Insurance and Risk Management PDF

MF 0018
Insurance and Risk Management

Contents
Unit 1
An Introduction to Risk 1
Unit 2
Mitigating Risk via Insurance Markets 24
Unit 3
Indian Insurance Industry and Economic
Reforms in Insurance Industry 46
Unit 4
Regulations Relating to Accounting and Insurance
Management in Insurance 72
Unit 5
Life Insurance 100
Unit 6
Non-life Insurance - 1 122
Unit 7
Non-life Insurance - 2 144
Unit 8
Functions and Organisations of Insurers 169
Unit 9
Product Design and Development 188
Edition: Spring 2010
BKID - B1319 16 Dec. 2010

Unit 10
Underwriting 206
Unit 11
Claims Management 226
Unit 12
Insurance Pricing and Marketing 251
Unit 13
Financial Management in Insurance
Companies and Insurance Ombudsman 272
Unit 14
Reinsurance 292
Unit 15
Information Technology in Insurance 311
Acknowledgement, Reference &
Suggested Readings 330
Dean
Directorate of Distance Education
Sikkim Manipal University (SMU DDE)
Board of Studies
Chairman
HOD Management & Commerce Mr. Pankaj Khanna
SMU DDE Director, HR, Fidelity Mutual Fund
Additional Registrar Mr. Shankar Jagannathan
SMU DDE Former Group Treasurer
Wipro Technologies Limited
Controller of Examination
SMU DDE Mr. Abraham Mathew
Chief Financial Officer
Dr. T.V. Narasimha Rao
Infosys BPO, Bangalore
Adjunct Faculty & Advisor SMU DDE
Ms. Sadhna Dash
Prof. K.V. Varambally
Ex Senior Manager HR
Director, Manipal Institute of Management
Microsoft India Corporation (Pvt.)
Manipal
Ltd.
Content Preparation Team Content Review
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Curriculum Revised : Spring 2010

Printed : December 2010
This book is a distance education module comprising a collection of learning

materials for our students. All rights reserved. No part of this work may be
reproduced in any form by any means without permission in writing from Sikkim
Manipal University, Gangtok, Sikkim. Printed and Published on behalf of Sikkim
Manipal University, Gangtok, Sikkim by Mr. Rajkumar Mascreen, GM, Manipal
Universal Learning Pvt. Ltd. Manipal - 576 104. Printed at Manipal Press Limited,
Manipal.
SUBJECT INTRODUCTION
Insurance and Risk Management (MF0018) is a 4 credit subject of 4th
semester of MBA (Finance) programme.
In any event there is an element of risk or uncertainty attached to the result.
Certainty and uncertainty are two extremes of a continuum and risk lies
somewhere between the two. It is important to know how to deal with risk if
we cannot avoid it totally. Risk is a possibility of an undesirable deviation
from a desired outcome that is expected or the uncertainty about what
outcome will occur. Insurance is an important risk management tool. Risk
financing refers to the different risk finance alternatives for every
organisation's liability. The major risk financing techniques are risk retention
and risk transfer. The main purpose of insurance is to offer economic and
social protection against the risks and losses due to events like death,
disability and economic losses. The insurance contract is based on utmost
good faith of both the parties involved - the insurer and the insured.
Insurance companies can be classified as public and private sector
insurance company. The professionals in the insurance industry are
underwriters, actuaries, insurance agents, brokers and risk and insurance
managers. The public sector life and general insurance companies in India
are, Life Insurance Corporation of India (LIC) and General Insurance
Company of India (GIC). There are 22 life and 18 general private insurance
companies in India.
The reforms in Indian insurance industry started when the Malhotra
committee was formed in 1993 headed by R. N. Malhotra to analyse the
Indian insurance industry and propose the future course of the industry. The
Insurance (Laws) Amendment Bill 2008 and The LIC (Amendment) Bill 2009
introduced further reforms. The Insurance (Laws) Amendment Bill 2008
amended the following three acts - the Insurance Act 1938, General
Insurance Business (Nationalisation) Act 1972 (GIBNA) and Insurance
Regulatory and Development Authority Act 1999.
Insurance regulations are a set of principles that cover the minimum
requirements for best practices in the area of licensing, prudential
regulations and requirements, managing asset quality and so on. The two
acts that primarily regulate the insurance industry in India are Insurance Act
1938 and Insurance and Regulatory Development Authority Act 1999.
Life insurance is a financial cover provided by a life insurance company for the
insured and their family, from any kind of loss, likely to be caused by an unsure
event. Non-life insurance is also referred to as general insurance. The general
insurance industry provides financial support against financial losses. It covers
the losses arising from destruction, damage to property, and loss incurred
through legal liabilities.
Functions of insurers include production/sales, underwriting, rate making,
managing claims and investments. The insurance organisations in India are
the Insurance Regulatory and Development Association (IRDA), Life
Insurance Council, Life Insurance Agents Federation of India (LIAFI),
Institute of Actuaries of India (IAI) and Insurance Brokers Association of
India (IBAI).
Product design and development is the basic responsibility of the
management of any company. Insurance policy innovations developed
when competitive forces and customer demand encouraged the companies to
propose attractive alternatives.
Underwriting is a process of assessing risks and deciding who or what the
insurance company can insure. An underwriter is a person who assesses the
risks and computes the premium.
Claims management is a system which sets up the rules and regulations for the
assessment of damages, using the data got from medical reports, surveyor
report, loss assessors report and warranties contained in the policy
document.
Insurance pricing has to balance the risks and returns of the insurance
company. It needs to take into account the role of the market in determining
the price of the insurance products. The pricing strategy must ensure that
the premiums received are sufficient to meet the cost of claims,
administrative expenses and provide fair amount of profits for investments.
The insurers must invest the company funds wisely if they want to make
profit from the premiums given by the policyholders or settle the claims of
the policyholders. The Insurance Regulations and Development Amendment
2001 regulates the investments of the insurance companies.
Reinsurance is the movement of a part or the whole insurance policy from one
insurer to another insurer. In this the reinsurer assures the cedant insurer
for a specific portion of a particular type of insurance claims that the cedent
insurer pays for any insurance policy or a set of policies.
The evolutionary technological changes in the last decade has
revolutionised the entire insurance sector. With greater competition among
insurers, providing a better service has become a matter of concern. The use
and application of information technology in insurance operations has improved
productivity and reduced the cost of various activities.
This Self-Learning Material (SLM) of the subject is divided into 15 units, the
overview of which is given below:
Unit 1: An Introduction to Risk
This unit introduces the definition and meaning to risk with regard to
insurance. It also discusses aspects like certainty, risk and uncertainty. This unit
explains the classification of risk. This unit also discusses the nature of risk
management and risk management strategies.
Unit 2: Mitigating Risk via Insurance Markets
This unit describes risk financing and explains how insurance forms a prime risk
management tool. It discusses the features and types of option pricing and
various risk management tools used by the insurance industry. It also explains
the concept of insurance markets.
Unit 3: Indian Insurance Industry and Economic Reforms in Insurance
Industry
This unit explains about the public and private insurance companies in India.
It lists the different types of insurance organisations. It discusses the
different professionals in risk and insurance management and the players in
insurance industry. It also explains the economic reforms in insurance
industry.
Unit 4: Regulations Relating to Accounting and Insurance Management in
Insurance
This unit discusses the need for regulatory intervention in the insurance
sector. It explains the composition of the authority and regulatory
framework. It explains investment accounting and accounting foreign
operations. It also includes IRDA guidelines for the preparation of final
accounts and investment guidelines.
Unit 5: Life Insurance
This unit introduces life insurance and explains the elements of life
insurance. It describes the features of life insurance and endowment
assurance. It also discusses the role of term and endowment in product
designing, types of life insurance policies annuity and pension policies,
whole life policies, money back policies and other types of life insurance.
Unit 6: Non-life Insurance - 1
In this unit you will be introduced to the various non-life insurances such as fire,
marine, rural and social insurances. It also explains in detail the coverage,
liability details, exclusion and the need for each of these insurances.
Unit 7: Non-life Insurance - 2
This unit explains the details about automobile policy and its coverages. It
explains the health insurance plan and other miscellaneous insurances.
Unit 8: Functions and Organisations of Insurers
This unit deals with the functions and organisations of insurers. It explains the
basic functions of insurers and insurance organisations. This unit also deals
with the different types of organisations formed by the insurers and the
professionals in the insurance industry.
Unit 9: Product Design and Development
This unit explains the product development process. It explains the product
design and development by different insurance companies. It also includes
product design in emerging scenario.
Unit 10: Underwriting
This unit describes the basics of underwriting. It explains the objectives,
principles and steps of underwriting. It also explains the sources of
underwriting information and the process of making an underwriting
decision.
Unit 11: Claims Management
This unit discusses about claims management. It describes the importance,
stages and factors affecting claims management. It introduces claims
settlement and the types of claims. It gives an overview of the guidelines for
settlement of claims by IRDA. It also explains time element in the claims
payment and terms in claims.
Unit 12: Insurance Pricing and Marketing
This unit explains the concept of insurance pricing. It explains the pricing
procedures, objectives and methods. It also explains the pricing and
marketing of insurance products.
Unit 13: Financial Management in Insurance Companies and Insurance
Ombudsman
This unit explains the concept of management and investment of funds in
insurance companies. It describes the regulations related to investment and
states the IRDA amendment, 2001. It also explains about the creation of the
institute of insurance ombudsman and lists its roles and functions.
Unit 14: Reinsurance
This unit explains the features and need of reinsurance. It explains the types of
reinsurance. It describes the treaties and agreements of reinsurance. It also
describes the alternatives to traditional reinsurance.
Unit 15: Information Technology in Insurance
This unit explains the application of information technology in insurance
sector. It describes the need and role of IT in various sectors of insurance.
Objectives of studying the subject
After studying this subject, you should be able to:
Define and explain the meaning of risk with regard to insurance
Describe how insurance forms a prime risk management tool
Explain about public and private insurance companies
Describe the economic reforms in insurance industry
Explain the need for regulatory intervention
Describe life insurance and its elements
Explain non-life and its elements
Define and explain the functions and organisations of insurers
Explain the product development process
Describe the basics of underwriting and claims management
Explain insurance pricing of insurance products
Define the concept of management and investment of funds
Define reinsurance and explain the different types of reinsurance
Explain the application of information technology in insurance sector
Insurance and Risk Management Unit 1
Unit 1 An Introduction to Risk
Structure:
1.1 Introduction
Objectives
1.2 Definition and Meaning of Risk
1.3 The Effect of Risk
Chance of loss
Degree of risk
1.4 Certainty, Risk and Uncertainty
1.5 Classification of Risk
Pure and speculative risk
Fundamental and particular risk
Static and dynamic risk
Enterprise risk
1.6 Management of Risk.
Nature of risk management
Risk management process
1.7 Risk Management Strategies
Risk avoidance
Risk reduction
Risk retention
Risk combination
Risk transfer
Risk sharing
Risk hedging
1.8 Summary
1.9 Glossary
1.10 Terminal Questions
1.11 Answers
1.12 Case-Let
1.1 Introduction
There is no single definition for risk, but it is better understood in terms of
uncertainty. In any event there is an element of risk or uncertainty attached
to the outcome. Certainty and uncertainty are two extremes of a continuum
Sikkim Manipal University Page No. 1

and risk lies somewhere between the two. This unit defines risk with respect
to insurance. It also discusses aspects like certainty, risk and uncertainty,
classification of risk. Risk is classified based on the outcome of an event,
the environment in which it occurs and the group of people it affects.
It is important to know how to deal with risk if we cannot avoid it totally. This
unit also discusses methods to resolve risks by using appropriate risk
management strategies. Risk management is a process which manages the
exposure to risk. The act of identification, evaluation, control, transfer,
retention, sharing and hedging of risks constitutes risk management.
Objectives:
After studying this unit you should be able to:
define and explain the meaning of risk with regard to insurance
discuss the effect of risk, certainty, uncertainty
explain the classifications in risk
describe risk management and its strategies
1.2 Definition and Meaning of Risk

Risk is defined in many different ways. Risk theorists, economists,
statisticians, behavioral scientists each have their own definition and
meaning of risk. But generally risk can be well associated and understood in
terms of uncertainty. We know that every action is followed by an outcome.
Uncertainty is encountered when an action has many likely outcomes and not a
single certain outcome. We can estimate risk on the basis of the certainty
level of the outcome of an activity. Greater the accuracy of predicting an
outcome lower is the risk.
Risk is a possibility of an undesirable deviation from a desired outcome that is
expected or the uncertainty about what outcome will occur. Hence risk with
regard to insurance is defined as uncertainty associated with the
occurrence of a loss. The term risk is used to identify the property or life
being insured. As risk is defined as uncertainty, it can be distinguished as
objective risk and subjective risk.
Objective risk is the variation of actual loss from expected loss. It declines
as the number of exposures increase. It can be calculated statistically by
using measures of dispersion. When the numbers of exposures increase,

the insurer is able to predict its future loss relying on the law of large
numbers. Subjective risk is defined as uncertainty based on an individuals
state of mind. If a person experiences mental uncertainty concerning the
occurrence of loss, the persons behaviour is affected.
Risk can also be termed as peril or hazard. A peril is a cause of risk or the
incident that may cause a loss. Fire, earthquake, collusion, flood are
examples of perils. Hazard is a condition that fosters the frequency of loss. For
example, theft is likely to happen in the absence of security.
Self Assessment Questions
1. _________________ as the number of exposures increase.
2. ________________________ increases the frequency of loss.
a) Peril
b) Subjective risk
c) Hazard
d) Objective risk
3. Earthquake happens due to a hazard present. (True/False).
1.3 The Effect of Risk

The previous section defined the meaning of risk. This section analyses the
effects of risk.
Before we assess risk it is important to know from whose point it is viewed
and assessed, whether from the point of view of the insurer or insured. Risk
may result in gain or loss. We need to determine the adverse results
following an occurrence .The result may be different from the expected
because of uncertainty. Higher the degree of uncertainty higher will be the
deviation. Risk here refers to a peril against which we need to take
precautions. Therefore if we limit risk to occurrence of financial loss then it
can be measured and to a certain extent be insured. Two concepts which
are used to measure risks are chance of loss and degree of risk.
1.3.1 Chance of loss
Loss is the injury or damage borne by the insured in consequence of the
happening of one or more of the accidents or misfortunes against which the
insurer, in consideration of the premium, has undertaken to assure the
insured. Chance of loss is defined as the probability that an event that
causes a loss will occur. The chance of loss is a result of two factors,

namely peril and hazard. Hazards are further classified into the following four
types:
Physical hazard - This is a danger likely to happen due to the physical
characteristics of an object, which increases the chance of loss. For
example defective wiring in a building which enhances the chance of fire.
Moral hazard - It is an increase in the probability of loss due to
dishonesty or character defects of an insured person. For example,
Burning of unsold goods that are insured in order to increase the amount
of claim is a moral hazard.
Morale hazard - It is an attitude of carelessness or indifference to
losses, because the losses were insured. For example, careless acts like
leaving a door unlocked which makes it easy for a burglar to enter, or
leaving car keys in an unlocked car increase the chance of loss.
Legal hazard - It is the severity of loss which is increased because of
the regulatory framework or the legal system. For example actions by
government departments restricting the ability of insurers to withdraw
due to poor underwriting results or a new environment law that alters the
risk liability of an organisation.
1.3.2 Degree of risk
Degree of risk refers to the intensity of objective risk, which is the amount of
uncertainty in a given situation. It can be assessed by finding the difference
between expected loss and actual loss. The formula used is
Difference betw een the expected and actual loss
Degree of risk =
Expected loss
Degree of risk is measured by the probability of adverse deviation. If the

probability of the occurrence of an event is high, then greater is the
likelihood of deviation from the outcome that is hoped for and greater the
risk, as long as the probability of loss is less than one. In the case of
exposures in large numbers, estimates are made based on the likelihood of
the number of losses that will occur. With regard to aggregate exposures the
degree of risk is not the probability of a single occurrence but it is the
probability of an outcome which is different from that expected or predicted.
Therefore insurance companies make predictions about the losses that are
expected to occur and formulate a premium based on that.


4. ________________ hazard increases the probability of loss due to
dishonesty or character defects of an insured person.
a) Moral
b) Morale
c) Legal
d) Physical
5. _______________ has an inherent tendency to amplify the degree of
risk.
6. _______________ can be assessed by finding the difference between
expected loss and actual loss.
1.4 Certainty, Risk and Uncertainty

The previous section analysed the effects of risk. This section differentiates
between certainty, risk and uncertainty.
Certainty is when there is no doubt of the outcome of an event. But
uncertainty is when there is doubt in the achievement of the desired
outcome and the potential deviation in the outcome is called risk. The
uncertainty in an event arises because of the knowledge which is not
sufficient to predict the outcome with certainty. Uncertainty implies that the
person does not have thorough knowledge and hence can only make a
vague assessment about an objective risk situation.
Uncertainty is a perceptual phenomenon that exists in different degrees to
different people. It can be represented on a straight line called continuum. This
continuum can be divided into different levels of uncertainty.
Certainty Uncertainty
Uncertainty is zero Uncertainty is very high

at this level
At level zero, the exposure to uncertainty is zero and at the right extremity the
exposure to uncertainty is 100%. Therefore in this context risk is defined as
exposure to uncertainty.

Level 0 (certainty) - There is no uncertainty at this level. The outcome of an

event is known in certain. Events that come under the law of nature such as laws
of physics and chemistry fall in this category.
Level 1 (objective probability) - Lowest level of uncertainty, events
occurring in this level are categorised by the likelihood of their occurrence. For
example tossing of a coin, has an established fact that there are two
outcomes either heads or tails, each with a probability 0.5.
Level 2 (subjective probability) - In this level, the degree of uncertainty
increases. The outcomes of the events in this level are known but assigning
probabilistic values to these outcomes is difficult. Probability is assigned with
respect to a person, scenario or circumstances. Therefore it is referred to as
subjective probability.
Level 3 (complete uncertainty) - The degree of uncertainty is the highest
here. The outcomes of the events in this level are difficult to predict and
hence the probability of occurrence is not known.
7. In ______________ the outcomes can be identified with known
probabilities.
8. Uncertainty does not exist in level 1 (objective probability). (True/False).
9. The different degrees of uncertainty can be represented on a straight
line called ____________.
1.5 Classification of Risk

The previous section explained the differences between certainty, risk and
uncertainty. This section explains the different types of risks.
Risks are classified or grouped into a similar category in the insurance
industry to quantify risk and define the insurance premium to be charged.
Classification of risks also helps in placing individual risks with similar
expectations of loss in a group or class of risks. By classifying we can also
estimate risks from probabilities associated with occurrence, timing and
magnitude of events.
1.5.1 Pure and speculative risk
Pure risks are defined as situation in which there are only two outcomes that
is the possibility of loss or no loss to an organisation but no gain - the event

either happens or does not happen. When this risk happens, the chance of
making any profit is very badly low. Few examples of pure risk are
earthquake, theft, accident, fire etc. A car may or may not meet with an
accident. If an insurance policy is bought for the car, then if accident occurs the
insurance company incurs loss but on the contrary if accident does not occur
there is no gain to the insured.
Speculative risks describe situations in which there is a possibility of gain as well
as loss. The element of gain is inherent or structured based on the situation.
Few examples are gambling on horses, investing in a stock market, merging
with an organisation. Thus most of the speculative risks are business related
and some speculative risks are optional and can be avoided if desired.
The distinguishing characteristics of pure and speculative risks which is of
importance to insurers are the following:
The contract of insurance is usually applicable only to pure risks but not
to speculative risks. Insurance is meant to assure us against losses that
arise as pure risk, but not to outcomes that lead to both loss and gain.
Moreover a particular type of risk may appear speculative for the
insurance company but a pure risk for the organisation.
The law of large numbers is easily applicable to pure risks than to
speculative risks. The law is important to insurers since it predicts future
loss experience. An exception is the example of gambling, where the
casino operators apply the law of large numbers in a most efficient way.
Speculative risk may profit the society even if a loss occurs. It carries
some inherent advantages to the economy. For example speculative
activity in the stock market may lead to more efficient allocation of
capital. The same does not apply to pure risk. A fire, flood, earthquake
cannot benefit the society.
Since pure risk is usually insurable, the discussion on risk is skewed
towards pure risks only.
Pure risk is broadly classified into the following four categories:
Property risk.
Personal risk.
Liability risk.
Loss of income risk.

Property risk
This is a risk to a person in possession of the property which faces loss
because of some unforeseen events. Property includes both movable and
immovable possessions. Movable assets are personal assets like personal
computer, any appliance. Immovable assets are land, building which suffers
loss due to natural calamities. Property risk is further divided into direct and
indirect loss.
Direct loss - A direct loss is defined as a physical damage due to a
given calamity or peril in a direct way. For example, if an office building
is damaged by fire, the damage incurred in the direct way is the direct
loss.
Indirect loss - The additional expense incurred due to the destruction
of the property is the indirect loss. Thus in addition to the physical
damage after a fire, the office would lose profits for several months
because of reconstruction. The loss of profits is a consequential loss as
a consequence of the damage incurred.
Personal risk
Personal risks are risks that directly affect the individuals income. This may
either be loss of earned income or extra expenditure or depletion of financial
assets. There are four major types of personal risks:
Risk of premature death.
Risk of insufficient income during old age.
Risk of poor health.
Risk of unemployment.
Risk of premature death - Premature death occurs when the bread earner
of a family dies with unfulfilled financial obligations. Therefore this can cause
financial problems only if the deceased has dependents to support. There
are four costs which results from this. First, the present value of the familys
share of the deceased breadwinners future earnings is lost. Secondly,
additional expenses like funeral expenses, uninsured medical bills,
inheritance taxes can result. Thirdly, due to insufficient income, the family of
the deceased has trouble in making ends meet. Finally, intangible costs due
to loss of role model, guidance, and counseling result.
Risk of insufficient income during old age - The risk arises when retired
people do not have sufficient income after their retirement and it leads to

social insecurity. Retired people need to have financial assets from which
they can draw income or have access to other sources like private pension.
Risk of poor health - The sudden disability of a person to earn income for
living happens to be a disadvantage or sudden risk to that person. The risk of
poor health includes payment of medical bills and the loss of earned
income. The loss of earned income is a financial insecurity if the disability is
severe. Employee benefits may be lost or reduced, savings are depleted and
extra care must be taken for the disabled person.
Risk of unemployment - This risk is due to socio-economic factors
resulting in financial insecurity. Unemployment results due to business cycle
down swings, technology and structure changes in the economy and
imperfections in the labor market.
Liability risk
This risk arises to a person when there is a possibility of an unintentional
damage caused by him to another person because of negligence. Therefore
this risk arises when ones activity causes adversity to another person. For
example, construction of factories or dams which results in dislocating
number of villagers. This risk arises due to government regulations and acts.
It is quite different from the other risks as there is no maximum upper limit to
the amount of the loss. A lien can be placed on ones income and financial
assets to satisfy legal judgment and the cost of legal defense could be huge.
Loss of income risk
This risk is due to an indirect loss from a certain given risk. For example if a firm
is not able to operate due to legal issues or destruction by peril, it takes time to
resume its normal operations. Therefore in this period, production stoppage
will lead to loss of income.
1.5.2 Fundamental and particular risk
This classification is based on the people who are affected by the event.
Those risks which affect an entire economy or a large group within the
economy are termed as fundamental risks. For example, cyclic
unemployment, epidemics, drought, political and economic changes, and
terrorist attacks of recent times affect a large group of people and hence
these are fundamental risks. On the other hand, losses that arise out of
individual events and are felt by particular individuals and not by a

community or a group is termed as particular risks. Examples are burning of a

house or an automobile accident.
The distinction between a fundamental and a particular risk is that an
individual or a concern can have control over particular risk but fundamental
risks can hardly be controlled. Social insurance and government insurance
compensates for the loss incurred by a fundamental risk but in case of
particular risk an individual or a particular enterprise bears the burden of
loss.
1.5.3 Static and dynamic risk
Based on the nature of the environment, risks are classified as static and
dynamic. Static risks are those which happen within a stable environment and
are constant over an observed period of time. They have a regular pattern of
occurrence and can be reasonably predicted. Dynamic risks arise from changes
in the environment like economic, social, technological and political changes.
They are generally less predictable because they do not occur in any degree of
regularity.
Static risks are immune to the changes in the environment. Dynamic risk
resembles speculative risk and static risk resembles pure risk.
1.5.4 Enterprise risk
This is a risk which includes all major risks faced by a business firm. It
encompasses risks such as pure risk, speculative risk, strategic risk,
operational risk and financial risk. We already studied about pure and
speculative risks. Strategic risk is when an organisation is uncertain about
its goals and objectives. Operational risks may result due to a firms
business operations. Financial risk is when there is uncertainty of loss
because of changes in interest rates, foreign exchange rates and value of
money.
Enterprise risk plays a vital role in commercial risk management, which is a

process in an organisation to treat all minor and major risks. Major risks can
be addressed by bringing them all together and treating them as one single
program. By doing so, the firm can offset one risk against another and also if
some risks are negatively correlated overall risk can significantly be
reduced.


10. _________________ risks happen within a stable environment and are
constant over an observed period of time.
a) Speculative
b) Pure
c) Dynamic
d) Static
11. Which among the following is not a pure risk?
a) Personal risk
b) Property risk
c) Loss of income risk
d) Strategic risk
12. The contract of insurance is usually applicable only to pure risks.
(True/False).
1.6 Management of Risk.

The previous section explained the different types of risks. This section
explains the management of risks.
Risk management helps an individual or an organisation in achieving a
planned objective. It is essential to avoid the risk of failure. Risk
management is a process which identifies loss exposures faced by an
organisation and selects the most appropriate technique to treat the
exposures. It also involves identification, analysis and assigns economic
value of these exposures, which holds the earning capacity of an
organisation.
1.6.1 Nature of risk management
Risk management aims to have a hold over the risk exposure of a firm. It
mainly aims to control the pure risk exposures. The risk management
function can also be grouped with other management functions such as
finance and human resource.
The various risks faced by an individual and an organisation are:
Risk due to fire.
Risk of theft.
Loss of customers.
Delay in delivery of raw materials.

Breakdown of machinery.
Accidents.
Bad debts.
The view of risk management differs from one organisation to another. In the
traditional view risk management does not change radically but it moves in
increments therefore it is an evolving science. Hence insurance purchase is a risk
management solution.
According to the holistic view, risk management must not only cover
insurable risks but also the ones that are uninsurable. This is based on
formal risk management and addresses sources of system failures. It
follows Total Quality Management principles and hence excludes external
sources of failure.
According to the financial management view of risk, risk management is
associated with financial management and the decisions are evaluated in
terms of their effect on the firms value. Therefore we can minimise the
impact of risks by applying the right risk management policies.
1.6.2 Risk management process
The six risk management processes are:
1) Determination of objectives.
2) Identification of risks.
3) Evaluation of risk exposures.
4) Consideration and selection of risk management techniques.
5) Implementation of decisions.
6) Evaluation and review.
Determination of objectives
The prime objective is to ensure the effective continuous operation of an
organisation. The efficiency of risk management is hindered if the objectives are
not clearly specified. If the objectives are specified clearly then the risk
management process can be a holistic one instead of having isolated
problems. The goals and objectives of an organisation have to be linked with
the risk management objectives. The various objectives of risk
management can be classified broadly as:
Post-loss Objectives
Survival of the organisation.

Perpetuity of the organisations operations.

Steady flow of income/earnings.
Social obligation.
Pre-loss objectives
Economy.
Fulfillment of external obligations.
Reduction in anxiety.
Social obligations.
Identification of risks
Risk identification is a process of identifying property, liability and personnel
exposures to loss on a systematic and continuous basis. There is no ideal
method to identify risk, but a combination of methods is used. Some
methods are appropriate for certain organisations and others for specific work
environments. The general methods for risk identification are checklists,
questionnaire, flowchart, financial statement analysis and close examination of
the operations.
Risk analysis questionnaire - The questionnaire has to be a simple listing
of points and phrases. It is helpful in identifying the possible risk of particular
departments. The questionnaire is to be distributed among the employees.
As it is more direct in approach, it directs the respondent. It covers both
insurable and uninsurable risks. The only drawback of this method is that it
is difficult to identify the industry specific risk as the questionnaire is general
in nature.
Checklist of exposures - This is a list for checking factors which may be risky
to the organisation. The list need not be exhaustive but it must cover the major
potential risky operations that apply to all businesses in general. In such a
case, certain exposures unique to a given firm may not be included. But the
risk manager needs to make sure that the checklist reflects the potential losses
the business is exposed to.
Flowcharts - They can describe any form of flow within the company but
they are system specific concentrating on specific events which are
potentially risky. The activities are represented in a structural manner. The
most important type is the one used in production flow. The risk manager

with the help of this becomes acquainted with the technicalities and hence can
ask a number of what if questions to suggest answers.
Analysis of financial statement - It is very vital for the risk manager to
have a thorough knowledge of the source and utilisation of funds. This
method involves studying each account in detail and determining the
potential losses created. The financial statements of a company include
balance sheet, profit & loss account, cash flow statement, auditors report and
report of chairperson.
Activity: 1
Do a research and find out the different ways of identifying risks.
(Hint: fault tree analysis, hazard and operability study)
Evaluation of risk exposure

After identifying all possible risks from all angles the next step is to evaluate and
measure them. Before evaluating, the risk needs to be measured in two
dimensions of loss frequency and loss severity. While evaluating risks, risk
managers need to consider the following:
The importance or the severity of a risk.
All types of losses due to a given event and their financial losses.
The specification of the exposure as to how many would be affected and
the timing of the exposure.
The importance or the severity of a risk is more important than the
frequency of occurrence.
Consideration and selection of risk management techniques
This should be done by selecting the most appropriate technique or a
combination of techniques for treating the loss exposures. These techniques are
applied based on the following two broad methods:
Controlling the risk - Here the frequency and severity of the loss is
reduced hence the risk is controlled. This is done by avoiding the risk
and through reduction of exposure.
Financing the risk - This method provides the financing needed for the
losses either by retaining the risk or transferring the risk. These two
methods seem to be different but they are not mutually exclusive, rather

they are complementary to each other. In most cases they are used in a
combined manner.
Implementation of decisions
The firm after identifying the risks and choosing the correct technique needs
to decide the financial and administrative resources required. The next step
is to identify the insurance company and negotiate and start the policy
statements. The statement must outline the risk management objectives and
the company policy with regard to treatment of loss exposures. The
development of a risk management manual is essential in order to train the
employees.
Evaluation and review
Evaluation and review is to be done periodically to check if the set
objectives are attained. This is done from the point of view of the loophole
identified in the existing strategy adopted. The review process is a
continuous and ongoing activity. New techniques are adopted to protect the
firm from new risks and maximum care is taken to make sure that existing
mistakes do not creep into future strategies. This step not only analyses the
extent to which the objectives are achieved but lays foundation for future
course of actions.
13. According to the holistic view, risk management must only cover
insurable risks. (True / False).
14. In ___________________ method of identifying risk it is difficult to
identify the industry specific risk, as it is general in nature.
15. Evaluating the risk needs to be measured in two dimensions that is
______________ and ______________________.
1.7 Risk Management Strategies

The previous section explained the process of management of risks. In this
section we will discuss the various risk management strategies used to
handle both pure and speculative risk.
1.7.1 Risk avoidance
Risk avoidance is where a certain loss exposure is never acquired or the
existing one is totally removed. This is one of the strongest methods to deal
with risks. The major advantage of this method is that it reduces the chance
of loss to zero. The two ways by which risk can be avoided are proactive
avoidance and abandonment avoidance. In the first case, the person does
not assume any risk and therefore any project which brings in risk is not
taken up. For example a company which has chances of nuclear radiation
will not set up the company, due to the perils which it can bring up.
In the case of abandonment avoidance, the existing loss exposure is
abandoned. All activities with a certain degree of risk are abandoned. The case
of abandonment avoidance is very few. If a firm abandons risky activities,
then it faces difficulties in remaining in the market. The firm in the process of
abandoning might take up new activities which exposes to another type of
risk.
1.7.2 Risk reduction
This strategy aims to decrease the number of losses by reducing the
occurrence of loss, which can be done in two ways namely loss prevention and
loss control.
Loss prevention is a desirable way of dealing with risks. It eliminates the
possibility of loss and hence risk is also removed. The examples of this are
safety programs like medical care, security guards, and burglar alarms.
Loss control refers to measures that reduce the severity of a loss after it
occurs. For example segregation of exposure units by having warehouses with
inventories at different locations. Insurance companies provide guidance
and incentives to the company which has taken the policy to avoid the
occurrence of loss.
1.7.3 Risk retention
Retention simply means that the firm retains part or all the losses incurred
from a given loss. Risks may be knowingly or unknowingly retained by the
organisation. They are hence classified as active and passive based on this.
Active risk retention is when the firm knows of the loss exposure and plans
to retain it without making any attempt to transfer it or reduce it. Passive
retention is the failure to identify the loss exposure and retaining it
unknowingly.
Retention can be used only under the following circumstances:
When insurers are unwilling to write coverage or if the coverage is too
expensive.

If the exposure cannot be insured or transferred. If

the worst possible loss is not serious.
When losses are highly predictable.
Based on past experience if most losses fall within the probable range of
frequency, they can be budgeted out of the companys income.
1.7.4 Risk combination
In this strategy, risks are retained in a proportion that reduces the overall risk
combination to a minimum level. In order to minimise the overall risk, one risk
is added to another existing risk instead of transferring a risk. This strategy is
mostly used in management of financial risk. The risk is distributed over a
number of issuers instead of putting it on a single issuer. This reduces the
chances of default. For example it is better to have multiple suppliers instead of
relying on a single supplier.
1.7.5 Risk transfer
If the risk is being borne by another party other than the one who is primarily
exposed to risk then it is termed as risk transfer. In this case, transfer of asset
does not take place but only the risk involved is transferred. The two parties
involved in this strategy are the transferor (party transferring the risk) and the
transferee (party to whom the risk is transferred). The contracts made in this
strategy are grouped as exculpatory contracts.
In this contract the transferor is not liable if the event of risk takes place. But if
the transferor is supposed to pay for the risk incurred then it cannot be
termed as risk transfer.
1.7.6 Risk sharing
This is an arrangement made by which the loss incurred is shared. For
example in a corporation, a large number of people makes investments and
hence each bears only a portion of risk that the enterprise faces. Insurance
involves the mechanism of risk sharing.
1.7.7 Risk hedging
Hedging is buying and selling future contracts to balance the risk of
changing prices in the cash market. A hedger is someone who uses
derivatives to reduce risk caused by price movements. Derivatives are
instruments derived from the base securities like equity and bonds. Forward
contracts, futures, swaps and options are examples of derivatives.

Derivatives are based on the performance of separately traded

commodities. These involve future commitments and hence are open to the
possibility of benefiting from favorable price movements.
Operators in the derivative market are hedgers, speculators and
arbitrageurs. Hedgers are those who transfer the risk component of their
portfolio. Speculators take the risk from hedgers intentionally to make profit.
Arbitrageurs operate in different markets simultaneously to make profit and
eliminate mispricing. Therefore the derivatives make provision by hedging to
reduce the existing risk.
Activity: 2
Compare the strategies discussed in this section and identify the
similarities and distinguishing factors between them.
Hint: Refer section 1.7.
16. Which of the following method reduces the chance of loss to zero?
a) Risk Transferring
b) Risk avoidance
c) Risk retention
d) Risk reduction
17. In ________________ strategy, risks are retained in a proportion so that
overall risk is reduced.
18. ______________ strategy involves two parties to reduce risk.
1.8 Summary
This unit introduces the concept of risk. Risk refers to situations in which the
outcomes are uncertain or there exist undesirable deviations of outcomes
from the desired one. Risk is also referred to as possibility of loss.
Risk can be distinguished as:
Objective risk - This is the variation of actual loss from expected loss.
Subjective risk - This is defined as uncertainty based on an
individuals state of mind.

The two concepts which are used to measure risks are:

Chance of loss - This is defined as the probability that an event that
causes a loss will occur.
Degree of risk - This refers to the intensity of risk, which is the amount
of uncertainty in a given situation.
Certainty is when there is no doubt of the outcome of an event. But
outcome and the potential deviation in the outcome is called risk.
The four levels of uncertainty based on the probability of outcome are:
Certainty.
Objective uncertainty.
Subjective uncertainty.
Complete uncertainty.
Based on nature of environment, the people affected by the outcome and other
factors, risks are classified into the following four types:
Pure and speculative risk.
Fundamental and particular risk.
Static and dynamic risk.
Enterprise risk.
Risk management is an attempt to manage a firms risk levels using
available sources among which insurance is the most common one.
Depending on the attitude toward risk, we can apply the following risk
management strategies:
Risk avoidance.
Risk reduction.
Risk retention.
Risk combination.
Risk transfer.
Risk sharing.
Risk hedging.

1.9 Glossary
Arbitrageurs: An investor who makes profits by using the price
inefficiencies in the market and trades simultaneously in stocks that offset
each other.
Loss frequency: The number of claims on a policy during the premium
period.
Loss severity: The amount or the degree of loss experienced in financial
terms.
Loss exposure: A loss exposure is any situation where a loss is possible,
regardless of whether a loss occurs.

1. Define risk. Distinguish it with regard to uncertainty.
2. Explain the effect of risk.
3. Describe the concept of certainty, risk and uncertainty.
4. Explain the different types of pure risk and the difference between pure
and speculative risk.
5. Briefly explain the six risk management processes.
6. Discuss the various risk management strategies to handle risk.
1.11 Answers
1. Objective risk
2. c) - Hazard
3. False
4. a) - Moral
5. Hazard
6. Degree of risk
7. Level 1 (Objective probability)
8. False
9. Continuum
10. d) - Static risk
11. d) - Strategic risk
12. True

13. False
14. Questionnaire
15. Loss frequency, Loss severity
16. b) - Risk avoidance
17. Risk combination
18. Risk transfer
Terminal Questions
1. Risk is defined as uncertainty associated with the occurrence of a loss.
Based on uncertainty, risk is distinguished as objective risk and
subjective risk. This is explained in section 1.2. Refer the same for
details.
2. The effect of risk is measured and to a certain extent it can be insured.
Two concepts which are used to measure risks are chance of loss and
degree of risk. This is explained in sections 1.3.1 and 1.3.2. Refer the
same for details.
3. Certainty is when there is no doubt of the outcome of an event. But
outcome and the potential deviation in the outcome is called risk. Refer
to section 1.4 for a detail explanation.
4. Pure risks are defined as a situation in which there are only two
outcomes - the possibility of loss or no loss to an organisation but no
gain. Speculative risks describe situations in which there is a possibility
of gain as well as loss. Refer section 1.5.1 for the different types of pure
risks.
5. The six risk management processes are determination of objectives,
identification of risks, evaluation of risk exposures, consideration and
selection of risk management techniques, implementation of decisions,
evaluation and review. Refer to section 1.6.2 for a detail explanation.
6. The various risk management strategies are risk avoidance, risk
reduction, risk retention, risk combination, risk transfer, risk sharing, risk
hedging. Refer section 1.7 for a detailed explanation.

1.12 Case-Let
Remote Sensing in Agriculture Insurance: Transition Towards a
Comprehensive Risk Cover in Developing Countries
In March 2009, ICICI Lombard General Insurance Company took initiative
in Surguja district of Chattisgarh and Nizamabad district of Andhra
Pradesh with the help of design and research by Center for Insurance and
Risk Management (CIRM) and PAN Network India (GIS implementation).
The goal was to
- To create a composite (weather cum NDVI) index for crop production
estimation.
- To test the accuracy of the same vis--vis normal weather index.
- To study the probable and actual acceptability of an insurance scheme
based on a composite index vis--vis normal weather index insurance
scheme for a given region.
In this project, CIRM offered a composite index insurance product
comprising of Normalised Difference Vegetative Index (NDVI) and rainfall
index in five villages each of Chhattisgarh and Andhra Pradesh. CIRM
studied the uptake issues systematically and tested the accuracy of the
product quantitatively by comparing it with hypothetically designed
weather index insurance products in the same areas.
CIRM also developed a premium calculator to insure the major crops in all the
districts of India. It would calculate optimal crop insurance premium for all the
major crops cultivated in these districts. The premium calculator will be a
public online tool which can be used by any participant of an agriculture
value chain which ranges from a farmer to a commodity trader. The tool can
also be of great help to insurance companies to design optimal weather
insurance products.
The tool can divide each district into agro-climatic zones and will publish:
The lists of crops optimal for growing in each agro-climatic zones.
Risks faced by each major crop and optimal risk transfer mechanism for each
product.
Correlation analysis of productivity against claims payout for each risk
transfer product and the approximate premium to be charged for each
product.

Discussion Questions
1. What is the composite index offered by CIRM?
(Hint: Normalised Difference Vegetative Index and Rainfall Index)
2. How can the insurance companies use the tool developed by CIRM?
(Hint: Risks faced by each major crop - Correlation analysis of
productivity against claims payout)
Source: http://www.ifmr.ac.in/cirm/projects-livelihood.htm
References
George E Rejda (2009). Risk Management and Insurance, Dorling
Kindersley, New Delhi, India.
Gupta P K. Insurance and Risk Management, Himalaya Publishing
House, India.
Kutty Managing Life Insurance, PHI Learning Pvt. Ltd.

Unit 2 Mitigating Risk via Insurance Markets

Structure:
2.1 Introduction
Objectives
2.2 Risk Financing
2.3 Insurance as a Prime Risk Management Tool
2.4 Option Pricing
Types of options
Option pricing models
Factors affecting option pricing
2.5 Risk Management Tools
2.6 The Insurance Market
Market economy
Consumers choice
Channels of distribution in insurance industry
Consumer protection
Global scenario of insurance markets
2.7 Summary
2.8 Glossary
2.10 Answers
2.11 Case-Let
2.1 Introduction
The previous unit defined risk and explained the effect of risk. It
differentiated certainty, risk and uncertainty. It discussed the classification of
risk, management of risk and risk management strategies. This unit will deal
with improvement of risks through insurance markets.
Insurance is an important risk management tool in India. Public and
classified organisations are the basic organisations for improving risks.
Regulatory controls reduce individual risks. For instance, in India, the IRDA
combines insurance mechanisms with regulatory controls to control risk
failures. In open markets, risk is improved through insurance markets by
diversifying the expenditures.

Risk management is major part of finance. But now insurance companies are
selling the financial risk management products and the substitutes are directly
put in capital markets. Insurance policies protect a large number of insurable
risks and cover financial risks.
This unit describes risk financing and explains how insurance forms a prime risk
management tool. It discusses the features and types of option pricing and
various risk management tools used by the insurance industry. It also explains
the concept of insurance markets.
Objectives:
describe risk financing
explain the manner in which insurance forms a prime risk management
tool
define option pricing theory
discuss risk management tools
analyse the concept of indian insurance markets
2.2 Risk Financing

Risk financing refers to the manner in which the risk control measures that
have been implemented shall be financed. It is necessary to transfer or
reduce risks when risk exposure of a company goes beyond the maximum
limit. But both these methods involve costs. Risk financing is defined as the
funding of losses either by using the internal reserves or by purchasing
insurance. The main objective of risk financing is to spread the losses over
time in order to reduce the financial strain. Three ways through which risk is
financed are:
Losses are charged according to the present operating costs.
Ex-ante provision is made for losses by procuring insurance or by
constructing an unforeseen event for which losses are charged.
Losses are financed with loans that are paid after few months.
Risk financing provides the techniques for funding of losses after their
occurrence.
The major risk financing techniques are:
Risk retention.
Risk transfer.

Risk retention
Risk retention finances the loss by retaining the operating revenues and
earnings. Most familiar type of risk retention is self insurance. Self-insurance
is a strategy in which part of an organisations earnings is set aside to deal
with losses. In its general form, self-insurance assigns a contingency fund
for all future losses. In its specific form, self-insurance plan assigns funds to
specific loss categories like property, health care policies and so on.
Risk retention implies that a firm always retains part or all the losses
resulting from a given loss. Risk retention is generally active. Active risk
retention defines a firm that knows about the exposure loss and plan in
order to retain part or all of it.
Risk transfer
Risk transfer is defined as shifting the loss to another party through
legislation, agreement and insurance. Risk of loss is transferred from one
entity to another entity in different ways. It plays a key role in managing
natural risks and mitigating them. In todays scenario, risk transfer is the
main component of overall risk management strategy. Latest developments use
risk transfer methods like catastrophe bonds, catastrophe pools, indexbased
insurance and micro-insurance schemes. All these transfer methods fall into
three basic categories:
Insurance: - Transmit to an insurer (under an insurance contract).
Judicial - Transfer to another party by asset of a legal action.
Contractual - Transmit to another party (under contracts other than
insurance).
1. _______________ refers to the manner in which the risk control
measures that have been implemented shall be financed.
a) Risk financing
b) Risk retention
c) Risk transfer
d) Risk sharing
2. _________________ finances the loss by retaining the operating the
revenues and earnings.
3. _____________ is transferred from one entity to another entity in
different ways.

2.3 Insurance as a Prime Risk Management Tool

In general, risk management deals with risks by designing the procedures and
implementing the methods that lessens the loss occurrence or the financial
impacts.
Insurance is a prime risk management tool which defines risk as a preloss
exercise reflecting an organisations post loss goals. The main purpose of risk
management is to minimise losses and protect people. Insurance is an easily
affordable loss prevention technique.
Insurance acts as contractual transfer for risks. Insurance is an appropriate
management tool when the amount of loss is low and amount of potential
loss is high. For smaller and medium sized organisations, insurance acts as
risk management tool. In certain cases, larger-sized organisations may also
need the services of insurance companies for loss settlements. Even after
insuring a loss procedure, risk manager faces some problems. Hence risk
managers need to choose an appropriate insurance company, policy and
agent. Increasingly, insurance is a prime management tool which resolves
the liability limitations. For example, if a production process requires
chemical components, then special toxic risk insurance is needed.
Activity: 1
Analyse IRDAs guidelines for general insurance risks.
Hint: Refer - http://www.irdaindia.org/guidelines/guideline_insrisk.pdf

4. ______________________ is a process to manage dangerous functions
and policies that cause losses to an organisation.
5. ______________ is the most famous tool of risk management
a) Certainty risk
b) Insurance
c) Loss prevention
d) Uncertainty risk
6. ______________ is a part of overall agenda for managing the risk and
safety of a construction project.

2.4 Option Pricing

The previous section analysed insurance as a prime management tool. This
section will deal with option pricing in insurance.
An option is a security that grants the right to buy or sell the given
underlying asset within the specified conditions. Options are really important for
many reasons in financial economics. Options are generally stocks, bonds,
financial assets and commodities that are traded in markets. During 1970s,
there was significant research on pricing the options. As option is a security
whose pay off is based on the underlying assets, many corporate liabilities are
expressed as options. The amount for a share that an option buyer pays to the
seller is known as option price. The significance of option pricing in insurance
is mainly due to the domain of life insurance. Option pricing theory is used
mainly for life insurance agreements. The early insurance application of
Black Scholes model was related to the pricing of loan guarantees and deposit
insurance.
2.4.1 Types of options
The two types of options are call option and put option. Call option offers the
rights to buy a specified asset like stocks at a particular price during
specified period. Put option provides the rights to sell the specified
underlying asset at an exercised date during specific period i.e. before the
expiry date. Generally there will be two parties for an option contract i.e. the
buyer of the option who buys the particular asset and seller of the option who
sells the underlying asset. The seller of the option commences option contract.
Hence seller of the option is known as writer. The act of selling the option is
known as writing an option.
For instance, a pharmacy companys share (current market price) is Rs 200.
An option contract is generated based on this and traded. A call option will
give the rights to buy this share at Rs 210 for next three months. This
created call option will be distributed between Purchaser and Seller. The
Purchaser will pay a small amount known as option premium of say Rs 10
to the Seller.
When the owner of call option procures the underlying asset, then the owner
exercises the option. The seller of the option is then allowed to sell the
underlying asset at a specified rate to the owner according to the option
contract. Now the buyer of the option should exercise the option on or

before the expiry date. Otherwise the option is said to be unexercised. In put
option, the buyer of the option has the rights to sell the underlying asset. If
the buyer exercises the right to sell the underlying asset, then the seller of
the option should buy it from the buyer at a specified rate or exercised price.
Other types of options are:
Stock options - A stock option is an agreement between two parties in
which the stock holder (buyer of the option) has the right to buy/sell
shares of an underlying stock at a specified price from/to the stock writer
(seller of the option) within the fixed period of time.
Currency options - A currency option is a contract whereby the buyer
of the option has the rights to buy or sell an underlying asset. The
exercise price determines the exchange rate between two currencies in
terms of base currency per unit Indian currency. For instance, suppose
exchange rate is Rs 50, then an option contract is created and traded
based on this share. A call option gives the right to procure the share at
a specified rate say Rs 51 for next three months. Then this call option
will be traded for between two groups - purchaser and seller. The
purchaser pays a small price for the share known as option premium to the
seller.
American/European options - An option contract is valid for a limited
period of time. The validity period of an option contract is known as
maturity or expiry date. Depending upon the maturity pattern of options,
option contracts are classified in to European options and American
options. Options that are exercised only on maturity date of the option or
the expiry date is known as European option. American option is
exercised till and including the expiry date.
Exchange traded vs. OTC options - Currency options are traded either
on organised exchange rates or in OTC (over the counter) market.
Options that are traded on organised exchanges are size, strike price,
expiry date etc. The OTC traded option contract will have the shares as
the underlying assets according to the needs of the consumers. The
OTC options market is referred as an inter-bank market as the major
private players in the market are the commercial and investment banks.
The exchange traded options mainly trade on the exchange rates of the

shares. In exchange traded options, the connection or link between

buyer and seller of the option is finished soon after the contract is
finalised. But in case of OTC traded options, the link between the buyer and
seller sustains till the final settlement of the contract. The
transaction rates of OTC traded options are higher according to the
needs of the customers.
2.4.2 Option pricing models

Black and Scholes option pricing model
This is the most frequently used option pricing model in finance. It was built
up in 1973 by Fisher Black and Myron Scholes and was structured to rate
European options on non-dividend paying stocks. Later it was extended for
American options, options on dividend paying stock and for future contracts.
Assumptions
It assumes that:
The expected return and standard deviation remains constant. (U and
are constant).
There are no taxes and transaction costs.
All securities/stocks are perfectly divisible.
There are no dividend payments on stock during the life of the option.
There are no risks less arbitrage probabilities.
Stock trading is continuous.
Investors can borrow or lend at the same risk free rate of interest
The short term risk free interest rate r is constant.
Black and Scholes pricing formula:

C=sn(d1)- ke-rt n(d2) (call option)
P= ke-rt n(-d2) - sn(-d1) (put option)
ln( s / k ) rt
D1= + 0.5 T
t
ln( s / k ) rt
D2= or d2=d1- T
t
Where
C= call option.
p=put option.
s= stock price.
k= strike price.
e= exponential (constant value = 2.7182818).
r=risk free interest rate annual.
t= time to expiry in years.
=sd of returns (volatility) as a decimal.
e-rt is present value of a future sum of money.
ln= natural log,nd1 is the area under the distribution to the left of d1 and
nd2 is left of d2.
One step binomial method
Consider a case where the stock price is currently at Rs 30 and it is
assumed that after 3 months it may be at Rs 32 or Rs 28. A European call option
buys the stock for Rs 31 in 3 months. In this option there are two values for
estimation i.e. Rs 32 and Rs 28, if the value turns up to 32, the option value twill
be 1 and if 18 it is 0.
Consider
So = initial stock price Rs 30.
S1 = stock price after period.
U0 = up factor.
D0 = down factor.
S1 = u0(s0) when stock price =32 and s1 = d0(s0) when stock price =
28.
When the initial stock price is 30,
Then U0 is 32/30 = 1.06 and the down factor D0= 28/30, 0.93. These are known
as price relatives. The assumption is that the stock price takes only one of the
two possible values at the end of each interval which is referred as the binomial
model.
2.4.3 Factors affecting option pricing
The current market price of the underlying asset is a very important factor to
determine the price of an option. Strike price of an agreement is another major
deciding factor that affects the option pricing. The intrinsic value of option
denotes the option amount that is in-the-money (ITM).

Underlying price
The underlying price is the main aspect that determines the option pricing. The
price of an option premium for strike price undergoes variations based on the
underlying stock price. If the market price is closer to the strike price, the rate of
change will be very high.
Strike price
Strike price is the contracted price that is exchanged when the buyer
exercises the option. Therefore strike price plays a key role in determining
and deciding the price of an option contract. The exercise price remains the
same throughout the life of an option contract and will never undergo any
changes. But, in case of a stock split there will be variations in the strike
price.
Expiry time
The option price is directly related to the expiry time of the option contract. The
buyer of an option makes profit if the option contract is finished with in the
expected estimation of money. If the expiry time of the option contract
decreases, the option value will erode. The longer the expiry term, the
greater is the probability that the share price will increase above the
exercised price.
Interest rate
The option price depends on the risk-free rate of interest in the market. The
higher the interest rate, the higher the call option price and lower the put
option price. The lower the interest rate, the lower will be the call option price
and higher will be the put option price.
Volatility of underlying
Volatility is the standard deviation of the underlying price over a specified
period of time. If the market becomes more volatile, the option premium
contracts will go up. Buying options before the expansion of volatility has a
higher probability of success.
Expected dividends
Dividends or expected dividends of an underlying stock affect the pricing of
options. Once the underlying asset undergoes ex-dividend, the market rate
of the underlying will reduce exactly by the amount of dividend (declared per

share). As a result of this, the future market rate of the underlying asset
should be discounted to the extent of the dividend per share.
The holders of call options on the same underlying stock are not eligible for
dividends. Therefore, when the company declares the dividend, the holders
of underlying stock are benefited to the extent of dividend declared, but the
holders of the call option are disadvantaged. This reflects the price of the
call option.
Henceforth, an increase in the dividend of underlying stock will affect call
prices by reducing it and the put prices by increasing it.
7. In insurance, the ________________ occurs in excess-of-loss or stop-
loss contracts.
8. The amount for a share that an option buyer pays to the seller is known
as _________________.
a) Call option
b) Put option
c) Option price
d) Send option
9. ____________________ offers the rights to buy a specified asset like
stocks at a particular price during specified period.
2.5 Risk Management Tools

The previous section dealt with option pricing. This section will discuss the risk
management tools.
Regulators have identified derivatives as risk management tools for
insurance organisations. Hence insurance companies use these within the
quantitative and qualitative limits determined by the legislation, supervisory
authority and the internal procedures of the organisations. The insurance
companies need to obtain prior authorisation needs for every derivatives it
intends to use. Additionally, the management of the organisation should
develop a system of estimation, quantitative limitation and supervision of
risks.
In case of investment choices, the administrators and supervisors must
improve risks like credit risk, market risk, legal and operational risk. VAR

(Value at Risk) models are accepted by banking and insurance

organisations as a risk management tool to control risks. VAR is defined as
the maximum potential change in value of financial instruments portfolio with
a provided probability for certain time period. VAR approach is useful for risk
management and regulatory purpose. The main aim of VAR approach in risk
management and capital regulation is to bring capital requirements close to
underlying risks of assets in a portfolio. This approach is really important for
insurance organisations as they operate the sufficient capital to cover the
liabilities and claims in future on a long-term basis. Risk exposure is also
covered through investment rules by restricting asset categories. Because
of VAR tools, the quantitative objection in risk management tools is
decreasing.
VAR is a financial engineering tool used by insurance companies. Some
other tools include credit assessments of individuals, pricing of risks and
valuations of combined risks of companies that engage in multiple markets.
Asset liability management and revenue management are optimised tools for
financial management and risk management.
10. The main aim of VAR approach in risk management and capital
regulation is to avoid capital requirements close to underlying risks of
assets in a portfolio. (True/false).
11. Regulators distinguished that __________________ are the risk
management tools for insurance organisations.
12. ____________________ is defined as the maximum potential change
in value of financial instruments portfolio with a provided probability for
certain time period.
2.6 The Insurance Market

Conventionally, life insurances were ruling banking industry primarily on the
agency distribution forces whereas business of general insurance is
dependent only on the development sectors. The private players are
introducing international experience, new technology and distribution
channels. The basic rules are redefined in insurance business. Many
insurance companies today are below tariff which implies that insurance
cannot rate the product according to the customer range. A simple way to
help the customer is to divide the market shares and give the appropriate
product at correct rate. The distribution channel acts as an intermediate to

reach the masses in urban and rural areas.
The insurance sector expanded its growth privately four years back. The
insurance market has seen dynamic changes due to the presence of a large
number of insurers in both life and non-life sectors. Many private insurance
organisations started joint ventures with well recognised international
players.
There are about 29 insurance companies presently ruling the Indian market with
14 private life insurers, 9 private non-life insurers and 6 public sectors. The
Indian insurance industry currently stands at a junction where the
competition is getting intensified and companies are preparing to survive in the
global scenario.
The health insurance division has marvelous growth potential in insurance
market. New players are entering the market and innovative enhancements of
products are being implemented. The strengthening of the health care over
time allows private players to grow and rate the products for the betterment
of society.
2.6.1 Market economy
Insurance business in India has a special place in the market economy as it is
being marketed globally. Insurance market in India is important for the
following reasons:
Insurance has become a highly technical industry where the customers
choice is of primary importance. This industry also produces a huge
amount of resources. Hence it is able to encourage the development of
infrastructure and overall economy. Insurance is long term basis
business with a long gestation period and requires lot of patience.
Insurance business follows ethics and rules of corporate governance. Its
recent adoption is Citizens Charter which signifies its commitment in
insurance industry.
Insurance is a risk financing method and mainly used for paying the
losses if any risk occurs. Society cannot neglect risks present around
them. The insurance business helps the risks to spread wider by
lowering the premium rates which in turn raises the profit rates.
Insurance is very important for savings. In certain countries, there is an
absence of state welfare profits. So people living there should make
provisions for their fiscal security. Insurance is not only important for tax
benefits but for both savings and security.
Insurance and reinsurance play a major role in the market economy of
nations and facilitates many economic activities. Insurance companies
help to spread the catastrophic fiscal effects of risks to mobilise the
savings for better development, productive use and internal and external
trade. As insurance distribute the risks worldwide, the effect of
catastrophe on group of companies is minimised.
Insurance industry is a reactive industry and responds to the external
influences after they occur.
Figure 2.1 compares the premium rates of private and public sectors before and
after removal of tariffs. The data is given for the period 2007-08. Before the
removal of tariffs, the private sector share of motor business was much lower
when compared to the public organisations because of negative underwriting
limits. But later on with the formation of a common motor pool, the situation
changed. The losses with respect to this sector are shared between the
players. Now after removal of tariffs, fire and engineering sectors are
contributing a lot to the private and public sectors. In totality, the focus is shifted
now towards the retail sectors of motor and health and growth is highly
expected to increase.

