independent opinion on
whether or not those financial statements are relevant, accurate, complete, and fairly
presented.
Financial audits are typically performed by firms of practicing accountants due to the
specialist financial reporting knowledge they require. The financial audit is one of many
assurance or attestation functions provided by accounting and auditing firms, whereby the
firm provides an independent opinion on published information.
This is an evaluation of whether a company’s financial information, financial statements,
and source documents comply with accounting standards and are a fair and consistent
depiction of the company’s financial condition and performance.
External Audits
An External auditor is an audit professional who performs an audit on the financial
statements of a company, government, individual, or any other legal entity or organization,
and who is independent of the entity being audited. In simple terms external audit can be
Page 22 of 27
defined as an evaluation by an auditor who is employed by a public accounting firm and

who is not associated with the insurance company. Mostly the users of this financial
information are investors, government agencies, and the general public. They all rely on the
external auditor to present an unbiased and independent evaluation on such entities. They
are distinguished from internal auditors for two main reasons:
1. The internal auditor’s primary responsibility is appraising an entity’s risk

management strategy and practices, management (including IT) controls
frameworks and governance processes, and
2. They do not express an opinion on the entity’s financial statements.
The primary role of external auditors is to express an opinion on whether an entity’s

financial statements are free of material misstatements. Normally, external auditors review
the entity’s information technology control procedures when assessing its overall internal
controls. They must also investigate any material issues raised by inquiries from
professional or regulatory authorities, such as the local taxing authority. For public
companies in the United States, the Sarbanes-Oxley Act (SOX) has imposed stringent
requirements on external auditors in their evaluation of internal controls and financial
reporting
The purpose of these external audits is to
Issue an independent opinion as to whether financial statements present fairly
the company’s operations
Recommend changes to the company’s system of internal control
Prepare reports of audit findings
Auditor’s opinion can be defined as a statement, prepared by an independent public

accounting company, which generally expresses the auditor’s opinion as to whether the
information contained in the insurer’s financial statements fairly represents the operations
of the company and also attests that the audit was conducted in accordance with generally
accepted auditing standards. It should be noted that the auditor’s opinion does not
guarantee the accuracy of the financial statements.
Page 23 of 27
5.15 Financial Condition Examination
Financial condition examination can be defined as a formal investigation of an insurer that is

carried out by insurance regulators and is designed to recognize and monitor any threats to
the insurer’s solvency. It ensures that that the insurer is financially sound. InsRis (InsRis is a
regulatory consulting group) performs financial condition examinations for insurance
departments by providing certified financial examiners in a supervisory capacity. The Group
also offers certified and accredited financial examiners and certified public accountants
functioning as staff support. Examinations are conducted in accordance with the NAIC
Financial Condition Examiners Handbook and with a thorough understanding of NAIC
accreditation standards.
The firm performs both comprehensive and limited scope examinations and provides all the
requisite expertise to conduct the entire examination or provides staff to assist insurance
department personnel.
Information system specialists provide evaluation of controls in information systems

reviews. Actuaries provide aggregate reserve, asset adequacy, loss reserve and actuarially
related examination assistance; EDP audit specialists provide computer assisted audit
support and are experienced in Audit Command Language (ACL). Investment specialists
perform analysis of complex and sophisticated investment portfolios; reinsurance
specialists provide in-depth knowledge of contracts, claims, accounting and underwriting,
coupled with related transactions.
InsRis utilizes its large, highly qualified and mobile national network of examiners to
conduct all aspects of financial examinations anywhere in the United States and its
territories.
Source: http://www.insris.com/financialexam.htm
The following things are taken into care by the examiners during a financial condition
examination. Almost all examiners try to:
Examine the insurer’s accounting records and calculate whether the insurer is
operating on a legal basis
Examine the insurer’s financial and business actions to make sure that they do not
contain any danger to the insurer’s solvency
Page 24 of 27
Summary:
Accounting (the methodology) or accountancy (the profession) is the
measurement, declaration or terms of guarantee about the financial information
mostly used by the managers, investors, tax authorities and other decision makers.
Simply internal users are the users within the company. The following are
considered as the internal users of accounting information: Board of directors,
Company managers, Employees, Company-affiliated sponsors
External users are generally those people outside an insurance company who have a
need for information contained in the company’s financial statements. The various
external users are as follows: Regulatory authorities, Rating agencies, Policy
owners, Investors, Taxing authorities, Competitors of the insurer, Creditors,
Other companies that distribute the insurer’s products
Recognition is defined as the process of

categorizing things in a financial operation as assets, liabilities, capital and
surplus, revenue, or expenses and
noting down each transactions in the business/ company’s on a day-to-day
basis maintaining the accounting records
The basic financial accounting operations in life insurance companies are classified
into one of the following class:
Premium accounting
Investment accounting
General accounting
Tax accounting
The Annual Statement normally includes:

Balance sheet (Assets, Liabilities, Surplus, and Other Funds page)
Income statement (a Summary of Operations page)
Capital and Surplus account page
Cash Flow statement
Exhibits, Schedules, and Supplemental reports
Page 25 of 27
Cash budget is defined as a budget that estimates a company’s opening cash

balance, cash inflows, cash outflows, and ending cash balance for a particular
period.
Capital budget is defined as a budget that shows a company’s plans for the
financial management of its long-term, high-cost investment proposals.
Page 26 of 27
Page 27 of 27
Chapter-4 Insurance - Legal Framework
Page 1 of 18
TCS.
Notice
Contents
Chapter – 4 Insurance Legal Framework ...........................................................................4
4.1 Introduction ................................................................................................................. 5
4.2 Contracts ..................................................................................................................... 5
4.3 Essentials of a Valid Contract .......................................................................................6
4.4 Fundamental Laws of Insurance ..................................................................................6
4.5 Methods of dealing with Insurance Frauds Legal Enquiry ...........................................8
4. 6 Special Features of Life Insurance Contract ................................................................9
4.7 Insurance Regulatory and Development Authority (Licensing of Insurance Agents)
Regulations, 2000 ........................................................................................................... 10
Summary ........................................................................................................................ 17
Page 3 of 18
Chapter – 4 Insurance Legal Framework
Introduction
Life insurance contract is a special type of contract. Hence the general provisions of the law
of contracts s are applicable to life insurance contracts. Another important piece of
legislation which has great significance in the Insurance Act, 1983 as amended from time to
time, the latest being the amendments made by the Insurance Regulatory and
Development Authority.
Learning Objective
Understand what are the legal frame works in Life Insurance and its importance
Know contracts and essentials of life insurance contracts
Know the special features of life insurance contracts
A look at the IRDA regulation 2000
Page 4 of 18
4.1 Introduction
Life insurance contract is a special type of contract. Hence the general provisions of the law
of contracts s are applicable to life insurance contracts. Another important piece of
legislation which has great significance in the Insurance Act, 1983 as amended from time to
time, the latest being the amendments made by the Insurance Regulatory and
Development Authority.
In the year 1956, government of India nationalized life insurance business carried out in
India by Indian and foreign companies. As a result the Life Insurance Corporation of India
came into existence. Many provisions of Insurance Act, 1938 were made applicable to the
LIC of India.
In the year 1999, the Insurance Regulatory and Development Authority was created, several
amendments were made to the Insurance Act, 1938 and the insurance sector has been
opened up for private operation.
4.2 Contracts
A contract is an agreement enforceable at law made between two or more persons by

which rights are acquired by one or more to certain acts or forbearances on the part of the
other or others.
Or
It can be defined as a promise or an agreement enforceable at law.
Insurance is defined thus in legal perspective:

“Insurance is a contract between two parties whereby one party called insurer undertakes
in exchange for a fixed sum called premiums, to pay the party called insured a fixed amount
of money on the happening of an uncertain event.”
In economic perspective, insurance maybe defined thus:

“A financial intermediation function for pooling resources from people/groups facing losses
from similar set of events and distributing the pool on occurrence of such events among
them”
Page 5 of 18
4.3 Essentials of a Valid Contract
The first requisite of a valid contract is that the parties thereto should be “ad idem” i.e. they
should of one mind. Two or more persons are said to consent when they agree upon the
same thing in the same sense. The expression “the same thing” refers to the entire content
of the agreement. That means the consent to the agreement should be free.
Consent, according to the Indian contract act is said to be free when not caused by:
Coercion
Under influence
Fraud
Misrepresentation
Mistake
4.4 Fundamental Laws of Insurance
Insurance contract is said to be concluded when the insured pays the premium and the
insurer accepts the risk. The insurance policy given by insurer acts as an evidence of this
transfer. Insurance contracts are subject to certain special principles of law, (called
fundamental or basic principles of law of insurance). These are:
Utmost Good faith:

The insured is accountable to disclose all relevant information which can help insurers take
the following decisions – 1) if or not to accept the risk (i.e. provide insurance or not) 2)
premium and terms and conditions. There should not be any fraud, any non-disclosure or
any misrepresentation regarding the material facts. Both the parties must be on the same
mind and must place all facts during the process.
Insurable interest:
Insurable interest entails a relationship to property such that damage or loss to property can
lead to financial loss to people or company. The loss can come via negligence, destruction
or court action against the property. Insurable interest can happen when:
The property is owned legally.
There is a monetary relationship with the insured.
There is mortgage or lien on property.
Page 6 of 18
There is custody or control over other’s property.
For insurance proceeds to be paid, the insurance buyer and/or insured must have an
insurable interest when insurance application is made and also when claim is made. Note
that insurable interest need not be there all through the insurance contract life. For
example, a housing loan is repaid, which means the lender no longer is interested – however
there is no need to cancel the policy, but the lender will not get any benefits simply because
there is no insurable interest now.
It also must be noted that not all risks are “insurable”. Insurers are reluctant to offer
protection against unusual or catastrophic risks. To this end, insurers require that a risk
meet certain conditions to be insured:
The insurer should be able to calculate the chance of loss
Premiums need to be affordable
There must be no catastrophic loss
There must be a large number of similar (homogeneous) exposures
Losses must be accidental and unintentional
Losses must be measurable and determinable
There can be certain exceptions. Though in normal course, insurers may not cover natural
disasters causing widespread damage (e.g., tsunami, floods), coverage can still be
purchased through special insurers or special clauses.
Indemnity:
Indemnity means that the insured in case of loss against which the policy has been insured
shall be paid the actual amount of loss and that should not exceed the amount of the policy.
Indemnity states how much an insured can collect as insurance payment. The object of the
principle is to place the insured back to his/her original financial condition, as far as possible,
after a loss has occurred. The effect of this principle is to prevent the insured from making a
profit out of his loss or gaining any benefit or advantage.
For example, a person insured his shop for Rs. 50,000 against fire, the shop is partially burnt
and it is estimated that with Rs. 10,000 the shop can be restored to its original condition. So
the insurer is liable to pay Rs. 10,000 only.
Page 7 of 18
Subrogation:
This involves transfer of rights and remedies from the insured to the insurer, who has taken
on the risk and guaranteed against loss. This can be explained by an example:
Suppose a person insured his house for Rs. 50 lakh against fire, the house is fully damaged
and the insurer pays the full value of Rs. 50 lakh and later the damaged house is sold for Rs.
5 lakh. Then the insurer is entitled to receive a sum of Rs. 5 lakh. This shows the transfer of
rights and remedies from insured to the insurer.
Contribution:
The principle of contribution comes into play when the insured obtains more than one
insurance/policy for the same risk. The objective of contribution is to distribute the actual
amount of loss among all the insurers who are liable for the same risk with their own
different policies. In this case, one insurer can claim some proportion of loss paid out to the
insured from other insurers.
Proximate Cause:
This rule states that the cause of the loss must be immediate and not remote. So in case a
loss is there due to multiple causes, then insurer has to decide which of these has been the
most effective. This cause is known as `proximate cause', and others are regarded as
`remote'.
4.5 Methods of dealing with Insurance Frauds Legal Enquiry

