Meaning of Risk and Uncertainty

Risk is the situation under which the decision outcomes and their probabilities of
occurrences are known to the decision-maker, and uncertainty is the situation
under which such information is not available to the decision-maker. Research
on decision-making under risk and uncertainty has two broad streams:
normative and descriptive. Normative research models how decision should be
made under risk and uncertainty, whereas descriptive research studies how
decisions under risk and uncertainty are actually made. Descriptive studies
have exposed weaknesses of some normative models in describing people’s
judgment and decision-making and have compelled the creation of more
intricate models that better reflect people’s decision under risk and uncertainty.

Risks, Perils, and Hazards

Risk, peril, and hazard are terms used to indicate the possibility of
loss, and are often used interchangeably, but the insurance industry
distinguishes these terms. A risk is simply the possibility of a loss, but
a peril is a cause of loss. A hazard is a condition that increases the
possibility of loss. For instance, fire is a peril because it causes losses,
while a fireplace is a hazard because it increases the probability of loss
from fire. Some things can be both a peril and a hazard. Smoking, for
instance, causes cancer and other health ailments, while also
increasing the probability of such ailments. Many fundamental risks,
such as hurricanes, earthquakes, or unemployment, that affect many
people are generally insured by society or by the government, while
particular risks that affect individuals or specific organizations, such as
losses from fire are considered the particular responsibilities of those
affected.

Types of Risk
There are different types of risks — only some are preventable, and
only certain types of risk are insurable. Risk can be categorized as to
what causes the risk, and to whom it affects.

Pure risk is a risk in which there is only a possibility of loss or no loss

— there is no possibility of gain. Pure risk can be categorized as
personal, property, or legal risk. Pure risk is insurable, because the law
of large numbers can be applied to estimate future losses, which
allows insurance companies to calculate what premium to
charge based on expected losses.

Static and dynamic risks are distinguished by their temporality. The

possibility of loss is uniform over an extended period of time for static
risks, so static risks are more predictable, and, therefore, more
insurable. Dynamic risks change with time, making them less
predictable and less insurable. For instance, the risk of
unemployment changes with the economy, so it is difficult to predict
what unemployment will be next year. On the other hand, the number
of houses that burn down within a given year within a specific
geographical area is steadier, not cyclical, and so is more predictable.

Personal risks are risks that affect someone directly, such as illness,
disability, or death. Property risk affects either personal or real
property. Thus, a house fire or car theft are examples of property risk.
A property loss often involves both a direct loss and consequential
losses. A direct loss is the loss or damage to the property itself.
A consequential loss (aka indirect loss) is a loss created by the
direct loss. Thus, if your car is stolen, that is a direct loss; if you have
to rent a car because of the theft, then you have some financial loss —
a consequential loss — from renting a car.

Legal risk (aka liability risk) is a particular type of personal risk that
you will be sued because of neglect, malpractice, or causing willful
injury either to another person or to someone else's property. Legal risk
is the possibility of financial loss if you are found liable, or the financial
loss incurred just defending yourself, even if you are not found liable.
Most personal, property, and legal risks are insurable.

Speculative risk differs from pure risk because there is the possibility
of profit or loss, such as investing in financial markets. Most speculative
risks are uninsurable, because they are undertaken willingly for the
hope of profit. Also, speculative risk will generally involve a greater
frequency of loss than a pure risk, since profit is the only other
possibility. So although many people take precautions to protect their
lives or their property, they willingly engage in speculative risks, such
as investing in the stock market, to make a profit; otherwise, a person
could avoid most speculative risks simply by avoiding the activity that
gives rise to it.

The speculative risk of investments can also be distinguished

as systemic risk (a.k.a. systematic risk) or diversifiable
risk (a.k.a. unsystematic risk). Systemic risk affects the whole
economy, causing the value of many financial instruments to lose
value. Diversifiable risk, on the other hand, affects only specific
investments, such as particular stocks or particular assets. It is called
a diversifiable risk because this risk can be minimized by diversifying
investments, by not putting all your eggs in one basket. By contrast,
systemic risk cannot be diversified away, because it affects almost all
investments. Systemic risk can be minimized if the investments are
diversified and held long enough, since the value of most investments,
like businesses, goes through cycles.

Unlike pure risk, where there is only possibility of a loss, society

benefits from speculative risks. For instance, investments benefit
society, and starting a business helps to create jobs and generate tax
revenue for society, and can lead to economic growth, or even
technological advancement.

Risk can also be classified as to whether it affects many people or only

a single individual. Fundamental risk is a risk, such as an earthquake
or terrorism, that can affect many people at once. Economic risks,
such as unemployment, are also fundamental risks because they affect
many people. Particular risk is a risk that affects particular individuals,
such as robbery or vandalism. Insurance companies generally insure
some fundamental risks, such as hurricane or wind damage, and most
particular risks. In the case of fundamental risks that are insured,
insurance companies help to reduce their risk of great financial loss by
limiting coverage in a specific geographic area and by the use
of reinsurance, which is the purchase of insurance from other
companies to cover their potential losses. However, private insurers do
not insure many fundamental risks, such as unemployment. These
risks are generally insured by the government, because the
government has some control over economic risks through specific
policies, such as monetary policy, and law. Fundamental and particular
risks can be pure or speculative risks.

Fundamental risks are risks that affect many members of society, but
fundamental risks can also affect organizations. For
instance, enterprise risk is the set of all risks that affects a business
enterprise. Speculative risks that can affect an organization are usually
subdivided into strategic risk, operational risk, and financial
risk. Strategic risk results from goal-oriented behavior. A business
may want to try to improve efficiency by buying new equipment or trying
a new technique, but may result in more losses than
gains. Operational risks arise from the operation of the enterprise,
such as the risk of injury to employees, or the risk that customers' data
can be leaked to the public because of insufficient security. Financial
risk is the risk that an investment will result in losses. Because most
enterprise risk is speculative risk, and because the enterprise itself can
do much to lower its own risk, many companies are learning to manage
their risk by creating departments and hiring people with the express
purpose of reducing enterprise risks — enterprise risk management.
Many larger firms may have a chief risk officer (CRO) with the primary
responsibility of reducing risk throughout the enterprise.

Peril and Hazard

Risk is the chance of loss, and peril is the direct cause of the loss. If a
house burns down, then fire is the peril. A hazard is anything that either
causes or increases the likelihood of a loss. For instance, gas furnaces
are a hazard for carbon monoxide poisoning. A physical hazard is a
physical condition that increases the possibility of a loss. Thus,
smoking is a physical hazard that increases the likelihood of a house
fire and illness.

Moral hazards are losses that results from dishonesty. Thus,

insurance companies suffer losses because of fraudulent or inflated
claims. The American legal system is a moral hazard in that it motivates
many people to sue simply for financial profit because of the enormous
amount of money that can sometimes be won, and because there is
little cost to the plaintiff, even if he loses. A good example is the current
asbestos litigation, which has bankrupted many companies, even
though very few plaintiffs show any real evidence of disease, and are
unlikely to ever develop any disease that can be shown, by the
preponderance of the evidence, to have resulted from asbestos
exposure. This type of moral hazard is often called legal hazard. Legal
hazard can also result from laws or regulations that force insurance
companies to cover risks that they would otherwise not cover, such as
including coverage for alcoholism in health insurance.
Insurance can be regarded as a morale hazard because it increases
the possibility of a loss that results from the insured worrying less about
losses. Therefore, they take fewer precautions and may engage in
riskier activities — because they have insurance. A good example of
morale hazard is when the federal government bails out financial
institutions who have made bad decisions. Many financial institutions
have taken significant risks in the recent subprime debacle by buying
toxic instruments, such as CDOs and mortgage-backed
securities based on subprime mortgages that paid high yields, but were
extremely risky. The financial institutions have considered
themselves too big to fail — in other words, if things started going
badly, then the federal government would step in to stop their collapse
for fear that the whole financial system will collapse, which is exactly
what the federal government did in September, 2008. Freddie Mac and
Fannie Mae have both been taken over by the government, and
American International Group (AIG) has been propped up by an
infusion of $85 billion of taxpayers' money. AIG sold credit default
swaps on mortgage-backed securities to buyers, mostly banks,
thinking that they could collect the premiums, but would never have to
actually to pay for defaults — but if they were wrong, then the
government would save them, because otherwise the banks that had
bought that credit default protection could also possibly fail. As recent
events have demonstrated all too clearly, this federal government
"insurance" creates a morale hazard for financial institutions —
taxpayers pay the premium, but the big financial institutions, with their
overpaid CEOs and managers, receive the benefits!

Financial Institutions Risks

1. Damage to Company Reputation

One of the most commonly cited fears was damage to their company’s reputation. This is
not surprising, as reputation is a vital ingredient to business success, whether in regards
to customer trust or employee loyalty. Companies that inspire employees and customers
alike find great success today, as was the case with the Massachusetts-based
supermarket chain Market Basket, which has continued to flourish following mass
protests in 2014 involving the ousting of a beloved CEO.

While key ingredients for acquiring a good corporate reputation, such as high quality,
outstanding service, and competitive prices, are relatively well understood, there are
seemingly countless ways in which a brand might be damaged. It could be the result of
unethical conduct, like what happened to the Volkswagen brand following the reveal of
its so-called emissions scandal in 2015. Reputational damage could also result from poor
security practices, as evidenced by the 2017 Equifax data breach, which exposed the
sensitive data of over one hundred million people and caused heavy damage to its
reputation.

2. Cybercrime – As One of The Major Financial Institutions Risks

Speaking of data breaches, the fear of cybercrime also commonly appeared as a

separate response in our survey. And that is no wonder, as cyberattacks like distributed
denial of service (DDoS) attacks are increasing in frequency every year. Such attacks
can wreak havoc on a company’s internet infrastructure, potentially sending domains and
web-based services offline for hours at a time and breaking functionality for their users.

Cybercrime can have serious consequences for a company’s bottom line in several ways,
whether measured in lost time and productivity, cost necessary to fight the attacks, or
simply in the loss of customer trust following a leak of sensitive data or failure to provide
services according to expectations. The above-mentioned Equifax breach resulted in
considerable brand damage, and DoS attacks can easily result in thousands of dollars in
damages stemming from a lower credit rating or higher insurance premiums.

3. Economic Slowdown
It seems that no matter where you turn for news, there is discussion about worldwide
economic stagnation. Whether focusing specifically on Europe or China, Japan or the
United States, the one constant seems to be the belief in some kind of synchronized
global economic slowdown.

In modern financial theory, a firm’s exposure to general market risk is known as its “beta.”
Although the betas of banks and financial service companies are relatively low compared
to other industries, they are still correlated in a positive direction, meaning that they are
still expected to be negatively impacted in response to a fall in the overall market.

Few financial organizations outside the biggest banks can hope to achieve any kind of
influence over fiscal and monetary policy, making the signs of an impending global
economic slowdown concerning for financial professionals who are otherwise mostly
powerless in the face of an economic downturn. With that said, there are ways for a
company to prepare for widespread economic turbulence.

Useful strategies include addressing the possibility of facing a poor economy well in
advance, maintaining a long-term orientation despite rocky short-term performance, and
making decisions based on growth prospects as well as cost reduction. Planning well in
advance and building financial buffers will go a long way towards mitigating the effects of
a coordinated economic downturn.

4. Regulatory/Legislative Changes

Similar to fears of general economic slowdown, a good number of financial professionals

responded that regulatory and legislative changes pose a risk to their companies in 2019.
Much talk has already been generated about the exceptionally high costs of compliance
for companies in the financial industry, with overall regulations seemingly doubling every
few years and costing banks upwards of one hundred billion dollars annually.

For an example of legislation significantly impacting the business operations of financial

institutions, look no further than the Dodd-Frank Wall Street Reform and Consumer
Protection Act. Passed in 2010 while still on the heels of the financial crisis and rolled out
over several years, the legislation placed restrictions on the way banks could engage in
investments and speculative trading, and once again eliminating proprietary trading
altogether.

While the ostensible purpose of the legislation was to reduce systemic financial risk and
protect consumers, it also strained the profitability of small community banks and drove
some out of business altogether, with the US losing 14% of such institutions between
2010 and 2014. An understanding of these consequences resulted in a partial Dodd-
Frank rollback in 2018, where small lenders were exempted from certain loan disclosure
requirements.

Looking outside the US, the European General Data Protection Regulation
(GDPR), enacted in 2016 and implemented in 2018, is perhaps the most high-profile
example of online data privacy regulation. The GDPR places many requirements on how
companies are to treat consumer data, individually costing companies millions of dollars
in compliance worldwide and imposing serious costs on small and medium-sized
businesses. Now, many believe that the US will soon follow suite in enacting data privacy
legislation, especially on large technology companies like Facebook, undoubtedly adding
further to compliance costs.

5. Increasing Competition

In an economic system marked by competition, successful companies cannot simply sit

on their laurels, lest an ambitious industry upstart appear and offer superior products or
lower prices to entice customers away. This is no different in the financial industry, with
the advent of financial technology and new means to invest and save appearing along
with the proliferation of smartphones and other mobile internet-connected devices.

Indeed, traditional financial institutions have encountered competition in recent years from
smartphone stock trading apps like Robinhood, as well as from online loan and impact
investing platforms. Meanwhile, tech giants like Amazon and Google always pose an
outside threat to disrupt virtually any industry, including financial services. Just look at
Apple Pay, which allows iPhone users to achieve common banking functions like swiping
a credit card or sending money to family or friends.

And this is all to say nothing about the potential for cryptocurrencies to one day gain more
traction and cause a huge upheaval in the way financial intermediaries operate. While
anyone who has followed the cryptocurrency scene over the past few years can attest to
the significant volatility in the sector, that has not stopped large financial institutions like
Bank of America from expressing worry about their growing popularity and seeking ways
to stay ahead of potential developments in block chain technology.

6. Failure to Innovate

In the face of such increasing competition in the financial sector, it is necessary for
companies to be able to innovate to continue to prosper. In technology, Apple was a
dominant force for innovation during the time of Steve Jobs, but sales decline has come
along rumblings concerning a lack of innovation coming out of the company.

Of course, Apple is still an industry giant and will not be going away anytime soon, as has
been demonstrated by the reveal of the Apple Card, a partnership with Goldman Sachs
and Mastercard that offers a credit card integrated directly into the iPhone’s Wallet app,
as well as new subscription services in news and television programming. Apple stock
has continued to rise despite poor headlines earlier in the year, serving as a reminder
that even the most successful companies must innovate to stay ahead of the competition.

7. Disruptive Technologies

Innovation that lets one company stay ahead of the competition could end up changing
the way the entire industry operates, leaving those slower to adapt behind. Disruptive
technologies can take the form of service ecosystems like Apple Pay, new investing
platforms like the Robinhood app, or even would-be money of the future like
cryptocurrencies.
In such a constantly changing industry as finance, there is always the threat of new
technologies that could draw consumers away from traditional practices. For
organizations to be successful and survive long into the future, such changes must either
be anticipated or adapted to as well as possible. Apple Card, for instance, promises to
attract existing Apple users with its ease of use and lack of annual fees, which has
undoubtedly already spurred other major credit card companies to evaluate and improve
their own offerings where they see fit.

8. Failure to Attract/Retain Talent

The problem of attracting and retaining quality talent was another common refrain from
the financial professionals we surveyed. High turnover rates require resources to be
devoted to hiring and training employees rather than put towards other valuable business
development goals. It also can affect employee morale and make it difficult to create a
positive company culture, where employees understand and share the organization’s
values and mission.

With unemployment low across the US, companies must work hard to attract the best and
brightest, offering perks such as professional development program, an appealing
workplace culture, and sometimes simply just more money than competitors.

9. Business Interruptions

“Time is money,” and nowhere is this more true than in the financial sector. Business
interruptions result in lower productivity, lower profit, and, depending on the situation,
potential brand damage. Such interruption could come as a result of cyberattacks, as
outlined before, or may be simply caused by extreme weather events.

Purchasing business interruption insurance is one option some companies use to

mitigate such a risk, although such policies cover only loss or damage to tangible items
and not lost profits. In any case, there is no doubt that business interruptions are best to
be avoided.
10. Political Risk and Uncertainty

Similar to the fear of regulatory or legislative changes, political risk and uncertainty also
factored among the twelve most common survey responses. Sudden changes in the
political winds can have very real consequences for companies.

Furthermore, recent threats of tariffs to be imposed against China and Europe by the
United States also impacts business prospects for many companies operating within their
borders. As with the fear of economic slowdown, the best way to deal with political risk is
to make contingency plans well in advance regarding how to deal with potential
disturbances to certain markets or supply chains. While no single company can control
such systematic risks, those that position themselves to be resilient in the face of external
shocks have the best chance to handle political uncertainty in stride.

11. Third Party Liability

Speaking of lack of control, respondents also mentioned third party liability as a major risk
that they fear in 2019. While the exact situations where third party liability arises may vary
between different industries, it can occur whenever a firm uses an outside company to
provide some kind of service. Third party liability risk is especially important in the financial
industry, where financial service firms face liability for the actions of vendors. As a result,
it is vitally important for financial firms to thoroughly evaluate third parties before entering
into official partnerships.

The banking industry in particular has been ahead of the pack in establishing systems for
addressing third party liability risk. Motivated by the aforementioned increase in frequency
and severity of cyberattacks, banks have increasingly integrated vendor risk
management into their operations. Processes commonly used to address third party
liability include preliminary risk assessments, careful drafting of contract provisions, and
ongoing oversight and monitoring of third party vendors.
While it is impossible to fully eliminate third party liability except by deciding to not engage
in partnerships entirely, the best way to mitigate third party risk is to select opportunities
carefully and exercise prudence in all dealing with outside business partners.

12. Commodity Price Risk

Rounding out the list of the 12 most common survey responses is commodity price risk.
Commodity price risk is defined as “the price uncertainty that adversely impact the
financial results of those who both use and produce commodities.” Notable commodities
that cause price risk for companies and consumers alike include oil, corn, cotton,
aluminum, and steel. Firms facing significant commodity price risk usually engage in
hedging through the use of futures contracts on global exchanges like the Chicago
Mercantile Exchange.

The steel and aluminum tariffs imposed by the United States illustrate how commodity
price risk may manifest and negatively impact companies involved. Following the
enactment of the tariffs, publicly traded steel companies have suffered in terms of stock
valuations and general company health as they face higher prices, lower output, and
lower sales.

While few of these risks can be fully eliminated, having a complete risk management
solution in place can go a long way towards mitigating catastrophic events.

What Is Pure Risk?

Pure risk is a category of risk that cannot be controlled and has two outcomes: complete
loss or no loss at all. There are no opportunities for gain or profit when pure risk is
involved.

