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1
INTRODUCTION
The most common reason for buying life insurance is to replace the
income lost when you die. For example, say that you work, and that
your income is used to support yourself and your family. When you die,
and your paychecks stop, the life insurance proceeds can be used to
continue to support the family members you've left behind.
Another common use of life insurance proceeds is to pay off any debts
you leave behind. For example, mortgages, car loans, medical bills,
and credit card debts are often left unpaid when someone dies. These
obligations must be paid from the assets left behind. This can deplete
the resources that your family needs. Life insurance can be used to
pay off these debts, leaving your other assets intact for your family to
use.
Life insurance provides liquidity to your estate. When you die, you may
leave some liquid assets (such as cash, CDs, and savings bonds), and
some illiquid assets (such as real estate, an automobile, and stocks).
Your liquid assets may not be enough to pay all the debts that you
leave behind, plus all the expenses that arise because of your death
(such as funeral expenses and estate taxes). Your illiquid assets may
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have to be sold in order to meet these obligations when they come
due. This may cause a financial loss if the assets must be sold cheaply
in order to get the money on time. Life insurance can avert this
situation, because the proceeds are available almost immediately upon
your death.
Life insurance creates an estate for your heirs. After your debts and
expenses are paid, there may not be much left over for your family.
Life insurance can automatically provide assets for them after your
death.
Life insurance is a great way to give to charity when you die. You may
have always had a great philanthropic desire, but not the means to
make it a reality. Life insurance can do that for you.
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Permanent insurance policies provide insurance protection for your
entire life as long as the policy remains in force. In addition to the
insurance protection provided, this type of policy also builds internal
cash values, often described as a savings account within the policy.
• You must be very careful about who owns the policy and who
the beneficiaries are, in order to avoid estate taxes on the
proceeds when you die.
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1.4 LIFE INSURANCE NEEDS AT VARIOUS LIFE STAGES
Your need for life insurance changes as your life changes. When
you're young, you typically have no need for life insurance, but this
changes as you take on more responsibility, and as your family grows.
Then, as your responsibilities once again begin to diminish, your need
for life insurance drops off. Let's look at how your life insurance needs
change throughout your lifetime.
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As a young adult, you become more independent and self-sufficient.
You no longer depend on others for your financial well being. But in
most cases, your death would still not create a financial hardship for
others. For most young singles, life insurance is still not a priority.
Some would argue that you should buy life insurance now, while you're
healthy and the rates are low. This may be a valid argument if you are
at a high risk for developing a medical condition (such as diabetes)
later in life. But you should also consider the earnings you could
realize by investing the money now instead of spending it on insurance
premiums.
If you have a mortgage or other loans that are jointly held with a
cosigner, your death would leave the cosigner responsible for the
entire debt. You might consider purchasing enough life insurance to
cover these debts in the event of your death. Funeral expenses are
also a concern for young singles, but it is typically not advisable to
purchase a life insurance policy just for this purpose. Instead, consider
investing the money you would spend on life insurance premiums, or
purchasing a small burial policy.
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When you have young children, your life insurance needs reach a
climax. In most any situation, life insurance for both parents is
appropriate.
For many people, career advancement means starting a new job with
a new company. At some point, you might even decide to be your own
boss and start your own business. It might not be your top priority, but
it is important to review your life insurance coverage any time you
leave an employer.
Keep in mind, you probably won't be able to keep any life insurance
that was provided by your employer. If you're going to work for a new
company, you might receive a comparable life insurance benefit. But if
you're going into business for yourself, you'll need to purchase an
individual life insurance policy.
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to consider. If you were not incorporated, your family would have to
pay those bills if you die.
Once your children are grown, your life insurance needs decrease.
You'll live off your retirement savings, and hopefully you have
accumulated assets that can be passed on to your heirs when you die.
Not only is life insurance expensive at this point, but it's probably
unnecessary.
One exception: if you will be leaving a large estate when you die, your
heirs may be stuck paying a hefty estate tax bill. Consider obtaining
cash value life insurance policy, because you don't actually know when
you're going to die. Your heirs can then use the death benefit to pay
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the IRS. If the policy is held by a trust, the proceeds won't be included
in your estate
A. Life Insurance
Life insurance in its existing form came in India from United Kingdom (UK)
with the establishment of a British firm, Oriental Life Insurance Company in
1818 followed by Bombay Life Assurance Company in 1823, the Madras
Equitable Life Insurance Society in 1829 and Oriental Life Assurance
Company in 1874. Prior to 1871, Indian lives were treated as sub-standard
and charged an extra premium of 15% to 20%. Bombay Mutual Life
Assurance Society, an Indian insurer that came into existence in 1871,
was the first to cover Indian lives at normal rates. The Indian Life
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Assurance Companies Act, 1912 was the first statutory measure to
regulate life insurance business. Later, in 1928 the Indian Insurance
Companies Act was enacted, inter alia, to enable the government to collect
statistical information about life and non-life insurance business transacted
in India by Indian and foreign insurers, including the provident insurance
societies.
