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CHAPTER 1

Introduction of insurance

Insurance is the equitable transfer of the risk of a loss, from one


entity to another in exchange for payment. It is a form ofrisk
management primarily used to hedge against the risk of a
contingent, uncertain loss. An insurer, or insurance carrier, is a
company selling the insurance; the insured, or policyholder, is the
person or entity buying the insurance policy. The amount
of money to be charged for a certain amount of insurance
coverage is called the premium. Risk management, the practice
of appraising and controlling risk, has evolved as a discrete field
of study and practice.

The transaction involves the insured assuming a guaranteed and


known relatively small loss in the form of payment to the insurer in
exchange for the insurer's promise to compensate (indemnify) the
insured in the case of a financial (personal) loss. The insured
receives a contract, called the insurance policy, which details the
conditions and circumstances under which the insured will be
financially compensated.

History

Early methods
Methods for transferring or distributing risk were practiced
by Chinese and Babylonian traders as long ago as
the 3rd and 2ndmillennia BC, respectively. Chinese merchants
travelling treacherous river rapids would redistribute their wares
across many vessels to limit the loss due to any single vessel's
capsizing. The Babylonians developed a system which was
recorded in the famous Code of Hammurabi, c. 1750 BC, and
practiced by early Mediterranean sailing merchants. If a merchant
received a loan to fund his shipment, he would pay the lender an
additional sum in exchange for the lender's guarantee to cancel
the loan should the shipment be stolen or lost at sea.
At some point in the 1st millennium BC, the inhabitants
of Rhodes created the 'general average'. This allowed groups of
merchants to pay to insure their goods being shipped together.
The collected premiums would be used to reimburse any
merchant whose goods were jettisoned during transport, whether
to storm or sinkage.[2]
Separate insurance contracts (i.e., insurance policies not bundled
with loans or other kinds of contracts) were invented in Genoain
the 14th century, as were insurance pools backed by pledges of
landed estates. The first known insurance contract dates
from Genoa in 1347, and in the next century maritime insurance
developed widely and premiums were intuitively varied with risks.
[3]
These new insurance contracts allowed insurance to be

separated from investment, a separation of roles that first proved


useful in marine insurance.

Modern insurance
Insurance became far more sophisticated in Enlightenment
era Europe, and specialized varieties developed.
Property insurance as we know it today can be traced to
the Great Fire of London, which in 1666 devoured more than
13,000 houses. The devastating effects of the fire converted the
development of insurance "from a matter of convenience into one
of urgency, a change of opinion reflected in Sir Christopher
Wren's inclusion of a site for 'the Insurance Office' in his new plan
for London in 1667".[4]A number of attempted fire insurance
schemes came to nothing, but in 1681, economist Nicholas
Barbon and eleven associates established the first fire insurance
company, the "Insurance Office for Houses", at the back of the
Royal Exchange to insure brick and frame homes. Initially, 5,000
homes were insured by his Insurance Office.[5]
At the same time, the first insurance schemes for
the underwriting of business ventures became available. By the
end of the seventeenth century, London's growing importance as
a centre for trade was increasing demand for marine insurance. In
the late 1680s, Edward Lloyd opened a coffee house, which
became the meeting place for parties in the shipping industry
wishing to insure cargoes and ships, and those willing to
underwrite such ventures. These informal beginnings led to the
establishment of the insurance market Lloyd's of London and
several related shipping and insurance businesses.[6]
The first life insurance policies were taken out in the early 18th
century. The first company to offer life insurance was