Pure risk is generally prevalent in situations such as natural disasters, fires, or death.
These situations cannot be predicted and are beyond anyone's control. Pure risk is also
referred to as absolute risk.
KEY TAKEAWAYS
• Pure risk cannot be controlled and has two outcomes: complete loss or no loss at
all.
• There are no opportunities for gain or profit when pure risk is involved.
• Pure risks can be divided into three different categories: personal, property, and
liability.
• Many cases of pure risk are insurable.
Understanding Pure Risk

There are no measurable benefits when it comes to pure risk. Instead, there are two
possibilities. On the one hand, there is a chance that nothing will happen or no loss at
all. On the other, there may be the likelihood of total loss.

Pure risks can be divided into three different categories: personal, property, and liability.
There are four ways to mitigate pure risk: reduction, avoidance, acceptance, and
transference. The most common method of dealing with pure risk is to transfer it to an
insurance company by purchasing an insurance policy.

Many instances of pure risk are insurable. For example, an insurance company insures
a policyholder's automobile against theft. If the car is stolen, the insurance company has
to bear a loss. However, if it isn't stolen, the company doesn't make any gain. Pure risk
stands in direct contrast to speculative risk, which investors make a conscious choice to
participate in and can result in a loss or gain.

Pure risks can be insured because insurers are able to predict what their losses may be.

Types of Pure Risk

Personal risks directly affect an individual and may involve the loss of earnings and
assets or an increase in expenses. For example, unemployment may create financial
burdens from the loss of income and employment benefits. Identity theft may result in
damaged credit, and poor health may result in substantial medical bills, as well as the
loss of earning power and the depletion of savings.

Property risks involve property damaged due to uncontrollable forces such as fire,
lightning, hurricanes, tornados, or hail.

Liability risks may involve litigation due to real or perceived injustice. For example, a
person injured after slipping on someone else's icy driveway may sue for medical
expenses, lost income, and other associated damages.

Insuring Against Pure Risk

Unlike most speculative risks, pure risks are typically insurable through commercial,
personal, or liability insurance policies. Individuals transfer part of a pure risk to an
insurer. For example, homeowners purchase home insurance to protect against perils
that cause damage or loss. The insurer now shares the potential risk with the
homeowner.

Pure risks are insurable partly because the law of large numbers applies more readily
than to speculative risks. Insurers are more capable of predicting loss figures in advance
and will not extend themselves into a market if they see it as unprofitable.

Speculative Risk
Unlike pure risk, speculative risk has opportunities for loss or gain and requires the
consideration of all potential risks before choosing an action. For example, investors
purchase securities believing they will increase in value.

But the opportunity for loss is always present. Businesses venture into new markets,
purchase new equipment, and diversify existing product lines because they recognize
the potential gain surpasses the potential loss.
The 5 Step Risk Management Process

Implementing a risk management process is vital for any organization. Good risk
management doesn’t have to be resource intensive or difficult for organizations to
undertake or insurance brokers to provide to their clients. With a little formalization,
structure, and a strong understanding of the organization, the risk management
process can be rewarding.

Risk management does require some investment of time and money but it does not
need to be substantial to be effective. In fact, it will be more likely to be employed
and maintained if it is implemented gradually over time.
The key is to have a basic understanding of the process and to move towards its
implementation.

1. Identify potential risks

What can possibly go wrong?

The four main risk categories of risk are hazard risks, such as fires or
injuries; operational risks, including turnover and supplier failure; financial risks,
such as economic recession; and strategic risks, which include new competitors and
brand reputation. Being able to identify what types of risk you have is vital to the risk
management process.

An organization can identify their risks through experience and internal history,
consulting with industry professionals, and external research. They may also try
interviews or group brainstorming.

It’s important to remember that the risk environment is always changing, so this step
should be revisited regularly.

2. Measure frequency and severity

What is the likelihood of a risk occurring and if it did, what would be the impact?

Many organizations use a heat map to measure their risks on this scale. A risk map
is a visual tool that details which risks are frequent and which are severe (and thus
require the most resources). This will help you identify which are very unlikely or
would have low impact, and which are very likely and would have a significant impact.

Knowing the frequency and severity of your risks will show you where to spend your
time and money, and allow your team to prioritize their resources.
3. Examine alternative solutions

What are the potential ways to treat the risk and of these, which strikes the best
balance between being affordable and effective? Organizations usually have the
options to accept, avoid, control, or transfer a risk.

Accepting the risk means deciding that some risks are inherent in doing business
and that the benefits of an activity outweigh the potential risks.

To avoid a risk, the organization simply has to not participate in that activity.

Risk control involves prevention (reducing the likelihood that the risk will occur) or
mitigation, which is reducing the impact it will have if it does occur.

Risk transfer involves giving responsibility for any negative outcomes to another
party, as is the case when an organization purchases insurance.

4. Decide which solution to use and implement it

Once all reasonable potential solutions are listed, pick the one that is most likely to
achieve desired outcomes.

Find the needed resources, such as personnel and funding, and get the necessary
buy-in. Senior management will likely have to approve the plan, and te am members
will have to be informed and trained if necessary.

Set up a formal process to implement the solution logically and consistently across
the organization, and encourage employees every step of the way.

5. Monitor results

Risk management is a process, not a project that can be “finished” and then forgotten
about. The organization, its environment, and its risks are constantly changing, so
the process should be consistently revisited.
Determine whether the initiatives are effective and whether chang es or updates are
required. Sometimes, the team may have to start over with a new process if the
implemented strategy is not effective.

If an organization gradually formalizes its risk management process and develops a

risk culture, it will become more resilient and adaptable in the face of change. This
will also mean making more informed decisions based on a complete picture of the
organization’s operating environment and creating a stronger bottom line over the
long-term.

Objectives of Risk Management

Risk management is a technique of controlling and avoiding threats to business

organisation. It involves determining, analyzing and mitigating harmful risk to an
organisation’s capital and earnings. Risk management is a practice which is required and
followed by every business irrelevant of their size and nature. It aims at recognizing the
potential threats in advance and takes all necessary steps to avoid their adverse effects
on business operations.

These risks and unfortunate events are faced by every business organisation and may
harmfully affect its capital or even may lead to its permanent closure. Timely identification
and prioritization of these risks are quite important which is all done by implementing risk
management techniques.
Risk management is a continuous process and works throughout the life of the project
towards monitoring all risk factors. It focuses on controlling all possible future events by
analyzing various past information like the probability of occurrence, historical data,
lessons learned etc. Risk management supports the organisation in the achievement of
their goals by ensuring that all activities are running on their normal track. It develops a
safe and secure work environment for all staff and customers and increases the stability
of business operations. Objectives of Risk management are discussed in the following
points:
Objectives of Risk Management
Identifies And Evaluates Risk
Risk management identifies and analysis various risk associated with business. It
identifies risk at early stages and takes all necessary steps to avoid their harmful effects.
Information from past is analysed to recognise all possible future unfortunate events. Risk
management properly evaluates risk originated in business and develops a proper
understanding regarding its real causes. This all help in taking all measures in mitigating
the effects of these risks.

Reduce And Eliminate Harmful Threats

Harmful risks and threat are part of every business organisation. They have negative
effect on productivity and profitability of business. Risk management techniques helps in
avoiding and reducing the effect of these threats to business. Risk manager formulates
strategic plans for each department and monitors their performance from time to time.

These perform series of workshop in organisation to develop proper understanding

regarding risk causes and how to overcome them among all employees. Managers guide
them in avoiding the identified faults and reduces these harmful threats.

Supports Efficient Use Of Resources

Risk management aims at efficient utilisation of all resources. Fuller utilisation leads to
better productivity and increased profits. Risk management techniques support strategic
planning for better results. It sets plans for functioning of business and ensures that all
activities are going on their planned track. Certain targets are set for each division within
organisations and perform routine check-ups from time to time. If any deviations arise, it
takes all possible steps.

Better Communication Of Risk Within Organisation

Risk management develops better communication network between directors, managers
and employees. It helps in spreading all information regarding risk easily around the
organisation timely. All people are able to interact with each other effectively and discuss
about core solution about these risk. This helps in better understanding of several threats
and taking timely action against them.
Reassures Stakeholders
Stakeholders are an important part of every business organisation. Business must aim at
serving the interest of its stakeholders for their support. Risk management helps in
increasing the confidence of stakeholders in business and assures them of non-
occurrence of any unfortunate incident.

They feel safe by the implementation of risk management techniques that will timely
control and avoid all harmful risk. This leads to better trust among business and its
stakeholders.

Support Continuity Of Organisation

Risk management has an efficient role in long term growth and survival of the business.
Every business faces several risk and unfortunate events during its life cycle. These
unfortunates, if not treated timely, will affect the organisation capital and profit or even
leads to its termination.

It avoids all these risks by monitoring continuously the operations throughout the life of
the project. It reduces anxiety by overcoming all fear of uncertainty and develops a safe
working environment within the organisation. This increase the productivity and overall
stability of business organisations.

What Does Risk Retention Mean?

Risk retention is an individual or organization’s decision to take responsibility for a

particular risk it faces, as opposed to transferring the risk over to an insurance company
by purchasing insurance. That means the individual or organization has chosen to pay
for any losses out of pocket rather than purchasing insurance as a means of transferring
the financial burden of a loss to a 3rd party.

Companies often retain risks when they believe that the cost of doing so is less than the
cost of fully or partially insuring against it. Shoplifting losses are one example of risks that
many companies choose to retain instead of purchasing or claiming on their crime
insurance policy.
Another reason companies may choose to retain a risk is when it is not insurable or falls
below their policy deductible. In this case, it is referred to as “forced retention”.

Insurance companies also have to make a decision about which risks to retain. Risks they
choose not to retain are transferred out via a reinsurance policy.

When a company chooses or is forced to retain a certain risk, they will be responsible for
paying any losses from that risk out of pocket. For this reason, it is important for
companies to make sure that they can properly afford to pay for potential losses before
they make the decision to retain particular risks.

Oftentimes, the money can come from their current cash flows, from reserve funds set
aside for these types of losses, or if they are frequent and predictable enough, they can
be put into the monthly budget.

Risk retention can either be done voluntarily or be forced.

The decision to retain a risk voluntarily usually comes down to an economic calculation.
If the losses happen often enough to be budgeted for or if the premiums for insuring
against this risk is too high, many companies will choose to voluntarily retain the risk.
Large organizations such as railway operators or government bodies may also choose to
forgo insurance and retain almost all of their risk because they are big enough to absorb
potential losses. These types of organizations can save money by not purchasing
insurance.

Other times, companies are forced to retain a risk or loss. This happens when the risk is
either excluded from their coverage, uninsurable, or when the value of the loss is less
than their policy deductible.

Levels of risk management

1. Project risk
This is perhaps the most obvious. These risks do not recognise interdependencies and
risks outside the scope of the project. Rick recommended doing Monte Carlo analysis at
this level to identify project risk. He also talked about scenario building as a good tool for
project risk identification and management, giving the example of Shell.

Shell was the only company which modelled the risk of the OPEC countries putting up
the price of oil. Because of their analysis they were able to adapt their plants to deal with
less refined oil and gained a two-year head start on the competition when the prices did
go up.

Rick recommended “building limited models around sensitive areas”: in other words, not
spending time on modelling when the risk is low or when it isn’t worth doing. Models and
analysis help explain the risk you are taking at the project level in comparative terms,
which helps set them in context for team members and stakeholders.

2. Project selection risk

At this level the question relates to how risk plays a part in making decisions about which
projects should be started. The challenge here is whether the business just says yes or
no to a project without looking at the overall position and the wider business requirements.

For example, a risky project may not be inherently bad for the business. If you always say
no to risky projects you end up with a portfolio full of low risk but also probably low benefit
projects that present reduced opportunities for the company.

This level links to the strategic objectives and how the deliverables will be achieved in the
organisational context.

It should also include the risk of not doing or deferring the project, as that decision
presents a different path forward for the business with its own challenges.

3. Project portfolio risk

This is where you start to look outside the projects as individual initiatives and start to
gather rich data about the organisation’s approach to risk management as a whole.

Rick recommended doing Monte Carlo analysis at programme level to identify risks
across dependent streams of work. He then talked about using this output to identify the
right combination of projects to work on at portfolio level.

The problem I found with this model is that there isn’t any level that I can see where risks
fit that fall outside the project but that are managed in some shape or form by the project
manager. For example, dependencies on other projects – the risk that the other project
may not deliver on time. Or the risk that the company might go bust – this is out of scope
of the project but something like this could feasibly be on your risk register.

This model also assumes that you have a process to apply risk management to.

Rick said that you can only do portfolio level risk management if there is one single
repository of project data. This isn’t the case in many businesses where project managers
are based in functional silos and even if there is a PMO it serves one business unit and
not the enterprise as a whole.

A spreadsheet is good enough for this: no need to invest in anything more complicated,
he said. You can start to put some science behind your spreadsheet once you have
everything documented in one place.

Corporate Risk Management

Corporate risk management refers to all of the methods that a company uses to
minimize financial losses. Risk managers, executives, line managers and middle
managers, as well as all employees, perform practices to prevent loss exposure through
internal controls of people and technologies. Risk management also relates to external
threats to a corporation, such as the fluctuations in the financial market that affect its
financial assets.

Protecting Shareholders
A corporation has at least one shareholder. A large corporation, such as a publicly-
traded or employee-owned firm, has thousands, or even millions, of shareholders.
Corporate risk management protects the investment of shareholders through specific
measures to control risk. For example, a company needs to ensure that its funds for
capital projects, such as construction or technology development, are protected until
they are ready to use.

Types of Risk

Consider the types of risk that a corporation must address every day. A corporation may
become insolvent if it hasn't bought insurance, implemented loss control measures and
used other practices to prevent financial loss. Insurance is no substitute for successfully
identifying measures to prevent losses, such as safety training to prevent worker injuries
and deaths. Risks can include hazard risks, financial risks, personal injury and death,
business interruption/loss of services, damage to a corporation's reputation, errors and
omissions and lawsuits.

Probability and Consequences

To prevent financial losses, a corporation engages in a certain amount of speculation.

A risk manager calculates the probability of each type of event that would damage the
firm's financial position and the consequences. Calculating the likelihood that something
will happen and its associated costs enables a risk manager to recommend ways to
address the most probable risks to senior management, the board of directors and
owners of the corporation.

Solutions

A corporate risk manager is a multi-disciplinary professional with an understanding of

internal business processes and many financial instruments. This professional might
have a background in business management, finance, insurance or actuarial science.
She might suggest solutions to a corporation to protect its assets. For instance, she
might recommend buying millions of dollars in commercial liability insurance coverage.
Some risks that she calculates, as potentially damaging to the corporation, are ignored
while others are covered by this liability policy. She might recommend buying other
types of insurance, such as fire or fraud, after first weighing the costs versus the benefits
of each type of coverage.

Risk Management for Individuals

Introduction

Risk management for individuals is a key element of life-cycle finance, which recognizes
that as investors age, the fundamental nature of their total wealth evolves, as do the risks
that they face. Life-cycle finance is concerned with helping investors achieve their goals,
including an adequate retirement income, by taking a holistic view of the individual’s
financial situation as he or she moves through life. Individuals are exposed to a range of
risks over their lives: They may become disabled, suffer a prolonged illness, die
prematurely, or outlive their resources. In addition, from an investment perspective, the
assets of individuals could decline in value or provide an inadequate return in relation to
financial needs and aspirations. All of these risks have two things in common: They are
typically random, and they can result in financial hardship without an appropriate risk
management strategy. Risk management for individuals is distinct from risk management
for corporations given the distinctive characteristics of households, which include the finite
and unknown lifespan of individuals, the frequent preference for stable spending among
individuals, and the desire to pass on wealth to heirs (i.e., through bequests). To protect
against unexpected financial hardships, risks must be identified, market and non-market
solutions considered, and a plan developed and implemented. A well-constructed plan
for risk management will involve the selection of financial products and investment
strategies that fit an individual’s financial goals and mitigate the risk of shortfalls.

In this reading, we provide an overview of the potential risks to an individual or household,

an analysis of products and strategies that can protect against some of these risks, and
a discussion regarding the selection of an appropriate product or strategy. Following the
introduction, Section 2 provides an overview of human and financial capital. Section 3
addresses the process of risk management, the financial stages of life for an individual,
the economic (or holistic) balance sheet, and individual risks and risk exposures. Section
4 discusses the types of products relevant to financial planning, including insurance and
annuities. Section 5 contains an insurance program case study and insights on
implementing risk management solutions for individuals. Section 6 summarizes the key
points of the reading.

Learning Outcomes

The member should be able to:

a. compare the characteristics of human capital and financial capital as components of

an individual’s total wealth;

b. discuss the relationships among human capital, financial capital, and economic net
worth;

c. discuss the financial stages of life for an individual;

d. describe an economic (holistic) balance sheet;

e. discuss risks (earnings, premature death, longevity, property, liability, and health
risks) in relation to human and financial capital;

f. describe types of insurance relevant to personal financial planning;

g. describe the basic elements of a life insurance policy and how insurers price a life
insurance policy;

h. discuss the use of annuities in personal financial planning;

i. discuss the relative advantages and disadvantages of fixed and variable annuities;

j. analyze and critique an insurance program;

 k. discuss how asset allocation policy may be influenced by the risk characteristics of
human capital;

l. recommend and justify appropriate strategies for asset allocation and risk reduction
when given an investor profile of key inputs.

