Introduction to Insurance

Risk Management
• Insurance is a tool of risk management.
• . In insurance parlance it means uncertainty about
the financial loss. . In ordinary parlance risk means
exposure to danger .
.It deals with only pure risks & not speculative risks. In
pure risks there is no possibility of gain.
 Characteristics of Insurance Risk
• Risk must be fortuitous
• Loss caused by the risk must be capable of
financial assessment.
• It must not be illegal in nature
• It must not be against public policy.
• It must not be of catastrophic nature.
 Functions of Insurance
• It provides financial security to the individual.
• It provides assistance to business enterprises.
• It serves as basis of credit . Industry depend
on bank finance for their development
activities & banks require insurance policies as
collateral security.
• It provides funds for investment.
 Theory of rating
• Basic principle of insurance is the distribution of the losses of
the few over the many.
• Rate varies according to the degree of hazard
• Variation in degree of hazard makes it necessary to classify
insured property according to the hazards involved.
• Rate depends on loss experience. The frequency & severity of
risk
• Premium covers administrative costs, agency commission,
reserve for fluctuating costs & a margin of profits.
• Law of probability :Insurance practice believes in theory of
large numbers
 Origin
• The first “insurance policy” on record is the codex
Hammurbai circa 1780BC which one can read in
original at Louvre Museum in Paris, if one is nimble
with Sumerian legalese. It avers shippers whose
goods were lost would be compensated by the
state.
• Marine insurance is the oldest form of insurance.
Lyolds coffee shop gave an impetus to develop
marine insurance.
• Fire insurance was the next to develop. the Great
fire of London in1666 begat the first instance of
modern insurance
 Definition of Insurance
• Insurance is a method in which a large number
of people exposed in similar risks make
contribution to a common fund out of which
the losses suffered by the unfortunate few,
due to accidental events are made good.
• It is a contract based upon certain
fundamental principles of insurance.
 Insurance Terminology
• Insured: policy holder.
• Insurer :party who promises to pay the insurance
company
• Beneficiary: the party to whom the policy
proceeds will be paid in the event of a
contingency.
• Policy – document which contains the terms&
condition of the contract & issued by the insurer.
• Premium- amount paid as consideration to the
insurer by the insured.
 Terminology
• Sum insured-This the maximum liability of the
insurer towards the insured.
• Peril-it is an event that causes the loss like ,fire
explosion ,collision dishonesty
• Exposure –a measure of physical extent of the risk.
• Hazard-a condition that may create increase or
decrease the chances of loss from a given peril.
Hazards are physical & moral.
• Chances of loss- probability in a given number of
exposures.
Principles special to Insurance Contract

• Insurable interest
• Utmost good faith
• Indemnity
• Subrogation
• Warranties
• Proximate cause
• Assignment {marine policies}
 Insurable Interest
• It is the pecuniary interest whereby the policy
holder is benefited by the existence of the
subject matter &suffers a monetary loss by
damage or death of the subject matter.
Sentimental loss can not be covered
 Utmost Good Faith
• In insurance contract legal maxim Let the
buyer beware does not prevail. Insurance
contract is of absolute good faith where
parties to the contract have to disclose all the
material facts. Non disclosure makes the
contract null & void.
• Material facts are those facts which influence
an underwriter to accept or decline the risk.
 Indemnity
• The insurer undertakes to put the insured, in
the event of loss in the same position he
occupied immediately before the happening
of the event insured against.
• This principle restricts over or under
insurance, since the policy sum is limited to
the actual value of the subject matter. In case
of under insurance average clause comes into
effect.
 Subrogation
• It is the transfer of rights & remedies of the
insured to the insurer who has indemnified
the insured in respect of the loss.
• Rights could be arising out of contract or out
of salvage.
 Warranties
• It means a promissory warranty by which the
assured undertakes that a particular thing
shall or shall not be done or some condition
will be fulfilled.
• Express warranties are attached to the policy
while implied warranty is not written in the
policy.
 Proximate Cause
• It means the active efficient cause that sets in motion
a train of events which brings about a result, without
the intervention of any force started &working
actively from a new & independent source.
• It is not necessarily the cause that is nearest to the
damage either in time or place but the one that was
responsible for the loss.
• Losses only due to insured peril is payable.
 Assignment
• Only Marine & life insurance policies can be
assigned.
• Marine cargo policy is frequently endorsed in
blank& in effect becomes a quasi negotiable
instrument .It can be negotiated through a
bank.
 Mitigation of Losses
• It places a duty on the part of the insured to
make every effort as a man of ordinary
prudence to minimise
minimi the loss.
Distinction between Life & General Insurance

• In life it is human beings, while in general it is

property& liability.
• Life has the element of protection & investment.
• Duration of general insurance policies are maximum
for a year, unlike life policies.
• One can insure for any amount in life while in
General insurance policies the sum insured cannot be
more than the market value.
• Life policies have surrender value.
• Payment of premium is made in instalments ,while
in general it is lump sum payment.
Classification of General Insurance
• Personal insurance e.g. accident & health
insurance.
• Property insurance marine automobile fire
• Liability insurance third party product liability
directors liability, fidelity insurance
 Practice of Insurance
• Proposal – name occupation. address & details
of subject matter. It also contains the details of
past insurance, details of claims proposed sum
insured, date & signature.
• Depending on the policy of individual insurers,
the proposal has to be accepted by the agent
or officer.
 Underwriting of risks
• Information contained in the proposal forms the basis for
acceptance or rejection. This process is called underwriting.
• The underwriter decides the premium depending on the
classification of risks. He may also decide to impose an excess
or deductible or franchise.
• Earlier insurance companies were operating in a closed
market .Rated determined by the tariff advisory committee.
Now the insurers are free to quote their own rate.
• Policy is issued on receipt of premium. It is either in cash or
by cheque. In the last couple of years certain policies are
issued online by using credit cards.
 Standard Policy
• Heading-name &address of the insurer
• Recital clause-name &address of the insured,
details of premium.
• Peril clause-contains the details of the
proposed risks
• Condition clause-specifies the conditions
applicable to the clause
• Exception clause-explains circumstances
under which liability does not arise
 Continuation
• Schedule-This is the part printed in the policy
form where the proposer furnishes
• Signature clause-insurers authorised person
signs here
• Interpretation clause-states that the policy is
to be interpreted after reading it along with
the schedule attached to it.
 Claims Reserve
• Adequate claims reserve is necessary because:
• At any point of time the insurer must be able
to meet the claims obligations.
• Claims reserve includes claims reported
liability worked out but not settled
• Claims reported but liability not yet worked
out.
• Orphan claims & repudiated claims
 Solvency Margin
• It is Assets/liabilities. Assets includes fixed &
investment. Liability means claims. The solvency
margin as per IRDA requirement is 150 %
• Insurers need to know the incurred claim ratio
for each line of business to be able to quote the
correct premium.
• Incurred claims ratio is: claims paid+ claims
outstanding/premium
 Valuation of Liabilities
• As per IRDA regulation reserve for unexpired risks :
• Fire & miscellaneous business not less then 50%
• Marine cargo Not less than 50%
• Marine Hull 100% of the premium net reinsurance.
• IRDA has issued guidelines that an actuary has to
certify the method adopted & the adequacy of the
reserves.
 Co-insurance & Reinsurance.
• Co-insurance is sharing of risks amongst 2or
more insurers.
• Reinsurance: It is a process whereby one
entity takes part of the risk covered under a
policy issued by an insurer inconsideration of
premium paid.