the Amicable Society for a Perpetual Assurance Office, founded in


London in 1706 by William Talbot and Sir Thomas Allen.[7]
[8]
Edward Rowe Mores established the Society for Equitable
Assurances on Lives and Survivorship in 1762.
It was the world's first mutual insurer and it pioneered age based
premiums based on mortality rate laying "the framework for
scientific insurance practice and development" and "the basis of
modern life assurance upon which all life assurance schemes
were subsequently based".[9]
In the late 19th century, "accident insurance" began to become
available. This operated much like
modern disabilityinsurance. The first company to offer accident
insurance was the Railway Passengers Assurance Company,
formed in 1848 in England to insure against the rising number of
fatalities on the nascent railway system.
By the late 19th century, governments began to initiate national
insurance programs against sickness and old age. Germany built
on a tradition of welfare programs in Prussia and Saxony that
began as early as in the 1840s. In the 1880s Chancellor Otto von
Bismarck introduced old age pensions, accident insurance and
medical care that formed the basis for Germany's welfare state. In
Britain more extensive legislation was introduced by
the Liberal government in the 1911 National Insurance Act. This
gave the British working classes the first contributory system of
insurance against illness and unemployment. This system was
greatly expanded after the Second World War under the influence
of the Beveridge Report, to form the first modern welfare state.

Insurance companies
Insurance companies may be classified into two groups:

Life insurance companies, which sell life insurance, annuities


and pensions products.

Non-life or property/casualty insurance companies, which


sell other types of insurance.

General insurance companies can be further divided into these


sub categories.

Standard lines

Excess lines

In most countries, life and non-life insurers are subject to different


regulatory regimes and different tax and accounting rules. The
main reason for the distinction between the two types of company
is that life, annuity, and pension business is very long-term in
nature coverage for life assurance or a pension can cover risks
over many decades. By contrast, non-life insurance cover usually
covers a shorter period, such as one year.
In the United States, standard line insurance companies are
insurers that have received a license or authorization from a state
for the purpose of writing specific kinds of insurance in that state,
such as automobile insurance or homeowners' insurance.[34] They

are typically referred to as "admitted" insurers. Generally, such an


insurance company must submit its rates and policy forms to the
state's insurance regulator to receive his or her prior approval,
although whether an insurance company must receive prior
approval depends upon the kind of insurance being written.
Standard line insurance companies usually charge lower
premiums than excess line insurers and may sell directly to
individual insureds. They are regulated by state laws, which
include restrictions on rates and forms, and which aim to protect
consumers and the public from unfair or abusive practices. These
insurers also are required to contribute to state guarantee funds,
which are used to pay for losses if an insurer becomes insolvent.
Excess line insurance companies (also known as Excess and
Surplus) typically insure risks not covered by the standard lines
insurance market, due to a variety of reasons (e.g., new entity or
an entity that does not have an adequate loss history, an entity
with unique risk characteristics, or an entity that has a loss history
that does not fit the underwriting requirements of the standard
lines insurance market). They are typically referred to as nonadmitted or unlicensed insurers. Non-admitted insurers are
generally not licensed or authorized in the states in which they
write business, although they must be licensed or authorized in
the state in which they are domiciled. These companies have
more flexibility and can react faster than standard line insurance
companies because they are not required to file rates and
forms. However, they still have substantial regulatory
requirements placed upon them.
Most states require that excess line insurers submit financial
information, articles of incorporation, a list of officers, and other
general information. They also may not write insurance that is
typically available in the admitted market, do not participate in
state guarantee funds (and therefore policyholders do not have
any recourse through these funds if an insurer becomes insolvent
and cannot pay claims), may pay higher taxes, only may write

coverage for a risk if it has been rejected by three different


admitted insurers, and only when the insurance producer placing
the business has a surplus lines license. Generally, when an
excess line insurer writes a policy, it must, pursuant to state laws,
provide disclosure to the policyholder that the policyholder's policy
is being written by an excess line insurer.
On July 21, 2010, President Barack Obama signed into law
the Nonadmitted and Reinsurance Reform Act of 2010 ("NRRA"),
which took effect on July 21, 2011, and was part of the DoddFrank Wall Street Reform and Consumer Protection Act. The
NRRA changed the regulatory paradigm for excess line
insurance. Generally, under the NRRA, only the insured's home
state may regulate and tax the excess line transaction.
Insurance companies are generally classified as either mutual or
proprietary companies. Mutual companies are owned by the
policyholders, while shareholders (who may or may not own
policies) own proprietary insurance companies.
Demutualization of mutual insurers to form stock companies, as
well as the formation of a hybrid known as a mutual holding
company, became common in some countries, such as the United
States, in the late 20th century. However, not all states permit
mutual holding companies.
Other possible forms for an insurance company
include reciprocals, in which policyholders reciprocate in sharing
risks, and Lloyd's organizations.
Insurance companies are rated by various agencies such as A. M.
Best. The ratings include the company's financial strength, which
measures its ability to pay claims. It also rates financial
instruments issued by the insurance company, such as bonds,
notes, and securitization products.
Reinsurance companies are insurance companies that sell
policies to other insurance companies, allowing them to reduce
their risks and protect themselves from very large losses. The