Summary

The risk management process for individuals is complex given the variety of potential
risks that may be experienced over the life cycle and the differences that exist across
households. In this reading, key concepts related to risk management and individuals
include the following:

• The two primary asset types for most individuals can be described broadly as human
capital and financial capital. Human capital is the net present value of the individual’s
future expected labor income, whereas financial capital consists of assets currently
owned by the individual and can include such items as a bank account, individual
securities, pooled funds, a retirement account, and a home.
• Economic net worth is an extension of traditional balance sheet net worth that
includes claims to future assets that can be used for consumption, such as human
capital, as well as the present value of pension benefits.
• There are typically four key steps in the risk management process for individuals:
Specify the objective, identify risks, evaluate risks and select appropriate methods to
manage the risks, and monitor outcomes and risk exposures and make appropriate
adjustments in methods.
• The financial stages of life for adults can be categorized in the following seven
periods: education phase, early career, career development, peak accumulation,
pre-retirement, early retirement, and late retirement.
• The primary goal of an economic (holistic) balance sheet is to arrive at an accurate
depiction of an individual’s overall financial health by accounting for the present value
of all available marketable and non-marketable assets, as well as all liabilities. An
economic (holistic) balance sheet includes traditional assets and liabilities, as well as
 human capital and pension value, as assets and includes consumption and bequests
as liabilities.
• The total economic wealth of an individual changes throughout his or her lifetime, as
do the underlying assets that make up that wealth. The total economic wealth of
younger individuals is typically dominated by the value of their human capital. As
individuals age, earnings will accumulate, increasing financial capital.
• Earnings risk refers to the risks associated with the earnings potential of an
individual—that is, events that could negatively affect someone’s human and
financial capital.
• Premature death risk relates to the death of an individual, such as a family member,
whose future earnings (human capital) were expected to help pay for the financial
needs and aspirations of the family.
• Longevity risk is the risk of reaching an age at which one’s income and financial
assets are insufficient to provide adequate support.
• Property risk relates to the possibility that one’s property may be damaged,
destroyed, stolen, or lost. There are different types of property insurance, depending
on the asset, such as automobile insurance and homeowner’s insurance.
• Liability risk refers to the possibility that an individual or other entity may be held
legally liable for the financial costs of property damage or physical injury.
• Health risk refers to the risks and implications associated with illness or injury. Health
risks manifest themselves in different ways over the life cycle and can have
significant implications for human capital.
• The primary purpose of life insurance is to help replace the economic value of an
individual to a family or a business in the event of that individual’s death. The family’s
need for life insurance is related to the potential loss associated with the future
earnings power of that individual.
• The two main types of life insurance are temporary and permanent. Temporary life
insurance, or term life insurance, provides insurance for a certain period of time
specified at purchase, whereas permanent insurance, or whole life insurance, is used
to provide lifetime coverage, assuming the premiums are paid over the entire period.
 • Fixed annuities provide a benefit that is fixed (or known) for life, whereas variable
annuities have a benefit that can change over time and that is generally based on
the performance of some underlying portfolio or investment. When selecting between
fixed and variable annuities, there are a number of important considerations, such as
the volatility of the benefit, flexibility, future market expectations, fees, and inflation
concerns.
• Among the factors that would likely increase demand for an annuity are the following:
longer-than-average life expectancy, greater preference for lifetime income, less
concern for leaving money to heirs, more conservative investing preferences, and
lower guaranteed income from other sources (such as pensions).
• Techniques for managing a risk include risk avoidance, risk reduction, risk transfer,
and risk retention. The most appropriate choice among these techniques often is
related to consideration of the frequency and severity of losses associated with the
risk.
• The decision to retain risk or buy insurance is determined by a household’s risk
tolerance. At the same level of wealth, a more risk-tolerant household will prefer to
retain more risk, either through higher insurance deductibles or by simply not buying
insurance, than will a less risk-tolerant household. Insurance products that have a
higher load will encourage a household to retain more risk.
• An individual’s total economic wealth affects portfolio construction through asset
allocation, which includes the overall allocation to risky assets, as well as the
underlying asset classes, such as stocks and bonds, selected by the individual.
• Investment risk, property risk, and human capital risk can be either idiosyncratic or
systematic. Examples of idiosyncratic risks include the risks of a specific occupation,
the risk of living a very long life or experiencing a long-term illness, and the risk of
premature death or loss of property. Systematic risks affect all households.

What Are Risk Measures?

Risk measures are statistical measures that are historical predictors of investment risk
and volatility, and they are also major components in modern portfolio theory (MPT). MPT
is a standard financial and academic methodology for assessing the performance of a
stock or a stock fund as compared to its benchmark index.

There are five principal risk measures, and each measure provides a unique way to
assess the risk present in investments that are under consideration. The five measures
include the alpha, beta, R-squared, standard deviation, and Sharpe ratio. Risk measures
can be used individually or together to perform a risk assessment. When comparing two
potential investments, it is wise to compare like for like to determine which investment
holds the most risk..

Understanding Risk Measures

Alpha

Alpha measures risk relative to the market or a selected benchmark index. For example,
if the S&P 500 has been deemed the benchmark for a particular fund, the activity of the
fund would be compared to that experienced by the selected index. If the fund
outperforms the benchmark, it is said to have a positive alpha. If the fund falls below the
performance of the benchmark, it is considered to have a negative alpha.

Beta

Beta measures the volatility or systemic risk of a fund in comparison to the market or the
selected benchmark index. A beta of one indicates the fund is expected to move in
conjunction with the benchmark. Betas below one are considered less volatile than the
benchmark, while those over one are considered more volatile than the benchmark.

R-Squared

R-Squared measures the percentage of an investment's movement attributable to

movements in its benchmark index. An R-squared value represents the correlation
between the examined investment and its associated benchmark. For example, an R-
squared value of 95 would be considered to have a high correlation, while an R-squared
value of 50 may be considered low.
The U.S. Treasury Bill functions as a benchmark for fixed-income securities, while the
S&P 500 Index functions as a benchmark for equities.

Standard Deviation

Standard deviation is a method of measuring data dispersion in regards to the mean value
of the dataset and provides a measurement regarding an investment’s volatility.

As it relates to investments, the standard deviation measures how much return on

investment is deviating from the expected normal or average returns.

Sharpe Ratio

The Sharpe ratio measures performance as adjusted by the associated risks. This is done
by removing the rate of return on a risk-free investment, such as a U.S. Treasury Bond,
from the experienced rate of return.

This is then divided by the associated investment’s standard deviation and serves as an
indicator of whether an investment's return is due to wise investing or due to the
assumption of excess risk.
What Does Insurance Risk Mean?

An insurance risk is a threat or peril that the insurance company has agreed
to insure against in the policy wordings. These types of risks or perils have
the potential to cause financial loss such as property damage or bodily injury
if it were to occur.

If the insured event takes place and a claim is filed, the insurance company
has to pay the policyholder the agreed reimbursement amount.

Examples of insurance risks include the risk of fire, earthquake losses, or

even liability when an insured is found responsible for causing bodily injury,
death, or property damage to 3rd parties.

The more risks your insurance provider agrees to insure, the more
comprehensive—and therefore expensive—your policy will be.

The best policies are the ones that cover the most relevant insurance risks
you might face at the most reasonable cost.

Put simply, insurance risks are risks or perils that the insurance company
has agreed to provide indemnity for. There are a wide range of events that
are considered insurance risks. For example, an auto accident is an auto
insurance risk, a policyholder's death is a life insurance risk, and water
damage is a homeowner's insurance risk.

Insurance premiums are calculated based on three factors:

• The chance that a certain insurance risk will be realized.

• The severity of the damage if the insurance risk is realized.
 • The number of risks the insurer is assuming liability for.

The greater the chance of the risk occurring, the higher the premiums will
tend to be. A driver with a history of accidents or traffic violations, for
instance, will be viewed as a higher risk to the insurer so will be charged
more for auto insurance coverage.

Another factor insurance companies look at when determining premiums is

the severity of the risk if it were to occur. In most cases, policies covering
potentially catastrophic risks like flood or earthquake will be more expensive
than those covering more common risks like theft. This is because
earthquake or flood losses are likely to cause greater financial loss than a
theft incident.

The amount of insurance risks the policy is covering also plays a big role. A
policy that offers coverage for a greater number of perils or risks will be more
expensive than one that does not cover as many. This is because the
probability that the policy will need to respond to pay is greater.

What is Insurance?
Insurance is a legal agreement between an individual and the insurance
company, under which, the insurer promises to provide financial coverage
(Sum assured) against contingencies for an amount (premium). Different
types of insurance policies available nowadays, can be broadly divided into
two categories:
 Different Types of Insurance
Policies Available in India
Following are the types of insurance available in India:

1. General Insurance
Following are some of the types of general insurance available in India:

• Health Insurance
• Motor Insurance
• Home Insurance
• Fire Insurance
• Travel Insurance

2. Life Insurance
There are various types of life insurance. Following are the most common
types of life insurance plans available in India:

• Term Life Insurance

• Whole Life Insurance
• Endowment Plans
• Unit-Linked Insurance Plans
• Child Plans
• Pension Plans
Let us look closely at the different types of insurance policies:

General Insurance
General insurance policies are one of the types of insurance that offer
coverage in the form of sum assured against the losses incurred other than
the death of the policyholder. Overall, general insurance comprises different
types of insurance policies that offer financial protection against losses
incurred due to liabilities such as bike, car, home, health, and similar. These
various types of General Insurance Policies include:
Health Insurance
Health insurances are types of insurance policy that covers the expenses
incurred due to medical care. Health insurance plans either pay or reimburse
the amount paid towards the treatment of any illness or injury. Different types
of health insurance cover varied medical care expenses.

It usually offers protection against:

a) Hospitalization
b) Treatment of critical illnesses
c) Medical bills post hospitalization
d) Daycare procedures

There are a few types of health insurance plans also cover the cost of
resident treatment and pre-hospitalization expenses. Rising costs of
healthcare in India Is making health insurance a necessity. Different types of
health insurance plans available in India include:

1) Individual Health Insurance: Offers coverage to only an individual

2) Family Floater Insurance: Allows your entire family to get coverage
under a single plan, which usually covers husband, wife, two children
3) Critical Illness Cover: Specialized types of health insurance that offers
coverage against various life-threatening illnesses like stroke, heart attack,
kidney failure, cancer, and similar others. Policyholders get a lump
sum amount on diagnosis of a critical illness.
4) Senior Citizen Health Insurance: These types of insurance plans cater
to all individuals above 60 years of age
5) Group Health Insurance: Offered by an employer to its employee
6) Maternity Health Insurance: Covers medical expenses for prenatal,
post-natal, and delivery stage, offering protection to both the mother and the
newborn
7) Personal Accident Insurance: These types of insurance plans cover
financial liabilities arising due to accidental injuries, disability, or death
Motor Insurance
Motor insurances are types of insurance that offer financial assistance in
case your bike or car get involved in an accident. Various types of Motor
insurance policies in India include:

1) Car Insurance: Individually owned four-wheelers are covered under this

plan. Different types of car insurance - third-party insurance and
comprehensive cover policies.
2) Bike Insurance: These are types of motor insurance where individually
owned two-wheelers are covered against accidents
3) Commercial Vehicle Insurance: One of the types of motor insurance,
which offers coverage to any vehicle used for commercial purposes
Home Insurance
As the name suggests, a home insurance policy offers comprehensive
protection to the contents and structure of your house against any physical
destruction or damage. In other words, home insurance will provide
coverage against any natural and human-made calamity, such as fire,
earthquake, tornado, burglaries, and robbery.

Different types of home insurance policies include:

1) Home Structure/Building Insurance – Protects the structure of the

house against damage during any calamity
2) Public Liability Coverage – Provides coverage against any damage to a
guest or third-party on the insured residential property
3) Standard Fire and Special Perils Policy – Coverage against damages
caused due to fire outbreaks, natural calamities (e.g., landslides, rockslides,
earthquakes, storms, and floods), and anti-social human-made activities
(e.g., explosions, strikes, and riots)
4) Personal Accident – Provides financial coverage to you and your family
against any type of permanent dismemberment or sudden demise to the
insured individual, anywhere around the world
5) Burglary and Theft Insurance – Provides compensation for stolen goods
in case of a burglary or theft
6) Contents Insurance – Provides compensation for loss of furniture,
vehicles, and other appliances in case of a fire, theft, flood, or riots
7) Tenants’ Insurance – Provides financial protection to you (as a tenant)
against any loss of personal property living in a rented house
8) Landlords’ insurance – Provides coverage to you (as a landlord) against
contingencies such as public liability and loss of rent
Fire Insurance
Fire insurance policies are different types of insurance coverages that
compensate any losses incurred due to a fire breakout with a sum assured.
These types of insurance policies usually provide a significant amount of
coverage to help both individuals and companies to reopen their places after
incurring extensive damage due to fire. These types of insurance covers war
risk, turmoil, riots losses as well.

Different types of fire insurance in India are –

1) Valued policy
2) Specific Policy
3) Floating Policy
4) Consequential Policy
5) Replacement Policy
6) Comprehensive Fire insurance policy
Travel Insurance
As the name suggests, travel insurance is a type of financial protection that
protects you and your loved ones while you are visiting any place in India or
abroad. Whether you are travelling solo or with your loved ones, the travel
insurance coverage will help ensure that you have a peaceful journey.

The travel insurance policy coverage takes care of any issues that you may
face during your trip such as loss of baggage, flight cancellations, loss of
passport, personal and medical emergencies. Different types of travel
insurance policies include:
 1) Domestic Travel Insurance: Within the country
2) International Travel Insurance: For any trips or vacations outside of India
3) Individual Travel Insurance: If you are travelling alone
4) Student Travel Insurance: If you are going abroad for further studies
5) Senior Citizen Travel Insurance: For senior citizens, ageing between 60
to 70 years
6) Family Travel Insurance: For any family vacations

Life Insurance
Life insurance plans offer coverage against unfortunate events like death or
disability of the policyholder. Besides financial protection, there are
various types of life insurance policies that allow the policyholders to
maximize their savings through regular contributions into different equity and
debt fund options.
You can choose a life insurance policy to secure your family's financial future
against life's uncertainties. The policy coverage comprises of a large amount,
which is payable to your loved ones if anything happens to you. You have
the flexibility to choose the life insurance policy period, coverage amount,
and payout option based on the financial requirements. Different types of life
insurance policy are as follows:
• Term Life Insurance
• Whole Life Insurance
• Endowment Plans
• Unit-Linked Insurance Plans
• Child Plans
• Pension Plans
Term Life Insurance Plans
Term insurance is the purest and most affordable form of life insurance in
which, you can opt for a high life cover for a specific period. You can secure
your family’s financial future with a term life insurance plan by paying a low
premium (term insurance plans generally do not have any Maturity value,
and thus, offer lower rates of premium than other life insurance products.)

If anything happens to you within the policy period, your loved ones would
receive the agreed Sum Assured as per the payout option chosen (some
term insurance plans offer multiple payout options as well)

Whole Life Insurance Plans

Whole life insurance plans, also known as ‘traditional’ life insurance plans,
provide coverage for the entire life of the insured individual, as opposed to
any other life insurance instrument that offers coverage for a specific number
of years.

While a whole life insurance plan offers to pay a death benefit, the plan also
contains a savings component, which helps accrue a cash value throughout
the policy term. The maturity age for whole life insurance policy is 100 years.
In case, the insured individual lives past the maturity age, the whole life plan
will become matured endowment.
Endowment Plans
Endowment plans essentially provide financial coverage to the policyholder
against life’s uncertainties, while allowing them to save regularly over a
certain period. Upon maturity of the endowment plan, the policyholder
receives a lump sum amount if he or she survives the policy term.

If anything happens to you (as Life Insured), the life insurance endowment
policy pays the complete Sum Assured to your family (beneficiaries)

Unit-Linked Insurance Plan (ULIP)

Unit Linked Insurance Plans are types of insurance policy that offer both
investment and insurance benefits under a single policy contract. A portion
of the premium that you pay towards a Unit Linked Insurance Plan is
allocated to a variety of market-linked equity and debt instruments.

The remaining premium contributes towards providing the life cover

throughout the policy tenure. ULIPs allow the flexibility to choose the
allocation of premium into different instruments as per your financial
requirements and market risk appetite.

Child Plans
Child plans are types of life insurance policy that helps you financially secure
your child’s life goals such as higher education and marriage, even in your
absence. In other words, child plans offer a combination of savings and
insurance benefits that aid you in the financial planning for your child’s future
needs at the right age.
The sum of money received on Maturity can be used to fulfill the financial
requirements of your child.

Pension Plans
Pension plan, also known as retirement plan, is a type of investment plan
that aids you in accumulating a portion of your savings over an extended
period. Essentially, a pension plan helps you deal with financial uncertainties
post-retirement, by ensuring that you continue to receive a steady flow of
income even after your working years are over.

In other words, a pension plan allows you to create a financial cushion for
your life post-retirement, in which you contribute a specific amount of money
regularly until your retirement. Subsequently, the accumulated amount is
given back to you as annuity or pension at regular intervals.

The Role and Importance of

Insurance
The following point shows the role and importance of
insurance:
Insurance has evolved as a process of safeguarding the
interest of people from loss and uncertainty. It may be
described as a social device to reduce or eliminate risk of loss
to life and property.
Insurance contributes a lot to the general economic growth of
the society by provides stability to the functioning of process.
The insurance industries develop financial institutions and
reduce uncertainties by improving financial resources.

1. Provide safety and security:

Insurance provide financial support and reduce uncertainties
in business and human life. It provides safety and security
against particular event. There is always a fear of sudden
loss. Insurance provides a cover against any sudden loss.
For example, in case of life insurance financial assistance is
provided to the family of the insured on his death. In case of
other insurance security is provided against the loss due to
fire, marine, accidents etc.

2. Generates financial resources:

Insurance generate funds by collecting premium. These
funds are invested in government securities and stock. These
funds are gainfully employed in industrial development of a
country for generating more funds and utilised for the
economic development of the country. Employment
opportunities are increased by big investments leading to
capital formation.

3. Life insurance encourages savings:

Insurance does not only protect against risks and
uncertainties, but also provides an investment channel too.
Life insurance enables systematic savings due to payment of
regular premium. Life insurance provides a mode of
investment. It develops a habit of saving money by paying
premium. The insured get the lump sum amount at the
maturity of the contract. Thus life insurance encourages
savings.

4. Promotes economic growth:

ADVERTISEMENTS:

Insurance generates significant impact on the economy by

mobilizing domestic savings. Insurance turn accumulated
capital into productive investments. Insurance enables to
mitigate loss, financial stability and promotes trade and
commerce activities those results into economic growth and
development. Thus, insurance plays a crucial role in
sustainable growth of an economy.
5. Medical support:
A medical insurance considered essential in managing risk in
health. Anyone can be a victim of critical illness unexpectedly.
And rising medical expense is of great concern. Medical
Insurance is one of the insurance policies that cater for
different type of health risks. The insured gets a medical
support in case of medical insurance policy.

6. Spreading of risk:
Insurance facilitates spreading of risk from the insured to the
insurer. The basic principle of insurance is to spread risk
among a large number of people. A large number of persons
get insurance policies and pay premium to the insurer.
Whenever a loss occurs, it is compensated out of funds of the
insurer.

7. Source of collecting funds:

Large funds are collected by the way of premium. These
funds are utilised in the industrial development of a country,
which accelerates the economic growth. Employment
opportunities are increased by such big investments. Thus,
insurance has become an important source of capital
formation.

