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Insurance, what?

financial protection against loss

due to risk
Definition: is the pooling of fortuitous
losses by transfer of such risks to
insurers, who agree to indemnify the
insured for such losses, to provide other
pecuniary benefits on their occurrence,
or to render services connected with
the risk

Two major concepts


probability concept
the co-operative concept

Basic Characteristics of Insurance

Pooling of losses(spreading of losses
incurred by the few over the entire group
so that av. loss is substituted for actual
Payment of fortuitous losses ( the payment
is one for the unforeseen and unexpected,
occurred as a result of chance)
Risk transfer(a pure risk is transferred
from the insured to the insurer)
Indemnification(the insured is restored to
the approximate financial position prior to
the occurrence of loss)

The Process



co-operative functioning

Risk & Premium

Premium is the price paid adequate to the
risk or it is the amount paid by the
insured to the insurer to save the risk
Hence, premium related to risk or higher
the risk, higher the premium
Premium also contains some amount
towards admin exp or
the rate of premium is directly prop to
a. the risk faced by the insured and
b. the probability of compensation to the
insured by the insurer

the chance (probability) of loss must be
The premium must be economically
( the insured must be able to pay the


Premium on life to cover

accident risk. Calculation of premium
based on
a. Estimates of the risks faced
b. Average of losses
Hence, calculation of premium depends
on 1.the presence of risk
2.the frequency of occurrence of risk

Primary functions

of payment
financial protection against chances of
risk is shared

Secondary functions

of loss
provides capital
helps to improve efficiency
helps in economic progress

Rejda classifies risk basically into three

Pure and speculative risks
Fundamental risk and particular risk
Enterprise risk
Pure Risk: a situation in which there are only two
outcomes adverse(loss ) or neutral(no loss).Eg:
premature death, job-related accidents, medical
expenses, damage to property from fire, flood,
earthquake etc
Speculative risk: a situation in which either profit
or loss is possible: investment in shares, betting
on a horse race etc.

Fundamental risk: a risk that affects the entire
economy or large number of persons or groups
within the economy. Eg: inflation, war, natural
disasters, acts of terrorism etc.
Particular risk: a risk that affect only individuals and
not the entire community. Eg. Car thefts, house
fires, bank robberies etc
Enterprise risk: all major risks faced by a business
firm; can be pure risks, speculative risks, strategic
risks, operational risk and financial risk. Strategic
risks are related to firms financial goals and
objectives(firm entering a new business, may not
be profitable); Operational risks can be human
errors in firms, technology breaking down etc

Costs of Insurance to society

Costs of doing business: in providing
insurance, insurers consume scarce
economic resources- land, labour, capital
etc and a real economic cost is incurred.
Fraudulent claims: Examples:
Inflated claims: Insured exaggerate the
amount and value of property stolen,
amounts damage in automobile collision
claims, attorneys for plaintiffs sue for
high liability judgments that exceed the
true economic loss etc.

Two basic categories of insurance

Life insurance and
General insurance

Types of Life Insurance


Period of protection temporary(1,5 10 or 20
Renewable usually with increased premium
Convertible at times
No cash accumulation & only coverage
No savings element and hence
inappropriate for a specific need
Effective for those who can spend only
limited amounts towards premium
Appropriate if the need for protection is

Effective as a guarantee for future
insurability. By purchasing inexpensive
term insurance, one can convert the
same into a permanent insurance policy
without additional evidence of

Whole-life Insurance

Value policy
Provides lifetime protection
Can be either straight life or continuous
premium whole-life
limited payment( for fixed periods such as
10,20,30 etc years)
An extreme form of limited is single-premium
Policy holder does not enjoy benefits, benefits
accrue to the nominees/surviving heirs

Endowment Insurance

Elements of savings and investments
Insured is the beneficiary if he lives for
the entire term
In the event of death within the term,
paid to the heirs

Money-back policies

for lump-sum benefits at

periodic intervals
The payment pattern varies depending on
the term (Eg.)
In the event of death ,any time within the
selected term, full sum assured is
without deducting any of the survival
benefit amounts, which have already
been paid.

Provides forlife insurance where the policy
at any time varies according to the value of the
underlying assets at the time. ULIP is life
insurance solution that provides for the benefits
of both protection and flexibility in investment.
The investment is denoted asunits and is
represented by the value that it has attained
called asNet Asset Value(NAV).