Fig 2.1: Indian General Insurance Industry
2.6.2 Consumers choice

Insurance business is developing and liberalising in India. Many foreign
organisations in Indian market are offering high quality services to the
consumers. The increase in number of insurance companies provides a
wider choice for the Indian consumers. Insurance companies design the
products based on the requirements of the consumers.
2.6.3 Channels of distribution in insurance industry
Now-a-days insurance companies are dependent on different distribution
channels such as PO (Post Office), NGOS (Non Government
Organisations), travel agencies, trade unions and financing companies. In
an era of financial sector unions, technology is used for expanding the reach
of insurance companies. Policies are designed and published on net to sell
the particular product and premiums are paid through ATMs, online. 52 per
cent of the people are using internet as a distribution channel. Many people

consider mobiles, kiosks and trade stores as new innovative channels for
distribution. Direct mailers are also used as a new innovative channel.
Agents
Agency power is still the most leading channel in India for distributing the
insurance products. But this channel cannot sell the insurance with
assurance. The fact is that agents concentrate more on numbers than
creating awareness about the need for insurance. Agents need to be trained
properly to explain the need for insurance.
Brokers
Brokers in insurance are the professionals who review the risks on behalf of
the clients, counsel the risk mitigation, recognise the optimal structure of
insurance policy, lending friendly hands among insured persons and
insurers and help the administration performance in contract where claims
occur.
The advantages of having brokers in insurance industry are:
Customer service improvement: - Due to the increased competition,
insurance brokers started new and creative products in order to satisfy
the needs of the consumer and deliver higher quality outputs. Indian
corporate offices and customers get benefited in terms of products and
new policy innovations and have secured insurance coverage.
Technology transfer: - Brokers in insurance industry introduced the
best practises in technical skills and services, training and management
programs internationally.
2.6.4 Consumer protection
Consumer protection safeguards the financial segments from political risks. The
consumer protection is very important as insurance has become a device of
significance.
Insurance lies in the category of goods and hence relies on publics trust by
delivering quality outputs accordingly. Insurance is a social activity with huge
positive influences. Insurance markets in developing and developed countries
have developed consumer components.
In developing markets, consumer protection is a secondary issue for the
sectorial growth and prudential lapse. In several developing countries, the
middle class guard themselves by trading with honest global insurers.

In India, the Consumer Protection Act of 1986 covers all forms of insurance like
life, property, health and so on.
Consumer protection assessment template
Consumer protection regime law must provide clear rules on consumer
protection in the field of insurance and sufficient institutional preparations for
execution and enforcement of consumer protection regulations. The rule
must have definite provisions in the law to generate effective regimes for the
fortification of trade consumers of insurance. This rule gives preference to the
role of the private sectors, along with charitable consumer protection firms
and self-regulatory organisations.
Claiming insurance is a very serious and prolonged task. Consumer
protection laws protect consumers from deficits in insurance. The consumer
protection provides coverages from general insurance to indemnity
insurance policies. In India, consumer protection law enables policy holders
to file cases against insurers if the insurers create any problems. Any delay
in the payment of a claim leads to deficiency of services. National Insurance
Commission defines a reasonable time frame within which the insurers
should resolve or reject a claim. Any delay (beyond the time limit) in the
payment leads to deficits in insurance. The plaintiff can claim compensation
which includes not only the value of the policy but also monetary damages
for the mental agony suffered due to the deficiencies in insurance services.
Consumer protection act established some special deliberations to prepare a
valid case against insurance deficit. They are:
Insurance premium payment - A policy owner should have timely
premium payments in order to make an insurance claim. Policies that
have elapsed can be revived with proper default to raise a claim.
Succession certificate - An insurer requires a succession certificate
when there is a dispute about legal beneficiaries of the policy holder.
2.6.5 Global scenario of insurance markets

The global scenario of insurance has undergone significant changes since
last few years especially after the terrorist attack on the World Trade Centre
on 9/11/2001. Accidentally, the stock markets suffered a steep decrease in
price towards the ending of last century. Such financial losses made large
number of insurers or reinsurers bankrupt and many of them suffered lower
ratings by reputed agencies. In spite of these setbacks, the insurance

industry finally recovered from serious and unforeseen fiscal losses and now
looks as solid and flexible as ever.
GDPs grew more rapidly than insurance premiums (both life and non-life)
diminishing the heights of insurance penetration (IP). The collective ratio
for the emerged markets was faintly above 100 per cent and insurance
industry showed huge profitability. Insurance density is calculated as the
gross premiums to population or capita. These calibrations on a relative
basis represent the progress of insurance and classiness of the insurance
markets.
The global issues that affected the insurance markets and the challenges
that shaped the future enhancements during recent years are:
The effect of WTC attack was the acceptance of the terrorism risk by
the insurance industry. The risk was viewed as analogous to the war risk
on land.
The world observed extraordinary increase in the rates for all the risks
guaranteed by the insurers to recover the huge looses. The policy terms
and conditions were stiffened. The primary insurers were pressurised to
reimburse the higher reinsurance costs.
The issue of "contract certainty" was also brought up after the WTC
attack.
Property insurance industry has stabilised through hardening lately.
Collateral issues still remain as one of the vital areas in casualty insurance
policies. Casualty insurance maintains agreements with insurance
regulations and with insurers. Regulations are still the main concern in most
areas.
Through globalisation the insurance market in every country stands as an
integral part of global insurance market. There is a need to scrutinise, study and
appreciate the dealings that emerged markets have with issues and losses.
National markets are dependent on reinsurance.
Activity: 2
Analyse general insurance market outlook of private sectors regarding
premium growth for the year 2007.
Hint: Refer-www.icra.in/Files/Articles/Insurance-ICRA-Moodys-200704.
pdf


13. ________________ safeguards the financial segments from political
risks.
14. ________________ is still the most leading channel in India for
distributing the insurance products.
a) Brokers
b) Agency power
c) Insurance market
d) National market
15. The __________________ division has marvelous growth potential in
insurance market.
2.7 Summary
Risk financing refers to the manner in which the risk control measures that have
been implemented shall be financed.
The main risk financing techniques are:
Risk retention.
Risk transfer.
Insurance is the most popular tool of risk management. Apart from health, life
and disability insurance, it is very necessary look at the forms of liability and
property insurance.
An option is a security that grants the right to buy or sell the given
underlying asset within the specified conditions. Options are really important for
many reasons in financial economics.
Options are generally stocks, bonds, financial assets and commodities that are
traded in markets.
Other types of options are:
Stock options.
Currency options.
American/European options.
Exchange trading and OTC options.
Regulators have identified derivatives as risk management tools for
insurance organisations.

VAR (Value at Risk) models are accepted by banking and insurance

organisations as a risk management tool to control risks.
VAR is defined as the maximum potential change in value of financial
instruments portfolio with a provided probability for certain time period. The
insurance sector expanded its growth privately four years back. So far, the
private players were active in the globalised atmosphere. Now-a-days
insurance companies are dependent on different distribution channels such as
PO, NGOS, travel agencies, trade unions and financing companies.
Insurance lies in the category of goods and hence relies on publics trust by
deliver quality outputs accordingly. Insurance is a social activity with huge
probable positive influences.
2.8 Glossary
Insurance penetration: Insurance penetration is measured as the
percentage ratio of premiums to GDP.
Reinsurance: Reinsurance protects the insurance company against a
certain portion of potential losses.
Casualty insurance: Casualty insurance covers the losses and charges due
to unpredictable accidents.

1. Define risk retention.
2. Explain how insurance a prime risk management tool is.
3. Define the concept of option pricing.
4. What is VAR and how it is useful in risk management tool?
5. Why is the insurance market very important in India?
2.10 Answers
1. a) - Risk financing
2. Risk retention
3. Risk of loss
4. Risk management
5. b) - Insurance
6. Insurance procurement

7. Pay off
8. c) - Option price
9. Call option
10. False
11. Derivatives
12. Value at Risk (VAR)
13. Consumer protection
14. b) Agency power
15. Health insurance
Terminal Questions
1. Risk retention finances the loss by retaining the operating revenues and
earnings. The further explanation regarding risk retention is discussed in
section 2.2.
2. Insurance is the most famous tool of risk management. Apart from
health, life and disability insurance, it is very necessary look at the forms
of liability and property insurance. The further explanation is given in
section 2.3.
3. The amount for a share that an option buyer pays to the seller is known
as option price. The significance of option pricing in insurance is mainly
due to the domain of life insurance. The further explanation is given in
section 2.4.
4. VAR is defined as the maximum potential change in value of financial
instruments portfolio with a provided probability for certain time period.
Risk management tools based on VAR are popular and well-known in
banking and insurance organisations. The further detail of VAR is
explained in section 2.5.
5. Insurance has become a highly technical industry where the customers
choice is of primary importance. This industry also produces a huge
amount of resources. Insurance is long term basis business with a long
gestation period and requires lot of patience. The further details about
importance of insurance industry are explained in sub-section 2.6.1.

2.11 Case-Let
Risk Financing
Catastrophe risk financing is a combination of all the methods that are
used to pay financial losses that occur during a disaster. Risk financing
concentrates on ex-ante (before the disaster) measures like risk transfer
and sharing. Ex-ante risk financing methods usage is increasing in
developing countries. But support of ex-post (after the disaster) financing
is also needed.
Risk financing is an integral part of general disaster reduction strategy.
Risk transfer is an integral part of risk financing strategy. For
strengthening the resources to avoid risks from occurring (both ex-post and
ex-ante), risk financing is an essential tool for countries as well as for
individuals, households and communities.
NGO (Non-government Organisation) Myrada developed the Indian
microfinance institution Sanghamithra as a separate organisation. It found
that credit, savings, insurance and capacity building are important
elements for sustaining livelihoods. Beneficiaries are organised in Self-
help Affinity Groups (SAGs) to manage savings, employ diversification
strategies like maintaining savings in both common SAG funds and local
banks. When Sanghamithra offers credit, Myrada and other NGOs also
offer infrastructure, business linkages and training to SAGs.
Birla Sun Life developed an insurance product called the Social
Development Plan which was appealing to the SAG members. It offers life
insurance for both accidental and natural death. It also offers the full sum
assured for full disability and 50% of the sum assured for partial disability.
Insurance policy management support is provided with a commission by
Community Managed Resource Centres. With this support, beneficiaries
can access products and choose the products for managing the risks.
Some of the learnings of risk financing by Sanghamithra and other
organisations at a micro level after the tsunami of 2004 are:
1. Aid is always necessary.
2. Demand management is a great challenge.
3. Different goals require different products.
4. Training and education are important as financial services.

5. Microfinance is necessary to support disaster mitigation.

6. Microfinance promotes a culture of prevention.
7. Funds for disaster are required at all the levels.
8. Micro-insurance is necessary to mitigate risks.
1. Explain why risk financing is an essential tool for countries as well as
for individuals, households and communities.
(Hint: Strengthening resources, avoid risks)
2. What are the important elements found by NGO Myrada to sustain
livelihoods?
(Hint: Credit insurance, savings).
Source: http://www.proventionconsortium.org/?pageid=19#financing
References
Neil.A.Doherty (2000). Integrated Risk Management, First edition,
McGraw Hill Companies, USA.
Justin Gooderl Longenecker, Carlos W. Moore, J.William Petty, Leslie E.
Palich (2006). Small Business Management, Thirteenth edition,
Thomson Corporation, USA.
Philip P. Purpura (2008). Security and Loss, Fifth edition, British Library,
USA.
E-References
http://www.bls.gov/oco/cg/cgs028.htm
http://www.rajputbrotherhood.com/eng/articles/principles-of-
insurance.html
Retrieved on 27th October, 2010
http://www.riscario.com/reqt-for-valid-ins-contract
http://www.ehow.com/list_6678421_insurance-contract-
requirements.html
http://www.scribd.com/doc/35370303/Miscellaneous-insurance
http://www.insurecan.com/4-317-miscellaneous-insurance-3
http://www.irmi.com/products/store/risk-financing.aspx
http://www.harder.com/html/risk_retention.html
http://www.lawisgreek.com/indian-insurance-services-and-consumer-
protection-laws/
Retrieved on 8th November, 2010
Unit 3 Indian Insurance Industry and Economic

Reforms in the Insurance Industry
Structure:
3.1 Introduction
Objectives
3.2 Public and Private Insurance Companies
Voluntary and involuntary coverages
3.3 Insurance Regulatory and Development Authority (IRDA)
3.4 Professionals in Risk and Insurance Management
Underwriters
Actuaries
Agents
Brokers
Loss adjusters
Risk and insurance managers
3.5 Players in the Insurance Industry
Public sector players and their products
Private sector players and their products
3.6 Economic Reforms in Insurance Industry
Recommendations of Malhotra committee
Amendments to the General Insurance Business (Nationalisation) Act
1972
Amendment to the Insurance Regulatory and Development Act
1999
The LIC (Amendment) bill 2009
3.7 Summary
3.8 Glossary
3.10 Answers
3.11 Case-Let
3.1 Introduction
The previous unit discussed about risks and mitigating risks via insurance
markets. It discussed the requirements of an insurance contract, nature,
benefits and cost and principles of insurance. It also explained the concept

of insurance markets. This unit discusses about Indian insurance industry and
economic reforms in the industry.
The Indian insurance industry gives importance to both life and general
insurance and is an active sector nowadays. After going through various
changes after 1999, public and private sector insurance companies have
flourished well in India. The largest life insurance company in India, Life
Insurance Corporation of India still remains under the public sector.
This unit explains about the public and private insurance companies in India. It
explains the different types of insurance organisations in India. It lists the
different professionals in risk and insurance management and the players in
insurance industry. It also explains the economic reforms in the Indian
insurance industry.
Objectives:
explain about public and private insurance companies
describe the types of insurance organisations
list the professionals in risk and insurance management
discuss the players in the insurance industry
describe the economic reforms in insurance industry
3.2 Public and Private Insurance Companies

Insurance companies are mainly divided into public and private sector
companies. The government to help manage the risks faced by the people of
India formed public sector insurance companies. Public insurance is also known
as social insurance as it helps citizens below the poverty line or people who
cannot face their basic risks by themselves.
A public sector insurance company works by redistributing profits to the
needy persons who does not have any means to cope with their basic risks.
Government takes action by relocating economically backward people
through the operations of social insurance program which will help to set up
basic security.
The social insurance programs are divided into social insurance approach
and welfare approach. In social insurance approach, people with high
income donate a sum on a regular basis to the insurance company which in

turn is used to help manage risks of people below the poverty line. The
welfare approach uses welfare funds to contribute to the economically
backward people.
Public sector provides both life and general insurances in India. The first
public sector insurance company, the Life Insurance Corporation of India
(LIC) remains the only one in India till now. The General Insurance
Corporation of India is a public sector general insurance company with its
four subsidiaries - National Insurance Company Ltd, Oriental Insurance
Company Ltd, New India Assurance Company Ltd, and United India
Assurance Company Ltd.
A private sector insurance company such as ICICI Prudential Life Insurance
Company limited or Bajaj Allianz General Insurance Company limited works
privately for organisations of individuals, policyholders and stockholders.
Private insurance companies also cover life and non-life insurances. Usually the
transfer of risk is done through a contract as private insurance
companies are voluntary.
The total number of insurance companies in India is given in table 3.1.
Table 3.1: Number of Registered Insurance Companies in India
Type of company Public sector Private sector Total
Life 01 22 23
General 06 18 24
Reinsurance 01 0 01
Total 08 40 48
3.2.1 Voluntary and involuntary coverages

Apart from the public and private sector classifications, insurance coverages are
classified as voluntary and involuntary. Voluntary insurance is an optional
insurance which is taken by an individual or a company by their own wish.
Private insurance is usually a voluntary insurance which includes automobile
insurance, workers compensation insurance etc. Only 3% of Indias
population is covered under voluntary health insurance and there is scope for
expansion.

Involuntary insurance comes under public sector where the individual is

liable to take up insurance by law. It is usually taken for social development,
unemployment or for the protection of particular class of people in the
society.
1. Public insurance is also known as __________________ as helps the
people below the poverty line or people who cannot face their basic
risks by themselves.
2. In a private sector company, usually the transfer of risk is done through
a contract and they are voluntary. (True/False).
3. Involuntary insurance comes under ____________sector.
3.3 Insurance Regulatory and Development Authority (IRDA)

The previous section discussed the different public and private insurance
companies in India. This section describes the role of IRDA.
Insurance Regulatory and Development Authority (IRDA) was shaped in the
year 1999 when the Indian parliament passed the IRDA bill. This
organisation was developed to control and enhance the insurance industry
standards. It aimed to protect Indian policyholders from different types of risks
faced by them.
IRDA is a team of ten appointed by the Government of India, which includes the
Chairman, five full time associates and four part time associates. The
functions and powers of IRDA are listed below.
Functions and powers of IRDA
The functions and powers of IRDA are:
It gives a certificate of registration, renewal, withdrawal, modification,
suspension or cancellation of registrations to the applicants in insurance
industry.
It safeguards the interests of policyholders of all insurance companies
regarding the assignment and nomination of policy, resolution of
insurance claim, insurable interest and submission value of policy and
other terms in the contract.
It states the mandatory credentials, code of conduct and practical
instructions for mediator, as well as the insurance company.

IRDA supports competence in the insurance industry. It promotes and

regulates professional organisations in insurance.
It has the responsibility of inspecting and examining the audits of the
insurers, agents, actuaries, insurance intermediaries and other
organisations.
It is also assigned the task of controlling and regulating the rates and
profits and conditions given by the insurers with respect to the general
insurance business which was not controlled or regulated by the Tariff
Advisory Committee.
It is permitted to oversee the performance of the Tariff Advisory
Committee.
It states the way in which the books of accounts should be maintained
and insurers and other insurance mediators shall provide the statement
of accounts.
It controls the investment of funds by insurance companies as well as
the upholding of the margin of solvency.
It can get involved and resolve the disagreements between insurers and
agents, brokers or other insurance intermediaries.
It has to state the share of premium income of the insurer to finance
policies.
It also states the percentage of share of life and general insurance
business to be received by the insurer in the rural or social sector.
The formation of IRDA had a major impact on the Indian insurance industry.
When IRDA started to function, it had to deal with only two players in the
industry - LIC and GIC. Now IRDA deals with more than 20 players of the
industry.
4. IRDA is basically a team of eight members.(True/False)
5. IRDA supports competence in the insurance industry.(True/False)
6. IRDA is permitted to oversee the performance of the _____________
Committee.
3.4 Professionals in Risk and Insurance Management

The previous section dealt with the functions of IRDA. This section
describes the professionals involved in risk and insurance management.

In the huge industry of insurance lots of people specialising in different

professions contribute their expertise. Nowadays millions of people work for
insurance companies. This section deals with different posts handled by
experts to run the insurance companies.
3.4.1 Underwriters
The insurance underwriters are skillful persons who do the tough job of
reviewing the insurance and other related applications. They have to identify the
risk taken by the company while it insures any property. They have to anlayse
this risk by gathering information from various sources and write policies to
manage it. These applications are accepted or rejected under some basic
criteria of individual companies.
An underwriter has to meet the policyholders, brokers, agents and mangers
on a daily basis. The underwriters work to create a pool of insured whose
actual loss will approximately be the expected loss of a given theoretical
pool of insured. So they work to find exposure whose specifications match
the theoretical pool. Their final goal is to bring the actual and the expected
loss very close and find the best policies accordingly. If the underwriter finds
it risky and rejects many applications, then the insurer suffers a loss.
Nowadays insurance companies use computerised systems to check the
applications and make the underwriters job easy. These applications help to
complete the work in a short time and will provide reliable and accurate
results. They analyse, rate the application and also recommend whether or
not to accept the risk. The system adjusts the premium to make the risk
acceptable. Through these systems, underwriters can also analyse reports
of losses and actuarial studies, reports on chances of insurance loss.
All insurance policies contain details about the types of losses covered.
Insurance underwriters can specify a supplementary uncovered item known
as exclusion. This means that if any loss occurs due to this exclusion, then
the insurance company is not obliged to pay. The underwriters should see if
any adverse selection or anti-selection does not affect an application. Anti-
selection does not give the actual cost of the exposure while giving the
average rate. If an underwriter does not analyse an application properly, the
actual loss can go well above the expected loss. Underwriting skills are
acquired from many years of experience and judgment.

3.4.2 Actuaries
Actuaries are experts who are involved in the prediction of future of the
policies based on past outcomes and probability models. They analyse the
insurance rates, rating procedures, rating strategies, and schedules of
insurance companies. Their basic skills are reviewing, anlaysing insurance
operation and underwriting. Actuaries determine in advance the uncertain
events that could take place in future and come to a conclusion accordingly.
Actuaries also do pricing, product design, financial management and
corporate planning. They use their professional skills and experience to
solve complicated financial problems. They need to be skilled
mathematicians to solve insurance problems easily.
Actuaries also have a legal responsibility to protect the payment promised by
insurance companies. Their role is challenging and demands the best
standards of reliability and application of professional skills.
3.4.3 Agents
Insurance agents are an essential part of the insurance industry. An agent is a
representative of the insurer who can act upon the insurers behalf. They are the
link between the insurers and the insured.
According to the agency law, a person who acts for another person is
termed as an agent. A life insurance agent does not have right to act upon as
the company and works simply as an agent who identifies people to sell the
policies. A property or liability insurance agent can act upon as the
company until the policy is issued. The person whom the agent acts upon is
known as the principal. The insurance companies are the principals of the
agents. When agents act for the principal they should obey the principal and be
loyal to the principals interest.
The principal in turn has the duty to pay the agents commission according to
the services done by the agent. The agency law clearly states all the rights
and responsibilities of insurance agents and principals.
The insurance agents who are given the authority to bind their principals to
insurance contracts are known as general agents. They work mainly for
property insurances. The agents have the power to support the claim made
by the customer, even if the agents act is beyond the scope of express
authority.

If the insurance agent does not deposit the premium paid by the insured,
then the company is legally responsible to pay such losses. Good insurance
agents not only do their duties towards the company but also help the
customers to find the best insurance policies according to the customers
needs.
3.4.4 Brokers
Brokers are people who legally represent the insured. The customer is the
principal of the broker who provides the broker with limited authority. The
brokers have to find a suitable insurer according to the principals needs.
They cannot act on the insured behalf but are given commission for their
work.
Brokers can also be insurance agents so that they can connect the insurers and
insureds. A broker may seem similar to an agent but there is a significant
difference. When a principal gives details regarding the risks to the agent, all
the facts and documents related to it is passed on to the agent. But if the
principal of a broker gives information about the risks no such facts or
documents are given to the broker. This is where the limitation in the brokers
authority appears.
There are clearly defined laws which list the responsibilities of a broker and
a principal. The insured gives the commission to a broker according to the
premium charged to the insured by the insurer. The broker in turn should
give priority to the principals risks and requirements. They have to design
the insurance programs in such a way that the principal gets a maximum
benefit from it.
The role of the broker in property and liability insurances is more in life and
health insurances. Nowadays, there are well established brokerage firms
which have a specialised broker for different types of insurances.
3.4.5 Loss adjusters
Insurance loss or claim adjusters decide whether a person who demands a
compensation for any loss due to injuries or property damage is asking for a
legitimate payment under any insurance policy. Usually insurance loss
adjusters work for insurance companies but they can also work as
independent advisors for the insured.

Loss adjustors should be experts in analytical and people management

skills. They should analyse the claim, interact with several people and study the
claim and policy documents well before coming to a conclusion about the
settlement. It may even require negotiation with the claimant or legal action
against the insurer.
Large insurance companies have a loss adjustment centre where the claims are
managed immediately and a cheque is issued for the claimant.
Independent adjusters handle cases like business losses or homeowner
claims, such as damages due to some hazards. The loss adjuster has to
physically examine the property and make sure that the claim is genuine and
decide the compensation accordingly.
There is one more type of loss adjuster who works independently for the
insured and not for the insurance company. They are known as public
adjusters and negotiate with the insurers for claim settlement.
3.4.6 Risk and insurance managers
Risk and insurance managers are experts who have the ability to predict the
future to a certain extent and identify risks. They have to identify and
manage all types of risks and the losses associated with it. They have to
study the budget of the insurance company to detect these risks.
Risk and insurance managers try to visualise the worst case scenario of the
companys future and work to avert that situation. If an unforeseen loss
occurs they are responsible to manage it. Their job is important as they
have access to all the resources and earnings of the insurance companies.
They have to keep the company away from any legal or financial damage
and prove to the insurers that the company is investing wisely.
7. ________________________have to anlayse risk by gathering
information from various sources and write policies to manage it.
8. An insurance agent represents the _____________.
a) Insured
b) Insurer
c) Government
d) Adjustment bureau

9. Loss adjustors should be experts in ___________________ and

___________________________ skills.
3.5 Players in the Insurance Industry

The previous section dealt professionals in risk and insurance management. This
section deals with the players in the insurance industry. As discussed earlier in
this unit, we know that the insurance industry in India has flourished in
both public and private sectors. We will discuss some of the main insurance
companies and their products in this section.
3.5.1 Public sector players and their products
The public sector players of the insurance industry were introduced in the year
1947. Even now, the majority of Indian citizens rely on the public sector
insurance. The life and general public sector corporations of India are:
Life Insurance Corporation of India.
General Insurance Corporation of India.
Life Insurance Corporation of India
Life Insurance Corporation of India or LIC founded in 1956 is the largest
public sector insurance company in India. It is owned by the government of
India and funds around 26% that of the expenditure of Indian government.
LIC has 8 zonal offices, 101 divisional offices, and around 2048 branches
located all over India. There are about 1.2 million LIC agents in India.
The products of LIC are:
Individual plans - LIC provides different individual insurance policies
for varied needs and requirements of each individual. Some of the plans
are:
o Endowment plans - These policies pay the face value of the policy
either on the death of the policy holder or when the policy matures.
o Children plans - LIC provides policies such as Jeevan Anurag,
Child fortune plus, Jeevan Kisore etc. to meet the educational and
other needs of growing children.
o Money back plans - These plans provide periodic payments of
partial survival benefits. For example, Jeevan Surabhi, Bima Bachat.
o Whole life plans - These policies provide payment of sum assured
plus bonuses on the death of the policyholder. Some such policies
are Jeevan Anand, Jeevan Tarang.

o Term assurance plans - These plans cover the insured person

from risk for a particular term. Examples are Anmol Jeevan - I,
Amulya Jeevan - I.
o Joint life plans - LIC provides plans such as Jeevan Saathi and
Jeevan Saathi Plus where a couple can have life insurance coverage
using a single policy.
o Pension plans - Pension plans like Jeevan Nidhi and Jeevan
Suraksha are individual plans that ensure financial stability after
retirement.
Withdraw plans - LIC offers withdrawal plans for life, health, market,
money and children. Only existing policy holders can avail these plans.
These policies can be returned within 15 days if the clients are not
satisfied.
Unit plans - Unit plans are investment plans to save the income and
yield benefits. They provide tax savings also. Bima Plus is one such
plan. The premiums paid are used to purchase units of a fund. On policy
surrender, the cash value of the units is paid to the policy holder.
General Insurance Corporation of India

General Insurance Corporation of India (GIC) was founded in 1972, due to
the Section 9(1) of the General Insurance Business (Nationalisation)
Amendment bill (GIBNA). It was formed under the Companies Act, 1956 to
generate and control business in general insurance sections.
The four subsidiaries of GIC are:
The Oriental Insurance Company Limited.
The New India Assurance Company Limited.
National Insurance Company Limited.
United India Insurance Company Limited.
The Oriental Insurance Company Limited
The Oriental Insurance Company Limited was founded in 1947. In 2003, all
shares of the company were transferred to Central Government. Its
products are in various areas such as:
Personal - Personal policies are used to provide health insurance to
individuals and groups. Some of the policies include:
o Oriental Royal Mediclaim policy.

o Group Mediclaim policy.

o Personal accident -Individual.
Commercial - Commercial policies include insurances for houses,
business etc. Some of the commercial policies are:
o Office umbrella policy.
o Shopkeepers insurance policy.
o Sweet home insurance policy.
Rural - Rural policies are used for the welfare of farmers and other rural
occupations. Some of the policies are:
o Cattle insurance.
o Grahmin accident insurance.
o Horticulture insurance.
The New India Assurance Company Limited
New India Assurance Company was found in 1919 by Dorab Tata and
nationalised in 1973. Some of its products are:
Personal - The New India Assurance Company provides personal life
and heath insurance policies for individuals, family, senior citizens etc.
Some personal plans are :
o Mediclaim policy.
o Personal accident policy.
o Householders policy.
o Money insurance.
Commercial - This category of policies cover shop keeping, marine,
aviation and other commercial areas. Some commercial plans are :
o Jewellers block policy.
o Bankers indemnity policy.
o Shopkeepers policy.
o Marine cargo policy.
Industrial - Industrial insurance policy is for losses or damages in heavy
machinery used in manufacturing industries. Some industrial plans are :
o Fire policy.
o Burglary policy.
o Contractors all risk policy.
o Electronics equipment policy.

Liability - It covers liability of public, products, employees etc. some

liability plans are:
o Public liability policy.
o Products liability policy.
o Professional indemnity policy.
National Insurance Company Limited
National insurance company limited was founded in 1906 with an initial paid up
capital of Rs.100 crores. Its products are:
Personal Line Insurance - Personal Line Insurance is meant to cover
risks of person and property of individuals or group of individuals or
liability upon them. Some personal plans are:
o Householders policy.
o Critical illness policy.
o NRI accident policy.
Rural line insurance - To provide financial protection against loss of their
small income for the rural people and weaker section of urban society.
Some rural line plans are:
o Cattle / Livestock insurance.
o Silkworm (Sericulture) insurance.
o Horticulture/Plantation insurance.
Industrial line insurance - Industrial insurance is another branch of non-
life insurance which covers various risks faced by the industry. Some
industrial line plans are:
o Erection all risks insurance (EAR). o
Machinery insurance (MI).
o Money insurance.
o Marine cargo insurance.
United India Insurance Company Limited
United India Insurance Company Limited was founded 1938 by merging 22
companies. Its products are:
Personal Policies - Personal policies are for individuals and their
families in case of any loss or injury. Personal policies include: o
Householders policy.

o Mediclaim policy.
o Unimedicare policy.
Commercial policies - Commercial policies include damage of
commercial equipments due to hazards or coverage for liability. Some of the
commercial policies are:
o Fire insurance policy.
o Marine insurance policy.
o Motor insurance (vehicle insurance) policy. o
Industrial insurance policy.
o Liability insurance policy.
3.5.2 Private sector players and their products
The private insurance sector in India was formed to reduce the domination of the
two public sector companies. Another reason for the formulation of the private
sector was to give better coverage on products and services. Private sector
also provides life and general insurances.
Life insurance companies - The private life insurance companies are:
ICICI Prudential Life Insurance Company Limited - It is one of the
first private sector insurance companies founded in 2000 with the
approval from Insurance Regulatory Development Authority (IRDA). Its
products are given below:
o Life insurance plans - Life insurance plans of ICICI are meant for
individuals and families for education, wealth creation, protection
etc.
o Pension and retirement solutions - These plans are for individuals
who want to save money for retirement as a pension. For example,
ICICI Pru ForeverLife.
o Health solutions - This plan is for health care of individuals and
families. It has hospitalisation plans like MediAssure and critical
illness plans.
o Group plans - Group insurance plans from ICICI Prudential
provides benefits for an individual as well a group of employees.
Examples are Group super annuation, Group gratuity plus etc.
Birla Sun Life Insurance Company Limited - It was formed in 2000 by
merging the Aditya Birla Group and the Sun Life Financial Inc. Its
products are:

o Individual solutions - These include wealth with protection

solutions, protection solutions, childrens future solutions, health and
wellness solutions, retirement solutions etc. Some examples are Birla
Sun Life Insurance Children's Dream Plan, Birla Sun Life Insurance
Term Plan.
o Group solutions - These include protection solutions, retirement
solutions, rural solutions etc. For example, Birla Sun Life Insurance
Group Unit Linked Plan, Birla Sun Life Insurance Group Protection
Solutions etc.
o NRI Solutions - Provides insurance for welfare of Non Resident
Indians. For example Birla Sun Life Insurance Prime Life, Birla Sun
Life Insurance Flexi Life Line Plan etc.
General insurance companies
The general life insurance companies are:
Bajaj Allianz General Insurance Company Limited - Bajaj Allianz
General Insurance Company Limited was formed as a joint venture of Bajaj
Finserv Limited and Allianz AG. It has products in the categories given
below are:
o Car & Two Wheeler - Bajaj Allianz Motor Insurance policy provides
protection for motor vehicles.
o Travel - Insurance policies such as Travel companion, Travel elite,
Student travel are provided by Baja Allianz to cover travel associated
risks.
o Health - Policies such as Health Ensure, Extra Care, Personal
Guard, Hospital Cash provide etc. coverage for health related risks.
o Property & Business - These are policies provided to protect
corporate and household risks.
Tata AIG General Insurance Company Limited - Tata AIG General
Insurance Company Limited was formed as a joint venture of Tata
Group and American International Group, Inc. (AIG).Its products are:
o Personal insurance - It includes motor, home, travel and health
insurance.
o Small business insurance - It provides insurance for offices, hotels
and restaurants, educational institution and so on.
o Corporate - It provides insurance for motor, fire and engineering,
marine cargo, financial line etc.

Activity: 1
Compare a life insurance policy provided by LIC and a private sector
insurance company. Analyse and identify which one is better.
Hint: Refer - http://www.apnainsurance.com/life-insurance-india/

10. The only public sector life insurance company in India is
______________________________.
11. The __________________________ is formed with four subsidiary
companies.
a) Life insurance Corporation of India
b) ICICI Prudential Life Insurance Company
c) General Insurance Corporation of India
d) Bajaj Allianz General Insurance Company
12. One reason for the formulation of the private sector was to give better
coverage on ______________and ____________.
3.6 Economic Reforms in Insurance Industry

The previous section described public and the private players in the
insurance industry and their products. This section deals with the economic
reforms in insurance industry.
In India, the insurance industry started in 1818, when a foreign life insurance
company, Oriental Life Insurance Company was formed in Kolkata. In 1912,
the Life Insurance Act was passed which the Indian Insurance Companies
Act followed in 1928. The first general insurance company in India was the
Triton Insurance Company Ltd found in 1850. But all these insurance
companies did not insure Indians. The first insurance company to insure
Indians was the Indian Mercantile Insurance Limited formed in 1907.
The Life Insurance Corporation of India, founded in 1956, was formulated by
combining 240 private life insurers and provident societies. This grouping of
private insurance companies to one public company was to generate
finances for rapid industrialisation.
3.6.1 Recommendations of Malhotra committee
The major reforms in Indian industry started when the Malhotra committee
was formed in 1993 headed by R. N. Malhotra (former Finance Secretary

and RBI Governor). This was formed to analyse the Indian insurance
industry and propose the future course of the industry. It modified the
financial sector to design a system appropriate for the changing economical
structures in India. The committee recognised the importance of insurance in
financial systems and designed suitable insurance programs. The report
submitted by the committee in 1994 is given below:
Structure
Government risk in the insurance Companies to be decreased to 50%.
GIC must be taken under the government so that the GIC subsidiaries
can work independently.
Better freedom of operation for insurance companies.
Competition
Private companies who have initial capital of Rs 1 billion must be
permitted to work in the insurance industry.
Companies should not use a single entity to deal with life and general
Insurance.
Foreign companies may be permitted to work in the Indian insurance
industry only as partners of some domestic company.
Postal life insurance must be permitted to work in the rural market.
Every state must have only one state level life insurance company.
Regulatory body
The Insurance Act must be changed.
An Insurance Regulatory body must be formed.
Insurance controller, which was a part of finance ministry, should be
allowed to work independently.
Investments
The mandatory investments given to government securities from the LIC
Life Fund must be reduced from 75% to 50%.
GIC and its subsidiaries should not be allowed to hold more than 5% in
any company.
Customer service
LIC must pay interest if it delays any payments beyond 30 days.
All insurance companies should be encouraged to create unit linked
pension plans.
The insurance industry should be computerised and the technologies

must be updated. The insurance companies should promote and fulfil
customer services. They should also extend the insurance coverage
areas to various sectors.
The committee allowed only a limited competition in this sector as any
failure on the part of new players could ruin the confidence of the public to
associate with this industry. Every insurance company with an initial capital
of Rs.100 crores can act as an independent company with economic
motives.
Since then there is a competition between the private and public sectors of
insurance, the Insurance Regulatory and Development Authority Act, 1999
(IRDA Act) was formed to control, support and ensure a structured growth
of the insurance industry. The private sector insurance companies were
allowed to work along with the public sector, but had to follow the conditions
given below:
The company must be registered under the Companies Act, 1956.
The total capital share by a foreign company held by itself or by through
sub sectors of the company should not exceed 26% of the capital paid to
the Indian insurance industry.
The company should only provide life, general insurance or reinsurance.
The company should have an initial paid capital of at least Rs.100 crores
to provide life insurance.
The company should have an initial paid capital of at least Rs.200 crores
to provide reinsurance.
Later in 2008, further reforms were made by introducing the plan for
Insurance (Laws) Amendment Bill - 2008 and The LIC (Amendment) Bill -
2009. These amendments influenced the Indian insurance industry in a
huge way.
The Insurance (Laws) Amendment Bill - 2008 amended three other acts
namely, Insurance Act 1938, General Insurance Business (Nationalisation)
Act 1972 (GIBNA) and Insurance Regulatory and Development Authority Act
1999.

3.6.2 Amendments to the General Insurance Business (Nationalisation) Act

1972
These amendments were made to privatise the General Insurance
Corporation and its four subsidiaries. The GIC is financially strong and has
strong reserves to meet its capital needs. GIC performs well and has never
violated any social objectives of the public sector. GIC and its subsidiaries
are making profits through their various schemes in both rural and social
sectors.
The Parliamentary Committee on Public Undertakings did not support
privatisation of GIC and suggested merging the four sectors of GIC into a
single company. This would help GIC to serve the social and rural sectors of India
in a better way.
3.6.3 Amendment to the Insurance Regulatory and Development Act
1999
This amendment proposed to increase the participation of foreign equity
from 26 percent to 49 percent. There were arguments in the amendment that
the Indian insurance business lacked resources to expand and also that by
increasing foreign direct investment (FDI) there will be an improvement in
technology, products and other resources.
This IRDA act canceled all the entry restrictions for the private players and
allowed foreign players to enter the industry. The foreign industries had to
follow some limitations on direct foreign ownership. This opening up has led to
the development of the insurance sector.
The number of life and non-life private insurance companies has increased to
around 20. This is increasing every year as 80 percent of the Indian
population is uninsured.
3.6.4 The LIC (Amendment) bill 2009
The LIC (Amendment) bill 2009 was proposed to increase the capital of LIC
from Rs.5 crores to Rs.100 crores. As per the IRDA act the insurance
companies are liable to maintain a capital of Rs100 crores, but LIC was
excluded from it.

The LIC (Amendment) bill 2009 put forward the following statements:
1. Increase in capital of LIC from Rs.5 crore to Rs.100 crore and can
increase further if needed.
2. Change the surplus distribution pattern from original distribution pattern
of 95% to the policyholders and 5% to the government to a new pattern
as 90% for the policyholders and 10% to the government.
3. Provide sovereign guarantee selectively on the amount of the policy
and the gratuity from the present 100% government guarantee.
4. Give more power to the IRDA to open branches and divisions rather
than giving it to the Zonal manager.
5. Make a legal change in the terms and conditions of service of LIC
agents.
The Committee recommended that the central government may give any
further increase in the capital from Rs.100 crores by moving an amendment
to this effect in the Principal Act governing LIC. But the committee did not
agree with the statement to change the pattern of surplus distribution. The
Committee suggested that the IRDA guidelines can be used to open LIC
branches, but the Zonal offices should retain the power of opening them.
The committee also did not agree to give the sovereign guarantee
selectively.
The insurance industry, with these reforms, is a rapidly growing sector in
India.
Activity: 2
Find out the impact of the latest reforms in the Indian insurance industry.
Hint: Refer - http://www.bellamy-associes.com/Insurance_Report.pdf

13. According to the Malhotra committee, private companies should have
an initial capital of _____________ to work in the insurance industry.
14. The Insurance (Laws) Amendment Bill 2008 was amended with the
help of three other acts namely, Insurance Act 1938, General
Insurance Business (Nationalisation) Act 1972 and Insurance
Regulatory and Development Authority Act 1999. (True/False).
15. The LIC (Amendment) bill 2009 was formed to increase the capital of
LIC from __________ to _____________.

3.7 Summary
This unit discussed about the Indian insurance industry which has gone
through several changes since the year 1999, when the private sector
insurance companies were allowed to operate along with the public sector
insurance companies.
Insurance companies can be classified as:
Public sector insurance company - It works by redistributing profits to
the needy persons who does not have any means to cope with their
basic risks.
Private sector insurance company - It works privately for
organisations of individuals, policyholders and stockholders.
Insurance policies can also be classified as:
Voluntary insurance - It is an optional insurance which is taken by an
individual or a company with their own wish.
Involuntary insurance - This is an insurance that the individual is liable
to take up by law.
The professionals in the insurance industry are:
Underwriters - The insurance underwriters are skillful persons who
have to identify the risk taken by the company while it insurers any
property and review the insurance and other related applications.
Actuaries - Actuaries are experts who are involved in the prediction of
future of the policies based on past outcomes and probability models.
Agents - Agents are representatives of the insurer who can act upon the
insurers behalf. They are the link between the insurers and the insured.
Brokers - Brokers can also be insurance agents so that they can
connect the insurers and insureds. But they are not given all the
documents related to the risks as given to an agent.
Risk and insurance managers - Risk and insurance managers are
experts who have the ability to predict the future to a certain extent and
to identify and manage all types of risks and the losses associated with
it.

The players in Indian insurance industry are classified according to public and
private sectors. The public sector companies are:
Life Insurance Corporation (LIC) - It is the one and only public sector
life insurance company in India.
The General Insurance Corporation (GIC) - It is the only public sector
general insurance company in India. It has four subsidiaries:
o The Oriental Insurance Company limited.
o The New India Assurance Company limited.
o The National Insurance Company limited.
o The United India Insurance Company limited.
Some of the leading private sector companies are:
Life insurance companies - ICICI prudential life insurance company
limited and Birla Sun Life Insurance Company limited.
General insurance companies - Bajaj Allianz general insurance
company limited and Tata AIG general insurance company limited.
The reforms in Indian industry started when the Malhotra committee was
formed in 1993 headed by R. N. Malhotra to analyse the Indian insurance
industry and propose the future course of the industry.
In 2008, further reforms were made by introducing the plan for Insurance (Laws)
Amendment Bill 2008 and The LIC (Amendment) Bill 2009.
The Insurance (Laws) Amendment Bill 2008 was amended with the help of the
following three acts:
Insurance Act 1938.
General Insurance Business (Nationalisation) Act 1972 (GIBNA).
Insurance Regulatory and Development Authority Act 1999.
3.8 Glossary
Foreign Direct Investment (FDI): Foreign direct investment is that
investment, which is made to serve the business interests of the investor in a
company, which is in a different nation distinct from the investor's country of
origin.
Tariff Advisory Committee: Tariff Advisory Committee controls and
regulates the rates, advantages, terms and conditions that may be offered

by insurers with respect of General Insurance Business relating to Fire,

Marine, Motor, Engineering and Workmen Compensation.
Stockholders: A stockholder is an individual or institution that legally owns one
or more shares of stock in a public or private corporation.

1. What are voluntary and involuntary insurances?
2. Describe the role of an insurance underwriter.
3. Explain the role of an insurance broker.
4. List the products of General Insurance Corporation of India.
5. Describe the recommendations of the Malhotra committee.
3.10 Answers
1. Social insurance
2. True
3. Public
4. False
5. True
6. Tariff Advisory
7. Underwriters
8. b) - Insurer
9. Analytical, people management
10. Life Insurance Corporation of India
11. c) - General Insurance Corporation of India
12. Products, services
13. Rs 1 billion
14. True
15. Rs.5 crores to Rs.100 crores
Terminal Questions
1. Voluntary insurance is an optional insurance whereas involuntary
insurance is mandatory by law. Refer section 3.2.1 for more details.
2. The insurance underwriters are skillful persons who do the tough job of
reviewing the insurance and other related applications. Refer section
3.4.1 for details.

3. Insurance brokers are professionals in the insurance industry who

legally represent the insured. Refer section 3.4.4 for details.
4. The GIC has four subsidiaries with corresponding products. Refer
section 3.5.1 for details
5. The major reforms in Indian industry started when the Malhotra
committee was formed in 1993 headed by R. N. Malhotra to analyse the
Indian insurance industry and propose the future course of the industry.
Refer section 3.6.1 for details.
3.11 Case-Let
LIC - Facing Private Sector
The case is about the various changes that happened in the Indian Life
Insurance sector after privatisation. Till privatisation, Life Insurance
Corporation of India (LIC) was the only company providing life insurance
services in India. LIC sold its policies as tax instruments and not as
products giving protection against risk. Most of the customers were
underinsured with no flexibility or transparency in the services provided.
Before the entry of private players, insurance penetration and awareness
was very low especially in rural India.
The insurance sector opened up for competition from private insurance
companies with the enactment of the Insurance Regulatory and
Development Authority (IRDA) Act, 1999. As per the provisions of the Act,
the IRDA was established on April 19, 2000. This marked the beginning of
liberalisation of the Indian insurance sector. By 2006, there were 14
private insurers in India whose market share was increasing every year.
Innovative products, smart marketing and aggressive distribution helped the
private sector grow within a very short period. Slowly but steadily,
awareness about insurance was also increasing in India. The increase in
penetration and awareness could be attributed to the stiff competition
generated among public and private players.
As a result of competition posed by the private insurers, LIC launched
many new products, improved their services and increased expenditure
on advertising. In the years 2006 and 2007, LIC has launched various
policies such as New Bima gold, Market plus, Money plus, Fortune plus,
Profit plus, Health plus, Child plus etc. It covered the various risks of

individuals and groups. LIC also advertised their policies to compete with the
private sector companies which resulted in an increased number of policy
holders of LIC.
1. What are the strategies adopted by private life insurers to grab market
share from LIC?
(Hint - Innovative products, smart marketing and aggressive
distribution helped the private sector grow within a very short period.)
2. How should LIC use its strengths to maintain the market share it had
in the life insurance market?
(Hint - LIC should launch many new products, improved their
services.)
3. What were the policies introduced by LIC after 2006?
(Hint - LIC launched policies such as New Bima gold, Market plus,
Money plus, Fortune plus, Profit plus, Health plus, Child plus etc.)
Source: http://ibscdc.org/Case_Studies/Strategy/Competitive%20
Strategies/COM01 44C.htm
References
Charan P (1994). Management Strategy for Insurance in Rural India,
Mittal Publications, New Delhi, India.
House, India.
E-References
http://indiacurrentaffairs.org/insurance-reforms-whom-will-it-benefit/
http://www.allconferences.com/conferences/2006/20060509064525/
http://www.economywatch.com/indianeconomy/indian-insurance-
companies.html
Retrieved on October 22 2010
http://financecareers.about.com/od/insurance/a/insuradjuster.htm
http://finance.indiamart.com/india_business_information/mutual_fund_
companies.html
http://www.financialexpress.com/news/impact-of-competition-on-public-
sector-insurance-companies/115041/2
http://www.hrdegrees.com/guide/guideid/115.htm
http://www.insuremagic.com/Content/Agents/Impguide/actuaries_role.
asp
http://www.iciciprulife.com/public/Group-Plans/Group-Solutions.htm
http://www.indianmba.com/Faculty_Column/FC407/fc407.html
http://www.irda.gov.in/Defaulthome.aspx?page=H1
http://www.thaindian.com/newsportal/uncategorized/india-moves-on-
insurance-reform-despite-opposition-round-up_100113619.html
http://www.irda.gov.in/ADMINCMS/cms/NormalData_Layout.aspx?page
=PageNo129&mid=3.1.9
http://www.irda.gov.in/ADMINCMS/cms/NormalData_Layout.aspx?page
=PageNo264&mid=3.2.10
Retrieved on November 10 2010

Unit 4 Regulations Relating to Accounting and

Insurance Management in Insurance
Structure:
4.1 Introduction
Objectives
4.2 Need for Regulatory Intervention
4.3 Composition of Authority and Regulatory Framework
Composition of authority
Regulatory framework
4.4 Accounting Principles for Preparation of Financial Statements
Premium accounting
Commission or brokerage accounting
Claims accounting
Accounting of expenses management
Co-insurance accounting
Re-insurance accounting
4.5 Investment Accounting and Accounting Foreign Operations
Investment accounting
Accounting foreign operations
4.6 IRDA Guidelines for Preparation of Financial Accounts and Investment
Guidelines
4.7 Summary
4.8 Glossary
4.10 Answers
4.11 Case-Let
4.1 Introduction
The previous unit discussed about the public and private insurance
companies and insurance organisations in India. It discussed the different
professionals in risk and insurance management and the players in
insurance industry. It also explained the economic reforms in insurance
industry.

Insurance is the most important subject in India. The two acts that primarily
regulate it in India are:
Insurance Act 1938.
Insurance and Regulatory Development Authority Act 1999.
Insurance regulations mainly concentrate on preventing insolvencies. It helps
in protecting the policyholders from losses when the insurance company
undergoes insolvency.
Investment operations are considered as incidental in the business of
insurance and are viewed as secondary to underwriting. Today fund
management is the important focus area in the insurance business. In
insurance business major parts of the funds come from investment and
therefore it has to be managed very carefully.
This unit covers the need for regulatory intervention. It explains the
composition of the authority and regulatory framework. It gives an idea about
the investment accounting and accounting foreign operations. It also includes
IRDA guidelines for the preparation of final accounts and investment
guidelines.
Objectives:
explain the need for regulatory intervention
analyse the composition of authority and regulatory framework
describe the accounting principles for preparation of financial statements
define investment accounting and accounting foreign operations
explain the investment guidelines and IRDA guidelines for preparation of
final accounts
4.2 Need for Regulatory Intervention

Insurance regulations are a set of principles that cover the minimum
regulations and requirements, managing asset quality and so on.
Insurance regulations help in controlling premium and investments, fixing fair
premium prices, continuing audit and intervention and approving policy
wordings. It also obtains equitable allocations of profits among the company and
the policyholders.

The basic regulations which deal with the insurance business in India are the
Insurance Act, 1938 and the IRDA Act, 1999. The acts that deal with various
aspects relating to accounts and audit in insurance are:
1) The Insurance Act, 1938.
2) The Insurance Regulatory and Development Authority Act, 1999.
3) The Insurance Regulatory and Development Authority Regulations.
4) The Companies Act, 1956.
5) The General Insurance Business (Nationalisation) Act, 1972 (including
Rules framed thereunder).
The Insurance Regulatory and Development Authority (IRDA) Act of 1999

was passed when the insurance sector opened to private companies. This
act was passed to provide the establishment of an authority that protects the
interests of the policy holders, to regulate, promote and ensure the orderly
growth of the insurance industry and to amend the Insurance Act, of 1938,
the Life Insurance Corporation Act, 1956 and the General Insurance
Business (Nationalisation) Act, 1972.
Protecting customers interest includes keeping prices affordable, having

some mandatory products and standardisation of services. It is important for the
regulatory authority to make sure that the insurers pay the customers. It also
has to make sure that the claims made are settled quickly without
unnecessary litigation.
Regulations relating to solvency and financial health have to be introduced to

make sure that the insurance companies follow suitable prudential norms like
solvency margins. The insurers keep the huge funds in their custody and
invest them to produce more returns. Management of these funds is important
to the insurer, the insured and the economy. Any private insurance
company that wants to enter into the insurance industry should be regulated with
appropriate capital adequacy norms. The insurance industry in India has a large
potential and the framework of regulation has to enable the industry in tapping
the vast potential.


1. Insurance regulations mainly concentrate on preventing
____________________.
2. The basic regulations which deal with the insurance business in India
are the _______________________ and the ____________________.
3. Protecting customers interest includes keeping prices affordable, having
some mandatory products and standardisation of services. (True/False).
4.3 Composition of Authority and Regulatory Framework

The previous section dealt with the need for regulatory intervention. This
section deals with composition of authority and regulatory framework.
In order to provide better insurance coverage to the citizens, the
government of India has set up a regulatory authority for the insurance
sector of India. The Insurance Regulatory and Development Authority
(IRDA) Act was passed in 1999. The central government decides the head office
of the authority.
4.3.1 Composition of authority
According to the section 4 of IRDA Act, the Insurance Regulatory and
Development Authority specifies the composition of Authority.
This Authority is a ten member team that comprises of:
1) A chairman.
2) Five full-time members.
3) Four part-time members.
The central government appoints these members based on their knowledge and
experience in life insurance, general insurance, finance, economics, law,
accountancy etc.
4.3.2 Regulatory framework
Insurance regulation is needed for the smooth functioning of the insurance
business. This is so because the business depends on the trust of the
customers and their confidence on the insurance company.
The three major concerns of insurance regulatory frameworks are:
Safeguarding the interests of the customers.
Ensuring the financial soundness of the insurance industry.
Assisting the healthy growth of the insurance market.

As long as there were only government insurance companies there was no need
for any regulatory authority but when the private insurance companies got
acceptance, the need for a regulatory authority became very important. As a
result of this, the Insurance Development and Regulatory Act was passed in
2000 and the Insurance Regulatory Authority has become a legal authority for
the insurance companies in India.
IRDA introduced a number of regulations over the last decade they received wide
spread approval. The IRDAs decision to move tariff free rule for some general
insurance products is widely accepted. The recommendation of tariff differs on
market principles and insurance products have to be priced based on market
forces.
4. The _______________________ decides the head office of the
authority.
5. __________________________ is needed for the smooth functioning of
the insurance business.
6. Which of the following is not a concern of insurance regulatory
framework?
a) It has to safeguard the interests of the customers.
b) It has to safeguard the interests of the stakeholders.
c) It has to ensure the financial soundness of the insurance industry.
d) It has to help in the healthy growth of the insurance market.
4.4 Accounting Principles for Preparation of Financial

Statements
The previous section dealt with the composition of the Insurance
Development and Regulatory authority and insurance regulatory framework.
This section deals with the accounting principles for preparation of financial
statements.
According to the IRDA guideline every insurance company needs to prepare
the financial statements from March 2002. Every insurance company is
required to prepare the financial statements and make disclosures in
accordance with the Insurance Regulatory and Development Authority
(Preparation of Financial Statements and Auditors Report of Insurance
Companies) Regulations, 2002, from March30, 2002 onwards.

