INSURANCE AND RISK MANAGEMENT

Unit 1
LEC. 1
Conceptual framework of insurance
Insurance is the one of the method of handling risks. It protects man from uncertainty and risks
in personal & business life. The main function of insurance is to spread these losses over a large
number of people through cooperative efforts. It denotes the contract where one party , in
consideration of money payment , called premium, undertakes to indemnify another party against
any loss or to pay to that party an agree some of money on the happening of the certain event.
It has been defined by an insurance expert as,”a form of cooperation through which all those who
are subject to certain risks and losses pool their resourses to compensate those who really suffer a
loss.” Some of the popular definitions are as follows:-
Prof D.S. Hansell, “A social device providing financial compensation for the effect of misfortune
, the payment being made from the accumulated contributions of all the parties participating in
the scheme.”
Riegel R and Miller J.S. , “ Insurance is a social device whereby uncertain risks of individual
may be combined in a group and thus made more certain ; small periodic contributions by the
individuals providing a fund out of which those who suffer losses may be reimbursed.”
Concept of Insurance
On the one hand, human life is subject to various risks- risk of death or disability due to natural
or accidental causes. Humans are also prone to diseases, the treatment of which may involve
huge expenditure. On the other hand, property owned by man is exposed to various hazards,
natural and man-made. When human life is lost or a person is disabled permanently or
temporarily, there is a loss of income to the household. The family is to hardship. Sometimes
survival itself is at stake for the dependents. When it comes to property , loss or damage to
property results in either whole or partial loss in income to the person or entity.
Risk has the element of unpredictability . Death/ disability or loss/damage could occur anytime.
Losses can be mitigated through insurance.

LEC. 2
CONCEPT AND MEANING OF INSURANCE
Insurance is a commodity which offers protection against various contingencies. Insurance
products available for life and non-life are many. In non-life, apart from personal covers such as
accident covers and health insurance, there are products covering liabilities under a particular
law and or a common law. The various products are design to cater to different needs of an
individual or industry such as fire insurance policy on multi-storeyed building, householder’s
policy.
Human life can not be valued . Hence the sum assured or the amount guaranteed to be paid in the
event of the loss, is by way of a ‘benefit’ in the case of life insurance. Life insurance products
provide a definite amount of money to the dependents of the insured in case the life insured dies
during his active income earning period or becomes disabled on account of an accident causing
reduction/ complete loss in his income earnings.
A Personal accident cover is also for protection. In the event of death or disability , permanent or
temporary , of the insured , it provides for compensation which is either the whole or a
percentage of the capital sum insured depending on the kind of loss.
In the case of Health Insurance , the policy seeks to cover expenses towards the treatment of
diseases or injury upto the sum insured opted for.
In respect of insurance relating to property , there are many products available.Property may be
covered against fire and perils of nature including flood, earthquakes etc. Machinery may be
insured for breakdown. Goods in transit may be insured under a marine cargo insurance cover .
Insurance covers are also available for ships and other vessels.
Insurance of property is based on the principle of indemnity. The idea is to bring the insured to
the same financial position as he/ she was before the loss occurred . It safeguards the investment
in the property. General insurance offers stability to the economy and to the society.
Insurance offers security and so peace of mind to the individual . The concept of insurance is that
the losses of a few are made good by contribution from many. It is based on the law of large
numbers. It stemmed from the need of a man to find a solution for mitigration of a losses. It also
reflects the nature of man to find a solution collectively.
It is important for all to understand the various products that life and general insurance
companies offer before they make a choice as to the product they want to buy.
As per regulations, insurers have to give the various features of the product,s at the point of sale.
The insured should also go through the various terms and conditions of the products and
understand what they have bought and met their insurance needs. They ought to understand the
claim procedures so that they know what to do in the event of loss.

LEC.3
NATURE AND SCOPE OF INSURANCE
Insurance can cater to risk only when the following conditions are met:
(i) There must be large numbers of similar risks.
(ii) The loss caused by the risk must be definite.
(iii) The occurrence of the loss must be accidental or fortuitous.
(iv) The potential loss must be large enough to cause hardships.
(v) The cost of insurance must be economically feasible.
The functions of insurance can be bifurcated into two parts:
1. Primary Functions
2. Secondary Functions
3. Other Functions

The primary functions of insurance include the following :

1. Provide Protection - The primary function of insurance is to provide protection against
future risk, accidents and uncertainty.

2. Collective bearing of risk – Insurance is a device to share the financial loss of few
among many others. Insurance is a mean by which few losses are shared among larger
number of people.

3. Assessment of risk- Insurance determines the probable volume of risk by evaluating

various factors that give rise to risk. Risk is the basis for determining the premium rate
also.