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business was confirmed mainly to cities and better off segments of the
society.
The then Finance Minister, Shri S.D.Deshmukh, while piloting the bill for
nationalization, outlined the objectives of LIC thus: to conduct the business
with utmost economy, in a spirit of trusteeship; to charge premium no
higher than warranted by strict actuarial considerations; to invest the funds
for obtaining maximum yield for the policy holders consistent with safety of
the capital; to render prompt and efficient service to policy-holders.
a.To spread life insurance much more widely and in particular to the
rural areas and to the socially and economically backward classes
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d.To conduct business with utmost economy and with the full
realisation that money belongs to the policy- holders.
f.To meet various life insurance needs of the community that would
arise in the changing social and economic environment.
B. General Insurance
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Insurance Act, this voluntary arrangement was formalised by notifying the
Indian Guaranty and General Insurance Company Ltd., a government
company, along with the Indian Reinsurance Corporation as ‘Indian
Reinsures’. In 1968, the Insurance Act was amended to provide for
extension of social control over insurers transacting general insurance.
The amendments provided, inter alia for regulation of assets, setting up of
the Tariff Advisory Committee (TAC) under the chairmanship of Controller
of Insurance. Before the amendments of the act could be implemented,
management of non-life insurers was taken over by the Central
Government in 1971 as a prelude to nationalisation. General insurance
business was nationalised with effect from 1.1.73. , by the General
Insurance Business Act, 1972.
Prior to 1973, general insurance was more cities oriented, catering to the
needs of trade and industry. One hundred and seven insurers including
branches of foreign companies operating here were amalgamated and
grouped into four companies, viz. the National Insurance Company Ltd.,
the New India Assurance Company Ltd., the Oriental Insurance Company
Ltd., and the United India Assurance Company Ltd. GIC was incorporated
as a company in November, 1972 and it commenced business on January
1, 1973.
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14
World Insurance Environment
Japan and Switzerland spent the most per capita on life and non-
insurance respectively.
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Growth in U.S.A. (+1.3%) remained significantly below economic
growth. Japan registered a decline in premium for the third consecutive
year (-3.0%). South East Asian countries, which had to contend with
sharp falls in premiums last year as a result of the Asian crises,
recovered to a certain extent.
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Introduction to Funds Flow and Cash Flow
In a narrow sense, the fund is synonymous with cash. In this sense, the
funds flow statement is simply a statement of cash receipts and payments.
Such a statement is called cash flow statement; it portrays the inflow and
outflow of cash during a period.
The term flow means change. Therefore, the term “Flow of Funds” refers
to the movement of funds as a flow in and out of the working capital area.
All the flow of funds pass through working capital. In other words any
increase or decrease in working capital means, “ flow of Funds”.
The balance sheet at the end of the period is generally different from the
balance sheet at the beginning of the year. The analysis method, which
discloses these changes, clearly is called “Funds Flow Statement”. In
short, funds flow statement is a statement, which is prepared to disclose
the changes in financial assets of balance sheets of two periods. Thus the
flow of funds could be studied with the help of funds flow statement.
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kit. Financial managers, financial analysts and credit granting institutions
use it.
4.5 Funds flow statement throws some light materially on the financial
aspects of the answers to the questions such as:
1) How much funds have been generated from recurring and non-
recurring activities?
5) Why are the net current assets up even though there was a net loss for
the period?
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4.6 Distinction between Funds Flow Statement and Balance Sheet.
A Cash Flow Statement is not much very different from a ‘Funds Flow
Statement’. In preparation of Funds Flow Statement, the sources and
uses of the funds raised are taken into account while in preparation of
Cash Flow Statement, the sources and used of cash and cash equivalents
alone are taken into account. Thus the focus is on movement of casual
cash equivalents rather than on ‘net working capital’. The term ‘cash and
cash equivalents’ here stands for cash and bank balances. Cash is part of
working capital but working capital does not necessarily mean change in
cash. Therefore, Cash Flow Statement is prepared to show the impact of
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various transactions on the cash position of the firm. It takes into account
the transactions resulting in cash inflows and cash outflows only. It
provides the details in respect of cash generated and applied during the
accounting period. Thus, a Cash Flow Statement may be defined as
summary of receipts and disbursements (or payment), reconciling the
opening cash (and bank) balance with the closing balances of the
concerned period with information about the various items appearing in the
Balance Sheet and the profit and loss account. Thus, a Cash Flow
Statement explains reasons for the changes in the cash position of the
firm. Transactions, which increase the cash position of the entity, are
labeled as ‘ inflow’ of cash and those, which decrease the cash position as
‘ outflow’ of cash. Cash Flow Statement traces the various fixed assets,
redemption f debentures and preference shares and other long-term debts
for cash. In short, a Cash Flow Statement shows the cash receipts and
disbursements during the period.