Insurance Regulatory & Development

Authority
The Insurance Regulatory and Development Authority of India (IRDAI) is a regulatory
body under the jurisdiction of Ministry of Finance , Government of India and is tasked with
regulating and licensing the insurance and re-insurance industries in India. It was
constituted by the Insurance Regulatory and Development Authority Act, 1999,an Act of
Parliament passed by the Government of India. The agency's headquarters are in
Hyderabad, Telangana, where it moved from Delhi in 2001.

IRDAI is a 10-member body including the chairman, five full-time and four part-time
members appointed by the government of India.

A. Organizational Structure of IRDAI:

Composition of IRDAI:
As per Sec. 4 of IRDAI Act, 1999, the composition of the Authority is:
a) Chairman;
b) Five whole-time members;
c) Four part-time members,
(appointed by the Government of India)
 IRDAI’s Head Office is at Hyderabad
All the major activities of IRDAI including ensuring financial stability of insurers and
monitoring market conduct of various regulated entities is carried out from the Head
Office.

IRDAI’s Regional Offices are at New Delhi & Mumbai

The Regional Office, New Delhi focuses on spreading consumer awareness and handling
of Insurance grievances besides providing required support for inspection of Insurance
companies and other regulated entities located in the Northern Region. This office is
functionally responsible for licensing of Surveyors and Loss Assessors. Regional Office
at Mumbai handles similar activities, as in Regional Office Delhi, pertaining to Western
Region.

B. Insurance Regulatory Framework:

1. Insurance Regulatory and Development Authority of India (IRDAI), is a statutory body
formed under an Act of Parliament, i.e., Insurance Regulatory and Development Authority
Act, 1999 (IRDAI Act 1999) for overall supervision and development of the Insurance
sector in India.
2. The powers and functions of the Authority are laid down in the IRDAI Act, 1999 and
Insurance Act, 1938. The key objectives of the IRDAI include promotion of competition so
as to enhance customer satisfaction through increased consumer choice and fair
premiums, while ensuring the financial security of the Insurance market.
3. The Insurance Act, 1938 is the principal Act governing the Insurance sector in India. It
provides the powers to IRDAI to frame regulations which lay down the regulatory
framework for supervision of the entities operating in the sector. Further, there are certain
other Acts which govern specific lines of Insurance business and functions such as
Marine Insurance Act, 1963 and Public Liability Insurance Act, 1991.
4. IRDAI adopted a Mission for itself which is as follows:
• To protect the interest of and secure fair treatment to policyholders;
• To bring about speedy and orderly growth of the Insurance industry (including
annuity and superannuation payments), for the benefit of the common man, and to
provide long term funds for accelerating growth of the economy;
• To set, promote, monitor and enforce high standards of integrity, financial
soundness, fair dealing and competence of those it regulates;
• To ensure speedy settlement of genuine claims, to prevent Insurance frauds and
other malpractices and put in place effective grievance redressal machinery;
• To promote fairness, transparency and orderly conduct in financial markets dealing
with Insurance and build a reliable management information system to enforce high
standards of financial soundness amongst market players;
• To take action where such standards are inadequate or ineffectively enforced;
• To bring about optimum amount of self-regulation in day-to-day working of the
industry consistent with the requirements of prudential regulation.
5. Entities regulated by IRDAI:
a. Life Insurance Companies - Both public and private sector Companies
b. General Insurance Companies - Both public and private sector Companies. Among
them, there are some standalone Health Insurance Companies which offer health
Insurance policies.
c. Re-Insurance Companies
d. Agency Channel
e. Intermediaries which include the following:
• Corporate Agents
• Brokers
• Third Party Administrators
• Surveyors and Loss Assessors.
6. Regulation making process:
• Section 26 (1) of IRDAI Act, 1999 and 114A of Insurance Act, 1938 vests power in
the Authority to frame regulations, by notification.
• Section 25 of IRDAI Act, 1999 lays down for establishment of Insurance Advisory
Committee consisting of not more than twenty five members excluding the ex-officio
 members. The Chairperson and the members of the Authority shall be the ex-officio
members of the Insurance Advisory Committee.
• The objects of the Insurance Advisory Committee shall be to advise the Authority on
matters relating to making of regulations under Section 26.
• Accordingly the draft regulations are first placed in the meeting of Insurance Advisory
Committee and after obtaining the comments/recommendations of IAC, the draft
regulations are placed before the Authority for its approval.
• Every Regulation approved by the Authority is notified in the Gazette of India.
• Every Regulation so made is submitted to the Ministry for placing the same before
the Parliament.
7. The Authority has issued regulations and circulars on various aspects of operations of
the Insurance companies and other entities covering:
• Protection of policyholders’ interest
• Procedures for registration of insurers or licensing of intermediaries, agents,
surveyors and Third Party Administrators;
• Fit and proper assessment of the promoters and the management
• Clearance /filing of products before being introduced in the market
• Preparation of accounts and submission of accounts returns to the Authority.
• Actuarial valuation of the liabilities of life Insurance business and forms for filing of
the actuarial report;
• Provisioning for liabilities in case of non-life Insurance companies
• Manner of investment of funds and periodic reports on investments
• Maintenance of solvency
• Market conduct issues

C. Supervisory Role:

1. The objective of supervision as stated in the preamble to the IRDAI Act is “to protect
the interests of holders of Insurance policies, to regulate, promote and ensure orderly
growth of the Insurance industry”, both Insurance and Reinsurance business. The powers
and functions of the Authority are laid down in the IRDAI Act, 1999 and Insurance Act,
1938 to enable the Authority to achieve its objectives.
 2. Section 25 of IRDAI Act 1999 provides for establishment of Insurance Advisory
Committee which has Representatives from commerce, industry, transport, agriculture,
consume for a, surveyors agents, intermediaries, organizations engaged in safety and
loss prevention, research bodies and employees’ association in the Insurance sector are
represented. All the rules, regulations, guidelines that are applicable to the industry are
hosted on the website of the supervisor and are available in the public domain.
3. Section 14 of the IRDAI Act,1999 specifies the Duties, Powers and functions of the
Authority. These include the following:
• To grant licenses to (re) Insurance companies and Insurance intermediaries
• To protect interests of policyholders,
• To regulate investment of funds by Insurance companies, professional organisations
connected with the (re)Insurance business; maintenance of margin of solvency;
• To call for information from, undertaking inspection of, conducting enquiries and
investigations of the entities connected with the Insurance business;
• To specify requisite qualifications, code of conduct and practical training for intermediary or
Insurance intermediaries, agents and surveyors and loss assessors
• To prescribe form and manner in which books of account shall be maintained and statement
of accounts shall be rendered by insurers and other Insurance intermediaries;

D. Prudential approach: Reporting, Risk

monitoring and intervention:
1. Reporting Requirements:
Insurers are required to submit various returns like financial statements on an annual
basis duly accompanied by the Auditors’ opinion statement on the annual accounts;
reports of valuation of assets, valuation of liabilities and solvency margin; actuarial report
and abstract and annual valuation returns giving information about the financial condition
for life Insurance business; Incurred But Not Reported claims in case of general Insurance
business; Reinsurance plans on an annual basis; and monthly statement on underwriting
of large risks in case of general Insurance companies; details of capital market exposure
on a monthly basis; Investment policy, Quarterly and annual returns on investments.
2. Solvency of Insurers:
In order to monitor and control solvency requirements, it has been made mandatory to
the insurers to submit solvency report on quarterly basis. In case of any deviation, the
Supervisor initiates necessary and suitable steps so as to ensure that the Insurer takes
immediate corrective action to restore the solvency position at the minimum statutory
level.
Computation of solvency margin takes into account the inherent risk that respective line
of business poses to the insurer. Higher requirements are placed for risky lines of
business compared to others posing less risk to the insurers. Even though the insurers
are required to maintain a minimum solvency ratio of 150% at all times, the actual
solvency margin maintained by insurers are well above the required solvency margin
leading to the solvency margin ratio significantly higher than 150% on average.
Quarterly solvency ratio reports have to be submitted to the Supervisor, maintaining
minimum solvency ratio of 150%. This provides the regular a mechanism to monitor the
solvency position periodically over the financial year in order to ensure compliance with
the requirements and hence to initiate suitable action in the event of any early warning
signal on the Insurer’s financial condition.

3. Asset-Liability Management:
Under Asset-Liability Management reporting, Insurer must provide the year wise
projected cash flows, in respect of both assets and liabilities. Insurers must maintain
mismatching reserves in case of any mismatch between assets and liabilities as a part of
the global reserves. Further, Life insurers are required to submit a report on sensitivity
and scenario testing exercise in the prescribed format. Non-life insurers must submit a
report on ‘Financial Condition’ covering the sensitivity analysis of the financial soundness
in meeting the policyholders’ liabilities.
The supervisor requires management of investments to be within the insurer’s own
organization. In order to ensure a minimum level of security of investments in line with
Insurance Act Provisions, the regulations prescribe certain percentages of the funds to
be invested in government securities and in approved securities. The regulatory
framework lays down the norms for the mix and diversification of investments in terms of
Types of Investment, Limits on exposure to Group Company, Insurer’s Promoter Group
Company. Investment Regulations lay down the framework for the management of
investments. The exposure limits are also prescribed in the Regulations. The Investment
Regulations require a proper methodology to be adopted by the insurer for matching of
assets and liabilities.

4. Reinsurance:
Transfer of risk through Reinsurance is recognized only to the extent specified in the
regulations. Due safeguards are built in to ensure that adjustments are made to provide
for quality of assets held. No other risk transfer mechanism exists in the current system.
In order to minimize the counterparty risk, the re-insurers with whom business is placed
must have the minimum prescribed rating by an independent credit rating agency as
specified in the regulations. Legislation has specified the minimum capital requirements
for an Insurance company. It further, prescribes that Insurance companies can capitalize
their operations only through ordinary shares which have a single face value.
Reinsurer
General Insurance Corporation of India (GIC of India) is the sole National Reinsurer,
providing Reinsurance to the Insurance companies in India. The Corporation’s
Reinsurance programme has been designed to meet the objectives of optimising the
retention within the country, ensuring adequate coverage for exposure and developing
adequate capacities within the domestic market. It is also administering the Indian Motor
Third Party Declined Risk Insurance Pool – a multilateral Reinsurance arrangement in
respect of specified commercial vehicles where the policy issuing member insurers cede
Insurance premium to the Declined Risk pool based on the underwriting policy approved
by IRDAI.

5. Corporate Governance:
In order to protect long- terms interests of policyholders, the IRDAI has outlined
appropriate governance practices applicable to Insurance companies for maintenance of
solvency, sound long-term investment policy and assumption of underwriting risks on a
prudential basis from time to time. The IRDAI has issued comprehensive guidelines for
adoption by Insurance companies on the governance responsibilities of the Board in the
management of the Insurance functions. These guidelines are in addition to provisions of
the Companies Act, 1956, Insurance Act, 1938 and other applicable laws.
Corporate Governance Guidelines issued by IRDAI, requires insurers to have in place
requisite control functions. The oversight of the control functions is vested with the Boards
of the respective insurer. It lays down the structure, responsibilities and functions of Board
of Directors and the senior management of the companies. Insurers are required to adopt
sound prudent principles and practices for the governance of the company and should
have the ability to quickly address issues of non-compliance or weak oversight and
controls.
The Guidelines mandated the insurers to constitute various committees viz., Audit
Committee, Investment Committee, Risk Management Committee, Policyholder
Protection Committee and Asset-Liability Management Committee. These committees
play a critical role in strengthening the control environment in the company.

6. On and off site Supervision:

Onsite Inspections:
The Authority has the power to call for any information from entities related to insurance
business – Insurance companies and the intermediaries, as may be required from time
to time.
On site inspection is normally carried out on an annual basis which includes inspection of
corporate offices and branch offices of the companies. These inspections are conducted
with view to check compliance with the provisions of Insurance Act, Rules and regulations
framed thereunder.
The inspection may be comprehensive to cover all areas, or may be targeted on one, or
a combination of, key areas. When a market-wide event having an impact on the insurers
occurs, the Supervisor obtains relevant information from the insurers, monitors
developments and issues directions as it may consider necessary. Though there is no
specific requirement, events of importance trigger such action. The supervisor reviews
the “internal controls and checks” at the offices of Insurance companies, as part of on-
site inspection.
Off-site Inspection:
The primary objective of off-site surveillance is to monitor the financial health of Insurance
companies, identifying companies which show financial deterioration and would be a
source for supervisory concerns. This acts as a trigger for timely remedial action.
The off-site inspection conducted by analyzing periodic statements, returns, reports,
policies and compliance certificates mandated under the directions issued by the
Authority from time to time. The periodicity of these filings is generally annual, half-yearly,
quarterly and monthly and are related to business performance, investment of funds,
remuneration details, expenses of management, business statistics, auditor certificates
related to various compliance requirements.
The statutory and the internal auditors are required to audit all the areas of functioning of
the Insurance companies. The particular area of focus is the preparation of accounts of
the company to reflect the true and fair position of the company as at the Balance Sheet
date. The auditors also examine compliance or otherwise with all statutory and regulatory
requirements, and in particular whether the Insurance company has been compliant with
the various directions issued by the supervisor. In addition, the Authority relies upon the
certifications which form part of the Management Report. The Board is required to certify
that the management has put in place an internal audit system commensurate with the
size and nature of its business and that it is operating effectively.
All Insurance companies are required to publish financial results and other information in
the prescribed formats in newspapers and on their websites at periodic intervals.

7. Micro Insurance and Rural & Social Sector Obligations

The IRDAI had issued micro Insurance regulations for the protection of low income people
with affordable Insurance products to help cope with and recover from common risks with
standardised popular Insurance products adhering to certain levels of cover, premium
and benefit standards. These regulations have allowed Non Governmental Organisations
(NGOs), Self Help Groups (SHGs) and other permitted entities to act as agents to
Insurance companies in marketing the micro Insurance products and have also allowed
both life and non-life insurers to promote combi-micro Insurance products.
The Regulations framed by the Authority on the obligations of the insurers towards rural
and social sector stipulate targets to be fulfilled by insurers on an annual basis. In terms
of these regulations, insurers are required to cover year wise prescribed targets (i) in
terms of number of lives under social obligations; and (ii) in terms of percentage of policies
to be underwritten and percentage of total gross premium income written direct by the life
and non-life insurers respectively under rural obligations.

Principles of Insurance

The concept of insurance is risk distribution among a group of people. Hence, cooperation
becomes the basic principle of insurance.

To ensure the proper functioning of an insurance contract, the insurer and the insured
have to uphold the 7 principles of Insurances mentioned below:

1. Utmost Good Faith

2. Proximate Cause
3. Insurable Interest
4. Indemnity
5. Subrogation
6. Contribution
7. Loss Minimization

Let us understand each principle of insurance with an example.

Principle of Utmost Good Faith

The fundamental principle is that both the parties in an insurance contract should act in
good faith towards each other, i.e. they must provide clear and concise information related
to the terms and conditions of the contract.

The Insured should provide all the information related to the subject matter, and the
insurer must give precise details regarding the contract.

Example – Jacob took a health insurance policy. At the time of taking insurance, he was
a smoker and failed to disclose this fact. Later, he got cancer. In such a situation, the
Insurance company will not be liable to bear the financial burden as Jacob concealed
important facts.

Principle of Proximate Cause

This is also called the principle of ‘Causa Proxima’ or the nearest cause. This principle
applies when the loss is the result of two or more causes. The insurance company will
find the nearest cause of loss to the property. If the proximate cause is the one in which
the property is insured, then the company must pay compensation. If it is not a cause the
property is insured against, then no payment will be made by the insured.

Example –

Due to fire, a wall of a building was damaged, and the municipal authority ordered it to be
demolished. While demolition the adjoining building was damaged. The owner of the
adjoining building claimed the loss under the fire policy. The court held that fire is the
nearest cause of loss to the adjoining building, and the claim is payable as the falling of
the wall is an inevitable result of the fire.

In the same example, the wall of the building damaged due to fire, fell down due to storm
before it could be repaired and damaged an adjoining building. The owner of the adjoining
building claimed the loss under the fire policy. In this case, the fire was a remote cause,
and the storm was the proximate cause; hence the claim is not payable under the fire
policy.

Principle of Insurable interest

This principle says that the individual (insured) must have an insurable interest in the
subject matter. Insurable interest means that the subject matter for which the individual
enters the insurance contract must provide some financial gain to the insured and also
lead to a financial loss if there is any damage, destruction or loss.

Example – the owner of a vegetable cart has an insurable interest in the cart because he
is earning money from it. However, if he sells the cart, he will no longer have an insurable
interest in it.
To claim the amount of insurance, the insured must be the owner of the subject matter
both at the time of entering the contract and at the time of the accident.

Principle of Indemnity

This principle says that insurance is done only for the coverage of the loss; hence insured
should not make any profit from the insurance contract. In other words, the insured should
be compensated the amount equal to the actual loss and not the amount exceeding the
loss. The purpose of the indemnity principle is to set back the insured at the same financial
position as he was before the loss occurred. Principle of indemnity is observed strictly for
property insurance and not applicable for the life insurance contract.

Example – The owner of a commercial building enters an insurance contract to recover

the costs for any loss or damage in future. If the building sustains structural damages
from fire, then the insurer will indemnify the owner for the costs to repair the building by
way of reimbursing the owner for the exact amount spent on repair or by reconstructing
the damaged areas using its own authorized contractors.

Principle of Subrogation

Subrogation means one party stands in for another. As per this principle, after the insured,
i.e. the individual has been compensated for the incurred loss to him on the subject matter
that was insured, the rights of the ownership of that property goes to the insurer, i.e. the
company.

Subrogation gives the right to the insurance company to claim the amount of loss from
the third-party responsible for the same.

Example – If Mr A gets injured in a road accident, due to reckless driving of a third party,
the company with which Mr A took the accidental insurance will compensate the loss
occurred to Mr A and will also sue the third party to recover the money paid as claim.

Principle of Contribution
Contribution principle applies when the insured takes more than one insurance policy for
the same subject matter. It states the same thing as in the principle of indemnity, i.e. the
insured cannot make a profit by claiming the loss of one subject matter from different
policies or companies.

Example – A property worth Rs. 5 Lakhs is insured with Company A for Rs. 3 lakhs and
with company B for Rs.1 lakhs. The owner in case of damage to the property for 3 lakhs
can claim the full amount from Company A but then he cannot claim any amount from
Company B. Now, Company A can claim the proportional amount reimbursed value from
Company B.

Principle of Loss Minimisation

This principle says that as an owner, it is obligatory on the part of the insurer to take
necessary steps to minimise the loss to the insured property. The principle does not allow
the owner to be irresponsible or negligent just because the subject matter is insured.

