INTRODUCTION 1.

1 Introduction Insurance, in law and economics, is a form of risk management primarily used to hedge against the risk of a contingent loss. More importantly, insurance company portfolio managers work under a different, and possibly more restrictive, set of regulatory constraints than other institutional investors (Badrinath, Kale, Ryan, & Jr, 1996). Insurance is defined as the equitable transfer of the risk of a loss, from one entity to another, in exchange for a premium, and can be thought of as a guaranteed small loss to prevent a large, possibly shocking loss. Insurance executives would like to allocate equity in such a way that risk-adjusted return on equity is maximized (Holmer & Zenios, 1995). An insurer is a company selling the insurance; an insured or policyholder is the person or entity buying the insurance. (Caillaud, Dionne & Jullien, 2000) found that, the insurance rate is a factor used to determine the amount to be charged for a certain amount of insurance coverage, called the premium. Integrated product management teams need new technical tools to determine the effects of alternative design, investment, and pricing strategies on the risk- adjusted return on the equity invested in each financial product (Holmer & Zenios et al, 1995). Insurance companies provide its customers with the assurance in return of their investment. This assurance is generally divided into two main categories i.e. life insurance and general insurance. (Carino et al, 1994). Life insurance is defined as a contract between the policy owner and the insurer, where the insurer agrees to pay a sum of money upon the occurrence of the insured individual's death or other event, such as terminal illness or critical illness. An empirical study by Hammond, Houston, and Melander (1967) and a theoretical article by Campbell (1980) both found that one of the main purposes of life insurance is to protect dependents against financial

Insurance is about managing risk: sharing risk exposure across a wide number of people or organisations. Insurance is therefore at root a community activity: each setting aside money on a regular basis to form a common fund which is used to assist members in times of crisis due to an insured event. Insurance is fundamental to daily life in developed nations, enabling individuals and businesses to manage their existence with a measure of security. The insurance industry is often seen in the mediain a negative way: "they keep premiums as high as possible and pay out as little as possible". However the truth is that insurance companies by definition exist to pay out, to provide help. That is the reason insurance is sold. Of course, the lower the threshold for paying out, the higher premiums have to be, but the problem is that many people think insurance companies treat them with suspicion when they need to make a claim. Insurance companies rely on accurate assessment of risk: set the calculations too low and they will attract a huge amount of business, and end up making huge losses. Set premiums too high, and they cannot sell. Underwriting therefore is the core skill of all insurers: highly complex estimates of likelihood of a claim from each policy, with every factor taken into consideration, and also estimates of likely size of the average claim. The challenge for insurance companies is that the world is changing and historic data is often an unreliable guide to future risks and future claim patterns. Therefore all insurance companies have to be future-thinking, constantly monitoring global and local trends including customer attitudes and behaviour, adjusting insurance premiumsfrequently to keep pace. Their view of the world is often much broader than other kinds of financial services companies. Even a 1% drift in calculations can have a dramatic effect on the success of an insurance company, especially in a relatively low margin and highly competitive business such as motor insurance. Insurance companies often carry more exposure torisks than prudent given the limitations of their own balance sheets - choosing to offset their exposure by re-insurance with other larger companies. So the international insurance industry is bound together by a complex web of underwriting commitments, designed to spread risk, and ensure that each insurance company remains solvent, even if they have an unexpected cluster of major claims. However reinsurance itself creates risks, if the reinsuring company only has partial insight into the total risks they are being asked to carry. This has some similarities to the challenges we saw in the sub-prime crisis where large corporations became tied into all kinds of financial commitments, which depended on valuations being correct of the assets on which those loans were issued, as well as estimates of the creditworthiness of the people or institutions to which the loans were issued.