The formats of the financial statements applicable as per the mentioned

guidelines are:
1) For life insurance business (schedule A part V)
o Revenue account for policyholders account [Form No. A - RA].
o Profit and loss accounts for shareholders account [Form No. A -
PL].
o Balance sheet [Form No. A - BS].
2) For general insurance business (schedule B part V)
o Revenue account [Form No. B- RA].
o Profit and loss accounts for shareholders account [Form No. B-
PL].
o Balance sheet [Form No. B- BS].
Apart from these guidelines every life insurance company has to comply with
the requirements of schedule A and every general insurance company has to
follow the requirements of schedule B. However Schedule A and Schedule B
are more or less the same for both life insurance and general insurance
business.
Schedule A and B
Part I
Applicability of Accounting Standards - The ICAI has specified some
Accounting Standards (AS) to the insurers carrying out the general
insurance business. All receipts and payments account including cash flow
statement, balance sheet, and profit and loss account (shareholders
account) of the insurer have to be in accordance with these The Accounting
Standards (AS) specified are:
Accounting Standard 3 (AS 3) - According to IRDA regulations of 2000
the insurance company should prepare its receipts and payment
accounts using the Direct Method of the Accounting Standard 3 (AS 3)
on the Cash Flow Statements.
Accounting Standard 13 (AS 13) - Accounting Standard 13 (AS 13) on
Accounting for Investments is not applicable for investments in
insurance sector.
Accounting Standard 17 (AS 17) - Accounting Standard 17 (AS 17) on
Segment Reporting is applicable to all insurance companies irrespective
of their requirements regarding listing and turnover.
Treatment of premium
Premium received in advance shall not be included in the unearned
premium and shall be shown separately.
Premium revenue recognition depends on the pattern of risk the insurer
is exposed to. For a particular insurance business, the insurer can
estimate the pattern of risk involved based on the past experience. Many
insurers bring premium revenue to account on the basis of passage of
time. This is usually correct when the risks that occur gives rise to the
claims more or less uniform throughout the policy.
For some classes of insurance usually premium is adjusted as a result of
events and information that is known during or after the policy period.
However in some cases, the risk pattern can not be spread evenly over
the period of insurance as the nature of risk covered varies. In such
cases the deposit premium is paid in the beginning of the policy period
and is adjusted subsequently.
The basis of premium earned can be justified and supported by external
evidences such as certification from an actuary or any other technical
experts.
General insurance
The treatment of premium for general insurance is as follows:
The premium is considered as the income for the contract period or for
the period of risk according to which it is appropriate. The unearned
premium and the premium that is received in advanced also represent
the premium income but are not related to the current accounting period.
These premiums are disclosed separately in the financial statements. A
reserve for the unearned premium can be created as the amount
representing the part of the premium written which is attributable and to
be allocated to the accounting period that follows.
The premium that is received in advance before the risk started must be
separately shown under the heading Current Liabilities in the financial
statements.
The unearned premium must be separately shown under the heading
Current Liabilities and proper disclosures based on the managements
assessment can be made separately in the financial statements.

The Premium deficiency must be recognised if the sum of related

expenses, expected claim costs and maintenance costs goes beyond the
related unearned premiums.
The future liability changes must be based on actuarial or the technical
evaluation for occurrences of premium deficiency on contracts that
exceeds four years.
Life insurance
The premium needs to be recognised as income on due basis. The due date for
payment can be considered as the date the associated units are created for
linked businesses.
Acquisition costs
Acquisition costs, are costs that vary with and are basically related to the
acquisition of new and renewal of the existing insurance contracts. These
must be treated as expense in the period in which they are incurred. The most
important test is the mandatory relationship between the cost and the execution
of the insurance contracts.
Claims
The components of the final cost of claims to an insurer include the claims
according to the policies and specific claims settlement costs. Claims under
policies include the claims made for losses experienced, and those
estimated under the policies following a loss that occurred. A liability for
outstanding claims can be brought into accounts with respect to both direct
business and inward reinsurance business. The liability includes:
1) Future payments that is related to unpaid reported claims.
2) Claims Incurred But Not Reported (IBNR) that include inadequate
reserves sometimes referred to as Claims Incurred But Not Enough
Reported (IBNER), which results in future cash or asset outgo for
settling liabilities against those claims. Change in estimated liability
represents the difference between the estimated liability for outstanding
claims at the beginning and at the end of the financial period. The
accounting estimates can also comprise of claims cost adjusted for
recovering the estimated salvage value if there is sufficient degree of
certainty of its realisation.
Claims made with respect to contracts where the claims payment period
exceeds four years can be recognised on an actuarial basis, subject to

regulation as prescribed by the authority. In such cases a certificate must be

obtained from a recognised actuary as to the fairness of the liability
assessment.
Procedure to determine the value of investments
According to this sub clause of the Regulations, a detailed procedure has
been prescribed for determining value of various investments like real
estate, debt securities and equity securities.
Real estate
Investment property - The investment property can be valued at a
historical cost after deducting the accumulated depreciation and
impairment loss. Residual value is considered zero and no re-evaluation
is allowed. The change in the carrying amount of the investment
property shall be taken to Revaluation Reserve.
The insurers can asses at every balance sheet date to check whether an
impairment of the investment property has occurred.
All impairment losses are recognised as expense in the Revenue/Profit
and Loss account.
Debt securities
Debt securities that include the government securities and the redeemable
preference share must be considered as held to maturity securities and
can be measured at an historical cost that is subjected to amortisation.
Equity securities and derivative instruments that are traded in active
markets
Limited equity securities and derivative instruments that are traded in
active markets must be measured at a fair value according to the
balance sheet date. The lowest of the last estimated closing price of the
stock exchanges where securities are listed can be considered for
estimating the fair value.
The insurer can assess the balance sheet date to check whether an
impairment of the listed equity security instruments has occurred.
An active market means the market where the securities that are traded
are homogenous, it has normal willing buyers and sellers and the prices
are available publicly.
Unrealised gains or losses that arise due to the change in the fair value
of listed equity shares and derivative instruments can be considered
under the heading Fair Value Change Account and reported in Profit or
Loss account. The profit or loss on sale of such investments can include the
accumulated changes of the fair value that was previously
recognised under the heading Fair Value Change Account with respect to a
particular security and recycled to Profit and Loss Account on actual sale of
that listed security.
The balance in Fair Value Change Account or any part thereof cannot
be distributed as dividends. In addition to this, while declaring dividends,
any debit balance in the Fair Value Change Account can be reduced
from the profits or free reserves.
Loans
Loans can be calculated at a historical cost that is subjected to impairment
provisions.
Catastrophe reserve
Catastrophe reserve can be created according to the norms, if any
prescribed by the authority. Fund investment out of catastrophe reserve can
be made according to the instruction given by the authority. Further it is
clarified that this reserve is created to meet the losses that may arise
because of some unexpected set of event and not any definite known
reason.
Part II
The following need to be disclosed as notes to the Balance Sheet:
Contingent liabilities:
o Partly paid-up investments.
o Outstanding underwriting commitments. o
Claims not judged as debts.
o Guarantees provided by or on behalf of the company. o
Statutory demands.
o Reinsurance commitments.
o Others (to be specified).
Encumbrances to company assets (inside and outside India)
Obligations made for loans, investments and fixed assets. Ageing
of claims.
Premiums, less reinsurance.
Recognition of premium income extent based on different risk patterns.
Contract values with respect to investments.

Procurements where deliveries are delayed and pending.
Sales where payments are not settled.
Operational expenditures of the insurance business.
Historical costs of valued investments on a fair value basis.
Calculation of remuneration of managers.
Amortisation basis of debt securities.
Unrealised gains or losses due to fair value changes of equity shares
and derivative instruments.
The credit balance in Fair Value Change account is not available for
distribution when realisation is pending.
Fair value of investment property and its basis.
Claims settled and outstanding claims for a period of more than six
months on the balance sheet date.
The following accounting policies form an integral part of financial
statements:
All important accounting policies with respect to accounting standards
issued by ICAI, important policies mentioned in Part I of Accounting
Principles. Other accounting principles of an insurer are stated
according to Accounting Standard AS 1 by ICAI.
Any departure from the accounting policies as abovementioned need to
be separately revealed with reasons.
The following information also needs to be disclosed:
Investments made according to statutory requirements need to be
disclosed separately together with its amount, security and special rights
inside and outside India.
Segregation of performing and non performing investments for income
purpose as per the directions issued by authorities.
Percentage of business sector-wise.
Summarised financial statements of last five years prescribed by
authorities.
Accounting ratios provided by authorities.
Allocation of interests, dividends and rents among revenues, profits and
losses.

Part III
All the fiscal statements for a year should show the equivalent figures for
the previous year.
Interests, dividends and rents should be grossed and TDS should be
included in 'Advance Tax Paid'.
Risks retained and reinsured must be indicated separately.
Provisions for losses (under lawsuits) should be arranged.
Excess provision for losses is considered as reserves.
Part IV
A management report is needed for attaching the financial statements which
verifies the following:
Verification of registration certificate.
Payment of statutory payables.
Description of shareholding pattern and share transfer according to the
prescribed norms.
Maintenance of solvency margin.
Asset valuation certificates.
Opinions and disclosures for various risk exposures and strategies
followed.
Ageing of claims.
Assessment of asset quality and performance.
Payment schedules.
Part V
Every insurer prepares the financial statements in prescribed forms.
Separate disclosures are needed for Participating policies and Non-
participating policies, Linked and Non-linked business for Life, General
Annuity, Pensions and Health Insurance and business in and outside
India.
In general insurance business, revenue accounts for fire, marine and
miscellaneous insurance must be prepared separately.
An insurer must prepare Receipts and Payments accounts separately
according to the Direct method mentioned in AS-3: 'Cash Flow
Statement' by ICAI.

4.4.1 Premium accounting

For the businesses that have a fixed rate like that of fire insurance, motor
insurance etc., the premium is charged based on the rate. Where as in
businesses that do not have fixed rate, the premium is charged based on
the guideline rates fixed by the respective technical departments of the
insurers Head Office. According to section 64VB of the Insurance Act,
1938; the insurer cannot assume any risk unless the premium is received in
advance.
Apart from collection of premium by cash, cheque DD etc., the IRDA
recently has permitted to collect the premium by other type of receipt like the
credit card, debit card, E transfer etc. However, the same has to be
collected before assumption of the risk. Service tax of 8% (presently) has to
be collected on taxable premium and deposited with the respective excise
authorities within prescribed time limit. If the same business is shared
among more than one insurer as preferred by the policy holder, then the
lead insurer has to collect the full premium along with service tax. But only
one share of premium is accounted as premium and the balance is shown
as the amount that is due to other co-insurers. As per the Stamp Act, a
policy stamp has to be affixed and has to be accounted properly by debiting
policy stamp expenses. A premium register is generated in the system on a
daily basis.
According to the IRDA Regulation, the premium has to be identified as the
income over the contract period or the period of risk, whichever is suitable. Most
of the general insurance policies are annual contracts and therefore the
premium earned is worked out using 1/365 method. In the insurance policies
in which the same is not practicable, it is worked out either using 1/24 or 1/12
method. According to the section 64V(1)(ii)(b) of the Insurance Act, 1938, the
unearned premium is compared with the reserve for unexpired risks at the
end of the financial year and if there is any shortfall it is accounted as unearned
premium.
4.4.2 Commission or brokerage accounting
Some insurance business has this facility of paying commission or
brokerage to the agent who gets the insurance policy done whereas some
do not have this facility. Commission is payable as soon as business is
countersigned. But it is paid on a monthly basis. The insurer discloses the

service tax that is applicable and pays it to the excise authorities. According
to the IT Act, the Tax Deductions at Source (TDS) is deducted and
deposited to the government account within the given time limit. In case the
policy is cancelled because of cheque dishonour or any other reason, the
commission or brokerage payable to the agent is reversed or recovered if
already paid.
4.4.3 Claims accounting
Claims outgo is the major outgo of an insurance company. The respective
technical department does the processing of claims and the competent
authority approves it. The accounts department does the payment and
accounting of the claims. When claim is made for a policy that has more than
one insurer the lead insurer pays the full amount of claims. Only own share of
claim is accounted as claims cost and the balance is shown as amount
recoverable from the other insurers (co-insurers). If a claim is made but not
settled by the end of the financial year, then enough provision is made for
such outstanding claims. By the end of the financial year the IRDA needs the
actuarial valuation of the claims liability of an insurer that the appointed
actuary makes and if there is any shortfall, it is provided as Incurred But Not
Reported (IBNR) losses.
4.4.4 Accounting of expenses management
Table 4.1 lists the administrative expenses of the insurance business.

Table 4.1: Accounting for Expense Management

Current Previous
Particulars
year year
1. Training expenses
2. Interest and bank charges
3. Employee remuneration and welfare benefits
4. Rents, rates and taxes
5. Advertisement and publicity
6. Pricing and stationary
7. Description
8. Auditors fees expenses etc
a) as auditor
b) as advisor or in any other capacity, with
respect to
i) Taxation matter
ii) Insurance matter
iii) Management services
c) in any other capicity
9. Repairs
10. Travel conveyance and vehicle running expenses
11. Others (to be specified)
12. Legal and professional charges
13. Communication
14. Total operating expenses
These expenses are first combined and then assigned to each business
class namely Fire, Marine and Miscellaneous revenue account on a
reasonable basis. Any major expenses like Rs. 5 lakhs or 1% of net
premium, whichever is higher has to be shown separately. According to the
section 40C of the Insurance Act, 1938, the insurers are not permitted to
spend expenses of management more than the prescribed limit in the Act.
Enough provision is made in the accounts for outstanding expenses at the end
of the financial year. An actuarial basis provision is made for leave
encashment, gratuity etc. at the end of each financial year.

4.4.5 Co-insurance accounting

When a policy has more than one insurer then the lead insurer collects the
full premium along with the service tax and pays the same to the respective
excise authorities. While accounting, the lead insurer shows only its own
share as premium and the balance is shown as he amount payable to other
co-insurers. In the same way in case of claims, the lead insurer pays the
entire claim amount to the policy holder, but while accounting the lead
insurer accounts only his own share as claims expense and the balance is
shown as the amount due from the coinsurer. Lead insurer also recovers
certain percentage of the co-insurers share for managing co-insurance
arrangement as a leader. Co-insurance accounts are settled as per the
agreement between the co-insurers. Usually, there is a provision for
charging of interest for delayed settlement of accounts. At the end of each
financial year, the lead insurer communicates provision for outstanding
claims, if any and all co-insurers exchange balance confirmation certificates.
4.4.6 Re-insurance accounting
Reinsurance accounting is explained as a subset of property and casualty
insurance statutory accounting. All licensed insurers either the primary,
policy-issuing companies or the reinsures, are subjected to the same
insurance statutes and the same state insurance departments regulate
them. The state insurance examiners examine them on a timely basis.
Reinsurance accounting has to act in accordance with the same statutory
accounting procedures (SAP), and report the same Annual Statement with
details of assets, liabilities, income, and expenses.
Foreign insurance companies doing reinsurance business in India -
Liability to Indian income-tax depends on various factors
The Central Board of Revenue recently assessed the position of the foreign
companies with respect to the taxability on its profits it got from its
reinsurance business with Indian companies. Standardised principles
cannot be applied for all cases of reinsurance. The ceding company
(insurer) can offer a single risk to the reinsurer or the reinsurance can be
affected in accordance with a standing agreement. Liability to taxes or tax
breaks depend on factors like the continuation of reciprocity among the
Indian insurer and the foreign reinsurer, the amount of local retention as
compared with the reinsurance premium that the Indian insurer pays to the
foreign reinsurer and so on. Therefore the income tax officers must examine
every case and decide what portion of the income from the reinsurance has to
be assessed under the section 42(2) of the Insurance Act of 1922.
Reinsurance has got an important influence on the finances of the insurance
companies. A reinsurance treaty in general defines payments between
insurance companies. The figure 4.1 depicts the payments between the
Ceding company cedes business to Reinsurer

Deposit premium
Annual premium
Investment income
Risk charge
Reinsurance commission
Expenses allowance
Claims
Increase in reserve
Profit
Profit sharing
Figure 4.1: Payments Between the Insurance Company and

Reinsurance Company
The ceding company cedes business to the reinsurer It makes payments or

transfers funds to the reinsurer. These payments generally include deposit
premium, annual premium, investment income and risk charge.
Similarly the reinsurers also have to make some payments or transfer funds to
the ceding company. These payments generally include reinsurance
commission, expense allowance, claims and increase in reserves.
Activity: 1
Analyse IRDA guidelines on the periodic disclosures to be made by the
Hint: Refer - http://taxguru.in/corporate-law/irdas-guidelines-on-periodic-
disclosures-to-be-made-by-insurance-companies.html


7. ____________________ is prepared only under the Direct Method.
a) Accounting for Investments
b) Segment Reporting
c) Cash Flow Statement
d) Revenue Recognition
8. According to the IRDA Regulation, the __________________ has to
be identified as the income over the contract period or the period of risk,
whichever is suitable.
9. According to the IT Act the _____________________________is
deducted and deposited to the government account within the given
time limit.
4.5 Investment Accounting and Accounting Foreign Operations

The previous section dealt with the accounting principles for preparation of
financial statements. This section deals with investment accounting and
accounting foreign operations.
4.5.1 Investment accounting
Investments are assets that an insurer gets from the income that is earned
through dividends, rent and interest etc.. Any insurance company makes
investment, from the income earned not just to fulfill the legal requirements but
also to meet any unforeseen incidents and claims. There are two main sources
of investible funds namely:
1) Surplus funds the arise from the business.
2) Income that arise from interest and dividends on existing investments.
The section 27B, 27C and 27D of the Insurance Act, 1938 has set certain
norms for insurance companies to regulate the investment of their funds. The
IRDAs regulation for preparation of financial statements has set some
procedures for determining the value of investments. More over the IRDA
under the IRDA Investment and Amendment Regulations issued detailed
guidelines to insurers for making investments. IRDA does not allow the
insurers to do any investments abroad. Accounting entries for investments are
included for certain investments like buying/selling investments, receipts,
interest, dividends, rent, and recording impairments, write off and write down of
certain investments.

According to the section 27 of the Insurance Act 1938 the funds that the
company controls has to be invested in some specified securities. The
assets that are related to, Annuity business, Pension business and Linked Life
Insurance business may not form a part of the controlled fund.
There are separate rules that are formulated for investing funds that is
earned from Pension business and Annuity business.
The funds that are related to Unit Linked Insurance business can be
invested as per the investment pattern that is offered to the policyholders
and approved by them. But the total investment made in other categories
other than the approved category of investments cannot exceed 25 % of the
fund.
4.5.2 Accounting foreign operations
To show the financial position globally, the foreign branch accounts are
merged with the Indian insurers operations. Besides the Indian
requirements, these foreign branch accounts offices have to act in
accordance with the local laws for the preparation of financial statements
and get the accounts audited by the local qualified auditors or the Indian
firms of auditors. According to the Accounting Statement 11 (AS 11) the
foreign branch accounts which are prepared in local currencies are
converted into Indian currency and merged with Indian accounts.
Activity: 2
Find out the accounting policy of any insurer.
Hint: Refer - http://www.moneycontrol.com/annual-report/3iinfotech/
accounting-policy/I11
10. _____________________ are assets that the insurer gets from the
income that is earned through dividends, rent and interest etc.
11. The IRDAs regulation fro preparation of financial statements has set
some ___________________ for determining the value of investments.
12. According to the ___________________________ the foreign branch
accounts which are prepared in local currencies are converted into
Indian currency and merged with Indian accounts.
e) Accounting Statement 11
f) Accounting Statement 3
g) Accounting Statement 17
h) Accounting Statement 13

4.6 IRDA Guidelines for Preparation of Financial Accounts and

Investment Guidelines
The previous section dealt with investment accounting and accounting
foreign operations. This section explains the IRDA guidelines for preparation of
financial accounts and investment guidelines.
In accordance to the section 114A of the Insurance Act, 1938, (4 of 1938), and
in control of the Insurance Regulatory And Development Authority
(Preparation Of Financial Statements And Auditors Report Of Insurance
Companies) Regulations, 2000, the Authority and the Insurance Advisory
Committee, has made the following regulations:
1) Related party transactions - All the related party transactions, as
required by the Accounting Standard, have to be compulsorily disclosed
by the insurers.
2) Transfer of securities to policy holders account -
o All the securities have to be transferred to the policyholders Account
at either cost price or market price, according to whichever is lower.
o With respect to debt securities, the transfers are to be carried out at
the net amortised cost.
3) Bank reconciliation as on 31st March - Every insurer is needed to set
down some internal guidelines on the reconciliation based on Generally
Accepted Accounting Principles (GAAP), and constantly follow the same
principles.
4) Investments of policy holders and shareholders - All insurers have
to maintain separate investment accounts for the shareholders and the
policyholders as these are two separate business segments and the
income or losses, accrued or capital, gains or losses on the investments
is to be credited or debited to the respective Revenue Loss Account and
Profit Account as the case may be. However, in case of practical
difficulties, the consulting actuary and the investment head can evaluate
issues, and constantly follow the same. The policy on this matter should
be spelt out in the Significant Accounting policies.


13. All the related party transactions, as needed by the
____________________, have to be compulsorily disclosed by the
insurers.
14. All the securities have to be transferred to the __________________
Account at either cost price or market price, according to which is
lower.
a) Stakeholders
b) Policyholders
c) Insurer
d) Reinsurer
15. All insurers have to maintain separate investment accounts for the
______________________ and the ________________________ as
these are two separate business segments.
4.7 Summary
This unit discussed about regulations related to insurance. Insurance
regulations are a set of principles that cover the minimum requirements for best
practices in the area of licensing, prudential regulations and
requirements, managing asset quality etc. Insurance regulation is needed for
the smooth functioning of the insurance business.
In order to provide better insurance coverage to the citizens, the

Government of India has set up an insurance regulating authority for Indian and
foreign insurance companies. The Insurance Regulatory and
Development Authority (IRDA) act was passed in 1999.
According to the section 4 of IRDA Act, the Insurance Regulatory and

Development Authority specifies the composition of Authority.
This authority is a team that comprises of:

1) A chairman.
2) Five full-time members.
3) Four part-time members.

The formats of the financial statements applicable as per the said guidelines
are:
1) For life insurance business (schedule A part V).
o Revenue account for policyholders account.
o Profit and loss account for shareholders account. o
Balance sheet.
2) For general insurance business (schedule B part V).

o Revenue account.
o Profit and loss account for shareholders account. o
Balance sheet.
Apart from these guidelines every life insurance company has to comply with
the requirements of schedule A and every general insurance company has to
follow the requirements of schedule B. However Schedule A and Schedule B
are more or less the same for both life insurance and general insurance
business.
The schedule A and B include five parts namely part I, part II, part III, part IV and
part V.
Part I deals with applicability of accounting standards, treatment of
premium, acquisition costs, claims, procedure to determine the value of
investments like real estate, debt securities and equity securities and
derivative instruments that are traded in active markets, loans and
catastrophe reserve.
Part II deals with the disclosing notes to the Balance Sheet.
Part III deals with considered certain reserves for the financial
statements.
Part IV deals with the management report which has to be attached in
the financial statements.
Part V deals with the preparation of Receipts and Payments accounts.
Investments are assets that the insurer gets from the income that is earned
through dividends, rent and interest etc. Any insurance company makes
investment, from the income earned not just to fulfill the legal requirements but
also to meet any unforeseen incidents and claims.
In accordance to the section 114A of the Insurance Act, 1938, (4 of 1938),
and in control of the Insurance Regulatory And Development Authority
(Preparation of Financial Statements and Auditors Report of Insurance

Companies) Regulations, 2000, the Authority and the Insurance Advisory
Committee, has made the following regulations:
Related party transactions.
Transfer of securities to policy holders account.
Bank reconciliation as at 31st March.
Investments of policy holders and shareholders.
4.8 Glossary
Solvency: It is the capability of any business to have enough assets for
covering its liabilities.
Statutory accounting procedures: These are a set of accounting
regulations that are prescribed by the National Association of Insurance
Commissioners for the preparation of an insuring firm's financial statements.
Debt securities: Any debt instrument that can be bought or sold between two
parties and has basic terms defined, such as notional amount that is amount
borrowed, interest rate and maturity or renewal date.

1. Explain the need for insurance regulatory intervention.
2. What is the composition of the insurance authority?
3. Explain premium accounting.
4. Describe investment banking.
5. Explain the IRDA Preparation of Financial Accounts and Investment
guidelines.
4.10 Answers
1. Insolvencies
2. Insurance Act, 1938, IRDA Act, 1999
3. True
4. Central government
5. Insurance regulation
6. b) - It has to safeguard the interests of the stakeholders
7. c) - Cash Flow Statement

8. Premium
9. Tax Deductions at Source (TDS)
10. Investments
11. Procedures
12. e) - Accounting Statement 11
13. Accounting standard
14. b) Policyholders
15. Shareholders and Policyholders
Terminal Questions
1. Insurance regulations are a set of principles that cover the minimum
regulations and requirements, managing asset quality etc. This is
explained in the section 4.2 of this unit. Refer the same for details.
2. According to the section 4 of IRDA Act the Insurance Regulatory and
Development Authority specifies the composition of Authority. The
composition of the authority is explained in the sub - section 4.3.1 of
this unit. Refer the same for details.
3. For the businesses that have a fixed rate like that of fire insurance,
motor insurance etc., the premium is charged based on the rate. Where
as in businesses that do not have fixed rate, the premium is charged
based on the guideline rates fixed by the respective technical
departments of the insurers Head Office. This is explained in the sub -
section 4.4.1 of this unit. Refer the same for details.
4. Investments are assets that the insurer gets from the income that is
earned through dividends, rent and interest etc. This is explained in the
sub - section 4.5.1 of this unit. Refer the same for details.
5. In accordance to the section 114A of the Insurance Act, 1938, (4 of
1938), and in control of the Insurance Regulatory And Development
Authority. This is explained in the section 4.6 of this unit. Refer the
same for details.

4.11 Case-Let
The Balance Sheet of ICICI Prudential Life Insurance Company
Limited for March 31, 2001.
ICICI Prudential Life Insurance Company did not draw up the balance
sheet, of policyholders account for the participating business and non-
participating business and the shareholders account together with the
notes according to the provisions of Section 11 of the Insurance Act,
1938 and subsection 5 of Section 227 of the Companies Act, 1956.
However, the financial statements of ICICI Prudential Life Insurance
Company are drawn up in accordance with the Regulation 3(1) of
Insurance Regulatory and Development Authority (Preparation of
Financial Statements and Auditors Report of Insurance Companies)
Regulations, 2000.
ICICI Prudential Life Insurance Company stated that the accounts give
the information that is needed by the Insurance Act, 1938, the Insurance
Regulatory and Development Act, 1999 and the Companies Act, 1956.
With respect to the balance sheet of the company all the policyholders
accounts for participating and non-participating business, the
shareholders account and the cash flow statements of the receipts and
payments has to be completed by March 31, 2001.
The Companys investments were valued according to the provisions of
IRDA (Preparation of Financial Statements and Auditors Report of
Insurance Companies) Regulations, 2000. The companys accounting
policies are correct and in accordance with the Accounting Standards
referred to in sub-section 3(C) of Section 211 of the Companies Act, 1956
and the accounting principles as prescribed by the IRDA (Preparation
of Financial Statements and Auditors Report of Insurance Companies)
Regulations, 2000.
The company further certified that they have verified the investments and
cash balances by inspections and production of certificates. It also
certified that no investments were made from the life insurance funds.

(Rupees in March 31,

Schedule
Million) 2001
Sources of funds
Shareholders funds:
Share capital 1 1,500.00
Reserves and surplus
Balance of profit in Shareholders 2.26
(Non-Technical Account)
Sub-Total 1,502.26
Policyholders' funds
Policy liabilities
Participating business 23.17
Non-participating business 26.27
Insurance reserves
Participating business (182.76)
Non-participating business (23.86)
Sub-Total (157.18)
TOTAL 1,345.08
Application of funds
Investments
Shareholders 2 1,215.39
Fixed Assets 3 141.88
Current assets
Cash and Bank Balances 4 34.09
Advances and Other Assets 5 63.76
Sub-Total (A) 97.85
Current liabilities 6 110.04

Sub-Total (B) 110.04
Net current assets (C) = (A - B) (12.19)

TOTAL 1,345.08
Notes to accounts 13
Shareholders' account (Non-technical
account)

Income from investments

(a) Interest 61.33
(b) Profit on sale of investments 4.62
Fees for professional services 1.00
TOTAL (A) 66.95
Expenses other than those directly

related to the insurance business
Employees, remuneration and welfare 7.66
benefits
Rent, rates and taxes 5.98
Traveling 2.88
Professional fees 1.50
Advertisement 14.62
Preliminary expenses 29.82
Depreciation 0.72
Others 1.51
TOTAL (B) 64.69
Profit carried to Balance Sheet 2.26

1. How were the ICICI Prudential Life Insurance Companys investments
valued?
(Hint: The Companys investments were valued according to the
provisions of IRDA (Preparation of Financial Statements and Auditors
Report of Insurance Companies) Regulations, 2000.)
2. What did the ICICI Prudential Life Insurance company certify in its
March 2001 balance sheet?
(Hint: The company further certified that they have verified the
investments and cash balances by inspections and production of
certificates.)
Source: http://www.icicibank.com/aboutus/zip/archive/F165-F172.pdf

References
Basu S. K., (2006). Auditing Principles and Techniques, Dorling
Kindersley Private Limited
Gurusamy, (2009). Indian Financial System, Second edition, Tata
McGraw-Hill Education Private Limited.
Gupta .P. K. Insurance and Risk Management, Himalaya Publishing
House.
Palande. P. S., Shah. R. S., Lunawat. M. L., (2003). Insurance in India:
Changing Policies and Emerging opportunities, New Delhi.
Singal .R. S., Mittal .R. K., Ahuja Satish. Corporate Accounting, Prince
Print Process.
E-References
http://law.incometaxindia.gov.in/DitTaxmann/IncomeTaxActs/2009ITAct/
sec_044.htm
http://www.irda.gov.in/ADMINCMS/cms/NormalData_Layout.aspx?
page=PageNo101&mid=18.3
http://www.irda.gov.in/ADMINCMS/cms/NormalData_Layout.aspx?
page=PageNo100&mid=18.2
http://www.strainpublishinginc.com/reinsure3.html
Retrieved on 19 October, 2010
http://www.irdaindia.org/Finance_And_Analysis/Preparation%20of%
20financial%20statements%20by%20the%20insurers%
20-% 20Non%20Life%20Dt.%2029-04-03.pdf
http://www.icai.org/resource_file/11199p1302-05.pdf

Unit 5 Life Insurance

Structure:
5.1 Introduction
5.2 Purpose, Functions and Advantages
5.3 Elements of Life Insurance
5.4 Classification of Life Insurance and Life Insurance Policies
Term life insurance
Permanent life insurance
Annuity or pension policies
Money back insurance policies
Other types of life insurance policy
5.5 Advantages and Disadvantages of Life Insurance
5.6 Role of Term and Endowment in Product Designing
5.7 Features of Endowment Assurance Policy
5.8 Summary
5.9 Glossary
5.11 Answers
5.12 Case-Let
5.1 Introduction
The previous unit dealt with the need for regulatory intervention in the
insurance sector. It explained the composition of the authority and
regulatory framework. It explained investment accounting and accounting
foreign operations. It also discussed IRDA guidelines for the preparation of final
accounts and investment guidelines.
This unit will describe a type of insurance, namely, life insurance. This unit will
cover the objectives, classification, purpose and need, advantages, functions,
principles, and elements of life insurance. This unit will also familiarise us
with the types of life insurance policies, namely, term life insurance policy,
and permanent life insurance policy. In this unit, role of term and endowment
in product designing, and features of endowment assurance are also
discussed.
Life insurance is a financial cover provided by a life insurance company for a
person and his family, from any kind of loss, likely to be caused by an

unsure event. Life insurance is a policy that helps to replace the loss of
income by bringing in financial stability whenever the breadwinner of the
family, who has a policy, leaves the world suddenly Life insurance is thus a way
of protecting yourself during an adverse event.
The main aim of life insurance is to eliminate the risk and to substitute
certainty for the uncertainty caused.
Objectives:
After studying this unit, you should be able to:
explain life insurance and its elements
describe the features of life insurance and endowment assurance
discuss the role of term and endowment in product designing
explain the types of life insurance policies annuity and pension policies
analyse the whole life policies, money back policies and other types of
life insurances
5.2 Purpose, Functions and Advantages

Life insurance is a policy that provides the basis of protection and financial
stability after ones death in a family. Its function is to support the other
family members with financial stability. So, it is important to understand the
purpose, functions and advantages of life insurance.
The primary objectives of life insurance are:
Protection - The main objective of life insurance is to give protection. If
a member in a family, particularly, the care taker of the family dies, the
family faces many problems. Life insurance decreases the financial loss
arising due to the death. After the death of insured member, the family is
helped with the sum assured. People insure themselves with life
insurance to make sure that their families do not face any difficulties
upon their death.
Investment - Life insurance not only protects a person from future risk,
but also is a good mean of savings for the people. The insured person
invests small amounts, in the form of premiums, with an insurance
company. If the insured person dies before the maturity date of policy,
then the nominees of deceased gets more amount than invested. It
helps the family to maintain the same standard of living.

Purpose of life insurance

The purpose of life insurance is to provide financial protection against the
losses that may be incurred due to uncertain difficulties caused by ill-health,
death of an earning family member or financial losses. A life insurance
policy on a non-working spouse is considered as an essential part of a
family life insurance plan since it would deliver income for a living parent
with children at home. The events that cause losses may or may not occur
during the running time of the contract of insurance. Insurance gives a kind
of peace of mind to the insured. For example, Mr. X takes a life insurance
policy, maturity period being 10 years. Annual premium for this policy is
Rs.2000/-, while sum assured is Rs.25, 000/-. After paying premium for 4
years, the insured person dies. After his death, the total amount payable to
his nominee would be Rs.25,000 + bonus, while he had paid only Rs.8000/-
till his death as premium. On the other hand, if Mr. X lives for 10 years, then
total amount payable to him, from that insurance company will be
Rs.25,000 + bonus(which will be around 70% of the sum assured). In this
manner, total amount received by insured will be Rs.42,500/- approximately,
while he has paid premium Rs.20,000 only.
Families need life insurance to:
Provide financial security to their family members at the times of
financial crisis.
Protect the home mortgage.
Plan their future financial requirements.
Avail the benefit of retirement savings and other investments.
Advantages of life insurance
Life insurance provides major benefits to the society. The following are the
advantages of life insurance:
Reduces Worries - Life insurance reduces stress due to the financial
security it offers.
Investment opportunity - Life insurance contracts provide double
benefits of both protection and investment, as the event assured against
is sure to happen. In fact, a life insurance investment offers attractive
returns.
Credit enhancement - Businessmen would enjoy a better credit
standing as they transfer the risks to the insurance company.

Employment opportunity - Insurance companies are playing a very

important role in challenging the problem of unemployment in the
country by offering employment opportunities for many people.
Moreover, there are large numbers of people working as insurance
agents, professionals, etc.
Tax Benefits - The premiums paid for certain life insurance are eligible
for tax rebate under section 80C of the income tax act.
Encourages thrift - As the premium paid is a form of compulsory
savings, it promotes thrift and builds savings.
Functions of life insurance
In business, family and personal life, life insurance has important functions. In
business, it plays a major role in calculated planning for future actions.
Families purchase life insurance mainly as a security against future loss.
Protection to stockholder - Companies with stockholders have life
insurance contracts in place so any unpredicted transition goes easily.
Both large and small companies insure the life of important employees,
whose loss would distress business operations.
Small business actions - People having sole ownership businesses
need life insurance to enable the business operations to continue even
after their death, at least until there is time to arrange for forthcoming
management. In a partnership, life insurance with an assigned
beneficiary contract will give a chance to the business to sustain and
weather the challenges of the business.
Retirement complement - Some life insurance policies can be
converted into an annuity that will pay bonuses to the policyholder after
retirement. These are more expensive policies.
Support to the family - Life insurance provides security to a familys
needy survivors with a financial help in their grief.
Final expenditures - Many persons carry enough life insurance to cover
funeral costs and other end-of-life expenses of the insured, and to repay
unsettled dues.
Gifts and special endowments - Another function of life insurance is to
enable special endowments such as a major gift to a charity. A special
facility in life insurance can be directed to fund education for a child.
Parents of a child with an ill health may want to set apart a portion of
their life insurance in a special fund to care for the child.

1. Life insurance not only protects a person from_________, but also is a
good mean of _________ for the people.
2. The purpose of life insurance is to provide _____________ against the
losses.
3. Life insurance in family life does not provide needy survivors with a
financial help in their grief. (True/False).
4. Both large and small companies insure the life of
___________________.
a) Managers
b) Technical Staff
c) Important employees
d) Team leaders
5.3 Elements of Life Insurance

The previous section discussed the purpose, need and advantages of life
insurance. This section discussed the elements of life insurance.
The two basic elements that all the individuals require from life insurance are
the coverage of risk and savings for the future. It is necessary to
understand the various elements of life Insurance. The following are the
elements of life insurance:
Premium - Premium is the amount of insurance payable by the
policyholder. The price fixed for the premium depends on the sum
assured, age and occupation of the policyholder.
Grace period - Grace period is the days after the due date of the
premium. Premium can be paid during the grace period. If the premium
is paid as monthly instalments then seven or fifteen days of grace period
is allowed to pay the premium. If the policyholder dies during the grace
period without paying premium then the due amount will be deducted
from the full amount of the policy.
Proof of age - Date of birth is necessary as the rate of premium is

decided on the basis of the age of the policyholder at entry. If date of
birth is not provided at the entry level then it should be proved to the
satisfaction of the insurance company at the time of claim.

Nomination and assignment - The policyholder can nominate anyone

at any time as nominee during the period of the policy. The person
designated as nominee will get the benefit of the policy if the
policyholder dies. Nomination is made by an endorsement in the policy.
o Assignment of a policy means the transfer of the policy to a third
party. A life insurance policy can be assigned to any person at any
time freely with or without consideration. But it should be in writing,
witnessed and registered. Assignment can be made on an
endorsement or on a separate signed instrument. The person who
makes the assignment is called Assigner and the person to whom
the policy is assigned is called as assignee.
Surrender value - Persons un-willing to pay the premium can surrender
the policy and ask for the surrender amount which is the cash value of
the policy. Surrender amount depends on the type of policy and
premium paid. Generally, it is one-third of the premium paid till date. A
person can apply for a surrender amount only if the premium has been
paid for minimum three years.
Paid-up value - Policyholders who want to close the policy can convert
their policy into paid-up policy. Paid-up value is equal to the premium
paid and greater than the surrender amount. But the Paid-up value
amount is payable only at the maturity of the policy. A policy can be
converted into paid-up policy only after two years.
Indisputable clause - Under the Insurance act 1950, no life insurance
policy can be disputed after it has run for two years except in case of
proof of age or fraud.
Penalty - The life insurance policy is penalised for non-payment of
premium, concealment of material facts, furnishing wrong information
and so on.
Revival of lapsed policies - If premium is not paid within the grace

period, the policy lapses. But the policy can be revived within a period of
five years from the due date of the first unpaid premium amount and
before the maturity date.

Claims - Claims mean issue of the insured amount to the policyholder.

Claims can be made at the middle of the policy term or on the maturity of
the policy.
5. _________ is the amount of insurance payable by the policyholder.
6. The person who makes the assignment is called Assignee and the
person to whom the policy is assigned is called as Assigner.
(True/False).
7. Which of these is not an element of life insurance?
a) Grace period
b) Nomination and assignment
c) Policyholder
d) Paid-up value
5.4 Classification of Life Insurance and Life Insurance Policies

In the previous section we dealt with the elements of life insurance. This
section deals with the classification of life insurance.
Life insurance is policy that is classified based on the factors such as cost,
length of coverage and accumulation of cash value of the different insurance
companies. The main purpose of the classification is to provide financial
resources to a decedent's family when the decedent dies. Basically, life
insurance is of the following two types:
o Term life insurance.
o Permanent life insurance.
5.4.1Term life insurance
Term life insurance is an inexpensive life insurance policy that pays a
financial benefit to the named beneficiary upon the death of the insured.
Term insurance is a basic form of life insurance and is the best worth for
most customers. For the people in their 20s and 30s, the premiums are less
costly than those for whole life insurance. Many customers opt for term life
insurance to provide the security to their families. In term life insurance, the
premiums on the term policy increase as the insured grows older. It covers the
insured only during a specified period of time and premiums are less
expensive. It doesnt accumulate a cash value.

In a term life insurance plan, the insured must undergo a basic physical
exam conducted by a nurse (including blood test) to make certain they are
insurable. The policy remains in effect as long as the premiums are paid. The
most popular models of term life insurance are annual, 7-year, and 10-
year policies. The premium slightly increases every year in annual policies and
in 7-year, and 10-year policies, the premiums remain the same for 7 or 10 year
periods of time.
Features of term insurance
The following are some of the features of term life insurance:
Initial affordability - Term life insurance policy premiums are less
expensive than those for whole life insurance. So, many customers
prefer this policy.
Adjustable premiums - Term life insurance policies have flexible
premiums. The premiums may increase or decrease at some point
specified in the policy based on likely changes of investment earnings,
humanity experience, persistence, and expenses. However, premiums
may never be raised above the maximum premiums specified in the
policy.
Renewability - Term insurance policies allow the policyholder to renew
coverage without having to undergo any medical test. Each time the
policy is renewed, the premium increases according to the attained age
of the insured. Conversion - Term insurance policies are convertible.
Conversion allows the policyholder to interchange a term life insurance
policy for any permanent life insurance policy accessible by the
company at any time while the policy is in force (subject to established
policy minimums).
Types of term insurance
The following are the various types of term life insurance:
Level term - Level term is currently the most common type of term
insurance. With this kind of policy, both the premium and the amount of
coverage are expected to stay the same for a specified number of years.
Some coverage may last outside the level period, but not always at the
same premium.
Decreasing term - Insurance can be useful for insuring a decreasing
debit such as a loan. The amount of insurance protection decreases

along with the level of needs while the premium generally stays the
same.
Renewable term - Renewable term is a common variant of term
insurance, the most general being yearly renewable term. With most
renewable term policies, the coverage by design renews at the end of
each term, regardless of any changes in policyholders health or
occupation. At renewal, the premium rises, replicating the increasing
probability of policyholders death, while the coverage amount stays
level. Several renewable term policies can be renewed until age 65 or
70; some until age 100.
While term policies hardly build cash values, most are guaranteed
convertible to a permanent policy without a medical exam. When reading
the particulars of a convertibility section, look specifically for how long
policyholders have the choice to convert, the category and superiority of the
permanent insurance and if the conversion is at the same risk class.
5.4.2 Permanent life insurance
Permanent life insurance covers the policyholder for a life time. As long as
the insured pays the premiums, life insurance stays in effect, no matter of
age or health. Hence this type of insurance is also called as whole life
insurance. Permanent life insurance helps to keep the premiums same
every year and provides guarantee of the premiums when the policy is first
purchased.
Permanent life insurance also includes a feature called cash value which
grows over time and insured can take a loan against it or use it as surety.
Types of permanent life insurance policy
The following are the basic kinds of permanent life insurance policy: o
Whole life.
o Limited-pay life.
o Endowment insurance.
o Universal life.
o Variable life.
Whole life
This policy covers the insured for whole of his life, with premiums to be paid
whole life. Whole life policy gives fixed amount on death of insured, and part

of the premium goes toward building cash value from investments made by the
insurance company. Cash value increases on a tax-deferred basis each year.
The amount paid usually doesn't change throughout the life of the policy. The
following are the advantages of whole life insurance:
Fixed premiums for the whole life policy.
Automatic savings account for the policyholder.
Cash value builds on a tax-differed basis.
Helps to borrow from cash value.
Cash value can be paid as policy premiums.
Converts cash value to an annuity at the time of retirement.
The following are the disadvantages of whole life insurance:
Higher initial premiums.
Long term guarantee that can reduce flexibility by locking in to a stream
of payments.
Limited-pay life
Limited-pay life is a permanent life insurance policy which involves premium
payment for a limited period-generally for a fixed number of years or until
the policyholder reaches a stated age. Examples for limited-pay policies are
twenty-pay-life (premiums payables for 20 years), pay-to-sixty-five
(premiums payable for 65 years). The premium is more for limited-pay policy
when compared to whole life policy for the same amount, but generally
cash-value builds up faster in limited-pay policy.
Endowment insurance
Endowment policy is basically a whole life policy with a maturity or
endowment date which occurs after a certain number of years or at a certain
age. The people who purchase the endowment policy work with the principle
that when a policy matures the amount by which the amount paid on view
exceeds the amount of premiums paid by the policyholder and added to the
policyholders income. Generally in endowment policy, the premiums are
paid when the policy matures or when the policyholder dies. If the
policyholder dies before maturity of the policy, the face amount of insurance
is payable to the designated nominee. An endowment policy matures more
quickly when compared to an ordinary life policy and its cash value will be
equal to its face value at maturity, the premiums should be considerably
more.

Universal life
Universal life policy is also known as flexible premium. It was first started in
the USA in 1970s and in India, the Insurance Regulatory and Development
Authority (IRDA) introduced it in 2009. The policy has gained more
prominence in Europe and US markets as they encourage the policyholder
to borrow money from insurance companies in the form of loans to raise the
finance support. In India, few companies such as Reliance Life Insurance
Co. Ltd and Bharti Axa Life Insurance Co. Ltd have universal life plans. It is
a variation of whole life insurance. Like whole life, it is also a permanent
policy providing cash value paybacks based on current interest rates. The
feature that distinguishes universal life policy from whole life policy is that
the premiums, cash values and level of security can step up or down during
the contract term when the policyholders wants to change. Cash values
earn an interest rate that is set occasionally by the insurance company and
is usually guaranteed not to drop below a certain level.
Universal life insurance addresses the apparent disadvantages of whole life -
namely that premiums and death benefit are fixed. With universal life, both the
premiums and death benefit are flexible. But with regards to guaranteed
death advantage in universal life, the flexibility comes at a price and the
guarantee is reduced.
Variable life
In variable life insurance most of the premium amount is invested in one or more
investment accounts. The policy holder can choose to invest in stocks, bonds,
mutual funds and fixed-income investments. The interest earned from these
investments increases the cash value of the policy. The risk tolerance and
the investment objectives of the policy holder determine the type of investment
made. Some insurance companies also permit the policy holders to switch from
one investment to another.
5.4.3 Annuity or pension policies
An annuity is an investment that a person makes, either in a single payment or
through investments paid for a definite number of years, for which he
collects a specific sum yearly, half yearly or monthly, either for whole life or for
certain number of years.

Upon the death of annuitant, or at the maturity of annuity, the invested

annuity fund is refunded with bonus which is calculated at that time.
All forms of life insurance differ from annuity in one essential way- an
annuity does not afford any life insurance cover but it offers an assured
income either for life or a certain period.
Typically annuities generate income during ones retired life, thus annuities are
also called as pension plans.
The following are the types of annuity or pension policy:
Fixed annuities -Fixed annuity is a type of annuity contract offering
investors a guaranteed return. The rate can increase or decrease. Fixed
annuities are useful for risk-opposing investors in search of a stable,
predictable return. Interest rates are generally somewhat higher than a
bank current deposit.
Variable annuities - Variable annuity is a type of annuity contract where
the consumer has the option of investing in mutual-fund investments in
areas like stocks, bonds, balanced, domestic, international, precious
metals, money markets, etc. This type of annuity allows investing to
provide future benefits that will hopefully keep step with or surpass
inflation.
Equity-index annuities - Equity-index annuity is a type of fixed-rate

annuity that combines a guaranteed minimum interest rate with the
potential for greater growth. Returns are normally based on a complex
formula secured with a specific market index. If the selected index rises
during the contract period, a higher rate of return (above the guaranteed
minimum interest rate) will be credited to annuity contract for that period.
5.4.4 Money back insurance policies

A money back insurance policy provides periodic payments of partial
survival benefits during the period of the policy, as long as the policy holder
is alive.
The following are the features of money back insurance policies:
Policy term - Money back policies are issued for a period of 15, 20, 25
years only.

Bonus - Bonus additions to the policy are calculated on the total sum
assured.
Insurance limits - Rs.5,000 is the minimum amount to issue the money
back policy.
Premium payment term - The premium for these policies for the
specified number of years, or till death if it occurs earlier.
Mode of premium payment - No restrictions on mode of premium
payment.
Loans - Loans are not available on this type of policies.
Eligibility - Minimum age for money back policy is 15 years. However,
these policies cannot cover beyond 70th year. In case of 9 year money
back policy. 20%of the sum assured is payable each at 3th and 6th
years, and the balance 60% plus the collected bonus at the end of the 9
year term. Similarly for 15 year money back policy, 25%of the sum
assured payable each at 5th and 10th years, and the balance 50% plus
the collected bonus at the end of the 15 year term. Also in case of 25
year money back policy, 15%of the sum assured payable each at 5th
10th 15th and 20th years, and the balance 40% plus the collected bonus
at the end of the 25 year term.
The main advantage of this kind of policies is that in the event of death at
any time within policy term, the death claim comprises total sum assured
without deducting any of the existence benefit amounts, which have been
previously paid. Similarly bonus is also calculated on the total sum assured.
5.4.5 Other types of life insurance policy
The following are the other types of life insurance policies:
Joint life insurance policy - It covers two or more persons with the
death benefit payable at the death of those insured. It can be either a
term or permanent policy insuring two or more lives of a family with the
proceeds payable on the first death or second death. Premiums are low
and its coverage includes spouses or two or more business partners.
For example, when a first person dies, the policy helps the surviving
policyholder with funds to pay his/her business or any other loans.
Survivorship life insurance policy - It is a whole life policy that insures

two lives with the proceeds payable on the second (later) death. Its
benefits are paid until the survivor of the dead person dies. Premiums
are low and the policy works best for couples and business people. For
example, a widow can get the benefit of this policy only after her death and
her children can get the benefits.
Single premium whole life policy - It is a policy with only one premium
that is payable at the time the policy is issued. It is the best form of life
assurance for family provision as it enables the life assured to pay the
premium during the most productive years of life, relieving him/her from
the necessity of making payments later in life when they might become a
burden. It is suitable for people of all ages and social groups who wish to
protect their families from a financial crisis that may occur due to their
death.
Modified whole life policy - It is a whole life policy that charges smaller
premiums for a specified period of time after which the premiums
increase for the remaining years of the policy. It often targets younger
people such as college students or newlyweds who expect future growth
in their income. It offers flexible payment terms but still provide a
guaranteed benefit.
Group life insurance - It is term insurance covering a group of people.
For example, family members, employees of a company or members of
a union or association. The policy considers the size and turnover of the
group, and the financial strength of the group. It has a provision for a
member exiting in the group to buy individual insurance coverage. It
covers the unexpected deaths of a family member or the death of an
employee. It offers coverage at low cost.
Preneed or prepaid insurance policy - It is a whole life policy that is
available at any age but is usually offered to older applicants. It covers
death expenses when the insured person dies. Payments are made in
advance in return for insurance services that are rendered over a
specified period of time.

8. Term life insurance policy premiums are ___________ than those for
whole life insurance.

9. Permanent life insurance helps to keep the premiums same every year
and provides guarantee of the premiums when the policy is first
purchased (True/False).
10. Money back policies are issued for a period of 15, 20, 25 years only.
(True/False).
11. ________________________ is a whole life policy that insures two
lives with the proceeds payable on the second (later) death.
a) Survivorship life insurance policy
b) Group life insurance
c) Joint life insurance
d) Prepaid insurance
Activity: 1
Visit any life insurance company or browse the Internet to list the features of
various life insurance policies offered by it.
Hint: Refer - http://www.iloveindia.com/finance/insurance/companies/sbi-
life-insurance.html
5.5 Advantages and Disadvantages of Life Insurance

The previous section discussed the classification of life insurance policies. This
section will discuss the advantages and disadvantages of life insurance.
Term life insurance
Advantages
Initial premiums are less when compared to permanent life insurance.
Allows the people to buy higher levels of coverage at a younger age
when the need for protection is obviously more.
It successfully covers requirements that are not permanent like
mortgages, car loans, education funding.
Disadvantages
Premiums increases with the age of the policyholder.
Coverage may lie off at the end of the term or turn out to be too
expensive to continue.
The policy cannot offer cash value or paid-up insurance.

Permanent insurance
Advantages
Protection is assured for life as long as the premiums are paid.
Fixed or flexible Premium costs to meet the personal financial
requirements.
The policy collects a cash value against which policyholder can avail
loans. However the loans must be paid back with interest or
policyholders nominees will receive a reduced death advantage.
Policyholder can borrow against the policys cash value to pay premiums
or use the cash value to offer paid-up insurance.
The policys cash value can be submitted (in total or in part) for cash or
renewed into an annuity.
Disadvantages
Essential premium levels may make it difficult to buy an adequate
amount of protection.
Permanent insurance may be more costly than term insurance if the
policyholder doesnt keep the policy long enough.
Activity: 2
Consider that you are working as a sales executive in an insurance
company. Identify the advantages and disadvantages of life insurance to a
customer.
Hint: Refer to section 5.5.

12. ______________ allows the people to buy higher levels of coverage at
a younger age when the need for __________is obviously more.
13. Term life insurance Premiums decreases with the age of the
policyholder. (True/False).
14. In Permanent life insurance, protection is assured for life as long as the
________________________.
a) Person survives
b) Premiums paid
c) Person claims the policy
d) Maturity period

5.6 Role of Term and Endowment in Product Designing

Term products are life insurance plans that offers financial cover equivalent
to the face value of the policy in case the policy holders dies during the
policy period. They do not carry any cash value. According to the plan,
policy holders pay a certain premium to protect their dependants against
their sudden death. But if the insured person lives upto the specified period
of the policy, the insured will not get any benefits from this plan.
Endowment products are plans that combine risk cover with financial
savings. Endowment plans are the most popular products in the world of life
insurance. In this plan, the sum assured is payable even if the insured
survives the policy term. But when the insured dies during the specified
period, the amount is paid to the sum assured. The insured who remain alive
upto the specified period of the plan get back the sum assured with some
other investment benefits. It also offers offer various benefits such as double
endowment and marriage/ education endowment plan. The cost of this plan is
slightly higher but is worth its value.
The following are the features of term and endowment products:
Term and endowment products provide death benefits ensuring the
security of those important persons of the insured.
They provide disability protection ensuring the insured that their
insurance will remain in force if they are disabled and unable to work.
They provide retirement planning and funds to the insured for the future
retirement needs. They cover other risks of the life of the insured such
as accidents, hospitalisation and business loss.
Term and endowment products have been in the market for a long time and are
very popular. Hence many insurance companies while designing products
offer these. They incorporate the basic features of these plans and try to provide
product differentiation by providing marginal benefits to attract more customers.
5.7 Features of Endowment Assurance Policy

The previous section discussed the role of term and endowment policies in
product design. This section discusses the features of endowment
assurance policy.

Endowment assurance policy is a fixed term life assurance policy in which

provisions are made for premiums to pay for life cover and to save or invest. The
policy pays out a sum of money (the sum assured) on the death of the
policyholder or at the maturity date if the policyholder is alive till the term of
completion. If an endowment policy is claimed prior to its maturity period,
then the amount returnable to the policyholder will normally be below the
value of the premiums paid up to cancellation.
The important features of the endowment assurance policy are:
Moderate premiums.
High bonus.
High liquidity.
Savings oriented.
Sum assured is payable to the policyholder either on survival to the term
or on death occurring within the term.
Under this policy with Profit and a without Profit plans are available.
Bonus for the full term is payable to the policyholder on the date of
maturity or in the occasion of death, whichever is earlier.
Premiums can be limited to smaller term or can be paid as single
premium.
Premiums come to an end on expiry of term or on death whichever is
earlier.
This policy provides provisions for the family of policyholder, in event of
his death, and also assures an amount at a desired age. The amount
can be reinvested, to provide an annuity during rest of his life or in any
other way. Premiums are payable for specified number of years.
Endowment assurance policy is affordable for people of all ages and
social groups, who wish to protect their family members from a financial
risk that might occur in future. If the policy holder becomes permanently
disabled on account of an accident, before reaching the age of 70 and
the policy is in full force, then it is not compulsory for him to pay the
remaining premiums; and the policy will be unaffected.
15. ___________________ policy is a fixed term life assurance policy.
16. Endowment assurance policy premiums can be limited to smaller term
or can be paid as single premium. (True/False).

17. Endowment assurance policy provides provisions for the

___________________.
a) Investors
b) Agents
c) Family of policyholder
d) Insurance company
5.8 Summary
Life-insurance is a financial cover provided by a life insurance company for a
person and his family, from any kind of loss, likely to be caused by an unsure
event.
It provides the basis of protection and financial stability after ones death in a
family. Its function is to support the other family members with financial
stability.
The two basic elements that all the individuals require from life insurance
are:
Coverage of risk.
Savings for the future.
The main types of life insurances are:
Term life insurance.
Permanent life insurance.
The various types of term life insurance are:
Level term.
Decreasing term.
Renewable term.
The basic kinds of permanent life insurance policy are:
Whole life.
Limited-pay life.
Endowment insurance.
Universal life.
Variable life.
The other types of life insurance policies include:

Joint life insurance policy.

Survivorship life insurance policy.

Single premium whole life policy.
Modified whole life policy.
Group life insurance.
Preneed or prepaid insurance policy.
Endowment assurance policy is a fixed term life assurance policy in which
provisions are made for premiums to pay for life cover and to save or invest.
5.9 Glossary
Endowment: Endowment is a type of life insurance that is payable to the
policyholder if the policyholder survives till the maturity date of the policy, or to a
nominee otherwise.
Reimbursement: Reimbursement means to make repayment to for
expense or loss experienced.