reinsurance market is dominated by a few very large companies,


with huge reserves. A reinsurer may also be a direct writer of
insurance risks as well.
Captive insurance companies may be defined as limited-purpose
insurance companies established with the specific objective of
financing risks emanating from their parent group or groups. This
definition can sometimes be extended to include some of the risks
of the parent company's customers. In short, it is an in-house selfinsurance vehicle. Captives may take the form of a "pure" entity
(which is a 100% subsidiary of the self-insured parent company);
of a "mutual" captive (which insures the collective risks of
members of an industry); and of an "association" captive (which
self-insures individual risks of the members of a professional,
commercial or industrial association). Captives represent
commercial, economic and tax advantages to their sponsors
because of the reductions in costs they help create and for the
ease of insurance risk management and the flexibility for cash
flows they generate. Additionally, they may provide coverage of
risks which is neither available nor offered in the traditional
insurance market at reasonable prices.
The types of risk that a captive can underwrite for their parents
include property damage, public and product liability, professional
indemnity, employee benefits, employers' liability, motor and
medical aid expenses. The captive's exposure to such risks may
be limited by the use of reinsurance.
Captives are becoming an increasingly important component of
the risk management and risk financing strategy of their parent.
This can be understood against the following background:

Heavy and increasing premium costs in almost every line of


coverage
Difficulties in insuring certain types of fortuitous risk

Differential coverage standards in various parts of the world


Rating structures which reflect market trends rather than
individual loss experience
Insufficient credit for deductibles and/or loss control efforts

There are also companies known as "insurance consultants". Like


a mortgage broker, these companies are paid a fee by the
customer to shop around for the best insurance policy amongst
many companies. Similar to an insurance consultant, an
'insurance broker' also shops around for the best insurance policy
amongst many companies. However, with insurance brokers, the
fee is usually paid in the form of commission from the insurer that
is selected rather than directly from the client.
Neither insurance consultants nor insurance brokers are
insurance companies and no risks are transferred to them in
insurance transactions. Third party administrators are companies
that perform underwriting and sometimes claims handling
services for insurance companies. These companies often have
special expertise that the insurance companies do not have.
The financial stability and strength of an insurance company
should be a major consideration when buying an insurance
contract. An insurance premium paid currently provides coverage
for losses that might arise many years in the future. For that
reason, the viability of the insurance carrier is very important. In
recent years, a number of insurance companies have become
insolvent, leaving their policyholders with no coverage (or
coverage only from a government-backed insurance pool or other
arrangement with less attractive payouts for losses). A number of
independent rating agencies provide information and rate the
financial viability of insurance companies.

Chapter 2
Indian view of insurance

Meaning of insurance
Insurance means a promise of compensation for any potential future
losses. It facilitates financial protection against by reimbursing losses
during crisis. There are different insurance companies that offer wide range
of insurance options and an insurance purchaser can select as per own
convenience and preference.
Several insurances provide comprehensive coverage with affordable
premiums. Premiums are periodical payment and different insurers offer
diverse premium options.The periodical insurance premiums are calculated
according to the total insurance amount.

Definition of insurance

According to Riepel& Miller, Insurance is a


social device whereby the uncertain risks of
individuals may be combined in a group and
thus made more certain small periodical
contributions by the individuals providing a
fund, out of which, those why suffer losses may
be reimbursed.