A legal framework is made to deal with frauds being committed in Insurance sector. Any
fraudulent activity committed in Insurance sector is treated as both – a civil as well as
criminal offence under law. The guilty party can be punished under both the offences. This
type of fraud is termed as a white-collar crime. E.g. In insurance sector, insider trading,
insurance fraud, tax fraud, securities and investment fraud, and identity theft are termed as
white collar crimes.
Electronic Transactions
In order to overcome fraudulent Health Insurance Claims, E-transactions are in the process
of coming up with the authorization approval. As an initiative IBM India has commenced
online claim management . With this development process, the speed of online processing
operations will increase and there would be transparency while managing the claims. .
Page 8 of 18
SAS software
Also known as called SAS (Statistical Analysis System), this specialized software is being
implemented in the market to deal with frauds in Insurance sector.
Benefits of SAS software include:

• Detection of Fraud and Alert Management
• Systematic detection of any sort of suspicious activity
• Generation of alerts from multiple monitoring systems
• Alert Prioritization
• Fraud scoring engine
Implications of Fraudulent claims

• It is treated as an offence under both civil and criminal laws.
• The person is stripped of the benefits of insurance policy cover.
• The person is sentenced to rigorous imprisonment.
• A heavy financial fine is levied on the guilty party/individual.
• With the increase in the number of fraudulent claims, the insurance sector has been
affected to a very large extent and this in turn has an impact on the financial institutions of
the country and subsequently the economy.
Ref: Fraudulent Health Insurance Claims - Dealing with Fraud

http://www.medindia.net/patients/insurance/fraudulent-health-insurance-claims-
dealing.htm#ixzz1GpzsC8gr
4. 6 Special Features of Life Insurance Contract
The Insurance Act, 1938 does not contain a definition of life insurance contract. But section
2(1) of the act defines life insurance as follows:
Life insurance business means the business of effecting contracts of insurance upon
human life, including any contract whereby the payment of money is assured on
death (except death by accident only) or the happening of any contingency
dependent on human life, and any contract subject to payment of premiums for a
term dependent on human life and shall be deemed to include.
Page 9 of 18
The granting of disability or double or triple indemnity accident benefits,, if so

provided in the contract of insurance.
The granting of annuities upon human life and the granting of superannuation
allowances and annuities payable out of any fund applicable solely to the relief and
maintenance of persons engaged or who have been engaged in any particular
profession, trade or employment or of the dependents of such person.
4.7 Insurance Regulatory and Development Authority (Licensing of Insurance Agents)

Regulations, 2000
In exercise of the powers conferred by sub-section (6) of section 42 and clauses (k), (l), (m),
(n), (o) and (p) of sub-section (2) of section 114A of the Insurance Act, 1938 (4 of 1938), the
Authority, in consultation with the Insurance Advisory Committee, hereby makes the
following regulations, namely:-
1. Short title and commencement:

These regulations may be called Insurance Regulatory and Development Authority
(Licensing of Insurance Agents) Regulations, 2000.
They shall come into force on the date of their publication in the Official Gazette.
2. Definitions:
In these regulations, unless the context otherwise requires,
a. “Act” means the Insurance Act, 1938 (4 of 1938);

b. “Approved Institution” means an Institution engaged in education and/or training
particularly in the area of insurance sales, service and marketing, approved and
notified by the Authority;
c. “Authority” means the Insurance Regulatory and Development Authority
established under the provisions of Section 3 of the Insurance Regulatory and
Development Authority Act, 1999 (41 of 1999);
d. “Composite insurance agent” means an insurance agent who holds a license to act
as an insurance agent for a life insurer and a general insurer;
e. “Corporate Agent” means a person other than an individual as specified in clause (i);
f. “Designated person” means an officer normally in charge of marketing operations,
as specified by an insurer, and authorized by the Authority to issue or renew
licenses under these regulations;
Page 10 of 18
g. “Examination Body” means an Institution, which conducts pre-recruitment tests for

insurance agents and which is duly recognized by the Authority;
h. “License” means a certificate of license to act as an insurance agent issued under
these regulations;
i. “Person” means
a. an individual;
b. a firm; or
c. a company formed under the Companies Act, 1956 (1 of 1956), and includes
a banking company as defined in clause (4A) of section 2 of the Act;
j. “Practical Training” includes orientation, particularly in the area of insurance sales,
service and marketing, through training modules as approved by the Authority;
k. “Proposal form” means an application for purchase of an insurance product which
shall be the basis of insurance contract;
l. “Prospect” means a potential purchaser of an insurance product;
m. “Recognized Board or Institution” means such board or institution as may be
recognized by any State Government or the Central Government.
3. Issue or renewal of license:

1. A person desiring to obtain or renew a license (hereinafter referred to as “the
applicant”) to act as an insurance agent or a composite insurance agent shall
proceed as follows:-
a. the applicant shall make an application to a designated person:
i. in Form IRDA-Agents-VA, if the applicant is an individual;

ii. in Form IRDA-Agents-VC, if the applicant is a firm or a company:
Provided that the applicant, who desires to be a composite

insurance agent, shall make two separate applications.
b. The fees payable by the applicant to the Authority shall be as specified in

Regulation 7.
Page 11 of 18
2. The designated person may, on receipt of the application along with the evidence of
payment of fees to the Authority, and on being satisfied that the applicant,
a. possesses the qualifications as specified under Regulation 4;

b. possesses the practical training as specified under Regulation 5;
c. has passed the examination as specified under Regulation 6;
d. has furnished the application complete in all respects;
e. has the requisite knowledge to solicit and procure insurance business; and
f. is capable of providing the necessary service to the policyholders;
3. If the designated person refuses to grant or renew a license under this regulation, he
shall give the reasons therefore to the applicant.
4. Qualifications of the applicant:

The applicant shall possess the minimum qualification of a pass in 12th Standard or
equivalent examination conducted by any recognized Board/Institution, where the
applicant resides in a place with a population of five thousand or more as per the last
census, and a pass in 10th Standard or equivalent examination from a recognized Board/
Institution if the applicant resides in any other place.
5. Practical Training:
1. The applicant shall have completed from an approved institution, at least, one
hundred hours’ practical training in life or general insurance business, as the case
may be, which may be spread over three to four weeks, where such applicant is
seeking license for the first time to act as insurance agent.
Provided that the applicant shall have completed from an approved

institution, at least, one hundred fifty hours’ practical training in life and
general insurance business, which may be spread over six to eight weeks,
where such applicant is seeking license for the first time to act as a
composite insurance agent.
2. Where the applicant, referred to under sub-regulation (1), is:
Page 12 of 18
an Associate/Fellow of the Insurance Institute of India, Mumbai;

an Associate/Fellow of the Institute of Chartered Accountants of India, New
Delhi;
an Associate/Fellow of the Institute of Costs and Works Accountants of
India, Calcutta;
an Associate/Fellow of the Institute of Company Secretaries of India, New
Delhi;
an Associate/Fellow of the Actuarial Society of India, Mumbai;
a Master of Business Administration of any Institution / University
recognized by any State Government or the Central Government; or
possessing any professional qualification in marketing from any Institution /
University recognized by any State Government or the Central
Government:
He shall have completed, at least, fifty hours’ practical training from an

approved institution.
Provided that such applicant shall have completed from an approved

institution, at least, seventy hours’ practical training in life and general
insurance business, where such applicant is seeking license for the first time
to act as a composite insurance agent.
3. An applicant, who has been granted a license after the commencement of these
regulations, before seeking renewal of license to act as an insurance agent, shall
have completed, at least twenty-five hours’ practical training in life or general
insurance business, as the case may be, from an approved institution.
Provided that such applicant before seeking renewal of license to act as a

composite insurance agent shall have completed from an approved
institution, at least, fifty hours’ practical training in life and general
insurance business.
Page 13 of 18
6. Examination:
The Applicant shall have passed the pre-recruitment examination in life or general
insurance business, or both, as the case may be, conducted by the Insurance Institute of
India, Mumbai, or any other examination body.
7. Fees payable:
The fees payable to the Authority for issue or renewal of license to act as insurance agent or
a composite insurance agent shall be rupees two hundred and fifty.
Every person holding a license shall adhere to the code of conduct specified below:-
(i) Every insurance agent shall:

a. identify himself and the insurance company of whom he is an insurance agent;
b. disclose his license to the prospect on demand;
c. disseminate the requisite information in respect of insurance products offered for
sale by his insurer and take into account the needs of the prospect while
recommending a specific insurance plan;
d. disclose the scales of commission in respect of the insurance product offered for
sale, if asked by the prospect;
e. indicate the premium to be charged by the insurer for the insurance product offered
for sale;
f. explain to the prospect the nature of information required in the proposal form by
the insurer, and also the importance of disclosure of material information in the
purchase of an insurance contract;
g. bring to the notice of the insurer any adverse habits or income inconsistency of the
prospect, in the form of a report (called “Insurance Agent’s Confidential Report”)
along with every proposal submitted to the insurer, and any material fact that may
adversely affect the underwriting decision of the insurer as regards acceptance of
the proposal, by making all reasonable enquiries about the prospect;
h. inform promptly the prospect about the acceptance or rejection of the proposal by
the insurer;
i. obtain the requisite documents at the time of filing the proposal form with the
insurer; and other documents subsequently asked for by the insurer for completion
of the proposal;
Page 14 of 18
j. render necessary assistance to the policyholders or claimants or beneficiaries in

complying with the requirements for settlement of claims by the insurer;
k. advise every individual policyholder to effect nomination or assignment or change
of address or exercise of options, as the case may be, and offer necessary assistance
in this behalf, wherever necessary;
(ii) No insurance agent shall:

a. solicit or procure insurance business without holding a valid license;
b. induce the prospect to omit any material information in the proposal form;
c. induce the prospect to submit wrong information in the proposal form or
documents submitted to the insurer for acceptance of the proposal;
d. behave in a discourteous manner with the prospect;
e. interfere with any proposal introduced by any other insurance agent;
f. offer different rates, advantages, terms and conditions other than those offered by
his insurer;
g. demand or receive a share of proceeds from the beneficiary under an insurance
contract;
h. force a policyholder to terminate the existing policy and to effect a new proposal
from him within three years from the date of such termination;
i. have, in case of a corporate agent, a portfolio of insurance business under which the
premium is in excess of fifty percent of total premium procured, in any year, from
one person (who is not an individual) or one organization or one group of
organizations;
j. apply for fresh license to act as an insurance agent, if his license was earlier
cancelled by the designated person, and a period of five years has not elapsed from
the date of such cancellation;
k. become or remain a director of any insurance company;
(iii) Every insurance agent shall, with a view to conserve the insurance business already
procured through him, make every attempt to ensure remittance of the premiums by the
policyholders within the stipulated time, by giving notice to the policyholder orally and in
writing;
Page 15 of 18
9. Cancellation of license:
The designated person may cancel a license of an insurance agent, if the insurance agent
suffers, at any time during the currency of the license, from any of the disqualifications
mentioned in sub-section (4) of section 42 of the Act, and recover from him the license and
the identity card issued earlier.
10. Issue of duplicate license:

The Authority may issue a duplicate license replace a license lost, destroyed, or mutilated
on payment a fee of rupees fifty.
11. Non-application to existing insurance agents:

Nothing contained in Regulations 4 to 6 of these Regulations shall apply to the existing
agents before the commencement of these Regulations.
(Source: www.irda.gov.in)
Page 16 of 18
Summary
Life insurance contract is a special type of contract. Hence the general provisions of
the law of contracts s are applicable to life insurance contracts.
A contract is an agreement enforceable at law made between two or more persons

by which rights are acquired by one or more to certain acts or forbearances on the
part of the other or others.
The first requisite of a valid contract is that the parties thereto should be “ad idem”
i.e. they should of one mind. Two or more persons are said to consent when they
agree upon the same thing in the same sense.
Consent, according to the Indian contract act is said to be free when not caused by:
Coercion
Under influence
Fraud
Misrepresentation
Mistake
The applicant shall possess the minimum qualification of a pass in 12th Standard or
equivalent examination conducted by any recognized Board/Institution, where the
applicant resides in a place with a population of five thousand or more as per the
last census, and a pass in 10th Standard or equivalent examination from a
recognized Board/ Institution if the applicant resides in any other place.
The Applicant shall have passed the pre-recruitment examination in life or general
insurance business, or both, as the case may be, conducted by the Insurance
Institute of India, Mumbai, or any other examination body.
The Authority may issue a duplicate license replace a license lost, destroyed, or
mutilated on payment a fee of rupees fifty.
Page 17 of 18
Page 18 of 18
Chapter- 3 Claims Management
Page 1 of 25
TCS.
Notice
Contents
Chapter –3 Claims Management ...........................................................................................4
3.1 Introduction ........................................................................................................ 5
3.2 Claims Management in Insurance Business – Different Aspects ..........................6
3.3 Life Insurance Claims...........................................................................................8
3.4 Personnel Aspects of Claims Management ....................................................... 12
3.5 Claims Procedure Followed in Insurance Companies ......................................... 12
3.6 The Key Aspects of Settlement ......................................................................... 17
3.7 Settlement ........................................................................................................ 18
3.8 Disputes ............................................................................................................20
3.9 Role of Negotiations .........................................................................................20
3.10 Importance of Arbitration in Claim Settlement ............................................... 21
3.11 Ethical Aspect of Claims Management ............................................................ 22
Summary ................................................................................................................ 23
Page 3 of 25
Chapter –3 Claims Management

Introduction
Claims management is one of the vital functions of insurance companies, because, the
success of any insurance company solely depends upon its effectiveness in handling claims.
This chapter will give an overview about claims management and people involved in it.
Learning Objective
Understand what claims management is
Know types of claims management
Different aspects of claims management
Page 4 of 25
3.1 Introduction
Claims management is one of the vital functions of insurance companies, because, the
success of any insurance company solely depends upon its effectiveness in handling claims.
The processing and settlement of claims is one of the most important functions in an
insurance organization. Indeed, the payment of claims may be regarded as the primary
service of the insurance sector to the public. Prompt and fair settlement of claims is the
hallmark of good service to the insuring public. Though claims handling follows a defined
sequence, the circumstances and the claims made varies from person to person, and
therefore, demands a need for the insurer to possess hands on experience and knowledge
about the principles, law and practices that governs insurance contracts. It is also necessary
for the insurer to show proficiency about the terms and conditions, of standard policies and
their extensions, modifications etc.
Source: Process Framework, Claims Management by Newlink Group, Inc.
Figure1 : The Claims Eco System
Page 5 of 25
3.2 Claims Management in Insurance Business – Different Aspects
Legal Aspects
Claims settlement involves examination of loss in relation to the coverage under the policy
and compliance with policy conditions and warranties. Therefore, the first aspect to be
decided is whether the loss is within the scope of the policy or not. The legal doctrine of
proximate cause provides guidelines to decide whether the loss is caused by an insured peril
or an expected peril.
The onus of proof that the loss is within the scope of the policy is upon the insured.
However, if the loss is caused by an expected peril, the onus of proof is on the insurer.
The second aspect to be decided is whether or not the insured has complied with policy
conditions, especially conditions which are precedent to ‘liability’. These conditions relate to
immediate notification of loss to the insurers, submission of proof of cause and extent of
loss.
The third aspect is with respect to compliance with warranties. The survey report would
indicate whether warranties have been complied with or not.
The fourth aspect relates to the observance of utmost good faith by the proposer before the
conclusion of the contract and during the currency of the policy, if provided by the policy
conditions. Especially on the occurrence of a loss, the insured is expected to act as if he is
uninsured. In other words, he has a duty to take measures to minimize the loss.
The fifth aspect concerns the determination of the amount payable. The amount of loss
payable is subject to the sum insured. However, the amount payable will also depend upon
the following:
1. The extent of insured’s insurable interest in property affected.
2. The value of salvage.
3. Application of contribution and subrogation conditions.
The claims which are dealt with under insurance policies fall into the following categories:
Page 6 of 25
Standard Claims: These are claims are clearly within the terms and conditions of the
policy, and settlement of these claims presents no difficulty.
Non-Standard Claims: These are claims where the insured has committed a breach of
condition or warranty. The settlement of these claims is considered subject to certain
rules and regulations framed by the insurance companies.
Ex-gratia Payments: These are losses which fall outside the scope of cover under the
policy and hence are not payable. However, in very special cases, settlement of these
losses is considered as a matter of grace to avoid hardships to the insured. For example
due to genuine oversight a certain item of property is not included in the insurance,
though the insured intends to include it.
Ex-gratia settlements are never made on the basis of the full amount of loss. A
certain percentage only is paid. Also, such claims are paid “without precedent” so
that the insurers do not have an obligation to meet similar claims in future. The
courts have approved of such settlements though there is no legal liability to pay for
such losses.
3.2.1 Role of Judiciary
The judiciary has considerable role to play in interpreting the insurance contracts and
deciding the disputed claims. When the matter goes to the judiciary, two important
considerations arise.
Firstly, it is the rule of contra referendum, which makes it obligatory for the judiciary to
interpret the policy in case of any ambiguity in favor of the claimant.
Secondly, the judiciary is inclined to be sympathetic with the individual plaintiff against the
corporate defendant. Therefore, unless the insurance company has absolutely strong
grounds of defense, there is no point in repudiating the claim and driving the insured to the
court ultimately leading to bad publicity and involving avoidable expenses.
Page 7 of 25
3.3 Life Insurance Claims
3.3.1 Maturity Claims:
Payment of maturity claims is by far the easiest to manage. These include, benefits payable
during the period of assurance called “survival benefits” under certain types of policies
popularly known as “money back policies”. Payment in these cases is easy because
There is no need to prove the happening of the event

The policy holder is alive so proof of title does not pose any problem
The insurance company need not await any claim from the policy holder and take
initiative to settle the claims expeditiously
All the insurance companies try to give excellent performance in respect of two key areas:
Zero ratio of outstanding maturity claims (i.e. settling all maturity and survival
benefit claims falling due in any year) and
A very high speed ratio (i.e. a very high percentage in the settlement of these claims
before due date)
The requirement for settlement of these claims is very simple. They are:
A discharge voucher to be sent in advance
Policy document
Any deed of assignment if the same was executed on a separate stamp paper
As the policy holder is alive, obtaining these requirements poses very little problems. A few
problems are likely to arise when a policy document is misplaced. In such cases the
insurance company settles maturity claims on the basis of an indemnity bond to be
executed on a non judicial stamp paper.
3.3.2 Death Claims
Life insurance is basically for providing financial security to the families of deceased policy
holders. Death claim settlement naturally assumes very great importance in the total
operations of any life insurance company. Despite several problems encountered, still life
insurance companies struggle to efficiently attend to this function. Unlike in maturity and
Page 8 of 25
survival benefit claims the policy holder is not alive. Broadly the problems in settlement of
death claims are:
Obtaining satisfactory proof of death

Obtaining satisfactory proof of title
These two requirements are independent of each other. It is necessary for an insurance
company to decide first whether any liability lies in the death claim or not. This not only
depends on the proof of the happening of the event, i.e. death but also the status of the
policy as on the date of death.
The life insurance company is not expected to know about the death of a policy holder
unless the same is intimated by the claimants. Any action can therefore be initiated only
after receipt of such intimation.
The letter of intimation should contain the particulars:

Policy number and the name of the life insured. These two should match otherwise
the policy number must be wrong.
Date of death, on which the depends the status of the policy and amount payable
Name and address of the claimant as requirements are to be called from them.
Usually the death intimation should be sent by the nominee or assignee or someone
near or dear to the deceased life assured.
Life insurance Corporation of India calls for the following requirements in case of death
claims:
1. Death certificate in original
2. Claimant’s statement: the claimant furnishes information
About the deceased life assured
His/her age
Date of death
Cause of death
Place of death
If hospitalized during a period of 3 years earlier to death (details of
the same)
Page 9 of 25
Details of claimants
Name
Address
Details of any other policies so that all can be considered together
3. Statement from the hospital/nursing home where the life assured had
treatment for terminal illness. Along with it the date of admission, date of
death, time of death, reason of admission, primary cause of death, duration
of illness and other details related to it.
4. statement from doctor who attended the person last, the identification of
the life assured, how long the doctor treated him, for what ailments,
whether doctor is the usual medical attendant of the life assured and if so
for what ailments the treated him.
5. Statement of a gentlemen who is not related to the deceased life assured
and who is not interested in the policy moneys, who has attended the
burial/cremation of the deceased life insured.
6. if the deceased life assured was an employee of any organization, a
statement from the employer furnishing the details of the life assured, date
of joining service, designation, date of last attended duty, details of any
leave for illness/sickness.
7. in case of death due to unnatural causes like accidents, suicide, etc. the
following records are called for:
First information report to the police
Panchanama report/police inquest report
Postmortem report
Chemical analysis/forensic report in case where postmortem is not
conclusive about the cause of the death
In very rare cases police final investigation report
3.3.3 Accident and Disability Benefits:
We shall now turn our attention to the settlement of Accident and disability benefit claims:
1. Death should be due to accident i.e. by external, violent means. Death must be
directly due to the accident and there should be no intervening cause.
Page 10 of 25
2. Death should take place within a specified period of time after the accident.
(Generally it 120 days)
3. Proof satisfactory to the insurance company should be submitted. Usually the
requirements called for are:
a. First information report
b. Police inquest report
c. Postmortem report
d. If viscera were sent for chemical examination, then the report of the
forensic laboratory is also called for
4. The police must be in full force at the time of the death. Policy holder should have
availed the accident benefit by paying the necessary additional premium. He must
not have been aged 70 years and above at the time of death.
5. None of the exclusion should apply for consideration of sanctioning accident benefit
in a case. There are several exclusions in considering granting accident benefits.
Such as the life assured should be not be under the influence of any intoxicating
liquor, drug or narcotic at the time of accident.
The proof of disability should be satisfactory to the insurance company. Usually the
following things are called for:
1. First information report to the police
2. A declaration from the life assured explaining the details of the accident and the
treatment undergone and the type of disability suffered.
3. Record of the hospital where the treatment was given
4. A statement from the hospital about the extent of disability, whether temporary or
permanent, details of any surgery performed, percentage of disability
3.3.4 Claims on Small Life Insurance Policies
1. In the event of any dispute relating to the settlement of a claim on a policy of life
insurance assuring a sum not exceeding two thousand rupees (exclusive of any
profit or bonus not being a guaranteed profit or bonus) issued by an insurer in
respect of insurance business transacted in India, arising between a claimant under
the policy and the insurer who issued the policy, the dispute may at the option of
the claimant be referred too the authority for decision.
Page 11 of 25
2. The decision of the authority shall be final not be called in question in any court.
3.4 Personnel Aspects of Claims Management
Smooth and successful handling of claims is possible only with people who are adept in
managing customers with unique set of personality traits. These are certain qualities which
the claims management personnel should possess in order to successfully manage claims
during normal times as well as during disputes. They are-
Patience
Tact
Diplomacy
Courtesy
Integrity
Technical skills
Good communication, both oral and written
Good public relations to impact customer education and to cultivate customer
relationship
Trust and empathy with the insured
A positive organizational culture and an atmosphere of mutual support at different
levels of hierarchy, both vertical and horizontal.
Most of the time claims department encounters demanding claimants. Dealing with them is
often very difficult. Therefore, the person working in the claims departments must be good
negotiators; also the company should always be aware of the type of people with whom
they do business with and should try to avoid habitual troublemakers.
3.5 Claims Procedure Followed in Insurance Companies
The claims management procedures followed by insurance companies are common for
both commercial as well as personal insurance policies. They are of the following sequence:
Intimation by the insured
Verification by the insurer
Registration of information
Page 12 of 25
Settlement of claim
Source: Process Framework, Claims Management by Newlink Group, Inc.
3.5.1 Notice of Loss
Policy conditions usually provide that the loss be intimated to the insurer. Immediate notice
is given to allow the insurer to investigate a loss at its early stages. Delays may result in
losing valuable information relating to the loss. It would also enable the insurer to suggest
measures to minimize the loss and take steps to protect salvage
On receipt of intimation of loss or damage, insurers check that:
1. The policy is in force on the date of occurrence of the loss or damage.
2. The loss or damage is due to a peril insured by the policy.
3. The subject matter affected by the loss is the same as is insured under the
policy.
4. Notice of loss has been received without undue delay.
Page 13 of 25
After this check up, the loss is allotted a number and entered in the claims register. A
separate file is opened for the claim and a claim form is issued to the insured. The claim is
now ready to be processed. The particulars to be entered in the claims register are as
follows:
1. Serial number
2. Date of information
3. Claim number
4. Name of the insured
5. Policy number
6. Particulars of the risk
7. Date of loss
8. Nature of loss
9. Estimated amount of the loss
10. Amount paid and date of settlement
11. Serial number of claims paid register
12. Remarks
The register assists the insurers in knowing the number and amount of claims intimated
during the period, and in ascertaining the number of claims, which remained outstanding on
a particular day, and their amount. This helps to keep a continuous watch over the
outstanding claims, for their review and follow-up.
3.5.2 Onus of Proof
In order to be in a position to claim, the insured must be able to show:

1. That he has sustained a loss and unless otherwise expressed the event causing
the loss occurred during the period of insurance;
2. That the cause of loss was the event which answers to the description of the
peril described in the policy and;
3. That it does not fall within the operation of an exception of the policy.
The onus of proof about all these three aspects i.e., the occurrence of the event, the
operation of an exception and the time of event, lies upon the insured to prove that the
cause of loss was the event which is described in the policy. Proof cannot always be a matter
Page 14 of 25
of certainty and if the insured has sufficiently discharged his duty by establishing facts, it is
reasonable to draw the inference that the event has occurred. The insured does not fail,
merely because the facts are equally consistent with another event e.g. if the insured is
found dead in circumstances which point either to accident or to suicide. However mere
guess is not sufficient, for example, the fact that goods have been lost from a warehouse
does not prove by itself that they have been stolen by housebreaking.
Thus where it has been established that the loss resulted out of the insured peril, the policy
operates unless it can be established by the insurers that the loss arose under an exception,
i.e., the onus lies upon the insurers to prove the exception. Here again, certainty cannot
always be established but it becomes a question of inference as to the conclusions to be
reasonably drawn from the facts submitted, for example, if a loss during riot or civil
commotion is excluded from the insurance, it is sufficient if the insurers are able to establish
facts from which it is proper and reasonable to draw the inference that the property was
stolen by the turbulent forces and not by ordinary thieves.
However it is possible, for the insurers to use such words in the policy as to shift the onus of
proof to the insured and make it his duty to establish that an exception does not operate.
This is particularly attempted where the policy contains an exception against riot, civil
commotion, and other special perils which might give rise to the insured event. The onus of
proving the time of event lies upon the insured. This again cannot always be definitely
established, and is sometimes a matter of reasonable inference from the facts submitted.
After allotting a claim number and making an entry in the claims intimation register, it has
to be ascertained whether, prima facie, the claim falls within the scope of the policy. If this
is not so, the claimant has to be advised promptly that the claim does not fall within the
purview of the policy. If the claim appears to fall within the policy, the insurers forward a
claim form to the claimant for completion and return. Theoretically, there is no need for a
claim form – it should be enough if all the relevant details of the claim are furnished to the
insurers. However in practice, the insurers almost invariably insist on the claimants to
complete the claim forms devised by them, so that information is obtained by them in the
manner they want. It is necessary to keep the requirement in view that the insured must
prove his claim to the satisfaction of the insurers and must comply with all the conditions of
the contract. However if the insurers consider that the misfortune which has occurred was
Page 15 of 25
caused by a peril which is outside the scope of the policy, the onus of proving it rests on
them.
The issue of a claim form by the insurers does not constitute an admission of liability on the
part of the insurers, which is made very clear by making a remark on the form to that effect.
Besides, all letters sent to the insured by insurers in connection with the claim are also sent
without prejudice to their rights and hence they carry the remark ‘without prejudice’.
3.5.3 Role of Specialists/Experts in Claims Settlement
Expert advice is sometimes required for the efficient settlement of claims. The various types
of specialists used in the processing and settlement of claim include professional, surveyor,
loss adjuster, loss assessor, accountants, engineers, architects, valuers, photographers,
investigators, surveillance, medical adviser, solicitors etc.
The general research work undertaken by the specialists may include:

Attending the scene
Questioning the claimant
Inspecting the damage
Gathering material about the loss
Discussing the terms and conditions of the policy contract with the claimant
Determining whether the property is restorable
Ensuring that the estimates are accurate
Reporting the findings and estimates to the insurers
Acting to minimize disruption of the business.
3.5.3.1 Loss Adjusters
Loss adjusters are employed by the insurers to investigate and negotiate settlement of a
claim. They are appointed to ensure no disputes arise between the insurer and the insured
in settling the claims.
Loss adjusters can be highly qualified individuals or firms with a great deal of experience in
claims. Thus experienced loss adjusters are available for fire, burglary, natural calamities,
Page 16 of 25
etc. The loss adjusters can assist the policyholders in contacting relevant specialist services
and getting repairs done, if necessary. They also ensure that the claim settlement terms are
acceptable to both the insurer and the insured.
The loss adjustor submits a final report to the insurer after negotiating with the insured. The
final report will contain a recommended settlement figure and also a satisfaction note
signed by the insured accepting the recommended sum. In normal circumstances, the
insurer also agrees to the sum recommended by the loss adjustor. The amount is then
transferred to the claimant by way of cheques. But in case of large claims, which are insured
by more than one insurer, arrangements are made for every insurer to send his cheques for
the proportionate amount.
3.5.3.2 Loss Assessors
Unlike loss adjustors who are appointed by the insurer, the loss assessors are appointed and
paid by the policyholder. The main purpose of loss assessors is to help the policyholder in
the efficient settlement of the claim. The sole interest of the loss assessor is to ensure that
the interests of the insured are satisfied.
The fees paid to the loss assessors are not normally insured any policy. Thus the insured
appoints a loss assessor only when he feels that he is not getting a favorable deal from the
insurers.
Loss adjusters and Loss assessors can be seen in the US markets. In India, Loss adjustors
and surveyors are same.
3.6 The Key Aspects of Settlement
Claims settlement involves examination of loss in relation to the coverage under the policy
and compliance with policy conditions and warranties.
Therefore, the first aspect to be decided is whether the loss is within the scope of the policy
or not. The legal doctrine of proximate cause provides guidelines to decide whether the loss
is caused by an insured peril or an expected peril.
The onus of proof that the loss is within the scope of the policy is upon the insured.
However, if the loss is caused by an expected peril, the onus of proof is on the
insurer.
Page 17 of 25
The second aspect to be decided is whether or not the insured has complied with policy
conditions, especially conditions which are precedent to ‘liability’. These conditions relate to
immediate notification of loss to the insurers, submission of proof of cause and extent of
loss.
The third aspect is with respect to compliance with warranties. The survey report would
indicate whether warranties have been complied with or not.
The fourth aspect relates to the observance of utmost good faith by the proposer before
the conclusion of the contract and during the currency of the policy, if provided by the
policy conditions. Especially on the occurrence of a loss, the insured is expected to act as if
he is uninsured. In other words, he has a duty to take measures to minimize the loss.
The fifth aspect concerns the determination of the amount payable. The amount of loss
payable is subject to the sum insured.
3.7 Settlement
Based on the survey report and the recommendations of the surveyor, the insurers decide
whether they are settling the claim, and if so, for what amount. The recommendations of
the surveyor do not bind on the insurers. The insurer’s decision has to be communicated to
the claimant. If a decision to settle the claim is taken, a discharge certificate is form the
claimant that he is accepting the amount in full and final settlement of his claim, and
therefore, a cheque for the claim amount is sent to the claimant. Where subrogation rights
are involved, a letter of subrogation duly executed by the insured is also obtained. Some
insurers combine the discharge with the subrogation letter and obtain a discharge-cum-
subrogation letter from the claimant.
When the insurers settle a claim, a note to that effect is made in the claims intimation
register, and has also to be entered in the claims paid register. The following items are
entered in the claims paid register:
1. Serial number
2. Claim number
3. Policy number
4. Particulars of the policy paid
Page 18 of 25
5. Name of the insured

6. Date of loss
7. Nature of loss
8. Amount paid
9. Date of payment
10. Remarks
The claims paid register helps in accounting, and also in enabling the insurers to ascertain
the number and amount of claims paid during a given period. Any salvage, if available, is the
property of the insurers after settlement of the claim. Quite often, the salvage is retained by
the insured and the value thereof is deducted from the amount of the claim. A salvage
register is also required to be maintained by the insurers, giving details of the salvage
recovered. Similarly, other possible recoveries, if any, also belong to the insurers.
If, in case of under-insurance and in terms of the conditions of the average, the claim is
settled for an amount less than the amount claimed leaving the balance to be borne by the
insured himself, the salvage and the recoveries from third parties have to be shared
between the insurers and the insured in the same proportion in which they have shared the
amount of claim. The expenses incurred, if any, for making the recoveries are also shared by
the insurers and the insured in the same proportion. If the insurers decide to repudiate a
claim, it has to be conveyed in writing to the claimant. Also it is not unusual for the
claimants to withdraw the claims after they are intimated. Whenever a claim is withdrawn
or repudiated, a note to that effect is made in the claims intimation register, so that these
claims are not shown as outstanding.
In some cases, it may so happen that the claim is not payable because of a technicality. The
insurers may feel reluctant to repudiate the claim merely on grounds of the technicality. At
the same time they may be wary of admitting the claim within the terms of the policy. In
such circumstances, when the insurers desire neither to settle the claim in terms of the
policy nor to repudiate it, they settle the claim ex-gratia. Such settlements are out of grace,
without admission of liability, and do not form precedents for future claims of similar
nature. The discharge to be obtained from the claimant has to be worded suitably so that
the ex-gratia payment is clearly brought out. No question of subrogation arises in
settlements of this nature, and hence no subrogation letter is obtained from the claimant.
Page 19 of 25
When a loss takes place, the hazard increases irrespective of the fact whether or not the
claim is settled. In some classes of miscellaneous (accident) insurance, the increase in
hazard may be so pronounced that the insurers may intend to amend or restrict the cover,
or cancel it altogether. However in view of the insurers’ reluctance to invoke the
cancellation condition, such amendment or cancellation is generally carried out at the next
renewal of the policy, except in those cases where such cancellation and amendment is an
immediate necessity. In such cases where the amendment or cancellation of the cover is
desired to be carried out at the next renewal of the policy, the claims department of the
insurers has to pass a note to the renewal department for necessary action at renewal.
3.8 Disputes
The major dispute between the insurer and the insured is usually regarding the amount of
claim and the scope of liability under the scheme. In most of the situations, the two parties
disagree upon the amount to be paid by the insurer. The insurers are not ready to pay as
much as the policyholder wants to receive. The process of arbitration is required to sort out
these differences. Sometimes, the insurer does not keep liability and is not ready to
entertain the claim of the insured. In such cases the insured has to take legal action against
the insurer for breach of contract. The process of arbitration is applicable to settle the
difference regarding amount of claim.
Other areas of disputes are:

The premium (amount, payment, penalties)
Indemnity
Currency or validity of contract
Fraud
Insurer’s procedures, including failure to meet response time limits set for both
informal and formal dispute resolution.
3.9 Role of Negotiations
Negotiations are necessary for the proper settlement of a claim. It is essential in cases
where the disputes arising between the insurer and the insured result in delay in claim
settlement.
Page 20 of 25
Negotiation terms may include indemnity or replacement, alternate discount replacement

or best replacement. The negotiations can be between:
An insurance claims officer and a broker
An insurance claims officer and a solicitor
A client and an insurance claims officer
A loss adjuster and an insurance claims officer
An insurance company and a third party
Between two solicitors.
3.10 Importance of Arbitration in Claim Settlement
Arbitration refers to the method of settling disputes arising between parties who have
entered into a contract. An arbitrator is an independent expert who will give an opinion that
is binding to both the parties in the dispute. The arbitrator is to be appointed by both the
insured and the insurer in consultation and in accordance with the necessary statutory
provisions. If there is no consensus between the parties on the appointment of the
arbitrator, the court can appoint an arbitrator. The decision of the court regarding the
appointment should be accepted by both the parties.
The role of arbitrators is significant in an insurance contract as disputes are inevitable in

claim situations. In most of the insurance contracts, there exists lack of consensus between
the insurer and the insured. The disputes thus arising need to be settled in an appropriate
manner for the benefit of both the parties. If these disputes are taken to a court of law, it
results in considerable delay and huge expenses for the parties. The concept of arbitration is
helpful in these situations.
Every insurance policy stipulates certain conditions for arbitration. As per the arbitration
condition, any dispute arising between the insured and the insurer shall be referred to an
arbitrator. In addition to the insurer and the insured, other relevant parties in a dispute may
include the employer, an authorized insurer, self-insurer, risk management consultant,
union, the community, employer and industry associations, a third party, legal service
providers, insurance brokers and underwriting agents, investigators and assessors, repairers
and suppliers. Arbitration applies to the amount of claims and only when the liability is
admitted.
Page 21 of 25
3.11 Ethical Aspect of Claims Management
Claims operation involves considerable sums of money. It is not uncommon to find that
some of the individual claimants are tempted, either knowingly or unknowingly, to make
use of insurance to the best possible ability to get a little more than indemnity. But, leakage
of insurance company’s funds due to the activities of such persons is not justifiable as far as
other honest claimants are concerned who are satisfied with what is due to them as per the
terms and conditions of the policy. Therefore, it is the responsibility of the insurance
companies, as trustees of the policyholders’ money, to ensure as far as possible, that moral
hazard is eliminated or at least minimized.
Since loss is personal, the individual is likely to react in a subjective manner and tends to
exaggerate his claim. This can be tackled without much difficulty. But, a more difficult
problem is corporate clients trying to take advantage of insurance. Some of them are said
to treat their insurance division as a profit center.
Therefore, it is necessary to successfully assess the moral hazard at the time of underwriting
itself. When this is subsequently found, it is essential that insurance companies share this
information with one another and deal with such clients in a suitable manner.
Page 22 of 25
Summary
Claims management is one of the vital functions of insurance companies, because,

the success of any insurance company solely depends upon its effectiveness in
handling claims.
Claims settlement involves examination of loss in relation to the coverage under the
policy and compliance with policy conditions and warranties.
The fifth aspect concerns the determination of the amount payable. The amount of
loss payable is subject to the sum insured. However, the amount payable will also
depend upon the following:
a. The extent of insured’s insurable interest in property affected.
b. The value of salvage.
c. Application of contribution and subrogation conditions.
Standard Claims: These are claims are clearly within the terms and conditions of
the policy, and settlement of these claims presents no difficulty.
Non-Standard Claims: These are claims where the insured has committed a breach
of condition or warranty. The settlement of these claims is considered subject to
certain rules and regulations framed by the insurance companies.
Ex-gratia Payments: These are losses which fall outside the scope of cover under
the policy and hence are not payable.
Payment in maturity claims are easy because

There is no need to prove the happening of the event
The policy holder is alive so proof of title does not pose any problem
The insurance company need not await any claim from the policy holder
and take initiative to settle the claims expeditiously
All the insurance companies try to give excellent performance in respect of two key
areas:
Page 23 of 25
Zero ratio of outstanding maturity claims (i.e. settling all maturity and
survival benefit claims falling due in any year) and
A very high speed ratio (i.e. a very high percentage in the settlement of
these claims before due date)
Unlike in maturity and survival benefit claims the policy holder is not alive. Broadly
the problems in settlement of death claims are:
Obtaining satisfactory proof of death
Obtaining satisfactory proof of title
The proof of disability should be satisfactory to the insurance company. Usually the
following things are called for:
a. First information report to the police
b. A declaration from the life assured explaining the details of the accident and
the treatment undergone and the type of disability suffered.
c. Record of the hospital where the treatment was given
d. A statement from the hospital about the extent of disability, whether
temporary or permanent, details of any surgery performed, percentage of
disability
The claims management procedures followed by insurance companies are common

for both commercial as well as personal insurance policies. They are of the following
sequence:
Intimation by the insured
Verification by the insurer
Registration of information
Settlement of claim
Areas of disputes are:
The premium (amount, payment, penalties)
Indemnity
Currency or validity of contract
Fraud
Insurer’s procedures, including failure to meet response time limits set for
both informal and formal dispute resolution.
Page 24 of 25
Page 25 of 25
Chapter-2 Insurance Underwriting
Page 1 of 18
TCS.
Notice
Contents
Chapter – 2 Insurance Underwriting ......................................................................................4
2.1 Underwriting - Introduction ......................................................................................... 5
2.2 Risk Classes .................................................................................................................6
2.3 Sources of Information ................................................................................................ 7
2.4 Why Underwrite?.........................................................................................................8
2.5 Underwriting Goals......................................................................................................9
2.6 Underwriting Guidelines ............................................................................................ 10
2.7 The Underwriting Process .......................................................................................... 12
2.8. Underwriting and Regulatory Compliance ................................................................ 13
2.9 Standards for Underwriting ....................................................................................... 14
2.10 The Technologies Used ............................................................................................ 15
Summary ........................................................................................................................ 17
Page 3 of 18
Chapter – 2 Insurance Underwriting

Introduction
In underwriting, the risk exposure is measured and the premium required to be charged for
insuring this risk exposure is determined. When viewed in whole, this is in fact the process
of insurance policy issuance. As such, underwriting is the key in creating an insurance policy,
getting premiums and paying proceeds. This chapter outlines underwriting basics, steps,
processes and everything needed to understand this crucial process.
Learning Objectives
After reading this chapter you will know:
Basics of underwriting
Underwriting goals and standards
The process involved
Page 4 of 18
2.1 Underwriting - Introduction
There are a specialized class of people in insurance who

assess the prospective customer’s risk and exposures. They
are known as Underwriters. In simple terms an Underwriter
can be a person or a firm who takes for granted financial
risks on behalf of another. The term can refer to an
insurance company, an investment bank, or an individual sponsor of an event. An
underwriter puts special terms in exchange for its services. They also determine the extent
of coverage, premiums to be paid and even whether the client’s risk is acceptable to the
insurance company or not.
In underwriting, the risk exposure is measured and the premium required to be charged for
insuring this risk exposure is determined. So, the underwriter essentially acquires (“writes’)
business that
generates income for the insurance company and
protects the insured company or individual from risks
When viewed in whole, this is in fact the process of insurance policy issuance.
Every insurance company establishes underwriting rules which determines if the
underwriter should recommend a risk for insurance or not. If the risk is not favourable, the
underwriter may suggest one of the following courses of action:
Decline to accept risk
Price premiums higher to compensate for the adverse risk
Include policy exclusions to limit the circumstances when a claim is paid
For example, an automobile insurer will charge higher rates to young, unmarried males, or it
may refuse coverage to drivers with a history of accidents. Fire insurers may inspect
properties, offer reduced premiums for safety features such as sprinkler systems, and so on
Most times, insurance firms employ automated underwriting systems which code in these
rules. This helps cut down on the manual labour put in processing and policy issue. This
situation is particularly true for simple insurance types such as life or personal lines.
LOMA has given the following definitions for Underwriting and Underwriter:
Page 5 of 18
“Underwriting is the process of (1) assessing and classifying the degree of risk represented
by a proposed insured or group with respect to a specific life insurance product and (2)
making a decision to accept or decline that risk.”
“An underwriter is an insurance company employee who evaluates risks, accepts or declines
life insurance applications, and determines the appropriate premium rate to charge
acceptable risks.”
Insured and Applicants - As per underwriting, the insured (also known as assured) is one
who is to be covered by the proposed insurance policy. The applicant is one who submits
insurance application and wants to buy insurance. When an applicant completes the process
of buying an insurance policy then he becomes the policy owner and can also be called as an
insured. Most times, the insurer, applicant and policy owner are one and the same.
The underwriter’s decision about risk classification and premium charge for insurance
coverage is known as “underwriting decision”.
2.2 Risk Classes
Underwriters determine risk of the proposed insurers, basing them on certain specified
classes. A risk class is defined as “a group of insureds that pose a similar risk level to the
insurance company.”
Generally there is certain standard risk classes used in underwriting proposed insured’s.
These include:
Preferred class - Their expected mortality is below average and present the minimal
mortality risk
Standard class - This class of proposed insured has average mortality
Substandard class - This class presents higher than average mortality risk, but yet
they are regarded insurable
Page 6 of 18
Declined class - The expected mortality is too high for being regarded for insurance.
Preferred class
Standard class
Substandard class
Declined class
Risk Factors: For an underwriting, the underwriter will take into account the various risk
factors, for example applicant’s financial condition, to determine whether the applicant will
be able to pay the required coverage. The risk factors taken onto account are:
Medical factor- A person with a history of heart attacks possesses a physical danger
that will increase the probability that the person will have huge medical expenses or
will die sooner than that of a person of the same age who does not have the same
medical history.
Financial factor- A person taking out more insurance than what he can afford may
not be able to pay the premiums and have to discontinue the coverage, which leads
to financial risk.
Personal factor- People playing or participating in high risk games or extreme
sports say bike racing, rock climbing are likely to have more accidents and a higher
mortality than those people who pass their time simply playing indoor games.
2.3 Sources of Information
For the purpose of classifying the risk, insurers rely on information from a range of sources.
The most common of these sources is the application form, which all applicants complete
regardless of the level of insurance. There could be other sources of information also. For
instance for life and health insurance, these may include medical examinations,
paramedical examinations, ECGs, doctors reports, blood tests and financial evidence.
Page 7 of 18
Each company determines its own mandatory requirements for insurance applications
which vary according to the type and level of insurance cover and the age of the applicant.
In determining the level of cover above which certain types of information are sought, the
company will consider the cost of obtaining such information and the value it may add to
the assessment process. It should be noted that in determining whether cover required is in
excess of the mandatory testing level, an insurer may take into account any insurance cover
in force on the applicant.
Based on the information provided by the mandatory requirements, Underwriters may

choose to exercise their discretion to request additional requirements. The most important
consideration for the Underwriter is to obtain sufficient information to assess the risk fairly.
Before requesting information the Underwriter may consider:
the cost of obtaining the additional information;

the value likely to be added to the assessment of the risk;
the inconvenience to the applicant;
the time it will take to obtain the information; and
the inconvenience to the intermediaries.
The overriding consideration for the Underwriter will be the need to make an accurate
assessment of the risk.
2.4 Why Underwrite?
Two key considerations that govern an insurer’s behavior are:

People are more likely to buy insurance if they have reason to believe they will incur
high costs in the near future. This phenomenon is known as “adverse selection.”
This may not be true for healthcare insurance though – people often buy policies
once they are aware of specific conditions
A small proportion of the insured population accounts for a very large share of total
claims costs.
Among non-elderly adults with employer group coverage in 2001, for example,
the highest-spending 3 percent of enrollees accounted for 37 percent of total
costs; the highest-spending 10 percent accounted for 60 percent of total costs.
In a competitive market, an insurer that could screen out the highest risks could
Page 8 of 18
offer lower rates to more favorable risks. No insurer can identify in advance
everyone who will have high costs.
2.5 Underwriting Goals
Underwriting aims to cover the maximum number of applicants for insurance while
maintaining the financial solvency of the insurance company. To achieve this goal, the
underwriter has three responsibilities – sound underwriting, gain from mortality or
morbidity and approve only those applicants who have persistency.
Sound Underwriting - Underwriting is said to be sound if risk is evaluated and classified

properly, and coverage is either denied or accepted at adequate premium. Sound
underwriting hence yields one of the following actions –
Coverage is accepted as applied
Coverage is denied completely
Coverage is given with changes to premium rates
Coverage is given with changes to extent of coverage
(Changes in premium rates and/or coverage is termed Rating)
This practice is important for competitiveness of insurer. If underwriting is too strict, then
applicants will go elsewhere, meaning loss of premium income for the insurer. If
underwriting is too lax, the insurer will be saddled with unacceptable risks and defaults,
resulting in losses. A company may consider these few factors for sound Underwriting:
Volume of billing
Types of service provided
Project handled
Firm’s experience
Coverage
Continuation
Competition
Geographic location
Mortality and Morbidity Gains - This is applicable for life/health/accident insurance. If

underwriting is sound, then the insurer will reap the benefits of mortality and morbidity
gains. An insurer gets “mortality gain” when actual mortality experience (no. of actual
deaths in the insured group) is less than expected mortality (no. of predicted deaths). That
Page 9 of 18
means that an insurer will gain if fewer than expected deaths occur. (Mortality rate can be
defined as the rate at which death occurs among a group of people during a specified period
generally one year). An insurer gets “morbidity gain” when the actual number of
illnesses/injuries (morbidity experience) are less than the predicted ones (expected
morbidity). (Morbidity rate can be defined as the rate at which illness/sickness or injury
occurs among a group of people during a specified period generally one year).
Anti-selection - People, who are aware that they may experience loss sometime in future,
perhaps to a greater extent than others, are more likely to renew insurance contracts than
others who were not aware. This makes underwriting particularly important as insurers
need to look out for such parties. For example a person suffering from any serious illness or
say cancer is more likely to increase the policy coverage than a person who is in nice health.
The possibility of antiselection makes the role of an underwriter very crucial during risk
assessment process.
2.6 Underwriting Guidelines
Every insurance company has a set of guidelines and objectives that direct the underwriter’s
actions. Underwriting objectives are also called as underwriting philosophies which are a
reflection of the insurer’s business goals and underlying pricing assumptions for premiums.
The philosophy will indicate which risks are agreeable to the insurer and which are not.
The underwriting philosophy forms the foundation for Underwriting Guidelines, which are
defined as a set of standards for underwriters to determine the risk level of the proposed
insured. In fact, underwriters work with a set of factors when determining risk and
premiums.
For instance for individual life/health insurance, the following parameters are often
considered:
Age
Height
Weight
Blood Pressure
Cholesterol
Medical History
Family Medical History
Page 10 of 18
Occupation
Financial Conditions
Any adverse behaviour (smoking, alcoholism, poor driving record, criminal records,
etc)
Purpose of Insurance
Extent of coverage requested
Group life/health insurance underwriting guidelines normally focus on factors relating to the
group such as:
Nature of business
The employee professional classes and demographics (age and sex) of the group
Type and amount of coverage
Group size
However, Underwriting philosophy and guidelines are not fixed, they are flexible and can
change based on insurer’s experiences and market trends and demographics. Irrespective of
the changing conditions, the insurer needs to provide coverage to eligible applicants, which
is equitable to the insurer and insured, and deliverable by the insurance company. Equitable
to the insured means that all the insured’s who belong to a similar risk class must be treated
in the same manner. This means that the premium rates need to be decided based on the
same set of underwriting standards.
Equitable to the insurer means that the coverage delivered must meet the insurer’s
business goals. If the underwriter has covered unacceptable levels of high risk, then the
number of claims will be higher than predicted. This could result in financial instability.
The policy is said to be deliverable if the proposed insured accepts it. If the insured does not
accept the policy, when the producer attempts to deliver it, it is said to be undeliverable or
not taken up, and this can happen if:
The insured is classified in less than desirable risk class or policy issued in class other
than the best available preferred class;
The premium charged is much higher than expected and/or
Page 11 of 18
The policy has been modified using riders limiting the total coverage or the amount
of coverage.
In case of such situations, it’s the task of underwriter to explain to the insurer the fact that
risk was not palatable and hence there was the need for stringent measures. An
underwriter’s success is measured not only through sound underwriting but also by gaining
the confidence of the insured.
2.7 The Underwriting Process
While underwriting individual insurance, the following steps are involved:
Individual Insurance Group Insurance

Conduct field underwriting Review features of the proposed group
Review insurance application Assess insurance and services applied for
Collect more information for sound Check for any previous claims and premium
underwriting experience
Take an underwriting decision
The process in which an insurance company checks an insurance application and collects
information about him/her is referred to as “Field underwriting”. Often insurance
companies create underwriting manual which helps field underwriting. The field
underwriting manual hence has two valuable roles to perform – guide proposed insured’s
risk assessment and assist in collecting data about the proposed’s insurability (i.e., the risk
can be insured).
In recent years, teleunderwriting is emerging as an alternative for field underwriting,

wherein a third party administrator or home office person, and not the insurers gathers
underwriting information. In this context, a third party administrator (TPA) is an
organization that offers administrative services to a financial services’ customer.
Teleunderwriting occurs via telephone discussions.
For every insurance product, the insurance company has a list of underwriting requirements
table. This details the information to be considered by the underwriter while assessing the
Page 12 of 18
insurability of an applicant. The amount of required information is directly proportional to

the risk. The higher the risk, higher is the information needed.
Underwriters generally employ a numerical rating system in risk classification and premium
rate decisions. Under this system, the proposed insured is given a number based on the risk
he/she presents to the insurer. Based on the assessments, if the underwriter approves
insurance coverages, then the proposed insured’s file is sent to the policy issue department.
The latter is the insurer’s operational department which creates and despatches policy to
the insured.
At the core of all these processes is the insurance application, which is essentially split into
two parts.
Part I – This segment of the application identifies the proposed insurer, fundamental
insurability information, the coverage type and amount
Part II – This gives specific insurance related data. For instance, for life
insurance/health insurance, one of the following may be required – medical report,
nonmedical substitute, paramedical report
2.8. Underwriting and Regulatory Compliance
While insurers and underwriters are free to create own guidelines, nevertheless, there are
several countries which do impose some regulations that impact these guidelines. These
laws often pertain to data protection and personal privacy. Often the proposed insured give
sensitive personal and financial information to the insurers. Regulators worldwide have laws
that provide protection to the insured pertaining to information confidentiality. In the US,
the Fair Credit Reporting Act (FRCA) regulates the collection and use of information of
customers and ensures that insurers gather information that is relevant, accurate and
recent. The HIPAA (Health Insurance Portability and Accountability Act) seeks to protect
security and privacy of health insurance information provided by applicants. The Gramm
Leach Bliley Act also has critical provisions to this effect. In addition, there are several state
and local laws in this area.
In addition, underwriters have to ensure that they meet nondiscrimination norms

worldwide. Discrimination is permissible on grounds of risk , unfair discrimination is not
permitted.
Page 13 of 18
Insurers are also subject to money laundering regulations worldwide, to prevent use of
insurance in illegal and terrorism activities.
2.9 Standards for Underwriting
There are certain globally accepted standards that underwriters need to adhere to so that
applications are reviewed and risks assessed fairly. Three standards are common-
Careful handling of insurance application
Prompt action on application
Total and accurate documentation of each underwriting step
This ensures that insurer’s legal rights are safeguarded and duties are fulfilled.
Careful Handling of Application - The underwriter must ensure that the application form is
completely filled in and is accurate and consistent. In case any information is missing or
inconsistent, then the insurer is said to have “waived” the right to get and use information
required for sound underwriting. Waiver means giving up a right voluntarily. A completed
application must not be changed unless the applicant agrees to it in writing. An amendment
is used to this effect.
Prompt Action on Application - This is necessary because of two reasons. If the

underwriter delays an application, then the customer has more time to reconsider decision
and may also go to a competitor. Secondly, laws of some countries hold that if during the
underwriting period, the applicant dies or suffers some problems or the insured object is
damaged in some manner, the insurer is held liable. That means the insurer has to pay the
policy benefits irrespective of assessment of insurability. If there is delay, then it is legally
assumed that the application has been accepted.
Underwriting Documentation -
Documentation is a very important aspect of underwriting
and is useful in case of any legal issues. Every important
action and information about a policy must be recorded in
writing and kept in the policy file. However, only pertinent
information must be put in avoiding any personal opinions
and remarks.
Page 14 of 18
2.10 The Technologies Used
Technology is extensively used in underwriting process to make it more efficient and

effective. The key tools used are business process management, straight through
management, data mining, predictive modeling and business rules engine. In addition,
management information systems are used in reporting, document management systems,
automated workflow systems, etc., are being applied.
Insurance companies are involved in managing their business processes through technology
and this mainly takes the form of straight through processing (STP). In STP, every stage of
the transaction is processed electronically – there is no manual intervention. The aim of STP
is a paperless environment, wherein policies and all records are kept electronically. From
applications to issue of policies, all actions are electronically performed. STP offers several
benefits to insurers mainly –
Greater efficiency and speed in policy issue leading to lesser costs,
Reduced manual work meaning reduced scope for error
Greater consistency and quality of underwriting
Ability to manage more applications and claims
There are some important components of STP as given below:

Data Mining - This involves the study and extraction of relevant data from a
vast amount of data to identify patterns and inter-relationships. For
instance, this technology can be applied to premium payments and claims
experience for all insured to arrive at a relationship specific to a profitable
insured. This knowledge can be used in underwriting.
Predictive Modeling - This involves statistical tools to predict future
behaviours and events. The patterns discovered by data mining form the
base for statistical model. The modeling can state the probability of
mortality and morbidity thus enhancing risk assessment and premium
calculation.
Business Rules Engine - This software tool applies rules (“if – then”) to all
information thus automating decision making process. BRE is particularly
useful in underwriting as it is based on applying specific rules for specific
conditions and their combinations.
Page 15 of 18
Document Management Systems -

These systems store information/documents in a digital format, and organize and help
retrieve them. To store documents, insurers often scan documents into images or directly
use electronic documents. Insurers or underwriters can search, print or share these digital
documents. This helps save a lot of logistics costs. Document management systems also
lend towards automated workflow systems which essentially function as tracking tools. The
system indicates the transaction type, responsible people, associated activities, time taken
for activities, completion date, etc.
Ethics in Underwriting:
Ethics combine the elements of honesty, integrity, and fair treatment. Making ethical
decisions involves behaving in accordance with the legal and moral principles of right and
wrong. Those underwriters that set up and stick to decent business practices have little to
fear from authoritarian investigations. Ethical behavior by the company in underwriting
enhances the superiority of the insurers business, improves the insurer’s status among the
masses, and helps in providing top-quality coverage and services to its customers.
Page 16 of 18
Summary
There are a specialized class of people in insurance who assess the prospective
customer’s risk and exposures. They are known as Underwriters.
In underwriting, the risk exposure is measured and the premium required to be
charged for insuring this risk exposure is determined.
The underwriter may suggest one of the following courses of action:
Decline to accept risk
Price premiums higher to compensate for the adverse risk
Include policy exclusions to limit the circumstances when a claim is paid
“An underwriter is an insurance company employee who evaluates risks, accepts or
declines life insurance applications, and determines the appropriate premium rate to
charge acceptable risks.”
The underwriter’s decision about risk classification and premium charge for
insurance coverage is known as “underwriting decision”.
For the purpose of classifying the risk, insurers rely on information from a range of
sources. The most common of these sources is the application form, which all
applicants complete regardless of the level of insurance. There could be other
sources of information also.
Underwriting aims to cover the maximum number of applicants for insurance while
maintaining the financial solvency of the insurance company.
To achieve this goal, the underwriter has three responsibilities – sound underwriting,
gain from mortality or morbidity and approve only those applicants who have
persistency
Every insurance company has a set of guidelines and objectives that direct the
underwriter’s actions. Underwriting objectives are also called as Underwriting
philosophies
While insurers and underwriters are free to create own guidelines, nevertheless,
there are several countries do impose some regulations that impact these guidelines.
There are certain globally accepted standards that underwriters need to adhere to so
that applications are reviewed and risks assessed fairly. Three standards are
common-
Careful handling of insurance application
Prompt action on application
Total and accurate documentation of each underwriting step
Page 17 of 18
Page 18 of 18
Chapter-1 Insurance Policy and Provisions
Page 1 of 19
TCS.
Notice
Contents
Chapter – 1 Insurance Policy and Provisions ..........................................................................4
1.1 Basics of the Contract Law ........................................................................................... 5
1.2 Insurance Policy – Is it a property? ............................................................................... 7
1.3 Components of an Insurance Policy .............................................................................8
1.4 Policy Provisions ........................................................................................................ 10
1.5 Deductibles ................................................................................................................ 16
1.6. Ten Tips for Insurance Policy Interpretation ............................................................. 17
Summary ........................................................................................................................ 18
Page 3 of 19
Chapter – 1 Insurance Policy and Provisions
Introduction
The entire base of an insurance contract is the policy and the provisions therein. For a
customer, it’s important to know what a policy is and how it is structured. There may be
several provisions of importance, which can completely change the policy from its original
shape. This chapter describes all of these.
Learning Objectives
After reading this chapter you will know:
Basics of insurance policy
Its components
Underlying contracts in a policy
Policy provisions
Page 4 of 19
1.1 Basics of the Contract Law
Insurance Policy is an insurance contract that describes the term, coverage, premiums and
deductibles. Insurance is a contract between the insurer and insured. For every individual
insurance contract, there are two parties – the insurance company and the policy owner. In
a group insurance contract, the policy holder is either a group or person who acquires
coverage for group members.
The contract is legally binding and if any of the two parties does not meet its promises, then
the contract is said to be breached. In such a situation, the innocent party can take legal
action against the other party or can ask for compensation for breach of contract.
There are different types of contracts as described below:
A formal contract is one wherein the parties concerned enter into an agreement in
writing with an enforceable seal. Some contracts are formal in nature.
An informal contract can be in written or oral, but is legally enforceable as the
concerned parties satisfy all requirements relating to the essence of agreement.
Emphasis is on essence and not on form of agreement. Insurance contracts fall under
this category
Bilateral contract is one wherein both the parties make mutual promises which are
legally enforceable. Insurance is not bilateral; it is unilateral as only the insurance
company makes promises to the insured, which must be met as long as premiums
are paid. In contrast, the insured makes no promise to pay premiums and such
payments are not legally enforceable.
Commutative contract, is one wherein the concerned parties agree in advance for
like-for-like exchange i.e., the equal values they would exchange. n this each of the
contracting parties gives and, receives equally.. For example, the contract of sale of
TV is of this kind. The seller gives/sells the TV, and receives the price, which is the
equivalent. The buyer pays the price and receives the thing sold, which is the
equivalent. A majority of contracts follow this type.
There are three underlying contracts in an insurance contract:

Aleatory - In an insurance contract, one party (the insured) offers something which
is of value to the other party (the insurer), in return for a promise to undertake an act
Page 5 of 19
if any specified occurrence happens. Aleatory contracts are those where the
outcomes for the parties to the contract are uncertain.This contract is based on a
random event which is beyond the control of the either of the party. This could be
illness in case of a health insurance contract. If such an event happens, the insured
party will receive an amount which would be perhaps greater than what is paid. Such
a contract is called aleatory contract.
Bargaining – Insurance is also a bargaining contract in which both the parties have
an equal status in setting the terms and conditions.
Adhesion – Insurance can be said to be a contract of adhesion, as the contract has to
be accepted or rejected as a whole. In case there is any vagueness in the contract, it
goes against the insurance company who has prepared the contract.
The legalities involved in any contract are described below:
Valid contract – Legally enforceable as it meets all legal requirements

Void contract – A contract that is void ‘ab initio’ that is illegal from the starting of
the contract or if it does not follow the basic principles from the beginning of the
contract; if it is done by unfair means and is beyond adherence to law.
Voidable contract – A voidable contract is a valid contract. Here one party to the
contract is bound. The unbound party may reject the contract, and at that time the
contract becomes void. For example, a minor has the right to reject contracts. So
any contract with a minor is a voidable contract. If a minor (age under 18 by law)
enters into a contract with an adult, the adult would be bound by the contract,
whereas the minor could choose to avoid performing the contract. This can happen
in four circumstances – mutual agreement, legal purpose, adequate need and
contractual capacity. These are defined in detail:
Mutual assent: The concerned

parties must be in agreement, wherein one
prepares the contract (“offer”) and the
other accepts it (“acceptance”). The parties
must accept to abide the deal and make a
formal expression about it.
Page 6 of 19
Contractual capacity: Both the parties must be in a position to

make the contract legal. While everyone is assumed to have such a capacity,
there are some exceptions, notably minors and those with the appropriate
mental faculty. In case, the latter people sign any agreements then they are void
or voidable.
Consideration: The contract should offer something of value to all

parties in the contract. For instance for life insurance, the applicant gives
consideration in the form of the application and the first premium. Without the
initial premium, no contract is created. In return, the insurer gives consideration
in the form of promise to pay benefits to the insured.
Legal Purpose: The contract must have a

legal purpose, if it’s illegal or harmful, it is deemed void.
Generally gambling contracts are not acceptable.
1.2 Insurance Policy – Is it a property?
Worldwide, insurance policies are treated as property.

Hence, they come under the purview of property law.
Legally, property is defined as the right an individual has
over something tangible and/or intangible including real
and personal property. Real property refers to real estate,
while personal property means all property excluding the
real. In effect, personal property consists of tangible (such
as furniture, cars) assets and intangible assets such as ideas or copyrights.
Based on this classification, an Insurance policy is an intangible personal property, with

policy owners having the right to legal recourse. When policy-holders have ownership over
property, it signifies they have all legal rights pertaining to it, which include the right to use
and enjoy property and the right to sell or dispose the property. Accordingly, the policy
owner may use the policy by naming a nominee or beneficiary. The owner can dispose the
property by gifting it to a third party. For example if a person has a house/plot, he has the
option of selling it, giving it as a gift or he can make someone else nominee/beneficiary of
that property.
Page 7 of 19
1.3 Components of an Insurance Policy
There are some core components to an insurance policy – the table of contents,
declarations, provisions, definitions, exclusions, general provisions, exclusions, and riders.
These are described below:

1. Table of Contents - Policies come with table of contents that help in finding various
policy elements and provisions.
2. Declaration page - This page states policy ownership and is at the very start of the
policy. The page gives name of the policy holder, date of issue of policy, insurance
amount, policy number, and other general information. It may also list policy “riders”
3. Insuring Provisions - These offer a description of what the insured is offered
coverage for. This information maybe in one location or dispersed at various
locations in the policy.
4. Definitions - Certain phrases and terms are commonly used in a policy. This section
defines these either in bold, italics or in quotes.
5. Exclusions - This section lists what the Insurance Policy does NOT cover. These are
very important in identifying the scope of insurance provided.
6. General Provisions - This section is most times located near policy end and includes
general provisions which apply to insurance claims such as legal jurisdictions, policy
cancellations/terminations, and process for claims submission.
7. Endorsements and Riders - Generally there is a standard for most insurance
policies. However, some policies may have additional features, which require
changes to the standard form. These changes are incorporated as riders or
endorsements and attached to the policy at the end.
1.3.1 The Insuring Agreement
This is critical component of a contract and summarizes the key promises and conditions
made by insurer. For instance in the property and liability insurance there are two forms of
an agreement - Named peril policy and all risk coverage. The former covers only specified
perils, while all risk coverage policy covers losses except those specifically excluded. Life
insurance is an illustration of all risks policy as it covers all death reasons excluding suicide,
aviation, war etc.
Page 8 of 19
1.3.2. Conditions
The conditions section is also a key component of an insurance contract. This section lists
provisions which limit or qualify an insurer's promise to the insured. The implication is that
this section outlines insurer duties. However, if the conditions given are not satisfied or
followed correctly by the insured, the insurer will not pay benefits. For example, if a sports
person gets injured while playing and he was not in his proper kits those required for safety
purpose then he may not be given the benefits under Sports accident insurance.
1.3.3 Exclusions
Exclusions are the fundamental part of insurance contract, which show what are not
covered under the policy. For instance in P&C, there are three kinds of exclusions:
Excluded perils [ e.g. peril of war in disability income policy]
Excluded losses [e.g. Professional liability losses are excluded from personal liability
section of home owner’s policy].
Excluded property [ ex. Planes in a home owner’s policy]
Suicide, drug abuse, etc are excluded in life insurance.
The driving forces for such exclusions are:

Some perils simply cannot be insured (such as war)
Some risks are predictable declines [like wear and tear]
Some perils are extraordinary hazards
To prevent coverage duplication (e.g. Car is excluded under home owners policy as
it is covered under auto policy)
To prevent moral hazard
Page 9 of 19
EXCLUSION MENTIONED BY ICICI IN THEIR INSURANCE POLICIES

90 Days Exclusion
Any pre-existing illnesses and procedures within 90 days from start date of policy will
not be covered. This clause does not apply for subsequent renewal (without a break) of
this policy with us.
Permanent Exclusion
The Company shall not be liable under this policy for:

Compensation/claim under more than one of the categories specified in the Policy
Coverage in respect of the same period of disablement of the Insured Person.
Mental Disorder or insanity
Intentional self-injury or suicide or attempted suicide
Use/ Misuse of liquor/drugs
Venereal diseases, AIDS
Pregnancy and childbirth
War, riot, strike, terrorism acts
Nuclear weapons induced acts
Mounting into, dismounting from or traveling in any aircraft other than as a fare paying
passenger or as licensed pilot, on a scheduled commercial flight.
Typically exclusions occur as the coverage is simply not needed!
1.4 Policy Provisions
Policy provisions stipulate the rights and obligations of the insurer and the insured.
Policy provisions represent the main source of rights of the policy owner. While there can be
other generally accepted provisions, all those laws which form the base for the policy are
required to be recorded in the policy provisions.
Page 10 of 19
Policy provisions are hence defined as “written laws that govern the rules and regulations
promulgated by various government administrative agencies in order to implement the
legislative enactments of insurance companies.” LOMA
The policy provisions therefore state the basic procedures of insurance contract. Often
these provisions are kept in the page following the insurance policy’s face page. These are
of prime importance as people study provisions before buying the policy.
It must be noted that not all policies are created equal. Hence, the same provisions may not
work for all people. Irrespective of the provisions made, the insured would want the
coverage to fulfill the requirements when funds are needed.
1.4.1 Naming the Beneficiaries
The policy holder has the right to stipulate beneficiaries or

nominees in the policy. They will get the promised payments.
Beneficiaries need not always be individuals, they may also be
a corporate entity or a business or a non-profit. If a minor is
the beneficiary, then the policy owner must also state the
child’s guardian. The policy owner also has the right to change
beneficiaries at any point of time by signing a new designation
form and sending it to the insurance firm. However, this is not possible if the policy owner
has stated that beneficiary is irrevocable /irreversible, but to some extent change would still
be possible if the insurance company agrees to it.
The policy owner must take care to designate all beneficiaries in writing to prevent any
misunderstanding. Designations also come with Disaster Provisions.
A common one is “Identifiable and unidentifiable beneficiary designations” . There are

