INSURANCE AND RISK MANAGEMENT : UNIT I

INSURANCE

INTRODUCTION:
Insurance is a legal agreement between two parties – the insurer and the insured, also known
as insurance coverage or insurance policy.
DEFINITION:
Insurance coverage can be defined as a contract in the form of a financial protection policy. This
policy covers the monetary risks of an individual due to unpredictable contingencies. The
insured is the policyholder whereas the insurer is the insurance-providing company/the
insurance carrier/the underwriter.

FEATURES OF INSURANCE
 It is a kind of risk management plan to use an insurance policy as a hedge against an
uncertain loss
 Insurance coverage does not mitigate the magnitude of loss one may face. It only assures
that the loss is shared and distributed among multiple people
 Various clients of an insurance company pool in their risks. Hence, they pay the
premiums together. So when one or a few incur a financial loss, the claimed money is
given out of this accumulated fund. This makes each client bear a nominal fee
 Insurance coverage can be provided for medical expenses, vehicle damage, property
loss/damage, etc. depending on the type of insurance
 Premium, policy limit, and deductible are the main components of an insurance coverage
policy. The policy buyer should check them thoroughly while buying an insurance policy

BENEFITS OF INSURANCE:
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1. Provides Protection

Insurance coverage does reduce the impact of loss that one bears in perilous situations. It
provides monetary reimbursement during financial crises. It not only protects the insured from
financial woes but also helps in checking mental stress arising out of it.

2. Provides Certainty

Insurance coverage provides a feeling of assurance to the policyholders. The insured pays a
small portion of the income for this certainty that will help in the future. So, there is a certainty
of handsome financial aid against the premium. It will protect the policy buyer when met with
accidents, hazards, or any vulnerability.

3. Risk Sharing

The very manner in which insurance policy functions makes it a cooperative scheme. An insurer
would be unable to pay from one’s capital. An insurance company pools in collective risks and
premiums because it covers a large number of risk-exposed people. The payout to the one who
claims insurance coverage is out of this fund. Thereby, all policyholders share the risk of the one
who actually suffered the loss.

4. Value of Risk

Insurance policy assesses the volume of risk and also anticipates the various causes of it. It
evaluates the amount for insurance coverage and the premium payment amounts on a risk value
basis. It safeguards against unforeseen events and consequential loss.

TYPES OF INSURANCE
Insurance policies can cover up medical expenses, vehicle damage, and loss in business or
accidents while traveling, etc. Life Insurance and General Insurance are the two major types of
insurance coverage.

1. Life Insurance

One can avail the life insurance in order to protect the family due to premature death or death
during the tenure of the policy. It provides the family with a lump sum when the insured person
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meets with an untimely death. This helps the grieving family to battle with financial struggles
that may occur in absence of a breadwinner.

2. General Insurance

Non-life insurance policies count as general insurance policies that include insurance coverages
for home, auto, education, etc. as mentioned below:

1. Health Insurance

You can buy health insurance for yourself or for your family that may include your spouse,
parents, siblings, and children. Some insurance companies have tie-ups with hospitals. So here
you can use your policy number to avail of cashless services in-network hospitals. In other
cases, you can claim reimbursement for hospitalization and treatments. Do check the coverage
of the type of disease/illness/health issue. Also, verify what are the type of cost are covered.

2. Education Insurance

Education insurance can also serve as an investment scheme. You pay premiums by the time
your child is 18 years of age or attains a certain age as decided by the insurance policy. You can
have a lump sum with imposed regulations that you can use for a child’s educational purposes
and not any other. Use an education calculator to estimate the amount you may need when the
child grows up. Such calculators are often provided by insurance companies or insurance
offering sites. The parent/ foster parent/legal guardian is the owner of the policy.

3. Home/Property Insurance

If man-made or natural calamities damage your valuable property then this policy can cover the
financial loss and provide monetary aid. Losses due to theft, floods, or any other mishaps can be
alleviated.

4. Motor/Auto/Vehicle Insurance

This is one of the mandatory policies in current times. First of all, it protects your valuable asset
against road accidents or any other damage and covers the losses. Secondly, the traffic rules
suggest you carry insurance papers while driving.

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 5. Travel Insurance

You may have seen that you get an option to buy insurance for minimal costs when booking a
rail or air ticket. Alternatively, you can buy travel insurance if you are a frequent flyer and
especially if you travel internationally. You can claim for baggage loss, trip cancellation, or delay
in flight.

Key Points Life Insurance General Insurance

It is an insurance contract, which covers It is an insurance that is not covered

Meaning
the life-risk of the person insured. under Life insurance.

Form It is a form of investment. It is a contract of indemnity.

Term of
It's a long term contract. It's a short term contract.
Contract.

Premium Premium has to be paid over the year. Premium has to be paid lump sum.

Loss is reimbursed, or liability will be

Insurance Insurable amount is paid either on the
repaid on the occurrence of uncertain
claim occurrence of the event, or on maturity.
event.

Insurable Must be present, at the time of contract

Must be present at the time of contract.
Interest. and loss both.

It can be done for any value based on The amount payable under life insurance
Policy Value.
the premium policy. is confined to the actual loss suffered.

IMPORTANCE OF INSURANCE
 Provides Safety and Security to Individuals and Businesses: Insurance provides financial
support and reduces uncertainties that individuals and businesses face at every step of their
lifecycles. It provides an ideal risk mitigation mechanism against events that can potentially
cause financial distress to individuals and businesses. ). For instance, with medical inflation
growing at approximately15% per annum, even simple medical procedures cost enough to

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 disturb a family’s well-calculated budget, but a Health Insurance would ensure financial security
for the family. In case of business insurance, financial compensation is provided against
financial loss due to fire, theft, mishaps related to marine activities, other accidents etc.