4. Provide Certainty- Insurance is a device , which helps to change from uncertainty to

certainty. Insurance is device whereby the uncertain risks may be more certain.
The secondary functions of insurance include the following:
1. Prevention of losses- Insurance cautions individuals and businessmen to adopt suitable
device to prevent unfortunate consequences of risk by observing safety instructions;
installation of automatic sparkler or alarm system, etc.

2. Small capital to cover larger risks- Insurance relieves the businessmen from security
investment by paying small amount of premium against larger risks and uncertainty.

3. Contributes towards the development of larger industries- Insurance provide

development opportunity to those larger industries having more risks in their setting up .
Even the financial institution may be prepared to give credit to sick industrial unitswhich
have insured their assets including plant & machinery.

The Other functions of insurance include the folloing:

1. Means of savings and investments- Insurance serves as savings and investment ,
insurance is a compulsory way of savings and it restricts the unnecessary expenses.

2. Source of earning foreign exchange- Insurance is an international business. The

country can earn foreign exchange by way of issue of marine insurance policies and
various other ways.

3. Risk Free trade- Insurance promotes exports insurance, which makes the foreign trade
risk free with the help of different types of policies under marine insurance cover.

LEC. 4
CLASSIFICATION OF INSURANCEE BUSINESS
Insurance may be divided into several saperate and distinct branches.
 1. Insurance of the property , e.g., marine insurance in respect of cargo, fire insurance on
building , etc.
2. Insurance of the property which includes all type of life assurance.
3. Insurance of the liability of the policy holder, where he may be liable to death or injury of
another person or property like liability of the employer to his employees.
4. Insurance of the rights or financial interest of the policy holders, like credit insurance,
etc.
Generally the different kind of insurance fall under the following subheads:
Life Insurance: It is the most popular form of insurance where the insurance company agrees
to pay a specified sum of money to the insured, on the expiry of the certain period of time or on
the death of the insured person, whichever is earlier. This kind of insurance therefore relieves the
widows , children , and other dependents of the hardships .

Fire Insurance: It is a contract whereby the insurer undertakes to indemnify the insured against
any loss caused by fire to the property insured up to the extent agreed upon by the insurer and
insured. This type of insurance is taken by the owners of factories, cinema halls, godowns etc.

Marine Insurance: It is a contract whereby the insurer agrees to indemnify the insured against
the risks of marine adventures up to the agreed sum . It also includes cargo and freight insurance.
It helps shipping companies and traders to insure their ships and cargo against risks of marine
adventures.

Miscellaneous Insurance: It covers a number of risks like twin insurance, accident insurance ,
workmen’s compensation insurance.

LEC. 5
LIFE INSURANCE
Life is very fragile and death is a certainty . We cannot control the uncertainties of life. But, we
can cover the risks surroudings us . Life insurance , simply put, is the cover for the risks that we
run during our lives. It protects us from the contingencies that could affect us.
Life insurance is not for the person who passes away , it for those who survive . It is the
unfortunate circumstance of his/her demise. Thus having a life insurance is very vital. Before
going for the life insurance policy it is imperative that you know about various types of life
insurance policies. Major among them are:
 Endowment Policy
 Whole life policy
 Term life policy
 Money back policy
 Joint life policy
 Group insurance policy
 Loan cover term assurance policy
 Pension plan or Annuities
 Unit linked insurance plan

LEC. 6
GENERAL INSURANCE
General Insurance provides much- needed protection against unforeseen events such as
accidents, illness, fire, burglary etc. Unlike Life Insurance, General insurance is not meant to
offer returns but is a protection against contingencies. Almost everything that has a financial
value in life and has a propability of getting lost, stolen or damaged , can be covered through
General insurance policy.
Property both movable and immovable , vehicle, cash, household goods, health, dishonesty and
also one’s liability towards others can be covered under general insurance policy.
Major insurance policies that are covered under general insurance are:
 Home Insurance
 Health Insurance
  Motor Insurance
 Travel Insurance

LEC. 7
ROLE OF INSURANCE IN ECONOMIC DEVELOPMENT
Insurance has an impact on the economic development by influencing the following factors
which are integral to the economic growth of any nation.
 Generates employment
 Reduces social security load on the nation
 Money ploughed for social development
 Revitalizes the financial market and stock exchanges
 Act as security/ collateral

LEC. 8
ROLE OF INSURANCE IN INSURERS / FUNDAMENTAL PRINCIPLES OF
INSURANCE
Insurance contracts are based on the following principles:
1. Utmost good faith
2. Insurable interests
3. Indemnity
4. Causa proxima
5. Risk must attach
6. Mitigation of loss
7. Contribution

A document of insurance being a contract should fulfill the following criteria:

