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Insurance. Insurance and Business. The term risk broadly refers to situations where outcomes are uncertain. Risk often refers specifically to variability in outcomes around the expected value.
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Insurance and Business. • The term risk broadly refers to situations where outcomes are uncertain. Risk often refers specifically to variability in outcomes around the expected value. • Major types of business risk that produce fluctuations in business value include price risk, credit risk, and pure risk. • Pure risk is loss form damage to and theft or expropriation of business assets, legal liability for injuries to customers and others, work place injuries to employees and obligations under employee benefit plans. • Major risk management methods include loss control, loss financing and internal risk reduction. • Pooling arrangements reduce risks for each participant, provided losses are not perfectly positively correlated. • The amount or risk that can be reduced through pooling arrangements increases as the number of participants increases, all other factors being held constant • Loss financing methods include retention (self insurance) ,insurance, hedging and other contractual risk transfers.
Definition Individuals face the following risks: • Risk of an early death • Risk of out-living ones income • Risk of illness and health problems to oneself & the family • Risk of accident causing loss of life or impairment • Risk of loss and damage of property • Risk from professional liability • Insurance is a contract by which the one party, in consideration of a price paid to him adequate to the risk, becomes security to the other that he shall not suffer loss, damage or prejudice by the happening of the perils specified to certain things which may be exposed to them”- Laurenace, J • “Insurance is a method of spreading over large number of persons, a possible financial loss too serious to be conveniently born by an individual.” – Maclean J B
Nature of Insurance • Following are the general characteristics of insurance: • insurance aids business • Co operative device under which large number of persons agree to share the financial loss due to a particular risk. • Payment is made at certain contingency – except for life insurance. • Insurance is not gambling • Insurance is not charity. It is against premium paid. • It is a service. • It is a species of general contract. All requisites of a valid contract are required.
Functions of Insurance Primary functions: • Provide protection against future risk – economic loss • Collective bearing of risk. • Assessment of risk • Provide Certainty- Secondary functions: • Prevention of Losses - safety instructions • Small capital to cover larger risks • Contributes towards the development of larger industries Other functions: • Means of savings and investment • Source of earning foreign exchange • Risk Free trade
Business of Insurance • Writings of Manu, Yagnavalkya and Kautiilya refer to pooling of resources that could be re- distributed in times of calamities such as fire, floods, epidemics and famine. • The first Insurance Company was started in India in 1818. • LIC of India formed in 1956 – 245 private Cosnationalised. • In 1972, four General Insurance Cos were formed by nationalising 107 General Insurance companies -(1) National insurance Co Lltd (2) New India Assurance Co Ltd (3) Oriental Insurance Co Ltd and (4) United India insurance Co Ltd. • Following Malhotra Committee Report ,IRDA was constituted in 2000. • This opened up insurance sector for Private players. • 16 new entrants during 2000-2001 and number increasing each year. • Banks entering the market - joint ventures with foreign finance majors • During 2008-2009 , 3 new entrants in Life Insurance (including Canara HSBC OBC Life Insurance Company Ltd.) and one in General Insurance. • Latest - ‘India First Life Insurance Co Ltd’, registered on 15.11.2009 • 21 Life and 19 Non life Insurance Companies are registered with IRDA, apart form ECGC and Agricultural Insurance Company of India Ltd.
Current Position and Prospects • As per the provisional figures provided by the Life Insurance Council, the life insurance penetration in year 2008-09 was 4.30 percent. • Gross direct premium during 2008-09 was Rs.87054.03 Crores. • As per press reports, first half of the current year shows a jump of 10.8 per cent in gross first year premium. • According to the Investment Commission of India, the Indian insurance market is expected to be around US$ 52 billion by 2010. The CAGR is expected to be over 30 per cent per annum. • The total investment opportunity is estimated to be US$ 14 - 15 billion. • In October, the cabinet approved the proposal for raising the foreign investment limit to 49% from the present 26%. • Largely untapped market with 17% of the world’s population • Nearly 80% of the population is without insurance • Strong economic growth with increase in affluence and rising risk awareness leading to rapid growth in the insurance sector • Innovative products such as ULIPs are likely to drive industry growth • Investment opportunities exist in both life and non-life segments.