1. Explain the purpose and need of life insurance.
2. Explain the features and types of term life insurance.
3. Explain the types of whole life insurance policy?
4. Discuss the elements of life insurance.
5. Describe features of endowment assurance.
5.11 Answers
1. Future risks and savings
2. Financial protection
3. False
4. Important employees
5. Premium
6. False
7. Policyholder
8. Less costly
9. True
10. True
11. Survivorship life insurance policy

12. Term life insurance and protection

13. False
14. Premium paid
15. Endowment assurance
16. True
17. Family of policyholder
Terminal Questions
1. The purpose of life insurance is to provide financial protection. Refer
section 5.2 for more details.
2. Term life insurance is an inexpensive life insurance policy that pays a
financial benefit to the named beneficiary upon the death of the
insured. Refer section 5.4.1 for more details.
3. Whole life insurance covers the policyholder for a life time. Refer
section 5.4.2 for more details.
4. The elements of life insurance are premium, surrender value,
nomination and claims. Refer section 5.3 for more details.
5. Endowment assurance policy is a fixed term life assurance policy.
Refer section 5.7 for more details.
5.12 Case-Let
Life Insurance Plan for Ram
Ram and Sita are a newly married couple. Ram is employed but Sita is
not. Ram wanted to ensure the financial security of his wife Sita if
something unforeseen should happen to him. He wanted a low cost plan
which would also guarantee him some returns. He also expected to
acquire some tax benefits. He enquired with some insurance companies
and decided on the BLSI Premium Back Term Plan from Birla Sun Life.
The plan offered 100% of the premiums paid on maturity. It also offered tax
benefits under Section 80Cof the Income Tax Act.
The policy offered Death benefit by which in the event of the death of the
policy holder, the nominee receives the sum assured along with the
premiums paid till date.
The plan offers three riders - Accidental Death and Dismemberment
Rider, Critical Illness Rider and Waiver of Premium Rider.

1. What were the benefits that Ram wanted in his life insurance plan?
(Hint: low cost, returns, tax benefits).
2. What were the benefits of the plan chosen by Ram?
(Hint: 100% premium pay back, death benefit, tax deductions, riders)
Source:
http://insurance.birlasunlife.com/ProductsSolutions/IndividualInsurance/
ProtectionSolutions/BSLIPremiumBackTermPlan/tabid/80/Default.aspx#
References
House, India
Sethi, Bhatia (2007). Elements of Banking and Insurance, PHI Learning,
India.

Unit 6 Non-Life Insurance - 1
Structure:
6.1 Introduction
Objectives
6.2 Fire Insurance
Perils covered
Exclusions under the fire policy
Types of fire policies
6.3 Marine Insurance
Marine cargo insurance
Marine hull insurance
Inland marine insurance
RBI guidelines on marine insurance
6.4 Rural Insurance
Need and potential of rural insurance
Rural insurance policies
6.5 Social Insurance
Characteristics and need for social insurance
Various social insurances
6.6 Summary
6.7 Glossary
6.9 Answers
6.10 Case-Let
6.1 Introduction
The previous unit explained the elements of life insurance. It described the
features of life insurance and endowment assurance. It also discussed the
different types of life insurance policies.
This unit introduces non-life insurance. Non-life insurance is also referred to
as general insurance. The general insurance industry provides financial
support against financial losses. It covers the losses arising from
destruction, damage to property, and loss incurred through legal liabilities.
The purpose of insurance is to restore the affected parties to their no loss

position prior to the happening of the event. This unit covers the various
non-life insurances such as fire, marine, rural and social insurance.
A general insurance policy is a contract of indemnity, where the insurer
bears the financial loss suffered. Since there is no certainty in the loss of the
asset insured, the premium paid is proportional to the probability of loss or value
of the asset. Insurance of property and person is of utmost importance in all
circumstances. This unit explains in detail the cover, liability, exclusion and the
need for fire, marine, rural and social insurance.
Objectives:
describe the perils covered and exclusions with regard to fire insurance
explain marine insurance and its divisions
discuss the need of rural and social insurance
list and explain the various rural and social insurance policies
6.2 Fire Insurance

This section discusses fire insurance, a type of non-life insurance.
Fire insurance is a contract of indemnity, taken by a person or organisation
seeking protection to indemnify against the loss of property by fire during an
agreed period of time. Fire insurance is defined under Insurance Act, 1938
as the business of effecting, otherwise than incidentally, to some other
class of insurance business, contracts of insurance against loss by
incidental to fire or other occurrence customarily included among the risks
insured against in fire insurance policies. The fire insurance policy covers
both movable and immovable assets having financial value.
The term fire in the context of insurance means production of light and heat by
combustion. Following are the various distinct connotation of the word fire in
insurance:
Fire needs to be actual, that is, there has to be actual flame witnessed,
and not just smoke or charring.
The occurrence of fire must be improper and a happening.
Fire should have occurred accidentally and not intentionally. The
cause of the fire must be an external factor.

6.2.1 Perils covered

A fire policy does not insure or pay for all types of losses incurred. The
instances which are covered in fire insurance are:
Fire - Damage to property by its own heating or spontaneous
combustion or fermentation is not treated as damage due to fire.
Damage due to heating or drying process and burning of property
insured by any public authority is also not considered.
Lightning - Lightning may result in fire damage or other types of
damage too. Both fire and non fire losses are covered.
Explosion - A general definition of explosion is a sudden violent burst
with a loud report. Explosion covers implosion or caving caused by
internal pressure being less than external pressure. It does not cover
damage by boilers and steam vessels, except the ones used for
domestic purposes. Industrial boilers are considered and covered based
on different conditions.
Riot, strike, malicious and terrorism damage - Any act causing
disturbance in public peace is considered to be a riot, strike or terrorist
activity. Physical damage caused by any such activity or by action of
lawful authorities in suppressing such disturbance or decreasing the
consequence caused is included. Direct physical loss, destruction or
damage by external violence is covered. Malicious act includes any act
with malicious intent is included. Burglary, theft, larceny which does not
constitute a malicious act are excluded, but are covered under burglary
insurance.
Impact damage - Impact caused by any rail/road vehicle or animal,
which is not belonging to or owned by the insured or any occupier of the
premises or their employees is covered.
Subsidence and landslide including rockslide - Subsidence means
sinking of land or building into the surface of the earth. Landslide is
sliding down of land, usually on a hill. Destruction caused by subsidence
of part of the site which is insured is covered. Normal cracking, coastal
or river erosion, defective design, use of defective materials, structural
alterations or excavations is not covered.
Storm, cyclone, typhoon, tempest, hurricane, tornado, flood and
Inundation - Storm, cyclone, typhoon, tempest, hurricane and tornado
are all various types of natural disturbances accompanied by strong

winds or heavy rainfall. Flood or inundation is caused, when water rises to

an abnormal level.
Bush fire - Damage caused by burning, whether accidental or by
clearing of lands is covered. But damage due to forest fire is excluded.
Leakage from automatic sprinkler installation - Damage caused by
water discharged accidentally from the automatic sprinkler installation, when
there is no fire. This risk covers the water damage, and is payable as damage
by fire.
A policy that covers all the above perils is called as Standard Fire and
Special Perils policy.
6.2.2 Exclusions under the fire policy
The losses or damages not covered under the fire policy are:
Five percent of every claim because of lightning or storm, cyclone,
tempest or subsidence and landslide covered under the policy. This is a
way of excess of deductible to be borne by the insured.
Loss or damage caused by war, act of foreign enemy, civil war,
rebellion, revolution and kindred perils.
Loss or destruction caused to the insured property, by radiation or
pollution from any nuclear fuel or waste.
Loss or damage caused to the insured property, by pollution or
contamination excluding cases which results from a peril insured or any
peril insured against which by itself results from pollution and
contamination.
Loss or damage to the following items:
Unset precious stones, curios.
Work of art whose amount is exceeding Rs. 10000.
Drawings, plans, manuscripts, obligations or documents of any kind.
Stamps, paper money, cheques, books of accounts or other
business books.
Computer system records or explosives.
The above items are covered if expressly stated in the policy or subjected to
special terms and conditions.
Damage or destruction to the stocks in places, such as, cold storage
premises, caused by change in temperature.

Loss to any electrical or electronic machines, excluding fans and

electrical wiring in dwellings, arising from short circuiting, self heating,
excessive pressure or leakage of electricity, which is termed as
electrical risks exclusion.
Expenses incurred due to architects, surveyors and consulting
engineers fees.
Damage by spoilage due to interruption of any process.
Loss or damage to machinery when moved to another place for
renovation or repair for a period beyond 60 days.
6.2.3 Types of fire policies
The different types of fire policies are:
Floating policy - Generally, fire policies are location oriented. But, for
traders who have godown facilities in more than one location, the value
of stocks at all locations is covered under this policy. The stocks at each
location will be continuously fluctuating depending on the volume of
goods changed with each transaction of sale or purchase. Hence, it is
difficult to quantify for each location and take a policy; therefore
preferably one floating policy can be taken against one premium.
Valued policy - When the approved value of the subject matter is
mentioned in the policy it is named as valued policy. This value may not
essentially be the real value of the property. In the occasion of toss by
fire the insurer pays the admitted price of the property.
Unvalued policy - When the value of the subject matter is not declared
at the time of purchasing the policy it is called unvalued policy. This is
also called an open policy because in case of loss, the value is
calculated by assessment.
Average policy - When a property is insured for a sum less than its
value, the insurer may not be liable to pay the full loss but only the
amount of loss that is insured for. Such a clause is known as the
average clause and policies containing an average clause are known as
average policies.
Specific policy - A specific policy is a kind of policy in which the assets
are insured for a specific sum irrespective of its value. The value of the
whole subject matter is irrelevant and as such it becomes a under
insurance policy. For example, if an asset is insured for Rs. 1,00,000

although its actual value is Rs. 2,00,000 and in the event of loss to
property, not more than Rs. 1,00,000 can be recovered.
Stock declaration policy - This policy is bought for covering the stock
where great changes in the value happen throughout the contract
period. Here 75 percent of the premium must be deposited in advance.
The highest liability of insurance company is specified in the policy. The
average stock and final premium is calculated at the end of year.
Comprehensive policy - It is a type of policy in which all types of risks
like fire, strikes, riot, explosion and burglary and so on are covered. This
policy is also called as all in one policy or all Insurance policies.
Re-instatement policy - This is a type of policy in which the insurer
undertakes to reinstate the property or goods lost by fire. In this policy
the property is replaced in totality instead of paying compensation for
the goods lost by fire.
Schedule policy - A schedule policy is a type of fire insurance policy
which insures many properties under collective terms and conditions,
Particulars of the properties and their individual rates of premium are
listed in a single policy only for the ease of the insured.
Excess policy - This policy is issued for the stock of merchandise
whose value is unpredictable or constantly fluctuating. The insurer takes
an excess policy for excess value of the stock and ordinary policy for
minimum value of the stock as in it is not suitable to take one policy for
certain sum. The real value of the stock will be reported occasionally.
Activity: 1
Research and find out the other various types of fire policies
Hint: Specific policy, average policy, consequential policy

1. _________________ policy is issued with respect to the available
inventory.
a) Floating
b) Declaration
c) Reinstatement
d) Standard fire

2. Damage or destruction to the stocks in places like cold storage premises

caused by change in temperature is usually covered in a standard fire
insurance policy. (True/False).
3. __________________ policy is not location oriented.
6.3 Marine Insurance

The previous section explained fire insurance and the different types of fire
insurance. This section discusses the features of marine insurance.
Marine insurance has developed over many centuries and is the second-
most popular insurance after fire insurance. Marine insurance is a contract
in which the insurer undertakes to cover the losses insured, in case of
marine happenings. It plays a very important role in both internal and
international trade. The insurance document is important in international
trade, as it provides collateral security to the banks. The scope of marine
insurance extends to a wide property coverage divided between land and
sea. It covers insurance of ships, insurance of hulls, cargo, wharves, ports,
container terminals, oil platforms, drilling rigs, and so on.
In India, the Marine Insurance Act of 1963 facilitated the development of
marine insurance according to the Indian conditions. The different types of
marine insurance will now be described in this section.
6.3.1 Marine cargo insurance
This insurance covers goods and commodities transported by the sea. It is a
critical part of overseas sea trade, where the trade is financed through a bill
of exchange, which is normally discounted by a bank. The bank does not
discount the bill unless the goods mentioned in the Letter of Credit are
insured against marine risks. Usually exporters, importers and their bankers
prefer to obtain maximum possible coverage for goods-in-transit. The cost of
insurance is a small fraction of the market value of the goods to make
insurance policy attractive. It covers loss to cargo, due to the following
perils:
Storm or collision.
Fire, explosion or lightning.
Leakage in vessels.
Sinking and capsizing.
Jettisoning of cargo overboard when vessels run aground.

Stranding that is grounding arising due to wrong navigation.

Washing overboard - where cargo is placed on deck and is subjected to
rolling and pitching under conditions of stormy weather.
Loss of package during loading or unloading at the ports.
Theft, pilferage and non-delivery.
The following are the exclusions in this policy:
Ordinary leakage, loss in weight or volume, wear and tear.
Caused by insufficient, unsuitable packing or preparation of goods.
Damage arising from use of weapon of war, by employing atomic or
nuclear fission or fusion.
6.3.2 Marine hull insurance
Marine hull insurance involves insurance of ships, including vessel
machinery. In this insurance, the insured is indemnified for losses by
damage to the ship. It is always written with a deductible. It also has the
condition that covers the owners legal liability if the ship collides with
another vessel. But, it does not cover legal liability arising due to injury or
death to other persons, damage to piers and docks and damage of crew
members.
The perils covered in this insurance include sinking, fire, stranding and
collision, violent theft by persons from outside vessel, breakdown or
accident to nuclear installation. It also covers all perils of the sea,
earthquake, volcanic eruption or lightning. The hull insurance covers the
construction risk, when the vessel is under construction.
6.3.3 Inland marine insurance
Inland Marine insurance is broader than insuring property under other
insurance coverage. Inland marine insurance is a floater policy as it covers
property which on the move by any mode of transportation. Thus most items
which are covered under inland marine policies carry the terms
instrumentalities of transportation. Unlike a property insurance policy,
floaters may include such items as flood, breakage, transportation, and
possibly earthquake. The coverage can be extremely broad as the covered
causes of loss are risks of direct physical loss or damage from any external
cause except that which is excluded or limited.

The inland marine floaters cover property while it is off premises or in the
course of transportation. It is not meant to cover fixed buildings, any
improvements and betterments nor fixed furniture, contents or supplies.
There may be exception under such movable property floaters and these
exceptions pertain to such items as a manufacturers output polity or a
builders risk policy.
Marine insurance is commonly associated with imports, exports and
domestic shipments but it also covers instrumentalities of transportation and
communications, which by definition includes auxiliary facilities and
equipment which is included within such facilities like radio or television
station equipment for broadcasting. Radio and television communication
equipment such as towers and electrical operating and control apparatus
are also included.
6.3.4 RBI guidelines on marine insurance
RBI has fixed some guidelines regarding marine insurance. Some of the
guidelines are as follows:
On exports
The insurance charges on the shipment must to be borne by exporter.
The exporter will undertake the insurance charges on the shipment on
behalf of overseas buyer of the goods and also undertake to add the
amount on the invoice and recover the payment so made from the buyer
in an approved manner.
On imports
The insurance charges on the shipment in question have to be borne by
importer in terms of the contract with the overseas seller.
The import is covered under an Import Licence and the importer must
undertake to ensure that the amount of insurance premium paid will be
endorsed on the import licence in due course.
4. The ____________________ insurance covers the construction risk
when the vessel is under construction.
5. The cost of _____________________ is a small fraction of the market
value of the goods.
a) Marine hull insurance

b) Marine cargo insurance

c) Floating policy
d) Reinstatement policy
6. Stranding, that is ground arising due wrong navigation is not covered
under the marine hull insurance. (True/False).
7. Inland marine insurance is a floater policy. (True/False).
6.4 Rural Insurance

The previous section discussed marine insurance and its types. This section
deals with rural insurance.
Rural insurance covers areas like fisheries, horticulture, floriculture, cattle and
living stock. This insurance is accepted to be a high-cost, low premium
business which requires different type of skills. It involves various
government organisations, agencies and departments.
6.4.1 Need and potential of rural insurance
With the increase in income of the rural community, the rural population is
purchasing consumer durables, constructing houses and purchasing
vehicles. These assets need insurance. Therefore the efforts by private
insurance companies backed by proper business can have direct impact on the
rural economic growth. In the farm sector, insurance supplements the
advances in science and technology.
The following factors indicate that there is a good potential for growth of
insurance services in rural markets:
Improving economic conditions.
Low penetration level of insurance products in the rural sector.
Rising rural demand for insurance products.
Increasing disposable income levels.
LIC (Life Insurance Corporation) and GIC (General Insurance Corporation)
have been providing insurance cover for the rural areas, but they are not
sufficient. The people residing in rural areas state that claim lodgment and
settlement procedure is time consuming and burdensome. Cattle and crop
insurance by the government, have not met the expected results.

To set up or improve the rural insurance, the following needs to be done:

Create products according to the rural requirements, and establish
efficient methods of premium collection and claims settlement.
Educate the rural about the need of insurance products.
The government should encourage the private and foreign insurance
companies to provide insurance to rural assets.
The educated young people of the villages need to be trained and
taught about the need for insurance.
6.4.2 Rural insurance policies
The Insurance Regulatory and Development Authority (IRDA) have defined
the rural and social insurance products with respect to the minimum and
maximum sum assured. The regulator also intends to include micro
insurance under its definition which will make sure that insurers will no
longer be able to get away with selling low-value and low-premium covers to
rural people to meet the rural and social criteria prescribed. IRDA has
written to insurers saying that rural products will have to offer a minimum
sum assured of Rs. 5,000 for general insurance and life insurance policies.
The health insurance for family and personal accident per person will have
to be a minimum of Rs10,000. There will be no upper limit on the amount
assured.
The types of policies which are associated with rural insurance are:
Aqua culture insurance: This policy is given to licensed farms, in
accordance with the government norms for growing brackish water shrimp
by adopting extensive systems. This policy grants cover against natural
calamities and diseases. It is given for a period of four and half months.
The requirements of the farm are:
It should be licensed to set up and conduct aqua culture operations. It
should be established as per standards.
The seed used should be of good quality and as per the prescribed
norms.
The seed should be availed from well-known sources.
Cattle insurance: This is best suited for farmers, who own the cattle
and the financial institutions that have financed the purchase. The term
of the policy is usually for a period of 12 months or for 3 to 5 years. It

covers loss due to death, illness or accident. It also covers the transit of
cattle from the place of purchase to the stables located within 80 kms.
A veterinary officer is required to fix the value of the cattle, and for accepting
the proposal. In case of death, the policy pays the market value of the
animal prior to the death or accident or the sum insured, whichever is lesser
among the two. Veterinary examination and tagging of the cattle is
necessary for granting insurance cover. Natural identification marks and
color should be clearly stated in the proposal form with the veterinarians
report.
Indian economy is based on agriculture; hence, a sound agricultural base can
only lead to economic stability. Therefore, the GIC has introduced rural
insurance schemes not just to offer financial protection, but also to fulfill their
goal. Hence, this cover gains the maximum importance amongst rural
insurance policies.
Failed well insurance - Wells financed by banks and re-financed by
NABARD are insured. Those wells that are financed by nationalised
banks but not re-financed by NABARD require approval of the head
office. It protects against the risk of low yield based. The selection of the
site must be done using scientific principles and methods. Bore wells
which yield up to 1000 gallons per hour are covered by this policy. If the
yield is below 500 gallons, then the well is counted to be a failure. If the
yield is between 500 to 1000 gallons per hour, the policy pays
proportionally to the actual yield.
The policy does not cover natural calamities, quality of water, structural
failure of work, defective design material, bad workmanship and allied
perils. Rate of premium is 17.5 percent of sum insured. The proposal
should be attested with site selection report obtained from
geohydrologist approved by insurers.
Inland fish insurance - It is also called as pond insurance. This policy
is made available for fresh water fish rearers. It covers total loss of fish
due to accident or disease during the period of insurance. It also covers
loss due to pollution and malicious act by third parties and strike. Flood
and allied risks are covered on payment of extra premium. The value of
fish increases due to growth and inputs and is affected as per the
scheduled valuation fixed. The value depends on the cost of input and

other incidental expenses. Premium is charged at 2.4 percent on the peak

value. Flood perils are covered by charging one percent extra in
non-flooded areas and 2 percent in case of flood prone areas.
The documents to be submitted are - a copy of the techno-economic
feasibility report deciding the sum insured for the items, specimen
copies of fish culture records, a certificate of government fishery
extension regarding viability of bunds.
Plantation / horticulture / floriculture insurance - This policy
provides cover for loss or damage to horticultural crops like trees of
citrus fruits, apple, banana and plantation crops like rubber, eucalyptus,
tea, and floricultural plants like roses, orchids etc. It also covers
damages due to fire, lightning, storm, hail storm, riot, strike and
terrorism. It excludes loss due to loss by theft, earthquake, climate
variations, pollutions, non-bearing fruits, damages by birds or animals,
damage by irrigation system or agricultural equipment. The duration of
insurance is from planting to harvest or one year whichever is shorter.
The amount of insurance is based on costs of cultivation, cost of
manures, cost of pesticides, labor cost of planting, and cost of
plant/seedlings.
Farmers package insurance - Various insurance companies are
making promotion of insurance schemes in rural places to bring
development among them. They are trying to promote insurance for
crop, health, agricultural tools and livestock. The farmers package
insurance is a complete policy package. It extends to give coverage for
wider risks and dangers. The insured farmers get full assurance for any
kind of risk. There are many sections included in the policy providing
protection for farmers and to their goods. The farmers policy package
provides coverage for any kind of damage to their household products
such as goods stock, television, bicycle, and other things insured.
Damage caused by accident, damages to their livestock, pump, cart and
even medical expenses incurred during any accident is covered by this
policy. Kissan Package Insurance provided by Oriental Insurance is an
example of this policy.
Various other insurances under rural insurance are poultry insurance, hut
insurance, irrigation insurance, and bee insurance.


8. The term of ______________ policy is usually for a period of 12
months or for 3 to 5 years.
9. Inland fish insurance is also called as _________ insurance.
10. _______________ policy does not cover the loss due to natural
calamities.
a) Aqua culture insurance
b) Cattle insurance
c) Failed well insurance
d) Fish insurance
11. The duration of horticulture insurance is one year. (True/False).
12. _________________________________ provided by Oriental
Insurance is an example of farmers package policy.
6.5 Social Insurance

The previous section explained the various rural insurance available. This
section explains social insurance which is another type of non-life insurance.
Social Insurance is a responsibility in which special care is taken of the
socially and economically weaker section. In India and many other countries
too, it is compulsory for the insurer to assign a certain percentage of the
business in favour of such classes as per the IRDA rules. This applies to
both private and public sector. Due to the current social changes, the
products offered in this insurance plan are retirement plans, disability
insurance, long term care for senior citizens and employee benefit plans.
6.5.1 Characteristics and need for social insurance
Social insurance is based on law, hence it is covered for all persons to
whom the law applies, and it cannot be denied. In social insurance,
minimum level economic security is provided for a large portion of the
population. The focus of this insurance is to provide maximum benefits to the
lower income groups.
The purpose of this insurance is to give individuals and families, the
confidence to maintain their level of living and quality of life, such that it is not
disturbed by social or economic factors. Protection against unemployment by
maintenance, and promotion of job creation, and providing benefits for the
maintenance of children are covered in this insurance.

The important idea in this insurance is that individuals postpone the

utilisation of a part of their present income for future needs. The benefit of the
insurance programme is that more than the actual contribution is paid back. It
also provides the right mechanism to achieve the goals to protect ones
inability to look after oneself.
6.5.2 Various social insurances
The various social insurances provided in India are:
Employee state Insurance - The Employee State Insurance Act which
was introduced in 1948, is a piece of social welfare legislation
introduced primarily with the object of providing quite a few benefits to
employees in case of sickness, injury and maternity and also to create
provision for certain others matters incidental to that. The Act in fact tries
to achieve the goal of socio-economic justice enclosed in the directive
principles of state policy which enjoin the state to make efficient
condition for securing, the right to work, good health, education and
public assistance in cases of unemployment, sickness, old age and so
on. The act endeavors to materialise these objects through only to a
restricted extent. This act provides a broader spectrum then any other
insurance or factory act. While the Factory Act deals with the health,
welfare and safety of the workers employed in the factory premises only,
the benefits of this act expand to employees whether working inside the
factory or establishment or elsewhere or they are directly employed by
the principal employee or by an intermediary agency, if the employment
is incidental or in connection with the factory or establishment.
Disability insurance - The most significant form of disability insurance
is the one offered by the government. This program makes sure that all
the citizens who are uninsured or underinsured are covered. This
program does not offer huge benefits but it pays enough to prohibit
poverty. Many well-known companies cover their employees against the
probable hazards of disability. Employees face a high chance of
meeting with an accident at the work place. So, it is crucial for
companies to offer disability insurance. Workers compensation policy
comes under disability insurance. It pays workers who get disabled by
job-related injuries. This program also pays benefits to the family
members of workers who died while performing job-related tasks and
also cover all the medical expenses. Individual disability insurance

policy is also a part of disability insurance. This policy is meant for the
temporary employees or those who are not covered under employer
disability insurance or the self-employed. Any individual can buy such an
insurance policy from any insurance company but premiums tend to stay
high for policies that offer great benefits or that defines disability in a
broader context.
Health insurance schemes for the poor - Over the last several years
there have been efforts to extend health insurance by various small
NGOs. Self-Employed Women's Association (SEWA) which is a
membership based women workers' trade union, has developed a
scheme to protect the poor women from financial burdens which arise
out of high medical costs and several other risks. Each member of the
association has an option to join the programme by paying Rs. 60 per
annum and it provides limited cover for risks arising out of sickness,
maternity needs, floods, accidents, widowhood and so on. The scheme
is also linked with the saving scheme. Members have the option to
either deposit Rs. 500 in SEWA Bank or pay annual premium of Rs. 60.
SEWA started this programme with the support of one of the public
sector insurance companies. According to SEWA the patients belonging
to lower income groups who opt for the schemes would need systems
which are straightforward, flexible, simple, prompt, and have less paper
work and consists of fewer tiers. SEWA experience illustrates that other
aspects of risk which need coverage include natural and accidental
death of women and her husband, disablement, loss because of riots or
flood or fire or theft. Other NGOS offering similar schemes are ACCORD
in Karnataka, Aga Khan Health Services, India (AKHSI) and Nav-sarjan
in Gujarat, and Sewagram medical college Maharashtra. The scheme
developed by government insurance companies to focus on poor is
called Jan Arogya Bima Policy.
Medicare - Medicare covers most of the medical expenses of elderly,
disabled workers and veterans. Medicare has a number of different
programs, which influence the types of benefits received by the
beneficiaries. Some plan levels cover different procedures and provide
assistance with bills incurred through hospital stays, prescription
coverage, and doctor appointments. Medicare receives the funding
through taxes deducted from current workers.

Unemployment insurance - Unemployment Insurance provides

temporary financial protection for workers who experience unforeseen
layoffs due to lack of work and other reasons that are no fault of the
employee. Unemployment programs also protect workers who suffer
unemployment due to natural disasters like floods and cyclones.
Funding for unemployment insurance is done through the employer's
unemployment tax. ICICI Lombard has introduced this insurance in
India.
Activity: 2
Do a research and find out the companies offering social insurance
policies in India.
Hint: Life Insurance Corporation, Oriental Insurance

13. The earliest act of old age security insurance in India is the
_____________________.
14. ______________________ makes sure the employer compensates a
worker for his loss.
15. The Employee State Insurance Act which was introduced in 1988, is a
piece of social welfare legislation introduced primarily with the object of
providing quite a few benefits to employees in case of sickness, injury
and maternity. (True/False).
6.6 Summary
Insurance in India is divided into life insurance, and general insurance. This unit
discussed some forms of general insurance like fire, marine, rural and social
insurance.
Fire insurance is a contract of indemnity, taken by a person or organisation
seeking protection to indemnify against the loss of property by fire during an
agreed period of time. The different types of fire insurance policies are:
Floating policy.
Valued policy.
Unvalued policy.
Average policy.
Specific policy.
Stock declaration policy.

Comprehensive policy.
Re-instatement policy.
Schedule policy.
Excess policy.
Marine insurance that is a contract in which the insurer undertakes to cover the
losses insured incase of marine happenings. Marine insurance is classified
into:
Marine hull insurance.
Marine cargo insurance.
Inland marine insurance.
The different rural insurance policies available in India include:
Aquaculture insurance.
Cattle insurance.
Failed well insurance.
Inland fish insurance.
Horticulture / plantation / floriculture.
Farmers package insurance.
Social insurance is a safety net against financial insecurity that results from
unemployment, poor health, disabilities and old age. The different social
insurances available in India are:
The Employee State Insurance Act.
Disability insurance.
Health insurance schemes for the poor.
Medicare.
Unemployment insurance.
6.7 Glossary
Aquaculture: This is also called aqua farming and deals with the cultivation of
fish, molluscs and aquatic plants.
Contract of indemnity: Property and liability insurance contracts that
restore the insured to his/her original financial condition after suffering a
loss.

Floriculture: This is concerned with the growing of flowers and ornamental

garden plants.
Horticulture: Horticulture is the cultivation of garden plants, fruits, berries, nuts,
vegetables, flowers, trees, shrubs and turf.
NABARD: National Bank for Agriculture and Rural Development is the main
institution in India that deals with all matter concerning policies, planning
and operations for providing credit for agriculture and other economic
activities in rural India.
Premium: The periodic payment made on an insurance policy

1. Explain the different perils covered in fire insurance.
2. Describe marine cargo insurance.
3. List and explain the various rural insurance policies.
4. List and explain the social insurances available in India.
6.9 Answers
1. b) - Declaration
2. False
3. Floating
4. Marine hull
5. b) - Marine cargo insurance
6. False
7. True
8. Cattle insurance
9. Pond
10. c) - Failed well insurance
11. False
12. Kissan Package Insurance
13. Employee Provident Fund (EPF) Act
14. Workmens compensation Act
15. False

Terminal Questions
1. The different perils covered in fire insurance are lightning, explosion, rot,
strike, malicious and terrorism damage, impact damage, subsidence
and landslide including rockslide, storm, cyclone, typhoon, tempest,
hurricane, tornado, flood and Inundation, leakage from automatic
sprinkler installation. For more details, refer to section 6.1.1.
2. Marine cargo insurance covers goods and commodities transported by
sea. Exporters, importers and their bankers prefer to obtain maximum
possible coverage for goods in transit. For further details concerning the
covers and the exclusions, refer to section 6.3.2.
3. The various rural insurance policies are aqua culture insurance, cattle
insurance, failed well insurance, fish insurance. horticulture insurance.
For detailed explanation of these insurances refer to section 6.4.2.
4. Old age security and disability insurance, workers compensation are the
various social insurances. For explanation, refer to section 6.5.2.
6.10 Case-Let
Bajaj Allianzs Coverage of the Loss Incurred by a Company for Fire.

Client: Cadila Pharmaceuticals Ltd., Ahmedabad.
Cover: Standard Fire and Special Perils Insurance for Stock of Raw
material which was sent for processing and lying at Pharma Chem
Industries Pvt.Ltd., who is Cadila Pharma's outsourced manufacturing
partner at Vapi, Gujarat.
What happened: Fire broke out in Cadila Pharmaceuticals Ltd at around
7.30 p.m. on July 10, 2004 and engulfed the entire factory. The fire was
extinguished by around 7 a.m. on July 11, 2004, but not before the entire
factory and its contents were gutted. The fire was believed to have been
caused by ignition of stock of solvent by sparks generated by electric
short circuit. The factory building, plant and machinery and the stocks
contained therein were almost damaged.
Loss suffered by the insured: Stocks worth Rs.21,40,800/- lying in the

custody of Pharma Chem Industries Ltd. for processing. The assessed Loss
was Rs.18,33,816/-.

Role of Bajaj Allianz

Bajaj Allianz, Ahmedabad received a mail intimating the loss from their
insurance department on July 12, 2004, and immediately a surveyor - was
assigned to carry out the survey. They carried out the survey in the
presence of a person from the insured's side.
The Surveyor also visited their Ankleshwar factory on the same day, for
verifying all records pertaining to the stock which was sent to Pharma
Chem at Vapi. An on-account payment of Rs.5 lakhs was released on,
after confirming all the facts, and verification of records based on the
interim survey report. Meanwhile, the process of finalising the claim was
initiated and meetings were held to sort out the queries. On receipt of all
relevant documents and clarifications from the client vide their letter dated
August 1, 2004, the claim was immediately settled and the balance
amount of Rs.13,28,916/- was released on August 5, 2004.
This delighted the customer and raised their confidence level in Bajaj
Allianz and also set the new benchmark in productivity.
1. What was the initiative taken by the insurance company?
(Hint: A surveyor was appointed immediately to carry out all the
formalities and survey)
2. What helped the claim settlement to happen so quickly?
(Hint: The verification of the records based on the survey and
submission of relevant documents and clarifications from the client)
Source: http://www.bajajallianz.com/BagicCorp/bajaj_home/pdf/claim_
settlement/cadila.pdf
Reference
House, India.
Fleischhaker A Karin. (2008). The Savvy Business Persons Guide to
Property and Casualty Insurance. Authorhouse, United States.
Kutty. Managing Life Insurance, PHI Learning Pvt. Ltd.

Sethi/Bhatia (2007). Elements of Banking and Insurance, PHI Learning

Pvt. Ltd.
E-Reference
http://ekikrat.in/Kissan-Package-Insurance-Oriental-Insurance
http://www.disabilityindia.org/socialsecurity.cfm
Retrieved on 18th November 2010

Unit 7 Non-Life Insurance - 2

Structure:
7.1 Introduction
Objectives
7.2 Automobile Policy
Automobile coverage
7.3 Health Insurance Plan
Family health insurance plans
Comprehensive health insurance plans
7.4 Miscellaneous Insurance
Types of miscellaneous insurance
Accident insurance
Hospitalisation insurance policy
Travel insurance policy
Business insurance policy
Package insurance policy
7.5 Summary
7.6 Glossary
7.8 Answers
7.9 Case-Let
7.1 Introduction
The previous unit dealt with non-life insurance like fire insurance, marine
insurance, rural and social insurance. This unit will deal with non-life
insurance covering automobile insurance, health insurance and
miscellaneous insurance.
Any insurance except Life Insurance is known as General Insurance or
Non-life insurance. Non-life insurance includes property insurance against fire,
burglary, and so on; personal insurance like accident and health insurance;
and liability insurance covering legal responsibilities. They also cover
miscellaneous insurance, automobile insurance apart from the above
mentioned insurance policies. The non-life organisations offer policies that
cover breakdown of machinery, ships and so on. Marine Cargo policies
insure products in transportation (by sea).

Additionally, automobile insurance and property insurance that covers

damages or thefts form a major part of non-life insurance. Accident and
health insurance schemes are applicable for individuals and groups. A
group is a set of employees or holders of credit cards in a bank etc. Usually when
a group is insured, insurers provide group discounts.
This unit explains the details about automobile policy and its coverages. It
explains the health insurance plan and other miscellaneous insurances.
Objectives:
discuss the features of automobile insurance
describe the health insurance plan
explain other miscellaneous insurances
7.2 Automobile Policy

This section will deal with one of the non-life insurances, namely,
automobile insurance. Automobile insurance is a contract for an
automobile, in which one party gets into an agreement to pay for another
party's fiscal loss during an event, such as, some damage or thefts.
Automobile insurance insures from losses occurred due to automobile
usage and provides fiscal security during an accident. Auto insurance
provides an opportunity to save wealth of an insurance organisation. The
chief strategy of automobile policy is to enhance the deductible amount of
an insurance policy, which decrease premiums accordingly.
The Personal Auto Policy (PAP) is issued to licensed individuals for
covering the risks. Many insurance companies make use of PAP for
covering personal vehicles. PAP covers only personal vehicles. It covers
other vehicles, such as, vans (weighing less than10,000 pounds), only if
they are being used for installing and repairing furnished equipments.
7.2.1 Automobile coverage
Automobile coverage includes many declaration sections of an insurance
contract. Any personal vehicle which is leased for minimum 6 months can
be included in automobile coverage. All the new vehicles have the broadest
coverage in declarations of an insurance contract (except collision
coverage). The policy holder needs to notify the insurer for collision
coverage, irrespective of collision damage within 14 days.

The classification of some of the automobile coverages is as follows:

Liability coverage - Liability coverage includes payments for damages
and liabilities including defense costs that go beyond the liability limit (it is
a single or spit limit). If the liability is covered, then the insurer has full
rights to examine and solve the claims independent of the insured. A
standard policy provides single limit for all the liability coverage. With the
help of endorsements, many of policy holders choose split limit. Split limit
splits the liability limit into three parts - limit for every person, property
damage limit and total limit.
For example, say if a person injures 3 people, Rs. 25,000 damage is
caused for the car, first person is brutally injured and needs treatment
worth Rs 1,25,000, second person moderately injured requires Rs 75,000
and third person who is injured requires Rs 50,000, then the policy
covers a single limit of Rs. 3,00,000 and covers all the costs of injury.
Medical payment coverage - This provides coverage for medical
payments for injury of an insured driver and passengers in the event of
a loss. It offers financial protection to the driver when personal health
insurance and/or personal injury protection is not sufficient to pay
medical expenses for the driver and/or passengers.
Uninsured motorists coverage - Many states need drivers to have
license in order to have minimum amount of automobile insurance.
Uninsured motorists coverage includes the insured persons, if they
undergo damages due to uninsured motorists (like certain drivers
without insurance or hit-run drivers or drivers insured with bankrupt
insurance companies). Therefore, if an X person is injured by some
vehicle that is insured but has no coverage for damages, then X can
claim the amount for his injury.
Damage coverage for personal automobiles - The two types of
automobile coverages are:
o Collision coverage - Collision coverage covers the damage
caused because of the collision of a vehicle with other vehicle or
object. Such damage, is deductible.
o Comprehensive coverage - Comprehensive coverage covers
the damage caused from missiles or any falling object, thefts,
earthquakes, windstorms or floods. This damage is not
deductible.

If the vehicle needs repair, the insurer uses cheaper after - market parts
(unless the vehicle is new). If the insured persons prefer OME (Original
Manufacturers Equipment) parts for older vehicles, then they should pay for the
betterment by paying the difference between OME part and the aftermarket
parts.
Responsibilities after an accident
According to the insurance contracts, the insured person has some
responsibilities with respect to the event of loss, as it can nullify the policy. The
insured person should protect the property from damage, and insurer will pay
the reasonable costs. The insured person co-operates with the insurer by
providing the evidence and furnishing witnesses. If the loss has occurred due
to a collision with another vehicle, then the insured person must notify the
police soon after the accident.
Activity: 1
Find the major differences between collision coverage and
comprehensive coverage.
(Hint: Refer - http://www.wisegeek.com/what-is-the-difference-between-
collision-and-comprehensive-auto-insurance.htm)

1. ____________________ is a contract for an automobile in which one
party gets into an agreement to pay for another party's fiscal loss of a
specified event like some damage or thefts.
a) Automobile insurance
b) Health insurance
c) Fire insurance
d) Individual health insurance
2. _____________ are responsible for paying damages and liabilities
including defense costs.
3. ____________________ are known as no-fault payment for the road
injurers to avoid the need of the proceedings.
4. The insured person should protect the property from damage, and insurer
will pay the reasonable costs. (True/False).
5. Any personal vehicle which is leased for minimum 6 months can be
included in automobile coverage. (True/false).

7.3 Health Insurance Plan

The previous section dealt with automobile insurance. This section will deal with
health insurance plans.
Health insurance is defined as an insurance against loss caused by illness
or body injury. Health insurance provides the coverages for medicine,
appointments for doctors and other medical expenses. Health insurance is
directly purchased by the individuals or may be offered by an employer. For
elderly, disabled or un-insured persons, Medicare and Medicaid programs
provide health insurance plans. Presently, the global scenario of health care
is approximately 2.75 trillion. Health care industry is one of the largest
industries in the world. In India, the form of health insurance is Mediclaim
policy for individuals, groups and corporate bodies. The total health
expenses on health care in India are about six percent of total GDP. State-
owned insurance companies (covering only 2.5 million people) take care of
these Mediclaim programs. Health care system in India is managed by
superficial government structure (health care facilities).
The various health insurance plans in India are:
Employer administered health plan - This plan is one of the most
significant health assurance plans in India. Many public organisations,
industries and defense services operate their own hospitals for
benefiting their staff members. There are many medical compensation
plans offered to private sector employees (even for commercial banks).
Government based plans - In India, central, state and local
governments manage, finance and run many hospitals, private health
centres and community health centres to offer medical services all over
the country. CGHS (Central Government Health Scheme) contributed in
offering comprehensive medical care services to the government
employees and their families. ESIC (Employee State Insurance
Corporation) a government-owned organisation provides and manages
ESIS (Employee State Insurance Scheme). This insurance organisation
provides cash and medical benefits. Apart from this, NGOS (Non -
Governmental Organisation), CINI (Child in need Institute) offer health care
facilities.
Market based plans - Apart from GIC (General Insurance Corporation)
and LIC, many private sectors like Bajaj Allianz, ICICI, Oriental and

Royal Sundaram provide health insurance policies. Currently existing

health insurance plans are individual /family/group insurance plans,
senior citizen plans, long-term health care plans and coverage for
specific diseases. Some of the foreign insurance companies developing in
India are New York Life, USA, UK etc.
Currently, many insurance companies are providing high range of health
schemes according to the needs of the people. Some of these companies
are:
Max NewYork life insurance - Max NewYork life insurance is one of
the insurance organisations that has started new health schemes
according to the requirements of the people. Some of these health plans
or schemes are:
o Medicash plan - This plan provides a fixed amount of cash for
covering the expenses on all forms for ICU admissions and
surgeries, all the way through hospitalisation.
o Wellness plan - Wellness plan offers coverage for thirty-eight
illnesses, such as, liver disease, heart ailment, and so on.
o Safety net - Safety net is a term plus health care plan which
provides coverage for losses to the insured person in cases of
accident or death.
New India Assurance Company Ltd: This company has introduced a
new health insurance plan known as Universal health insurance plan.
Some benefits of this plan are:
o Medical compensation - This plan offers compensation for
hospitalisation cases, which amounts upto Rs. 30,000 covering the
expenditures of ICU admission, surgeries, medicine expenses and
charges, and so on.
o Personal accident coverage - This scheme offers coverage for the
main persons death in a family in an accident, summing up to Rs.
25000.
o Disability cover - This plan offers a compensation of Rs. 50 on
daily-basis till 15 days, and after 3 days in case if the main earner of
the family gets hospitalised.
o Premium - The premium rate for this scheme is rated at Rs. 300 for
an individual per year, Rs. 450 per year for a family, Rs. 600 per

year for a family of 7 (families falling under poverty line for a

premium of Rs. 100/family).
Apollo DVK insurance company: This company offers health schemes
such as the Easy Health insurance plan. Easy Health is available for
families and individuals to offer prevention with cure. The benefits of this
plan are:
o It provides a range of insured amount, from Rs.1 lakhs to 10 lakhs. o It
covers the expenditures of before and after hospitalisation.
o It offers incentives for each renewal and claim every year.
o It offers tax benefits for premiums.
Maxima health plan
This plan offers benefits for outpatient as well as inpatient segments.
Under outpatient section, consultation fees, medical tests, pharmacy
costs etc to annual check up are covered. Under inpatient sector, from
pre and post hospitalisation expenditures to maternity expenses are
covered.
7.3.1 Family health insurance plans
The government has been offering different health insurance plans for
senior citizens. The main aim of these plans is to promote health and
independence of senior citizens.
National Policy
The Indian central government introduced a National Policy in 1999, to
support the health and well-being of senior citizens and their families. This
policy supports non-governmental organisations to provide care and
protection to the elderly persons in a family. The benefits of this policy are:
Strengthening of basic health care systems, in order to meet the health
care requirements of older persons.
Orientation programmes for elderly persons.
Promoting healthy ageing.
Distributing materials on geriatric care.
Integrated program
Integrated program for older persons is a plan that offers fiscal assistance to
develop old age homes, day care centres, and medicare centres that offer
non-institutional services to elderly persons. This plan helps older persons as it
strengthens their family and offers productive healthy ageing.
National mental health program

The national mental health program targets the requirements of senior
citizens, who are affected by dementias, depression and psychological
disorders. In 2007-08 budget, the finance minister proposed to offer monthly
income to seniors citizens, and enhance new family health insurance plans.
Low cost family health insurance plan
Low cost family health insurance plan provides financial assistance for
families, when an unexpected illness occurs. There are many group health
insurance plans, child health insurance plans for lower and middle class
income people.
Managed care plan
Managed care plan is one of the significant low cost family health insurance,
which creates networks of doctors, specialists and hospitals to offer medical
services, with reasonable discounts. This plan offers flexible coverages, as
all the family members (insured) get discounts while visiting a network
physician. This coverage also includes out-of-network physicians.
HMO (Health Maintenance Organisations) is one of the most common
managed cares. In this, people have to opt for a primary care physician from
HMO network, and if a family member requires a specialist care, then any of the
physicians from HMO network can give a referral.
Individual Health Insurance Plan
Almost all the employers opt for and offer only group health insurance. But,
those who are not under these plans opt for individual health insurance
plans. Those who seek insurance under these plans are usually self-
employed individuals or freelancers. Persons not covered by individual
health insurance for 62 days, may be subjected to a 12 month pre-existing
condition waiting period (pregnancy is not considered as pre-existing
condition).
There are many individual health insurance plans covering the
complications of pregnancy (not the process of pregnancy and child birth).
Traditional medical methods are not covered under this individual health
scheme. Individual health insurance plan may vary at different stages of life.
Mental health and vision are not covered under this plan. There may be

separate policies for dental care. Depending upon the needs, individual
health insurance coverage also varies.
7.3.2 Comprehensive health insurance plans
National Common Minimum Programme, a comprehensive health
insurance plan for each district in all the states, has been originated for
execution with participation of community, in the year 2004-05.
The chief characteristics of this programme are:
The basic focus of health insurance in the district will be on the poorer
section of the society (i.e. both BPL (Below Poverty Line) and Non-BPL).
UPA government declared National Common Minimum Programme in
2004. It proposed to raise the public investment on health to at least 3
percent of the total Gross Domestic Product (GDP) for the next five
years (focusing on healthcare). The present government proposed to
initiate steps to ensure the accessibility of life saving drugs at
reasonable prices with the renewal of Public Sector Units.
The three major initiatives in the health sector in 2004-05 budgets are:
o Restructuring the Universal Health Insurance scheme (which was
introduced in 2003) for below poverty level people with a reduced
premium exclusively.
o Initiation of Group Health Insurance scheme for Self Help Groups and
Credit Link Groups at a premium rate of Rs 120 per head (for a
coverage cover of Rs 10000).
o Exclusion of income tax for the hospitals operating in rural areas.
The public sector insurance firms will market the present channels.
The settlement process of claims will be simplified on the basis of the
availability of TPAs (Third Party Administrators).
The programs will be going on in one district of every state, with strong
help of community-based programs and organisations with health
infrastructure.
Benefits of health insurance
Health insurance is very significant for individuals and families, as it
provides financial assistance during unforeseen medical crisis. Every year, the
price of medical treatment in India is increasing drastically.

Surgeries and blood tests can cost thousands of rupees. Health insurance
enables an individual and his family to obtain medical treatment without
worrying about the costs.
Health insurance in todays scenario is very essential because of:
High medical rates.
Requirement for daily medical check-up and care for certain illnesses.
High fees of specialist physicians.
Expensive hospitalisation and medication.
Advantages of group health insurance are:
No physical tests - In a group health insurance, the insurance
organisation insures all the group members, irrespective of present
physical health and previous health history. The main condition for the
group members is that they should apply for insurance within the
particular eligibility time. This is a benefit for individuals with chronic
health situations (who cannot afford individual insurance).
Less costlier than individual insurance - When a policy is issued for
an entire group, the starting rates will be lower than the issuing cost of a
single policy to every person. Group health insurance is less risky for
insurers as the risk gets spread among larger numbers.
Advantages of individual health insurance are:
Customised health care - Individual health insurance provides the
direct control over the policy and its reimbursements. Certain provisions
are also included or excluded in the policy. The individuals decide the
deductible amount and co-payments.
Choosing the doctors - Individual health insurance provides specialist
physicians based on HMO network.

6. _______________________is one of the significant low cost family
health insurance, which creates networks of doctors, specialists and
hospitals to offer medical services with reasonable discounts.
7. _______________ plan provides financial health for families when an
unexpected illness occurs.
a) Low cost family health insurance
b) Family floater

c) Miscellaneous insurance
d) High cost family health insurance
8. ________________________ is one of the most common managed
cares.
9. UPA government declared National Common Minimum Programme in
2005. (True/false).
10. The Indian central government introduced a ____________________ in
1999 to support the health and well-being of senior citizens and their
families.
7.4 Miscellaneous Insurance

The previous section discussed about health insurance plans. This section will
focus on miscellaneous insurance.
There is a wide range of insurance coverage in India today. There are many
insurance policies, and many enclosures and omissions in all the insurance
policies with varieties which must be considered before procuring the policy.
The insurance company pays definite amounts in case of losses, and the
customer pays the premiums required for maintaining the policy. If the
customer does not pay the premium, the insurance company cancels the
policy leaving the customer defenseless. With the growth in public
consciousness and the resulting drives of the insurance companies, liability
insurance and miscellaneous insurance are referred to as sunrise collection
of general insurance.
7.4.1 Types of miscellaneous insurance
Some of the types of miscellaneous insurance are:
Motor vehicle insurance
Under the motor vehicle insurance, a personal or commercial vehicle is
subjected to combined insurance against the risks of:
Loss or damage to the vehicle and its accessories in case of accident or
theft.
Injury or death of the owner/driver and passengers of the vehicle due to
accident.
Damages payable to third parties by the owner of the vehicle for
accident.

A comprehensive insurance policy covers all these risks. Insurance against the
first two types of risks is optional. However, under the Motor Vehicles Act,
1956, every owner of a motor vehicle, is required to take out an insurance
policy to cover the third party risks. This policy is called as 'third party insurance
or liability insurance'. Under this policy, the third party who has suffered any loss
can sue the insurer directly even though he was not a party to the contract of
insurance. For example, motor insurance by United India Insurance Company
Limited. This policy provides insurance cover to those who have insurable
interest in a motor vehicle such as owners of the vehicle, lessee or financiers.
Fidelity insurance
Under the Fidelity insurance, the insurer accepts to compensate the insured
such as the employers against the losses suffered due to the employees.
The losses may be because of fraud, misappropriation of funds, damages to
property caused by the employees. To avail protection under it, the
employer is required to provide all material facts about their employees to
the insurer and notify all changes in the condition of their service. Under the
fidelity insurance by New India Assurance Company Limited policy, the
insurance company agrees to indemnify the insured employer against a
direct financial loss sustained due to any act of fraud or dishonesty
committed by employee.
Credit insurance
Credit Insurance policy covers the loss occurred due to non-payment of dues
by debtors. It offers protection to business people who sell their products on
credit terms by reducing the risk of exposure to non-payment. It safeguards
business organisations against the losses occurring due to insolvency of
their debtors.
For instance, credit insurance by New India Assurance Company Limited offers
two fold credit administration supports like:
Credit supervising: - During the policy period, the insurance
organisation receives clients monthly statements of sales and maintains the
records of their payment patterns.
Credit control: - When proposal form is processed, a section of the
clients buyers is assessed. This enables the company to fix the credit
limits. These limits indicate the clients buyers payment capacity.

In India, Export Credit and Guarantee Corporation of India Ltd offers credit
insurance to the exporters. The export credit insurance is prepared to guard
exporters from payment risks (both political and commercial) and to allow
them to enlarge their overseas business without any fear of occurrence of
loss.
Workmen's compensation insurance
Employers need to pay compensation to their workers who are injured or
suffer from occupational diseases due to their work. This compensation is
paid under Workmen's Compensation Act. An employer obtains insurance
policy to cover this. The premium amounts are paid based on the wages.
This is also known as 'Employers Liability Insurance'. United India Insurance
Company Limited offers Workmens compensation insurance. This
insurance policy provides coverages against the following risks:-
Protection to the insured person against his liability as an employer' for
accidental injuries (including fatal) while at work.
Medical, surgical and hospital expenditures along with the transport
costs, hospital costs and accidental employment injuries (if extra
premium is paid).
Liability for the diseases mentioned under the Workmen's Compensation
Act, caused during the course of employment.
Travel insurance
Travel insurance covers all individuals (traveling abroad) against risks like
baggage loss, travel accidents like injuries, illnesses and medical
contingencies with hospitalisation. In India, this insurance is popular now
among international travelers.
7.4.2 Accident insurance
Accident insurance covers accidental injuries and deaths. Accidental policy
in an insurance organisation provides benefits for individuals and families.
With the increase in sales of automobiles, there is a huge growth in auto
accidental insurance. The different types of accident insurance are:
NRI accident insurance: This insurance policy covers Non-Resident
Indians from 3 months of age to 70 years. This policy is a
comprehensive insurance which covers accidental loss, permanent
disablement due to accident, medical expenses, education funds of
dependent children etc.

Personal accident insurance: Personal Accident insurance is an

insurance policy for individuals or groups that protects against personal
accident or illness. Personal accident insurance covers the expenses
from an accident with a specified sum payment (a daily or monthly
amount) or a payment for loss of life due to an accident.
Accident and health insurance: Accident and health insurance policy
provides coverage when the policyholders or their dependents fall sick,
or get injured or die due to an accident. Accident and health insurance
policy covers physicians visits, medical procedures etc.
Premium amount calculation for accident insurance
The premium amount paid, for accident insurance, depends on many
issues. For an accident insurance policy, the occupation of insured person is the
main decisive factor for calculating the premium. The individuals are placed
in a risk group according to their profession, and the premium is calculated
based on it. People who work in hazardous conditions need to pay higher
premiums. In personal accidental insurance policy, age factor is not of much
importance. But in Mediclaim policies, age and health conditions
determine the premium. Premium is computed on monthly or quarterly or
half-yearly or yearly basis.
Claim system for accident insurance
The primary step for raising a claim is to fill a claim form. The company
inspector analyses the hospital and nursing bills to create a report. The
processing period for claims is between 7-21 days.
The documents necessary for claiming accident insurance are:
Hospital bills.
Disability documents from doctor.
Lab reports.
Police records.
The insurance companies that provide accident insurance in India are:
Bajaj Allianz (provides accident and injuries coverage).
The New India Assurance (provides accident coverage policy).
Tata AIG general insurance (for accidental protection).
United India Insurance (provides accident & hospitalisation policies).
HSBC (provides MahaRaksha personal injury policy).

7.4.3 Hospitalisation insurance policy

Insurance is a long-term saving that offers fiscal stability and helps during
emergency. Medical insurance helps senior people by reimbursing costs for
health checkups and long-term healing. Section 80 D of Income Tax Act
provides tax relief for premium amounts upto Rs. 15,000. Medical insurance is
offered by many private insurance organisations. Public sector insurance
companies offering medical insurance for hospitalisation are:
National Insurance business - The National Insurance Company
provides Varistha Mediclaim policy for senior people. This plan covers
hospitalisation and home care hospitalisation expenditures (under
section I) as well as treatment expenses for critical illnesses (under
Section II). The major diseases covered under critical illnesses are
coronary artery surgery, cancer, renal failure, heart stroke, sclerosis and
organ transplants. Coverage is provided for paralysis and blindness
with extra premium.
Oriental Insurance organization - Oriental insurance company offers
comprehensive health scheme, group insurance policy and individual
mediclaim policy. These schemes pay for insured hospitalisation or
home care hospitalisation when a sudden illness, an accident occurs.
New India Assurance Company - The New India Assurance Company
provides Mediclaim policy. This policy allows any Indian (between 5-80
years) to get insured (as stated on March 31, 2007). This policy also
offers cashless hospitalisation for treating illness or accidental injury
endured during policy period. The claims are paid through third party
administrators who are taken by the organisation.
United India Insurance Company - United India Insurance Company

also provides Mediclaim policy to cover a person (between of 5-75
years). This policy actually pays for hospitalisation expenditures of
different types (ranging from Rs. 15,000 to Rs. 5,00,000). The above
limit is preferred by the insured person before starting the policy.
Life Insurance Corporation - Life Insurance Corporation offered a
special Nav Prabhat plan in 2001 for senior people. This plan is for risk
coverage for a comparatively lower cost and a great relief for disability,

due to accidents or illness. It also gives an option for life pension even after
the policy is matured.
7.4.4 Travel insurance policy
A travel insurance policy is type of insurance coverage, which covers
hospitalisation and medical costs during a persons travel in a foreign
country.
Travel insurance policy is referred to as holiday insurance. The most
important thing about this coverage is that it encompasses all the kinds of
vacations and business travels. A travel insurance policy is extremely
beneficial, and its coverage is cost-efficient.
In general, companies sell travel insurance policies with many benefits to the
travellers. This policy offers single-trip coverage, if a person is planning one trip
overseas. And, the policy offers a multiple-trip policy, if a person is planning for
many trips overseas, in a year.
7.4.5 Business insurance policy
Business insurance protects a business person against losses. Some of the
business owners work with belief and get profits with a positive cash flow.
Business insurance spreads and manages the risks among all the business
owners. Insurance organisations collect premium amounts from all the
covered businesses, and generate a pool of money, to pay the covered
business, if that business experiences a loss. Since 300 years, insurers
have enhanced the mathematical models to decide the probability of a risk
occurrence and premiums charges that an insurer should pay to survive in
business to make profit. The insurers developed certain policies to deal with
the losses.
Business insurance has the following forms:
Property insurance - Property insurance protects against losses or
damages to the location and the contents of the business. It also insures
others property under the control of the insured for the occurrence of
loss. Property insurance can also cover a specific risk. For instance, a
fire insurance policy protects only against a fire loss. A tornado is not a
fire hence that loss is not covered in this policy. The insured location can
be owned or rented.