Min term : 5 years(originally 3 years)
Agents to disclose commission to investors.
For pension funds: life-cover compulsory.
Mortality cover: Min 10 times the annual regular
premium(earlier 5 times) or 125% of single
premium(for age at entry below 45 years) and
7 times and 110% for age at entry above 45)
Min death benefit to be not less than 105% of
premiums paid.
Any pre-surrender, charges prescribed subject
to a maximum of 15% for policy periods more
than 10 years and 12.5% for less than 10 years.
(Draw table).

No partial withdrawal for ULIP
pension/annuity products
ULIP pension/annuity schemes to offer
guaranteed annual return of 4.5%
Customers can avail of loans upto 40% of

General Insurance
Classification based on the nature of
they enter into
Includes- Property Insurance
- Liability Insurance
- Other forms
- Reinsurance

A. Property Insurance

Covers losses of marine perils

Fire- Covers risks of fire
Automobile- covers risk of accidents
and consequent damages
Cattle- covers against deceases etc
Machinery- covers against loss,
damages etc
Theft- covers against theft

B. Liability Insurance

is liable to pay the damage of property or to

compensate the loss of personal injury or death.
Eg: a) Transport companies insuring against property
b) Manufacturing companies insuring against injury or
loss of life.
Types:1.Third party
Limits of Liability: Usually specify two types of limits;
AOA(Any One Accident) and AOY(Any One Year)
Can be Public, Product, D&O Liability, Workmans
Compensation etc

C. Other forms

credit: protects the exporter from the risk

of the non-payment by a foreign buyer
Employees State Insurance :all employees
earning Rs.15,000 or less are covered under the
scheme; employer contributes to 4.75% and
employee contributes to 1.75% of the wages
towards premium; managed by ESIC.
Guarantee Insurance-covering losses arising due
to dishonesty, disloyalty etc
Eg:Traders getting protected from the insolvency
of the debtors;cover against financial losses due
to dishonest acts of employees etc

D. Reinsurance(Insurers Insurance)
Just like individuals or corporates want to transfer
insurers also would like to transfer their risk to
others. This process is known as re-insurance. A
of the premiums collected by the insurers is paid as
premium to other (re)insurance companies and thus
a coverage. Losses can thus be shared by many
than one.

There is no such thing as an absolute
value. You can only estimate what a
thing is worth to YOU
Charles Dudley Warner
Sum assured is the base on which
insurers apply premium, and hence
appropriate choice of value is essential
for fixing premium. This is based on the
max. financial loss that can be caused
to the property or person by the
insured peril.


insuring for a higher value, one has to

pay a higher premium. And ,this does not
give any advantage at the time of claim.
Claims are settled on the basis of
indemnity, ie actual loss.
Insuring for a lesser value will result in
under-insurance and insurer will pay only
the max. insured amount even when the
losses incurred are more.
Sometimes insurers make it mandatory for
a particular property to be covered by a
particular method. Eg: Properties under
burglary policy have to be on market value
while machinery breakdowns at
replacement cost. But in fire insurance,

Contd-- Sum assured should not only cover the

total assets but also individual assets
Hence, selection of sum insured shall be
done after sufficient detailed study.



cost- only in the year of purchase

Book Value-Purchase value less depreciation
(actual cost of loss may be different)
Market value-the price at which a similar
asset can be purchased in the market
Replacement/Reinstatement value-the price
of a similar new property; differs from
market value since no depreciation or
allowance for obsolescence is considered.
Agreed value-usually applicable for offmarket items like paintings and antiques;
insurers dont raise questions of value at the
time of claim.

Valuation Basis For Different

Types of Risks
Types of risks

Basis of valuation
Market value/
Replacement value
(Value of land
excluded; plinth&
foundations and
roads & pathways



mkt value/
Replacement value
Only mkt value
should be specifically
declared; insurer at
times impose limit
on max. value payable
per article
Insured declared value,
based on the latest list
price subject to specific
rates of depreciation


Personal Insurance Based on the earning capacity

the individual (from productive occupation, incl perks)
Liability Insurance
Based on max. Liability that may
occur due to accidents which in turn depends on the
of people exposed to
the risk and the severity
loss likely to occur & value of
property likely to be
damaged in
the event of an accident
Pecuniary Insurance Based on max. possible loss
(money policy, fidelity
guarantee, business
interruption etc)