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Part-B
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1. Funds Management
In narrow sense fund the word fund is synonymous with cash. However in
broader sense funds means working capital. They are used in same sense
so Funds management is same as working capital management current
asset management.
For our purpose first two are important since 3rd is largely determined by
legal provisions. There is always conflict between profitability and liquidity
(risk). If a form does not have adequate working capital, i.e. it does not
invest sufficient funds in current assets it may become illegal and
consequently may not have ability to its current obligations and thus risk of
bankruptcy. If current assets are too large profitability is adversely affected.
The key strategies and considerations in enduring a trade off between
profitability and liquidity is one major dimension of working capital. In
addition to this current assets should be efficiently managed so those
neither inadequate nor unnecessary funds are locked up.
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1. An overview of working capital as a whole
In the past it has been found that mismanagement of funds is the major
reason for liquidation of the company.
Company
State
Total Assets
Family Guaranty Life Insurance Co.
Mississippi
$28.9 million
Farmers & Ranchers Life Insurance Co.
Oklahoma
$13.7 million
First National Life Insurance Co. of America
Mississippi
$126.2 million
Franklin American Life Insurance Co.
Tennessee
$76.1 million
Franklin Protective Life Insurance Co.
Mississippi
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$30.1 million
General American Life Insurance Co.1
Missouri
$14.1 billion
Integrity Life Insurance Co.
Arizona
$7.4 billion
International Financial Services Life Insurance Co.
Illinois
$206.9 million
Life Insurance Co. of Alaska
Alaska
Not available
National Affiliated Investors Life Insurance Co.
Louisiana
$4.6 million
Settlers Life Insurance Co.2
Virginia
$205.9 million
Universal Life Insurance Co.
Tennessee
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• Maintaining adequate funds for routine business activities like:
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3. Liquidity Flow Cycle
Inflow
• Settlement of Claims.
• Commission on Reinsurance Accepted.
• Expenses on Management.
• Payment of Ex-Gratia /Arrears for Salary.
• Staff Loans, Housing, and Vehicles etc.
• Payment for purchase of capital items.
• Other Miscellaneous Disbursements.
• Investments.
• Money Market Lending (Loans)
Outflo
ws
As clear from the above cycle, the sources of cash flow can be divided
into three groupings.
1. New Money arising from the net savings of policy holders in life
insurance companies; This portion is made up of the inflow from
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premiums, investment income, consideration for annuities, and other
types of income, less the outflow of funds for death claims and other
benefits, commissions, expenses, taxes and other disbursements. In
simplified terms new money is roughly equivalent to net savings of
policyholders in life insurance. More technically, the new money portion
of cash flow is made up of net investment income plus net income from
insurance operations, less the net increase in policy loans. The later
are investment assets but don’t represent investments under the
control of financial officers. Hence a rise in policy loans means a
decline in cash flow available for long-term investments in the capital
markets.
The above listed forms of cash flow may be considered as the basic
cash flow against which investment officers may design their future
investment programs and issue forward investment commitments.
These forms of cash flow are beyond the direct control of investment
officers since they depend upon the decisions of policyholders to save
through life insurance, or upon scheduled repayments of bonds and
mortgages, or upon certain repayment options made available to the
borrower.
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3. The third major form of cash flow constitutes outright sales and
advancement of cash position. The sale of Government securities may
often involve taking if capital loses. A switch from Governments bonds
into private bonds or mortgages, therefore, requires a significantly
higher rate of return to recoup the loss incurred on sales below par.
Decisions to liquidate these securities, however, are likely to additional
factors such as the desire to broaden the diversification of bond
portfolio or to move out of securities in which the borrower’s credit
standing has deteriorated. For example, if it were considered desirable
to purchase a new bond being offered on the market, the only source
of available funds might be the liquidation present holdings, which are
relatively less attractive for a variety of reasons.