Casualty insurance - Casualty insurance protects against losses or

damage to the business. Casualty insurance is combined with property
insurance and known as property and casualty insurance. For instance,
if a particular business is on seventh floor of a building and suddenly a
natural disaster like flood occurs that washes out the first floor, but there
is no damage caused to the seventh floor, then the loss that has
occurred will not be covered by property insurance because there is no
direct loss to the business location. But casualty insurance covers
indirect losses to the business also.
Liability insurance - Liability insurance protects against liability, which
is legally imposed on business due to the neglect of the business or its
workers. It also protects the business when it is sued for damages.
Workers compensation insurance - The businesses insure employees
against on the job injuries. Almost all the states follow workers
compensation system. Workers compensation system is a system where
the employee is restricted by law to prosecute their employer for on the
job injuries but at the same time the employer should participate in a
system that offers automatic compensation to the employee (in case of
injury for medical bills).
Business interruption insurance - Business interruption insurance
protects against losses or damages of cash flow and profit in a business
caused because of interruption. For instance, a critical piece of
machinery gets struck by lightning. The machine is repaired through
casualty insurance.
Life and disability insurance - Life and disability insurance insures the
business against the death or disability of main workers. For example, a
partner holds a life insurance policy having the partnership as a
beneficiary. If that partner dies the amount obtained from the policy can
be used to buy the shares of the deceased.
7.4.6 Package insurance policy
A package policy includes different types of insurance packed together and
financed together. Many companies provide better coverages when the
customers insure everything in the same organisation.

Almost all the organisations offer discounts to customers who insure both
their home and vehicles with the same organisation. A package policy is
different because the financer reviews the entire contract and creates a
policy covering all the property and liability insurance requirements of a
consumer.
Package insurance is mainly intended to meet the requirements of more
"prosperous" customers. People who have collective assets and
investments in real estate require complete insurance. Packing everything
together enables an insurance organisation to have an overall idea of risks
and exposures that a customer has. Some package policies under general
insurance are:
Householders insurance:
This package policy covers household contingency in a single policy. This
policy has following sections:
Loss of buildings and contents in insured buildings from fire, lightening
etc.
Loss to contents due to thefts, housebreaking etc.
Damage to jewellery due to accident.
Damage of fixed plate glass accidentally.
Personal accident for self and family.
Damage to TV apparatus like VCR.
Shopkeepers insurance
This is another comprehensive package policy which is similar to household
package policy. This policy is meant for shopkeepers whose property rate is less
than 10 lakhs. The coverages under this policy are:
Building damages in insured premises.
Damage to contents due to housebreaking, thefts etc.
Legal liability of accidental injury, death, bodily injury, damage to third
party property etc.
Liability to employees in Workmens Compensation Act according to
Common Law.
Bankers blanket policy
This policy is a combination of specific coverages like fire, burglary and
even marine. It offers protection for the lost money or securities of an

insured person. Money indicates bank notes, jewellery etc. The exclusions in
this policy are:
Trading losses with or with out insured persons knowledge.
Atmospheric disasters, war etc.
Losses because of negligent acts of insured employees.
The proposer selects the limit of insureds liability for any one loss as the
basic insured sum. For certain losses, a percentage of the insured sum is
applied. The premium amount is based on the indemnity limit which the basic
insured sum.
Jewellers block policies
This package plan covers many types of losses faced by jewellers. It guards
jewels like gold, silver, pearls etc of insureds business. The coverage is
provided for loss or damage in the premises of the insured, in the custody of the
insured, partners, employees, directors, diamond sorters or while in transit.
Chartered accountants assess the claims.
The different products offered by insurance organisations in the field of
property and casualty insurance include:
Primary and secondary vacation homes.
Rental property.
Autos and motorcycles.
Motor homes.
Boats and yachts.
Small companies.
Personal liability and Umbrella Liability coverage.
These types of insurance products have higher insurance credits and get more
insurance for lower cost. The time taken to receive quotes is more and the
company asks some questions before giving it.
There has to be a minimum asset amount with the customer to get these
package policies. Package policies can also be designed to meet the
customer specifications. Some companies may not allow qualifying some
packages due to their underwriting standards.
Package insurance can also be claimed by anyone who is retired or
invested in real property and need to shop around. Additional personal

liability umbrella coverage is mostly preferred among package insurance

products.
Activity: 2
Compare employee benefits offered by a public sector and a private
sector insurance company.
(Hint: Refer - http://www.questia.com/googleScholar.qst?docId=
5000111202)

11. __________________ includes different types of insurance packed
together and financed together.
a) Package policy
b) Travel policy
c) Business policy
d) LIC policy
12. _____________________ protects a business person to against
losses.
13. ____________________ policy covers the loss occurred due to non-
payment of dues by debtors.
14. Package insurance is mainly intended to meet the requirements of
more "prosperous" customers. (True/false).
15. The Oriental insurance organisation provides Mediclaim policy.
(True/false).
7.5 Summary
This unit briefly gives an idea about non-life insurance like automobile
insurance, health insurance plans and miscellaneous incurance schemes.
This unit dealt with automobile insurance., Automobile insurance is a
contract for an automobile, in which one party gets into an agreement to pay
for another party's fiscal loss during an event, such as, some damage or
thefts.
This unit discussed about health insurance, which is defined as an
insurance against loss by illness or body injury. Health insurance provides the
coverages for medicine, appointments for doctors and other medical
expenses. The benefits of family health insurance policy are:

Strengthening of basic health care systems inorder to meet the health

care requirements of older persons.
Orientation programmes for elderly persons.
Promoting healthy ageing.
Assisting to distribute materials on geriatric care.
Health insurance in todays scenario is very essential because of:

High medical rates.
Requirement for daily medical check up and care.
Expensive visits to specialist physicians.
Hospitalisation and medication.
Different possible types of accident insurance are:
NRI accident insurance.
Personal accident insurance.
Accident health insurance.
Car accident insurance.
The different types of miscellaneous insurance are:
Motor insurance.
Fidelity insurance.
Credit insurance.
Workmens compensation insurance.
Travel insurance.
Business insurance has the following forms:
Property insurance.
Casualty insurance.
Liability insurance.
Workmens compensation insurance.
Burglary and theft insurance.
Life and disability insurance.
The following package insurances are available in India:
Householders insurance.
Shopkeepers insurance.
Bankers blanket policy.
Jewellers block policies.

7.6 Glossary
Collision coverage: Collision coverage is a standard insurance coverage for
automobiles and other forms of transportation, where there is a
probability of an accident occurring in case of an insured vehicle striking a
stationary object.
Umbrella liability policy: A liability policy that is designed to provide
liability protection above and beyond of standard policies.
Pre-existing condition: A pre-existing condition affects health insurance
coverage. If an insurance policy is taken by a person, then some health
insurance companies accept that person conditionally by providing a
preexisting condition waiting period.

1. Explain automobile insurance policy.
2. What are the benefits of Universal health insurance plan?
3. Explain family health insurance plan.
4. Describe travel policy.
5. Define causality insurance.
7.8 Answers
1. a) - Automobile insurance
2. Liability coverages
3. Medical payment coverages
4. True
5. True
6. Managed care plan
7. a) - Low cost family health insurance
8. Health Maintenance Organisation
9. False
10. National policy
11. a) - Package policy
12. Business insurance
13. Credit insurance
14. True
15. False

Terminal Questions
1. Automobile insurance is a contract for an automobile, in which one party
gets into an agreement to pay for another party's fiscal loss of a
specified event like some damage or thefts. Further explanation of
automobile insurance policy in section 7.2 - Automobile insurance
policy.
2. Medical compensation, Personal accident covers, disability coverages
etc are some of the benefits of Universal health insurance plan and
further explanation is given in section 7.3 - Health insurance plan.
3. Central government introduced a National Policy in 1999 to support
health and wellbeing of Indian senior citizens. This policy encourages
individual persons to make provisions for their families. Further
explanation is given in sub-section 7.3.1- Family health insurance plans.
4. A travel insurance policy is type of insurance coverage, which covers
hospitalisation and medical costs during a persons travel in a foreign
country. Further explanation of travel policy is given in sub-section 7.4.3-
Travel insurance policy.
5. Casualty insurance protects against losses or damage to the business.
Casualty insurance is combined with property insurance and known as
property and casualty insurance. Further explanation is given in
section 7.4.4 - Miscellaneous insurance.
7.9 Case-Let
ICICI Lombard Health Insurance Plan
ICICI Lombard introduced the concept of Mediclaim. Health Insurance
known as Mediclaim provides protection during unexpected medical
emergencies. When a sudden illness or accident occurs, health insurance
policy provides hospitalisation and medical costs obtained. ICICI Lombard
offers a wide range of innovative policies. Each scheme provides a unique
policy suiting peoples specific needs.
ICICI Lombard offers the following policies:
Health insurance plus policy
A comprehensive health insurance covers both hospitalisation expenses,
Out Patient Treatment expenses (OPD). The major benefits of this policy
are, it covers OPD expenditures like diagnostics, dental tests, ambulance

expenses etc. There is no sub limit for room rent, doctor fees and extra
charges in hospital.
Family Floater health insurance
This health insurance policy secures family against fiscal emergencies if a
sudden illness, surgery or accidents occur. Family Floater health
insurance plan shares the total sum insured among the families under a
policy without upper limits of individual policies.
Individual Personal accident insurance
ICICI Lombard Individual Personal Accident Insurance policy insures
against accidental death and Permanent Total Disablement (PTD).This
policy protects against terrorism acts. Personal Accident Insurance
involves global coverages.
1. Which health insurance scheme of ICICI Lombard protects against
PTD?
(Hints: ICICI Lombard Individual Personal Accident Insurance policy,
accidental death)
2. Enlist the policies offered by ICICI Lombard.
(Hints: Family floater health insurance, Health insurance plus)
Source: HTTP://WWW.ICICILOMBARD.COM/APP/ILOM-
EN/PERSONALPRODUCTS/ HEALTH.ASPX#
References
Sethi Jyostna, Bhatia Nishwan (2007). Elements of Banking and
Insurance, First edition, PHI Learning Private Ltd, New Delhi.
E-References
http://www.altiusdirectory.com/Insurance/health-insurance-plans-
functions-I.html
http://www.always-health.com/healthinsurance_adv_disadvantages.html
Retrieved on October 29th, 2010
http://www.economywatch.com/insurance/travel-insurance/policy.html
http://www.instanthealthinsurancequotespro.com/benefitsofhealth
insurance.html
http://insurance.families.com/blog/what-is-package-insurance
Retrieved on October 30th, 2010

http://business.gov.in/manage_business/miscellaneous_insurance.php
http://www.insurecan.com/4-317-miscellaneous-insurance-3
http://www.scribd.com/doc/35370303/Miscellaneous-insurance
http://www.searo.who.int/en/Section313/Section1519_10849.htm
Retrieved on November 2nd, 2010

Unit 8 Functions and Organisations of Insurers

Structure:
8.1 Introduction
Objectives
8.2 Functions of Insurers
Production and sales
Underwriting
Rate making
Managing claims
Investments
Functions of insurance organisations
8.3 Organisations of Insurers
8.4 Summary
8.5 Glossary
8.7 Answers
8.8 Case-Let
8.1 Introduction
The previous units discussed about life and non-life insurances. Life
insurances insure a persons health and life. Non-life or general insurance
insures a persons property, profession etc.
This unit deals with the functions and organisations of insurers. The basic
functions of insurers can be classified as - underwriting, rate making,
managing claims and investments. The insurance organisation should also
follow certain functions, such as, accounting, legal functions and other
departmental functions. This unit also deals with the different types of
organisations formed by the insurers and the professionals in the insurance
industry.
Objectives:
explain the functions of insurers
list and explain the functions of insurance organisations
discuss the organisations of insurers

8.2 Functions of Insurers

This section will deal with the functions of insurers. Functions of insurers are
different for life and general insurance. But some general functions in the
insurance organisations which are ensured by the insurer are discussed in this
section.
8.2.1 Production and sales
Production or sales is usually used in manufacturing and marketing
industries. In insurance industry, the term production and sales refers to the
process where an insurer creates and sells policies to the applicants. A
producer is the insurer who produces a particular insurance policy. If an
insurer gets more number of applicants, then the production is said to be
high. The sales section of insurance industry highly depends upon the
insurance agents.
Agency arrangement
To create an effective sales team, the insurer should have a good
relationship with agents. Insurance agents are the ones who reach the
applicant in person and help them choose the suitable policy for their risks.
They are recruited, trained and supervised by managers. The insurers
maintain a market research division for revision of products and launching of
new products as per the evolving felt needs. The agents need to associate
themselves with the production department in identifying the marketing
goals to be achieved, study new products and marketing techniques. In
India, the public sector life insurance company LIC, has around 1.2 billion
working insurance agents.
Professionalism in selling
The insurance industry is growing fast and insurance coverages are given in
almost all risks faced by an individual or an organisation. As the agents are the
first ones to reach the applicant, they have to be aware of the field to be insured.
This is possible only if the agents are professionals with good technical
knowledge in particular areas of insurance. Professionalism is needed in
marketing the products also. The insurance agents must categorise and
choose the applicants, study the risks faced by them and recommend the best
solution.

8.2.2 Underwriting
Underwriting is defined as a process of analysing risks of insurance
applicants, and deciding whether the insurance company should accept or
reject the application. Underwriting is a challenging task where the
underwriter has to consider the applicants side and also the risks that the
company will have to face if it accepts the new policy. Though the task of
choosing polices is the responsibility of underwriters, the power to accept or
reject the policy lies with the insurer.
For example, if an applicant asks for a health insurance, the provider has to
thoroughly scrutinise the present and past health of the applicant, within
applicable terms. Sometimes the underwriter may have some reservation
due to past medical records, but decide to insure the applicant, with some
conditions not included in the coverage for a period of time. At some other
times, the medical records may indicate a level of risk that the company
cannot accept, and the provider will decide to not underwrite the health
coverage. If the underwriter discards the applications where the applicant is
expected to take long time medial coverages then the insurance company
can maintain a steady monetary base and serve other clients.
Underwriting differs for life and property insurances. For life insurance,
either a numerical method or a judgmental method is used. In judgmental
method, an underwriter judges the application, by studying the applicants
medical history records and present health conditions. In numerical method,
the underwriter (insurer) numerically rates every type physical disability.
These rates are added up and used to find the risks involved in the
particular policy. In some cases, the underwriters do not consider policy
proposals wherein the applicant has very bad health conditions.
Underwriting is carried out in accordance with an underwriting policy and
principles.
Statement of underwriting policy
The underwriting policy is the first step in underwriting. This policy clearly
obeys the companys policies and is written to ensure that the company
gains more profit and business. This policy establishes certain rules and
conditions which the underwriters follow thoroughly. This policy defines the
statements of insurance policies that will be written, prohibited exposures,

the coverage to be given for each exposure and similar terms and
limitations.
The underwriting officers write the underwriting policy and the desk
underwriter applies these terms and conditions to the applications and
chooses the best policies.
Basic underwriting principles
The basic principles of underwriting, which the underwriter has to follow, to
achieve profit in insurance business, are:
To select the applicants according to the companys underwriting
principles - The underwriters should consider only those applicants
whose actual loss rating is less than the expected loss rating. For
example, a company may consider insuring buildings which are highly
protected against fire hazards as the actual loss rate will be less than
the expected loss rate. Assume that the loss percentage is expected as
20%. Then the underwriters should make sure that the applicants meet
the underwriting requirements strictly so that the actual loss percentage
does not exceed 20%.
To balance the rate classification effectively - The underwriters

should ensure that there is a balance in rates between the
belowaverage applicants and above average applicants. The applicants are
grouped according to the percentage of expected loss rate. Then the
underwriters have to use their skills wisely and choose the applications to
keep the rate balanced.
To charge equitable rates to the policy owners - Apart from the rate
balancing, the underwriter should make sure that one set of policy
holders should not subsidise some other set. For example, a 25-year old
person and an 84-year old person should not be charged the same
premium for a life insurance policy. Here the rate is inequitable, as the
25-year old person will be charged more premium compare to the 84-
year old. This equity balance should be maintained while underwriting.
Other underwriting factors
The underwriter should consider some more factors while underwriting.
They are rate adequacy, reinsurance, renewal underwriting. The underwriter
should ensure that the business has adequate profit rate available. They

have to check if reinsurance is available for the application, if so the

underwriting can be made liberal. Insurance policies cannot be renewed if the
loss due to an insured-insurer partnership is not favorable.
8.2.3 Rate making
Rate making is yet another important operation of insurers. Rate is defined
as the price per each unit of protection or exposure of insurance. The rate is
the cost of production and its value is known only when the policy period is
over. The premium paid at first should be sufficient for the claims and other
expenses. If it is inadequate, then the insurer will be in loss. Insurance rates
are subjected to government regulations. Government allows rates which
are not too high and which are not biased. The rate and premium
determination is the function of insurance actuaries. To determine the rates
for life insurance, an actuary has to study the statistical data of births,
deaths, marriages, employment, retirement, illnesses, and so on. The basic
goal of an actuary is to determine the best premium for policies, such that
there is a profit for the company, and the company can effectively compete
with other insurance companies.
Insurance premium
Insurance premium is the product of rate and the number of units of
protection purchased. It involves the cost of the policy, requirements,
benefits and the cost of writing the insurance. The insurance premium
depends upon two factors, loss expected (Pure premium), and cost required
for the business (Loading). The insurer calculates the pure premium by
dividing the total expected loss by the total number of exposures. Loading is
calculated as the sum of the agents fee, insurance expenses, tax and other
fees. The gross premium is the sum of pure premium and the loading
amount. The first year insurance premium of some life insurers for the
period of September 2010 is given below in the table 8.1.

Table 8.1: First Year Premium of Life Insurers for September 2010
Period in Crores
Individual Individual Group Group Non-

No: Insurer Single Non-Single Single Single
Premium Premium Premium Premium
1 Bajaj Rs. 41.12 Rs.161.57 Rs.14.00 Rs.60.56
Allianz
2 ING Rs.1.33 Rs.59.19 Rs.0.43 Rs.0.00
Vysya
3 Reliance Rs.53.58 Rs.139.69 Rs.0.75 Rs.9.93
Life
4 Tata AIG Rs.15.48 Rs.76.13 Rs.2.72 Rs.29.18
5 HDFC Rs.9.78 Rs.224.83 Rs.0.23 Rs.29.90
Standard
Rate making guidelines

The basic rate making guidelines are:
The rate should be just enough to cover the losses, but should not be in
excess.
The rate should allocate equal cost burden to the insureds without any
biasness.
The rates should encourage the insureds to do loss control.
The rates should be revised and updated often.
The guidelines seem to be simple, but have to be maintained strictly. If the
rate is high, then it is easy to cover the losses, but it will be challenging to
compete in the insurance market. If the rates are calculated incorrectly, then
it cannot be bargained again. The cost is assigned differently in different
situations. For example in life insurance, the rates are fixed after considering
the occupation, income and expenditure, marital status, and so on.
8.2.4 Managing claims
Claims management is the basic goal of the insurance industry. It means to
settle the losses of the insurer and the differences between the insurer and
the insured. Claims management is more than just settling the losses with
money. Insurance companies have claim settlement representatives to carry
out this task. An insurance company should pay for the claim reasonably.
Rejection of undeserved claims also falls under claims settlement. Claim

management is the function of an insurance adjuster. There are various such

adjusters working in the insurance industry.
Basic objective of claims settlement
The basic objective of claims settlement includes:
Confirmation of a covered loss - The insurer should make sure that
the claim to be covered had actually occurred or not. The insurer should
check, if the applicant of a life or property insurance is eligible to claim it.
Reasonable and timely payment of claims - The claims settlement
should be fair, and without any delay. If the applicants reasonable claim
is rejected, it may defy the main objective of insurance. It may also affect
the insurers reputation.
Personal support to the insured - Apart from the legal responsibilities
as per the contract, the insurer should help the insured personally in
some cases. For example, an insurer should help the insured to find a
temporary house, if there is any natural hazard.
8.2.5 Investments
The investment function of an insurer is the most important function to run the
company. The insurance company gets their income from the
policyholders, who pay their premium regularly. The insurer invests this
money in financial schemes efficiently to use it for the payment of loss of the
insured. As the premium of the policy is paid in advance, it can be invested in
other financial schemes till the insured claims it for a loss. An insurance
company makes all the investments according to the government
regulations. The investment manager working for a company must follow all
these rules before investing.
Investment for life insurance differs from property insurances. These
differences are discussed below:
Life insurance investments - In case of life insurance companies, the
insurers decide the solvency through the minimum assured return on
investment. This means that, in life insurance policy, most of the amount
to be claimed during a loss is decided at the time of selling the policy to
the applicant. In life insurances, the safety of the insured is given the
first priority and it is usually a long term insurance policy. This allows the

company to invest more funds received from the regular premiums given
by the insured. Another aspect of a life insurance policy is that it reduces
the cost of life insurance. An insurance company can invest the premium
of life insurance policies and earn interest. The policyholders also get a
payment of dividends accordingly and thus the cost of life insurance
policy is reduced. Generally, life insurance companies invest their
finances in real estate or policy loan. Life insurance policies are of two
types:
o General account - In general account the obligations towards the
insured person is fixed. It mainly insured the life of the person.
o Separate account - In separate account the obligations towards the
insured person are in regard with the assets of the person. It is used
for pension funds and maturities.
Property and liability insurance investments - In property and liability
insurance, the investment is not fixed. It computes the profits obtained
from the investment and the frequency of underwriting losses. Property
and liability insurance mainly depends on the term of investment. If the
investment is for a long term, then the profits will be more, and if the
term is small, then the profit is also less. Property and liability insurance
companies invest their funds in bonds and equity shares.
8.2.6 Functions of insurance organisations
Apart from functions discussed above, the insurance organisations have
some more functions as listed below. The functions already discussed were
mainly related to the owners of the company or the insurers, but the
functions covered in this section are common to all financial organisations.
Accounting - Accounting department handles the financial accounting
processes of an insurer. An insurance company recruits and assigns
accountants to do this task.
Legal functions - In an insurance organisation, legal function is a very
important function. Legal functions are mainly to address the general
corporate operations of the company.
Loss control services - An insurance company is obliged to provide
loss control services as an important part of the risk management.

Generally, property and liability insurers provide many loss control

services.
Electronic data processing - Like any other commercial company,
insurance companies are also using technology in every process.
Electronic data processing (EDP) is used to computerise every
operation performed in an insurance company. The use of EDP has
transformed the insurance industry as it speeds up the processing and
storage of information which lessens many routine tasks.
Other departments - Some other departments of insurance
organisations are engineering, administrative, statistical etc.
Functions of public sector insurance organisations in India
In India there is only one public sector life insurance company, Life
Insurance Corporation of India (LIC). The functions of LIC are as given
below:
Provide long-term investments in governmental securities, public
sectors, private sectors and joint sectors.
Provide financial support through loans to the development of industries
in India.
Developing schemes to mobilise funds from public.
Underwrite and subscribe to share new bonds and debentures.
Provide financial support for various industries such as electricity,
agriculture, industry and other development schemes.
The functions of the only public sector general insurance company in India, the
General Insurance Corporation of India has the following functions:
Advise acquiring companies in the matter of setting standards in general
insurance business.
Render services to policyholders.
Advise the acquiring companies in the matter of investment and finance
management.
Encouraging competition among the acquiring companies to provide
their best service.

Activity: 1
Analyse the different types of claims that must be managed by an
insurance company.
Hint: Refer - http:// www. Scribd. com/ doc/ 14217786 /Project -on-claims -
management -in-life-insurance
1. If an insurer gets more number of applicants then the production is said
to be high. (True/False).
2. ________________ is the product of rate and the number of units of
protection purchased.
a) Insurance premium
b) Insurance exposure
c) Pure premium
d) Loading
3. ___________________________________ is used to computerise
every operation performed in an insurance company.
4. The underwriter should ensure that the business has adequate profit
rate available. (True/False).
5. Loading is calculated as the difference of the agents fee, insurance
expenses, tax and other fees. (True/False).
6. Which of the following is not a basic rate making guidelines?
a) The rate should be just enough to cover the losses, but should not
be in excess.
b) The rate should allocate equal cost burden to the insureds without
any biasness.
c) The rates should encourage the insurer to do loss control.
d) The rates should be revised and updated often.
7. Which of the following is not a basic objective for claims settlement?
a) Confirmation of a covered loss
b) Reasonable and timely payment of claims
c) Personal support to the insured
d) Personal support to the insurers
8. An insurance company can invest the premium of life insurance
policies and earn interest. (True/False).

8.3 Organisations of Insurers

The previous section dealt with the various functions of insurers and
insurance organisations. This section deals with the various associations or
organisations of insurers and insurance professionals in India.
The professionals involved in the insurance industry unite and organise
themselves into different insurer organisations. In India, there are such
organisations, which help the professionals to study and discuss their
insurance related functions. These organisations are as given below:
Insurance Regulatory and Development Association (IRDA) - The
Insurance Regulatory and Development Authority (IRDA) was formed in
the year 1999, when the Indian parliament passed the IRDA bill. This
organisation was developed to control and enhance the insurance
industry standards. It aimed to protect Indian policyholders from different
types of risks faced by them. Details of IRDA were discussed in previous
units.
Life Insurance Council - The Life insurance council of India connects a
variety of stakeholders in the insurance sector. It was formed in 1938
under the Insurance act. All the life insurance companies in India and
some other committees are the members of this council. It was formed
to coordinate the discussions between the Government, Regulatory
Board and the Public. Some of its functions are listed below:
o Generate trust and confidence among the customers towards the
insurance industry.
o Preserve the ethics of the insurance industry.
o Promote awareness about the benefits of life insurance.
o Conduct structured and effective discussions with Government,
insurers and regulators.
o Conduct research in life insurance.
o Develop the life insurance sector.
Life Insurance Agents Federation of India (LIAFI) - The Life
Insurance Agents Federation of India (LIAFI) was formed on 2nd of
October, 1964. This association was formed by Life Insurance
Corporation of India with all its agents as the members. This non political
federation addresses all the issues of the LIC agents in India. It has an
Agents Consultative Forum meeting every six months where the LIAFI
discusses these issues with the L.I.C. management. LIAFI promotes life
insurance education through many institutions. It is concerned about the
problems of the LIC policy holders also. It has a larger association i.e., Life
Insurance Agents Association (LIAA) which connects all the LIC agents
worldwide.
Institute of Actuaries of India (IAI) - The Institute of Actuaries of India
(IAI), formerly known as the Actuarial Society of India (ASI) was shaped
in September,1944 to organise and unite the actuarial professionals of
India. It is the Indian equivalent of the Institute of Actuaries, London. It
was formed to prepare and educate the actuaries of India. Its basic
objectives are:
o Progress of the actuarial profession in India.
o Provide better opportunities for communication among professional
actuaries.
o Develop actuarial research.
o Provide guidance for actuarial exams.
Insurance Brokers Association of India (IBAI) - Insurance Brokers
Association of India (IBAI) was formed in 1956 under the Section 25 of
the Companies Act. It is the only IRDA recognised insurance association
of brokers in India. Only IRDA licensed brokers can be members of this
association. The objectives of IBAI include:
o Promote interaction among brokers in India.
o Support and carry out interests of the IBAI members. o
Train and educate brokers.
Activity: 2
Identify and analyse the recent developments in the Life Insurance
Agents Federation of India.
Hint: Refer - http://www.liafi.org/

9. The Life Insurance Agents Federation of India (LIAFI) was formed on
2nd of October, 1965. (True/False).
10. The IAI was shaped in September, 1944 to organise and unite the
__________________ of India.
a) Agents

b) Brokers
c) Insurers
d) Actuaries
11. Only ______________ licensed brokers can be members of the
Insurance Brokers Association of India.
12. ___________________ aims to protect Indian policyholders from
different types of risks faced by them.
13. LIAFI has an Agents Consultative Forum meeting every six months
where it discusses issues of the agents with the L.I.C. management.
(True/False).
14. IBAI is the one of the IRDA recognised insurance association of
brokers in India. (True/False).
15. All the life insurance companies in India and some other committees
are the members of the life insurance council. (True/False).
8.4 Summary
This unit described the functions of insurers, who own the insurance
company and provide insurance. Functions of insurers are different for life and
property insurance. They are production/sales, underwriting, rate making,
managing claims and investments.
Production and sales - A producer is the insurer who produces a
particular insurance policy. The sales section of insurance industry
includes the insurance agents who sell polices to the public.
Underwriting - It is defined as a process of analysing risks of insurance

applicants and deciding whether the insurance company should accept
or reject the application. An underwriter always follows the underwriting
policies and steps.
Rate making - It is also an important operation of insurers. Rate making
involves finding the rates and premiums for different policies according
to the government regulations.
Claims management - It is the basic goal of the insurance industry. It
means to settle the losses of the insurer and the differences between
the insurer and the insured. Insurance companies appoint loss adjusters
to do this task.

Investments - The insurance company gets their income from the

policyholders who pay their premium regularly. Insurers invest this
income in financial schemes efficiently to use it for the payment of loss
of the insured. Income investment differs for life and property
insurances.
Apart from the core functions of insurance organisations, there are some
generic functions such as accounting, legal function, loss-control services,
electronic data processing and other departments.
The professionals involved in the insurance industry unite and organise
themselves into different insurer organisations. In India there are some such
organisations, which help the professionals to study and discuss their
insurance related functions. These are:
Insurance Regulatory and Development Association (IRDA).
Life Insurance Council.
Life Insurance Agents Federation of India (LIAFI).
Institute of Actuaries of India (IAI).
Insurance Brokers Association of India (IBAI).
8.5 Glossary
Reinsurance: Reinsurance involves protecting the insurance company
against a certain portion of potential losses.
Renewal underwriting: Renewal underwriting is the process of evaluating
renewal business, identifying and correcting rating errors, and preventing
premium leakage at the time of policy renewal.
Insurance actuaries: Insurance actuaries are experts who are involved in the
prediction of future of the policies based on past outcomes and
probability models.
Pure premium: it refers to the part of the premium, which is sufficient to pay
losses and loss adjustment expenses only, but not other expenses.
Loading: It refers to the amount added by an insurance company to the basic
premium, to cover the expenses of securing and maintaining the business.

Insurance adjuster: Insurance adjusters decide whether a person who

demands a compensation for any loss due to injuries or property damage is
asking for a legitimate payment under any insurance policy or not.

1. Explain underwriting in detail.
2. How do insurance companies carry out rate making?
3. What are the basic objectives of claims management?
4. Discuss the functions of insurance organisations.
5. List and explain briefly the organisations of insurers in India.
8.7 Answers
1. True
2. a) - Insurance premium
3. Electronic data processing (EDP)
4. True
5. False
6. c) - The rates should encourage the insurer to do loss control.
7. d) - Personal support to the insurers
8. True
9. False
10. d) - Actuaries
11. IRDA
12. IRDA
13. True
14. False
15. True
Terminal Questions
1. Underwriting is defined as a process of analysing risks of insurance
applicants, and deciding whether the insurance company should accept
or reject the application. Refer section 8.2.2 for more details.
2. Rate making is an important operation of insurers. Rate is defined as the
price per each unit of protection or exposure of insurance. Refer section
8.2.3 for more details.

3. There are some basic objectives of claims settlement like confirmation of

a covered loss and timely payment of claims. Refer section 8.2.4 for
more details.
4. There are some functions that are related to insurance organisations like
accounting, legal and loss control. Refer section 8.2.6 for more details.
5. The professionals involved in the insurance industry unite and organise
themselves into different insurer organisations. Refer section 8.3 for the
details about some such organisations in India.
8.8 Case-Let
Bajaj Allianz Group Health Insurance Coverage Case Study

This case study is about the loss control services and claims
management of a Bajaj Allianz group health insurance coverage.
Client - The client in the claim was a lady employee of Gujarat
Paguthan Energy Corporation. The patient in need of Health Insurance
coverage was her spouse. The client was earlier handled by a Third
Party Administrator (TPA) and was quite satisfied with the services. The
proposal of services by the Health Administration Team of Bajaj Allianz was
made to the client at the time of renewal. Initially, there was some
hesitancy from the client's side as they were apprehensive about an
insurer coordinating cashless services directly.
Coverage: Group health insurance coverage - The policy covered the
hospitalisation fee and cost of surgery.
Claim - The patient was suffering from inguinal hernia and needed an
operation. The client intimated the insurer of the hospitalisation 3 days
in advance to ensure smooth cashless dealings with the hospitals.
Role of Bajaj Allianz - The Bajaj Allianz Health Administration Team
(HAT) network suggested hospitalisation at a prominent hospital in
Mumbai, which was a part of HAT. HAT contacted the hospital and
arranged for the preauthorization of the client to get an estimate of the
expenses.
The hospital provided an estimate of Rs.50,000 excluding the surgeon's
charges as the latter would be provided by the surgeon after the patient

was admitted. Based on past experience with TPAs, HAT deduced that this
may be a trick to increase the bill once the patient has been admitted,
as, by then, changing hospitals wouldn't be a viable option. Meanwhile,
HAT had gathered data about the approximate costs for this surgery in
other hospitals.
The client was concerned, expecting a costly bill for the surgery, and
more so, as HAT was handling its first case with a big corporate
hospital. After admission, a pre-authorization estimate of Rs.1, 25,000
was sent to HAT for approval which was much above the average cost
of this surgery in other hospitals. The hospital billings department was
immediately contacted and negotiation of the rates was conducted.
HAT took a strong stand on the weak logic behind the high estimate
and insisted that the rates be reduced to a reasonable level. The
hospital responded by stating that other TPAs had been adhering to
this rate without objections. HAT compelled the hospital authorities to
revise the rates on the basis that HAT would halt the agreement unless
preferential rates were extended to our members.
After further negotiations, HAT was able to persuade the hospital to
reduce the cost of the treatment and surgery to Rs.65,000 including all cost
components. The patient underwent surgery for and the operation was
conducted successfully.
Lessons learnt - In this case, HAT was able to help the patient by
drawing on its past experience. HAT could gather accurate information
from its network of affiliated hospitals, which enabled it to verify the
correctness of the cost estimate of the surgery. This made it possible for
HAT to negotiate with the hospital for of the patient on genuine reasons,
and bring the estimate of the operation down by a significant amount. Thus,
the patient was ensured the highest quality of heath care at a reasonable
price.
Benefit to the claim - The balance sum insured can be used later. The
client was very satisfied with the services offered by HAT, and
responsiveness to the situation at hand. They were glad to have got
hassle-free hospitalisation with all the modalities being taken care of by
HAT. They were particularly happy about the price differentiation that they
got by moving away from the TPA services to HAT.

1. What strategy did the HPA adopt, when the surgery cost was found
to be much more than that provided by other hospitals?
(Hint - HAT took a strong stand on the weak logic behind the high
estimate and insisted that the rates be reduced to a reasonable
level.)
2. How did the HAT help the claimant with its past experiences?
(Hint - HAT could gather accurate information from its network of
affiliated hospitals, which enabled it to verify the accuracy of the cost
estimate of the surgery.)
3. What was an extra benefit achieved by the claimant from HPA?
(Hint - HAT gave the balance sum to the insured to be used later.
Source: http://www.bajajallianz.com/BagicCorp/bajaj_home/ claims/
case study.jsp
References
George E Rejda(2009): Risk Management and Insurance, Dorling
Gupta P K: Insurance and Risk Management, Himalaya Publishing
House, India.
Vaughan J Emmett, Vaughan Therese (2007): Fundamentals of risk and
Insurance, Wiley, India.
E-References
http://www.investorwords.com/5136/underwriting.html#ixzz13eBglmzt
http://www.referenceforbusiness.com/encyclopedia/Thir-
Val/Underwriting-Insurance.html
http://thismatter.com/money/insurance/rate-making.htm
http://www.wisegeek.com
http://www.actuariesindia.org/About/about%20iai.htm
http://www.bimaonline.com/cgi-bin/ind/careersnew/actuary/actuaryhome.
asp
http://www.ibai.org/

http://www.insuremagic.com/content/Agents/AgentsAssociations/Liaa.
asp
http://www.lifeinscouncil.org/

Unit 9 Product Design and Development

Structure:
9.1 Introduction
Objectives
9.2 Product Development Process
Classification of new products
Stages in new product development
Pricing strategy for new products
9.3 Product Design and Development by Insurance Companies
Defining the product
Analysis of the market
Analysis of data
The product itself
Product development: role of tariffs and after
Intermediaries
9.4 Product Design in Emerging Scenario
Changing scenario
Role of technology
9.5 Summary
9.6 Glossary
9.8 Answers
9.9 Case-Let
9.1 Introduction
The previous unit dealt with the functions of insurers like production, sale,
underwriting, rate making, managing claims and losses and investments. It also
explained different types of insurance organisations. This unit will deal with the
product design and development in insurance.
Product design and development is the basic responsibility of the
management of any company. Insurance policy innovations developed
when competitive forces and customer demand encouraged the companies
to propose attractive alternatives. The standardisation of insurance
contracts in property and liability leaves a small place for new product
development. The other factors that influence the new product development

are the changes in regulations and environment. Before introducing any new
product, there are some points to be considered, like, nature and size of the
market, legal and regulatory problems, predicted responses and
competitions, start up cost, promotion and advertising, pricing, underwriting,
expected losses, production, distribution, planning etc.
This unit covers the product development process. It explains the product
design and development by different insurance companies. It also includes
product design in emerging scenario.
Objectives:
explain the product development process
describe the product design and development by different insurance
companies
analyse the product design in the emerging scenario
9.2 Product Development Process

Any business organisation faces problem due to the threats from the
environments like political and economical conditions, social, technology and
supply conditions, changes in client requirements, and so on. The clients
ask for better products and services. They seek more benefits in the products
they buy, and more value for money. In addition to this, competition is
another threat-causing factor. In order to overcome these threats and fulfill
the customer requirements, business organisations have to develop new
products. The new products provide new opportunities for the growth and
security of the organisation.
The new products are also needed to ensure profits to the company. The
products that already exist have some limitations in improving the profit level of
the organisation. Therefore, it is very important that the organisation
introduce new products to substitute the old, declining and losing products.
Thus, the new products become a part of the growth requirements of the
organisation, and yields profits to the organisation.
Therefore, new product development is an important part of the product
policy of any organisation. For an organisation to grow higher, it has to go
beyond the existing product as it cannot obtain its desired growth just by
appraising the existing product appropriately.
9.2.1 Classification of new products

The new products introduced in any sector are classified into two groups:
New products that arise from technological innovations: These are
the products that have new functional value.
New products that arise from marketing oriented modifications:
These are the new versions of the existing products. The products may
look new because of some changes in the existing product design,
adding a new feature to the existing product, presenting the existing
product with a new sales strategy to a new market segment.
9.2.2 Stages in new product development
Stages of product development differ from one company to another.
Generally, product development is carried out at the top-level management. The
different stages of product development are:
1. Generating Ideas - While developing a new product, the main
challenge is to avoid mistakes and reduce risk. Before developing the
product, the company should conduct a formal market research. This
can help get some ideas on the customer needs and thus, develop the
product accordingly. The different sources of information are customers,
product development executives, consumer groups, intermediaries, legal
pronouncement, employees, journals, magazines, and so on.
2. Screening Ideas - After generating the ideas, screening of those ideas
take place. The evaluation committee must screen the product for its
objectives, policies, and so on. All the ideas need not be thoroughly
followed. While screening the products, it is better to determine the
following:
o Is the new product an improvement over the existing product? o
Is there any need for the new product?
o Is it in the same line of business or different from the business?
3. Concept testing - This is the third stage in the process of development
of a new product. In this stage, the product concept is tested. It is a
function of customer market research. It tests whether the customers
have understood the product idea, whether they have interest in the
idea, whether they need the product, and so on. This testing helps the
company to make the concept of the new product clear.

4. Business analysis - This stage of the product development life-cycle

helps in designing the product based on the market analysis. It indicates
the customer interest in the product, and thus helps in deciding whether
to proceed with the project or not. In this stage, the impact of the project
on the financial position of the organisation with and without the new
product is compared, and calculated. While comparing and evaluating
the products, different departments of the organisations have their own
responsibilities.
5. New product development - In this stage, the elements of the products
are identified and highlighted. The prototypes of the products are
developed in this stage, and after their approval, the actual product is
developed. At this stage of product development the organisation is
generally committed to the new product. In the development of the
product, the production and marketing departments of the organisation
are also actively involved apart from the research and development
department.
6. Commercialisation - In this stage, the organisation releases the
product to the market. Insurance companies distribute their products
through various channels including banks.
Developing new product is time-consuming; it involves risks, and is

expensive. New products have a high attrition rate due to the following
reasons:
Many new products do not even reach the market at all, thus wasting
considerable amount of money, time and effort.
Some products that manage to reach the market after many years of
development, also fail some time.
Some products are successful only for a short period of time. They soon
lose their initial boom.
Therefore, for a product to be successful, it has to have an exclusive and
better idea that fulfils the customer requirements and yields benefits. It
should have a powerful production expertise and a good marketing strategy.
9.2.3 Pricing strategy for new products
After the new product is developed, it is essential to price the product before
releasing in the market. Therefore, it is important for insurance organisations

to have an efficient pricing strategy. Pricing new insurance products is an

important phase in product development process.
Pricing a new product of insurance is quite difficult, as there are no previous
versions of these products. Thus, there is no data on the possible market
reaction for this product and the probable demand rate of the product. So,
demand-based pricing is not possible. Competition-based pricing is also not
useful while pricing these products, because the customer compares the product
only after it is released to the market.
Cost-plus pricing strategy may be difficult, as the research and
development cost may have been shared among different products while
generating ideas for new products. Therefore, it is difficult to assign the cost
for a particular product. Pricing of the new insurance products includes four
steps:
1. Drafting a pricing strategy.
2. Actuaries testing.
3. Rate setting and testing.
4. Managing of pricing outcomes.
1. In the ________________ step the customer requirements has to be
analysed.
2. While developing a new product the main challenge is to avoid mistakes
and reduce risk. (True/False).
3. ______________________ stage of the product development lifecycle
helps designing the product based on the market analysis.
Activity: 1
Find out the product development process of any insurance company.
Hint: Refer section 9.3.
9.3 Product Design and Development by Insurance Companies

The previous section explained the product development process. This
section will explain the product design and development by insurance
companies.
One main issue in the liberalised scenario of the insurance sector is in the
area of developing new products. Constant activity in this area is very

important for determining the overall profitability, and growth of any

insurance company. The main reason for the liberalisation of the insurance
sector is that it the public sector was not practical in the process of
developing products that satisfied the needs of the customer.
Product development process is an important process for an insurance
company. Developing insurance products include the following steps:
1. Customer requirement analysis - In the first step, the customer
requirements are analysed. In this phase, the information on the amount
to be insured, total income, client biometrics such as age and family
size, current purchasing habits, and so on are analysed.
2. Business analysis - In the business analysis stage of product
development, different departments of the insurance company have the
following responsibilities.
o Marketing department has to perform the market analysis to know
the customer needs, and make a forecast for sales.
o Underwriting department has to prepare the manuals.
o Customer service department assesses the procedural requirements
of the new products.
o Actuarial department develops the specifications of the product, and
the resulting impact on product portfolios.
o Accounting department reports the financial requirements of the new
product.
o Information systems department checks whether the insurer has
enough operating systems to accommodate the new product or not.
o Investment department along with the actuarial department
determines the investment needs for the new product.
3. Prototype development - In this step, a prototype of the product is
designed and testing is carried out.
4. Pricing the product - The pricing of the insurance products plays an
important role in the design and development of the product. The price
of the product should include the risk premium that the insurance
company needs for accepting the policy, and the cost for distributing and
administering the product to the client. The policy price that is charged to
the client includes the risk premium and the cost of the distributor.

5. Product release - This stage is called as the technical design stage. It

involves creation of drafts for policy documents, commission structure,
underwriting, forms and procedures and issue specifications. Before the
product is released to the market the insurance companies have to take
care of the following:
o Arrangement of training material.
o Designing promotional materials for the products.
o Releasing all the information that is needed to understand the
product.
o Administration of the product after release.
o Complete policy filing, the process by which the organisation obtains
all the regulatory approvals from all the applicable authorities that
are needed to release the product.
o Educating and training the staff and the sales agents on
administrative procedures and forms that are needed to sell,
administer and service the product.
The environment in which the insurer functions inspires its product
development. This comprises of the legal framework which the insurance
industry has to follow and social and economic factors. Any stage of product
development has to be carried out in accordance with the customers
interest. Thus, since 1973, the Indian Insurance sector has directed the
product development towards meeting this goal. In the last three decades,
the General Insurance Company (GIC) together with its four subsidiaries
has developed 150 new products, and has met its customer requirements.
To control poverty and provide employment in the rural areas, the insurance
sector developed the Integrated Rural Development Program (IRDP).
Besides this, the industry developed a solution for the healthcare products like
mediclaim and also introduced travel-related products.
9.3.1 Defining the product
While designing the product, we must follow some steps for defining the
procedures. These steps are:
1. In the first step of the design process the managers plan and identify the
research objectives. They also verify the consistency of these objectives
in all the national market.

2. In the next step the aspects of the procedural operations to ensure the
consistency in the process of data collection is defined.
The other points to be considered while defining a product are:
Incorporate study control - All external factors must be thoroughly
investigated, so as to minimise their impact on the end results.
Counting the cost - The market analysis, the actuarial research and
the competitive research help in determining the cost of the product.
Premium rating and product design - To compete in the competitive
market, it is essential to know the increased customer demands,
improving the product design, bringing in new marketing strategies,
releasing the product on time, and so on. Superior premium ratings and
the ability in responding quickly to the changing market needs help in
meeting this problem.
9.3.2 Analysis of the market
This is an important stage while designing a product. It helps in identifying
the customer needs and the nature of the market. It includes calculating the
present market size, establishing the products and the rating methods that
are used in the competition, understanding the market needs and
profitability, investigating who decides to buy which product, determining the
basic reason for buying the product, advising the effective method for sales
and distribution by comparing the advantages of the different distribution
methods.
9.3.3 Analysis of data
The actual premium rating is based on the collection of the relevant data in a
proper format, and its analysis. The insurance companies can address this issue,
by giving an advice on the design database, and the collection of statistical
information.
The following steps need to be implemented while analysing the data:
Consider the possible effect on the collection of particular rate changes.
Analyse the claims that are experienced to know the effect of rating
factors on the risk.
Carry out sensitivity analysis.
Compare the theoretical results with the existing rating structure and
understanding the results.

Provide financial forecasts on the future results depending on the

premium rates that is calculated.
9.3.4 The product itself
Insurers are constantly developing new products on the basis of advanced
ideas. They have to constantly develop the new products, keeping in mind
the new challenges of the society. The insurance products promise the
service even in the occurrence of a particular threat operating on a risk.
There are only a few products developed on the basis of new market
requirements. Developing a standardised product is cost effective, faster
and obtains economies of sale in mass selling. Insurance companies have
to develop suitable products, verify price properly and increase profitability.
As it is not possible for a single policy to meet all the insurance objectives,
the insurance companies should have a collection of policies that covers all
the needs of the customer. With the product life-cycle of the insurance
product weakening, either the product lifecycle has to be extended by
improving the existing product or a new product has to be developed to fulfill
the customer requirements.
Some insurance companies have launched many new insurance products
recently. The table 9.1 lists these products and their features.
Table 9.1: New Insurance Products
Insurance company Product Features
AEGON Religare AEGON Religare It has a zero premium
growth plan allocation charges and
has an option of four
funds.
It has a Invest Protect
option according to which
the policyholders funds
will be moved
automatically from equity
to debt while the period
of the policy is ending.
It allows partial
withdrawal of 20 percent
of the funds after the first
three years of the policy.

Aviva Wealth Protect This product assures the

highest Net Asset Value
(NAV) for the first seven
years of the policy.
Birla Sun Life Bachat Plan It has the options of paying
premium monthly,
quarterly, half yearly and
annually.
One the policy matures,
the policyholder gets all the
monthly paid premium, the
bachat and the loyalty
additions
DLF Pramerica Dhan Suraksha It provides the money back
that is equal 15 percent of
the total sum guaranteed
at the end of five years.
Once the policy matures,
the policyholder will get the
amount assured but the
money back amount that is
already paid will be
deducted.
Future General Life Nivesh Plan It is a single premium plan
with a death benefit of the
fund value and the sum
assured.
One the policy matures,
the policyholder can either
receive the entire fund
value or opt for settlement
option according to which
the fund amount will be
paid in five years through
annual installments.
HDFC Standard Life Endowment Once the policy matures
Champion Suvidha the policyholder receives a
Bumper Additions along
with the fund value,
depending on the term of
the policy. This additional
amount can be obtained at
once or in installments for
five to ten years.

It also has the option of

partial withdrawal after fifth
years of the policy
India First Life Group Term Plan It is a yearly renewable
plan.
It offers life coverage of
minimum Rs. 5,000 per
member.
Group Credit Life It is offered against the
Plan loans to the borrowers of
any common lenders.
Reliance Life Super Golden Years It is pension plan with a
Term 10: Senior regular or single premium
Citizen Plan option.
On the day of investment
the policyholder can opt for
a life annuity with return of
purchase price payable on
death or a life annuity
assured up to 15 years and
there after payable.
Reliance Life Traditional It is a savings plan.
Investment
Insurance Plan Once it matures, the
policyholder get the total
premium paid as returns.
9.3.5 Product development: role of tariffs and after

The Indian regulators at different forums have stated that the insurance
companies are free to develop their own products without any interference of
the regulatory authority. The only condition laid was that the non-life
insurance companies have to concentrate only on non-life sectors, whereas the
life insurance companies have to concentrate on developing life insurance
product. This helps in meeting the policy holders expectations in covering for
suitable insurance sector. The Tariff Advisory Committee (TAC) controls the
pricing of new products. The Tariff prices are inflexible and not responsive as
per the market requirements.
According to the emerging market trends, the insurance industry has to
develop non-tariff rule. The products developed under the non-tariff rule will

have features, like, customer friendly documentation, simplicity, quality,

speed, relevance to risk, and so on.
9.3.6 Intermediaries
In the insurance industry, distribution is an important link of value chain. The
insurers are finding it difficult to do away with the distribution even in this
technology-based generation. Intermediaries act as the important link
between the insurer and the insured. Insurance intermediaries are the
brokers and agents who represent the insurance company. Market is going to
come across the appearance of intermediaries in developing business and
servicing clients. The intermediaries bring innovative marketing practices
in the insurance market.
4. One main issue in the liberalised scenario of the insurance sector is in
the area of developing ____________________.
5. All external factors must be thoroughly investigated so as to maximise
their impact on the end result. (True/False).
6. There are only a few products developed based on the new market
requirements. (True/False).
9.4 Product Design in Emerging Scenario

The previous section discussed about the product design and development by
insurance companies. This section will explain the product design in the
emerging scenario.
In India, insurance is not bought, but it is sold. The agents or the insurance
intermediaries use different strategies to convince the customers, and sell
the products. Therefore, the insurance companies have to bear in mind the
need of the customer while developing the product, and also while pricing
the product.
While developing a product in the initial stages, around 80 percent of the
cost is determined. Thus, if the insurance companies take a wrong decision
at this stage, the cost of the product will be too expensive. Involving the
research team in the discussion, during all the stages of project
development, helps in obtaining maximum advantage in the design process.

9.4.1 Changing scenario

With the opening of the insurance sector to private investors, including the
foreign investors, and the implementation of the IRDA act, the responsibility of
developing the products is not restricted to the nationalised companies. Many
regulations that are needed for the functioning of the new players in the
insurance sector have also being identified.
Policyholder expectations - Identification of the needs of the customers acts
as a stimulant for the improvement of the product. It flows right from the
process of analysing the customer needs. This includes the analysis of the
economy, and the main moves in the economy, which affects the business
environment either directly or indirectly. The moves or changes in the
economy are due to the changes in choice and activities of the customer,
changes in the demographic profile, and changes in the environment and
expectations. Identifying the policy holders expectations helps in getting
idea for initiating the development of new products, helps in converting the
knowledge into products, which helps offer value for customers.
Generally, when new products are developed, the old products are
subjected to some changes; whereas in insurance, when a new product is
developed, it does not change the old product, as the basic needs of the
customers cannot be ignored. There are many examples in the market
where the old products continue to serve the target market, and at the same
time the new product is developed based on the market requirements.
9.4.2 Role of technology
The introduction of technology in the insurance sector has improved in the
development of the industry. Product development can be improved by
making use of new technologies together with the environmental factors in
order to make the entire product development process a continuous one.
The present day insurance companies have to meet the needs of the
customers in a faster way as there is a lot of competition among the
insurance companies. Therefore, technology plays an important role in the
process of product design and development. Use of technology as a tool for
distribution is presently in the emerging stage, but there is a great possibility
that it provides a stage for the development of cost-effective products. In
future, we can use the technology for creating new and value for money

insurance products. The advantages of using technology can speed up the

services and reduce the cost distribution.
7. While developing a product in the initial stages around
___________________ of the cost is determined.
8. Identifying the needs of the ____________________ acts as a
stimulant for the improvement of the product.
a) Customers
b) Stakeholders
c) Insurer
d) Investors
9. Product development can be improved by making use of new
technologies together with the environmental factors so that it makes
the entire product development process a continuous one.
(True/False).
Activity: 2
Find out the emerging scenario of product development process in Life
Insurance Corporation of India.
Hint: Refer to section 9.4.
9.5 Summary
This unit discussed about the product design and development. Product
development process is an important process for an insurance company.
Developing insurance products includes many steps. In the first step, the
customer requirements have to be analysed. In the next step, a prototype of the
product is designed and a testing.
The new products introduced in insurance sector are classified into two
groups:
o New products that arise from technological innovations, these are
the products that have new functional value.
o New products that arise from marketing oriented modifications, these
are the new versions of the existing products.
The different stages of product development are:
Generating ideas.
Screening ideas.
Concept testing.
Business analysis.
New product development.
Commercialisation.
After the new product is developed, it has to have some rate for it to be
released to the market. Therefore, the pricing strategy for new insurance
product is an important phase in product development process.
One main issue in the liberalised scenario of the insurance sector is in the area
of developing new products. Constant activity in this area is very important
for determining the overall profitability and growth of any insurance
company. While developing a product in the initial stages around 80 percent of
the cost is determined.
9.6 Glossary
Liberalisation - It refers to the reduction of previous government
restrictions, usually in the areas of social or economic policy.
Attrition rate - It is the percentage rate at which something is lost, or is
reduced by, over a period.

1. Explain the product development process.
2. What is analysis of data in product design and development?
3. Describe the process of product design and development by insurance
companies.
4. Explain the role of technology in the product development.
5. Describe the emerging scenario of the product design process.
9.8 Answers
1. First
2. True
3. Business analysis
4. New products
5. False
6. True

7. 80 percent
8. a) - Customers
9. True
Terminal Questions
1. Product development process is an important process and includes
many steps like generation of ideas, concept testing, business analysis
and so on. Refer section 9.2 of this unit for details.
2. The actual premium rating is based on the collection of the relevant data
in a proper format, and its analysis. This is explained in the sub -
section 9.3.3 of this unit. Refer the same for details.
3. One main issue in the liberalised scenario of the insurance sector is in
the area of developing new products. This is explained in the section 9.3
of this unit. Refer the same for details.
4. Product development can be improved by making use of new
technologies together with the environmental factors so that it makes the
entire product development process a continuous one. This is explained
in the sub - section 9.3.2 of this unit. Refer the same for details.
5. With the opening of the insurance sector to private investors, including
the foreign investors, and the implementation of the IRDA act, the
responsibility of developing the products is not restricted to the
nationalised companies. The changes in the product design scenario are
9.9 Case-Let
New Product Development By Life Insurance Corporation of India
The Life Insurance Corporation of India (LIC), one of the biggest life
insurance companies has recently launched the life product Jeevan
Madhur. This is a policy meant for the low income category specifically for
those who have no fixed or stable income. It is available for both men and
women without any medical examination. It is also a saving plan for
individuals in the age group of 18 to 60 years.
According to the plan of this product, it covers life insurance from a
minimum amount of Rs. 5,000 to a maximum amount of Rs. 30,000.
Therefore product is customisable which means that the customer can
make a minimum of Rs. 25. as premium payments for a week, Rs. 50

fortnightly, Rs100 for one month and a minimum of Rs. 250 for a longer
period of time. The period of the policy ranges from 5-15 years.
This is not the first time that LIC has introduced new policies that offers
insurance services to the financially poor. The organisation had tried to
sell the Janashree Bima Yojana a government subsidised life insurance
product, a new policy in 2001-2002, using microfinance institutions (MFIs)
and NGOs (Non Government Originations) as delivery channels. While
the subsidies were attractive, there were many issues related to different
aspects of the product life cycle and the institutions bureaucratic manner
of functioning, which made LIC policies unworkable in practice.
1. Explain the coverages of the Jeevan Madhur policy of LIC.
(Hint: According to the plan of this product, it covers life insurance from
a minimum amount of Rs. 5,000 to a maximum amount of Rs. 30,000.)
2. Why did the Janashree Bima Yojana policy fail?
(Hint: While the subsidies were attractive, but there were many issues
related to different aspects of the product life cycle and the institutions
bureaucratic manner of functioning, which made LIC policies
unworkable in practice.)
Source: http://microcapitalmonitor.com/cblog/index.php?/archives/393-
Indias-Largest-Life-Insurance-Company-sweetens-MicroInsurance-
Space-with-a-New-Product.html
References
Mishra R.K and Sethi Nandita, (2008). Rethinking India's Growth
Strategy Services Vs. Manufacturing, Institute of Public Enterprise,
Hyderabad.
Outreville Jean Franois. (1998). Theory and Practice of Insurance,
Kluwer Academic Publishers, USA.
Pezzullo Mary Ann. (1998). Marketing Financial Services, American
Bankers Association.
United Nations Conference on Trade and Development, Trade and
Development Aspects of Insurance Services and Regulatory
Frameworks.