History of insurance in India

In India, insurance has a deep-rooted history. It finds mention in the


writings of Manu ( Manusmrithi ), Yagnavalkya (Dharmasastra ) and
Kautilya ( Arthasastra ). The writings talk in terms of pooling of resources
that could be re-distributed in times of calamities such as fire, floods,
epidemics and famine. This was probably a pre-cursor to modern day
insurance. Ancient Indian history has preserved the earliest traces of
insurance in the form of marine trade loans and carriers contracts.
Insurance in India has evolved over time heavily drawing from other
countries, England in particular.

1818 saw the advent of life insurance business in India with the
establishment of the Oriental Life Insurance Company in Calcutta. This
Company however failed in 1834. In 1829, the Madras Equitable had
begun transacting life insurance business in the Madras Presidency. 1870
saw the enactment of the British Insurance Act and in the last three
decades of the nineteenth century, the Bombay Mutual (1871), Oriental
(1874) and Empire of India (1897) were started in the Bombay Residency.
This era, however, was dominated by foreign insurance offices which did
good business in India, namely Albert Life Assurance, Royal Insurance,
Liverpool and London Globe Insurance and the Indian offices were up for
hard competition from the foreign companies.
In 1914, the Government of India started publishing returns of Insurance
Companies in India. The Indian Life Assurance Companies Act, 1912 was
the first statutory measure to regulate life business. In 1928, the Indian
Insurance Companies Act was enacted to enable the Government to
collect statistical information about both life and non-life business
transacted in India by Indian and foreign insurers including provident
insurance societies. In 1938, with a view to protecting the interest of the
Insurance public, the earlier legislation was consolidated and amended by
the Insurance Act, 1938 with comprehensive provisions for effective control
over the activities of insurers.
The Insurance Amendment Act of 1950 abolished Principal Agencies.
However, there were a large number of insurance companies and the level
of competition was high. There were also allegations of unfair trade practices. The
Government of India, therefore, decided to nationalize insurance business.
An Ordinance was issued on 19th January, 1956 nationalising the Life Insurance
sector and Life Insurance Corporation came into existence in the same year. The LIC
absorbed 154 Indian, 16 non-Indian insurers as also 75 provident societies245
Indian and foreign insurers in all. The LIC had monopoly till the late 90s when the
Insurance sector was reopened to the private sector.

The history of general insurance dates back to the Industrial Revolution


in the west and the consequent growth of sea-faring trade and commerce
in the 17th century. It came to India as a legacy of British
occupation. General Insurance in India has its roots in the establishment of
Triton Insurance Company Ltd., in the year 1850 in Calcutta by the British.
In 1907, the Indian Mercantile Insurance Ltd, was set up. This was the first
company to transact all classes of general insurance business.
1957 saw the formation of the General Insurance Council, a wing of the
Insurance Associaton of India. The General Insurance Council framed a
code of conduct for ensuring fair conduct and sound business practices.
In 1968, the Insurance Act was amended to regulate investments and set
minimum solvency margins. The Tariff Advisory Committee was also set up
then.
In 1972 with the passing of the General Insurance Business
(Nationalisation) Act, general insurance business was nationalized with
effect from 1st January, 1973. 107 insurers were amalgamated and grouped
into four companies, namely National Insurance Company Ltd., the New
India Assurance Company Ltd., the Oriental Insurance Company Ltd and
the United India Insurance Company Ltd. The General Insurance
Corporation of India was incorporated as a company in 1971 and it
commence business on January 1sst 1973.
This millennium has seen insurance come a full circle in a journey
extending to nearly 200 years. The process of re-opening of the
sector had begun in the early 1990s and the last decade and more has
seen it been opened up substantially. In 1993, the Government set up a
committee under the chairmanship of RN Malhotra, former Governor of
RBI, to propose recommendations for reforms in the insurance sector.The
objective was to complement the reforms initiated in the financial
sector. The committee submitted its report in 1994 wherein , among other
things, it recommended that the private sector be permitted to enter the
insurance industry. They stated that foreign companies be allowed to enter