How is premium determined

Premiums are fixed on the basis of
assessed risks based on
The probability of the peril occurring
The severity of the loss likely in case the
event happens
The past actual experience of the
insurance industry from that category of

Claims Settlement
Claims intimation-insurer allocates a claim
number ;sends a claim form which provides
all information pertaining to the accident
based on which insurer decides on further
course of action
List of documents to be filed-Depends on the
type of coverage like Fire, Machinery, Motor,
Marine etc
-Policy, Survey Report, Photos, Claim Form,
RC books, Invoices, Consignment notes,

Contd--Packing list, ,Fitness Certificates, FIR, Bill of

Entry, etc.

Principles related to settlement of claims

Principle of contribution: Where a particular
property is insured with two or more insurers
against the same risk, it is called double
insurance. In the event of actual loss, he will be
compensated by insurers by sharing the burden of
payment in proportion to the amount assured by
Eg: Insurance with company X =Rs.2,00,000
Insurance with company Y =Rs.1,00,000
Damage to the property
=Rs. 50,000
Loss division ---X=2,00,000*50000=Rs.33,333.33


principle (inserted as a clause):

Suppose the insured covers a property
worth Rs.80,000 to the extent of
Rs.60,000 and the actual loss is
Rs.20,000,the insured will get only
from the company. (In case the clause is
not inserted, the insured can claim

Requirements of Insurance


a. Elements of general contract

b. Elements of special contract
relating to insurance
General Contract-Indian Contracts Act
1872(sec 10)
1.Agreement(Offer & Acceptance): Offer may
come from the insured or the insurer may
propose. The main point is acceptance.
There can be offers and counter-offers and
acceptance happens when notices of
acceptance are exchanged or when the
agreement is signed.

2.Legal consideration: The contract becomes

legally binding on the insurer to pay a sum
at the end of the period provided the
premiums are paid.
3.Competence to make a contract: The
person entering into contract must be
competent to enter into contract-a. He
should have acquired
b. He is of sound mind .
c. He is not disqualified
entering into any
contract by the law.

4.Free Consent: The parties should enter into

contract by their free consent.
-No coercion
-No undue influence
-No fraud
-No misrepresentation
-No mistake
5.Legal object: The object of agreement must be
lawful. The object should not be
-forbidden by law
-opposed to public policy
-does not defeat the provisions of any law.

Special Contract of Insurance


following principles
#Insurable interest-is the pecuniary interest
whereby the policy-holder is benefited by
the existence of the subject-matter and is
prejudiced by the death or damage of the
subject matter. The pre-requisites of
insurable interest are:
a. there must be a subject matter to be
b. policy-holder should have monetary
relationship with the subject-matter.

c. the relationship between the policy-holders

and the subject-matter should be recognized
by law or there should not be any illegal
relationship between the policy-holder and
the subject-matter to be insured.
d. The financial relationship between policy
holder and subject-matter should be such
that the policyholder is economically
benefited by the survival or existence of the
subject-matter and/or will suffer economic
loss at the loss of existence of the subjectmatter. Eg: Life in life insurance, property in
property insurance, liability in liability
insurance etc.


interest is essentially pecuniary

since the loss caused by happening of the
risk of the subject-matter is capable of
being valued financially.
#Utmost Good Faith-relates to disclosure of
all material facts-there should not be any
misrepresentation, non-disclosure or fraud
concerning the material facts. Let the
buyer beware (caveat emptor) does not
apply in insurance-seller also have to
disclose all material facts-both parties of
contract must disclose all material facts
truly & fully.

#Principle of indemnity-all insurance

contracts are contracts of indemnity-the
insured undertakes to put the insured ,in
the event of loss, in the same position
that he occupied immediately before
happening of the event insured against.
While in the true sense of indemnity, the
insured is not to make a profit of his loss,
in certain (marine or fire) types, certain
profit margin which would have earned in
the absence of the event, is also included
in the loss.