 Intention to create legal obligation
 Unrevoked offer
 Unqualified acceptance
 Consideraton
  Legality
 Capacity of the parties to contract

LEC. 11
Role of Financial Institution:
Financial institution refer to such privately owned corporate or public sector corporation or
institutions, which are meant for financing projects or extending term loans to industries falling
within their jurisdictions. In financial economics, a financial institution acts as an agent that
provides financial services for its clients or members. Financial institutions generally fall
under financial regulation from a government authority. Common types of financial institutions
include banks, building societies, credit unions, stock brokerages, asset management firms,
and similar businesses.
Financial institutions provide service as intermediaries of the capital and debt markets.
They are responsible for transferring funds from investors to companies, in need of those
funds. The presence of financial institutions facilitate the flow of money through the
economy. To do so , savings are pooled to mitigate the risk brought to provide funds for
loans.
Financial institutions can be categorized as follows:
 Deposit taking institution
 Finance and insurance institutions
 Investment institutions
 Pension providing institutions
 Risk management institutions
The primary functions of financial institutions of this nature are as follows:
 Accepting deposits
 Providing commercial loans
 Providing mortgage loans
  Providing real estate loans
 Issuing share certificates

LEC. 12
Insurance Companies:
Insurance company means any insurer being a company , association or partnership
under companies Act 1956 or Partnership Act 1932: Sec 2(8).
Insurance Intermediary:
Insurance Intermediary or intermediary includes brokers , reinsurance brokers, insurance
consultants , surveyors and loss assessors , or any other person representing or assisting
an insurer in one or more of the following :
(i) Soliciting , negotiating , processing or effectuating an insurance contract or a
renewal of an insurance contract .
(ii) Disseminating information relating to coverage or rates.
(iii) Forwarding an insurance application.
(iv) Servicing and delivering an insurance policy or contract.
(v) Inspecting a risk.
(vi) Setting a rate.
(vii) Investigating or assessing a claim or loss.
(viii) Transacting a matter after the effectuation of a contract or
(ix) Representing or assisting an insurer or other person, in any other manner in
the transaction of insurance with respect to a subject of insurance resident ,
located or to be performed in India.
(x) Servicing a policy or a contract.

LEC. 13
Financial Markets
A financial market is a mechanism that allows people to easily buy and sell financial
securities, commodities and other tangible items of value at low transaction costs and at
prices that reflect the efficient market hypothesis.
Both general markets(where many commodities are traded ) and specialized markets
(where only one commodity is traded) exist. Markets work by placing many interested
buyers and sellers in one “place” , thus making it easier for them to find each other.

In finance, financial markets facilitate-

 The raising of capital
 The transfer of risk
 International trade

LEC. 14
Financial structures and functions
Financial market is the market where financial securities like stocks and bonds and
commodities like valuable metals are exchanged at efficient market prices. Here by
efficient market prices we mean the unbiased price that reflects belief at collective
speculation of all investors about the future prospect. Financial markets can be domestic
or international.
There are different type of financial markets which are as follows-
 Capital market
 Money market
 Derivatives market
 Foreign exchange market
 Insurance market
 Commodity market

Basis of financial market

Basis of financial markets are –
 Borrowers
 Lenders
LEC. 15
Mutual Fund:
A mutual fund is a professionally managed type of collective investment scheme that pools
money from many investors and invests it in stocks, bonds, and other securities. The mutual
fund will have a fund manager that trades the pooled money on a regular basis.
Mutual funds belong to a group of financial intermediaries known as investment companies,
which are in the business of collecting funds from investors and pooling them for the purpose of
building portfolio of securities according to stated objectives. Mutual funds are generally
organized as corporations or trusts and as such they have a board of directors or trustees elected
by the shareholders.
Types of Mutual Funds:
Different types of mutual funds are as follows-
1. Open-end fund:
Open-ended means that, at the end of every day, the fund issues new shares to investors
and buys back shares from investors wishing to leave the fund. There is no fixed maturity
period. It can be repurchase on the continuous basis.

2. Exchange-traded fund:
A relatively recent innovation, the exchange-traded fund is often structured as an open-
end investment company. It is a open-ended fund that is traded by stock exchanges.
Exchange traded index funds are based on an underlying index, which could be market
index , sector specific index. ETFs are no load funds that can be traded continuously
through a broker all the day. Traditional open-ended funds are bought from and sold
back to the fund at prices based on NAV calculated at the close of the market.

3. Equity funds:
 Growth or equity oriented funds aim to provide capital appreciation over the medium to
long term. A major part of their corpus is invested in equities as a result of which such
funds have comparatively higher risks.