by floating Indian companies, preferably a joint venture with Indian


partners.
Following the recommendations of the Malhotra Committee report, in 1999,
the Insurance Regulatory and Development Authority (IRDA) was
constituted as an autonomous body to regulate and develop the insurance
industry. The IRDA was incorporated as a statutory body in April, 2000. The
key objectives of the IRDA include promotion of competition so as to
enhance customer satisfaction through increased consumer choice and
lower premiums, while ensuring the financial security of the insurance
market.
The IRDA opened up the market in August 2000 with the invitation for
application for registrations. Foreign companies were allowed ownership of
up to 26%. The Authority has the power to frame regulations under Section
114A of the Insurance Act, 1938 and has from 2000 onwards framed
various regulations ranging from registration of companies for carrying on
insurance business to protection of policyholders interests.
In December, 2000, the subsidiaries of the General Insurance Corporation
of India were restructured as independent companies and at the same time
GIC was converted into a national re-insurer. Parliament passed a bill delinking the four subsidiaries from GIC in July, 2002.
Today there are 28 general insurance companies including the ECGC and
Agriculture Insurance Corporation of India and 24 life insurance companies
operating in the country.
The insurance sector is a colossal one and is growing at a speedy rate
of 15-20%. Together with banking services, insurance services add about
7% to the countrys GDP. A well-developed and evolved insurance sector is
a boon for economic development as it provides long- term funds for
infrastructure development at the same time strengthening the risk taking
ability of the country.

Principles of Insurance

The important principle of insurance are as follows:


The main motive of insurance is cooperation. Insurance is defined
as the equitable transfer of risk of loss from one entity to another,
in exchange for a premium.
1. Nature of contract:
Nature of contract is a fundamental principle of insurance
contract. An insurance contract comes into existence when one

party makes an offer or proposal of a contract and the other party


accepts the proposal.
A contract should be simple to be a valid contract. The person
entering into a contract should enter with his free consent.
2. Principal of utmost good faith:
Under this insurance contract both the parties should have faith
over each other. As a client it is the duty of the insured to disclose
all the facts to the insurance company. Any fraud or
misrepresentation of facts can result into cancellation of the
contract.
3. Principle of Insurable interest:
Under this principle of insurance, the insured must have interest
in the subject matter of the insurance. Absence of insurance
makes the contract null and void. If there is no insurable interest,
an insurance company will not issue a policy.
An insurable interest must exist at the time of the purchase of the
insurance. For example, a creditor has an insurable interest in the
life of a debtor, A person is considered to have an unlimited
interest in the life of their spouse etc.
4. Principle of indemnity:
Indemnity means security or compensation against loss or
damage. The principle of indemnity is such principle of insurance

stating that an insured may not be compensated by the insurance


company in an amount exceeding the insureds economic loss.
In type of insurance the insured would be compensation with the
amount equivalent to the actual loss and not the amount
exceeding the loss.
This is a regulatory principal. This principle is observed more
strictly in property insurance than in life insurance.
The purpose of this principle is to set back the insured to the same
financial position that existed before the loss or damage occurred.
5. Principal of subrogation:
The principle of subrogation enables the insured to claim the
amount from the third party responsible for the loss. It allows the
insurer to pursue legal methods to recover the amount of loss, For
example, if you get injured in a road accident, due to reckless
driving of a third party, the insurance company will compensate
your loss and will also sue the third party to recover the money
paid as claim.
6. Double insurance:
Double insurance denotes insurance of same subject matter with
two different companies or with the same company under two
different policies. Insurance is possible in case of indemnity
contract like fire, marine and property insurance.

Double insurance policy is adopted where the financial position of


the insurer is doubtful. The insured cannot recover more than the
actual loss and cannot claim the whole amount from both the
insurers.
7. Principle of proximate cause:
Proximate cause literally means the nearest cause or direct
cause. This principle is applicable when the loss is the result of
two or more causes. The proximate cause means; the most
dominant and most effective cause of loss is considered. This
principle is applicable when there are series of causes of damage
or loss.