Example – If a fire breaks out in your factory, you should take reasonable steps to put
out the fire. You cannot just stand back and allow the fire to burn down the factory
because you know that the insurance company will compensate for it.

Life Insurance
The average penetration and density of life insurance in India is a measly 2.76%.
There have been improvements in this arena but overall the growth has been
rather slow in India. Not many people are aware of the benefits of life insurance
and the numbers for penetration are an indicator of the same.
 Accidents and mishaps are strong indicators of how fragile human life can be and
how we need to systemically insure our lives. It is an important tool for providing
an individual's family with safety and security. It acts as a protective cover to
safeguard the insured's dependents. In the event individuals do not insure their
lives, their dependents end up facing the tragic loss of their loved one along with
a whole host of liabilities such as rent, loans, EMI's and child services.

Life insurance is crucial for families to feel security and a sense of confidence to
continue their lives without losing their everyday stability. To help understand the
key features and advantages of life insurance, here's a quick lowdown:

Features of Life Insurance Plans

• Policyholder: Policyholder is the individual who pays the premium for the life
insurance policy and signs a life insurance contract with a life insurance company.
• Premium:
A premium is the cost the policyholder pays the life insurance company for
covering his/her life.
• Maturity: Maturity is the stage at which the policy term is completed and the life
insurance contract ends.
• Insured: Insured is the individual whose life is secured via the life insurance. After
his/her death the insurance company is accountable to provide a financial amount
to the dependents.
• Sum Assured: The amount the insurance company pays the dependents of the
insured if those events occur which are specified in the life insurance contract.
• Policy Term: Policy term is the specified duration (listed in the life insurance
contract) for which the insurance company provides a life cover and the time period
during which the contract is active (listed in the life insurance contract).
• Nominee: A nominee is an individual listed in the life insurance contract who is
entitled to receive the predetermined compensation, as a part of the policy.
• Claim: On the insured's demise, the nominees can file a claim with the insurance
provider in order to receive the predetermined payout amount.
• Death Benefits

life insurance enables individuals to protect themselves and their families, in case
of any unfortunate happening in the life of the insurer. The insurer pays an amount
equivalent to the sum assured as specified in the contract along with applicable
bonuses. This is know as the death benefit.
• Investment Components

Certain whole life insurance policies offer two-pronged benefits of both insurance
and investment. While one half of your premium is paid toward insurance, the other
half is invested in equity, debt or combinations of both. You get the best of both
worlds with a protective covering as well as high returns on your investments. You
can make the most of this component by investing in funds that align with your
investment horizon and risk appetite. Certain policies allow you to switch between
funds as per your evolving goals.
Maturity Benefits

Life insurance policies can also double as a savings instrument by offering maturity
benefits. If the insured survives the policy term and no claims have been made,
the total premiums paid are returned at the time of maturity of the policy. In this
manner, your life insurance plan can have a savings component, while also
offering a protective cover.
• Tax Benefits

Under the umbrella of Section 80C of the Income Tax Act (ITA), individuals can
 reduce their tax liabilities by investing in specific instruments. Term insurance is
one of them. Under section 80C, the premium paid for your life insurance policy is
eligible to attain a maximum tax deduction for up to Rs. 1.5 lakh. In addition to this,
under Section 10(10D), any payouts you receive from your insurance policy are
completely tax-free (provided your premium does not exceed 10% of your Sum
Assured, annually). If you have opted for a health-related rider, such as a critical
illness or surgical care rider, you can also avail tax deductions under 80D of the
ITA.
• Coverage Against Liabilities

To fulfill your dreams and attain your goals, you may have required a certain
amount of financial support - in the form of loans, mortgages and other types of
debt. Be it student loans or credit card debt, dealing with such liabilities can be a
source of great financial strain, without a steady stream of income. While you may
have the funds to pay off a part of your loans now, your family may find it difficult
to manage such liabilities in the event of your unfortunate demise, owing to the
loss of income. Thus, taking a life insurance policy ensures that your family has
the financial means to steadily meet your loan and mortgage repayments, even in
your absence.
• Riders
You can opt for riders to enhance your life insurance coverage. A number of riders,
ranging from Critical Illness to Accidental Total Permanent Disability are available
and help protect you and your loved ones against instances wherein your life cover
may not come into play.
Importance of life insurance plans:
Here are the reasons why life insurance plans are important –
• Life insurance policies provide financial security. They promise to give your
family financial assistance in case of your premature death
 • There are different types of life insurance plans and each plan helps you in
fulfilling your life’s financial goals
• By investing in life insurance policies you can buy peace of mind for yourself
as far are financial stability is concerned
• Life insurance policies also give you tax benefits and help in lowering your
tax liability Given these benefits of life insurance plans, you should invest in
a suitable policy.
Different types of life insurance policies
As stated earlier, life insurance plans come in different variants. Let’s
understand these variants and their respective features –
1. Term insurance Term insurance is the most basic type of life insurance
policy. The policy promises death benefit during the term of the plan. On
maturity, usually, nothing is paid. Term plans are the cheapest form of life
insurance which gives you unmatched financial protection.
Salient features of term insurance
a. Term plans allow high coverage levels at a low cost
b. Coverage can be taken for very long durations going up to 30 or 35 years or
till 85 years of age. Different plans have different options available
c. There are different types of term plans which are as follows
i. Increasing term plans where the sum assured increases every year
ii. Decreasing term plans where the sum assured reduces every year
iii. Level term plans where the sum assured does not change
iv. TROP or Term Plan with Return of premium option where the premiums paid
are returned if the plan matures
• Whole life insuranceWhole life plans, as the name suggests, run for your
whole life and allow coverage till you reach 99 or 100 years. These plans are
like term insurance plans but with indefinite coverage duration.
 • Salient features of whole life insurance plans
a. Coverage is allowed till 99 or 100 years of age
b. Different types of whole life plans are available in the market. You can buy
endowment oriented plans, money back whole life plans, pure protection
plans or even unit linked plans
c. Premiums under whole life plans are payable for a limited period
d. Under endowment oriented, money back or unit linked plans, there is also a
maturity benefit if you survive till 99 or 100 years of age
• Endowment assuranceEndowment plans are traditional savings-oriented
life insurance plans. These plans provide coverage against premature death.
Moreover, on maturity, a guaranteed maturity benefit is also promised.
Endowment plans, therefore, promise insurance as well as savings.
• Salient features of endowment assurance plans
a. Endowment assurance plans are a combination of insurance as well as
investment options
b. Coverage duration can range from 10 years to up to 30 years
c. The plan usually offers guaranteed benefits on death or maturity at 99 years
of age
d. The plan can be a participating or a non-participating plan.
I. Participating plans earn bonus
II. Non-participating plans do not earn bonus
e. Guaranteed additions or loyalty additions are also promised under many
endowment assurance plans
• Money back plan Money back plans are also called anticipated endowment
plans because they are like endowment plans but with anticipated benefits.
Under these plans, the sum assured is paid in instalments at specified
 durations over the policy tenure. This allows liquidity while at the same time
providing life insurance coverage.
Salient features of money back plans
a. The money back benefits are called survival benefits
b. Money back plans are offered as participating plans where bonuses are
added
c. In case of death of the insured, the entire amount of sum assured is paid
irrespective of the survival benefits already paid earlier
d. The tenure of a money-back plan often ranges from 12 or 15 years till 20 or
25 years.
• Unit linked insurance plans Unit linked insurance plans are unique life
insurance plans which provide the double benefit of insurance as well as
investment returns. Premiums paid for these plans are invested in market
linked funds. This fund then grows as per the performance of the market. If
the insured dies during the policy tenure, a death benefit is paid. On maturity,
the fund value is paid which is equal to the premiums invested along with the
returns that they earned over the term of the policy.
Salient features of unit linked plans
a. There are different types of investment funds suitable for different risk
appetites
b. You can choose the premium that you want to pay, the investment fund and
the duration of the plan
c. Partial withdrawals are allowed after the completion of 5 policy years wherein
you can withdraw from the fund
d. Switching is allowed for changing the selected investment fund
e. Many unit linked plans also allow additional premiums through top-ups
f. Higher of the sum assured or the fund value is paid on death. On maturity,
however, the fund value is paid
• Child plan Child insurance plans are life insurance plans which are created
to secure your child’s future. Under these plans, there is an inbuilt premium
waiver rider. This rider waives the premiums in case of death of the parent
who is also the policyholder. Though the premiums are waived, the policy
continues and pays a benefit after the end of the term when the child needs
it for higher education or marriage. Child insurance plans, therefore, ensure
a corpus for the child’s future whether the parent is alive or not.
Salient features of child insurance plans
a. Child plans can be traditional endowment or money back plans or unit linked
plans
b. Only parents of minor children can buy the policy
c. The life insured can be parents or the minor child. The policyholder, however,
would always be the parent
d. When the child attains 18 years, he/she becomes the policyholder. The
policy, then, vests in the child’s name
e. If the parent is the life insured, in case of death during the term, a death
benefit is immediately paid. The plan, however, continues to run and the
insurance company pays the premiums. Thereafter, on maturity, a maturity
benefit is paid again
• Health plan Life insurance companies also offer health insurance policies.
These policies either cover specific illnesses or a list of critical illnesses. If
the insured suffers from the illnesses covered by the plan, a lump sum benefit
is paid as per the policy’s benefit structure.
Salient features of health plans
a. The plans are offered for a period of 5 years to 30 years
b. The plans pay a lump sum benefit irrespective of the medical costs incurred
c. Heart related illnesses, cancer and other critical illnesses are some of the
commonly covered illnesses under health plans
• Annuity Annuity plans or pension plans are retirement oriented life
insurance plans. Under these plans you can either create a retirement corpus
or avail lifelong incomes from an already accumulated corpus. Pension plans
help you plan for your financial needs post retirement.
• Salient features of pension plans
a. There are two types of pension plans – deferred annuity plans and immediate
annuity plans
b. Under deferred annuity plans you can choose a policy tenure and pay
premiums to build up a retirement corpus
c. Under immediate annuity plans annuity payments commence immediately
after you buy the plan
d. Under deferred annuity plans, 1/3rd of the accumulated corpus can be
withdrawn in cash through commutation. The remaining would then be used
to avail annuities
• Life insurance riders Besides the above-mentioned types of life insurance
plans, there are riders too which are additional coverage benefits. Riders are
available with almost all types of life insurance plans (except health and
immediate annuity plans). You can choose any rider as per your coverage
needs by paying an additional premium.
Salient features of life insurance riders
a. Riders have their own sum assured which can be equal to or lower than the
sum assured of the base policy
b. You can choose multiple riders
c. Each rider comes with an additional premium
d. Riders do not have any maturity benefit. They cover a specific contingency
and pay a benefit only if that contingency occurs

MEANING OF FIRE INSURANCE

The term fire in a fire insurance is interpreted in the literal and popular sense. There is
fire when something burns. In other words fire means visible flames or actual ignition.
Simmering/ smoldering is not considered fire in Fire Insurance. Fire produces heat and
light but either of them alone is not fire. Lightening is not a fire but if it ignites something,
the damage may be due to fire.

Under section 2(6A) Insurance Act 1938, the fire insurance business is defined as follows:
“Fire insurance business means the business of effecting, otherwise than independently
to some other class of business, contracts of insurance against loss by or incidental to
fire or other occurrence customarily included among the risks insured against in fire
insurance policies”.

Example: The following are the items which can be burnt/ damaged through fire:

• Buildings
• Electrical installation in buildings
• Contents of buildings such as machinery, plant and equipments, accessories, etc.
• Goods (raw materials, in–process, semi–finished, finished, packing materials, etc.)
in factories, godowns etc..
• Goods in the open
• Furniture, fixture and fittings
• Pipelines (including contents) located inside or outside the compound, etc.

The owner of abovementioned properties can insure against fire damage through fire
insurance policy which provides financial protection for property against loss or damage
by fire.

FEATURES OF FIRE INSURANCE:

(Dear learner, most of the features to be discussed in the following paragraphs of Fire
Insurance you must have studied under Principles of General Insurance in other module)

1) Offer & Acceptance : It is a prerequisite to any contract. Similarly, the property will be
insured under fire insurance policy after the offer is accepted by the insurance company.
Example: A proposal submitted to the insurance company along with premium on
1/1/2011 but the insurance company accepted the proposal on 15/1/2011.

The risk is covered from 15/1/2011 and any loss prior to this date will not be covered
under fire insurance.

2) Payment of Premium: An owner must ensure that the premium is paid well in advance
so that the risk can be covered. If the payment is made through cheque and it is
dishonored then the coverage of risk will not exist. It is as per section 64VB of Insurance
Act 1938. (Details under insurance legislation Module).

3) Contract of Indemnity: Fire insurance is a contract of indemnity and the insurance

company is liable only to the extent of actual loss suffered. If there is no loss, there mis
no liability even if there is fire. Example: If the property is insured for Rs 20 lakhs under
fire insurance and it is damaged by fire to the extent of Rs. 10 lakhs, then the insurance
company will not pay more than Rs. 10 lakhs.

4) Utmost Good Faith: The property owner must disclose all the relevant information to
the insurance company while insuring their property. The fire policy shall be voidable in
the event of misrepresentation, mis-description or non-disclosure of any material
information. Example:

The use of building must be disclosed i.e whether the building is used for residential use
or manufacturing use, as in both the cases the premium rate will vary.

5) Insurable Interest: The fire insurance will be valid only if\ the person who is insuring the
property is owner or having insurable interest in that property. Such interest must exist at
the time when loss occurs. It is well known that insurable interest exists not only with the
ownership but also as a tenant or bailee or financier. Banks can also have the insurable
interest. Example: Mr. A is the owner of the building. He insured that building and later on
sold the building to Mr. B and the fire took place in the building. Mr. B will not get the
compensation from the insurance company because he has not taken the insurance
policy being a owner of the property. After selling to Mr. B, Mr. A has no insurable interest
in the property.

6) Contribution: If a person insured his property with two insurance companies, then in
case of fire loss both the insurance companies will pay the loss to the owner
proportionately. Example: A property worth Rs. 50 lakhs was insured with two Insurance
companies A and B. In case of loss, both insurance companies will contribute equally.

7) Period of fire Insurance: The period of insurance is to be defined in the policy. Generally
the period of fire insurance will not exceed by one year. The period can be less than one
year but not more than one year except for the residential houses which can be insured
for the period exceeding one year also.

8) Deliberate Act: If a property is damaged or loss occurs due to fire because of deliberate
act of the owner, then that damage or loss will not be covered under the policy.

9) Claims: To get the compensation under fire insurance the owner must inform the
insurance company immediately so that the insurance company can take necessary steps
to determine the loss.

What is Marine Insurance?

Marine insurance refers to a contract of indemnity. It is an assurance that the goods

dispatched from the country of origin to the land of destination are insured. Marine
insurance covers the loss/damage of ships, cargo, terminals, and includes any other
means of transport by which goods are transferred, acquired, or held between the points
of origin and the final destination.

The term originated when parties began to ship goods via sea. Despite what the name
implies, marine insurance applies to all modes of transportation of goods. For instance,
when goods are shipped by air, the insurance is known as the contract of marine cargo
insurance.

Importance of Marine Insurance

Marine insurance is required in many import-export trade proceedings. Admitting the

terms, both parties are liable for the payment of goods under insurance. However, the
subject matter of marine insurance goes beyond contractual obligations, and there are
several valid arguments necessary for buying it before dispatching the export cargo.

Goods in transit need to be insured by one of the three parties:-

• The Forwarding Agent

• The Exporter
• The Importer

Types of Marine Insurance

• Freight Insurance
• Liability Insurance
• Hull Insurance
• Marine Cargo Insurance

Freight Insurance
In freight insurance, for example, if the goods are damaged in transit, the operator would
lose freight receivables & so the insurance will be provided on compensation for loss of
freight.

Liability Insurance
Marine Liability insurance is where compensation is bought to provide any liability
occurring on account of a ship crashing or colliding.
Hull Insurance
Hull Insurance covers the hull & torso of the transportation vehicle. It covers the
transportation against damages and accidents.

Marine Cargo Insurance

Marine cargo policy refers to the insurance of goods dispatched from the country of
origin to the country of destination

Typical Components Of An Auto

Insurance Policy
If you're buying a new car or shopping for auto insurance, you'll likely need
to understand the common types of coverage available on a car
insurance policy. The various types of car insurance coverage are available
to help protect you, your passengers and your vehicle if you're involved in
a car accident.

Six common car insurance coverage options are: auto liability coverage,
uninsured and underinsured motorist coverage, comprehensive coverage,
collision coverage, medical payments coverage and personal injury
protection. Depending on where you live, some of these coverages are
mandatory and some are optional. Understanding what's required in your
state and what each helps cover can help you choose the right coverage
for your situation.

1. LIABILIT Y COVE RAGE

Auto liability coverage is mandatory in most states. Drivers are legally
required to purchase at least the minimum amount of liability coverage set
by state law. Liability coverage has two components:

• Bodily injury liability may help pay for costs related to another
person's injuries if you cause an accident.

• Property damage liability may help pay for damage you cause to
another person's property while driving.

2. UNI NS URE D AND UNDERI NSURED MOT ORIST COVERAGE

If you're hit by a driver who doesn't have insurance, uninsured motorist
coverage may help pay for your medical bills or, in some states, repairs to
your vehicle. If you're hit by an underinsured driver, that means they have
car insurance but their liability limits aren't enough to cover your resulting
medical bills. That's where underinsured motorist coverage may help.

Uninsured and underinsured motorist coverage is required in some states

and optional in other states.

3. COMPREHE NSI VE COVERAGE

Comprehensive may help cover damage to your car from things like theft,
fire, hail or vandalism. If your car is damaged by a covered peril,
comprehensive coverage may help pay to repair or replace your vehicle (up
to the vehicle's actual cash value). This coverage has a deductible, which
is the amount you'll pay out of pocket before your insurer reimburses you
for a covered claim.
Comprehensive is typically an optional coverage — but your lender may
require it if you're leasing or paying off your vehicle.

4. COLLISIO N COV ERAGE

If you're involved in an accident with another vehicle, or if you hit an object
such as a fence, collision coverage may help pay to repair or replace your
car (up to its actual cash value and minus your deductible).

Collision coverage is typically optional. It may be required, however, by your

vehicle's leaseholder or lender.

5. MEDICAL PAYME NT S CO VERAGE

If you, your passengers or family members who are driving the insured
vehicle are injured in an accident, medical payments coverage may help
pay for costs associated with the injuries. Covered costs may include
hospital visits, surgery, X-rays and more.

Medical payments coverage is required in some states and optional in

others.