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4. Basic Steps In Funds Management
4.2.1 Strategy 1 and Strategy 3 the companies could either set up their
own networks or could take the help of established bank networks of
various commercial banks providing cash management services package.
The broad Business situations, which arises in normal coarse of
business of Insurance
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Insurance Companies with many locations will have to keep separate
bank account for each location and must separately reconcile each
account.
30
Insurance Companies with many locations or distribution / sales network
or franchise network will have collection from these locations.
Often companies are deprived of access to the funds of their own for
profitable deployment.
Companies will not normally know when the cheques tendered for
collection will be realized and relative proceeds will be credited to its
account. Sometimes such realizations take considerable time.
At times although cheques are paid by the drawee bank at the destination
& there is considerable delay in ultimate credit into the companies
account.
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Estimate the cash flow based on the outstation cheques tendered for
collection is difficult.
Example: ‘A’ has accounts in major cities but it sells the product in
countryside areas also. It receives outstation cheques in the due course of
business. The company normally does not know when it will get credit for
outstation cheques. It could not plan its investment. Even it could not
match its payoff schedules.
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Citibanking online
Citicheck anywhere
Camslink service
And various other banks like ABN- AMRO Bank, Standard Chartered
Grindlays Bank, Hong Kong Bank, Corporation Bank.
4.2.2 The second strategy i.e. Proper estimation and efficient investment
management, has two parts. Proper estimation of funds requirement on
daily, monthly, quarterly and yearly bases needs accurate Assets Liability
Management. And efficient investment of funds requires answers to
various questions mentioned in next section.
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. A life insurance company offers a variety of product lines, which include
life insurance, disability income, and annuities. Selling these products
involves collecting premiums from customers on a one-time or periodic
payment basis in return for future promises, also called liabilities, which
provide protection or benefits in case of death, disability, or retirement.
Why do companies take risks? There are two basic reasons. First,
because they can make money at it. Second, because they have no
choice — it is just part of being in business. Let's look at the four different
types of risk from this perspective.
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but lower than the benefit, is worth to the person. That's a win-win
situation.
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Risks Affecting Management
Financial Risks
Six general types of financial risks face the insurance industry. These
include:
• Actuarial
• Systematic
• Credit
• Liquidity
• Operational, and
• Legal risks
As these risks vary with the type of services provided, management of life
insurance companies work very hard to define the inherent financial risks
that can alter their course of success.
Actuarial risks arise from raising funds by means of issuing policies and
other liabilities. The two risks that affect companies are (1) paying too
much for the funds received and (2) receiving too little for the risks taken.
Systematic risk, also called the market risk, deals with changes in value of
assets and liabilities. These include interest rates and basis risk. Life
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insurers measure and manage their vulnerability to interest rate
movements. Companies with common stock holdings, large corporate
bonds, and mortgages watch closely swings in the basis rate. Any
movement in the rates affects the yields on those instruments. Life
insurers invest in assets that vary in credit quality, liquidity, and maturity,
which subject them to market value variations independent of fluctuating
liability values.
Credit risk takes considers that borrowers will not fulfill their obligations
and is affected by borrowers’ financial condition and the value of their
collateral. Life insurers need to be concerned with this type of risk,
because investments in bonds form part of their asset portfolios
Operational risk not only looks at management and employees but also at
management information systems used for processing data and record
keeping. Inefficiency in this area can produce costly outcomes for life
insurance companies.
Legal risk should be of great concern to the life insurance industry. New
legal trends can be observed in litigation outcomes, especially in the U.S.,
and globalization adds new meaning to the legal environment. Other
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reasons such as fraud, violation of regulations, and misinterpretation of
contracts by policyholders add to the complexity of this kind of risk. This
legal risk can result in catastrophic losses to life insurance companies.
Actuarial Risk
• C1 — asset default risk, or credit risk. C1 risk is the risk that the
company's investments go bad. Junk bonds in the 1980s and
commercial real estate in the 1990s were sources of huge losses
for many insurers and several U.S. insolvencies.
• C3 — interest rate risk. C3 risk is the risk that the company will lose
money because of an unfavourable change in interest rates. The
example in the
introduction provides a
sense for how this risk
could occur.
• C4 — general
management risk. C4 risk
is the risk that
management will make
an error or that systems will fail or any similar incident that causes
the company to lose money.
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Asset-Liability Management (Alm) Strategies
Life insurers operate either as mutual or stock companies and their overall
financial objectives generally involve a target return on capital and the
ability to provide prompt payments to their customers arising out of
contractual obligations. Thus, management’s role in a life insurance
company is to be proactive in scanning the environment. As shown in this
chart, this helps management to understand the trends that are happening
so that they can incorporate that understanding in planning and design of
asset-liability portfolios.