#Principle of subrogation-refers to the right of the

insurer to stand in the place of the insured, after
settlement of a claim ,as far as the insureds right
of recovery from an alternative source is involved. If
the insured can recover loss in full/part from a third
party due to whose negligence the loss may have
happened, his right of recovery is subrogated to the
insurer on settlement of the claim. The insurer can
recover the claim from the third party.
#Warranties-there are certain conditions and promises
in the insurance contract called warranties.
Warranties can be explicit or express (mentioned in
the policy like fire alarms/burglar alarms in the
shop/house insured for fire/theft ) or implicit which
are applicable even

Contd--when not explicitly mentioned.(Eg:In marine, the

ship has to be seaworthy, no deviation in route,
used for legal purpose)
On breach of warranty, the insurer becomes free
from his liability. Contract will continue only
when warranties are fulfilled. Of course, when
the warranty itself is declared as illegal and
there is no reverse effect on the contract , the
warranty can be waived.
#Proximate cause-means the most closely and
directly connected causes insured against, or
the insurer is liable for loss, if the risk insured
against is the proximate or the last cause of loss
occurred. It is not required to go further
investigating the cause of causes. Sometimes
there may be a series of causes of damage and
in such a case, principle of causa proxima is
applied. (Eg.) Contd---

Contd--#Assignment clause-life insurance policies

can be freely assigned to another partytwo types of assignments-absolute (where
all ownership rights are transferred to the
new owner) and collateral (where only
certain rights are transferred to the
creditor and the policy owner retains the
remaining credits) except accident
policies. In the case of general,
assignability varies depending on the
types-while Marine can be freely assigned,
fire and accident policies need prior
consent from insurers

#Return of premium-Generally, the premium once

paid cant be refunded. But exceptions exist
depends on agreement.

Social Insurance
These schemes are usually run by Government
and financed entirely or in large part by
mandatory contributions from employers,
employees or both. Eg: ESI Schemes in India. In
developed countries like US, there are many
schemes like Old-age, Disability, Unemployment,
Medical care, Workers Compensation etc

Postal Insurance(Targeted at government

Started on Feb 1,1884
A PLI branch in every district P.O.
No agents, regular employees sell policies;
hence no agent expenses and pays
maximum bonus.
No employee tries to persuade anybody to
Five types of policies:
Santosh: for age limits 19-50,minimum amt
Rs.20,000, max.amt.Rs.5,00,000; no limit on
duration, can be surrendered after 3 years

Suraksha: for age limits 19-50,min amt.Rs.20,000

max amt Rs.5,00,000,duration for the life,
be surrendered after 3 years, whole-life

Suvidha: age limits 19-50,min amt Rs.20,000

and max amt Rs.5,00,000, no limit on
duration, can be surrendered after 3 years,
whole life policy convertible intro limited
period policy
Sumangal: age limit 16-45,min amt Rs.20,000,
max amt Rs.5,00,000, period 15 years and 20
years; money back policy; no surrender clause
Yugal-Suraksha: Age limit 21-45,min amt
Rs.20,000 and max amt Rs.5,00,000, no limit
on duration; spouse also get protection; can
be bought jointly by a couple

PLI has also started policies targeted at Rural

people(started from 24th March 1995):
Gram Santosh:Age between 19 and 45,min
amt Rs.10,000 and maximum amt
Rs.1,00,000, no limit on duration, can be
surrendered after 3 years, limited period.
Gram Suraksha:Age between 19 & 45,min amt
Rs.10,000 and max amt Rs.1,00,000,surrender
possible after 3 years, whole life.
Gram Suvidha : Age between 19 & 45, min amt
Rs.10,000 and max amt Rs.1,00,000 no limit
on duration, can be surrendered after 3 years;
whole life convertible into limited period.


Sumangal : Age between 19 &

40,min amt Rs.10,000, max amt
Rs.1,00,000,period 15 and 20 years, no
surrender possible , money-back policy.
Gram Priya:Age between 21 & 45, min
amt Rs.10,000, max amt
Rs.1,00,000duration max 10 years, no
surrender possible, spouse can get
protection when not a govt. employee.

Nomination facility in insurance

Provides easy and fast transfer of insurance
amount to the insured persons legal heirs.
Or else, at times it may take sometimes
very long time to determine the succession
rights. Nomination can be made in the
proposal itself or can be incorporated at a
later date. If done later, it has to be
endorsed in the policy document. The
holder can also change nominees during
his life as he wishes but need endorsement
again. Nomination can also be made in the
name of a minor, in which case another
major person has to be named as

guardian. If the holder has also made a

will, and if the policy finds specific
mention there and if it has been made in
the name of a person other than the
nominee/s, then the amount has to be
paid to him. Or, nomination can be
cancelled because of a will but will cant
be cancelled by nomination. The nominee
is connected to the policy only till its
maturity; if the holder outlives the term,
the nominee has no right.