Applicable Laws • Life Insurers transact life insurance business; General Insurers transact the rest. No composites are permitted as per law. • The following legislations deals with insuracne: • The Insurance Act, 1938 • The Life Insurance Corporation Act, 1956 • The Marine Insurance Act, 1963 • The General Insurance Business (Nationalisation) Act, 1972 • Insurance Regulatory & Development Authority Act, 1999. • Insurance Industry has Ombudsmen in 12 cities. Each Ombudsman is empowered to redress customer grievances in respect of insurance contracts on personal lines where the insured amount is less than Rs. 20 lakhs, in accordance with the Ombudsman Scheme.
Principles of Insurance • Utmost Good Faith • Insurable Interest • Indemnity • Double Insurance • Reinsurance • Subrogation • Attachment of risk. • Contribution • Proximate Cause
Uberrimaefidei • A contract of insurance is of utmost good faith. It is the duty of the proposer to disclose all material facts. • Material Fact: affect the judgment or decision of both parties to the contract – whether to offer/ accept and on what terms. • Full and True disclosure: Disclosed in that form in which they really exist. No concealment, misrepresentation, mistake or fraud . Duty extends to material facts which the insured ought to know. • Duty on both parties: rule holds good for both. • Facts need not be disclosed: • which diminishes the risk • comes to the knowledge of the insured after the contract • known to the insured or which cab be inferred from the facts. • Waived by the policy.
Insurable Interest • The legal right enjoyed by the owner of a property to insure is called ‘Insurable Interest’. • The insured derives pecuniary benefit from the existence of the property and will suffer loss from its destruction. • The insurance will become null and void, without the insurable interest. An insurable interest must be: • Definite. • Capable of valuation. • Valid and subsisting. • Should involve legal liability. • Time of insurable interest • Insurable interest arises by • ownership • Law • Contract • Legal liability • Interest of a Person in Life
Insurable Interest in .. • Life Insurancee • Own life • Close ties of blood or marriage • When pecuniary interest is involved • creditor in the life of debtor, partnership firm - partners, an insurer- assured, an employee - employer, an employer - key employee. • Property Insurance • Part or Joint Ventures • Mortgagees and Mortgagors • Executors and Trustees • Bailees, Agents • Husband and Wife • Liability Insurance • to the extent of any potential liability may be incurred by way of damages or other costs. • Insurable Interest of Insurer - reinsurance
Indemnity • A contract of indemnity is one in which the promiser promises to make good the loss that occurs to the promisee on the happening of an event. • Indemnity Contract – Fire or Marine Insurance • Non-indemnity Contract – Life Insurance • The principle of Indemnity states that under the policy of insurance, the insured has to be placed after the loss in the same financial position in which he was immediately before the loss. • Applicability: • When the losses suffered by the insured can be measured in terms of money • It is practicable to place the insured in the same financial position which he occupied before the loss • In Marine Cargo where valued polices are issued, there is only commercial indemnity- the value declared for insurance is accepted at the time of loss. • If the sum insured is less than the indemnity, only the sum insured is payable. • Property insurances- Condition of average- If there is under insurance only proportionate value is payable. • Exceptions for Indemnity: Life, Personal Accident
Return of Premium • Premium once paid cannot be refunded, except: • Non attachment of risk - when risk is not run. • Agreement in policy • Undeclared balance in the open policy
Proximate Cause • The active efficient cause that sets in motion a train of events which brings about a result without intervention of any force started and working actively from a new independent source. • Insurer is liable to indemnify only against the insured peril • Proximate cause literally means the nearest cause or the direct cause. • The insurer is only liable for loss, if the risk insured against is the proximate to the last cause of loss • The insurer is responsible only if the nearest cause comes within the meaning of the risk insured. • A man fell from a horse and sustained injuries that prevented him from moving. As a result he contracted pneumonia due to lying in the wet and died. The proximate cause of his death was the fall and not pneumonia.