4. Bond funds:
Bond funds account for 18% of the mutual fund assets. Types of bond fund include term
funds, which have a fixed set of time ( short, medium or long term) before they mature.

5. Money market fund:

income funds that aim to provide easy liquidity, with preservation of capital and
moderate income. They invest in short term money market instruments such as treasury
bills, certificates of deposite, commercial paper, govt. securities etc. money market funds
entail the least risk, as well as the lower rate of return.

6. Funds of fund:
It invest primarily in other mutual fund schemes. This allows investors greater
diversification through investment in a single scheme.

7. Real Estate mutual funds:

Its aim to invest directly or indirectly in real estate. Other investment include mortgage
backed securities, securities of companies that deal in properties and property
development and other securities

LEC. 16
Housing Finance

LEC. 17
Important life insurance products
Life is very fragile and death is a certainty . We cannot control the uncertainties of life. But, we
can cover the risks surroudings us . Life insurance , simply put, is the cover for the risks that we
run during our lives. It protects us from the contingencies that could affect us.
Life insurance is not for the person who passes away , it for those who survive . It is the
unfortunate circumstance of his/her demise. Thus having a life insurance is very vital. Before
going for the life insurance policy it is imperative that you know about various types of life
insurance policies. Major among them are:
 Endowment Policy
 Whole life policy
 Term life policy
 Money back policy
 Joint life policy
 Group insurance policy
 Loan cover term assurance policy
 Pension plan or Annuities
 Unit linked insurance plan

LEC. 18
IMPORTANT GENERAL INSURANCE PRODUCTS
General Insurance provides much- needed protection against unforeseen events such as
accidents, illness, fire, burglary etc. Unlike Life Insurance, General insurance is not meant to
offer returns but is a protection against contingencies. Almost everything that has a financial
value in life and has a propability of getting lost, stolen or damaged , can be covered through
General insurance policy.
Property both movable and immovable , vehicle, cash, household goods, health, dishonesty and
also one’s liability towards others can be covered under general insurance policy.
Major insurance policies that are covered under general insurance are:
 Home Insurance
 Health Insurance
  Motor Insurance
 Travel Insurance

LEC. 19
DETERMINATION OF PREMIUMS AND BONUSES
Premium: “Premium” is the amount which is paid by the assured to the insurance
company which has accepted the risk under the policy. Thus premium is :
(i) The monetary value of the risk , contingent upon the duration of human life,
and accepted by the insurer, or
(ii) The ‘consideration’ against the payment of which the insurer has undertaken
the risk.

Bonus System: Divisible profit is allotted to the various types of policies in proportion
to individuals’ contribution to the surplus. The distribution is made in cash to be
applied to reduce the premiums.
Simple and Compound Reversionary Bonus: The bonus is allotted as a uniform
percentage addition to the sum assured or sum assured plus existing bonus addition, and
is payable along with the sum assured in terms of the policies conditions. If the bonus
is allotted on the sum assured alone , it is termed as a “simple reversionary bonus” ; if
on the sum assured and existing bonus, as “compound reversionary bonus”.
Interim Bonus: This is not a method of distribution of surplus in the usual sense.
Bonuses are allotted only after valuation made and if it discloses a surplus available for
distribution.
COMPUTATION OF PREMIUM/BONUSES
Premium in life insurance is based on mortality rate. The premium worked out is called
‘basic premium’. A premium table shows the premium for every age and every term of
policy according to the sum assured. For example, for a policy of Rs. 1000 for a period
of six years of an insured age 26 is the Rs. 170 yearly. So for a policy of Rs. 1 lakh
the premium will be 170x1,00,000/1000= Rs. 17,000 . following rebates are allowed in
this premium.
 (i) For large sum assured , e.g. for sum assured of Rs. 50,000 to 1 lakh rebate @
Re. 1 per thousand.
(ii) For mode of payment of premium . Premium paid yearly is allowed rebate as
compared to premium paid quarterly.
(iii) Age. This may be age near birthday or last birthday or next birthday. For
example, if birth date of the proposer is 27-10-1967, the proposal is made on
1-10-2000, the age near birthday will be (1-10-2000) minus (27-10-1967) 4-11-
32 years, which is near to next birthday. Then age will be taken as 33 years.
If date of proposal is 25-4-2000 , then nearer birthday age will be 32 years. It means
if the difference is six months or more , add one to the difference in years to arrive
at the age and if the less than six months , the exact number of years is taken.
LEC. 20
VARIOUS DISTRIBUTION CHANNELS
Distribution channels in insurance
An insurance cover is an intangible product evidenced by a written contract known as
the policy. Insurer market various insurance covers either directly or through various
distribution channels.
The various distribution channels are—
(i) Insurance Agent
(ii) Corporate Agent
(iii) Brokers