Insurance & Tax Planning

Govt has allowed tax benefits for money invested in

insurance in order to encourage people to buy
insurance for protection from risks and as investments.
Deduction under Section 80C.Insurance premiums paid
together with PF/PPF contributions, Tax saver bank
deposits, NSCs, Housing loan principal repayments etc
upto a max of Rs.1,50,000 is eligible. Policy need to be
held continuously for two years.
No tax under Section 10(D).All survival benefits and
amount received on maturity is tax-free.
Concession under 80D for mediclaim.Upto a maximum
of Rs.25,000(Rs.30,000 for senior citizens) is deductible
from income.

Risk Management: All businesses involve

speculative risks. Every corporate wants to
maximize profits from the positive outcomes
from those speculative risks and minimize losses
arising from the negative outcomes of those risks.
Objectives of risk management: Minimize a.
losses caused by pure & speculative risks
b. costs incurred in handling , preventing or
containing them over a sustained period of time.
Steps in the process of risk-management Ref.
Flow chart)
1.Identification of risks
2.Ascertaining the value of potential losses
and match against the cost of reducing the
potential losses.
3.Grade the risks according to the net
residual impact on your firm and classify into pure

4.Loss control & reduction

Identifying cost-effective measures to reduce
the loss potential-avoidance,
reduction(reducing exposure),spreading or
Identifying cost-effective methods of dealing
with the financial impact of the residual
risks(retention, transfer by hedging or
insurance etc)
5.Establishing control systems to ensure that
systems are operated as planned and
continue to be effective, and also plan for
corrective action wherever slippages are

Risk identification: conduct safety audits, threat

analysis, event analysis, input-output analysis
etc (A risk identification table can be prepared)
(Table 2.1)
Risk evaluation (assessing potential losses):
Two methods- the maximum probable loss and
the average likely loss-Eg: A vehicle can get
completely damaged in an accident , the
maximum possible loss is the value of the car.
But certain events may happen with different
frequency or likelihood and with varying
. intensities. Eg: The value of stocks stolen in
transit will depend on the value of stocks in the
truck at that time. This may differ from shipment
to shipment. The average likely loss would be
the average value per shipment during the

The powers and functions of the Authority
issue to the applicant a certificate of
registration, renew, modify, withdraw,
suspend or cancel such registration
protection of the interests of the policy
holders in matters concerning assigning of
policy, nomination by policy holders,
insurable interest, settlement of insurance
claim, surrender value of policy and other
terms and conditions of contracts of
specifying requisite qualifications, code of
conduct and practical training for
intermediary or insurance intermediaries
and agents


the code of conduct for

surveyors and loss assessors
promoting efficiency in the conduct of
insurance business
promoting and regulating professional
organizations connected with the
insurance and re-insurance business
levying fees and other charges for
carrying out the purposes of this Act
calling for information from,
undertaking inspection of, conducting
enquiries and investigations including
audit of the insurers, intermediaries,
insurance intermediaries and other


and regulation of the rates,

advantages, terms and conditions that
may be offered by insurers in respect
of general insurance business
specifying the form and manner in
which books of account shall be
maintained and statement of accounts
shall be rendered by insurers and
other insurance intermediaries
regulating investment of funds by
insurance companies
regulating maintenance of margin of


of disputes between
insurers and intermediaries or
insurance intermediaries
supervising the functioning of the
Tariff Advisory Committee
specifying the percentage of premium
income of the insurer to finance
schemes for promoting and regulating
professional organizations referred to
in clause
specifying the percentage of life
insurance business and general
insurance business to be undertaken
by the insurer in the rural or social

Key Provisions of IRDA Act for Insurance

General Registration Requirements
Capital Structure Requirements
Private insurers are to maintain a
minimum solvency margin
Policyholders' funds to be invested within
Obligation to Rural and Social Sectors
Disclosure of Financials

General Registration Requirements

Registered under 1956 Companys Act
Should form a separate entity
26% of equity participation for foreign
company(now increased to 49%)
Separate Companies for more than one
Name of the company should contain
words insurance company or
assurance company