bound to be no issues if the beneficiary can be identified clearly. However, if by chance in
case of a life insurance contract, the beneficiary dies before the policy owner, then there
could be a problem. To tackle such a problem, there is a need to have a clear definition of
the "customized beneficiary designation" in the "per stripes clause."
Page 11 of 19
1.4.2 Other Common Provisions
Some of the most common provisions are listed below:
Minimum coverage clause - Irrespective of the policy terms and conditions, the insurer is
obligated to provide a minimum level of coverage as required by law.
Optional modes of settlement - life insurance policy holders can choose from various
options:
Interest option- In this, the insurance company keeps the death benefit as deposit,
with interest payments paid to the beneficiary annually. The beneficiary may also
withdraw some portion or all of this deposit depending on the policy wording.
Fixed amount option – The insurer pays benefits to the insured as fixed payments
on a monthly basis until the principal and interest are exhausted.
Fixed period option – The insured deposits death benefit with the insurer, who pay
the principal and interest as fixed installments for a specified period.
Life income option – Here death benefits and the interest earned are paid via life
annuity.
Misstatement of age - In case the insured has stated a wrong age, then the insurer will
adjust the coverage and premiums to reflect the correct age.
Accidental death clause - This provision pays death benefit even if the death has occurred
due to an accident.
War exclusion clause - This states that no benefits would be paid if the insured dies due to
war or related events. Instead, the insurer will pay premiums and interest on them.
Spendthrift trust clause - This ensures that the beneficiary’s creditors cannot attach
insurance policy proceeds before payment to the beneficiary. However, after payment is
made, the creditors may initiate legal action to attach the proceeds.
Life insurance, creditor rights - The government generally mandates that a widow and
children should not pay creditors with the life insurance proceeds. Hence, life insurance
proceeds may not be attached by the insured’s creditors.
Page 12 of 19
Policy Loan (cash value insurance) - The policy owner can take a loan which cannot be
more than the policy’s cash value at the next “anniversary” date. In case, the loan is not
repaid before the individual’s death, the said amount will be subtracted from the death
benefit repayable to the beneficiaries.
Automatic Premium Loan (cash value insurance) - This clause is not automatically
included in a policy, unless the policy holder asks for it. In case, premium is not paid when
due, then it will be paid from the policy’s loan value.
Renewability Provision (term insurance) -The insurer will automatically renew the policy
when its term ends. There is no need to prove insurability for this.
Convertibility Provision (term insurance) - The insured can convert to a cash value policy
from a term policy. This may entail changes to the premium rate.
Assignment Clause - As mentioned earlier, the insurance policy is transferable. Hence, the
policy holder has the right to assign the policy to another person. This aspect is critical in
several business dealings. For instance, a policy is assigned to the bank for a home loan.
Grace Period - This provides a grace period (often 31 days) after the premium due date
within which the policy holder can pay the premium. The policy continues to be active
during this time and does not lapse.
Reinstatement Clause - The policy holder can reinstate (reactive) a policy which has lapsed
within the period specified in the provisions (generally it is three years after premium
payment default). However, the insured needs to show proof of insurability and pay all the
back premiums for the period.
Incontestability Clause- If an insurance contract has been active for a specified time (often
two years), the insurance company cannot deny claim on account of misstatement,
concealment and any error made by the policy holder. For example, when asked on the
application if there is a history of diabetes in the family, the applicant writes no, knowing
that his or her father and mother both have diabetes. This does not void the policy after two
Page 13 of 19
years even after it is found out. However, if the age of the applicant had been understated-
say, to obtain a lower premium-the company will recalculate the benefit according to the
correct age.
Suicide Clause - Often insurers do not pay death benefits if the insured commits suicide
within a certain time period (generally two years). The company will only pay back the
premiums paid till such a date. Interest may or may not be paid depending on the policy
wordings. However, after a certain period of time, suicide is also treated as a covered risk
and death benefits are paid to beneficiaries.
Delay Clause - The insurance company may not always immediately pay the policy’s cash
value. The delay clause allows the company to delay the payment of policy value by up to
six months. This shields the insurers against insolvency if there are excessive claims due to a
crisis. However, this clause is applied only during extreme circumstances.
Non-forfeiture provisions options - These are applicable when the policy holder ceases
insurance payments relating to a policy.
a) Cash Surrender Value – In case the insured gives up the policy in return for its
cash value, the insurance company is no longer liable for life insurance. No further
benefits are paid.
b) Reduced Paid-Up Life Insurance – The policy owner can use the original policy’s
cash value to buy paid-up insurance at a lesser face value, but the insurance must be
of the same type. An example it allows the policy owner to stop paying premiums
and use the cash value of the policy to purchase a lesser amount of death benefit
coverage.
c) Extended Term Life Insurance – The policy owner has the option to convert the
policy’s cash value into term insurance.
Eligibility - This states the minimum and maximum age limit to obtain insurance coverage.
Where long term cover (LTC) is concerned, a majority of policies have a minimum age
ranging between 50-60 years and the upper age is stated as 69-89 years.
Premiums - These are computed on the basis of the insured’s age while purchasing the
policy. The lower the age, the lower is premium. Premium will also change on the basis of
Page 14 of 19
period of insurance. Hence if the period is longer, premium is lower and vice versa. In
addition, additional risk factors could result in premium variations.
1.4.3 Long Term Care Provisions
Given below are lists of standard provisions for long term care:
Elimination Period - This is a “time deductible", wherein

benefits are paid after a certain elimination period is
completed. The insured needs to be confined in a long term care facility for a specified
number of days, only after which will the promised benefits be paid. Generally, the policy
premium is lower if the elimination period is longer.
Waiver Of Premium - Most LTC policies waive premium if the insured has been confined to
a facility for a given time period (could range from 90-180 days). Premiums start again once
the insured is out of the long term care facility.
Benefit Amount -This is the promised amount to be paid to the insured as per the policy. In
long term care (LTC), this may be paid on a daily basis.
Benefit Periods - The policy specifies the maximum duration of time for which benefits are
paid. This could range from three to five years.
Care Level - This indicates what kind of care the policy will pay for in a facility – specialized
treatment, skilled nursing or custodial care.
Hospice Care - A hospice is a place where terminally ill patients are admitted – there is no
cure and the only aim is to let the patient die in as painless and dignified manner as possible.
Hospice care is often an option in LTC policies, and cover expenses relating to boarding and
pain medication charges.
Respite Care - This is often related to hospice care. The patient may be admitted in a
facility for a short period of time and the policy will meet expenses for the same.
Alternatively, it may also pay expenses to a primary care giver (often a family member) who
is caring for the insured.
Page 15 of 19
Home Health Care - A large number of LTC policies offer coverage for home health care.
For this purpose, care at home needs to begin within a given time period after stay at a
nursing home.
Exclusions - Insurance policies carry a large number of exclusions specifying what are
covered and what are not covered.
Pre-existing Conditions - A number of long term care and health policies do not offer
insurance for conditions that the insured had during a given time period before the effective
policy date.
1.5 Deductibles
Deductibles are the amount of money which the insured party must pay before the
insurance company's plan starts paying the benefits. Generally, insurance companies
include a deductible in their policies to avoid paying out benefits on comparatively small
claims. It can be better understood by an example: An auto insurance policy may carry
Rs.7500 as deductible. Now if the owner of that car unintentionally hits another car while
parking and both drivers agree the damage is minimal, he or she would pay the Rs.7500
repair bill out of his or her own pocket. Insurance companies would not support a claim for
such minor damages. But if the expenses exceed the deductible, then the insurance
company would pay the total charges minus the deductible. Say if the expenses go to
Rs.9000 then the insurance company would pay only Rs.1500 (Rs.9000 - Rs.7500).
A deductible is a provision seen in property, health and auto insurance policies. It is not part
of life insurance contracts as when the insured dies it’s a total loss and deductible can
decrease the face amount. A deductible is a provision whereby some given amount is
reduced from the total loss payment that otherwise would be payable. Deductibles are
mainly used to
Deter small claims as they are costly and hard to manage
Decrease premiums as large deductibles reduce premiums to be paid
Reduce moral and morale hazard, as it discourages fraud and carelessness of
insured
For instance deductibles in property insurance are two types:

straight deductibles applicable to each loss
Page 16 of 19
aggregate deductibles, wherein all covered losses are totaled until a specific level is
attained in a given period
Deductibles in health insurance include:

Calendar year deductible [aggregate]
Corridor deductible [supplements major medical expense plan].
Elimination [waiting] period deductibles
1.6. Ten Tips for Insurance Policy Interpretation
1. The policy wording is to be interpreted ordinarily

and not in a technical manner, unless otherwise
mentioned.
2. The policy must be interpreted in line with the policy
holder’s insurance protection expectations.
3. The policy must be read as a whole, without looking
at only some provisions alone.
4. Coverage provisions must be interpreted broadly;
while limits must be interpreted narrowly.
5. Provisions which limit coverage must be described clearly. If this is not done, then
such provisions are not legally enforceable.
6. A court of law will interpret an ambiguous policy against the insurance company,
thus favoring the insured.
7. Some policies such as homeowners, health and disability need to have certain
mandated provisions by law. So, if the policy does not include these provisions, it will
be treated as it does contain these provisions.
8. The policyholder has the right to depend on the information given by insurance
company agent when buying the policy, irrespective of what is there in the policy.
9. A policyholder has the responsibility of proving that the claim is in the purview of the
coverage provided.
10. The insurance company has to bear the responsibility of showing that claim is
excluded as per a policy provision.
Page 17 of 19
Summary
Insurance Policy is an insurance contract that describes the term, coverage,

premiums and deductibles. Insurance is a contract between the insurer and
insured. For every individual insurance contract, there are two parties – the
insurance company and the policy owner.
The contract is legally binding and if any of the two parties does not meet its
promises, then the contract is said to be breached.
Different contract types are – Formal, informal, bilateral, commutative
Underlying contracts in an insurance contract are Aleatory, bargaining and
adhesion.
Worldwide, insurance policies are treated as property. Hence, they come
under the purview of property law.
An Insurance policy is an intangible personal property, with policy owners
having the right to legal recourse
There are some core components to an insurance policy – the table of
contents, declarations, provisions, definitions, exclusions, general
provisions, exclusions, and riders
Exclusions are the fundamental part of insurance contract, which show what
are not covered under the policy
Policy provisions stipulate the rights and obligations of the insurer and the
insured
Deductibles are the amount of money which the insured party must pay
before the insurance company's plan starts paying the benefits.
Page 18 of 19
Page 19 of 19

Combinepdf PDF

Uploaded by

Document Information

Original Title

Copyright

Available Formats

Share this document

Share or Embed Document

Sharing Options

Did you find this document useful?

Is this content inappropriate?

Copyright:

Available Formats

Combinepdf PDF

Uploaded by

Copyright:

Available Formats

Chapter-12 Fraud Management

Certificate in Insurance Operations

Chapter – 12 Fraud Management

12.1 What is Fraud?

Fraud can be defined as an act or omission intended to gain dishonest or unlawful

Insurers rely greatly on the accuracy and completeness of information provided by

The broad categories of fraud would include:

• intermediary fraud - fraud by intermediaries1 against the insurer and/or

12.2 Costs of Fraud

You could also…

(Source: Coalition against Fraud)

12.3 Risk Management Framework

An insurer should consider establishing a fraud management functions if warranted by its

12.3.3 Policies and Procedures

The insurer’s anti-fraud policies should be communicated throughout the organization. An

12.3.4 Risk Identification, Control and Monitoring

Risk Identification and Measurement

• Policyholder and Claims Fraud

Risk Control and Mitigation

These measures should be designed in order to detect incorrect and/or incomplete

• checks against internal database or other sources for confirmed or potential

12.3.5 Risk Monitoring and Review

An insurer should adopt adequate measures to ensure that the intermediaries it

Certificate in Insurance Operations

Chapter - 11 Distribution Management

Figure 1: The Insurance Back Office

11.2 Insurance Distribution Models

Figure 2: Insurance Channels

11.3 Channel Characteristics:

Readily available customer base:

In insurance parlance, an Agent is the representative of insurance company. The key

11.4.1 The Professional Agent

11.4.2 Group Representative

11.4.3 Corporate Agent

A corporate agent is a company or co-operative society acting as an insurance agent. As per

In these organizations, someone is vested with responsibility to act as agent in solicitation

India has about 397 brokers

Figure 3: Insurance Brokerage Firm

11.6 Agents Vs Brokers

11.8 Third Party Administrators

Third party administrators were introduced through notification of TPA-Health Services

11.10 Personal Selling Distribution Systems

2. Non-agency-building distribution system is the other type where the insurer

An agency relationship is considered as a legal relationship where one party generally

The contracts have the following specialties:

The contract is defined as an agreement between an insurer/ insurance company

11.11 The Sales Procedure

11.12 Agency-Building Distribution Systems

Figure 4: Agency Building Distribution Systems

11.12.1 General/Ordinary Agency System

11.12.2 Multiple-Line Agency (MLA) System

Basic concepts in this MLA system:

11.12.3 Salaried Sales Distribution System

11.12.4 Location-Selling Distribution System

Contrast with non-agency building distribution system. Agency-building distribution

11.12.5 Career Agency System

The career agency distribution systems generally rely on company-associated insurance

11.12.6 Branch/Agency Office System

11.12.7 Home Service Distribution System

11.12.8 Worksite Marketing Distribution System

11.13 Non-agency-Building Distribution Systems

Non-agency-building distribution system is a totally different kind of agency system and

11.13.1 The Brokerage Distribution System