E-References
http://www.acadjournal.com/2008/V22/part7/p2/
http://www.powerdecisions.com/product-research.cfm
http://www.subramoney.com/2010/03/changing-scenario-in-the-life-
insurance-industry/
http://www.towerswatson.com/assets/pdf/2176/TW_Newsletter_38_Life.
pdf

Unit 10 Underwriting
Structure:
10.1 Introduction
Objectives
10.2 Basics of Underwriting
History of underwriting
Underwriting defined
The trade-off
The conflict
Guiding principles of underwriting
10.3 Objectives and Principles behind Underwriting
10.4 Underwriting Steps
10.5 Sources of Underwriting Information
10.6 Making an Underwriting Decision
10.7 Other Underwriting Considerations
10.8 Summary
10.9 Glossary
10.11 Answers
10.12 Case-Let
10.1 Introduction
The previous unit explained the product design and development process of
different insurance companies. It also discussed the aspects of product
design in the emerging scenario.
Underwriting is a process of assessing risks and deciding who or what the
insurance company can insure. An underwriter is a person who assesses
the risks and computes the premium. Underwriting decision is the decision
made by the underwriter about the rating and risk classification. This unit
describes the basics of underwriting, including the meaning of underwriting,
history of underwriting, definition of underwriting, the trade-off, the conflict,
and twin-guide principles. This unit explains briefly the objectives and
principles behind underwriting, and the process of underwriting.. Sources of
underwriting information are also discussed in this unit. This unit also

focuses on the underwriting decision-making, and some other

considerations in underwriting.
Objectives:
briefly describe the basics of underwriting
understand the objectives and principles of underwriting
explain underwriting steps
describe the sources of underwriting information
describe decision making in underwriting
10.2 Basics of Underwriting

This section covers the basics of underwriting, including its meaning.
Underwriting is a process of evaluating the risk and exposures of potential
clients. It is related to the rate-fixing function of an insurer.
Underwriting is an insurance factor, which decides how much coverage the
client should receive, how much clients should pay for it, or whether even to
accept the risk and insure clients. Underwriting involves determining risk
exposure and defining the premium that needs to be charged to insure that risk.
Underwriting is the process that makes decisions regarding issuing
insurance policies.
The person, who evaluates, accepts or rejects risks and calculates premium is
called as Underwriter. Underwriting decision is the decision made by the
underwriter regarding risk pricing and evaluation. . Underwriting decisions are
very critical for insurers. Good underwriting in insurance companies makes
them financially strong, and competitive.
10.2.1 History of underwriting
Underwriting can be traced to the Victorian times in United Kingdom,
wherein a community of sailors and traders began insuring against risks
involved in sea journey. They insured the goods transported against
expected risks such as piracy, damage to goods, bad weather and so on.
The practice evolved with times and resulted in an insurance model. In the
initial days of marine insurance, the details of the ship or cargo were written
on a slip and submitted to Lloyds and the person, who was willing carry the
risk read the details, and signed the slip under the risks mentioned. In this

manner, the person carrying risk became the underwriter. Thus, insurance
business evolved from United Kingdom and the first insurers were the
Lloyds industries.
10.2.2 Underwriting defined
In the insurance industry, the term underwriting refers to the process of
evaluating risk. Important principle of insurance is the transfer of risk. The
risk is taken away from the insured, and transferred to the insurer. The
insurance company assumes the risks for a large number of persons.
Since many people who are insured pay premiums, there are sufficient
funds available to pay claims, and still permit the insurance company to pay its
expenditures and make a sensible profit. In order to ensure that this is
accurate, there must be a very good understanding of the risks and
estimates must be made of how many claims are likely to be paid. When this
data is understood, a premium rate can be determined that will guarantee
that adequate funds are available.
Underwriting is basically the evaluation of risk. Life insurance underwriting is the
evaluation of factors such as, health and life expectation. This is done by the
preparation of lifespan lists. These life lists are called humanity tables. They
basically give the estimated lifespan of humans at a given age and given
health condition.
Life insurance underwriting is typically done on an individual basis. In this
underwriting, every person presents a completely different condition.
Individual health, age, life style, and even gender will be considered. The idea
is to give a certain risk factor to an individual, and use this risk factor to
determine the amount of premium to be paid for the insurance policy in order
to make the statement of risk acceptable.
10.2.3 The trade-off
The underwriting isometrics is a trade-off between the business and
survival. A trade-off has to be made between premium growth and
underwriting profits. In general insurers hold more capital than the amount
required by regulators. The main advantage of this buffer capital is that
policyholders are sure that their claims will be paid and shareholders feel
comfortable that the ability of the company to continue making profits is
protected. The insurers indirect investment risk in the capital market is

thereby improved by the process of underwriting risk. If the insurance

company charges more for premiums, the company will lose competitive
advantage. Hence, proper balance should be maintained for a good
business.
10.2.4 The conflict
The underwriters need to consider the conflict between the insurers and the
consumers. Consumers demand a lot of insurance coverage. But insurers
shun risky exposures. For insurers evading their underwriting risks by
combining negatively related lines of insurance seems natural. Positive
correlation requires additional capitals for creditworthiness and thus the
supply of insurance is limited. But, this argument oversees three facts. First,
supposing that insurers want to limit volatility, they can still evade by holding
assets that are positively related to their liabilities. Second, as long as risk
increases with increased probability, an insurance company still seems
attractive to investors. Finally, it is not clearly stated whether the
shareholders of a company want management to avoid risk. Thus it is clear
that positive correlation of risks causes consumers to demand more
coverage but insurers to decrease supply. This causes conflict.
10.2.5 Guiding principles of underwriting
The two main underwriting principles are:
Adverse selection.
Persistency.
The underwriter should always secure himself against the adverse selection of
risks, as the adverse selection will affect the policyholders in purchasing the
policy. For example, a healthy person will be less interested in purchasing
insurance than one who is often ill. Hence, the underwriter should assess
these inherent risks carefully and fix the premium which minimises significant
losses.
In addition, the underwriter should only offer products which are affordable. The
premium fixed for the policies should also support the cash flow model of
insurers. The regular renewal of policies is essential to run the business
smoothly. The underwriter should carefully analyse the paying capacity of likely
customers before approving a policy. If many policies are surrendered or become
lapsed, the company will incur huge losses.


1. ____________ is an art started at Victorian times in United Kingdom.
2. Life Insurance underwriting is typically done on an individual basis.
(True/False).
3. The main underwriting principles are ______________________.
a) Profit and investment
b) Adverse selection and persistency
c) Reliability and assurance
d) Deliverable to the consumer
10.3 Objectives and Principles behind Underwriting

The previous section explained the basics of underwriting. This section will deal
with the objectives and principles behind underwriting.
Underwriting deals with the selection of risks. The main objective of
underwriting is to ensure that the risks accepted by the insurer conform to
the standards of the rating structure. The basic objective of underwriting is
to analyse if the applicant accepted will have a loss experience or not which
is quite different from the assumed scenario while formulating the rates.
Hence, certain standards of selection should be maintained relating to
physical and moral hazards that are set up when rates are estimated. For
example, a company may decide that it will not consider any fire related
insurance in areas where there is no fire brigade protection or any life
insurance policy for a person having cancer for past five years.
The objectives of underwriting are:

Providing justified premiums - The underwriter should evaluate the
risk in an application fairly and fix an appropriate premium for the
consumer.
Ensure deliverables to the consumer - Consumers are the
concluding authorities who buy the product. If the marketing department
fails to sell the product, then the product becomes undeliverable; the
responsibility will be on the underwriter to carry an analysis of the
various factors which causes differences between the consumers and
companys expectations.
Financial feasibility to the insurance company - The underwriting
profit should be replicated through financial statements. Although the

underwriters are not involved in pricing the insurance products directly, yet
their role is as important as that of actuaries.
Generally, most of the insurance companies express underwriting policies,
which offers the framework for underwriting decisions and It is also known as
underwriting philosophy. The underwriting policy specifies:
The line of insurance that will be written.
Banned exposures.
The amount of coverage to be allowed on different types of exposure.
The area of the country in which each line will be written, and similar
restrictions.
Generally, the person who applies the underwriting guidelines and rules is
called as desk underwriter.
The underwriting philosophy can be considered as underwriting guidelines,
which gives clear information about general standards that specify which
applicants are to be allotted the risk recognised for each insurance product.
In life insurance, underwriters are supported by physicians medical reports of
the applicant, information from the agent, an inspection report of the
applicant prepared by an external agency created for that purpose, as
advised by the medical advisor of the company. In property and life
insurance, the underwriter has the services of reinsurance facilities and
credit departments to report on the financial standard of the applicants and also
to review applicants loss histories.
4. The main objective of underwriting is to ensure that the risks accepted
by the insurer conform to the standards of the
structure.
5. The underwriter should evaluate the risk in an application fairly and fix
affordable premium for the consumer. (True/False).
6. In life insurance, underwriters are supported by ___________________
____________.
a) Physicians medical reports.
b) Information from the agent.
c) An inspection report of the applicant.
d) All of the above

10.4 Underwriting Steps

The previous section dealt with the objectives and principles in underwriting. This
section will describe the steps in underwriting process.
The underwriting of life-insurance falls under a category that is different from all
other forms of insurances. When the underwriter measures risk at
beginning, the company assures a cover for 30 years or throughout life. Life
assurance underwriting must consider factors, like, medical history, family
details, occupational hazards, and persons lifestyle.
The underwriting process for life insurance involves the following steps:
1) Execution of field underwriting.
2) Renewing the application in the office.
3) Gathering additional information, if required.
4) Taking and underwriting decisions.
Additional information is always essential for the underwriter in order to take
a decision. This additional information may be in the form of questionnaires,
a detail medical report from proposals own doctor (Medical Attendants
Report), and an examination by an independent doctor (Medical Examiners
report).
The general steps followed by Underwriters are:
1) Getting applications -The application for insurance is the main source
of insurability information that the underwriter of the life insurance
company evaluates first. Applications are generally collected by the field
officers, the agents. A typical life insurance consists of:
General information - The general information consists of general
aspects like name, age, address, date of birth, sex, income, marital
status and occupation of the applicant. It also includes the details of
requested insurance cover like type of policy, amount of insurance,
name and relationship of the nominee, other insurance policies that
the customer owns and the pending insurance applications as on
date.
Medical information - The medical information consists of
consumers health condition and several queries about health history
and family history. The medical section of the application is
comprehensive and it is mandatory to fill it completely with relevant

information. Information is also collected through a medical

examination, depending on age and face value of the policy.
2) The medical report - An average medical test is compulsory (which is
free of cost to the applicant except in case of revivals). Depending on
the information filed in the application, an insurance company may ask
the physician of the consumer for further information. Gathering
information is a standard method used in all domestic insurance
companies. Basically, life insurance companies have several sources of
medical and financial information to assist them in the underwriting
process. These include personal medical records and physicians, the
medical information department, inspection reports and credit records.
3) Underwriting review - After collecting all the relevant information about
the applicant, an underwriter from the insurance company evaluates the
information. During this evaluation, the underwriter will organise the risk
offered to the company and also determines the premium for the policy
depending upon the primary and secondary factors influencing the
premium. The premium rates are set by the companys registrars
depending upon the applicants risk profile. During each step of the
underwriting process, the life insurance agent usually provides details,
and is well-informed about the insured status in the process. If the
applicant offers more risk than the insurance company standards, then
the underwriter rejects the application.
4) Policy writing - A special department writes the policy, whose main
function is to issue written contracts according to the instructions from
the underwriting departments. A register must be maintained as most
policies are long-term. Insurance companies generally use
computerised systems to maintain the records of the customers,
premium payments, and they to verify that all the requirements of
underwriting have been met.
Activity: 1
Analyse how technology helps the underwriting process.
Hint: Refer http://www.accenture.com/NR/rdonlyres/7FEEB33B-2867-
4A1F-8CDB3ED259CF94C2/0/Accenture_Insurance_CPCU_
Underwriting_Survey.pdf


7. Additional information is always essential for the underwriter in order to
take a __________.
8. An average medical test is not compulsory. (True/False)
9. A typical life insurance consists of _____________________.
a) General and medical information
b) Policy writing
c) Underwriting Review
d) Getting applications
10.5 Sources of Underwriting Information

The previous section dealt with the underwriting steps. This section will
cover the sources of underwriting information.
There are many sources of underwriting information. Some of these sources
are:
Application containing the insurers declarations - Customer
application is the basic source of underwriting information, which will
vary for each line of insurance and for each type of coverage.
Depending upon the broadness of the contract, more information is
required. The questions on the application help the underwriter to
decide whether to accept or reject the application or ask for some more
information.
Information delivered by the agent - Agents have information about
the cancellation or non-renewal of policies of a policy holder. Insurance
companies use this information while underwriting policies.
Prior experiences - Previous history of claims is also a source of
information for underwriting. Insurance company penalises the
policyholder in case if the policyholders claim experiences are
unfavourable.
Information collected by inspection - Companys specialists will
conduct surveys to measure the accuracy of information written in the
application. This information then becomes a source of underwriting
information.

The three primary types of objective underwriting data are as follows:

MVRs - Motor Vehicle Reports (MVRs) are provided by the respective
state departments. Some states allow companies to submit reports
directly, while others report through intermediaries.
Claims history reports - Companies that wish to order reports from the
database are required to submit detailed information on the claims they
pay. Accident history reports provide information on the insurance
coverage and the claim amounts paid.
Other third party information products - Other third party information
products include reports such as additional drivers at a given address
and information about the title history and/or accident history of specific
vehicles.
10. _______________ is the basic source of underwriting information.
11. Previous history of claims is also a source of information for
underwriting. (True/False).
12. Who conducts survey to measure the accuracy of information written in
the application?
a) Insurance company
b) Policyholder
c) Companys specialists
d) Government
10.6 Making an Underwriting Decision

The previous section discussed the sources of underwriting information. This
section discusses the aspects of making an underwriting decision.
For years, complete underwriting decisions were the result of judgement
and experience. Young underwriters improve their skills by working under
the guidance of an experienced senior underwriter. This method of
underwriter training is similar to the apprentice system still used in many
trades. The advantage of such a system was that senior underwriters
progressively passed their knowledge and experience to a younger
generation, who could then do the same for the next generation.

Advances since World War II in the study of decision making, and the
development of multiple-line insurers in a growing market made the
apprentice system obsolete. The apprentice system has become outdated due
to the following reasons:
A scientific approach is required for decision making and not luck or
guesses.
The insurance businesss growing need for underwriters demanded that
training should be efficient and consistent. Insurers needed trained
underwriters quickly and could not afford to wait for many years that was
required to develop an underwriter through the apprentice system.
Specialisation and the development of comparatively honest products
designed to meet the insurance needs of a mass market, specifically in
personal lines, meant that some underwriters could be creative in much
less time.
The apprentice system is both time-consuming and costly. Bad habits as
well as good habits could be passed on through this system.
Changing employment trends decreased the availability of expert
underwriters, and increased the need to train or cross-train underwriter
quickly.
Analysis of underwriting decision making has led to an increase in the use of
automation in underwriting. Computers do not underwrite, but they can be
programmed to screen proposals. Computers can compare underwriting
standards with information provided on applications, and select those risks which
are clearly adequate and reject those which are clearly unacceptable. Such
procedures enable underwriters to use their cleverness on applications
for insurance that require alteration. This procedure is known as underwriting by
exception.
The underwriting decision-making process generally includes the following
steps:
Gathering, organising, and analysing information relevant to the
decision.
Identifying and developing alternative options of action.
Evaluation of the alternatives.
Choosing one of the alternatives.
Applying and observing the selected option of action.
Gathering, organising, and analysing the information.

After the underwriter evaluates the information, an underwriting decision

must be made. There are three basic underwriting decisions made
regarding an initial application for insurance:
Accept the application.
Accept the application subject to certain restrictions or modifications.
Reject the application.
First, the underwriter can accept the application and recommend that the
policy be issued. A second option is to accept the application subject to
certain restrictions or modifications. Several examples illustrate this second
type of decision. Before a crime insurance policy is issued, the applicant
may be required to place iron bars on windows or install an approved central
station burglar alarm system. The applicant can be refused a homeowners
policy and offered a more limited dwelling policy. A large deductible may be
inserted in a property insurance policy or a higher rate for life insurance may
be charged if the applicant is substandard in health. If the applicant agrees
to the modifications or restrictions, the policy is then issued.
The third decision is to reject the application. However, excessive and
unjustified rejection of applications reduces the insurers profitability and
alienates the agents who solicited the business. If an application is rejected, the
rejection should be based on a clear failure to meet the insurers
underwriting standards.
Many insurers now use computerised underwriting for certain personal lines of
insurance that can be standardised, such as auto and homeowners
insurance.
The quality of an underwriting decision reflects on quality, quantity, and
relevance of information gathered to a great extent, before the decision is
made. Information is essential to making good underwriting decisions. The
underwriter must understand that the source of subjective information
provides information according to their interpretations. When a source
certifies that Underwriters must not only collect information, but also
reinterpret it from the point of view of the insurance company, which is in the
business of accepting risks in order to generate premiums that surpass
losses and expenditures in the long run.

Underwriting information can be classified as:

Objective information - It consists of information details that can be
verified and that have been noted like, date of birth, type of construction,
and so on. The underwriter has to only verify objective information.
Subjective information - It consists of relevant, opinions or
impressions of various characteristics of the risk.
Activity: 2
Analyse how insurance companies use credit reports to make
underwriting decisions.
Hint: Refer - http://www.unionmutual.com/assets/Uploads/Insurance-
Scoring-FAQ.pdf

13. In the past, the only way for a new or young underwriter to improve
underwriting skills was by working under the guidance of an
_________________ and gradually gaining experience.
14. An advantage of the study of underwriting decision making has been a
decrease in the use of automation in underwriting. (True/False).
15. Changing employment trends decreased the availability of
______________.
a) Policyholders
b) Expert Underwriters
c) Insurance company
d) Agents
10.7 Other Underwriting Considerations

The previous section discussed aspects of underwriting decision making. This
section discusses other underwriting considerations.
The additional factors considered in underwriting include the following:
Rate adequacy - When rates are considered adequate for a class,
insurers are more willing to underwrite new business. However, if rates
are inadequate, prudent underwriting requires a more conservative
approach to the acceptance of new business. If moral hazard is
excessive, the business generally cannot be insured at any rate.

Pricing of a commercial risk - In addition, in commercial property and

liability insurance, the underwriters have a considerable impact on the
price of the product. A great deal of negotiation over price takes place
between the line underwriter and the agent concerning the proper
pricing of a commercial risk.
Underwriting profits or losses - Finally, the critical relationship
between adequate rates and underwriting profits or losses results in
periodic underwriting cycles in certain lines of insurance, such as
commercial general liability and commercial multiperil insurance. If rates are
adequate, underwriting profits are higher and underwriting is more liberal.
Conversely, when rates are inadequate, underwriting losses occur, and
underwriting becomes more restrictive.
Reinsurance and underwriting
Availability of reinsurance may result in more liberal underwriting. However, if
reinsurance cannot be obtained on favourable terms the underwriting may be
more restrictive.
Renewal underwriting
In life insurance, policies are not cancellable. In property and liability
insurance, most policies can be cancelled or not renewed. If the loss
experience is unfavourable, the insurers may either cancel or not renew the
policy. Most states have placed restrictions on the insurers right to cancel.

16. A great deal of negotiation over price takes place between the
________________________ and the agent concerning the proper
pricing of a commercial risk.
17. When rates are considered inadequate for a class, insurers are more
willing to underwrite new business. (True/False).
18. In life insurance, policies are not cancellable. (True/False).
10.8 Summary
Underwriting is the process of classification, evaluation, and selection of
risks, or in other words it is a risk selection process.
The underwriter's work is, to use all the information collected from various
sources, to determine whether to accept or reject a specific applicant.

The underwriting isometrics is a trade-off between the business and

survival.
The two main underwriting principles are:
Adverse selection.
Persistency.
Objectives and principles behind underwriting include:
Providing justified premiums.
Ensuring deliverables to the consumer.
Financial feasibility to the insurance company.
The process of underwriting covers the following steps:
Execution of field underwriting.
Renewing the application in the office.
Gathering additional information if required.
Taking underwriting decisions.
The sources of underwriting information are:
Application containing the insurers declarations.
Information delivered by the agent.
Prior experiences.
Information collected by inspection.
The decision making related to underwriting involves:
Gathering, organising, and analysing information relevant to the
decision.
Identifying and developing alternative options of action
Evaluation of the alternatives
Choosing one of the alternatives
Applying and observing the selected option of action.
The additional factors considered in underwriting include the following:
Rate adequacy.
Pricing of a commercial risk.
Underwriting profits or losses.

10.9 Glossary
Actuaries: Specialists in the mathematics of risk, especially as it relates to
insurance calculations such as premiums, reserves, dividends, and
insurance and annuity rates. Actuaries work for insurance companies to
evaluate applications based on risk.
Financial statements: A formal record of the financial activities of a
business, person, or other entity.

1. Describe the basics of underwriting.
2. What are the objectives and principles behind underwriting?
3. Mention the steps of underwriting.
4. Mention the sources of underwriting information.
5. Explain the underwriting decision making process.
6. Briefly describe other underwriting considerations.
10.11 Answers
1. Underwriting
2. True
3. b) - Adverse selection and persistency
4. Rating
5. True
6. d) - All of the above
7. Decision
8. False
9. General and Medical information
10. Customer application
11. True
12. c) - Companys specialists
13. Effective senior underwriter
14. False
15. b) - Expert underwriters
16. Line underwriter
17. False
18. True

Terminal Questions
1. Underwriting is a process of evaluating the risk and exposures of
potential clients. It is related to the rate-fixing estimating utility of an
insurer. Refer section 10.2 for details.
2. The basic objective of underwriting is to analyse that the applicant
accepted will have a loss experience or not. Refer section 10.3 for
details.
3. The underwriting process for life insurance involves the following steps:
execution of field underwriting, renewing the application in the office,
gathering additional information, if required, taking and underwriting
decisions. Refer section 10.4 for more details.
4. There are many sources of underwriting information. Refer section 10.5
for details.
5. The method of underwriter training is similar to the apprentice system
still used in many trades. Refer section 10.6 for details.
6. Other underwriting considerations are the general underwriting
considerations valid for all or most categories of group insurance. Refer
section 10.7 for details.
10.12 Case-let
LICs Underwriting Guidelines for Life Insurance of Minor or Major
Children.
A. INSURANCE TO MINOR LIVES
Komal Jeevan is allowed to insure children up to 10 years of age without
medical examination and in Jeevan Kishore no medical examination is
required if age is less than 10 years. For other plans related to minor
lives, full medical report and special reports as per the chart of special
reports are required.
The above guidelines were reviewed according to the rules relating to
medical examination / special reports in respect of minor lives and are as
follows:
a. Uniform guidelines should be there for all risk plans allowed to minor
lives.
b. No medical examination will be required up to Sum Under
Cover(SUC) of Rs.8 lacs.

c. For SUC between Rs.8 lacs and Rs.25 lacs only juvenile FMR will be
required between 10 to 17 years.
d. Juvenile FMR will be required for SUC above Rs. 25 lacs in respect of
all children irrespective of their age at entry.
e. Special reports will be required for SUC Rs. 50 lacs and above for
children with ages of 5 years and above at entry.
f. A special format for Full Medical Report for Juvenile lives (Juvenile
FMR) has been designed.
g. Fees for Juvenile FMR and other guidelines (such as MEs limit,
requirement of juvenile FMR by DMR, validity of juvenile FMR) will be
the same as applicable to FMR at present.
The revised guidelines in respect of minor lives are as under:
1. DEFERRED RISK (CDA) PLANS
a. Maximum sum assured (SA) Rs. one crore subject to twice the
insurance on parents (father and mother put together) lives and
adequacy of their income.
b. Insurance on the lives of parents will not be claimed upon upto Rs. 2
lacs. However matching insurance is to be claimed upon if the
nominator is a widow falling under female category III.
c. Proposals for SA in excess of Rs. one crore may be referred to CUS
for individual consideration on merits of the case with special
recommendations from MM or SDM.
d. Clause 76 is to be imposed if sum proposed is Rs. one crore or less.
e. Clause 76 is not to be imposed if sum proposed is more than Rs. one
crore as medical underwriting is required to be done at proposal stage
itself.
2. OTHER PLANS
a. Maximum SA Rs. 50 lacs, not exceeding the insurance on parents
(father and mother put together) lives and adequacy of their income.
b. Insurance on lives of parents will not be claimed upon up to Rs. 2
lacs. However matching insurance is to be claimed upon if the
proposer is a widow falling under female category III.
c. Proposals for SA in excess of Rs. 50 lacs may be referred to CUS for
individual consideration on merits of the case with special
recommendations from MM or SDM.

3. Premium Waiver Benefit (PWB) under children plans

At present PWB under children plans is permissible only under medical
scheme. It has now been decided to allow PWB under childrens plans on the
lives of parents under non-medical (special) scheme and non-medical
(general) scheme to professionals.
B. INSURANCE TO MAJOR CHILDREN UP TO AGE 25 YEARS
At present major children are allowed insurance cover under non-medical
(general) to others up to maximum SUC of Rs. 3 lacs. As per the above
revised guidelines minors will be allowed risk plans without any medical
requirements up to SUC Rs. 8 lacs. In view of this revision it has been
decided to permit major students not exceeding 25 years insurance cover up
to SUC Rs. 8 lacs under non-medical (general). Some features of this
insurance are as follows:
a. A declaration is to be obtained from the major students as well as from
their parents that they are regularly attending their colleges.
b. Copy of passing certificate / appearance report at the examination of
the just completed academic year is to be obtained.
c. Cover will be allowed subject to matching insurance on parents lives
and adequacy of their income.
C. MATCHING INSURANCE FOR ALLOWING COVER TO CHILDREN
At present minor and major children up to age 25 years are allowed
insurance cover subject to matching insurance on the life nominator. If
nominator is father, then only his insurance and income eligibility is
considered. If father and mother both have matching insurance and
income eligibility then both have to recommend separately.
This matter was reviewed and it has been decided to consider matching
insurance on the lives of parents and their income eligibility (insurance on the
lives of both father and mother and their combined income eligibility)
irrespective of whosoever proposes (father or mother) in the process of
allowing insurance cover to children.
D. SPECIAL REPORTS FOR AGES UP TO 35 YEARS
At present for SUC of Rs. 1 crore and above and age of 35 years at entry level,
CTMT is a manual requirement along with Rest ECG, Haemogram, SBT-18,
RUA and Chest X-ray. It has been decided not to call for CTMT for SUC Rs. 1
crore and above and age at entry up to 35 years.

1. What are the guidelines providing insurance to minor lives? (Hint:
Refer Section A of the case study.)
2. Describe the process of providing insurance cover to major children
up to 25 years of age. (Hint: Refer - Section 3C of Case-Let.)
Source: http://lic-policies.blogspot.com/2009/02/underwriting-guidelines-
in- respect-of_24.html
References
Beam T Burton, McFadden J John. (2001). Employee Benefits, Sixth
edition, Dearborn Financial Publishing, United States of America.
House, India.
E-References
http://www.aicpcu.org/comet/programs/intro/assets/docs/IntroUW.pdf

Unit 11 Claims Management

Structure:
11.1 Introduction
Objectives
11.2 Basis of Claims Management
11.3 Stages in Claims Management
Claims management
Claims handling
11.4 Claims Settlement
General guidelines for claims settlement
11.5 Types of Claims
Life insurance claims
Marine insurance claims
Fire insurance claims
Motor insurance claims
Mediclaim insurance
Miscellaneous insurance claims
11.6 Guidelines for Settlement of Claims by IRDA
Proposal for insurance
Matters to be stated in life insurance policy
Claims procedure of life insurance policy
11.7 Factors Affecting the Claim Management
General factors affecting claims
Time element in the claims payment
11.8 Terms in Claims
Maturity claims
Death claims
11.9 Summary
11.10 Glossary
11.12 Answers
11.13 Case-Let

11.1 Introduction
The previous unit discussed the concept of underwriting in insurance. This unit
discusses claims management in insurance.
Claims management is a system which sets up the rules and regulations for the
assessment of damages, using the data got from medical reports, surveyor
report, loss assessors report and warranties contained in the policy
document. It also regulates the payment of damages and the payment of
loss of future earnings.
An insurance company is usually accepted as good or bad, on the basis of the
time it takes to finalise, and pay back the claim. To settle a claim promptly
is the important function of an insurance organisation. The goodwill of the
insurance company depends on the claim satisfaction level of its
customers. Effective claim management is necessary for an organisation as it
deals with the cash outflows of the company.
Therefore, this unit describes the basis, stages and factors affecting claims
management. It introduces claims settlement and the types of claims. It
gives an overview of the guidelines for settlement of claims by IRDA. It also
explains time element in the claims payment and terms in claims.
Objectives:
explain claims management, its basis and stages
list and explain the types of claims
discuss the guidelines for settlement of claims by IRDA
describe factors affecting claim management
discuss the importance of time element in claims payment and the terms
in claims
11.2 Basis of Claims Management

Claims management comprises of all the managerial decisions, and the
processes involved regarding the settlement and payment of claim with
regard to the terms in the insurance contract. The main emphasis here is on
monitoring and lowering the costs related in carrying out the claim process. The
elements or the basis of claims management are claims preparation, claims
philosophy, claims processing and claims settlement.

Claims preparation - Claims preparation includes reporting the

damages occurred to property, or injuries to people along with
documentary proof of the assessment of loss and details of the loss.
Claims philosophy - Claims philosophy deals with the claims handling
methods and procedures. It also contains the guidelines required to
prepare the receipt of claims from the insurers, analysis of the claim, the
decision to be taken on the issue or dispute, evaluation of the claim cost
and expenses, supervise the claim payment, and enhance the efficiency
of claims settlement.
Claims processing - The claim process deals with the claims
procedures and handling of claims. Handling of claims is keeping track
of the events which causes the loss to the insured and gives a cause to
the insured to file a claim. The claims process has two procedures for
the insurer and insured to be pursued. Considering from the view of the
insured, it includes the loss or damage by understanding the cause for
the loss, giving notice of the loss to the insurer, make available the
required proof of the loss to the insurer or the loss assessor and
surveyors. From the point of the insurer on receiving the receipt of the
claim from the insured, the immediate steps such as verification of the
claim, reviewing the claim application, responding to the insured and
carrying out claims investigation, claims negotiation and claim
settlement.
Claims settlement - Settling a claim is a process of negotiation
between the insured person and insurance provider. Insurance
companies receive claims relating to accidents and medical procedures. If
there is evidence to support claims, the claims settlement claims is very
easy. The insurer may try to compare the claim with similar ones in the past
and try to lower the settlement. Thus good negotiation skills are essential for
an insured to get a good claims settlement.
1. __________________ deals with the claims handling methods and
procedures.
2. The claims process is to be pursued only by the insurer. (True/False).
3. The basis of claim management is to ____________ and
_____________ costs related in carrying out the claim process.
11.3 Stages in Claims Management

The previous section described the basis of claims management. This
section describes the stages in claims management.
Managing insurance claims is one of the most significant management
tasks. Claim management tasks involve filing, verifying insurance coverage,
determining co-payment levels and checking the status of submitted claims.
Claims handling and claims management are the stages in the claim
system. Externally both appear to be the same, but they are different by
nature. Claims handing is a vital part of claims management as it executes
the decisions by the claims management of the insurance company.
11.3.1 Claims management
Claims management by the insurer involves analysing the data, processing
applications and making decisions, funding and controlling the business
management. The claims management makes the principles and guidelines for
profitable settlement of claims.
Claims management comprises of the process of claims handling and
claims payment. The review of claims performance, monitoring of claims
expenses, legal and settlement costs, planning of future payments and
avoiding delay and disputes in payment of claims is included in claims
management. Risk management, loss assessment, business forecasting
and planning of insurance claims are also done in claims management.
Claims reserving is an important part of the overall claim management
process. Insurance companies need to ensure adequacy of claims reserves in
order to meet their claim obligations.
11.3.2 Claims handling
Claims handling is a way to process claims application and manage the
claims settlement. It is a method, where the laid down principles and
measuring methods are utilised to settle the claims. It handles the various
stages of the insurance claims. Its functions include reviewing, investigating and
understanding the negotiation process. This does not involve policy making
and decision making or any managerial activity.
It involves only procedural methods and interpretations of the claims
philosophy. Claims handling depends on each case or situation and
changes accordingly. It is flexible, as well as, rigid keeping in mind the

interest of the insurer. It involves receiving the claims and other procedures for
efficient payment of claims. The insurers commitment to the customer is part of
the claims management.
While handling claims insurers need to ensure that:
Claims are handled fairly.
Claims are settled promptly.
Information is provided to the customers about the claim handling
process.
Reasons are provided when claims are rejected or not fully paid.
4. __________________ is a way to process claims application and
manage the claims settlement.
a) Claims management
b) Claims handling
c) Claims verifying
d) Claims negotiation
5. Planning of future payments, avoiding delay and disputes in payment of
claims is included in claims management. (True/False).
6. __________________ is flexible as well as rigid, keeping in mind the
interest of the insurer.
11.4 Claims Settlement

The previous section dealt with stages of claims management. This section will
deal with the concept of claims settlement.
An insurance company to the insured to settle an insurance claim according the
guidelines stipulated in the insurance policy defines claims settlement as the
payment of proceeds.
The information furnished in the proposal form of an insurance contract is
proved correct only at the time of claim. If after inspection of the property, the
claim appears to be misinterpreting or false, then the insurance company
can decline the claim or avoid the policy or in certain instances the reduced
amount of the claim is paid. The points to be covered in case of a claim
settlement procedure are:

The loss or damage is to be intimated to the insurance company

immediately or as soon as possible. On intimation, the insurance
company is to forward a claim form.
The completed claim form must have an estimation of all the items
suffered loss.
A licensed surveyor is arranged, if the loss incurred is major.
The insured needs to provide the required documents to support the
loss.
To establish the cause of loss, the insured should prove that the loss
has occurred because of an insured peril.
11.4.1 General guidelines for claims settlement
There are some guidelines that must be followed while settling the claims.
These guidelines are general in nature, and are not compiled to be the
same always. Therefore, the claim settling authority uses discretion and
records reasons.
Appointment of surveyor
The Insurance Act states that surveyor should survey claims above Rs.
20,000. The surveyors appointment should be based on the following
points:
The surveyor should have a valid license.
The surveyor selected should consider the type of loss and nature of the
claims.
Depending on the situation, if technical expertise is required, a
consultant having technical expertise assists the surveyor.
One surveyor can be used for various jobs, if the surveyors competence
is good for both.
Appointment of investigator
Depending on circumstances, it is necessary to appoint an investigator for
verifying the claim version of loss. The appointing letter of the investigator o
mentions all the reference terms to perform.

Activity: 1
Analyse the work activities of an insurance claims inspector.
Hint: Refer - http:// ww2. prospects. ac.uk/ p/types _of _job/ insurance_
claims_inspector_job_description.jsp
7. The Insurance Act states that claims above Rs. __________________
are to be surveyed by surveyor.
8. The surveyor cannot be based on the type of loss. (True/False).
9. After inspection of the claim, the insurance company can decline the
claim or reduce the amount of the claim. (True/False).
11.5 Types of Claims

The previous section dealt with the concept of claims settlement. This
section will discuss the types of claims.
The basic process of filing a claim is similar for different types of insurance
policies. But there are certain differences according to the nature of the
policies which the insured must be aware of in order to file the claims. The
most common types of claims under life policies are discussed in this
section.
11.5.1 Life insurance claims
A life insurance policy claim is filed in the following situations:
On maturity of the policy i.e. completion of the term for which the
insurance was taken.
On death of the life insured. If it occurs before the policy is matured then
the provided policy on the date of death is acquired.
The various types of claims covered under life insurance claims are:
Death claim - This claim is paid, when the person insured dies.
Following are the conditions to be fulfilled for a death claim to be paid:
o The policy document, original death certificate, burial permit copy of
the ID of the deceased must be provided to the insurance company.
o A report from the doctor who treated the deceased.
o Filled in claim form.
o A police abstract report is required if death occurs in an accident.

Maturity claim - A maturity claim is paid on endowments and education

insurance policies whose duration has expired. Payment in a maturity
claim is straightforward, where the customer returns the original policy
document and signs a discharge form. The claim cheque is cleared in a
period of about two weeks, once all the required conditions are fulfilled.
Partial maturity claim - Many endowments and education policies
provide a provision for payment of partial maturities after a given
duration. The partial maturity is paid according to the set dates in the
policy document. For example, an education policy of 10 years has an
option for payment of 20% of the sum insured after four years and every
year after that until the expiry of the policy. Partial maturity cheques are
prepared in an automated manner, and there is no need for claim.
Surrender value claim - This claim is raised when a customer is unable
to continue with the payment of premiums due to unforeseen events.
He/she has the option of encashing the policy to receive the surrender
value if the policy has been in force for more than 3 years. The
procedure for lodging this claim is simple, and the procedures are similar to
the maturity claim where the customer returns the policy document and
signs a discharge form. The claim cheque is paid to the customer within two
weeks.
Disability claim - This claim is seen in life insurance policies where the
customer procures the personal accident policy as an additional benefit.
Disability claims are payable, when subjected to sufficient medical
evidence being provided as proof of disablement.
11.5.2 Marine insurance claims
Marine insurance claims are made due to many causes which depend on
weather conditions, collisions, loss of cargo and so on. But Marine
insurance policy does not cover loss or damage due to willful misconduct,
ordinary leakage, improper packing, delay, war, strike, riot and civil
commotion.
Marine insurance claim procedure:
In case of loss/damage in transit, a monetary claim must be lodged with
the carrier within the time limit to protect recovery rights.

Appointment of surveyor or claim representative in agreement with the

insurer to determine the nature, cause and extent of loss/damage is
must.
The surveyor should inform the insurer about the value of loss incurred.
The claim procedure takes nearly about 1-3 weeks.
Depending on the nature of operations, deployment and the hazards that can
occur, the marine hulls are divided into vessels under tariff advisory
committee, vessels insured under policies. The types of claims which are
covered under marine insurance claims are total loss, particular or partial
charges, salvage and salvage charges, general expenses, collision liability and
accident claims.
The procedure to claim with respect to hulls is:
A licensed surveyor is appointed in all cases of partial losses/ expenses.
In case of total loss, if the vessel is available for inspection a licensed
surveyor is appointed.
Abandonment of the vessel or wreck in writing is essential for
constructing total loss claims as a notice. The insurer refuses the
acceptance of the abandonment of the wreck till the probable liabilities
attached to the wreck are estimated.
Total loss claims are settled on the basis of statements, documents and
surveyors report.
In case of partial loss, the surveyor must assess the amount of salvage.
A survey report consisting the following is required for processing and
documentation for the settlement of hull claims:
Name of the registered owner of the vessel.
Identities regarding the vessels including registration details, license
particulars, including validity.
The details of the losses incurred.
The surveyors observation on the circumstance of the loss.
Quantifications of repairs, replacements, salvage and labour as
applicable.
Cause of the loss as per the perils/hazards.

11.5.3 Fire insurance claims

Fire insurance covers damages due to fire for buildings, equipments and
stocks. Hence, it is essential that the insurance company officials visit the site
of losses to assess the damage caused by fire. If the loss incurred is within
Rs. 20,000, and loss of profits claim is not involved, then the officer has the
discretion to do an independent survey and settle the claim on the basis of the
documents.
The documents generally required for processing fire insurance claims are:
Policy documents with terms conditions and warranties.
Claim form filled by the insured.
Survey report that consists of the indication of the cause of loss,
assessment of loss, confirmation of policy terms.
Salvage from fire and allied peril losses deteriorate. Hence disposal of the
salvage is undertaken on priority basis without waiting for the liability to be
established. In circumstances where the records required are destroyed in fire or
through perils like flood, then settlement is negotiated by the surveyor who asses
such losses on a realistic and reasonable basis.
11.5.4 Motor insurance claims
Motor insurance claim, facilitates the repair of the vehicles in any of the
cashless garage network. Nevertheless, if the vehicle is serviced in a
garage outside the network, then an insured person can reimburse the
claim.
The documents that are required for settling motor claims are:
Filled claimed forms.
Registration certificate usually verified, for purchase details.
Driving license as per policy, to verify validity and class of vehicle. This
is not relevant for the loss incurred to the parked vehicles.
Load challan, to verify the load carried was within the permissible limits.
Fitness certificate of the vehicle, to check its road worthiness.
Report by police is required in case of an accident involved.
Survey report which assesses and quantifies the payable claim, the
detailed explanation of the happening and the list of the replacement of
parts.

The insurance company appoints a surveyor on intimation of loss. In case of

major accidents, the insured arranges the photographs of the vehicle at the spot
of the accident, depicting the external damages and the number plate of the
vehicle. If for any reason the driving license cannot be produced, the claim is
considered on non-standard basis.
11.5.5 Mediclaim insurance
Medical insurance is also known as Mediclaim policy or Mediclaim
insurance in India. It is a tool to deal with health related crisis. It offers
financial assurance during medical emergencies. Mediclaim insurance
covers medical and hospitalisation expenses.
Mediclaim insurance plays a significant role in individuals financial planning.
It offers many benefits by lessening the burden on financial aspects and
assisting in solving medical problems. Mediclaim insurance is a non-life
insurance. The documents to be submitted, to avail mediclaim are
hospitalisation claim form consisting duly completed claim form, bills
receipts, discharge card, cash memos, bills from chemists with the
prescription, test reports and surgeons bill and receipt consisting of the
nature of operation.
The cases which are to be given special care in Mediclaim are:
If previous medical history is not shown, discharge card and admission
papers of the hospital are asked for verification.
The claims cannot be made for routine visits to the hospital.
There is indication of malpractice in the cash memos and bills.
11.5.6 Miscellaneous insurance claims
Miscellaneous insurance claims cover claims based on the nature of
package policies. These policies are made user friendly, and they require a
high degree of skill and tact as they deal with emotions and sentiments of
individuals. The different types of miscellaneous insurance claims are:
Workmens compensation insurance claims - Worker's compensation
claims are raise by an employee who has been hurt on the job to obtain
reimbursement for medical treatment and salary lost. To receive this
compensation, the injured employee or the nominee must file a claim within
a specified time period. In some cases, the employee may need to undergo
a check-up by a physician who is authorized by the Worker's Compensation

Board. For permanent disablement claims, the agreement letter is to be

submitted to the workmens compensation commissioner while demanding
compensation as per the Workmen Compensation Act.
In addition to the claims form, the following documents must also be
submitted:
o Medical certificate.
o Wages statement.
o Age proof as given in the company.
Personal accident insurance claims - Personal accident insurance claims
can be raised when some accidents occur that results in either death or
disablement of the policy holder. Following documents are to be submitted to
process this personal accident insurance claim:
o Filled in claim form.
o Doctors report.
o Investigation reports, like lab tests, x-rays and reports to confirm the
injury.
o Age proof, in case the claim is for a dependent child.
o Medical bills, if there is provision to claim for medical expenses.
In case of fatal claims, the claim payment is made to the assignee. If there is no
assignee, then the legal representative receives the payment. In case of group
policy, the payment is made to the individual beneficiary, but payment to the
employer is also made with respect to the employee.
Activity: 2
Analyse the features of any mediclaim policy available for students in
India.
Hint: Refer-http://www.mediclaim.in/category/types-of-mediclaim-policies

10. ____________________ claim is when a customer is not able to
continue with the payment of premiums.
11. Abandonment of the vessel in writing is essential for
_________________ claims as a notice.
a) Constructive total loss
b) Total loss

c) Partial loss
d) Marine insurance
12. The claim is for routine check up to the hospital is covered in
mediclaim. (True/False).
11.6 Guidelines for Settlement of Claims by IRDA

The previous section dealt with the various types of claims. This section will deal
with the IRDA guidelines for settling the claims.
11.6.1 Proposal for insurance
The proposals for insurance are:
In all cases to claim insurance, a proposal for grant of cover should be
submitted with proof (a written document). But a written proposal form is
not required for marine insurance markets.
Depending on the circumstances of the claim, forms and documents in
the grant of cover can be made available in the languages recognised
by the constitution of India.
The prospect is to fill the form of proposal, under the guidance of the
provisions of section 45 of the Insurance Act.
If a proposal form is not used, the insurer has to record the information
obtained, orally or in writing, and confirmation is to be done by the
insurer within 15 days. If any information is not recorded, the burden of
the missing information lies on the insurer, in case he claims that the
insured is suppressing information or is providing misleading
information.
The insurer is to educate the proposer, concerning the facilities
available, like appointing nominee or any facility based on the terms of
act or conditions of policy.
The insurer has to process the proposal quickly and efficiently. All the
decisions and confirmations should not exceed 15 days from the receipt
of proposal by the insurer.
11.6.2 Matters to be stated in life insurance policy
A life insurance policy should clearly state the following:
The name of plan in the policy, its terms and conditions.
Whether participating in profits or not.

The profits such as cash bonus deferred bonus, simple or compound

bonus, if participating.
The terms and conditions of the contract, benefits payable and
contingencies on which the benefits are payable.
The dates of commencement of the policy, benefits availing date and
maturity date.
The time gap to pay premiums, the amount of premium, the grace period
to pay premium.
The implications of not paying premium and the provisions of a
surrender value.
Policy requirements for converting the policy into paid-up policy,
surrender value, non-forfeiture and to revive lapsed policy.
The provision for loan keeping the policy as the security and the rate of
interest on the loan amount is to be mentioned at the time of taking the
loan.
The address of the insurer to communicate with regard to the policy.
All the documents to avail claim under a policy.
When acting under regulations to forward policy to the insured, the
insurer has to inform that the letter forwarded has a time span of 15 days
from the date of receipt, to review the terms and conditions of the policy. If, in
case, the insured do not agree, they can return the policy stating the
reasons for objection. The insured is entitled to refund the premium which
is subjected to a deduction with respect to a proportionate risk
premium.
With respect to the policy coverage, if the premium charge depends on age, the
insurer should verify the age before issuing the policy document. If the premium
charge does not depend on age, the insurer is to obtain the proof of age as soon
as possible.
11.6.3 Claims procedure of life insurance policy
The claims procedures with respect to life insurance policy are:
1. A life insurance policy should state all the documents to be submitted
by a claimant, to support a claim.
2. A life insurance company on receiving a claim, has to process the
claim. Any additional document, if needed, is to be raised within a
period of 15 days of the receipt claim.

3. A claim under a life policy has to be paid or disputed, by giving relevant

reasons, and clarifying within 30 days from the date of receipt. All
investigations, that is, initiations and completions of investigations,
must be done not later than 6 months.
4. If a claim is ready for payment, but the payment is not made because
of reasons related to proper identification of the payee, the insurer has
to hold the amount for the benefit of the payee, and earn interest at the
rate applicable to a savings bank account.
5. If there is a delay in payment from the part of the insurer, in processing
a claim, then the insurance company has to pay the claim amount at a
rate two percent above the bank rate, according to the rate at the
beginning of the financial year, in which the claim is reviewed.
13. All decisions and confirmations regarding the proposal of a claim are to
be done not exceeding __________ days from the receipt of proposal
by the insurer.
a) 30
b) 20
c) 15
d) 10
14. Due to improper identification of the payee, the insurer can hold the
amount for the benefit of the payee. (True/False).
15. If there is a delay on payment from the part of the insurer then the
insurance company is to pay the claim amount at a rate __________%
above the stated bank rate.
11.7 Factors Affecting the Claim Management

The previous section explained the general guidelines set by the IRDA to
settle claims. This section explains all the factors, which affect claims
management, and the importance of time element in claims settlement.
11.7.1 General factors affecting claims
The factors that affect claim settlement are:
The risk and cause of event covered in the policy.
The cause of event is directly related to the loss, a remote cause cannot
be placed in the settlement.

The policy should be valid on the date of event.

If conditions and warranties are not fulfilled according to the cover of the
policy, the cover of insurance does not come into effect even though
premium is paid.
The loss occurred should not be intentional in order to make profit.
Without the presence of the insurable interest for the property insured at
the time of loss, the benefit or compensation cannot be availed.
The assured has to make gains out of the insurance contract, as the
contract is indemnity in nature as it makes good the loss suffered.
Documentary evidence must support the claim.
The insured has the following alternatives for settling the claims:
Pay the claims as reported by the surveyor or the insurer, whichever is
less.
Take help of agent or some persons who are well-versed in insurance,
and come to an agreement, if it is a disputed claim
In case of litigation caused by rejection of claim, the cost might be more
if the insurer loses the litigation.
Arrangements to replace asset, by repairing or by purchasing a similar
asset can be made. Repaired assets should continue to provide service
as before.
11.7.2 Time element in the claims payment
The time value is very important in the settlement of a claim. Insurer should
submit the claim details within the specific period mentioned in the policy
document. In few cases, either the policyholder or the claimant or the
claimant representative, has to intimate the death of a person or the
accident of vehicle, either orally or in person, immediately.
The reasons for the importance of time element in the claims payment are
as:
The delay in the claim settlement causes an unfavourable opinion about
the insurer.
The extension of time increases the cost of claims.
The delay may result in the insurer having to pay interest on the due
insurance amount, or insurers may have to pay the case costs to the
assured, as per the direction of the court, which increases the costs.
The delay in payment, may lead to legal action, which is costly.
The delay may cause extra burden to the insurer due to the
unproductive use of manpower to defend, expenses incurred and waste
of time on legal actions.
Legal actions will affect on the productive areas of the business mainly
in the marketing of the insurance business.
The delay may increase the number of cases with consumer protection
councils.
Thus, the delay in the claims payment influences the present and future
insurance business along with the cost burden. Therefore, it is necessary to settle
the claim payments faster.
The reasons for the delay in claims settlement may include:
Late submission of claim form: The reasons for the late submission of
claim form may be:
o The ignorance or lack of knowledge of the existence of the insurance
policies against the lives of the persons, who face the event.
o Non-availability of the information to the beneficiary.
o The policy may not have any nominee details.
Innocence and illiteracy of the claimant: The claimant or assured may

not have the knowledge, and may fail to:
o File the claim papers.
o File the insurance claims within a specified period.
o Follow the claims procedure.
Incompletely filled claims forms: If the insured do not properly fill the
claim forms, then the insurers will:
o Fail to provide the necessary information to settle the claims.
o Delay the claim settlement asking for the desired information.
Insufficient proof: If the assured fails to submit the sufficient proof or
the supporting documents along with the claim form, which assists the
claim evaluator to know the event date or cause, then it may lead the
claim evaluator to delay the settlement of claims. The reasons include:
Reasons from insureds or claimants side:
Non co-operation with the insurer to settle the claim or attain some
compromise.
Destroyed the evidences, with or without intention, which would

otherwise assist the estimation of the loss payable under the claim.
Not providing the information about the changes in the constitution of the
organisation or the changed address or any other information necessary
to settle the claim.
Reasons from insurers side:
Due to the pressure of work or may be intentional.
Lack of motivation.
Lack of awareness of importance of the claims settlement.
Lack of awareness among the staff of the organisations or imperfect
supervision or organisational structure.
Insurers can avoid the delay in submitting the claims or settlements, by
providing the awareness of the facts and importance of the insurance and the
claims procedure, to the claimant or the assured. They can take the help of agent
or the local staff to attain certain compromises with the claimants in the complex
cases. They must design the organisation in such a way, that it avoids holding of
papers. They should have well-trained and motivated staff. They can also use the
latest technologies, to assess the losses and recruit suitable staff for using the
same.
16. Incompletely filled claim forms are not a reason for delay in claims
settlement. (True/False).
17. In case of litigation due to rejection of claim, it might cost the
___________ if he losses the litigation.
18. _____________ actions will affect on the productive areas of the
business mainly in the marketing of the insurance business.
11.8 Terms in Claims

The previous section discussed the factors affecting claims management.
This section will deal with the terms in claims.
The general terms used in claims, on the basis of variety of claims, are
maturity and death claims. These claims are life insurance claims based on the
type of life policies.

11.8.1 Maturity claims

Maturity claims are availed in general endowment policies, which include
money back policies. The insurance company makes the payment on the
maturity date or post-dated cheques should be sent to policy holders in
advance. The policyholder or the nominee to of the policy makes the claims on
maturity. If the life assured dies before the maturity date, the claim is
considered as death claim.
Those who can claim these policies are:
The assured.
The payee, whose name appears in the benefit schedule of the policy as
a party interested.
The creditor who is assigned and nominated, to receive the payment
under the policy.
Amount payable
The amount paid on the maturity of the policy is the sum assured, plus profits
and bonus that increases with the policy. The profits are paid on prorata basis,
i.e., in the proportion of the premium paid and declared bonuses. The payment of
profits is a clause in the policy. Hence it is compulsory for the insurer to pay the
bonus.
Dispute in payment of maturity claims
The general dispute that arises in payment of maturity claims, is regarding the
proof of age. If the age is not correctly checked at the time of issuing the policy
document, then malpractice can take place. Another dispute is regarding
the good title of the claimant on the policy. In case the insurer delays the
payment of bonus to the insured upon maturity, and if the payment of bonus
is not as per the contract, the policy holder can move to the court to claim such
payment.
11.8.2 Death claims
Death claim policy is a request made by the beneficiary of a life insurance policy
on the death of the insured to the insurance company to make the payment
according to the terms of the policy.
Death claim is claimed, if the insured dies before the expiry term of the
policy. The occurrence of death must be intimated to the insurance
company in writing. The intimation must be from a concerned person, and

must beyond doubt establish the identity of the deceased person. The
claimants paid on the happening of the event are:
The legal heirs of the policyholder.
The nominees, assignees and transferees.
The wife and children of the assured according to the Married Womens
property Act.
The creditor in whose name the policy has been endorsed
The claim amount which is paid in a life insurance policy includes:
The amount insured or the face value of the policy.
Bonus declared by the company, which is recoverable as an insurance
amount.
The share of profits in case of participation policy.
Surrender value, if the policy has lapsed due to non-payment of the
premium or if the assured surrenders the policy, the insurance company
may pay a percentage of the premium paid, according to the ordinances
of the company.
19. If the life assured dies before the maturity date, the claim is
considered as __________ claim.
20. The amount paid on the maturity of the policy is the ____________,
______________ and __________ that increase with the policy.
21. In death claims for life insurance policies, the share of profits is paid
in case of ______________ policy.
11.9 Summary
This unit covered the necessity of claims management in an insurance
company. This unit also covered the basis of claims management, which
comprises of all the managerial decisions and the processes involved
regarding the settlement and payment of claim with regard to the terms in the
insurance contract. Claims handling and claims management are the two
stages in the claim system. The steps in settling claims and the general
guidelines to be followed to settle claims are discussed.
The most common types of claims are:
Life insurance claims.
Marine insurance claims.
Fire insurance claims.

Motor insurance claims.
Mediclaim.
Factors affecting claim management and the importance of time element are also
discussed in this unit. The reasons which can affect the time element in claims
management are:
Late submission of claim form.
Innocence and illiteracy of the claimant.
Incomplete (filled) claims forms.
Insufficient proof.
The general well known terms based on the variety of life polices are
maturity and death claims.
11.10 Glossary
Endowment - A financial endowment refers to the transfer of money or
property donated to an institution.
Salvage - Salvage in marine is the process of rescuing a ship, its cargo, or
other property from peril.
Assignee - An individual to whom a title, claim, property, interest, or right is
transferred is known as assignee.