6. PE RSO NAL INJ URY PR OT ECT ION

Personal injury protection, or PIP, is only available in some states. Like
medical payments coverage, PIP may help pay for your medical expenses
after an accident. In addition, PIP may also help cover other expenses
incurred because of your injuries — for example, child care expenses or
lost income.
 Personal injury protection is required in some states and optional in other
states where it's available.

What are TPAs or Third Party Administrators?

TPA or Third Party Administrator (TPA) is a company/agency/organisation
holding license from Insurance Regulatory Development Authority (IRDA) to
process claims - corporate and retail policies in addition to providing cashless
facilities as an outsourcing entity of an insurance company.

TPAs function as an intermediary between the insurance provider and the

insured. The stakeholders involved are as follows:

• Insurance companies
• Healthcare providers
• Policyholders
Introduced by the IRDA in 2001, TPAs handle various pertinent aspects of
insurance as listed below:

• Processing of claims and settlement includes the following:

• Accepting intimations
• Approving cashless claims
• Disbursing the claims
• Utilization review
• Provider network
• Enrolment
• Premium collection
• Cashless processing (if and when a policyholder is admitted to a listed
hospital of an insurance provider, the latter pays the bill)
• Value added services such as the following:
• Ambulance services
• Specialised consultation
• Availability of beds
• 24-hour toll-free helplines
• Lifestyle management
• Wellbeing programmes
• Medicine supplies
• Health facilities
• Database maintenance
According to experts, providing cashless hospitalization of the insured
should be the primary service offered by TPAs. It is important to note that
some insurance companies have a separate department which performs the
functions of TPA instead of outsourcing it to another entity.

Need for Third Party Administrators:

According to industry observers, TPAs can bring in the following changes:

• Greater efficiency/quality (delivery of services)

• Improved standardisation (procedures and due diligence)
• Increase knowledge base of healthcare services
• New management system
• Greater penetration of health insurance
• Minimize costs/expenditure
• Develop protocols to streamline investigation and avoid unnecessary
delays
• Pave way for lower insurance premiums
 All the same, there is much discrepancy between the aims and the ground
realities of functioning of TPAs. As a result, the jury is still out on the efficacy
of TPAs in the growing and complex health insurance sector in the country.
The institutionalization of TPAs, therefore, leaves a lot to be desired.

Revenue model of Third Party Administrators:

There is a view that the organisation and revenue generation model of TPAs
will determine the extent of their success. TPA’s major revenue comes in the
form of fees or commission on premium, which is standardised by the IRDA.
The other sources of revenue of TPAs include the following:

• Benefit management
• Provider network management
• Data management
• Medical management
• Claim administration

Challenges
According to experts, there are several impediments to the effective
functioning of TPAs. Some of the problem areas in the health
insurance sector in the country adversely affecting TPA-related services are
listed below:

• Information asymmetry
• Weak networking
• Inordinate delay in the issuance of identity cards to the insured
• Lack of strong standardisation procedures in terms of billing
• Under-reporting across hospitals
• Nexus between corporate hospitals and insurance companies (i.e., low
claim ratio for individual insurance and high claim ratio for corporate
insurance)
• IRDA has not put any strict regulations or mechanisms in place to
effectively appraise the performance of TPAs. IRDA, therefore, assesses
TPAs based on the latter’s financial performance in terms of policy
premium rather than customer satisfaction. There is, therefore, a view that
TPAs should be evaluated/accredited on the basis of quality of services
provided
• Low awareness about TPAs amongst general public/policyholders.
According to reports, many policyholders are unaware of the extra
premium charged by insurance companies for TPA services. Likewise,
pertinent information related to cashless hospitalization and exclusions
listed in insurance policies is not examined by many policyholders.
• Policyholders’ dependence on insurance agents rather than TPAs. In
many cases, policyholders do not see TPAs as distinct entities vis-a-vis
their insurance agents and intriguingly place more faith in the latter.
• Most hospitals have no substantial evidence to prove that TPAs increased
their patient turnover
• Experts point out that TPAs need to invest in developing human capital to
improve their delivery of services and rein in costs.
• Inadequate knowledge about the provisions and benefits of TPAs amongst
policyholders
• look for well-trained TPAs to effectively deal with the operational
inadequacies in the system. Poorly developed and half-baked protocols
and systems instil little confidence amongst stakeholders. TPAs should
have several in-house experts such as legal experts, IT professionals,
 doctors, management consultants and hospital managers among others
given that claims management and settlement requires bargaining power
and negotiation skills, i.e., combination of technical and management skills
• Hospitals which already have robust delivery mechanisms in place are
more likely to pave way for hassle-free claims settlement and other related
services offered by TPAs.
• While the primary purpose of outsourcing claims settlement is to minimise
the claim period, claims processing, in several cases, is riddled with
delays.
• The insured do not have adequate knowledge about empanelled hospitals
for cashless services
• Many hospitals also report additional expenditure incurred by them in
terms of smooth coordination with TPAs for efficient delivery of services to
the policyholders

What Is Micro Health insurance?

India comes top in the list of developing country, but they are not developed yet. A data
by the World Bank in 2019 stated that more than 65% population of India are from rural
areas. People living in rural areas are more prone to illnesses and injuries. And the
healthcare sector in these areas is still developing. So, to get proper medical treatment,
people from rural areas have to travel to semi-urban or urban areas.
We all know that cost of basic healthcare in India has skyrocketed enormously in the last
few decades. This as result has taken a major toll on the finances of the common man.
Especially, now when the majority of Indian rural area is infected with COVID-19 and they
need proper financial security. This is where micro health insurance helps people.
Micro health insurance is specially designed to help the rural sector of our country. This
insurance provides coverage to individuals that are living in rural sectors. Some of the
features of micro health insurance are mentioned below:
You will get a limited sum insured under this plan, which ranges from Rs 1 lakh to Rs 5
lakh.
This insurance is highly affordable as premium rates are on the lower side.

This policy comes with the tenure of a year only.

This policy covers all the family members if taken on a family floater basis.

No medical check-ups are required before buying this plan as the sum insured is low.

The policyholder should be 65 or less.

One can renew this plan lifelong without any hindrance.

Now let's talk about what is covered and what is not covered under this plan. Given below
are the benefits that you will be eligible for if you buy this health insurance online:
Coverage for both pre-hospitalization and post-hospitalization expenses.

The policyholder will get coverage against the hospitalization bills. For that, a
policyholder should be hospitalized for 24 hours or more.

It will also provide coverage for day-care treatments.

The cost of the ambulance will also be paid under this plan.

Micro Health insurance In India

As of now, there are only a few insurance companies in India that offer micro health
insurance plans for the population of rural India. This plan provides extremely good
coverage to the rural population at an affordable premium rate. The main objective of this
plan is to provide financial support to the people of rural areas so that they can get the
best treatment without using their hard-earned savings.
Other than this plan, the Government of India has introduced several health plans for the
poor and backward class of our country. One of the most popular health plans is the
Ayushman Bharat Scheme or the Pradhan Mantri Jan Arogya Yojana or PMJAY. This
plan has revolutionized the health insurance sector in India, especially for low-income
class individuals.
Under this plan, the policyholder only has to pay Rs 30 as a premium and they can get a
coverage of Rs 5 lakh. Another scheme introduced by the Government of India is the Aam
Aadmi Bima Yojana scheme. However, this plan is not open for everyone as it only
provides coverage to individuals engaged in 48 specific occupations such as fishing,
weaving, etc.
What Is Underwriting? Definition and Types
Underwriting is the process of vetting risks so only calculated risks are taken to protect
investors, banks, applicants and the market in certain financial contracts. In this article,
we discuss what underwriting is, what an underwriter does, the main types of underwriting
and what elements an underwriter looks at during the underwriting process.

Key Takeaways:

• Underwriting is the process an investor or institution evaluates, researches and

quantifies a financial risk.
• The role of an underwriter is to evaluate financial risks, rates and rules for a loan
or investment.
• Underwriters work in commercial banking, insurance, investment banking and
medical stop-loss industries.

What is underwriting?

Underwriting is determining and quantifying the financial risk of an individual or institution.

Typically, the risk is associated with providing loans, insurance or investments and is
conducted by financial institutions' in-house underwriting professionals. Underwriting has
an important function in the financial world because it:

• Assesses the degree of risk of the person or investment

• Establishes fair rates on loans
• Sets the right premiums to properly cover the real cost of insuring policyholders
• Prices investment risk accurately to establish a market for securities
• Ensures proper assessment and coverage
• Helps investors make sound investment decisions

What do underwriters do?

An underwriter is a professional who assesses risk and establishes a stable and fair
market for financial transactions. An underwriter does this by approving of calculated risk
when making decisions on a case-by-case basis. They determine which contracts are
worth the risk and the rate they will assign to these cases to ensure they or their employer
make a profit.

The following are the top duties of an underwriter:

• Examining applications for insurance, loans, mortgages or IPOs

• Vetting potential borrowers based on their backgrounds, assets, incomes and
other factors
• Using software to evaluate risk
• Conducting research and evaluating applicant documents
 • Approving or declining applications based on research and evaluations

Types of underwriting

There are five types of underwriting that are used to assess risks for a variety of important
contracts, including:

1. Loan underwriting
2. Insurance underwriting
3. Securities underwriting
4. Real estate underwriting
5. Forensic underwriting

1. Loan underwriting

Loan underwriting involves evaluating and calculating the risks of lending to potential
borrowers. Loan underwriters make the assessment of loan repayment based on four
main factors: income, appraisal, credit score and asset information.

2. Insurance underwriting

Insurance underwriting is the process of evaluating a prospective insurance candidate for

life, health and wellness, property and rental or other types of insurance. It determines
the risks of filing large or frequent claims and assessing how much coverage a person
can be given, how much they should pay and how much an insurance company is likely
to pay to cover the policyholder.

The life insurance underwriting process involves assessing the risk of the potential insurer
by evaluating age, occupation, health, family medical history, lifestyle, hobbies and other
traits. Health insurance may have restrictions resulting from health factors or pre-existing
conditions. Other types of insurance assess the likelihood of accidents, potential damage,
environmental impacts and more to determine the scope of a policy.

3. Securities underwriting

Investors and investment banks use securities underwriting to determine how profitable
investments—such as individual stocks and debt securities—are likely to be.

In securities underwriting, an investor identifies profitable securities supplied by a

company attempting Initial Public Offering (IPO). The investor, then, sells those securities
in the market for a profit. Underwriters involved in this process can form an underwriter
syndicate, which is a group of underwriters that buys securities to resell them to dealers
or investors who will also sell them to other buyers. When this group makes an income
from the difference, it is called an “underwriting spread.”
Sometimes the underwriter and securities issuer will make an exclusive deal. In this case,
the underwriter will pay a higher price for the bonds and the issuer will make the
underwriter the sole agent of the securities. When this happens, the underwriter will be
the only agent doing the initial sale of the securities.

The potential investor and underwriter benefit from the underwriting process because the
process assesses whether the IPO company will be able to raise the amount of capital
required, thus ensuring the underwriters earn a profit for their service.

4. Real estate underwriting

In real estate underwriting, a borrower’s background is assessed, as well as the property

they want to get a loan for. The underwriting process will determine whether the property
can recoup its value if the borrower cannot pay back the loan.

5. Forensic underwriting

Forensic underwriting occurs when a borrower fails to pay back a loan. In this case, the
borrower will be assessed again to determine whether the person can be given a new
loan or a refinance.

How loan underwriting works

There are four basic elements that an underwriter evaluates during the underwriting
process:

Income

Income refers to both gross and net income and is used to estimate whether a borrower's
income can cover the monthly payment for the loan. Borrowers must submit IRS Schedule
K-1s, balance sheets, profit and loss sheets and personal and business tax returns as
relevant to the purpose of the loan.

Appraisal

Appraisals ensure that the property or other purpose of the loan is worth the amount being
requested. In this part of the process, an appraiser visits the property or evaluates the
purpose of the loan to collect the necessary determining information, such as viability or
quality of the investment.

Credit score

Knowing the borrower’s credit score helps determine if the borrower is reliable in paying
on credit, including loans and credit cards. The credit score also provides a borrower's
debt-to-income (DTI) ratio, which can be used to estimate whether the borrower can pay
back this loan, as well as other existing debts. If a borrower has a good credit score, they
can benefit from a lower interest rate.

Asset information

Assets are valuable items a borrower owns that can be sold if they cannot pay back their
loan, such as buildings, federal treasury notes, corporate bonds, guaranteed investment
accounts, mutual funds and land.

While it is best to score high in all these areas, an applicant can still be offered a loan if
they are strong in only one or two. For instance, the borrower may have a high credit
score or financial savings but a lower income or minimal assets and still be approved for
a loan.

If the underwriter determines the risk is too high to offer a borrower a loan, a loan can be
denied. In this case, the underwriter must be able to provide the applicant with a valid
reason for the denial. The loan can also be filed as suspended if there are missing
documents, but it can be filed as approved with conditions when certain documents, such
as tax forms, still need to be submitted.

Claim Process of General Insurance

General insurance policies or non-life insurance plans are taken to secure cars, bikes,
property, etc. The claim settlement process is a service that is very important to the
policyholder as well as the insurer. Claim settlement in general insurance can make the
policyholder stay with the insurer. It is a process where the policyholder claims financial
support from the insurer. Claim Settlement in general insurance is offered only after the
due process gets completed. The insurance companies need to offer an easy settlement
process because they want to stay ahead in the market.

Every policyholder wants to receive the claim amount easily, which is why insurance
companies want to offer the most efficient claim service to its customers.

Here is a normal claim process -

• The policyholder must make the insurer aware of the damage or loss.
• The insurer must give the policyholder knowledge on what to do next.
• If the policyholder doesn’t offer everything requested of them about the damage or loss,
then their assessment might get delayed.
• The surveyor must give a report about the loss or damage to the insurer in 30 days.

Car Insurance Claims

1. Cashless Car Insurance

If the policyholder takes their damaged car to a network garage, then they might not have
to pay the money. The insurer will cover the cost.

The process for filing cashless car insurance is easy. The policyholder must make the
insurer aware of the damage. The insurer will get a surveyor to assess the damage on
the car before the car gets repaired.

2. Car Reimbursement Claim

The policyholder must pay the money in case they don’t take their car to a network
garage. However, the money will be reimbursed to them when they make a claim with
bills.

The policyholder can claim reimbursement after the car is repaired. However, the damage
must be surveyed by the insurer within 48 hours of the accident.

Home Insurance Claims

The policyholder should know what is covered in the policy. A policy can be taken for a
property such as building or household products that can be transported. The policyholder
must make the insurer aware of the damage to the property. The insurer will survey the
damage to the property, and the reimbursement will take place after that.

Travel Insurance Claim

A travel insurance claim can help the policyholder receive financial assistance for events
such as personal accident, baggage loss or damage, etc. during the journey. However,
the process might be different from policy to policy.

A policyholder can get benefits such as cashless and reimbursement facilities with
insurance. The process of claiming it is easy too. A policyholder doesn’t have to hassle
much in order to get the financial help they need. Be it a property or a car, securing them
is important. If they meet with damage, then repairing it will become easy with the financial
help that the insurer offers.

Claims Process
Filing a Life Insurance Claim

Claim settlement is one of the most important services that an insurance company can provide to
its customers. Insurance companies have an obligation to settle claims promptly. You will need
to fill a claim form and contact the financial advisor from whom you bought your policy. Submit all
relevant documents such as original death certificate and policy bond to your insurer to support
your claim. Most claims are settled by issuing a cheque within 7 days from the time they receive
the documents. However, if your insurer is unable to deal with all or any part of your claim, you
will be notified in writing.

Types of claims

Maturity Claim- On the date of maturity life insured is required to send maturity claim / discharge
form and original policy bond well before maturity date to enable timely settlement of claim on or
before due dates. Most companies offer/issue post dated cheques and/ or make payment through
ECS credit on the maturity date. Incase of delay in settlement kindly refer to grievance redressal.

Death Claim(including rider claim) - In case of death claim or rider claim the following procedure
should be followed.

Follow these four simple steps to file a claim:

1.Claim intimation/notification

The claimant must submit the written intimation as soon as possible to enable the insurance
company to initiate the claim processing. The claim intimation should consist of basic information
such as policy number, name of the insured, date of death, cause of death, place of death, name
of the claimant. The claimant can also get a claim intimation/notification form from the nearest
local branch office of the insurance company or their insurance advisor/agent. Alternatively, some
insurance companies also provide the facility of downloading the form from their website.

2.Documents required for claim processing

The claimant will be required to provide a claimant's statement, original policy document, death
certificate, police FIR and post mortem exam report (for accidental death), certificate and records
from the treating doctor/hospital (for death due to illness) and advance discharge form for claim
processing. Based on the sum at risk, cause of death and policy duration, insurance companies
may also request some additional documents.

3.Submission of required documents for claim processing

For faster claim processing, it is essential that the claimant submits complete documentation as
early as possible. A life insurer will not be able to take a decision until all the requirements are
complete. Once all relevant documents, records and forms have been submitted, the life insurer
can take a decision about the claim.

4.Settlement of claim

As per the regulation 14 (2)(i) of the IRDAI (Policy holder's Interest) Regulations, 2017, the insurer
is required to settle a claim within 30 days of receipt of all documents including clarification sought
by the insurer. However, the insurance company can set a practice of settling the claim even
earlier. If the claim requires further investigation, the insurer has to complete its procedures
expeditiously, in any case not later than 90 days from the date of receipt of claim intimation and
claim shall be settled within 30 days thereafter.

Claim Intimation

In case a claim arises you should:

Contact the respective life insurance branch office.

Contact your insurance advisor.

Call the respective Customer Helpline.

Claim Requirements

For death claim:

* Death Certificate

* Original Policy Bond

* Claim Forms issued by the insurer along with supporting documents

For accidental disability / critical illness claim:

• * Copies of Medical Records, Test Reports, Discharge Summary, Admission Records

of hospitals and Laboratories.
•
* Original Policy Bond
•
* Claim Forms along with supporting documents

For maturity claims:

• * Original Policy Bond.

•
* Maturity Claim Form

Fire Insurance claims

Motor Insurance Claim
Formalities for a motor insurance claim

A claim under a motor insurance policy could be

• For personal injury or property damage related to someone else. This person is
called a third party in this context) or
• For damage to your own, insured, vehicle. This is called an own damage claim and
you are eligible for this if you are holding what is known as a package or a
comprehensive policy.
Third Party Claim

In a third party claim, where your vehicle is involved, it is important to ensure that the
accident is reported immediately to the police as well as to the insurance company.
On the other hand, if you are a victim, that is, if somebody else’s vehicle was involved,
you must obtain the insurance details of that vehicle and make an intimation to the insurer
of that vehicle.