Capital Structure Requirements

Minimum paid up equity capital of Rs.
1bn for Life insurance and General
insurance business

2bn For Reinsurance Business


holding of 26% paid up equity

capital for a promoter

Minimum Solvency Margin

Rs 500million for Life insurance business
( Rs 1bn for Reinsurance)
In the case of General insurance business
highest of the following amounts
Rs. 500million (Rs 1bn for reinsurance)
20% of net premium income
30% of net incurred claims

Obligation to Rural and Social Sectors

Rural sector
In respect of a life insurer (i) 5% in the first financial year;

7% in the second financial year;

(iii)10% in the third financial year;
(iv) 12% in the fourth financial year;
(v) 15% in the fifth year.
In respect of a general insurer
(i) 2% in the first financial year;
(ii) 3% in the second financial year;
(iii) 5% thereafter

Social Sector
In respect of all insurers
i) five thousand lives in the first
financial year;
ii) seven thousand five hundred lives in
the second financial year;
(iii) ten thousand lives in the third
financial year;
(iv) fifteen thousand lives in the fourth
financial year;
(v) twenty thousand lives in the fifth

Data looked into for personal life insurance cover

Age: the mortality rate correlates with age; in
general, the older the applicant, the higher the
Sex: Women have a longer life expectancy than
men of the same age and hence lesser premium
Build: refers to the relationship between height,
weight and girth(comparison of expanded chest
with abdomen);mortality rates higher for
overweight people
Personal health history: whether they have had
certain diseases, received treatment for drug or
alcohol addiction, whether they have been
refused LI in the past or offered insurance at
higher rates than standard


health history: Certain health

characteristics are hereditary. Hence family health
history such as heart disease, cancer, diabetes
and other diseases.
Smoking: Applicants asked whether they smoke or
when they discontinued smoking as smokers have
seen to have higher mortality rates.
Indulgence in hazardous sports and hobbies such
as sky diving, scuba diving, race car driving etc
Habits and morals: Asked about habits like use of
alcohol and drugs; however alcoholics who have
successfully undergone treatment or have
abstained for many years may get standard rates.
Moral factors such as financial frauds/financial
problems leading to bankruptcy etc are also


Mortality rates vary across the

world due to living standards, climate,
diseases, sanitation, war and other
factors; applicant might plan to live or
might have travelled or resided in a
foreign country
Occupation: Different types of
occupations have different types of
occupational hazards. For example
underground mining, construction,
asbestos manufacturing and/or
processing etc

Decision making
After collecting details, applicants will be
rated as
Standard and charged normal premium
for normal coverage
Sub-standard and charged higher
Rejection-cant be insured

Group Life Insurance

Numerous individuals covered under a
master contract; the group policy owner is
usually the employer.
If the group is sufficiently large,
experience rating is used to determine
the premium or past loss experience is a
major factor in determining the premium.
Individual members normally not required
to provide evidence of insurability; overall
characteristics of the group rather than
individual characteristics looked into


cost of insurance per person is

usually less than that at individual
coverage because the insurer incurs low
cost in selling and other expenses.
Usually term insurance
Can be non-contributory(employer bears
entire cost ) or contributory(employees
bear part of the cost)

Group underwriting requirements

The group is not formed for the purpose of
purchasing insurance; this can help the
insurer not insuring sub-standard groups
Ideally, there should be a low turnover of
persons in the group; higher turnover may
increase the administrative expenses; but
low turnover can increase the average age
of the group leading to higher premiums
Size must be reasonably large so that prior
group loss experience can be used as
proxy and expenses will be distributed

Group LI benefits

Yearly renewable term insurance to members

Amount can be flat for all or based on earnings,
position, remaining service etc
Provide cover equal to a multiple of employees
annual earnings
Can be converted to individual cash value
policy within stipulated time if the service with
the employer is terminated
Most also provide for accident or disability
At times group plans provide cover for
dependents lives

Prerequisite for Group Insurance

Efficient administration of pay-roll deduction
premium; information about prior loss
of the group; information about composition
the group in terms of age and sex;
knowledge of
occupational hazards in the industry the
group is
subjected to etc.