1. Explain claims management and its basis.
2. Describe the stages in claims management.
3. List and explain the types of claims.
4. Discuss the guidelines for settlement of claims by IRDA.
5. Describe factors affecting claim management, and the importance of
time element in claims payment.
11.12 Answers
1. Claims philosophy
2. False
3. Monitor, lower
4. b) - Claims handling
5. True
6. Claims handling
7. Twenty thousand
8. False
9. True
10. Surrender value
11. a) - Constructive total loss
12. False
13. c) - 15
14. True
15. Two
16. False
17. Insurer
18. Legal
19. Death
20. Sum assured, profits and bonus
21. Participation policy
Terminal Questions
1. The basis in claims management is monitoring and lowering the costs
related in carrying out the claim process. The elements of claims
management are claims preparation, claims philosophy, claims
processing and claims settlement. For further details, refer to
section 11.2.
2. Claims handling and claims management are the stages in the claim
system. Externally both appear to be the same but they are different by
nature. For details, refer to section 11.3.
3. The most common types of claims are life insurance claims, marine
insurance claims, fire insurance claims, motor insurance claims,
mediclaim and miscellaneous insurance claims. For detailed explanation
of these claims, refer to section 11.5.
4. Proposal for insurance, matters to be stated in a life insurance policy,
claims procedure in respect of life insurance policy are covered under
the guidelines for settlement of claims by IRDA. Refer to section 11.4,
for details.

5. The factors affecting claim management are conditions, warranties, loss

incurred and the evidenced provided. The time value is very important in
the settlement of a claim. Insurer has to submit the claim a paper within
a period specified in the policy document or else as it is stated in the
Act. For more details, refer to section 11.7.
11.13 Case-Let
Computerisation of the Claims Management System in ICICI

Prudential Life Insurance
ICICI Prudential, one of the largest insurance companies in the private
sector, has been relying heavily on technology for all its needs. Right
since its inception, about nine years ago, as a part of the mammoth
ICICI Group, IT was adopted in full scale. And, there were very few
hurdles to IT adoption, as the group company was already ahead of the
curve in adopting some the best IT infrastructure and applications in the
industry.
Under the aegis of Anita Pai, EVP, ICICI Prudential Life Insurance, the
company has adopted IT as an essential part of its operations and
customer service. Not only robust CRM tools, ICICI Prudential have
also invested in a very nimble HRMS system that has automated
almost 99% of the employee processes on the platform. Apart from that
ICICI Prudential has also recently deployed a Sybase data
warehousing application and a claims processing system using the
ACORD models.
Based on the BizRules engine, the internal IT team has also built a
customised underwriting system.
The fact that the company has set up a project management office
comprising senior officials from all departments of the company, to
ensure that all projects are completed in time has enabled faster
adoption of technology. Now, the company plans to focus on delivering
services on the mobile and as part of its customer self service models.
One IT project that has provided maximum benefits to the company has
been the Health Claims Management System (CAPS). "The project

was conceived to build a robust, scalable web based integrated system that
will serve as a single application to be used by all third parties.
The system would be accessed by the entire ecosystem of health
insurance domain nation wide comprising payers (insurance
companies), providers (hospitals and clinics), TPA and branch offices.
The project was innovative in many respects. It was a pure SOA based
health claims solution; it was the first successful usage of ACORD
(international insurance data model standard) for health insurance
claims system in India. It provided pure accord XML driven integration
with third party system which facilitated real-time hospital access to
provided claims decision within hours instead of days. It also featured a
flexible claim benefit calculation engine built primarily on actuate
engine.
The project has been implemented with best of breed design patterns by
using spring and hibernate framework. The solution is compliant with
international health insurance standards such as HIPAA and ACORD. It also
has inbuilt fraud rules for alerting blacklisted customers and hospitals.
The system is completed integrated at the back end. The claims solution
is integrated in real-time with sms, e-mail and document management
engine for customer and hospital communication at various stages of
claims processing.
The project has reduced the turnaround time for cashless claims
decisions from 8 hours to 3 hours providing access anywhere and
everywhere, it allows real time information for analytics that reduces the
fraudulent claims. It also allows the executives to track per customer wise
claims that help in up-selling the portfolio of products.
The claims management system also features hospital credential
ratings to help take right cost decisions and communicates with the
customer at all stages of the claims lifecycle as all processes are
integrated at the back end and made available through e-mail and
SMS. The system has also improved employee productivity as it auto
allocates the claims cases to respective assessors.
Discussion Question
1. Describe the features of the project that has provided maximum
benefits to the company.
(Hint: Health Claims Management System)

2. What are the benefits of the new claims management system?

(Hint: reduced the turnaround time, reduced fraudulent claims,
allocates the claims cases to respective assessors)
Source: http://dqindia.ciol.com/content/casestudy/2010/110010702.asp
References
House, India.
E-References
http://www.scribd.com/doc/14217786/Project-on-claims-management-in-
life-insurance
Retrieved on 11th November 2010

Unit 12 Insurance Pricing and Marketing

Structure:
12.1 Introduction
Objectives
12.2 Overview of Insurance Pricing
12.3 Pricing Procedure
12.4 Pricing Objective
12.5 Basic Pricing Methods
12.6 Pricing of Insurance Products
12.7 Marketing of Insurance Products
Issues in insurance marketing
12.8 Summary
12.9 Glossary
12.11 Answers
12.12 Case -Let
12.1 Introduction
The previous unit dealt with the concept of claims management, including the
importance and stages of claims management, and also the factors affecting
claims management. The previous unit also discussed claims settlement and
the types of claims.
Insurance pricing has to balance the risks and returns of the insurance
company. It needs to take into account the role of the market in determining
the price of the insurance products. The pricing strategy must ensure that
the premiums received are sufficient to meet the cost of claims,
administrative expenses and provide fair amount of profits for investments.
Insurance companies need to perform the following activities in order to
market their products successfully:
They must research the market and determine the customer
requirements.
They need to design products that meet these needs and ensure profits.
They must determine ways to distribute the products.
They must persuade the potential customers to buy their products.

This unit deals with the concept of insurance pricing and marketing. This unit
explains the pricing procedures, pricing objective and basic pricing methods.
It also explains the pricing and marketing of insurance products, including the
issues in insurance marketing.
This unit will enable us to decide the pricing objective and determine the
price in the business.
Objectives:
define insurance pricing
describe the pricing procedures, objectives and methods
explain the pricing of insurance products
discuss the marketing of insurance products
12.2 Overview of Insurance Pricing

This section gives an overview of insurance pricing.
The success of the competitive market depends on pricing. Basically, price is
the value that sellers set on the products they offer for marketing.
Insurance pricing determines the premiums collected for an insurance
contract. Insurance pricing is a difficult actuarial technique. In insurance, the
sales price or premium is collected before specific services, such as claim
payments are made. It is difficult for the insurers to decide the price of
insurance products. Insurers build a reserve from the premiums collected and
invest it in financial markets according to the norms of the appropriate
regulatory authority. Thus, insurance firms fulfil an important financial
intermediary function.
The basic principle of insurance pricing is that insurers selling policies or

insurance coverage must receive premiums that are enough to fund their
expected claim costs and managerial costs, and provide an expected profit to
pay off for the cost of acquiring the investment necessary to support the
coverage sale.
The base premium is calculated using the equivalence principle on the basis of
expected claims distribution as,
P = E(s) + k + R

Where, E(s) = Mathematical expectation of claims

k = Ongoing company running costs
R = Risk premium
The risk premium allows for coverage of unforeseen deviations in the claims
amount to be paid, but still provides the company with the standard pricing
methods. Within large, expanded and identical underwriting securities, the
claims payload should meet its expected value.
Insurance prices or premiums consist of three components. They are pure
premium, operating expenses, and margins and other income, as shown in
figure 12.1.
Figure 12.1: Types of Insurance Premiums
Pure Premium - Pure premium is the most important component of the

insurance premiums. It includes the amount that covers expected
losses, and loss adjustment costs based on actuarial estimations.
Operating Costs - Operating costs include the sales commission,
marketing costs, taxes, and claims handling costs. These costs depend
on the extent and variety of policyholder services which the insurer
provides.
Margins and Other Incomes - Margins and other incomes include an
allowance for unforeseen events, and contingency funds. Contingency
funds are necessary to meet unexpected increase in the number or
amount of benefit payments, and underwriting profits are necessary to
provide funds for growth and expansion.
1. Operating costs depend on the _________ and _______ of policyholder
services which the insurer provides.
2. Insurance pricing determines the basic salary collected for an insurance
contract. (True/False).

3. The most important component of the insurance premiums is

_____________.
a) Operating expenses
b) Margins and other incomes
c) Pure premiums
d) Risk premiums
12.3 Pricing Procedure

The previous section dealt with the concept of insurance pricing. This
section will deal with the pricing procedure, and its determination.
Basically, pricing procedure is a methodical and sequential use of technique to
determine the right price of the product. The insurer can determine the pricing
procedure based on Sales area (Sales Organisation, Distribution Channel,
and Division), Customer Pricing Procedure (CPP), and Document Pricing
Procedure (DPP).
The following elements are considered while pricing insurance products:
Claims cost - It includes claims paid in conjunction with settlement
expense, estimate far outstanding claim, and so on.
Business acquirement cost - It includes commission, brokerage and
business development cost, and so on.
Management expenses - These include salaries, rent and other
expenses necessary for managing an organisation.
Profit - It include return on the capital cost.
Pure premium method
The pure premium is the average loss per coverage unit, or in particular, the
product of the average severity and the average frequency of loss.
The average frequency of loss (F) is obtained by dividing the number of
losses invited (NL) from the number of coverage units (NE) in the
appropriate class. This concept is used to calculate the average number of
losses for all insured.
The average severity loss (S) is obtained by dividing the monetary amount of all
losses (SL) from the number of losses invited (NL). It represents the severance
of the loss.

Thus, the pure premium is determined by multiplying the average frequency of

loss and the average severity of loss, but it reflects the average loss of insured
expectations. In order to meet all the losses, each insured who are involved in
the particular class of business must pay the amount before commissions
and administrative expenses.
Pure Premium (PP) = (average frequency of loss) * (average severity of
loss)
PP = (NL/NE) * (SL/NL) = (SL/NE)
These concepts can be used to determine the losses, but they do not
consider the distribution of losses. Thus, the pure premium distribution is
defined as the probability distribution of total losses for an appropriate class of
business.
A measure of the intrinsic variation in the population is the variance
represented by:
PP2 = (PP - ) / (n-1)
Where, = theoretical pure premium distribution mean.

However, the marketing manager refers only a sample but not the entire pure
premium population. Thus, while estimating they are expected to refer to
the true value.
Assume that the insurance marketing manager refers to a sample randomly
from the basic pure premium distribution. Then, it shows that the average
losses for a sample of n coverage units follow a normal distribution. In other
words, if they refer random samples continually then it represents the
average or mean of the sample pure premium follows a normal distribution.
Thus, the standard variation or error of the mean of a sample pure premium
distribution (m) is defined as the standard deviation of the pure premium
population distribution adjusted by the number of coverage units and is
given by,
m = PP / n

The calculation of standard error of the pure premium distribution is

necessary because the average pure premium is incremented by a risk
factor that compensates the error to the expected variations in the
productivity.
In addition, the accuracy of the estimation increases with the increase in the
number of coverage because the standard error of the average of the pure
premium decreases with the increase in the sample size.
Two other factors also come into picture during the estimation of pure
premium, which are credibility factor and loading factor.
Credibility factor refers to the extent to which an experience of an
appropriate insured considered in the pricing process. It refers to the
amount of confidence of the price-maker (marketing manager) to show that
the available data represents the losses to be expected in the future
accurately. Thus, the equation for the acceptable pure premium is given by,
PPacceptable = (C*PPi) + ((1 - C)*PP)
Where, PPi = pure premium derived from the experience of the insured.
PP = pure premium derived from the experience of the actual
population.
C = credibility factor, 0 C 1
Loading factors refers to the transaction expenses and the profit margin
expressed in terms of percentage. Taking into account the traditional issues
in concern with the economic objectives of regulation and the fair price
discrimination, the gross premium value is determined by using the
equation,
Gross premium = Pure premium / (1 - loading factor)
The pure premium can also be determined as follows,

Let,
The costs of set of events to be covered for an individual on yearly basis, {c} =
{c1,c2,,cn}
Probabilities that occur for each events in a year, {p}={p1,p2,,pn} The
risk function of this insurance policy be X. Then, X(ci) =pi

Group of persons insured, {H} = {1,2,,h}

Thus, without security charges the pure premium is calculated as follows:
Activity: 1
Assume that you are working as an actuary in an insurance company. List the
factors which affect your pricing of a policy.
Hint: Refer -
http://books.google.co.in/books?id=UCtxXm6E7wQC&pg=PA75&dq=Pricing+c
onsiderations+%2B+actuaries+%2B+India&hl=en&ei=kl_mTP7PNYj5cfGJmd0
K&sa=X&oi=book_result&ct=book-preview-
link&resnum=7&ved=0CEwQuwUwBjgK#v=onepage&q&f=false

4. A methodical and sequential use of technique to determine the right
price of the product is known as ______________.
5. Commission, brokerage comes under ________________ costs.
a) Management
b) Claims cost
c) Business acquirement
d) Profit
6. The ________________ is the average loss per coverage unit.
12.4 Pricing Objective

The previous section dealt with the pricing procedure. This section
describes the pricing objective.
The marketing manager has to decide the objectives of pricing. Pricing
objectives guides the decision makers to make price policies, to plan pricing
strategies and to set actual prices.
Pricing objectives are the overall goals that describe the role of price in the
long-range plans of organisations. The pricing objectives guide the
marketing manager in developing marketing plans.

The insurance pricing has the following general objectives:

1) The rating system must create adequate premium income for the
insurance corporation to be able to settle its claims and expenses; to
provide a realistic return rate to the sponsors of funds and to finance
continuing growth and expansion.
2) The rate must not be excessively high and allow unusual gains for the
insurer. The rate must be justifiable.
3) The rates must not be discriminatory, in the sense that it must not be the
same for heterogeneous buyers and must not be different for
homogeneous buyers.
4) The rating system must be easily understandable.
5) The pricing system should not be expensive to use.
6) The rates should not be frequently changed as the public cannot face
wide variation in costs every year.
7) The methods should encourage the reduction of losses by providing
inducement to the insured to avoid losses.
7. Pricing objectives are the ___________ that describe the role of price
in the long-range plans of organisations.
8. The rate must be excessively high and allow unusual gains for the
insurer. (True / False).
9. The _________________ must create adequate premium income for
the insurance corporation to be able to settle its claims and expenses
12.5 Basic Pricing Methods

The previous section described different types of pricing objectives. This
section will describe the basic pricing methods.
Basically, the pricing method gives us an idea on how to set the product
price. The price value that is set for the product in the insurance company will
change over time for many reasons. The company can decide to change the
pricing method only when it finds out the customers needs and
competition in the market.
The pricing methods allow companies to think about their business, industry
and customer. The vendors must understand the variety of options available
along with the merits and demerits of the pricing methods, before selecting

any one of them. They may also merge a number of pricing methods to suit their
business and the type of products they sell.
There are three basic pricing methods, which are:
Cost-based pricing - In this method, the price includes the cost of
ingredients and cost of operating the business. This method is based on
product cost subtotal, which includes the costs of operating the business
such as costs of reserves, transportation, advertisement, rent and other
costs involved in manufacturing the products. The cost-based pricing
comprise of three methods, which are:
o Mark-up pricing - Mark-up pricing includes a profit percentage with
product cost. All businesses with many products use this type of
pricing because it is simple to calculate. The profit level must be
specified in terms of percentage. This is added to the production cost
to set product price. This type of pricing is common in retail business
as they have many types of products and purchases from many
vendors.
o Cost-plus pricing - In a cost-plus pricing, a percentage is added to
an unknown product cost. This type of pricing works properly when
production costs are not known. The only difference between mark-
up and cost-plus pricing is that, in cost-plus pricing both consumer
and vendor settle on the profit percentage and believe that product
cost is unknown whereas in mark-up pricing product cost is known.
The cost-plus pricing reduces your risk if you produce custom order
products for other firms or individuals.
o Planned-profit pricing - Planned profit pricing method enables you
to earn a total profit for the business. It is different from the first two
types of cost-based pricing. The first two pricing methods focus on
per unit price. In planned-profit pricing, the product price is
calculated by combining per unit costs with output projections.
Planned-profit pricing uses break-even analysis to calculate product
price. This method is suitable for manufacturing businesses since
the manufacturer has the ability to increase or decrease the
production depending upon the available demand or profit.
Advantage of cost-based pricing
The main advantage of this type of pricing is that it enables the
manufacturer to determine how different levels of output can affect the
product price as well as to examine how different prices affect the amount of
output needed.
Disadvantages of cost-based pricing
The following two disadvantages of cost-based pricing result in it not
working for some businesses:
The cost-based pricing does not consider how customer demand affects
price.
The cost-based pricing method does not include competition in the
market.
Competition-based pricing - In this method, the product price includes
costs of raw materials and the cost of operating the business and is
similar to the competitors price. In competition-based pricing, vendors
must ensure the following three factors:
o The product price needs to be similar to the competitors price. o
Set price to increase the customer base.
o Larger market share through price.
Advantage of competition-based pricing:
The main advantage of this pricing method is that it focuses on industry as
well as competition. The companies that follow competition-based pricing
examine the types of existing and upcoming competition. It helps you to
manage the business according to the competition. Products that have a
unique or innovative quality can be priced more than their net-worth.
Disadvantages of competition-based pricing:
Though the competition-based pricing has advantages, there are few
disadvantages:
The production costs of the company may be ignored due to the focus
on the prices set by competitors.
This method requires more time to carry out and update market
research.
Competitors can easily copy the price chosen.
Customer-based pricing - Customer-based pricing is also known as
value-based pricing. In this method, the product price is based on the
customer demand or need for the product. Product that are unique or
innovative, create greater demand.

The different factors to be considered in customer-based pricing are: o

Setting a price that supports the value of the product.
o Setting a price to increase product sales.
o Designing a range of prices that attracts many customer groups. o
Setting a price to increase sales volume.
o Pricing a bundle of products that reduces the catalogues or excite the
customers.
Disadvantages of customer-based pricing
The disadvantages of customer-based pricing method are:
Production costs can get ignored.
Competition may be neglected.
It is necessary to set both wholesale and retail prices products.
Volume discounts and rebates need to be considered.
Tips for Successful Pricing

Below are some tips for the insurer to be successful in pricing insurance.
Be creative - Apply new techniques to sell more to existing customers
as well as to attract new customer groups.
Listen to your customer - Review the consumer comments periodically
to gather new ideas.
Do your homework - Record notes on how you arrived at a price so
that you can make related assumptions in the future.
Cover the basics - Merge pricing methods to ensure the three basics
of pricing which include product price, competition and customers.
Be flexible - Regularly review both internal and external issues and
calculate how a price change would affect the new situation.
Activity: 2
Assume that you are a marketing manager in a XYZ insurance company
and you have an insurance policy to be priced accordingly. Which
method
or the combination of pricing methods will you make use of and why?
Hint: Refer the different types of pricing methods in section 12.5


10. In __________ pricing method, the price includes the cost of
ingredients and cost of operating the business.
11. The three basic pricing methods are ________________________,
_________________________ and ___________________________.
12. In customer-based pricing, knowing your customers needs is optional.
(True/False).
12.6 Pricing of Insurance Products

The previous section dealt with the three basic pricing methods. This section
deals with the pricing of insurance products.
Basically, there is a difference between insurance products pricing and
physical products pricing. It is difficult to determine the investment costs in
insurance products pricing than that of physical products pricing. Thus,
pricing of insurance products means the determination of the investment
costs on insurance products. It is still complicated when compared with the
other services, where we can estimate the cost of providing the service with
sound accuracy. Furthermore, in insurance transactions, the premium is
collected before providing predetermined services, that is, the payment of
claims. Insurance can be considered as the business of buying risk. Insurers
have to face difficult situation while selling a policy, as they have to decide
the appreciable cost of the policy because it depends upon whether or not
the losses occur and if they do, how many and how large they will be. Thus,
they charge different prices (premiums) for different people for the policies
that provide same kinds and amounts of insurance.
The methods used to determine the pricing of insurance products are:
Insurance rating methods
Insurance rating methods are used to determine the pricing of the insurance
products. That is, an insurance price is the price per unit of insurance and is a
function of the price of insurance. The three basic insurance pricing (rating)
methods are:
Judgement rating - This method is applicable where we find very less or
no quantitative data of the risk similar to that of proposed risk. The rate is
mostly based on the sponsors own judgement after evaluation of all

coverages. This method is commonly used in ocean marine insurance and

in some lines of inland marine insurance.
Class rating - Generally, this method is practically applied rating method
in insurance business. In this method, the risks are classified based on
some important characteristics. Insurer will charge the same price per unit
of coverage for the insured risks that belong to the same class. In this
method, the classifications and the respective rates are in the form of
printed manuals. Thus, this rating method is also known as manual rating.
In this method, prices are based on age, gender, physical fitness,
lifestyle, and so on. This method is used in life insurance, proprietary
insurance, automobile insurance, workers compensation and health
insurance and so on.
Merit rating - The modification of class rating is referred to as merit
rating. It alters the class rate of a particular class insured based on
individual loss experience. In this method, insurer assumes that the loss
experience of a particular insured will differ considerably from the loss
experience of the other insured. There are three different types of merit-
rating plans. These plans are:
o Schedule rating - In this plan, all insurance coverage is rated
separately. For calculating the schedule rates, firstly, the risk (the
person or object insured) must be examined, to make out the features
that are about to cause losses or to prevent them. Then, the risk is
compared with the average or standard risk of its type. Finally, the
risks desirable features are deducted from the standard rate and its
undesirable features are added, thus, the resultant rate is the modified
rate that reflects the characteristics of risk for which it is used.
o Experience rating - This plan modifies the class rate based on the
claim experience of a particular coverage where the actual losses for
a time (normally two or three years) are compared with the average
risks in the same class. If the risk has a better value than the average,
you have to reduce the rate; else if the risk has a worst value than
average, you have to increase the rate. This plan is used only for
larger risks that are having many losses each year that reflect on
trend. Thus, this plan is generally restricted to larger firms that
generate a sufficiently high volume of premiums and more probable
experience.

o Retrospective rating - This plan modifies the insurance price on the

basis of current experience. This is usually done by determining the
final prices retrospectively in the policy contract. Normally, in this plan,
insurers specify the maximum and minimum range and determine the
final premium after the policy expires and depends on the Life
Insurance and/or Non-life insurance Pricing.
13. In insurance transactions, the ________ is collected before providing
predetermined services.
14. Merit rating alters the class rate of a particular class insured based on
______________________________.
15. Pricing of insurance products means the determination of the
_________________________ on insurance products.
12.7 Marketing of Insurance Products

The previous section dealt with the pricing of insurance products. This
section will help in understanding the marketing of insurance products.
Marketing of insurance products is an important tool in the insurance
business. The marketing of insurance is possible in both the life insurance and
the non-life insurance departments.
The type of advertisement and marketing suitable for insurance business
must be decided. The insurers must consider their budget, and plan their
marketing strategy according to their budget. They must also consider their
target market. For example, Vendors who want to develop their insurance
market need to determine the types and nature of insurance offered. They also
need to research the market segment they are targeting.
The marketing tools that help in advertising the companys insurance
policies are:
Online advertisement - It is one of the insurance marketing tools.
Since, internet plays a very important role nowadays, online
advertisement help the insurance marketers to get noticed. Through
studies it is found that 75 percent of households have access to
computers and internet resources. Thus, online advertisements plays very
important role in advertising the companys insurance policy.

Block line advertisement - It is another marketing tool used in trade

journals, industry publications and periodicals. This insurance marketing
tool is useful with the perspective of industry professionals who read
these publications.
Television advertisements and print advertisements - These are the
other types of insurance marketing tools. These advertisements are the
excellent forms of insurance marketing as they have a greater impact
and reach. However, the only drawback is that both are very expensive.
These may affect the insurance companys advertising budget.
12.7.1 Issues in insurance marketing
Just like the other business marketing, there are some issues in insurance
marketing also.
Marketing issues for young growth-oriented insurance companies as well as
other insurance companies are as follows:
Initial marketing focus issues - A potential initiator of an insurance
marketing business is needed, because, without support, the insurance
company cannot succeed. Thus, if the insurer or the insurance company
does not have potential to do marketing may have to face lot of
difficulties in insurance marketing.
Marketing the company vs. sponsoring products issues - A new or
young unknown insurance company has to be accepted within the
market place before marketing effectively to the end-users (consumers).
These companies must be what they are. Every prospect will not value
innovation and dexterity; instead the correct ones will value it. Thus,
young insurance companies might face issues while finding out the
correct prospect of policies.
Marketing programs issues - Once after a young insurance company
is positioned in the market, if its marketing program is not designed
specifically to accomplish their current insurance programs objectives,
then the whole effort is almost worthless. Thus, it should re-evaluate its
marketing program to acquire good marketing.
Exit strategy issues - It is also one of the marketing issues. Right at
the beginning, an insurer or a founder must understand, and be able to
explain how they can exit. Even though they had given their expectation
about companys growth and prosperity, if they fail to describe which

type of customers would ultimately want to purchase into it, they are said to
be facing a marketing issue. Thus, they must plan for organising the
company, provisioning of funds, and positioning of company in the
market for the ultimate exit opportunity.
Pricing issues - The desired price or premium at which an insurer
seeks to sell their policy can impact on the distribution of the same.
Since all the insurers wants to make profit for their contributions, their
distribution schemes may affect the insurance products pricing. If too
many competitors are involved, then ultimate selling price may become
barrier to meet sales targets, in such cases an insurer may go for
alternative distribution options.
Target market issues - An insurance marketing is said to be effective,
only if customers obtain the policies. The insurers must determine the
level of distribution coverage needed that effectively meet customers
requirements to reach their target market.
Activity: 3
Assume that a new insurance company want to get noticed soon after they
enter into the marketing field. What would be the measures that the
marketing manager would take?
Hint: Refer the different marketing tools explained in the section 12.7.
Self-Assessment Questions
16. Insurance marketing refers to the marketing of _______________.
17. The _____________ and _________________ advertisements are the
excellent forms of insurance marketing.
18. An insurance marketing is said to be effective, only if _________ obtain
the policies.
12.8 Summary
In this unit, insurance pricing, pricing procedures, pricing objective, and
methods, and also the pricing and marketing of insurance products are
covered in detail.
Insurance pricing determines the premiums collected for an insurance
contract.

Insurance prices or premiums consist of the following three components:

Pure premium.
Operating expenses.
Margins.
Other income.
Pricing procedure is a systematic way to determine the correct price of the

product. The elements that must be considered while pricing the insurance
products include:
Claims cost.
Business acquirement cost.
Management expenses.
Profit.
The marketing manager has to decide pricing objectives before determining
the prices. The pricing objectives are like guidelines for the marketing
managers. The main pricing objective is to avoid unfair price discrimination.
Pricing methods helps in setting the product price. One can change the pricing
method after finding out the needs of the customers as well as the competitions
in the market. The three basic pricing methods are:
Cost-based method.
Competition-based method.
Customer-based methods.
Similarly, pricing of insurance products is done by determining the
investment costs on insurance products. The three types of insurance rating
methods that are used to determine the insurance product price are:
Judgement rating.
Class rating.
Merit rating.
The marketing tools used to market insurance products are:
Online advertisements.
Book line advertisements.
Television advertisements.
Print advertisements.

12.9 Glossary
Freight: It refers to the goods that are usually transported for business
purposes. Modes of transport may include ship, truck, train, and so on.
Deregulation: It is the elimination or modification in government rules and
regulations that limit the process of market services. It does not mean that, it
is eliminating the laws against fraud, but it means, removing or reducing
government control of how business is done, thereby moving toward a more
free market.
Surcharges: An additional or excessive sum added to the usual amount or
cost.
Pay-back period: The period of time required to recover the cost of an
investment. (Payback Period=costs of project per investment/annual cash
inflows).
Riders: An attachment to a policy that modifies its conditions by expanding or
restricting benefits or excluding certain conditions from coverage. For
instance, a life insurance policy can have an 'accident cover' as a rider for a
marginally higher premium.

1. Define insurance pricing.
2. Describe the pricing procedures with an example.
3. Explain different types of pricing objectives and methods.
4. Explain the pricing of insurance products.
5. Discuss the marketing of insurance products.
12.11 Answers
1. Extent, Variety
2. False
3. c) - Pure premiums
4. Pricing procedure
5. c) - Business acquirement
6. Pure premium
7. Overall goals

8. True
9. Rating system
10. Cost-based
11. Cost-based pricing, Competition-based pricing, Customer-based pricing.
12. False
13. Premium
14. Individual loss experience
15. Investment costs
16. Insurance products
17. Television, Print
18. Customers
Terminal Questions
1. Insurance pricing is the sales price or premium collected before specific
services such as claim payments. The different types of insurance
pricing are explained in the section 12.2 of this unit. Refer the same for
details.
2. Pricing procedure is the sequential way of defining a set of condition
types in series. This is explained in the section 12.3 of this unit. Refer
the same for details.
3. While we are considering the insurance pricing it is important to focus on
the pricing objectives and pricing methods. The three types of pricing
objectives and pricing methods are explained in the section 12.4 and
12.5 respectively. Refer the same for details.
4. Pricing of insurance products refers to the determination of investment
costs on insurance products based on any one of the rating methods.
Some of the rating methods are explained in the section 12.6. Refer the
same for details.
5. While considering the insurance products it is important to focus on the
marketing of the same. Few marketing tools are explained in the
section 12.7. Refer the same for details.

12.12 Case-Let
Case study on the Improvement of the Online Marketing of ABC

Insurance Company
Problem the ABC Insurance Company was facing
ABC Insurance Companys online marketing for car insurance was almost
dependent on similar sites. So, it wanted to use a traditional affiliate
marketing model to come up with its own website only.
ABC Insurance Company had affiliate campaign for 16 months when it was
working with another company. ABC insurance company was unable to reach
their target in marketing. So they asked XYZ media to deliver a strategic
solution to gain traction with affiliates and increase the proportion of online
sales being delivered.
The XYZ media has to meet the three important objectives of ABC
insurance company.
1. Increase visibility of the ABC insurance company brand on important
affiliate sites.
2. Improve the accuracy of the conversion rate from leads to valid leads.
3. Increase the number of valid leads being delivered through the affiliate
site in the long term.
Solution provided by XYZ media
XYZ media launched the strategy development phase by sending a
questionnaire to the campaign affiliates to determine what would
encourage giving increased exposure to the ABC insurance brand, with a
vision to increase the valid leads being delivered by the site. As a result of this,
they decided to change the campaign to pay out on last click than a first click
basis. The affiliates were happy with this and also it reflected the nature of the
car insurance market, where there is an increasing tendency for users to
purchase via comparison sites rather than taking out the policy directly
from the brand sites.
In addition, they introduced the following two incentives in conjunction with
each other for duration of two months at the commencement of the year in
order to make benefits on the biggest month of the year:

Prize incentive - entry into a prize draw for every sale created to win a trip
to Switzerland worth Rs.1450000
Cash incentive - Company introduced a bonus module to support signup and
volume
Result
The number of leads increased 20 times than that of the before changing to a
first click model over a period of one month, with a total effect of 12 times
increase over the year.
The overall conversion rate from leads to valid leads minimised. Thus, the
accuracy of the conversion rate increased the valid leads being delivered
by the affiliate site and the net effect was three times than that were there
before.
1. Mention the three objectives of ABC insurance company.
[Hint: Refer the problem part of the case study]
2. What was the role of XYZ media in improving the visibility of ABC
insurance Company?
[Hint: Refer the solution part of the case study]
Source: http://www.bigmouthmedia.com/live/articles/affiliate-marketing-case-
study--kwik-fit-insuranc.asp
References
Sethi/Bhatiya, (2007), Elements of banking and insurance, PHI Learning
Pvt Ltd.
E-References
http://sapmm.wordpress.com/category/po-pricing-procedure/page/2/
http://www.witiger.com/marketing/pricingobjectives.htm
http://www.marcbowles.com/courses/adv_dip/module12/chapter7/amc12
_ch7_three.htm
Retrieved on November 2, 2010
http://pubs.cas.psu.edu/freepubs/pdfs/ua441.pdf
http://factoidz.com/pricing-objectives-and-strategies/
http://www.ndsapps.com/webhelp/index.htm#pricing_procedure_so.htm
Retrieved on November 3, 2010

Unit 13 Financial Management in Insurance

Companies and Insurance Ombudsman
Structure:
13.1 Introduction
Objectives
13.2 Management and Investment of Funds
Financial objectives of an insurance company
Types of investments
13.3 Regulation Relating to Investment
Investment criteria and prudential norms
Asset Liability Management (ALM)
13.4 The Insurance Regulatory and Development Authority (Investment)
(Amendment) Regulations, 2001
13.5 Creation of the Institution of Insurance Ombudsman
Roles and functions
13.6 Summary
13.7 Glossary
13.9 Answers
13.10 Case-Let
13.1 Introduction
The previous unit explained the concept of insurance pricing. It explained the
pricing procedures, objectives and marketing of insurance products.
This unit deals with the financial management of insurance companies. It
explains the financial and investment management in the companies. The
insurers must invest the company funds wisely if they want to make profit from
the premiums given by the policyholders or settle the claims of the
policyholders. The different types of investments are also discussed in the unit.
This unit also discusses the investment regulations that an insurance company
has to follow while investing. The Insurance Regulations and Development
Amendment 2001, states these investment regulations. This unit also
explains about the creation of the institute of insurance ombudsman
and lists its roles and functions.

Objectives:
define the concept of management and investment of funds
describe the regulations related to investment
discuss the IRDA amendment, 2001
explain the creation and functions of the institute of insurance
ombudsman
13.2 Management and Investment of Funds

This section will discuss the management of funds, and also the investment of
funds.
An insurance company should manage and invest its funds wisely in order to
maximise the profits of its investments, and reimburse the money for an insured
person in case of a loss. Financial management is the responsibility of the
financial managers. The basic functions of financial managers are:
Preparation of the companys financial plan.
Managing capital and excess income.
Managing cash flows and investments.
Creation of financial reports and measurement of financial performance.
Auditing and internal cost control.
13.2.1 Financial objectives of an insurance company
Insurance is a vital element of any sound financial plan. Insurance
companies are financial institutions with financial goals. Insurance prevents the
risk of a financial loss. The major financial objectives of an insurance
company are:
Profitability - This is a financial objective that increases the returns of
the stakeholders of the company. It determines the insurers ability to
manage the business. The insurer must perform the following tasks in
order to ensure long-term profits :
o Attain high quality ratings from insurance rating agencies. o
Offer funds for savings/investment.
o Ensure payment of dividends to stake holders.
o Provide funds to broaden products and supply channels. o
Provide funds for growth and achievement.

Solvency - This is defined as the capability to meet the financial

requirements arising out of obligations. Insurance companies should
frame their policies according to the obligations to be paid to certain
benefits in future. They must preserve the minimum standard of capital
and surplus as per the law. The risks related to the insurers
investments, and the definite businesses the insurer sells, determines
the legal minimum standard of capital.
The risks that an insurance company faces while performing and managing the
business that affects its solvency are:
Pricing risk - Pricing risk is a risk that arises when regulations affect the
premium rates of the insurance companies or the possibility of the
insurers claims and expenses being different from what was anticipated.
Asset risk - Asset risk is the risk of loss of an investment because of
various reasons, other than a change in market interest rates.
General business risk - This is the risk, in which the losses arise as a
result of ineffective business practices or because of the environmental
factors that are purely beyond the control of the insurer.
Interest rate risk - This type of risk occurs due to variations in the
market interest rates. For example, loss on sale of a bond when market
rates increase, is an interest rate risk.
Planning financial goals and strategy
The financial goals of insurers are to maximise profits and maintain
solvency. The insurer is forced to maintain the tradeoff between the two
since profit involves risk taking and maintaining solvency involves risk
avoidance. Therefore the correct balance between the two is vital for the
financial success of an insurance company. Financial strategy is related to
the investment strategy as well, since the investment strategy helps in
taking decisions concerning the investments to be made. To identify
investment strategies the following factors must be considered:
The money needed after a certain amount of time.
The time period after which the money is required. The
financial risk involved.
The return expected after the time period.
If the financial goals are established and the risk relationship is known, then the
strategy is formed in the following two ways:

1) Aggressive strategy emphasises profitability and can threaten the

companys solvency.
2) Conservative strategy is a way wherein strategies which affect solvency
are avoided and the rate of return is enhanced.
13.2.2 Types of investments
To achieve profitability, an insurer has to continue to invest funds in different
areas efficiently. The insurer invests most of the funds in accordance to the
policy chosen by the applicant. While investing, the insurer has to check if there
are liquid funds for settling claims, and then invest the rest in a long term
investment plan to get higher returns. The investor (insurer) should consider
the quality, security and marketability of the investments to attain the highest
rate of interest.
Different types of claims have different types of investments. As a policy can be
life or non-life, long term or short term; similarly, the investments are
classified into the following:
Government bonds - Government bonds are debt securities given by
the Government of India and are issued in Indian rupees. Government
bonds have a period of maturity from one year to 30 years. The investor
can buy these bonds at face value with discount or at the premium. The
investor avails a fixed rate interest for the bond period. When the bond
reaches the maturity date, the investor receives the full amount (face
value). The investor can also sell these bonds in a secondary market,
even if the bond maturity date is not reached.
Some benefits of government bonds are:

o Regulation of nationwide cash circulation.
o Safer than stock market investments.
o Insignificant credit risk, as the government has the highest credit ratings.
The risks associated with government bonds are:
o The political issues in the country affect them.
o If the government bond is purchased from any foreign country, then the
return depends on fluctuations in foreign currency market.
o Inflation may affect the return of these bonds.
o Government bonds have lower returns than corporate bonds.

Other types of bonds - The other types of bonds include the following:
o Public sector undertaking bonds - These bonds are meant for
long term or medium term investments. Public sector undertaking
bonds are also government bonds, but these are sold in a private
basis. Here, the government finds out and offers the bonds to
investors at fixed rates.
o Corporate bonds - Corporate bonds are private sector bonds
offered by different private sector corporations of India. These can
be long term bonds, which may have term up to 15 years. These
bonds can be purchased by any investor, but with a higher degree of
risk than the government bonds. The risk depends upon the
marketing conditions and investment rates. When the investor
expects a higher return, then the degree of risk is also more.
o Financial institutions and banks - In India, more than 80 percent
of the total bonds in the market are sold by financial institutions and
banks. These bonds are well regulated, and offer higher returns to
the investors. Such bonds are suitable for investors aiming at large
scale investment.
o Emerging markets bonds - The Government of India issues bonds
abroad, to raise capital for economic development in India. Unlike
other bonds in India, these bonds are issued in U.S dollars or in
Euro. The insurer itself pays the higher interest rates charges on
these bonds. The risk involved in this bond is that, it is subjected to
the economic conditions of the country.
o Tax-saving bonds- the Government of India, to help the citizens to
save taxes fully or partially, issues Tax-saving bonds. These five-
year bonds are usually issued by the Reserve Bank of India. These
bonds have an interest rate of 6.5 percent, and are paid in every six
months. The investor does not have to pay the tax for the interest
income until the bond maturity.

1. Profitability is a financial objective that increases the returns to its
stakeholders. (True/False).
2. ____________________ are private sector bonds offered by different
private sector corporations of India.

3. ____________ bonds are issued in dollars and euros.

a) Tax-saving
b) Emerging markets bonds
c) Corporate bonds
d) Government bonds
13.3 Regulation Relating to Investment

The previous section dealt with the financial objective of insurance
organisations and the types of investments. This section deals with
regulations related to investment of insurance companies in India.
As per the insurance act, every insurer has to keep investing a certain
amount of capital in India. The income from the policyholders premium
cannot be invested outside India.
In life insurance business, an insurer has to constantly invest funds. The
value of the funds invested should not be less than the total amount to be
paid to the life insurance policyholders, in case of a loss or maturity of the
policy. The insurers in life insurance business can keep on investing their
controlled funds (i.e. funds other than pension, unit liked life insurance and
general annuity business) in a manner, as given in the table 13.1.
Table 13.1: Regulations on Investments in Life Insurance Business
Areas of investment Percentage of funds invested
Government securities 25 %
Government securities or other Not less than 50 %
approved securities:
Approved investments: Not less than 15%
(a) Infrastructure and social sector:
(b)Other to be governed by Not exceeding 35%

exposure/prudential norms :
Other than in Approved Investments to Not exceeding 15%
be governed by Exposure/Prudential
Norms:
While calculating investments, the amount of funds the insurer gives the RBI
with respect to the life insurance business will be taken as an investment to
the government securities. If the insurer makes any investment other than in

Indian rupee or purchases any immovable property outside India, then it will be
considered as a personal investment. Any investor should not invest funds
out of the given budget in shares of private companies.
Insurance companies (inside or outside of India) that have one-third of their
share capital outside India or that have one-third of their governing
members residing outside India need to maintain the required assets in India
in the form of a trust in order to discharge their liabilities.
Every insurer shall keep on investing the funds of unit linked life insurance
business with respect to the model of investment approved by policy
holders. The insurer can invest unit linked policies only in categories, where the
assets are easily marketed. The total investment in other approved
investment categories should not exceed twenty five percent of the total
funds. In general insurance business, the insurer shall keep on investing the
assets all the time in a manner, as given in the table 13.2.
Table 13.2: Regulations on Investments in General Insurance Business
Areas of investment Percentage of funds
invested
Central government securities: Not less than 20%
State government securities and other guaranteed Not less than 30%
securities including the aforesaid:
Housing and Loans to State Government for Not less than 5%
Housing and Fire Fighting Equipment
Investments in Approved Investments Not less than 10%
(a) Infrastructure and Social Sector:
(b) Others to be governed by exposure/prudential Not exceeding 30%
Norms:
Other than in Approved Investments to be Not exceeding 25%
governed by Exposure/Prudential Norms:
In pension and annuity business, an insurer needs to invest the funds as per
the table 13.3.

Table 13.3: Regulations on Investments in Pension and Annuity

Insurance Business
Areas of investment Percentage of funds
invested
Government Securities: Not less than 20%
Government securities or other approved Not less than 40%
securities, including the above:
Balance to be invested in Approved Not less than 60%
Investments and to be governed by
Exposure/Prudential Norms:
In Indian reinsurance business, every re-insurer has to constantly invest

funds as per the rules of general insurance business.
13.3.1 Investment criteria and prudential norms
IRDA has laid down the following criteria to govern all insurers:
Depending on the total policies written in a particular year, for general
insurance companies the criteria for investment in the rural sector is the
following percentage:
For non-life insurer
o 2% in the 1st financial year.
o 3% in the 2nd financial year.
o 5% in the 3rd financial year.
For life insurer
o 5% in the 1st financial year.
o 7% in the 2nd financial year.
o 10% in the 3rd financial year.
o 12% in the 4th financial year.
o 15% in the 5th financial year.
The positive side of these IRDA norms is that it prevents risky and false
investments, and fuels the priority sectors. But, investing in high returns
funds is also prevented since the returns on gifts and government securities
is lower.

Prudential norms
The prudential norms include:
Investment in equity shares and debentures must not to exceed more
than 15% of the total capital by both life and non life insurers.
Loans must not to exceed 10% of the estimated annual accretion of
funds.
Separate statements are required for activities yielding 10% more
revenue according to accounting norms.
There are two auditors appointed, one with 4 years tenure and another
with 5 years tenure, to ensure that there is no lack of audit in the
insurance company.
Activity 1:
LIC had launched thee plans under the brands Jeevan Dhara, Jeevan
Akshay and Jeevan Suraksha in 1980s and 1990s with assured returns
of 11-12%. LIC is running a notional loss of around Rs.14,000 crore in
these three assured return schemes. What are the implications on the tax
payers?.
Refer. Mint newspaper dated 16th Nov 2010
13.3.2 Asset Liability Management (ALM)

ALM is a cash flow management program in which the financial effects of
the insurers product liability are co-ordinated with the financial effects of the
business investment. The financial managers of the insurance company are
responsible for asset liability management as it is important for the cash
flows arising out of assets and liabilities to match and support the insurers
strategic objective of solvency and profitability. They identify the patterns of
companys cash out flows and construct a portfolio of assets that increase
cash inflows which are sufficient to meet the companys obligations on time.
The risk arising due to growth in a company is because the growth is not
matched with the sufficient resources or wrong selection/pricing of products is
done. To maintain good asset liability ratio, insurers follow the following
asset-liability management methods:
Cash flow testing - In this method, the cash flow of the insurance
company is tested under various interest rate conditions.
Cash flow matching - In this method, a block of liabilities with certain
cash flows is matched with a block of assets with identical cash flow.

Immunisation - Here the liability portfolio duration is calculated and

matched with asset portfolio of identical duration.
4. If the insurer makes any investment other than in Indian rupee or any
investment made to purchase any immovable property outside India
then it will not be taken into account. (True/False).
5. In general insurance business, the insurer shall invest not less than
________ percent in the central government securities.
a) 30
b) 10
c) 20
d) 35
6. In life insurance business, the total investment in other approved
investment categories should not exceed ____________ percent of the
total funds.
13.4 The Insurance Regulatory and Development Authority

(Investment) (Amendment) Regulations, 2001
The previous section dealt with the regulations related to the investment. This
section deals with the Insurance Regulatory and Development Authority
(Investment) (Amendment) Regulations formed in 2001.
IRDA investment regulations of 2001 were amended by the Insurance
Advisory Committee to update the investment regulations for insurance
companies in India.
To implement the powers granted by sections 27A, 27B, 27D and 114A of
the Insurance Act, 1938 (4 of 1938), the Authority, in consultation with the
Insurance Advisory Committee, made the following regulations to modify the
Insurance Regulatory and Development Authority (Investment) Regulations,
2000.
There were totally 14 modifications made to the Insurance Regulatory and
Development Authority (Investment) Regulations, 2000. The modifications
made for the third and fourth regulations are as given below:
The insurers should make an effort to keep a balance between
infrastructure sector investments and social sector investments. The

bonds provided for these sectors were rated AA and guaranteed by the
government and other reputed rating agencies.
All investment of funds in assets, which are rated as per market practice
will be based on rating of such assets. The rating should be by an
independent, reputed and recognised Indian or foreign rating agency.
All the assets for investment shall be have an investment grade AA
and not less than that. If the investment grade is not up to the mark to
meet the investment requirements of the insurance company but the
investment committee is fully satisfied about the same, then the
investment of the asset is approved for not less than +A rating.
All the debt assets issued by all India financial institutions are given an
AAA rating and are recognised as such by RBI. If the investment grade
is not up to the mark to meet the investment requirements of the
insurance company but the investment committee is fully satisfied about
the same, then the investment of the asset is approved for not less than
AA rating from a reputed Indian or foreign rating agency.
If any asset is capable of being rated only on the basis of market
practice, then the asset shall not be invested.
Investments in equity shares should be made in liquid instruments in a
recognised stock exchange. The investment trade volume should not be
below ten thousand units in the last 12 months.
Activity: 2
Browse the Internet and find the details about the Insurance Regulatory
and Development Authority (Investment) (Amendment) Regulations
formed in 2001.
Hint: Refer - http://www.irda.gov.in/ADMINCMS/cms/ frmGeneral_
Layout.aspx
?page=PageNo51&flag=1&mid=Insurance%20Laws%20etc.%20%3E
%3E%20Regulations

7. IRDA investment regulations of 2001 were amended by the
_________________________________.
8. There were 14 modifications made to the Insurance Regulatory and
Development Authority (Investment) Regulations, 2000. (True/False).
9. In IRDA 2001, the existing regulation 4 was modified in

_____________________ and _____________________ areas.
13.5 Creation of the Institution of Insurance Ombudsman

The previous section described the Insurance Regulatory and Development act.
This section describes the creation and functioning of the Insurance
Ombudsman Institute.
In 1998, Government of India formed the Institute of Insurance
Ombudsman, to address the complaints of insured persons against the
insurance companies. This institution became a way for the insured persons to
express their problems against the companies, and to solve it as soon as
possible. This institution helps the policyholders to build up confidence in the
Institution of Insurance Ombudsman resolves complaints, which the
insurance company denied to solve. The insured persons can approach the
insurance ombudsman in their own states to solve their problems.
13.5.1 Roles and functions
The roles and functions of the Institution of Insurance Ombudsman ranges from
appointment of the ombudsman, to the rewarding of insured persons. The
various functions of the institution are:
Appointment of insurance ombudsman - The appointment of
insurance ombudsman is the main function of the institution. A
committee consisting of the chairman of IRDA, chairman of LIC,
chairman of GIC, and a representative of the Central Government
mandates the governing body of insurance council to choose the
insurance ombudsman. The Insurance council includes the members of
life insurance council, and the general insurance council is formed under
section 40C of the Insurance Act,1938. Some representatives of
insurance companies form the governing body of insurance council.
Eligibility and term of service - Officials from insurance industry, civil

services and judicial services are chosen as the insurance ombudsmen.
The ombudsman changes every three years and retires from the post at
sixty-five years of age. Insurance ombudsmen cannot be re-appointed.

Territorial jurisdiction of ombudsman - Presently, in different states of

India, there are around 12 insurance ombudsmen appointed by the
governing body. These ombudsmen may hold meetings with the insured
persons in their corresponding areas of jurisdiction, in order to speed up
and resolve their grievances. Currently, the offices of the insurance
ombudsmen in India are located at Bhopal, Bhubaneswar, Cochin,
Guwahati, Chandigarh, New Delhi, Chennai, Kolkata, Ahmedabad,
Lucknow, Mumbai and Hyderabad.
Office Management - The insurance council provides the office of the
insurance ombudsman, and it consists of the secretarial staff, which
supports the ombudsman in carrying out duties. The total expenses of
this office are decided by the governing body, and are provided by the
insurance companies of the insurance council.
Removal from office - An insurance ombudsman can be removed from
office on committing a gross misconduct during the three years of
service. The governing body selects a person fit to do a detailed enquiry
and investigation about the misconduct and all these details are given to
the Insurance Regulatory and Development Authority (IRDA). IRDA then
takes a decision regarding the action to be taken against the guilty
ombudsman.
Power of ombudsman
The two main functions of the insurance ombudsman are:
Addressing and solving the issues of the insured persons and
insurance companies - The insurance ombudsman helps any person
who has a complaint against the insurance company. The complaints
can be of various types:
o Issues regarding any partial or total denial of claims by the
o Issues with regard to payment of premium in terms of the policy.
o Disputes on the legal structuring of the policy statements which
resulted in disputes related to claims.
o Delay in resolution of claims.
o Delay in issuance of any insurance papers to customers after
acceptance of premium.

Awarding a payment to the insured persons - The insurance

ombudsman can issue up to Rs. 20 lakhs as awards to the insured
persons. The corresponding insurance companies are obliged to credit these
awards within three months.
Method of lodging complaint
The complainant should submit a written complaint to the insurance
ombudsman of the jurisdiction, where the insurance company is situated. The
legal heirs of the insured person can also lodge the complaint to the insurance
ombudsman.
Some rules to be followed while sending the complaint are:
The insured person should approach the ombudsman: If the
insurer rejected the complaint.
It the complainant has not received any reply within a month after the
insurer has received his complaint.
If the insured person is not satisfied with the reply of the insurer.
The insured person should complain to the ombudsman within a year
after the insurer had replied.
The insured person should not bring any complaints to the ombudsman,
if the same complaint is pending with any court, consumer forum or
intermediary.
Recommendations of the ombudsman
The ombudsman suggests the solution to the complaint with regard to the
conditions of the case. The solution to the case is found within a month. The
office staff sends the copies of the complaint and solution to the complainant
and the insurer. The complainant can send a written acceptance if the
solution proposed by the ombudsman is agreeable within 15 days of
receiving the communication of the proposed solution.
Awards
The insurance ombudsman issues an award to the insured person within
three months from the reception of the complaint. These awards are
obligatory for the insurance companies. If the applicants are not content with
this award, they may approach the courts of law or consumer forums from a
revision of the complaint. To readdress this complaint the insurer has to
inform the insured person under which jurisdiction the insurance
Ombudsman office falls. If the number of complaints and cases solved by an

insurance ombudsman is more, then it shows that the insured person has more
confidence in the institution of insurance ombudsman.
10. A committee consisting of the Chairman of IRDA, Chairman of LIC,
Chairman of GIC and a representative of the Central Government
suggests the governing body of insurance council to choose the
insurance ombudsman. (True/False).
11. The total expenses of office of the insurance ombudsman are decided
by the governing body and are provided by the policyholders of the
insurance companies. (True/False).
12. In case of misconduct by the insurance ombudsman, ___________
will make a decision regarding the action to be taken against the
Ombudsman.
a) IRDA
b) ICICI
c) LIC
d) IAI
13.6 Summary
This unit discussed about the management and investment of funds by
insurance companies. The insurance company invests the income from the
policyholders premiums, in various ways, to achieve a profit, and to help the
insured person from any unexpected losses.
The financial managers of the insurance company should invest the
companys funds wisely in order to get maximum profit from the investment and
reimburse the money for an insured person in case of a loss.
The major financial objectives of an insurance company are:
Profitability - This objective increases the returns to the stakeholders
and determines the insurers ability to manage the business.
Solvency - This ensures the capability to meet the financial
requirements.
The investment of funds is in accordance to the policy chosen by the
applicants. The policy can be life or non-life, long term or short term. The
insurance company can make investments in:
Government bonds.

Public sector undertaking bonds.

Corporate bonds.
Financial institutions and banks.
Emerging markets bonds.
Tax-savings bonds.
These investments are subjected to certain regulations. There are
regulations in life, general, pension and annuity insurance businesses. In
2001, the IRDA investment regulations were amended by the Insurance
Advisory Committee to update the investment regulations for insurance
companies in India. There were 14 modifications made to the Insurance
Regulatory and Development Authority (Investment) Regulations, 2000.
In 1998, Government of India formed the institute of insurance ombudsman to
address the complaints of insured persons against the insurance
companies. The roles and functions of the institution of insurance
ombudsman include:
Appointment of Insurance ombudsman - A committee consisting of
the Chairman of IRDA, Chairman of LIC, Chairman of GIC and a
representative of the Central Government suggests the governing body
of insurance council to choose the insurance ombudsman.
Eligibility and term of service - Officials from insurance industry, civil
services and judicial services are chosen as the insurance ombudsmen.
Every three years the ombudsman changes and they retire at the age of
sixty-five years.
Territorial jurisdiction of ombudsman - Currently, the offices of the
insurance ombudsmen in India are located at Bhopal, Bhubaneswar,
Cochin, Guwahati, Chandigarh, New Delhi, Chennai, Kolkata,
Ahmedabad, Lucknow, Mumbai and Hyderabad.
Office Management - the insurance council provides the office of the
insurance ombudsman and it consists of the secretarial staff which
supports the ombudsman to carry out his duties.
Removal from office - The governing body selects a person fit to do a
detailed enquiry and investigation about the misconduct and all these
details will be given to the Insurance Regulatory and Development
Authority which will take a decision regarding the action to be taken
against the Ombudsman.

The powers of ombudsman include:

Addressing and solving the issue of the insured persons and insurance
companies.
Awarding a payment to the insured persons
13.7 Glossary
Reinsurance: Reinsurance involves protecting the insurance company
against a certain portion of potential losses.
Face value: In bond investing, face value is commonly referred to the
amount paid to a bondholder at the maturity date.