Own Damage Claim

In the event of an own damage claim, that is, where your own vehicle is damaged due to
an accident, you must immediately inform insurance company and police, wherever
required, to enable them to depute a surveyor to assess the loss.
Do not attempt to move the vehicle from the accident spot without the permission of police
and the insurance company.

Once you receive permission for removal of the vehicle and for repairs, you can do so.
If your policy provides for cashless service, which means you do not have to pay out of
your pocket for covered damages, the insurance company will pay the workshop directly.
In either of these situations, you must intimate the insurance company immediately.

Theft Claim

If your vehicle is stolen, you must inform the police and the insurance company
immediately. In addition you must keep the transport department also informed.
As soon as you receive the policy document, read about the procedures and
documentation requirements for claims rather than wait for a claim to arise.
If you have to make a claim, ensure that you collect all the required documents and submit
them along with the requisite claim form duly filled in, to the insurance company.
There may be certain specific documentation requirements for specific types of claims.
For instance in respect of a theft claim, there is a special requirement that you should
surrender the vehicle keys to the insurance company.

Marine Insurance Claim

Notice to Insurer
Intimating insurance company about the loss or damage of goods is the first step to be
taken by the insured under claim of Marine Insurance. In the event of loss or damage to
the goods, insured or his agent has to give immediate notice to the insurance company.
Reasonable Care
Ina marine Insurance, it is a condition of the policy that the insured and his agents should
act as if the goods are uninsured and should take all such measures and actions as may
be reasonable and necessary to minimize the loss or damage. They must also ensure
that all the rights against carriers, baileys or third parties are protected. So Reasonable
care is one of the measures to be taken in to consideration under the procedures of
claiming Marine Insurance against loss or damage of export import goods of international
trade.
Survey and Claim
Survey and claim is the next step to be followed under procedures and formalities to claim
Marine Insurance under export and import goods. In a Marine Insurance, at the time of
taking delivery, if any package shows signs of outward damage, insured or his agents
must call for a detailed survey by the ship surveyors and lodge the monetary claim with
the shipping company for the loss or damage to the packages. A certified marine surveyor
can be appointed at the location where damaged cargo is available.
Outward Condition
When the outward condition of the packages is apparent, the insured takes delivery
unsuspectingly. After reaching warehouse, one opening the packages, they find damages
to goods. In such an event, the insured and or agent should immediately inform the
insurance company and call for the ship surveyor for detailed survey. They should not
make any delivery of goods. They should not disturb the packing materials or the contents
in packages. This is important in claiming Marine Insurance under export and import
trade.
Missing Packages
In case any package is found missing, the insured must lodge the monetary claim with
the insurance company and its baileys (shipping company) and obtain a proper
acknowledgement from them. This is one of the formalities to claim Insurance under
import export of international trade.
Time Limit
In a Marine Insurance, the time limit for filing suit against the shipping companies is one
year from the date of discharge of goods, which may change as per the rules and
regulations of insurer.
Documents Required
The following documents are to be submitted by the insured to enable the insurance
company to settle the claims expeditiously :
1. Original insurance Policy or Certificate.
2. Copy of Billing Lading.
3. Survey report / Missing certificate.
4. Original Invoice and Packing List together with shipping specification or weight notes.
5. Copies of Correspondence exchanged with the carriers or bailees.
6. Claim Bill.
Precautions
While procuring insurance, exporter should observe the following precautions in claiming
Insurance under export import goods:
(i) Amount of insurance is 110% of C.I.F value of goods. 10% covers anticipated profits.
In other words, exporter is allowed to take a policy to cover profits up to a maximum
amount of 10% of CIF value.
(ii) Insurance documents is not later than the date of shipment.
(iii) Amount insured must be in the same currency invoice to take care of the exchange
fluctuations.
(iv) Insurance document is issued by the insurance company or its agents or underwriters.
The document issued by the brokers is not a good document

Claims on consignment by road /rail

Compensation claims for loss, damage, etc. to consignments in transit are dealt with by in
accordance with the provision of the Indian railways Act 1989.
Insurance company assumes responsibility for the loss, destruction, damage or
deterioration, or non-delivery of any consignment in transit, arising from any cause except
the following, namely :-
• a) Act of god;
• b) Act of war;
• c) Act of public enemies;
• d) Arrest, restraint or seizure under legal process;
• e) Orders or restrictions imposed by the Central Government or a State Government
or by an officer or authority subordinate to the Central Government or a State
Government authorized by it in this behalf;
• f) Act or omission or negligence of the consignor or the consignee or the endorsee or
the agent or servant of the consignor or the consignee or the endorsee;
• g) Natural deterioration or wastage in bulk or weight due to inherent defect, quality or
vice of the goods;
• h) Latent defects;
• i) Fire, explosion or any unforeseen risk :

According to the rules notified under the said Act, every person entrusting any cargo
to insurance company for carriage by rail or road shall execute a Forwarding note in such
form as may be specified and the consignor shall be responsible for the correctness of the
particulars furnished by him in the forwarding note. The consignor shall indemnify
the insurance company administration against any damage suffered by it by reason of the
incorrectness or incompleteness of the particulars in the forwarding note. Further, the liability
of insurance company for general goods shall not exceed an amount calculated on the basis
of invoice value subject to a maximum rate of Rs 50/- per kg unless the consignor had
declared the value of the consignment at the time of booking, and paid in addition to freight
charges, a percentage charge which varies from 0.25% to 1% of the value depending on the
distance for which the consignment is booked.
In order to avoid a time bar on settlement of claims the claims should be preferred within
six months of the date of booking.
All claims should be addressed to the Head of the Region (CGM/RGM) where the
destination station/depot lies.

To assist us in dealing with claim case promptly, claimants are requested to furnish the
following details in their claim letter in the format which can be downloaded:
FORMAT FOR CLAIM LETTER
• Copy of Inland Way Bill which shall be prime facie evidence of weight and no. of
packages.
• Booking station
• Destination station
• Factory stuffing/Terminal stuffing
• Terminal destuffing/factory destuffing.
• Commodity-description & weight
• Details of loss/shortage/ damage
• Shortage certificate/open delivery/ assessment delivery certificate issued
by insurance company at the time of delivery.
• Amount claimed (indicating the basis on which this has been arrived at, such as
original trade invoice, beejuk, bill,etc.
Exoneration from responsibility under section 102 of IR Act 1989:

Insurance company administration shall not be responsible for the loss, destruction,
damage, deterioration or non-delivery of any consignment in following circumstances:
• When such loss, destruction, damage, deterioration or non-delivery is due to false
declaration.
• Where fraud is practiced by consignor/consignee/agent.
• In case of improper loading/ unloading by consignor/ consignee/ agent.
• Riot, civil commotion, strike, lock-out, stoppage or restraint of labour from whatever
cause arising whether partial or general
• Any direct/indirect or consequential loss or damage or for loss of particular market

Mediclaim Claim Procedure

Step 1 - Put all receipts, bills and medical reports in order. Arrange them in chronological
order. Check that all the documents contain required information like the patient name,
document number, serial number, cost price, signature of the authorised person and so
on.
Step 2 - Request your insurance company for the claim form. Usually the claim form can
be downloaded from the insurance company’s website. Read the instructions given in the
claim form carefully. Fill in the claim form with all the required details. Make sure the
information is correct.
Next, get the claim form signed by the policy holder as well as the treating consultant. It
must also be stamped with the official hospital seal.
Finally, attach all the relevant medical and policy documents to the claim form
Medical documents include

The discharge summary

All documents relating to the patient’s illness
All reports with details of the treatments and procedures conducted
A certificate from the attending medical practitioner stating that the patient has recovered
or is recovering

Policy documents include

The Third Party Administrator (TPA) card
Step 3 - Prepare copies of all the original documents. Both, the original documents as
well as their copies, need to be submitted with the claim form. Submission of only copies
is usually not accepted. Attach the documents in serialised or chronological order. Review
the documents carefully. Make sure that none of the documents issued at the time of
treatment are missing. If any documents are missing at the time of submission, the claim
may not go through.
Step 4 - Submit the documents with the correct TPA. You can get the name of the TPA
from your insurance company. When you visit the TPA branch, ask an executive to check
the submitted documents. Then submit the documents with the executive. You should
also inform the health care insurance company that the claim has been submitted, by
sending them a set of copied documents.
Responsibilities of Insurance Manager

• Manage operations and productivity at an insurance company.

• Create and modify procedures and documents related to policies.
• Assist in claims management.
• Identify and analyze risks associated with policies.
• Achieve target budgets.
• Minimize risk of financial loss.
• Obtain and oversee company insurance or related funds that management uses to cover costs
such as disability benefits or lawsuits.
• Direct information for claimants.
• Preside over claims investigations.
• Review insurance policies.
• Manage insurance data for reports.
• Analyze statistical data, such as mortality, accident, sickness, disability, and retirement rates
and construct probability tables to forecast risk and liability for payment of future benefits
• Determine premium rates.
• Ascertain cash reserves necessary to ensure payment of future benefits.

• What Is an Insurance KPI?

• An insurance Key Performance Indicator (KPI) or metric is a measure that an
insurance company uses to monitor its performance and efficiency. Insurance
metrics can help a company identify areas of operational success, and areas that
require more attention to make them successful. These KPIs are often used to
compare companies in the insurance industry against each other to see which
would be a better investment.
• KPIs and Reporting in the Insurance
Industry
• The insurance industry is large and complicated. Insurance KPIs and reporting can
be just as complicated. Most of the time, thinking about KPIs and reporting will give
you a headache. At insight software, we like life to be simple. As such, this blog
post will break the insurance industry and its KPIs down into small bite sized pieces
that you can easily digest. We will go over insurance KPI examples for the sales,
 claims, and finance departments, as well as how you can streamline your reporting
process using insurance reporting solutions.

How to Develop a Key Performance

Indicator for an Insurance Company
As we stated previously, the insurance industry is large and complicated. As such, you
might find yourself looking for different performance metrics to evaluate your company’s
performance. To completely tailor a KPI to your needs, you can create your own. This
section will go over what should be taken into consideration when developing a new key
performance indicator for an insurance company.

• Have a goal. This is fundamental. You can’t create a KPI without having a clear
goal in mind. This goal cannot be subjective. It needs to be numerically
assessable.
• Take a holistic approach. When thinking about your KPI, think about the impact
the insurance KPI will have on the company. Will it impact other business units?
Or does it help the whole company move together as a homogenous unit?
• Align with company processes. Don’t create a KPI that would be resource
intensive. Try to integrate the performance metric with the existing company
framework. Not only will this reduce the resource burden, it will help to quickly
identify inefficient processes.
• Create a company culture. This might sound like a lot to think about when
creating a KPI, but it can be helpful. Consider the mentality of your staff at the
company. Create an environment in which the KPI positively impacts the
workplace and encourages/rewards people for doing things that will benefit the
company.
• Compiling the data and reporting it. This is one of the most critical aspects of
creating a KPI in our opinion. A lot of thought and effort has been put into creating
a new insurance KPI and implementing it, but this KPI is only useful if you can
track and interpret the data. A KPI dashboard can streamline this process making
it very simple and efficient.
• Make informed decisions. This is the whole purpose of implementing insurance
key performance indicators. The KPI that you have created should be able to
provide the company with insight into their operations, and help the company make
informed decisions.
This should give you an idea of what makes a good insurance key performance indicator.
Coupled with the top insurance KPIs that we talked about for your sales force, you should
be ready to streamline your company. We can’t emphasize enough the importance of
using insurance dashboard software to keep track of your KPI performance.

ALM
1. Definition of ALM

The Society of Actuaries ALM Principles Task Force provided the following definition for ALM.
Asset Liability Management is the ongoing process of formulating, implementing, monitoring, and
revising strategies related to assets and liabilities to achieve financial objectives, for a given set
of risk tolerances and constraints

While managing the risks associated with the assets and liabilities remains a key focus of ALM,
the task force recognized that ALM had a more strategic role to achieve the financial objectives
of an entity. This is in contrast to the view of ALM as solely a compliance exercise where the only
goal is risk mitigation.

2. Relative Risk

The risk exposure of an insurer is a function of the assets and the liabilities. ALM is less concerned
with absolute risk than relative risk. Consider a highly volatile asset portfolio whose market value
is subject to large swings. On a standalone basis, this portfolio may have a high absolute risk.
However, if this portfolio is backing liabilities whose value changes by the same amount for a
given change in a financial variable, then the relative risk associated with the assets and liabilities
is what matters. This is the reason why an “asset-only” asset management approach for insurance
portfolios is inappropriate. It is better to have a portfolio with a lower or even negative return on
assets than a portfolio with a higher return on assets if in the former case the liabilities and
possibly the capital requirements increased by less and in the latter case the liabilities and capital
requirements increased by more.

One ALM strategy, which can be executed on many different bases, is immunization. The,
concept of immunization is to rebalance the asset portfolio as necessary so that the change in
the value of the assets on some basis (economic, market value or book value) will be equal to the
change in the liabilities within some tolerance level. Immunization is only possible for those
liabilities that are predictable and largely impacted only by the same financial variables that impact
the assets.

3. Key Elements of ALM: Measurement and Management of Risk

Two key elements of ALM include: 1) measurement of the risk exposure and 2) management of
the risk exposure.

Measurement of the risk exposure can be done in a number of ways:

1. Calculating the sensitivity of the assets and liabilities to changes in financial variables. This can
be done using traditional ALM metrics such as duration and convexity, the Greeks or scenario
testing.

2. Calculating the risk distribution of the assets and liabilities

This is done using stochastic simulation and can be expressed using various measures such as
value at risk (“VAR”) and conditional tail expectation (“CTE”).

In some jurisdictions where the capital requirements are risk-sensitive, the impact on the capital
requirements would also be considered. This is not always intuitive as it may be that interest rate
risk, or market risk, may diversify against the capital required to be held against other risks, and
hence the aggregate capital required may be insensitive to increasing risk exposure until the
diversification benefit is used up.

The above ways of measuring risk can be classified as either measuring the sensitivity to a
change in financial variable at a point in time versus the sensitivity to a change in financial variable
over time. For example, duration, convexity, delta, gamma and rho all measure the exposure to
an immediate shock in the financial variable on the price of the underlying asset or present value
of a series of cash flows and assumes that shock persists indefinitely into the future. Scenario
testing and stochastic simulation can also look at future economic scenarios over time and test
the impact under the ALM strategy or reinvestment assumption.

Monitoring of the risk can be performed intra-day, weekly, monthly or quarterly – often depending
on how volatile the results are and the extent of surplus funds to absorb any mismatch.
Measurement of the risk exposure and the impact of potential ALM strategies provides valuable
decision support to an insurer.

Management of the risk exposure involves formulating and executing ALM strategies. Many
companies use traditional ALM metrics such as duration and convexity to manage the risk
exposure, set risk limits and rebalance the portfolio and then measure the resulting risk
distribution using stochastic simulation.

4. Influence of Regulatory Regime on ALM practice

Supervisory and financial reporting trends that value all elements of the balance sheet
independently may not sufficiently consider ALM exposures. Accounting rules have sometimes
encouraged mismanagement of risk as a result of a disconnect between the accounting treatment
and economic reality.

Many of the large losses and failures suffered by insurance companies with long duration liabilities
could have been avoided by applying basic ALM techniques. Failures and near failures of life
insurance companies as a result of asset liability mismatches continue today.

Accounting rules in some jurisdictions have encouraged mismanagement by ignoring the

economic risk exposure and rewarding companies for taking mismatch risk. In countries where
the reserve and capital requirements do not reflect the interest rate risk exposure associated with
a mismatch of the asset and liability cash flows, and/or where there is a large disconnect between
the exposure on an accounting basis and risk exposure on an economic basis, insurers have had
less motivation to implement effective ALM.

5. Unique Considerations and Challenges for Insurance Companies in a Low Interest

Rate Environment

ALM for life insurers can be complex due to the long term nature of some product guarantees
(e.g. for the lifetime of insured/annuitant) extending beyond the term to maturity of available fixed
income assets, the presence of optionality in either or both of the asset and liability cash flows
(e.g. resets, ratchets in variable annuities with guarantees), the presence of adjustable features
in some products (e.g. participating insurance with dividends) and the dependence on
demographic assumptions which can undermine the matching as assumptions change.

One of the greatest challenges facing life insurance companies has been the prolonged extreme
low interest rate environment11. Life insurers who were short asset duration were not able to earn
the returns assumed in pricing of the liabilities. This has resulted in lower earned rates on insurer
portfolios, decreased investment income, higher reserves, spread compression on products
offering minimum credited rate guarantees and reduced ability to support dividend scales. Even
those insurers who were immunized on a duration basis and within their board approved risk limits
for the maximum allowable mismatch between the duration of assets and duration of liabilities
found themselves offside as a result of their convexity exposure as interest rates declined, the
duration of liabilities increased by a greater amount than the duration of assets. Many of these
insurers started chasing yield, decreasing the credit quality of their portfolios and increasing the
allocation to riskier asset classes. The resulting pressure for higher yield has resulted in more risk
being taken.

Traditional guaranteed products with long durations have been difficult to immunize with available
fixed income assets. Many insurers have assets backing liabilities that have a shorter duration
either because longer duration fixed income assets are not available or because they do not want
to invest in long low yielding bonds and lock in losses. Insurers who have taken a market view on
the direction of future interest rate changes and have not lengthened their assets to match the
duration of the liabilities have essentially taken a bet that interest rates will not fall further in the
medium to long term.

Life insurers are faced with the prospect of having to rebalance their portfolios to lengthen the
duration of their assets by purchasing longer term bonds and locking in unattractive yields in a
low rate environment. Because of a growing disconnect in Canada between the accounting and
economic results, some Canadian insurers were further penalized with an increase in reserves if
they immunized their portfolio on an economic basis.

There have been three main ways that insurers have sought to increase the yield on their
portfolios.

1. Add credit spread.

This is achieved by decreasing the credit quality of the portfolio and taking on more credit risk
exposure, and often aiming to capture the illiquidity premium where they are intending to hold
assets to maturity.

2. Increase expected return.

This is achieved by increasing the allocation to riskier assets classes such as equities, real estate
and other non-fixed income assets.

3. Increase yield to maturity in an upward sloping term structure.

This is achieved by selling shorter assets that have a lower yield to maturity and buying longer
assets that have a higher yield to maturity. In some cases, for life insurance companies that had
assets shorter than the liabilities to begin with, this increases yield and decreases the interest rate
risk. Albeit the insurance company is giving up both the downside risk if rates fall as well as the
upside gain if interest rate rise.