Proximate Cause - Liability of insurer • There are three types of perils related to a claim under an Insurance policy • Insured Perils • Excepted Perils • Uninsured Perils • Insurers are liable to pay claims arising out of losses caused by Insured Perils only. • Losses can occur in the following manners • Loss due to a single cause. • A series or chain of events one following and resulting from the other causing the loss – Event starting the chain should be insured peril. • A series or chain of events, which is broken by a new event independently from a different source causing the loss – Broken sequence. The event interrupting and causing the loss should be insured peril. • Two or more events occurring simultaneously and resulting in loss – All events should be insured perils.
Subrogation • Subrogation means the restitution of the rights of an assured in favour of the insurer against the third party for any damages caused by him in place of the assured after the insurer has indemnified him for the loss. • The doctrine of subrogation is a corollary to the principle of indemnity and applies only to fire and marine insurances. • all rights and remedies which the insured has against third person will pass on to the insurer • when an insurer has paid the loss as per contract of insurance. • The right cannot be exercised for his benefit until the insurer recoups the amount he has paid under the policy. • This right extends only to the rights and remedies available to the insured in respect of the thing to which the contract of insurance relates.
Contribution • The right of insurers who have paid a loss under a policy to recover a proportionate amount from other insurers, who are liable for the same loss. • Where there are two or more insurances on same risks, the loss will be shared proportionately among the insurers according to the ratable proportion of the loss. 1) the insured asset must be common to all the policies 2) the risk insured against must be common to all the policies 3) the insured owner of the asset must be the same person 4) All policies must be in force during the occurrence of loss.
IRDA • “Insurance Regulatory and Development Authority Act” constituted by an act of parliament • The Authority is a ten member team consisting of (a) a Chairman; (b) five whole-time members; (c) four part-time members, • All the members are appointed by the Central Government from persons of ability, integrity and standing who have knowledge or experience in Life Insurance, General Insurance, Actuarial Science, Finance, Economic, Law, Accountancy, Administration or any other discipline which the Govt. feels may be useful to the Authority • The Authority shall have the duty to regulate, promote and ensure orderly growth of the insurance business and re-insurance business.
Powers and Functions include.. • Registration of Insurers, Intermediaries and Agents • Regulating returns and conditions of contract of Insurance. • Promoting and regulating professional organisations connected with Insurance and Reinsurance business • Monitoring investment of funds and solvency margin of Insurance Company. • Regulation for advertisements whether issued by insurance company or an insurance intermediary including an agent. • Authority to be advised by Insurance Advisory Committee (IAC), which shall consist of not more than 25 members
Insurance Co. - Certain regulations • Paid-up capital of company - not less than 100 crores for life or general Insurance and 200 crores in the case of reinsurance business. • Company to appoint an actuary to be approved by the IRDA whose duty will be to • Valuate assets in appropriate manner • Valuate liability as required • Ensure maintenance of prescribed solvency margin. • Assets of insurer should be invested as … • 25% in Government securities(including deposit in RBI), • At least 25% in Government/other approved securities; • Up to 15% of the controlled fund of the insurers can be invested in other insurance; • Up to 25% of the assets of GIC can be invested in other investment; • No fund of policy holder can be invested outside India.
Rural or Social Sector For all new life insurer:-( percentage of total insurance) • First year-7% • Second year-9% • Third year-12% • Fourth year-14% • Fifth year-16% • Sixth year-18% • For Genral Insurance • First year- 2% • Second year- 3% • Third year- 5% • Fourth year- 5% so on… All insurers are obliged to issue 5,7,10,15,20,and 25 thousand lives in first six years respectively.
Life Insurance • 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. • Popular Products: Endowment Assurance (Participating), and Money Back (Participating). More than 80% of the life insurance business is from these products. • New products have been launched by life insurers. These include linked-products
Assignment and Nomination • Nomination – claim amount is paid to the nominee in case of death of the assured. • can be made by insured – own life policies only. • At the time of proposal • later only by endorsement in the policy with notice to insurer. • Can be changed. • Assignment transfers the right on the policy to the assignee. • Made by an endorsement on the policy • Can also be by a separate deed. If deed, stamp duty is payable. • Notice of Assignment to the insurer • In absolute assignment, all rights are transferred to the assignee. • In conditional assignment, right till death of the assignee. • Cannot be revoked by the assignor • Only life policies can be assigned. • Reassignment by the assignee similar manner. • Assignment cancels nomination.