1. What is the financial objective of an insurance company?
2. What are the different types of investments in India?
3. What are the regulations to be followed while investing?
4. List the changes made in the third and fourth regulations in the
Insurance Regulatory and Development Authority (Investment)
(Amendment) Regulations, 2001.
5. Describe the roles and functions of the institution of insurance
ombudsman.
13.9 Answers
1. True
2. Corporate bonds
3. b) - Emerging bonds
4. True
5. c) - 20
6. 25
7. Insurance Advisory Committee
8. True
9. General business, reinsurance business
10. True
11. False
12. a) - IRDA

Terminal Questions
1. The major financial objectives of an insurance company include
profitability and solvency. Refer section 13.2.1 for more details.
2. The investment of these funds is in accordance to the policy chosen by
an applicant. Refer section 13.2.3 for more details.
3. Life, general, pension and annuity insurance businesses have insurance
regulations. Refer section 13.3 for details.
4. The insurers should make an effort to keep a balance between
infrastructure sector investments and social sector investments. Refer
section 13.4 for more details.
5. The roles and functions of the institution of insurance ombudsman
ranges from appointment of the ombudsman to the rewarding of insured
persons. Refer section 13.5 for more details.
13.10 Case-Let
Ombudsman (Claims Settlement)
This case study is about a Mediclaim settlement by an insurance
ombudsman.
Complainant - Mr. A, who along with his wife Mrs. A had taken a
Mediclaim Policy for the period 30.03.2008 to 29.03.2009 with New India
Assurance Company Ltd for a sum insured of Rs. 1, 00,000 each.
Complaint - The Complainant preferred a mediclaim for his wifes
hospitalisation at CJC Group of Hospitals from 27.05.2008 to 15.06.2008
for her Renal Failure and Hyperuricemia. She was again hospitalised in the
same hospital from 30.08.2008 to 15.09.2008 for Hyponatremia with
metabolic disorder. As the business was serviced through Third Party
Administrator, the Insurance Company referred the matter to the TPA who
after processing the same informed the Complainant that his claims were
rejected as the disease of Hypertension which induced chronic renal
failure was not disclosed prior to taking the policy.
Case intervention - Not satisfied with the decision of the Company the
complainant, Mr. A approached insurance ombudsman to intervene in the
matter. The ombudsman checked all the records of both the parties in the
dispute and called for hearing. On a further scrutiny of the records
submitted it was observed that the hospital record was very specific in

mentioning the 15 years hypertension. It was later corrected by Dr. S in

his own capacity to certify that it was for 8 years which was again rectified
to 5 years with his initial. The ombudsman approached the Medical
Superintendent of CJC Group of Hospitals for further verification and
found that there had been an attempt to tamper with the duration of
hypertension because the claim was rejected by the company on that
ground and there was a desperate attempt to revive the case only through
revision of the earlier statement. Unfortunately, this was the base of the
dispute on which the claim rested and only on this ground the entire claim
could be repudiated.
Ombudsmans solution - Considering the fact that the patient was of
advanced age and had been insured since 1991 and did not claim under
the policy before this claim which earned her maximum cumulative bonus
of 50%, the ombudsman sympathetically viewed the lapse as an over
enthusiasm to get the claim at any cost. He decided that 15 years
hypertension should be taken to be within the policy period thus making
the claim admissible but only 50 % of payment shall be made to meet the
ends of justice.
1. Why did the insurance company deny Mr. As claim?
(Hint - Claims were rejected as the disease of Hypertension which
induced chronic renal failure was not disclosed prior to taking the
policy.)
2. What were the factors considered by the ombudsman to take a
decision regarding the case?
(Hint - The patient was of advanced age and had been insured since
1991)
Source: http://eiblhealth.com/default2.aspx?oc=ombudsman.html
References
House, India.
Palande P.S, Shah R. S (2003). Insurance in India - Changing Policies
and emerging Opportunities, Response Books, New Delhi, India.

E-References
http://www.economywatch.com/bonds/government/
http://www.economywatch.com/indianeconomy/indian-insurance-
companies.html
http://www.ehow.com/about_5628255_types-bonds-india.html
http://www.indianinsurance.com/forums/showthread.php?p=328
http://www.irdaindia.org/pressnoteinsomb11feb05.htm

Unit 14 Reinsurance
Structure:
14.1 Introduction
Objectives
14.2 Overview of Reinsurance
14.3 Reasons for Reinsurance
Increase underwriting capacity
Stabilise profit
Reduce the unearned premium reserve
Provide protection against a catastrophic loss
Other reasons for reinsurance
14.4 Types of Reinsurance
Facultative reinsurance
Treaty reinsurance
14.5 Alternatives to Traditional Reinsurance
Securitisation of risk
Catastrophe bonds
14.6 Summary
14.7 Glossary
14.9 Answers
14.10 Case-Let
14.1 Introduction
The previous unit discussed about the management of funds and their
investments by insurance companies. It explained the regulations related to
investment and also IRDA regulation of 2001. It also discussed about the
insurance ombudsman insurance creation and their roles and functions. This
unit will discuss about reinsurance.
Reinsurance is a kind of insurance. It is an important operation of insurance. It is
the movement of a part or the whole insurance policy from one insurer to
another insurer. In this the reinsurer assures the cedant insurer for a
specific portion of a particular type of insurance claims that the cedent
insurer pays for any insurance policy or a set of policies.

This unit covers the reinsurance and gives the reasons for reinsurance. It
explains the types of reinsurance. It gives an idea about the treaties and
agreements of reinsurance. It also includes alternatives to traditional
reinsurance.
Objectives:
define reinsurance
explain the different types of reinsurance
analyse the treaties and agreements of reinsurance
describe the alternatives for traditional reinsurance
14.2 Overview of Reinsurance

Reinsurance is the transaction in which one insurer agrees to pay a
premium of another insurer either a part of the policy or the whole policy.
The insurance company that purchases reinsurance is called as the ceding
insurer and the company selling the reinsurance is called as reinsurers or
the assuming insurer. It can also be known as the insurance of insurance.
The amount of insurance the ceding company retains for its own account is
called the retention limit or the net retention. The amount of the insurance
policy that is ceded to the reinsurer is called as the cession. The
reinsurance of the risk involved either a part of it or the whole risk is called
retrocession. In such cases the second reinsurer is called as the
retrocessionaire.
The purpose of reinsurance is to decrease the financial cost of the
insurance companies that arise from the possible occurrence of the
particular insurance claims. As an insurance company purchases an
insurance policy from any reinsurer just like an individual or company
purchases an insurance policy from an insurance company. Purchasing the
reinsurance coverage may reduce the reinsurance risk that the reinsurer
assumes for both the domestic as well as international insurance.
Reinsurance gives the reimbursement to the ceding insurer for the losses
covered by the reinsurance agreement. It improves the basic objectives of
the insurance for spreading the risk so that no single unit finds itself loaded
with a financial burden beyond its ability to pay. Reinsurance can either be

acquired directly from a reinsurer or through a broker or reinsurance

intermediary.
1. The insurance company that purchases reinsurance is called as the
________________ insurer.
2. The amount of insurance the ceding company retains for its own
account is called the retention limit. (True/False).
3. Reinsurance gives the _______________________ to the ceding
insurer for the losses covered by the reinsurance agreement.
14.3 Reasons for Reinsurance

The previous section discussed about the overview of reinsurance. This
section will discuss about the reasons for reinsurance.
The insurance business is basically risky because this is a business that is very
sensitive to losses and when these losses occur they occur with an
unreliable frequency. In case of new and small insurance company the
probability of these losses are more and when old and existing insurance
companies underwrite some new business also the loss occur. In such
cases some amount of their insurance risk cover should be reinsured so as
ensure that the risks are spread.
Reinsurance allows the insurer to retire from an area or class of business and to
get the underwriting advice from the reinsurer. Reinsurance is used for many
reasons. Some of the important reasons include:
Increase underwriting capacity.
Stabilise profit.
Reduce the unearned premium reserve.
Provide protection against a catastrophic loss.
14.3.1 Increase underwriting capacity
The underwriting capacity is the highest amount of exposure that an
insurance company can underwrite. The companys retained earnings, paid-
in capital or other forms of capital support generally determine the limit.
Reinsurance helps in increasing the companys underwriting capacity. This
is done by decreasing the companys exposure to a particular risk. It allows
the insurance companies to increase the highest amount that they can

insure for any given loss or any type of losses. This helps the insurance
companies to enable underwriting a number of risks, larger risks, without
increasing their need to cover their solvency margin, and also their capital
base.
The insurer may be asked to assume liability for losses in excess of its
retention limits. The agent or intermediary will have to place a large amount of
insurance with many insurance companies if there is no reinsurance. This is not
good and creates a bad impression on the policyholder. Reinsurance permits
the insurance company to issue a single policy in excess of its retention limit
for the full amount of insurance.
14.3.2 Stabilise profit
The insurance companies often seek to reduce the wide fluctuation in profit
and loss margins that is inbuilt in the insurance business. These fluctuations
result partly due to the exclusive nature of the insurance, this involves
pricing of a product whose real cost will not be known until sometime in the
future. The insurance companies can decrease the changes in loss with the
help of reinsurance and thus stabilise the overall operating results of the
companies.
Reinsurance can be used to stabilise profits. An insurance company
possibly will want to avoid huge amount of fluctuations in the yearly financial
result. The changes in the economic and social conditions, natural disasters and
chance can lead to fluctuation in loss. Thus reinsurance helps in stabilising
the effects of the loss that an insurance company experience. Reinsurance
can be used to cover a large exposure. For instance, if an insurance
company undergoes a huge unexpected loss then the reinsurer pays a part of
the loss in excess to a specified limit. Another arrangement the reinsurer
make is that it reimburse the losses of the ceding insurer if it exceeds the
specified loss ratio for a year.
14.3.3 Reduce the unearned premium reserve
When any insurance company sells a policy, the whole amount of the
premium is transferred to the unearned premium reserve as specified by the
law. Premiums are paid for the insurance coverage in future, therefore when
an exact amount of time is passed during the coverage the premium is
earned. However, the insurance company cannot use the money in the
unearned premium reserves for its own expenses. For example, if an

insured pays Rs.12,000 per year for health insurance, then the insurance
company can transfer Rs.1,000 every month from the unearned premium
reserve to a general account which the insurance company uses to pay its
expenses. Besides this the insurance company has more expenses in the first
year of its existence like giving commissions to the sales agent and
administrative processing and other expenses. While determining the size of the
unearned premium reserves, the allowance for the first year purchase
expenses are not considered and the insurance company has to pay this from
its surplus amount.
Reinsurance reduces the unearned premium reserve that an insurance
company needs according to the law and it increases the surplus position of
the insurer. Accordingly the ratio of the policyholders surplus to that of the
net premium is enhanced and this allows the insurer to grow. Therefore it
helps the insurer to expand its business in a faster manner. For some
insurers particularly the new and small ones these unearned reserves that is
needed may restrict the capability of writing large amount of the new
insurance policy that is it restricts the ability of the insurers growth. This is
because the whole gross premium should be placed in the unearned
premium reserves when the policy is written for the first time. The unearned
premium reserve is a liability item on the balance sheet of any insurance
company. This shows the unearned portion of the gross premiums on all the
outstanding policies at the time of evaluation.
The unearned premium reserves indicate the fact that the premiums are paid
in advance and the period of protection is not expired. As the time passes a
part of the premium is considered as earned whereas the remaining part is
considered as unearned. Only after the completion of the protection period, the
premium is considered as fully earned.
14.3.4 Provide protection against a catastrophic loss
Reinsurance also gives protection against a catastrophic loss in the same way
as it helps in stabilising an insurer's loss experience. Insurers often
experience catastrophic losses due to industrial explosion, natural
calamities, and similar events. Reinsurance can provide some amount of
protection to the ceding company that undergoes catastrophic losses. The
reinsurer pays some amount of loss or the entire loss of the ceding
company that is going beyond the maximum limit.

To protect against the catastrophic loss, insurers use reinsurance in the

following two ways:
The first is to protect against catastrophic loss that are resulting from a
single event, like the loss that a large manufacturing plant suffers due to
fire accident.
On the other hand, insurers also request reinsurance for the protection
against the collection of many smaller claims that results from a single
event and affects many policyholders at the same time like a major
hurricane, volcano or an earthquake. The insurer is able to pay for the
losses individually, but when the losses are combined together, it may
be finally more than what the insurer wishes to retain.
The disruptive effect that the catastrophic loss has on the insurer can be
reduced by carefully using the reinsurance. The decisions that a company
makes while purchasing a catastrophe coverage is exclusive to every
individual company and varies extensively form one company to another
depending on the type and size of the company that is purchasing the
reinsurance and the risk that it has to reinsure.
14.3.5 Other reasons for reinsurance
Any insurer can make use of reinsurance when they want to retire either from
the business or from some insurance policies. Reinsurance allows the insurers
to transfer their liabilities to another carrier so that the policyholders coverage
remains the same. It can allow an insurer to provide the underwriting
advice and assistance of the reinsurer. The reinsurer can often provide valuable
assistance with respect to rating, retention limits, policy coverages and other
underwriting details.
Activity: 1
Analyse what would happen to insurance companies if there were no
reinsurers.
(Hint: Refer - http://www.irmi.com/expert/articles/2010/schiffer01-
insurance-reinsurance-law.aspx).

4. Reinsurance allows the insurer to retire from an area or class of
business and to get the ______________________ advice from the
reinsurer.
5. ______________________ helps in increasing the companys

underwriting capacity.
a) Reinsurance
b) Insurance
c) Banks
d) Investors
6. The insurance companies can increase the changes in loss with the
help of reinsurance and thus stabilise the overall operating results of the
companies. (True/False).
14.4 Types of Reinsurance

The previous section discussed about the reasons for reinsurance. This
section will discuss the different types of reinsurance.
The two different types of reinsurances are:
Facultative reinsurance.
Treaty reinsurance.
14.4.1 Facultative reinsurance
It is a type of reinsurance that is optional; it is a case-by-case method that is
used when the ceding company receives an application for insurance that
exceeds its retention limit. It is based on the individual agreements that help
to cover specific losses. When any primary insurer wants reinsurance for a
specific coverage, it enters the market, and bargains with different
reinsurance companies for the amount of coverage and premium, looking
out for a better value. According to most of the contracts, the reinsurer pays
a ceding commission to the insurer to pay for purchase expenses.
Before issuing the insurance policy the insurer looks for reinsurance and
speaks to many reinsurers. The insurance company does not have any
commitments to cede insurance and also the reinsurer has no commitments
to accept the insurance. However if the insurance company find a reinsurer
who is willing to take the insurance policy then they can enter into a
contract.
Facultative reinsurance is used when a huge amount of insurance is
preferred and while considering a specific risk involved in an individual
contract. Facultative reinsurance is the reinsurance of a part of a single
policy or the entire policy after negotiating the terms and conditions. It
reduces the risk exposure of the ceding company against a particular policy.
Facultative reinsurance is not mandatory.
One advantage of facultative reinsurance is it is flexible as a reinsurance
contract is arranged to fit any kind of cases. It helps the insurance
companies in writing large amount of insurance policies. Reinsurance
moves the huge losses of the insurers to the reinsurer and thus helps the
insurer.
One main disadvantage of facultative reinsurance is that it is not reliable. The
ceding insurer will not know in advance whether a reinsurer will agree to pay
any part of the insurance. The other disadvantage of this kind of
reinsurance is the delay in issuing the policy as it cannot be issued until the
reinsurance is got for that policy.
14.4.2 Treaty reinsurance
Treaty reinsurance is one in which the primary insurer agrees to cede the
insurance policy to the reinsurer and the reinsurer has to accept it. It
includes a standing agreement with a specific reinsurer. The amount of
insurance that the primary insurer sells and those policies where both the
parties provide the service is specified in the contract. All the business that
comes under the contract is automatically reinsured according to the
conditions of the treaty.
Treaty reinsurance needs the reinsurer to assume the entire responsibility of the
ceding company or a part of it for some particular sections of the business
with respect to the terms of the policy. The contract is a compulsory
contract because according to the treaty the ceding company has to cede the
business and the reinsurer is compelled to assume the business. It is a type
of reinsurance that is preferred while considering the groups of homogenous
risks.
The treaty reinsurance provides many advantages to the primary insurance
company. It is automatic, more reliable, and there is no delay in issuing the
policy. It is also more cost effective as there is no need to shop around for
reinsurers before writing the policy.
The treaty reinsurance is not advantageous to the reinsurer. Usually the
reinsure does not know about the individual applicant of the policy and has
to depend on the underwriting judgment that the primary insurer gives. It

may be so that the primary insurer can show bad business like more losses and
get reinsured for it as the reinsurer does not know the real fact. The primary
insurer may pay insufficient premium to the reinsurer. Therefore the reinsurer
undergoes a loss if the risk selection of the primary insurer is not good and they
charge insufficient rates.
There are different types of treaty reinsurance arrangements which may differ
according to the liability of the reinsurer. They are:
Quota-share treaty.
Surplus-share treaty.
Excess-of-loss treaty.
Reinsurance pool.
Quota-share treaty - According to this treaty the reinsurer and the ceding
insurer agree to share a fixed percentage of premium and also losses
depending on some proportion. Therefore because of this the quota share
treaty is also called proportional reinsurance.
For instance, the primary insurer can take a decision of retaining around
70% of the new business with it and transferring the rest 30% to the
reinsurer. Accordingly, it also divides the expenses, incomes and losses in
the same proportion. The ceding insurers retention limit is stated as a
percentage. Premiums are also shared in the same proportion as agreed in
the treaty. A ceding commission is paid to the primary insurer by the
reinsurer that helps in balancing the expenses that it encountered while
writing the business.
The major advantage of the quote-share treaty is that it permits the primary
insurer in reducing its unearned premium reserve considerably by
transferring a lot of profitable business to the reinsurer.
Surplus-share treaty - This is an agreement that shares some of the
qualities of the quote-share and excess-of-loss treaties. According to this
treaty the reinsurer accepts the insurance in excess to the ceding insurers
retention limit. If the amount of any insurance policy is more than the
retention limits, then the reinsurer pays the excess amount up to a specified
maximum limit. The loss and premium are shared among the primary
insurer and the reinsurer in the same proportion.

The major advantage of the surplus-share treaty is that it increases the

underwriting capacity of the primary insure.
The major disadvantage of this treaty is that the coverage that a reinsurer
provides for each policy has more record keeping and thus creates more
administrative expenses.
Excess-of-loss treaty - This treaty is largely designed for providing
protection against the catastrophic losses. It is an agreement where the
reinsurer covers only the losses that are more than the retention limit of the
primary insurer. This coverage is obtained mainly for covering the
catastrophic losses. This treaty can be written to cover:
1) A single occurrence.
2) A single exposure.
3) Excess losses when the primary insurers total losses exceed some
amount during some started time period.
Reinsurance pool - The reinsurance pool also provides reinsurance. It is an
organisation of insurers that underwrites insurance on a joint basis. These
are formed as a single insurer possibly will not be financially able to write huge
amount of insurance policies, however a group of insurers can combine their
financial resources and get the financial ability to write the huge insurance
policies.
These pools are created to provide coverage for nuclear accidents, aviation
disasters and exposure in foreign countries where losses can be
catastrophic and that could easily exceed the financial capability of any
single insurer.
The method of sharing premiums and losses are different for different types of
reinsurance pools. The pool works in the following two different ways:: First all the
members of the pool decide to pay some percentage of amounts for every loss
that occurs.
Second the agreement is same as that of the excess-of-loss reinsurance
treaty.

Activity: 2
Analyse the advantages and disadvantages of each type of
reinsurance.
Hint: Refer- http://www.indianmoney.com/moneyschool/money-gyan-
articles . php? cat_ id= 1&sub _id= 15& aid = 346 & acat =& page _id =
3&ahead=Types%20of%20Reinsurance%20%20&subcat=2
7. ____________________________ is a type of reinsurance that is
optional; it is a case-by-case method that is used when the ceding
company receives an application for insurance that exceeds its
retention limit.
8. According to ________________________ treaty the reinsurer and the
ceding insurer agree to share a fixed percentage of premium and also
losses depending on some proportion.
a) Surplus-share treaty
b) Excess-of-loss treaty
c) Quota-share treaty
d) Reinsurance pool
9. ________________________ is an organisation of insurers that
underwrites insurance on a joint basis.
10. Treaty reinsurance needs the insurer to assume the entire
responsibility of the ceding company or a part of it for some particular
sections of the business with respect to the terms of the policy.
(True/False).
11. A _____________________ is paid to the primary insurer by the
reinsurer that helps in balancing the expenses that it encountered while
writing the business.
12. The reinsurance pools are formed as a single insurer possibly will not
be financially able to write huge amount of insurance policies, however
a group of insurers can combine their financial resources and get the
financial ability to write the huge insurance policies. (True/False).
14.5 Alternatives to Traditional Reinsurance

The previous section discussed about the types of reinsurance. This section will
discuss about the alternatives to traditional reinsurance.

The level to which the reinsurance arrangements change depends on the type
of risks that they cover. The property and casualty sector continues to have
some reliable purchaser of reinsurance. The top 10 purchasers of
professional liability coverage now reinsure 60 percent less risk compared to that
in 2004. Therefore this shows that something is happening to reduce the
market need for traditional reinsurance.
There are some alternatives to traditional reinsurance that have increased in
recent years. These involve the use of alternative risk transfer by means of
the capital markets. The major insurance companies are increasingly
investigating the use of investment vehicles like catastrophe bonds.
Some insurers and reinsurers are using the capital market as an alternative to
traditional reinsurance. Capital markets can offer an alternative
reinsurance to the traditional risk transfer. The differences are depending on a
variety of deal structures. The financial ability of the casualty and property
industry in paying the catastrophic losses from the natural disasters like
earthquake, hurricanes etc are limited to a certain extent. Some insurers and
reinsurers use the capital market to increase the access to the capital of
institutional investors instead of relaying only on the financial ability of the
insurance industry to pay for the catastrophic risks.
14.5.1 Securitisation of risk
There is an increasing use of the securitisation of risk to obtain funds to pay for
catastrophe loss. The traditional methods that were used for risk
management and transfer in the insurance industry is reinsurance. Although
more recently securitised alternatives like bonds, options, and swaps have
become available.
Securitisation of risk means that an insurable risk is transferred to the capital
markets by creating financial instruments like catastrophic bonds and other
financial instruments. These are securities that transfer insurance related
risks to the capital markets. Among the different financial institutions the
insurance companies were the first to experiment on the securitisation of
risk.
14.5.2 Catastrophe bonds
Catastrophe bonds are one of the good examples of securitisation of risk.
These are the corporate bonds that allow the issuer of the bond to miss the

payment schedule if there are any catastrophic losses. These are an

alternative to insurance that allows to transfers risk to investors instead of
transferring it to the insurers.
Catastrophic events like hurricanes and earthquakes are the major risks that
insurers and reinsurers face. These risks may result in big losses and
financing problems. Reinsurance contracts are the only way that is used for
protecting these losses form a long time. As an alternative to the traditional
reinsurance contracts, new risk transfer instruments have emerged since
the early 1990s. The introduction of these new instruments came together
with the availability of new products that determined the payoff of the
contract. The payoffs of the traditional reinsurance contracts' depends on
the loss that the policyholder understand. Therefore new risk transfer
instruments where introduced as an alternative to this. According to these
instruments the payoffs depends on the index or parametric triggers. A well-
known example for such a contract is catastrophe (cat) bonds.
Catastrophe bonds are complex financial instruments that an insurer and a
reinsurer can issue to spread risk, so as to protect their own balance sheets
when there is an occurrence of large scale expense like the one caused due
to some natural disasters. Therefore the insurers reassure the policy
holders. These bonds pay relatively huge interest rates and help the
investors to expand their portfolios as natural disasters occur accidentally
and are not connected with the economic factors and stock market.
13. The level to which the reinsurance ____________________ changes
depends on the type of risks that they cover.
14. There is an increasing use of the securitisation of risk to obtain funds to
pay for catastrophe loss. (True/False).
15. ___________________________ are complex financial instruments
that an insurer and a reinsurer can issue to spread risk, so as to protect
their own balance sheets when there is an occurrence of large scale
expense like the one caused due to some natural disasters.
14.6 Summary
This unit discussed about the importance of reinsurance in the insurance
industry.

Reinsurance is the transaction in which one insurer agrees to pay a

Reinsurance allows the insurer to retire from an area or class of business and
to get the underwriting advice from the reinsurer. Reinsurance is used for the
following reasons:
Increase underwriting capacity - The underwriting capacity is the
highest amount of exposure that an insurance company can underwrite.
Reinsurance helps in increasing the companys underwriting capacity.
Stabilise profit - The insurance companies often ask for the reduction
of the wide fluctuation in profit and loss margins that is inbuilt in the
insurance business. Reinsurance can be used to stabilise profits.
Reduce the unearned premium reserve - When any insurance
company sells a policy the whole amount of the premium moves in to the
unearned premium reserve which is needed as per the law.
Reinsurance reduces the unearned premium reserve that an insurance
company needs according to the law and it increases the surplus
position of the insurer.
Provide protection against a catastrophic loss - Reinsurance also
gives protection against a catastrophic loss in the same way as it helps
in stabilising an insurer's loss experience.
The two different types of reinsurances are:
Facultative reinsurance - It is a type of reinsurance that is optional, it
is a case-by-case method that is used when the ceding company
receives an application for insurance that exceeds its retention limit.
Treaty reinsurance - Treaty reinsurance is that where the primary
insurer agrees to cede the insurance policy to the reinsurer and the
reinsurer has to accept it.
The different types of treaty reinsurance arrangements which may differ
according to the liability of the reinsurer are:
Quota-share treaty - According to this treaty the reinsurer and the
ceding insurer agree to share a fixed percentage of premium and also
losses depending on some proportion.

Surplus-share treaty - This is an agreement that shares some of the

qualities of the quote-share and excess-of-loss treaties.
Excess-of-loss treaty - This treaty is largely designed for providing
protection against the catastrophic losses.
Reinsurance pool - The reinsurance pool also provides reinsurance. It
is an organisation of insurers that underwrites insurance on a joint basis.
Some insurers and reinsurers are using the capital market as an alternative to
traditional reinsurance. The tools used were:
Securitisation of risk.
Catastrophe bonds.
14.7 Glossary
Surplus: It is the difference between the value of the product produced
by labor and the actual price of labor as paid out in wages in Marxian
analysis of capitalism.
Catastrophic loss: It is the loss in excess of the working layer, usually
of such magnitude as to be difficult to predict and therefore rarely self-
insured or retained.
Ceding insurer: Is the insurance company that purchases reinsurance.
Retrocession: Is the reinsurance of the risk involved in the insurance
policy either a part of it or the whole risk.

1. Discuss the overview of reinsurance.
2. Explain the reasons for reinsurance.
3. What are the different types of reinsurance? Explain.
4. Explain the alternatives used to replace the traditional reinsurance.
5. Explain the Catastrophe bonds.
14.9 Answers
1. Ceding
2. True

3. Reimbursement
4. Underwriting
5. Option a. Reinsurance
6. False
7. Facultative reinsurance
8. Option c.Quota - share treaty
9. Reinsurance pool
10. False
11. Ceding commission
12. True
13. Arrangements
14. True
15. Catastrophe bonds
Terminal Questions
1. Reinsurance is the transaction in which one insurer agrees to pay a
This is discussed in the section 14.2 of this unit. Refer the same for
details.
2. Reinsurance allows the insurer to retire from an area or class of
business and to get the underwriting advice from the reinsurer.
Reinsurance is used for many reasons and these reasons are explained
in the section 14.3 of this unit. Refer the same for details.
3. There are mainly two different types of reinsurances are facultative
reinsurance and treaty reinsurance. These are explained in the sections
14.4.1 and 14.4.2 of this unit. Refer the same for details.
4. There are some alternatives to traditional reinsurance that have increase
considerable momentum in recent years. These are like the use of
alternative risk transfer by means of the capital markets. This is
5. Catastrophe bonds are one of the good examples of securitisation of
risk. These are the corporate bonds that allow the issuer of the bond to
miss the payment schedule if there are any catastrophic losses. This is
explained in the section 14.5.2 of this unit. Refer the same for details.

14.10 Case-Let
Reinsurance by General Insurance Company of India.
The General Insurance Corporation of India (GIC) planned in December
2009 to increase reinsurance premiums on aviation risk that covers
about 10 to 15 percent in April.
Economic woes
The recommended increase in aviation insurance premium added to the

burden of the global aviation sector that was already hit hard by
economic slowdown. A number of aviation accidents that had taken
place worldwide in 2009 prompted reinsurers across the world to
consider increasing their rates.
These accidents include the Air France flight 447 crash, Colgan Air,
Turkish Airlines and Yemenia Airways' plane crashes and the Caspian
Airlines flight 7908 (Iran) accident.
GIC that offers around 90 per cent of its total aviation reinsurance
contracts to the foreign airlines also experienced some losses in some of
these cases. For instance in the Air France accident, it had claim
exposure of 5 million dollar, which had already been paid reported a
senior officer of GIC.
Out of the total reinsurance premium of Rs 8,000 crore that GIC earned
in the year 2009, nearly Rs 500 crore came from the aviation sector.
Domestic airlines
There were also some accidents even in some of the domestic airlines in
the same year. In two such incidents, insurance claims had emerged
from Air India and Kingfisher Airlines. The domestic airline companies
also take a considerable portion of insurance coverage from the foreign
reinsurers. For example only about 10 percent of the total 23-million
dollar annual premium paid by Air India was reinsured by the GIC and
the rest of the amount was reinsured by international reinsurers.
A large portion of the domestic aviation insurance business comes from
the insurance covers for corporate aircraft and helicopter, a senior officer
in National Insurance Company said. The reinsurance rate for aviation

cover has increased only marginally over the last couple of years. But we
anticipate both GIC and foreign reinsurers to increase the rates for
2010-11. The reinsurance premium rate for the aviation insurance
differs between 0.18 and 0.23 percent.
The senior officer of National Insurance Company also stated that the
commission that the insurance companies got from this aviation
insurance business was about 15-20 percent. The aviation reinsurance
rates are mostly governed by the London market, which has large
players such as Global Aerospace Agency, Catlin Syndicate, Ace and
Aspen Re.
The GIC sources said that the reinsurance rates for all other categories of
general insurance policies apart from the aviation insurance are
expected to remain unchanged in 2010-11.
1. What are the economic woes that the GIC faced in 2009?
(Hint: Refer Economic woes section of the case study.)
2. What did the senior officer of the National Insurance Company say
regarding the aviation reinsurance?
(Hint: The reinsurance rate for aviation cover has increased only
marginally over the last couple of years. But we anticipate both GIC
and foreign reinsurers to increase the rates for 2010-11.).
Source: http://www.thehindubusinessline.com/2009/12/08/stories/
2009120852910600.htm
References
George E Rejda (2009): Risk Management and Insurance, Dorling
House, India.
E-References
http://www.casact.org/admissions/syllabus/ch7.pdf
http://www.finweb.com/insurance/7-types-of-reinsurance.html

http://www.indianmoney.com/moneyschool/money-gyan-
articles.php?cat_id=1&sub_id=15&aid=346&acat=&page_id=3&ahead=
Types%20of%20Reinsurance%20%20&subcat=2
http://ezinearticles.com/?Types-Of-Reinsurance-Policies&id=390055
http://www.economywatch.com/insurance/general/reinsurance.html
http://www.icai.org/resource_file/11213p1355-58.pdf
http://www.slideshare.net/rohitr6/final-pptdomain-study
http://www.wisegeek.com/what-is-the-reinsurance-treaty.htm

Unit 15 Information Technology in Insurance
Structure:
15.1 Introduction
Objectives
15.2 Application of Information Technology in Insurance Sector
Database management systems
Data warehouse
Decision support systems
Group support systems
Imaging and work-flow technologies
Mapping
Call centre technology
Video linking
Catastrophe models
Intranet, extranet and internet
15.3 Need for Information Technology in Insurance Sector
15.4 Role of Information Technology in Insurance
Marketing
15.5 Summary
15.6 Glossary
15.8 Answers
15.9 Case-Let
15.1 Introduction
In the previous unit, reinsurance, reasons for reinsurance and its types
along with treaties and arrangements were discussed. This unit will describe
about application of information technology in insurance sector. The need
and the role of IT in various sectors of insurance will also be covered in this
unit.
Insurance industry is facing a major economic and competitive challenge.
To succeed in the rapidly developing business climate insurers are forced to
investigate ways by which they can improve end product efficiency and drive
top-line growth, and still meet and go beyond the expectations of their
customers. The use and application of information technology in insurers
operations has a direct impact on the productivity of resources, and huge

impact on reducing the cost of various activities.
Objectives:
explain the application of information technology in insurance sector
describe the need for information technology in insurance sector
explain concepts of database management systems, decision support
systems, mapping, video linking, catastrophe models, intranet, extranet
and internet and so on
analyse how information technology is used for marketing, customer
knowledge and consumer service in the insurance sector
discuss the role of information technology in various insurance sector
15.2 Application of Information Technology in Insurance Sector

Today, information technology is applied in almost all the sectors, such as,
engineering, medicines, and so on. One such sector is the insurance sector. This
section covers brief explanation about the application of Information
Technology (IT) in insurance sector.
The evolutionary technological changes in the last decade has
revolutionised the entire insurance sector. With greater competition among
insurers, providing a better service has become a matter of concern.
Additionally, customers are getting more and more sophisticated and
inclined towards technology, so they do not want to accept the current value
proposals, and prefer personalised interactions and better service.
Managing the customer intelligently is extremely significant for the insurer,

especially in the competitive environment of today. Different set of rules and
strategies need to be applied by the companies for different customer
segments. Insurers need to capture customer information in an integrated
system, for enhancing personalised interactions.
With the increased use of internet and better access to direct policy
information, better techniques need to be developed, to provide customers a
truly personalised experience. Personalisation facilitates organisations in
producing new revenue through cross selling and up selling activities, and in
reaching their customers with more impact. Many organisations incorporate

knowledge database-repositories of content, to ensure that the customers

receive personalised information. This is done by installing a search engine,
which helps the customers to locate all document and information related to their
queries. Customers use the database to mange their products or the
company information, claim records, and histories of the service inquiry.
These products also use the customers information, when determining the
significance of the customers search request.
Information technology enhances the speed and competence with which
underwriters assess new applicants, and analyse aspects of their lives
affecting the carrier's proposed financial risk.
Some significant applications of IT in insurance sector will now be described in
this section.
15.2.1 Database management systems
A database is a collection of data (or facts) that are logically organised and
can easily be searched or manipulated. A database management system
(DBMS) is the group of computer software programs used for generating,
organising, retrieving, analysing, and sorting information in computer-based
databases.
The principles of tracking and measuring responses can pay off for the
conventional insurance industry. For the insurance industry, data and
documents are important, as the industry significantly depends on the
promises made on paper that are ultimately recorded into the databases. To
analyse the operations effectiveness, data is important, so that the cost of
operations can be managed in a better way. Acquisition of data in the
insurance industry uses new business management, HR, accounting,
distribution and policy management systems that make data available in
their individual data structures, in a combined way. The personal computer
and RISC (Reduced Instruction Set Computing) technology empowers
companies to keep millions of policies on a device with thousands of bytes
of data per policy or client. To maintain precision, data quality needs to be
constantly managed by checking, correcting and preventing data errors.
Using database technology, companies can get a comprehensive,
performance, loyalty, and lost opportunity.

Thus, it can be concluded that insurance companies depend on DBMS

(Database Management System), to maintain proper records or track of the
financial accounts of the respective customers.
15.2.2 Data warehouse
A data warehouse is a central storehouse for all or major parts of the data that
an enterprise's various business systems collect. Typically a data
warehouse is either a single computer or several computers (servers) tied
together to create one giant computer system. Data from various online
transaction processing (OLTP) applications and other sources is selectively
extracted and organised on the data warehouse database for use by
analytical applications and user queries.
Data warehouses analyse data in a different and new way with additional
information, fewer details and rapid access. Data warehousing technology is
based on integrating a number of information systems into a one stop
shopping database. The new data warehousing and mining products
guarantee to make it even easier for companies to analyse, and store
information for better understanding of their customers. The potential
benefits of data warehousing and data mining for the insurance industry are
similar in many respects to the benefits realised in other industries where data
warehousing is in widespread use.
In insurance sector, a data warehouse can produce a composite customer view
by linking customer information across lines of business. Relative analysis
and profiling can generate symbolic portfolios of insurance coverage.
Gap analysis helps in identifying customers who have potential needs. This
supports insurance marketing campaigns by outbound telemarketing, and
helps traditional field agents to sell more business into the existing customer
base. Data warehousing also facilitate the creation of better pricing strategies
for products. Ultimately, data warehousing will set the stage for the securitisation
of risk portfolios.
15.2.3 Decision support systems
A Decision Support System (DSS) is a collection of integrated software
applications and hardware that form the backbone of an organisations
decision making process. Insurance companies across all industries rely on
decision support tools, techniques, and models to help them assess and
resolve everyday business questions. Business Intelligence (BI) reporting

tools, processes, and methodologies are the chief components to any

decision support system, which provides end users with rich reporting,
monitoring, and data analysis facility. Insurance companies need to utilise
DSSs, by implementing data warehouses that pull information from existing
legacy systems into a customer information database. Such DSSs will equip
the insurance managers with the ability to allow for customised products and
services that are more in line with what customers want. Decision support
systems have become a necessity across all types of business including the
insurance business. In todays global marketplace, it is crucial that
companies react quickly to market changes. Companies with wide-ranging
and efficient decision support systems have a significant competitive
advantage.
15.2.4 Group support systems
Group Support System (GSS) is a set of techniques, software and
technology improve the communication, deliberations and decision-making of
groups.
Newly developed group technologies are attracting attention from
practitioners and researchers, as they assist and significantly improve the
quality of the decisions taken by companies. GSS potentially offer benefits in
the field of communications, productivity, and decision-making within an
organisation, by incorporating the input from various decision makers in a
timely manner. GSS are projected to assist a group of decision makers, who are
working to make better decisions, regardless of their physical locations with a
certain task. These systems utilise computer and communication
technologies processing, formulating and implementing a decision-making task
by a group of decision makers.
In insurance sector, GSS reduces communication barriers and introduce
order and efficiency into situations that are inherently disorderly and
inefficient. A GSS facilitates the process of decision-making in insurance
sector, and provides an apparent focus for organising attention around the
critical issues arising in insurance.
15.2.5 Imaging and work-flow technologies
Imaging and workflow technologies give financial services organisations a
distinct platform for managing customer transactions across multiple
products and delivery channels. In insurance, it enables the customers to

interact with the insurance company, whenever they want, and increases
customer satisfaction by quickly responding to queries and processing
requests.
Imaging and workflow technology also reduce processing times for loans,
insurance claims and other transactions, by automating business processes and
supporting full electronic lodgements. Flexible template-driven workflow
supports rapid response to business and market changes. Ensuring
regulatory compliance and meeting corporate governance requirements with full
audit trails, and a complete record of all customer interactions, is also an
advantage of this technology. The customers experience is more engaging,
personalised and consistent, leading to improved customer retention and
driving new opportunities for growth.
15.2.6 Mapping
Mapping is a technique used to collect geographical information using
sophisticated technologies that include computer systems and satellite
networks. Mapping helps to meet different needs, such as identifying loss
prone areas or geographic claim analysis can use mapping technology. It
helps the insurers to analyse the extent of the mapping network, and the
insurer can determine the extent of agency force present in a particular
area. Mapping technology further helps in designing the elevated societal
and governmental support, by understanding the major gaps in the form of
policy, institutional and infrastructural support. The elements of action
identified are effectively integrative, and they help the insurance companies
by enabling them to prepare a roadmap, for increasing knowledge
competitiveness through a series of technology driven measures, such as,
upgrading the applications of technology, networking, improving market
reach through, enhancing human capabilities, reducing cost, and increasing
usage of IT.
15.2.7 Call centre technology
A call center is a centralised office where calls from customer are handled by an
organisation, generally with some amount of computer automation. A call
centre is made operational by a company to administer incoming product
support or information inquiries from consumers. The majority of businesses
use call centres to interact with their customers.

Good customer service is a crucial element in gaining, maintaining and

retaining profitable customer. Call centre concept based on Interactive Voice
Response Services (IVRS) is gaining importance in this aspect. A call centre is
an enquiry system that provides information to customers through
telephone lines. It is a fully automated computerised exchange, but lacks
flexibility, as it provides answers to only predefined queries.
In insurance sector, call centre technology helps to capture and consolidate
customer interaction data and discover individual usage patterns of
consumers and their preferences from these interactions. Effective
communication strategies are also devised from these learnings, and then this
knowledge is adapted across multiple channels of communications for
improved insurance business results.
15.2.8 Video linking
Video linking is a set of interactive telecommunication technologies which
permit two or more locations to interact by means of two-way video and
audio transmissions simultaneously. It is a live connection linking people in
separate locations for the need of communication, usually involving audio, text
and video.
A video linking facility between two remote units of an insurance company or
between an insurer and a broker allows them to discuss risk inherent in a
proposal face to face. The core technology used in a video linking facility is
digital compression of audio and video streams in real time. In insurance
sector, video linking enables the individuals in faraway places to have
meetings on short notice. Time and money is saved, as instead of traveling
the time can be used to have short meetings. Technology which is popularly
known VoIP (Voice over Internet Protocol) is used in union with desktop
video linking to enable low-cost face-to-face insurance business meetings.
VoIP enables employees to work without leaving the desk, which is
beneficial for businesses with widespread offices. The technology also
facilitates telecommuting, in which employees work from home.
15.2.9 Catastrophe models
Catastrophe modeling is also known as cat modeling. It is the procedure of
using computer-aided calculations to approximate the losses that are
sustained by collective investments due to a catastrophic event such as a
hurricane or earthquake. Cat modeling is particularly applicable to analysing

risks in the insurance industry and is the union of actuarial science,

engineering, meteorology, and seismology.
Catastrophic models use data from the recent occurrences of natural
disasters that helps in the development of more predictions of insurers
property exposures in future disasters. These models provide a mechanism
to integrate and synthesise all the relevant science, data, engineering
knowledge and even behavior of claimants and insurers in the aftermath of
a catastrophe. They also provide an environment in which all this knowledge
can then be harnessed by reinsurers, property owners and policymakers to
make informed risk management and mitigation decisions. Finally, an
underwriting policy that limits the companys exposure to catastrophic losses
is implemented. Insurers and risk managers employ cat modeling, to assess
the risk in a portfolio of exposures, which acts as a help guide for an
insurer's underwriting strategy, and help them decide how much reinsurance
to purchase.
15.2.10 Intranet, extranet and internet
The Internet is a global system of computer networks which are
interconnected. It is not controlled or managed by a central entity and hence it
relies on network devices and established conventions and protocols to
transmit the data traffic until it gets to its destinations. The Internet is now
global and can be accessed by anyone who gets an access from an Internet
service provider.
An intranet is a private network that is established and controlled by an
organisation to support interaction among its members, to get better
efficiency and to share information. An intranet works much like the Internet
but is a restricted-access network and it is isolated from the internet.
An extended intranet can be called as an extranet. It allows access to the
members of an organisation and also uses firewalls, access profiles, and
privacy protocols to allow access to users from outside the organisation. An
extranet is a private network that uses public networks and Internet
protocols networks to share resources with customers, suppliers, vendors,
partners and so on.
Intranet, extranet and internet are networks that use various network
protocols and topologies to allow communication between computers and

other network devices, such as, printers and VoIP systems. These networks
define a specific way of doing things, of sharing information and resources
between people and companies. Insurance companies can contact and
interact with people from different places and explain them, the policies and
securities the company provide, and if interested, customers can buy the
policies through these networks.
The World Wide Web is one of the most powerful distribution channels for
information today. Combining the Internet and business intelligence has
created a technological synergy that will maximise a business intelligence
(BI) investment. Web-enabled business intelligence tools provide access to
the decision support system via browsers, such as Netscape Navigator and
Microsofts Internet Explorer. End-users can access the Internet through an
ISP (Internet Service Provider) and log on to the corporate data warehouse
via a Web Server, and have instant access to their company information.
The field staff will have the same capability as the corporate office to
monitor loss ratios, policy counts, sales, sales goals, cancellation
information, and so on. Instead of deploying BI tools on all home office PCs,
insurers are beginning to implement intranets, a more cost-effective
approach, whereby home office end-users access the corporate data
warehouse via browsers. This approach reduces the licensing costs and
compatibility problems that may be encountered with implementing BI on all
PCs.

1. The insurance companies today must apply a more _____________
approach for handling the customer.
2. The personal computer and ______ technology empowers companies
to keep millions of policies on a device with thousands of bytes of data
per policy or client.
3. Companies need to utilise ______ by implementing data warehouses
that pull information from existing legacy systems into a customer
information database.
4. Mapping technology helps in designing the elevated societal and
governmental support. (True/False).

5. Which of the following is not an important application of IT in insurance

sector?
a) Video linking
b) Internet
c) CCTV
d) Mapping
6. Catastrophic models use data from the recent occurrences of natural
disasters. (True/False).
Activity: 1
Analyse how the Life Insurance Corporation of India uses information
technology to aid its operations.
Hint: Refer - http://www.licindia.in/it_lic.htm
15.3 Need for Information Technology in Insurance Sector

The above section dealt with applications of information technology in
insurance sector. This section will describe the need for information
technology in insurance sector.
Today insurance industry is heading towards an exciting phase.
Liberalisation and globalisation started allowing international players in the
insurance sector. As many private and international players enter the
insurance business, customers have a wide choice of insurance companies
to do business with. Fundamental changes taking place in customer profile,
is changing the life style of brand loyalty. In order to survive in insurance
industry, modern insurers are focusing mainly on customer-centric
relationship.
The insurance sector which was nationalised in 1950s was also liberalised
in 1999, by Malhotra committee. After Insurance Regulatory and
Development Authority (IRDA) Act in 1999, the first private sector business
was started in 2001. Currently 15 players are ruling life insurance sectors,
and 11 players are ruling non life insurance sectors. This expansion is
mainly due to the technological enhancements in insurance sector. In 1985,
information technology represented 52 percent of the total capital
investments made by insurance sectors.

Effective utilisation of information technology is very important for the

success of insurance sector. Insurers adopt technology for information
revolution. Customers can choose from a wide range of innovative products.
The insurance companies use the applications of information technology for
better customer service, cost reduction, product design and development.
New technology offers insured persons, a faster access to products.
Insurance sectors are being modernised by new technologies. Computing
technology and network technology together form today's information
technology. Advanced computer devices provide multimedia facilities in this
sector. The need of information technology in insurance business is growing
day by day. Insurers need to use information technology for the following
reasons:
Developing new products - Insurers must develop new products,
which are based on forward-looking designs. Insurers must address
their challenges by introducing innovative products. Companies must
constantly develop products, in order to meet the upcoming changes in
consumer requirements. Understanding the customer better enables the
insurance organisations to develop the correct products, determine the
rates correctly, and increase the profits. Presently, life insurers are
focusing on the new pension plans, and non-life insurers are trying to
enrich the market shares.
Management of client data - Insurance companies need to use new
technologies to maintain accurate client information records. They need
to use information technology to store and retrieve client personal
details, policy details, claim details and so on.
Marketing of policies - Insurance companies can market their policies
using new technologies like the mobile phones and internet. They can
describe the salient features of their products and enable customers to
choose products they need. They can expand their customer base using
information technology.
Claims management - For any insurance company, paying and

recording claim's data is a crucial responsibility for maintaining its
financial stability. Information technology plays a critical role in
insurance, for recording claim's particulars and sharing information with

claims inspectors and beneficiaries. Advanced computer devices ensure that

significant data remains reachable and updated.
Payment of premiums - Insurance companies can use information
technology like internet and ECS systems to collect premiums from their
customers.
Improve the efficiency of their operations - By using information
technology, insurance companies can quickly process proposals and
dispatch policy documents. Computerisation of payment related
modules pertaining to loans and claims can help to reduce time-lag and
ensure accuracy.
7. Liberalisation and ______________ started allowing international
players in the insurance sector.
8. Companies must constantly develop products in order to meet the up-
coming changes in ____________ requirements.
9. The insurance sector was liberalised in 1999 by the
_________________ committee.
a) Malhotra
b) Mehra
c) Narang
d) Narayana
10. For any insurance company, paying and recording claim's data is a
crucial responsibility for maintaining financial stability. (True/False).
11. Life insurance organisations use database technology to confirm and
record policy holder's beneficiary designations. (True/False).
12. Computerisation of payment related modules pertaining to loans and
claims increase time-lag (True/False)
Activity: 2
Analyse the need for information technology in life insurance sector. Hint:
Refer-www.ehow.com/facts_7220654_information-technology-
used -life-insurance_.html

15.4 Role of Information Technology in Insurance

Previous section dealt with the need for information technology in insurance.
This section will deal with the role of information technology in insurance.
The rapid developments in information technology are posing serious
challenges for insurance organisations. The use of information technology in
insurance industry has an impact on the efficiency of the organisation as it
reduces the operational costs. After many private players entered the
insurance industry, the competition in the insurance sector has become
immense. Information technology has helped in enhancing the insurance
business. Insurance industry uses information technology for internal
administration, accounting, financial management, reports, and so on.
Indian insurance organisations are rapidly growing as 'technology-driven'
organisations, by replacing billions of files with folders of information.
Insurers are heading towards the technological enhancements, in order to focus
on the key areas of insurance business.
This section will now cover the role of IT in different fields of insurance like:
Actuarial investigation - Insurers depend on the rates of actuarial
models to decide the quantity of risks which create loss. Insurance
organisations are using new technologies, to analyse the claims and
policyholder's data for providing connection between risk characteristics
and claims. Developments in technology allow actuaries to examine
risks more precisely.
Policy management - Most of the insurance policies are printed and
conveyed to policy owners through mail every year. The method of
creating documents is accomplished by technicians and typists. In most
of the cases, this task is generally completed by using new technology.
Customer data is accessed by computer systems, and maintained in
huge folders, in order to renew each policy. To assemble the policies,
complex software packages are used, and to print the policies high
speed printers are utilised.
Underwriting - Underwriters can use knowledge based expert systems
to make underwriting decisions. By using automated systems,
underwriters can compare an individuals risk profile with their data and
customise policies according to the individuals risk profile.

Front end operations: CRM (Customer Relationship Management)

packages are used to integrate the different functional processes of the
insurance company and provide information to the personnel dealing
with the front end operations. CRM facilitates easy retrieval of customer
data. LIC is using CRM packages to handle its front end operations.
15.4.1 Marketing
There is a huge scope of information technology in insurance marketing
sectors. Information technology in insurance marketing strategy includes
pricing, promotion and customisation techniques. Information technology is
used in the marketing of insurance products in the following manner:
Customer knowledge
Information technology helps insurance companies to create awareness of
insurance products among public. With the help of internet, information
regarding products and rating polices can be conveyed to the public within
seconds. Information about new products and changes in old products can be
provided at a faster pace and lower price.
Consumer service
Consumer service needs lot of attention, right from distribution of
information to policy, and claims management. The new private players are
posing threats and challenges to LIC. The developing areas of Information
technology applications are:
Market research
Products customisation
Agent analysis
13. The use of information technology in insurance industry has an impact
on the efficiency of the organisation as it reduces the
____________________ costs.
14. Developments in technology allow ______________ to examine risks
more precisely.
a) Managers
b) Agents
c) Actuaries
d) Policy holders

15. With the help of internet, information regarding products and rating
polices can be conveyed to the public within seconds. (True / False).
15.5 Summary
Let us now summarise what we have learnt in this unit on Information
Technology in Insurance Sector:
Information technology enhances the speed and competence with which
underwriters assess new applicants and analyse aspects of their lives
affecting the carrier's proposed financial risk.
Using database technology, companies can get a comprehensive,
performance, loyalty, and lost opportunity.
Data warehouses analyse data in a different and new way with
additional information, fewer details and rapid access.
A GSS facilitates the process of decision-making and provides an
apparent focus for organising attention around the critical issues.
Mapping technology helps in designing the elevated societal and
governmental support.
Call centre technology helps to capture and consolidate customer
interaction data and discover individual usage patterns of consumers
and their preferences from these interactions.
Intranet, extranet and internet are networks that use various network
protocols and topologies to allow communication between computers
and other network devices such as printers and VoIP systems.
The insurance companies use the applications of information technology
for better customer service, cost reduction, product design and
development.
New technology offers insured persons a faster access to products.
Companies must constantly develop products in order to meet the up-
coming changes in consumer requirements.
The rapid developments in information technology are posing serious
challenges for insurance organisations.
Understanding the customer better enables the insurance organisations
to opt for products, determine the rates correctly and increase the
profits.
Information technology enables insurance companies to create
awareness of insurance products among public.
Consumer service needs lot of attention right from distribution of

information to policy and claim management.
15.6 Glossary
Actuarial: A statistician who computes insurance and pension rates and
premiums on the basis of the experience of people sharing similar age and
health characteristics.
Business Intelligence: Skills, technologies, applications, practicing for the
compilation, assimilation, analysis, management and presentation of
business information.
Cross selling: The strategy of pushing new products to current customers
based on their past purchases.
Database-repositories: These repositories refer to the location for the
storage of data.
Gap analysis: The process by which a company compares its real
performance to its expected performance to decide whether it is meeting
expectations and using its resources efficiently.
Liberalisation: This refers to relaxing controls of the government on trade and
commerce.
RISC: It is a type of microprocessor that recognises a relatively limited
number of instructions.
Risk portfolios: Possibility that an investment portfolio will not earn the
expected or desired rate of return.
Turn around Time: Period for completing a process cycle usually
expressed as an average of previous such periods.
Up selling: A sales strategy where the seller provides opportunities to
purchase related products or services, for the solitary purpose of making a
larger sale.
VoIP: It is a technology that allows telephone calls to be made over
computer networks like the Internet.


1. Explain the application of database management systems in the
insurance sector.
2. Discuss the importance of DSS and GSS for an insurance company.
3. Imaging and workflow technologies give financial services organisations
a distinct platform for managing customer transactions. Discuss.
4. Elaborate on the reasons which demanded the need for information
technology in insurance sector?
5. Describe the role played by information technology in insurance.
15.8 Answers
1. Personalised
2. RISC
3. DSSs
4. True
5. a) - Video linking
6. True
7. Globalisation
8. Consumer
9. a) - Malhotra
10. True
11. True
12. False
13. Operational
14. c) - Actuaries
15. True
Terminal Questions
1. The principles of tracking and measuring responses can pay off for the
conventional. Refer to section 15.2.1 for more details.
2. DSS is a collection of integrated software applications and hardware that
form the backbone. Refer to section 15.2.3, and 15.2.4 for more details.
3. Imaging and workflow technologies give financial services organisations
a distinct platform for managing customer transactions. Refer to section
15.2.6 for details.

4. Liberalisation and globalisation started allowing international players in

the insurance sector. Refer to section 15.3 for more details.
5. The rapid developments in information technology are posing serious
challenges for insurance organisations. Refer to section 15.4 for further
details.
15.9 Case-Let
Information Accessibility Solution for Reliance Life
Client overview
The Indian insurance industry has undergone a significant change over
the last decade. It has started attracting foreign direct investment apart
from being a nationalised player. Globalisation and the establishment of
new companies have greatly increased the competitive intensity and
zing of the insurance business. This has stimulated a need for superior
flexibility in operations and processes to achieve competitive
advantage.
Business need
The need was to utilise the power of technology and create an
allinclusive self-service infrastructure to provide employees, customers
and agents of Reliance Life Insurance, with the information they need at
the time they ask for it, through a variety of channels.
Solution
The solution for this business need was to create an efficient, scalable,
comprehensive, self-service resolution that allows Reliance Life to
attain its goal of constructing an implicit office and an end-to-end
selfservice portal. The resolution should also ensure that the solution's
assets can be reused and extended to future efforts.
Benefits
The benefits of the solution after being carried out are:
- Centralising processes and dropping down Turnaround Time (TAT) in
policy issuance and claims disbursement.
- Providing dependable and efficient information, as and when needed. -
Augmented customer, agent and employee convenience.
- Entitles customers, by making information available through self-
servicing facilities.

1. Discuss how globalisation increased the competition in the insurance
sector.
(Hint: Globalisation and the establishment of new companies).
2. What were the benefits of the solution that was provided to Reliance
Life Insurance?
(Hint: Centralising processes and dropping down Turn Around Time).
Source: http://www-07.ibm.com/in/casestudies/case_reliance_life/
References
Arumugam Vijayakumar (2009). Indian Insurance Sector in 21st
Century: An Outlook. Kalpaz Publications. India.
E-References
http://www.objectwin.com/Insurance.aspx
http://www.referenceforbusiness.com/encyclopedia/Cos-Des/Database-
Management-Systems.html
http://findarticles.com/p/articles/mi_m0DUD/is_n2_v18/ai_19197105/
http://www.vignette.com/dafiles/docs/Downloads/Vignette-Imaging-and-
Workflow-for-Financial-Services-and-Insurance-brochure.pdf
http://www.icai.org/resource_file/13528Module-IV.pdf
http://www.objectwin.com/Insurance.aspx
Retrieved on 8th November, 2010

Acknowledgement, References & Suggested Readings

House, India.
Sethi Jyostna, Bhatia Nishwan (2007). Elements of Banking and
Insurance, First edition, PHI Learning Private Ltd, New Delhi.
Palande. P. S., Shah. R. S., Lunawat. M. L., (2003). Insurance in India:
Changing Policies and Emerging opportunities, New Delhi.
Vaughan J Emmett, Vaughan Therese (2007): Fundamentals of risk and
Insurance, Wiley, India.

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MF 0018

Insurance and Risk Management

BKID - B1319 16 Dec. 2010

Curriculum Revised : Spring 2010

This book is a distance education module comprising a collection of learning

Unit 1 An Introduction to Risk

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1.2 Definition and Meaning of Risk

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1.3 The Effect of Risk

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Degree of risk is measured by the probability of adverse deviation. If the

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Self Assessment Questions

1.4 Certainty, Risk and Uncertainty

Uncertainty is zero Uncertainty is very high

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Level 0 (certainty) - There is no uncertainty at this level. The outcome of an

1.5 Classification of Risk

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community or a group is termed as particular risks. Examples are burning of a

Enterprise risk plays a vital role in commercial risk management, which is a

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Self Assessment Questions

1.6 Management of Risk.

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Perpetuity of the organisations operations.

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Evaluation of risk exposure

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1.7 Risk Management Strategies

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If the exposure cannot be insured or transferred. If

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Derivatives are based on the performance of separately traded

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The two concepts which are used to measure risks are:

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1.10 Terminal Questions

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Unit 2 Mitigating Risk via Insurance Markets

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2.2 Risk Financing

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2.3 Insurance as a Prime Risk Management Tool

Self Assessment Questions

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2.4 Option Pricing

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shares. In exchange traded options, the connection or link between

2.4.2 Option pricing models

Black and Scholes pricing formula:

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