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Since working capital management mainly deals with the management of
trade off between risk and liquidity, the investment decisions plays an
important role together with the fact that roughly 35% in 1999-2000 and
36% in 1998-1999 of the total income of LIC is earned from returns from
investments. The investment manager should take the following important
decisions:
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J 0.3 Other investments
a
Assets of LIC
b
c
d
e
f
g
h
I
j
k
The specific securities in the type depends upon past records, and return
of these securities
The percentage of funds to invest in each depends upon the risk return
continuum and the expected % of return by the policyholders.
d) What is the approximate level of funds needed on each day, week, and
month, quarter, year?
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42
5. INVESTMENT POLICY OF LIFE INSURANCE
COMPANIES.
5.1 Introduction
It is axiomatic that as a life company grows over a period of time the level
of premium income also grows, adding additional amounts to the life funds
every year. Besides the receipts of investments from the previous year
would provide additional source of finance for additional purposes. As the
funds placed at the disposal of the life company are long term in nature
there is a assumption that on an average claims against the addition to the
policy reserves will not materialize for many years hence, i.e., usually upon
the death of the insured or at the maturity of the endowment policy. As
such, it is considered that investment of these reserves must be in long-
term obligations, such as govt. securities, real estates and mortgages.
Before life insurance contracts are entered into by life company, premium
rates are fixed making the requisite assumption regarding the rate of
interest at which earnings and policy holder reserves can be compounded
over the period of a life contract. Such an assumption regarding the rate of
interest allows the life company in placing its funds in those investment
outlets, which yield a fixed rate of return, a fairly regular payment of
interest over the life of the investment and assured repayment of a fixed
sum of rupees at the end of the investment period. Investment sin long-
term obligation satisfies these essential requirements. The advantages of
investing in long-term securities are
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1) Higher rate of return
TRADITIONAL THINKING
MARKOWITZ’S HYPOTHESIS
44
set of available portfolios that set of portfolios which represent an efficient
combination of expected return and standard deviation of return when
these efficient combinations are plotted hey will yield an what is called an “
opportunity locus”.
It can be sub divided into two heads: capital value risk and income risk.
Capital Value Risk arises when the liquidity position of the company
becomes of bad as to necessitate a sale of security in the market before
maturity date, which results in a capital loss. The income risk arises when
there is possibility that the market rate of interest will change either during
the period life insurance contract is in force or at the time of deployment of
funds consequent on the maturity of securities. The first type of income
risk is peculiar to life insurance contract as premium are received at
different points in time while the rate of interest to be earned on those
funds has to be stipulated at the time the insurance contact is entered into.
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time, when there are significant excratios to these funds. Consequently the
companies cannot normally postpone investment purposes out of current
income, so they have weak speculative motive.
It is axiomatic that a life insurance company must earn at least the rate of
return assumed in fixing the premium rates the question that need to be
discussed here related to the risk that arises as a result of uncertainty
about future variations in interest rates. This type of risk is particularly
relevant, as substantial portion of funds required to meet obligations
emanating from the existing life insurance contracts will only be received
at future dates. The funds that will become available for investments in
future arise mainly from two sources. First, premium payable in future on
existing life insurance contracts. Second, realization of previously invested
funds. The second source namely the turnover of the funds invested in the
past is n important problem. Suggestion offered for tackling this problem is
in the nature of matching and those, which are based on the basis on the
consideration of the expected yield. According to Clark, the investment
policy of Life Company must aim at maximizing the expected yield, with
minimum deviation of such yield from the realized yield.
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1. Effect of Guidelines as issued by Insurance Regulatory Authority, India.
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Part-C
Case Study-
L.I.C.
48
1. LIFE INSURANCE CORPORATION OF INDIA (LIC)
The LIC has a network of 7 zones, 100 divisions and over 2,000 branches.
LIC personnel exceed 700,000, with approximately 125,000 employees
and over 550,000 agents.
The Life Fund of the LIC, which was established in 1956 to conduct life
insurance transactions, has grown to approximately USD 25 billion from a
mere USD 94 million in its inaugural year. Over 100 million lives are
covered. The annual premium income, which was USD 21 million in 1956,
was estimated at USD 4.5 billion in 1997-98. Presently, business
investments of the LIC total over USD 23 billion.
The table below shows the expanding business over the years of the LIC.
1.2 Investments:
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The Investment pattern of LIC has undergone a change with it today
parking a lot of funds in the infrastructure sector as compared to before.
The following table indicates the above.