Term Insurance • Provides death cover only. • Benefit comes to the nominee only in case of death of the holder • The premiums are very low • This is an ‘expense’ similar to ‘motor insurance’ Options Available • Term Insurance policy convertible to whole life or endowment plan • Term Insurance with increasing sum assured • Term Insurance with decreasing sum assured – for mortgage loans protection
Whole Life Insurance • Covers the risk of death of insured, whenever it may happen, i.e. for the whole life • “The Term Insurance for the longest term” • Premium rates low but higher than Term Insurance Options available • Pure Whole Life Insurance – premiums payable continuously throughout the life • Limited Payment Whole Life Insurance – premiums payable for a limited and shorter period
Endowment Assurance • Provides ‘death cover’ to the insured during the policy period; and survival benefits at the end of the policy period • Premium rates are high • Options Available • Money Back Plan • Endowment Plan for marriage/education • Endowment Plan with/without profit • Endowment Plan with double/triple risk cover • Unit Linked Endowment Plan
Unit Linked Insurance Plan • The savings (investment) component of the policy premium is invested into the financial market instruments to avail a greater rate of return than from traditional insurance policies. • Return on investment linked to the financial market Options Available • Investments can be made into equity (asset appreciation), debt (regular income), or money market instruments, etc.
Pension Plan • Provides for a lump sum amount and annuity benefit payments at the stipulated retirement age. • An effective way of contributing to ones own retirement benefits • Helps in achieving financial independence for ones “Golden Years” • An built-in life insurance cover, as an option • Unit liked pension plans also available
Special insurance Plans • Children Policies: To provide for expenses (lumpsum/recurring) related to education , etc. of children or for the benefit of disabled children, in the event of death of the parent. • Joint Life Policies: Provides risk cover on ‘either or survivor basis’. During policy period, on death of one life, sum assured paid to the second life, and subsequent premiums waived, but the risk cover on second life continues.
Calculation of Human Life Value • A person aged 30 has Annual salary 2lacs • His personal expenses annually is 1lac • He give for the family 1lac • His earning span is 30 years, so the family requires 30lacs(this is over a period of 30years) • Human Life value= 100000*1-(1/(1+i)^30)/i • I=present bank rate of interest so at 8% it will be 1lac*11.2578=1125780
Premium • the monetary value of the risk contingent upon the duration of human life and accepted by the insurer • Premium is a ‘consideration’ paid by the policyholder, to the insurance co for ‘Insurance Contract’ in order to get benefits offered by an Insurance policy. • A default in premium payment will result into discontinuance of contract. The Policy will be treated as lapsed and expected benefits will not be available
Factors for determining premium • Mortality • a measure of the number of deaths in some population, scaled to the size of that population, per unit time. Mortality rate is typically expressed in units of deaths per 1000 individuals per year. Thus, a mortality rate of 9.5 in a population of 100,000 means 950 deaths per year in that entire population. • Expenses • Some margin are added to cover the company’s future expense levels to be experienced in administering the policy. • Investments • Premiums received are invested from which bonuses are given • Contingency • A major catastrophe like an earthquake , riots, or epidemic can raise the number of deaths to higher levels than indicated by the mortality tables. Insurers therefore as a matter of safety provide for such contingencies and fluctuations by loading the premium suitably
Calculation of Premium Two methods 1. Value of Service: • premium determined according to the utility of insurance to each proponent. This is impracticable. 2. Cost of Service • includes all expenses of the business plus small profit margin. At least premium should cover cost of claim. • Net premium: • The premium charged to meet the amount of claim • Cost of administration • Fixed cost- spread over the policy life • recurring cost. • Method of distribution of expenses is called loading. • Interest Factor: • Benefit of interest on premium collected to be given to policy holders.