Break-up of premium
The premium is intended to cover two major costs:
the expected loss, called pure premium and the
cost of doing business, called loading(L).
The pure premium(PP)=
Total expected loss/no. of exposures
For eg.,if an insurer expects to pay Rs.1,000,000 of
accident losses, and 1000 cars in the insured
group, the pure premium will be Rs.1,000 per car.
The loading will cover such items as agents
commissions, admin exp of the insurer, taxes and
other levies plus allowance for profit. Usually it is
expressed as a percentage of the expected gross

If the loading L is, say, 20%,

Then GP= PP+L(GP)
or GP(1-L) = PP
or GP = PP(1-L)
or GP =
Rs.1,000 =Rs.1,250
Thus, as the loading increases the premium
the insured needs to pay increases.

The Law of Large Numbers in Insurance

The average losses for a random sample of n exposure
units will follow a normal distribution because of the
central limit theorem. According to this, irrespective of
the nature of the population distribution, the
distribution of sample means approaches normal as the
sample size increases. Also, the standard error of the
sample mean distribution declines as the sample size
increases.( x = x n )
Or the standard error of the sample means loss
distribution is equal to the standard deviation of the
population divided by the square root of sample size.
Since population standard deviation is independent of
the sample size, the standard error of the sampling
distribution can be reduced by increasing the sample
size, n.

The above result has important implications

or insurers.
Consider an insurer selecting sample to insure
from a population where the mean loss is
$1,000 and the standard deviation is
$650.As the insurer increases the number of
units insured(n), the standard error of the
sampling distribution ( x ) will decline as
shown below:
n x
10 205.55
100 65.00

Of course, when an insurer increases the

size of the sample insure, underwriting
risk (maximum insured losses) increase
because more of the insured units could
suffer a loss. But the underwriting risk for
an insurer is equal to the standard error
of the average loss distribution,
x times the number of units insured.
We know that x = x n
So, n x =n x n = n x
Hence, while the underwriting risk
increases with an increase in the sample
size, it does not increase proportionately.

Loss Forecasting
We know that the probability of any event
x occurring can be estimated based on
the standard variate z;
z = x-

Eg:If the number of say, weather related

property losses is normally distributed
with a mean( ) equal to 500 and a
standard deviation equal to 100.What is
the probability that the weather related
losses will be between 500 and 650?

z = x-

=650-500 =1.5
Looking up at the table for areas under the
standard normal probability distribution
will tell us that the probability is 0.4332
or there is 43.32% chance of the weather
loss being between 500 and 650.

With the above data,
1.What is the probability that the property
loss is more than 700?
2.What is the probability that the property
loss lies between 550 and 650?
3.What is the probability that the loss will
be less than 580?
4.What is the probability that the loss will
lie between 420 and 570?

Important Loss Exposures

1.Property loss exposures
Buildings, plants and other structures
Furniture, equipments and supplies
Computers and softwares
Accounts receivables, valuable papers
and records
Company owned planes/vehicles and
other mobile equipments

2.Liability loss exposures

Defective products
Environmental pollution
Sexual harassment of employees,
discrimination against employees,
wrongful termination
Premises and general liability loss
Liability arising from company vehicles
Misuse of internet and e-mail
transmissions, transmission of prohibited

Other types of loss exposures

A.Business income loss exposures
Loss of income from a covered loss
Continuing expenses after a loss
Extra expenses
Contingent business income losses
B.HR loss exposures
Death or disability of key employees
Retirement or unemployment
Job-related injuries or disease experienced by workers
C. Crime loss exposures
Holdups, burglaries, robberies
Employee theft and dishonesty
Fraud and embezzlement
Internet and computer crime exposures

D. Employee benefit loss exposures

Failure to comply with government regulations
Violation of fiduciary responsibilities
Group life and retirement plan exposures
Failure to pay promised benefits
E. Foreign loss exposures
Acts of terrorism
Plants, business property, inventory
Foreign currency risks
Kidnapping of key personnel
Political risks

Direct & Indirect losses

Direct losses are losses arising from the
physical damage, destruction or theft of a
property. Eg: Fire destroys a shop selling mobile
phones. The direct loss is the value of the
mobile phones destroyed, the value of the
furniture and other items(including may be
parts of building) damaged etc.
Indirect losses are those that results indirectly
from the occurrence of a direct physical
damage to the property. For example, the
mobile shop owner will take some time before
the shop is rebuilt and sales start. He may lose
profit during the period .which is an indirect or
consequential loss.