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1.3 Life Fund:
The Life fund of LIC has crossed Rs. 1,200 billion at the end of fiscal 1999
as compared to Rs.1,05 8.3 billion recorded in the previous fiscal.
YEAR FUND
1993 409.98
1994 496.65
1995 599.79
1996 727.80
1997 877.60
1998 1,05 8.32
1.4 Claims Settlement:
Over 110 million lives have been covered by the LIC under the Individual,
Group and Social Security schemes as on March 1998.
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1997-98 11.63 55.14 66.77
1.5 Highlights of 1998-99:
The first premium income, which is really the indicator of growth in the
business of Life Insurance, has grown by 28% during 1998-99. The LIC
has collected Rs.26.91 billion during the year, up from Rs.20.99 billion in
1997-98. About 14,843,680 new policies were added in 1998-99 to the
existing 80 million policies. The total sum assured is pegged at Rs.753.16
billion during 1998-99 up from Rs.631.67 billion during 1997-98.This would
give a new business premium of Rs.26.91 billion. The individual
Pension business grew with the sale of 105,638 policies generating a first
premium income of Rs. 1.11 billion posting growth rates of 63% and 131%
respectively. Under the group Insurance scheme a total of 1.27 billion lives
were covered generating a new business premium of Rs. 4.43 billion
registering a growth of 195% and 295% respectively. The institutions total
fund size has crossed Rs.1,200 billion during the year.
The growth in policies, minimum sum assured and the premium incomes
during the last five years has been highlighted below
Growth In Percentage
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Contribution to 8th plan: Rs.561 billion
Contribution upto31.3.98 in
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Some Trends
• Less than half of the finance is raised from internal sources and more
• The growing substitution of private debt for govt. debt. Govt. Bonds
serve as residual sources and uses of funds, they are the primary
standard in terms of which the investment qualities of alternate
investments are judged. As a rule they turn to govt. securities, first,
when there is a lack of high yielding private obligations processing
sufficient safety features and, secondly when the structure of interest
rates changes in a way that narrows the spread between the yield on
govt. and that on private obligations.
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CONCLUSION
1969-70 6%
1974.75 6.93
But it is less impressive than the rise in yield earned by the leading
British and U.S. life companies (their yield is approx. more than
7%).
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5. There is a rise in the amount of policy loans advanced by the L.I.C.
as well corporate investment in land and house property
On the whole it has been observed that frequent govt. intervention and
handicap autonomy in taking investment decisions is affecting the
performance of L.I.C.
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RECOMMENDATIONS
• Yield risk may be sub-divided under two heads: (a) capital value risk:
and (b) income risk. L.I.C. during the 70`s and 80`s did not care about
its capital value risk. It cares only for income risk. It used to neglect it
because of high degree of accuracy with which actuaries can forecast
mortality rates.
However, the situations will not remain same in the open and
competitive market. They have to make suitable policies for it. The
need for its consideration will increase due to two reasons:
(b) The right to secure loans from life companies up to a ceiling of the
surrender values.
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• With the permission to invest greater percentage in stock markets and
Here are a six of the most important decisions it must take before making
investments
2. Investment policy
Does the current investment policy accurately reflect the purpose and
goals of the investment function you have just outlined? The policy should
not start with the basis of what other companies are doing? That is one of
the many problems to which all human decision-making is subject. It is
called farming, and it means we automatically use to comfortable frame of
references within which to make decisions. Setting forth even a draft of an
investment policy requires a complex set of decisions. Of course, that
does not mean that your company’s investment policy will not look like
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many other insurer policies. After all, similar investors with similar goals
and constraints will tend to have similar policies. However, it does mean
that the investment manager will have considered asset classes and policy
issues that, perhaps, he might have not fully considered in the past. And
the result may indeed be investment results.
3. Liability characteristics
What does the manager know about the company’s liabilities, and what
more does he needs to know to fashion an appropriate investment policy?
Your company has funds to invest to satisfy two major constituencies:
policyholders and stockholders. For stock companies, that means
understanding the impact of your company’s capital structure on the
investment portfolio. For stock or mutual companies, that means
understanding more than just what duration of liabilities are, but it means
understanding how the liabilities will react in different economic, market
and underwriting environments.
Duration might be the most overly relied upon and ill-used financial. A
duration of 5 years on liabilities means assets must have the same
duration, more or less. For any single duration numbers there are literally
countless combinations of cash flows that will produce the same number.
Thus duration is only part of the story – amount, timing and variability of
the amount and timing to cash flows for both assets and liabilities must be
considered.
4. Asset allocation
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and other modeling done for us? Let’s face it there really isn’t all that much
difference in core fixed income manager performance – certainly nowhere
near the amount of variability found in the world of equities.