 Generates Long-term Financial Resources: The Insurance sector generates funds by way of
premiums from millions of policyholders. Due to the long-term nature of these funds, these are
invested in building long-term infrastructure assets (such as roads, ports, power plants, dams,
etc.) that are significant to nation-building. Employment opportunities are increased by big
investments leading to capital formation in the economy.

 Promotes Economic Growth: The Insurance sector makes a significant impact on the overall
economy by mobilizing domestic savings. Insurance turn accumulated capital into productive
investments. Insurance also enables mitigation of losses, financial stability and promotes trade
and commerce activities those results into sustainable economic growth and development. Thus,
insurance plays a crucial role in the sustainable growth of an economy.

 Provides Support to Families during Medical Emergencies: Well-being of family is important

for all and health of family members is the biggest concern for most. From elderly parents to
newborn children, medication and hospitalization play important role while ensuring well-being
of families. Rising medical treatment costs and soaring medicine prices are enough to drain your
savings if not well prepared. Anyone can fall victim to critical illnesses (such as heart attack,
stroke, cancer etc.) unexpectedly. And rising medical expense is of great concern. Medical
Insurance is a policy that protects individuals financially against different type of health risks.
With a Health Insurance policy, an insured gets financial support in case of medical emergency.

 Spreads Risk: Insurance facilitates moving of risk of loss from the insured to the insurer. The
basic principle of insurance is to spread risk among a large number of people. A large population
gets insurance policies and pay premium to the insurer. Whenever a loss occurs, it is
compensated out of corpus of funds collected from the millions of policyholders.

PRINCIPLES 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:

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 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 Proximal’ 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. The demolition of 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.

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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 Minimization
This principle says that as an owner, it is obligatory on the part of the insurer to take necessary
steps to minimize 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.
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 The Insurance Regulatory and Development Authority of India

The Insurance Regulatory and Development Authority of India were established on the
recommendations made by the Malhotra Committee in its report. This committee was headed by
Mr. R.N. Malhotra (retired Governor of the Reserve Bank of India). It was finally set up at New
Delhi on April 2000, but later on, it was shifted to Hyderabad, Telangana in 2001. The main
recommendation made by this committee was to allow the entrance of private sector companies
and foreign promoters and independent regulatory authority for the Insurance sector in India.

Objectives of IRDA
Following are the objectives of the IRDA:

 To carry forward the interests of the policyholders.

 To uphold the development of the Insurance industry.
 To ensure speedy resolution of claims.
 To prevent frauds and malpractices.
 To ensure fair conduct on the part of the financial market and transparency when
dealing with insurance.

Powers of IRDA / IRDA Functions

As per Section 14 of the Insurance Regulatory and Development of Authority Act, 1999 the
Authority has to ensure the regulation, development and promotion of the insurance business
and reinsurance business. Following are the other powers, duties and functions of the Authority:

 To avail the applicant a certificate of registration, renewal, modification, withdrawal,

suspension or cancellation of such registration.
 To protect the interests of the policy holders in cases related to assigning and
nomination of policy holders, understanding of insurance claims, insurable interests,
surrendering of the value of the policy and other terms and conditions of the insurance
contract.
 To specify the necessary qualifications, code of conduct and practical training for
intermediary or insurance intermediaries and agents.
 Explaining the required code of conduct to the surveyors and loss assessors.
 To ensure that the proficiency and efficiency of the conduct of the business of
insurance.
 To encourage and regulate the relationship between the professional organizations and
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 the insurance and reinsurance businesses.
 To levy charge to carry out the purpose of the Act.
 To call for the information, undertaking an inspection of, conducting enquiries and
investigations including the audit of insurers, intermediaries, insurance intermediaries
and other organizations connected with the insurance business.
 To control and regulate the rates, benefits, terms and conditions which are offered to
the insurer in respect of general insurance business that is not controlled and regulated
by the Tariff Advisory Committee under Section 64U of the Insurance Act of 1938 (4 of
1938).
 To specify the manner in which the books are to be maintained and the way in which
the statement of accounts shall be rendered by insurers and other insurance
companies.
 To maintain the investment funds by the insurance companies.
 To regulate the maintenance of margin solvency.
 Deciding the disputes between the insurers and the intermediaries of insurance
intermediaries.
 Administering the functioning of the Tariff Advisory Committee.
 To set down the percentage premium income of the insurer of finance schemes for
promoting and regulating the professional organizations.
 To protect the interests of the policyholders in cases related to assigning and
nomination of policyholders.
 To set out the percentage of life insurance business and general insurance business to
be taken forward by the insurer in the rural or social sector.
 Exercising other powers as may be prescribed.

Role of IRDA
The role of IRDA includes:

 To ensure interests and fair treatment to the insurance policy holders.

 To ensure the development of the insurance industry or sector and to impart benefits to
people and long-term funds to increase the growth of the economy.
 To promote and apply high standards of integrity, fair dealing, the ability of all those
companies that it administers.
 To ensure clarity and accuracy while contracting with the insurance policyholders. The
Authority has to ensure that true information has been rendered regarding products and
services. Also, to make policyholders aware of the different plans and policies that are being

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 implemented by the Insurance sector.
 To provide speedy trials in case of disputes and to prevent fraud or any other misconduct.
 To initiate new standards where they are needed or where there is lack of such standards.
 To promote self-regulation in daily activities with the necessary regulations

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