Objectives for the ALM Function

At its most fundamental level, the goal of ALM is to manage the financial risk exposure associated
with the assets backing liabilities. While this seems straightforward enough, several basic
questions need to be answered before ALM can be properly performed. For example:

What sources of financial risk should fall within the scope of ALM?

Which risk exposure matters and which does not?

On what basis should risk be measured and managed?

What assets and what liabilities should be included and which, if any, should be excluded?

At what aggregation level should ALM be performed?

Getting any of these basic questions wrong can have disastrous results for a financial institution,
potentially doing more harm than not doing ALM at all.

Once the insurer has defined what risk will be managed, it needs to determine how this will be
done. Before this question can be answered, the objectives for the ALM function need to be
determined. In some insurance companies, ALM is viewed as a risk mitigation exercise primarily
and the objective is simply to ensure all risk exposures are within the board approved risk limits.
Other insurers have integrated ALM within their broader Enterprise Risk Management (”ERM”) to
be executed as a strategic decision-making framework to run the company by formulating,
implementing and executing investment strategies related to the assets and liabilities that achieve
the financial objectives and setting this up as an optimization program. The objectives for the ALM
function will determine how asset management is performed. Other objectives for the ALM
function may include

Demonstrating to internal and external stakeholders that the company is being well managed
 Minimizing capital requirements, especially RBC

Determining how much interest should be credited to policyholders

Determining impact on account items which have immediate impact on earnings

One complication that arises in RBC regimes, such as Solvency II, is that interest-rate and market
capital requirements interact with the capital arising from other risks when they are aggregated.
Hence the ALM function needs to work closely with the team responsible for overall capital
management. Another complication is the increasing need to look at the future liability and capital
requirements in the ORSA, rather than simply looking at the current balance sheet.

I. Strategic Use vs. Mitigation Only

In practice, some insurance companies execute ALM as a risk mitigation exercise where the goal
is simply to keep the risk exposure within the specified risk limits. For other insurance companies
the goal is not to eliminate or minimize risk, the goal is to formulate ALM strategies to achieve the
financial objectives subject to the risk tolerances and constraints.

The ALM definition presented in the previous section, contemplates that ALM will be executed as
a strategic decision making framework to achieve financial objectives subject to risk tolerances
and constraints.

II. Economic vs. Accounting

The risk exposure can be measured on different bases. There is a wide range of practice within
the insurance industry globally regarding the basis the risk should be managed on. One of the
first steps in defining the ALM objectives is to determine what interest rate risk to manage. Is it
the interest rate risk associated with the long term future cash flows, the market value of the
assets and liabilities or the financial statement results?

In general, it will not be possible to manage the risk exposure on all three bases perfectly.
Insurance companies must choose on what basis the risk will be managed. Best practice is to
measure the exposure on multiple bases and use this to inform decisions regarding risk / reward
tradeoffs.

A challenge for insurance companies that can threaten solvency and the financial health of the
company occurs when there is a disconnect between the economic and accounting or regulatory
results. Many insurance company executives will say that they are focused on the long term
economic value. However, they are reluctant to immunize the interest rate risk exposure on an
economic basis (e.g. lengthening duration) when that creates losses on a financial statement
basis. The accounting regime can encourage the whole industry to systematically take on interest
rate risk.

The basis for managing interest rate risk will determine which yield curve should be used for
calculating present values of cash flows and the various ALM metrics such as duration, convexity
etc.
One challenge facing insurance companies wishing to manage the economic risk exposure is that
the very long term end of the yield curve may not be observable or be available for investment.

Ratio Analysis of Insurance Companies

1. Persistency ratio

This ratio helps you understand how persistent customers have been in
renewing their policies every year. It is measured at different intervals
—13th month, 25th month, 37th month and 61st month.
It gauges the trust customers have in the long-term products and
services being offered by the insurer.

Persistency ratio is calculated thus: number of policyholders paying the

premium divided by net active policyholders, multiplied by 100.

Higher the persistency ratio, the better. “It implies that the associated
policyholders are satisfied with the product portfolio, customer service,
post sales service, product utility, returns on their product, customer
loyalty, etc. and are renewing their policies as and when due,” says
Harjot Narula, CEO, ComparePolicy. According to the latest data
available, Kotak Mahindra Old Mutual has the highest 61stmonth
persistency ratio, while Star Union has the lowest.

2. Solvency ratio

It defines how good or bad an insurance company’s financial situation

is on defined solvency norms. According to Irdai guidelines, all
companies are required to maintain a solvency ratio of 150% to
minimise bankruptcy risk. “Solvency ratio helps identify whether the
company has enough buffer to settle all claims in extreme situations,”
Hence, it is a good indicator of an insurance company’s financial
capacity to meet both its short-term and long-term liabilities.

Solvency ratio is calculated as the amount of Available Solvency Margin

(ASM) in relation to the amount of Required Solvency Margin (RSM).
The ASM is the value of the company’s assets over liabilities, and RSM
is based on net premiums and defined as per Irdai guidelines.

Higher the solvency ratio, the greater the chances of your claims getting
paid. There are unusual trends insurance buyers should watch out for
here. For instance, among all the 24 life insurance companies, Sahara
Life has the highest solvency ratio of 812%. However, this figure is
misleading because the company isn’t doing well financially. It has
posted losses of Rs 4.57 crore for the third quarter ended 31 December,
2016. It had posted a profit of Rs 3.05 crore in the third quarter of the
previous fiscal.

In fact, the insurance regulator has taken over the management of

Sahara Life. In the general insurance space, stateowned Oriental
Insurance and National Insurance have poor solvency ratios of 122%
and 126% respectively. Policy buyers should opt for companies that
have maintained a good solvency ratio over the last few years.

3. Combined ratio

This indicates a general insurance company’s total outflow in terms of

operating expenses, commissions paid, and incurred claims and losses
on its net earned premium. Opt for companies with lower combined ratio
as it means that the expenses or losses of the company are lesser than
its premium revenue for that time period. “If the combined ratio is
greater than 100%, it usually means the cash outflow of the insurance
company is more than its earned premium, which is not a healthy
financial condition,” says Narula.

According to the latest data available, Cigna TTK and Kotak Mahindra
have one of the highest combined ratios at 167% and 147%,
respectively. However, do note that the higher combined ratio does not
mean the company is running at a loss as the ratio does not include
earnings from investments or investment income, say experts.

4. Incurred claims ratio

The ICR metric indicates a general insurer’s ability to pay claims. It is

calculated as the total value of all claims paid by the company divided
by the total amount of premium collected in a financial year. For
instance, an ICR of 85% implies that the company has spent `85 on
claims for every Rs 100 collected as premium.“An ideal ICR range
should be between 75 and 90%, which indicates a healthy settlement
of claims by the insurer against the premium collection,”

An ICR greater than 100% may not be a good indicator. “It shows that
a large part of the premium is used to cover actual risk transfer,” says
Verillaud. “But it is also a function of the company’s ability to avoid fraud
and select business,” he adds. A higher ICR can be seen in a new
company which may not have earned substantial premium in the initial
years of operation and faced a high rate of claims. The ICR does not
reflect the company’s process of claim settlement. A company with a
good ICR can have a long claim settlement process.

5. Commission expense ratio

This ratio tells us what is the outflow towards commissions from the
written premium during a particular period. It is important to keep a tab
on this ratio as it directly impacts the premium that you pay. “After a
threshold, the higher the commission expense ratio, the lower the
discount offered, leading to a higher premium paid,”

The lower the commission expense ratio, the better it is. Some
companies may also have negative commission ratios, like in the case
of HDFC Ergo, ICICI Lombard and others. However, that doesn’t mean
it is always good. “Negative commission expense ratio could be due to
various factors such businesses where direct deals are done and no
commission is paid like for crop insurance and mass health schemes
operated by the government in several states,”.In the life insurance
space, Reliance Life Insurance has the lowest commission expense
ratio at 0.05%, while Max Life and Star Union have commission ratio of
about 9%.

6. Claim settlement ratio

This has to be looked at before you buy any insurance policy. Claim
settlement ratio (CSR) indicates how many claims a company has
settled against the number of claims received. Higher the CSR, the
greater are the chances of settlement of a claim. It is also a measure of
the insurer’s reputation. Among life insurers, LIC has the highest claim
settlement ratio of 98.33%.
It means, out of every 100 claims received in a financial year, it has
settled 98. “It is prudent to cumulatively analyse the past few years’
claim settlement data to assess the trend for a particular insurer,”. You
must not ignore CSR especially before buying pure risk covers such as
term plans.

“For other genres such as protection-cum-investment products, do look

at other factors as well like returns, guaranteed benefits, cost, tenure,
portfolio, etc.,”. While all the ratios are important, none should not be
looked at in isolation. Along with these ratios, do consider all the
parameters such as quality of service, policy features, terms and
conditions, etc, before making a purchase decision

Reinsurance
Reinsurance is insurance that an insurance company purchases from another
insurance company to insulate itself (at least in part) from the risk of a major claims event.
With reinsurance, the company passes on ("cedes") some part of its own insurance
liabilities to the other insurance company. The company that purchases the reinsurance
policy is called a "ceding company" or "cedent" or "cedant" under most arrangements.
The company issuing the reinsurance policy is referred to as the "reinsurer". In the classic
case, reinsurance allows insurance companies to remain solvent after major claims
events, such as major disasters like hurricanes and wildfires. In addition to its basic role
in risk management, reinsurance is sometimes used to reduce the ceding company's
capital requirements, or for tax mitigation or other purposes.
The reinsurer may be either a specialist reinsurance company, which only undertakes
reinsurance business, or another insurance company. Insurance companies that accept
reinsurance refer to the business as 'assumed reinsurance'.
There are two basic methods of reinsurance:

1. Facultative Reinsurance, which is negotiated separately for each insurance

policy that is reinsured. Facultative reinsurance is normally purchased by ceding
companies for individual risks not covered, or insufficiently covered, by their
reinsurance treaties, for amounts in excess of the monetary limits of their
reinsurance treaties and for unusual risks. Underwriting expenses, and in
particular personnel costs, are higher for such business because each risk is
 individually underwritten and administered. However, as they can separately
evaluate each risk reinsured, the reinsurer's underwriter can price the contract
more accurately to reflect the risks involved. Ultimately, a facultative certificate is
issued by the reinsurance company to the ceding company reinsuring that one
policy.

2. Treaty Reinsurance means that the ceding company and the reinsurer negotiate
and execute a reinsurance contract under which the reinsurer covers the
specified share of all the insurance policies issued by the ceding company which
come within the scope of that contract. The reinsurance contract may obligate the
reinsurer to accept reinsurance of all contracts within the scope (known as
"obligatory" reinsurance), or it may allow the insurer to choose which risks it wants
to cede, with the reinsurer obligated to accept such risks (known as "facultative-
obligatory" or "fac oblig" reinsurance).
There are two main types of treaty reinsurance, proportional and non-proportional, which
are detailed below. Under proportional reinsurance, the reinsurer's share of the risk is
defined for each separate policy, while under non-proportional reinsurance the reinsurer's
liability is based on the aggregate claims incurred by the ceding office. In the past 30
years there has been a major shift from proportional to non-proportional reinsurance in
the property and casualty fields.

Functions
Almost all insurance companies have a reinsurance program. The ultimate goal of that
program is to reduce their exposure to loss by passing part of the risk of loss to a reinsurer
or a group of reinsurers.
Risk transfer
With reinsurance, the insurer can issue policies with higher limits than would otherwise
be allowed, thus being able to take on more risk because some of that risk is now
transferred to the re-insurer.
Income smoothing
Reinsurance can make an insurance company's results more predictable by absorbing
large losses. This is likely to reduce the amount of capital needed to provide coverage.
The risks are spread, with the reinsurer or reinsurers bearing some of the loss incurred
by the insurance company. The income smoothing arises because the losses of the
cedant are limited. This fosters stability in claim payouts and caps indemnification costs.
Surplus relief
Proportional Treaties (or "pro-rata" treaties) provide the cedent with "surplus relief";
surplus relief being the capacity to write more business and/or at larger limits.
Arbitrage
The insurance company may be motivated by arbitrage in purchasing reinsurance
coverage at a lower rate than they charge the insured for the underlying risk, whatever
the class of insurance.
In general, the reinsurer may be able to cover the risk at a lower premium than the insurer
because:

• The reinsurer may have some intrinsic cost advantage due to economies of scale or
some other efficiency.
• Reinsurers may operate under weaker regulation than their clients. This enables them
to use less capital to cover any risk, and to make less conservative assumptions when
valuing the risk.
• Reinsurers may operate under a more favourable tax regime than their clients.
• Reinsurers will often have better access to underwriting expertise and to claims
experience data, enabling them to assess the risk more accurately and reduce the
need for contingency margins in pricing the risk
• Even if the regulatory standards are the same, the reinsurer may be able to hold
smaller actuarial reserves than the cedant if it thinks the premiums charged by the
cedant are excessively conservative.
• The reinsurer may have a more diverse portfolio of assets and especially liabilities
than the cedant. This may create opportunities for hedging that the cedant could not
exploit alone. Depending on the regulations imposed on the reinsurer, this may mean
they can hold fewer assets to cover the risk.
• The reinsurer may have a greater risk appetite than the insurer.
Reinsurer's expertise
The insurance company may want to avail itself of the expertise of a reinsurer, or the
reinsurer's ability to set an appropriate premium, in regard to a specific (specialised) risk.
The reinsurer will also wish to apply this expertise to the underwriting in order to protect
their own interests. This is especially the case in Facultative Reinsurance.
Creating a manageable and profitable portfolio of insured risks
By choosing a particular type of reinsurance method, the insurance company may be able
to create a more balanced and homogeneous portfolio of insured risks. This would make
its results more predictable on a net basis (i.e. allowing for the reinsurance). This is
usually one of the objectives of reinsurance arrangements for the insurance companies.

Types of reinsurance
Proportional
Under proportional reinsurance, one or more reinsurers take a stated percentage share
of each policy that an insurer issues ("writes"). The reinsurer will then receive that stated
percentage of the premiums and will pay the stated percentage of claims. In addition, the
reinsurer will allow a "ceding commission" to the insurer to cover the costs incurred by
the ceding insurer (mainly acquisition and administration, as well as the expected profit
that the cedant is giving up).
The arrangement may be "quota share" or "surplus reinsurance" (also known as surplus
of line or variable quota share treaty) or a combination of the two. Under a quota share
arrangement, a fixed percentage (say 75%) of each insurance policy is reinsured. Under
a surplus share arrangement, the ceding company decides on a "retention limit": say
$100,000. The ceding company retains the full amount of each risk, up to a maximum of
$100,000 per policy or per risk, and the excess over this retention limit is reinsured.
The ceding company may seek a quota share arrangement for several reasons. First, it
may not have sufficient capital to prudently retain all of the business that it can sell. For
example, it may only be able to offer a total of $100 million in coverage, but by reinsuring
75% of it, it can sell four times as much, and retain some of the profits on the additional
business via the ceding commission.
The ceding company may seek surplus reinsurance to limit the losses it might incur from
a small number of large claims as a result of random fluctuations in experience. In a 9
line surplus treaty the reinsurer would then accept up to $900,000 (9 lines). So if the
insurance company issues a policy for $100,000, they would keep all of the premiums
and losses from that policy. If they issue a $200,000 policy, they would give (cede) half
of the premiums and losses to the reinsurer (1 line each). The maximum automatic
underwriting capacity of the cedant would be $1,000,000 in this example. Any policy
larger than this would require facultative reinsurance.
Non-proportional
Under non-proportional reinsurance the reinsurer only pays out if the total claims
suffered by the insurer in a given period exceed a stated amount, which is called the
"retention" or "priority". For instance the insurer may be prepared to accept a total loss up
to $1 million, and purchases a layer of reinsurance of $4 million in excess of this $1 million.
If a loss of $3 million were then to occur, the insurer would bear $1 million of the loss and
would recover $2 million from its reinsurer. In this example, the insurer also retains any
excess of loss over $5 million unless it has purchased a further excess layer of
reinsurance.
The main forms of non-proportional reinsurance are excess of loss and stop loss.
Excess of loss reinsurance can have three forms - "Per Risk XL" (Working XL), "Per
Occurrence or Per Event XL" (Catastrophe or Cat XL), and "Aggregate XL".
In per risk, the cedant's insurance policy limits are greater than the reinsurance retention.
For example, an insurance company might insure commercial property risks with policy
limits up to $10 million, and then buy per risk reinsurance of $5 million in excess of $5
million. In this case a loss of $6 million on that policy will result in the recovery of $1 million
from the reinsurer. These contracts usually contain event limits to prevent their misuse as
a substitute for Catastrophe XLs.
In catastrophe excess of loss, the cedant's retention is usually a multiple of the
underlying policy limits, and the reinsurance contract usually contains a two risk warranty
(i.e. they are designed to protect the cedant against catastrophic events that involve more
than one policy, usually very many policies). For example, an insurance company issues
homeowners' policies with limits of up to $500,000 and then buys catastrophe reinsurance
of $22,000,000 in excess of $3,000,000. In that case, the insurance company would only
recover from reinsurers in the event of multiple policy losses in one event (e.g., hurricane,
earthquake, flood).
Aggregate XL affords a frequency protection to the reinsured. For instance if the
company retains $1 million net any one vessel, $5 million annual aggregate limit in excess
of $5m annual aggregate deductible, the cover would equate to 5 total losses (or more
partial losses) in excess of 5 total losses (or more partial losses). Aggregate covers can
also be linked to the cedant's gross premium income during a 12-month period, with limit
and deductible expressed as percentages and amounts. Such covers are then known
as "stop loss" contracts.
Risks attaching basis
A basis under which reinsurance is provided for claims arising from policies commencing
during the period to which the reinsurance relates. The insurer knows there is coverage
during the whole policy period even if claims are only discovered or made later on.
All claims from cedant underlying policies inception during the period of the reinsurance
contract are covered even if they occur after the expiration date of the reinsurance
contract. Any claims from cedant underlying policies incepting outside the period of the
reinsurance contract are not covered even if they occur during the period of the
reinsurance contract.
Losses occurring basis
A Reinsurance treaty under which all claims occurring during the period of the contract,
irrespective of when the underlying policies incepted, are covered. Any losses occurring
after the contract expiration date are not covered.
As opposed to claims-made or risks attaching contracts. Insurance coverage is provided
for losses occurring in the defined period. This is the usual basis of cover for short tail
business.
Claims-made basis
A policy which covers all claims reported to an insurer within the policy period irrespective
of when they occurred.