Hence, a few words of caution: First, all of these models invariably assume
that we human beings are rational and always act that way. Thus, any
significant deviations are accounted for within bounds of confidence inside
the models. We trust these models implicitly, despite the fact that none of
us really know any 100% rational humans. And it is those times of
irrationality that can truly wreak havoc with our company’s financial
statements. Second, all of these models must be questioned on three
basic levels – assumptions, model structure (how the thing works), and
output (what all that stuff means).
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myriad, but we’ll name there recent ones: General American, ARM
Financial and Long Term Capital Management. Go ahead and add a few
names of your own to the list.
Of Course, for many companies, simply following what other insurers are
doing seems to be the answer to the asset allocation question. This is an
answer that should, in itself, be questioned, for the reasons noted in
number 2 above. It will be inevitable spell investment under performance –
a recipe for problems in an increasingly competitive market.
5. Investment benchmarks
A world of caution here: In their continuing effort to keep the business, the
manager will spend a lot of time fashioning a benchmark that should be
relatively easy to beat. If the company would like to maintain relationship
with the investment manager no matter his performance, this is an
excellent solution. However, if superior performance is a goal, setting the
bar as high as possible should be your company’s goal.
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6. Manager monitoring
Under what circumstances will you consider replacing your manager? This
is important, even when hiring a brand new manager. The company must
ask itself the question that “value” investors ask every day. Based upon
what investment has been done for so far, would the company continue to
own it.
Here are the six key investment decisions, which should be made by a
company before investing. Not easy decisions by any means, but
important decisions that will set the tone for a successful, high
performance investment operation.
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Model 1
In the following model, I tried to reshuffle the portfolio of the LIC, taking
into account the average of the opening and closing balances and tried to
suggest better allocation of funds available with the LIC.
In the first two tables, returns on the investments of the year 1998 and
1999 have been calculated. As either opening or closing balance cannot
give the actual picture of the funds invested over the year so that average
of the opening and closing balances has been taken in to consideration for
the calculation of the return.
In next table, reshuffled portfolio has been shown and return on the new
portfolio has been calculated. All though the minimum limit for investing in
Government Securities is 50% but to play safe we have invested 53% of
the total funds in the government Securities. This is also done because
the proportion of investments has to be 50% minimum on any given date
so by investing 53% we provide a margin of 3%. All though the returns in
the non approved security are high but still we have invested 28.5% of the
funds and not the entire 30%, this is done because such securities carry
along with them a high risk factor also. So we have invested 28.5% only.
Here, we can see that after the reshuffling of the portfolio, percentage
return has just increased to 11.33% from 11.24%, but in the actual
monetary terms it results in increment of Rs. 132.68 crores.
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ANNEXURE 1
A) Exposure Norms
Type of Investment Limit for Investee Limit for the Limit for the
Company entire group to industry sector to
which the which the
investee investee company
company belongs
belongs
Not exceeding 15%
(a) Equity/ Preference (i) As on any date (i) As on any
of the total capital
Shares/ Convertible date
Not exceeding employed* in all
portion of Debentures 20% of the total Not exceeding such companies.
at face value. capital employed*. 15% of the total
(b) Debentures - (face capital employed*
value) including of the group
private placed NCD companies.
and Non-convertible
portion of Convertible (ii) During the (ii) During the
Debentures. year year
(c) Short/ Medium/ Long Not exceeding 5% Not exceeding
Term Loans and any of estimated 10% of estimated
other direct financial annual accretion of annual accretion
assistance. funds. of funds.
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Exposure Norms for Investment in Public Financial
Institutions
Equity Share and Preference Shares (at Not exceeding 15% in general of the paid
their face value). up equity/ preference capital of the
institution or the existing holding % level, if
higher.
Investment in Equity Capital, Bonds, Not exceeding 10% of the capital employed
Debentures, Term Loans. by an institution as per the last audited
Balance Sheet.
Total Investment vis-à-vis Net Worth of Not exceeding 60% of Net Worth of the
the Company. institution.
Total Investments in all the Financial Annual aggregate financial assistance to all
Institutions. Development Financial Institutions put
together in a single year shall not exceed
20% of the estimated annual accretions for
the year.
Prudential Norms
i) Debentures:
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a) Rate of interest at the time of subscription to said debentures,
b) Appreciation and
1. Eligibility Amount
a) Working Capital 20% of the current assets, loans and advance minus
Debentures outstanding amount of existing working capital NC
Debentures.