Cost of Claims Mortality: • Forecasting of death of single individual is not possible, but expectation of number of deaths from a group of persons of same age can be forecasted on the basis of Theory of probability and Law of large numbers • Mortality is a measure of the number of deaths in some population, scaled to the size of that population, per unit time. Mortality rate is typically expressed in units of deaths per 1000 individuals per year. Thus, a mortality rate of 9.5 in a population of 100,000 means 950 deaths per year in that entire population. Expenses- Contingency • A major catastrophe like an earthquake , riots, or epidemic can increase the risk of the insurer. Insurers therefore as a matter of safety provide for such contingencies and fluctuations .
Certain concepts Days Of Grace: • The premium paid after due date but within certain period fixed. 30 days for yearly, half yearly and quarterly mode & 15 days for monthly mode. Lapse: • If the premium is not paid within the grace period, it calls for termination of policy contract. Non-Forfeiture: • If premium is paid for minimum 3 years, policy can not be forfeited. Paid-Up-Value: • When premiums are paid for minimum three years but not for entire term of the policy, the S.A. is reduced by calculating paid up value and policy continues for certain duration with out paying further premium.
Certain concepts • Surrender Value : • amount refunded on total discharge of the contract, in case the assured wishes to surrender this policy. • Surrender Value = (Paid up Value + vested bonus)*S V factor % • Sub standard risks : • Increasing extra risk, decreasing extra risk, constant extra risks • Increase in premium, decrease in death benefits, change in class and period of insurance, postponement of risk are the methods used • Rider premium: • For extra benefits, like double accident benefit etc. extra premium charged.
Reserves • Reserves in Life Insurance is not on an accumulation of profit. • Reserve is that fund, which together with future premiums and interest will be sufficient to pay the future claims. • It is also considered as accumulation of the difference between the net premiums revived in the past and the claims paid out. • ‘Life insurance fund’ is the surplus of revenue over expenditure. • ‘Net liability’ is excess of present value of future claims over the present value of the future premiums. – Valuation is required. • Life Insurance fund should be sufficient to cover net liability. • Deficiency call for drastic actions by the Management. • Surplus is to provide for General contingency fund, divided equalisation fund, bonus equalisation fund and taxation fund. • Balance available is profits – can be divided among the share holders and policy holders.
Bonus • Uniform bonus plan: Uniform bonus rate is given to all policy holders of particular type. The bonus rate is based on the policy amount. • Contribution Method: Divisible surplus allotted to the polices in proportion to the individual contribution of each policy to the surplus. Bonus options: • Cash bonus: • immediate payment with option for conversion. • Reversionary Bonus: • uniform percentage addition to sum assured or to the sum assured plus accumulated bonus . Former is called simple and later compound . Simple reversionary bonus is paid in India. • Reduction in premium : • permanent reduction in future premiums . • Accumulation at interest Bonus: • Insurer pays interest on bonus. • Endowment option: • Bonus is accumulated with interest . When accumulated value of the policy becomes equal to the policy amount, the policy amount is paid in full before maturity.
Policy conditions Revival: • Bringing lapse policy in to force is called revival. This is subject to underwriting. Surrenders: • It is a voluntary termination of the contract by policy holder before it becomes a claim. This is allowed after minimum three years and value paid is called surrender or cash value. Loans: • Policy holder can receive money from policy by assigning policy to insurer. The interest is payable to insurer. Foreclosure: • The closure of policy before its maturity due to unpaid interest of loan is called foreclosure.
Claims • Maturity Claim: Maturity claim is paid when the term of the policy is over. • Survival Benefit Payments: This is paid during the currency of the policy and before the date of maturity. e.g. money back benefit. • Death Claim: This claim is received by insurer on death of insured during the policy term. • Claim Concession: Policy is lapsed, yet the insurer pays the death claim. • After three policy years, within six months from the date of lapse. • After five or more policy years, within twelve months from the date of lapse.
IRDA on claims • The insurer should ask for all requirements in the case of a claim at one time and not piecemeal • The decision to admit or to repudiate should be made 30 days of receipt of papers • If an investigation is necessary ,it should be completed within 6 months • Interest at 2% over the bank rate will be payable for the delays in settling the death claims • Interest at the savings Bank rate will be paid if the insurer is ready to pay but the claimants are not ready to collect