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Asset Cover (as specified in Schedule III):
Not less than 2 times for the latest year or on the basis of the average of
the immediately preceding three years after including the interest on the
proposed debentures at the applicable rate.
Dividend Payout:
The insurers need to place the deposits with a view to cater to working
capital needs of the corporate sector. The placement of the deposit is to
be decided after evaluating financial and non-financial aspects of the
performance parameters of the companies. The analysis need to include
study of financial position, track record and other features such as quality
of management, future prospects and market potential for the company's
products. Credit rating of borrower should be uniformly maintained at a
position which is indicative of a very strong financial position being not
less than AA of Standard and Poor or equivalent rating of any other
reputed and independent rating agency.
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The maximum amount of Short Term Deposit that may be placed with any
company is restricted to Rs 2 crores or 10% of net worth whichever is
less.
The various norms/ parameters for the placement of term loans are as
under:
Particulars Limits
Unsecured borrowing as a % Not to exceed 25% of net worth including the proposed
of net worth. loan, subject to net worth of the borrowing company
being not less than Rs. 15 crores.
Interest Cover. At least 2.5 times including interest on proposed loans.
Debt/ Equity Ratio. Not to exceed 2:1.
Current Ratio. Not less than 1.33:1.
Dividend Record. At least 10% for the last 5 years or 15% and above for
3 out of 5 years.
Listing Equity shares of the Company shall be listed on any
recognised stock exchange and the price should
continuously been quoting above par at least for 12
months prior to the date of sanction of loan.
Collateral Security Cheques shall be obtained for principal and interest
amount. Personal guarantee of promoters and pledge
of shares may be taken.
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Guidelines on subscription to Preference Shares:
e) Dividend should have been paid on equity shares for two years out of
immediately preceding three years.
h) Dividend cover on the basis of average profit of last 3 to5 years should
be 3 times.
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S.No Form No as Short description Periodi Time limit for Verified/
annexed to city of submission Certified by
these returns
regulations
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The Authority may, by any general or special order, modify or relax any
requirement relating to the above.
The Authority may, by general or special order, require from the insurers
such other information in such manner, intervals and time limit as may be
specified therein.
Every insurer shall report to the Authority forthwith, the effect or the
probable effect of any event coming to his knowledge, which could have
an adverse impact on the investment portfolio held by him.
Miscellaneous
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72
SCHEDULE I
(See Regulation 3)
‘Approved Investments’ for the purposes of Section 27A of the Act shall be
as follows:
In addition the Authority under powers given vide clause (s) of sub-section
(1) section 27A of the Act declares the following investments as approved
investments:
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e. Investments in Venture Capital Funds of such companies/
organisations, which have a proven track record and have been, rated
‘very strong’ or more by a reputed and independent rating agency (e.g.
AA of Standard and Poor).
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CONTENTS
TOPICS PAGE NO
PART-A
Introduction 2
Indian Insurance Industry: A Perspective 10
World Insurance Environment in 1999 15
Introduction to Funds Flow and Cash Flow 17
PART-B
Funds Management 22
Objectives of funds Management or Liquidity 25
Management
Liquidity Flow Cycle 26
Basic Steps in Funds Management 29
Investment policy of Life Insurance companies 43
PART-C
Life Insurance Corporation of India 48
Conclusion 57
Recommendations 59
Annexure 66
FUNDS MANAGEMENT OF
INSURANCE COMPANY
PROJECT GUIDE:
75
ANURAG BHATNAGAR
MAX NEW YORK LIFE INSURANCE CO. LTD.
NEW DELHI.
SUBMITTED BY:
MANISH GAUTAM
ENROLMENT NUMBER # 980135177
REGIONAL CENTRE # New Delhi
PROJECT PROPOSAL NUMBER # 100000
SUBMITTED TO:
SCHOOL OF MANAGEMENT STUDIES
INDIRA GANDHI NATIONAL OPEN UNIVERSITY
MAIDAN GARHI
NEW DELHI.
CERTIFICATE
FUNDS MANAGEMENT OF
INSURANCE COMPANY
SUBMITTED BY:
76
MANISH GAUTAM
ENROLMENT NUMBER # 981035177
STUDY CENTRE #
REGIONAL CENTRE # New Delhi
PROJECT PROPOSAL NUMBER #
PROJECT GUIDE:
ANURAG BHATNAGAR
MAX NEW YORK LIFE INSURANCE CO. LTD.
NEW DELHI
ACKNOWLEDGEMENT
77
PROVIDING ME WITH THE INFORMATION AND FACILITIES AT THEIR
PREMISES FOR THE PROJECT WORK.
MANISH GAUTAM
78