Introduction to Insurance

IRDA 50 Hours refreshers

IRDA 50 hours Training Nov08 For Internal Circulation Only

Agenda
In this session you will: Review the basic concepts of life insurance Show the different kinds of risks Distinguish between a risk and a peril Show the ways of managing risks Outline the need for insurance as a risk sharing device Outline the importance of insurance on society and economy

What is Insurance?
Insurance is related to the protection of the economic value of assets. Every asset is created through the efforts of the owner. As asset provides benefits to the owner and so it is valuable.

What is an asset?
Anything that has a monetary value

ASSET

Assets

These assets serve 2 main purposes

For Generating Income

Eg. Factory

For Comfort or Convenience

Eg. Your car or House

Assets have a specific lifespan

Assets have a specific lifespan, but it is possible that during the lifespan, the asset may:

Be Destroyed

Become nonfunctional

How is this likely to affect the owner of the asset? The destruction of the asset or the asset becoming non-functional will cause a loss to the owner.

Insurance is a promise to pay a certain sum to the owner or beneficiary of the asset, if such loss occurs.

Origins of Insurance
Insurance has existed in some form or the other since 3000 BC The origins can be traced to Lloyds Coffee House (London) Traders who gathered in Lloyds coffee house agreed to share losses to their goods being transported by ships. These losses occurred due to pirates or bad weather.

Origins of Insurance in India

Insurance in India began with the Oriental Life Insurance Co. Ltd. in. This was followed by the Bharat Insurance Co. in 1896 in Delhi, the Empire of India in 1897 in Mumbai, the United India in Chennai, the National, the National Indian and the Hindusthan Cooperative in Kolkata

Purpose & Need of Insurance

Assets are lost or damaged due to accidental occurrences called Perils
BREAKDOWNS FLOOD

OLD AGE

PERILS
ILLNESS LIGHTNING

EPIDEMIC

EARTHQUAKE

FIRE

Need and purpose of Insurance

The damage that are caused due to these perils is the Risk that the asset is exposed to.

Peril

Cannot be prevented

Damage/ Financial Loss The RISK can be insured against.

Asset

Purpose & Need of Insurance

Peril is the Risk that every asset is exposed to Peril cannot be prevented The financial loss due to the damage can be compensated by taking proper insurance Non financial loss is not covered by insurance

Insurance only compensates the monetary loss but cannot protect the asset against the Peril

Classification of Risks
Risks can be classified on many basis:
On the extent of damage likely to be caused Dynamic & Static Pure and Speculative Risks

Critical or Catastrophic
Those which may lead to the bankruptcy of the owner

Important

May upset family or business finances badly, requiring a lot of time to recover

DynamicCaused by perils which have national consequence, like inflation.

Static- caused by perils which have no consequence on the national economy, like a fire or theft.

Pure Risk Not under the control of the person.

Speculativewhich is somewhat under the control of the person. For exampleGambling.

Financial and Non-Financial

Fundamental and Particular risks

Fundamental Risks- are those that affect large populations. Eg- a train crash Particular Risksaffect only specific persons. Eg. A theft in a persons house.

Financial- which may result in financial loss.

Non- FinancialWhich may not result in a financial loss.

Insurance as a risk-sharing device

People exposed to the same risk come together. If any one member suffers a loss, the same will be shared by others The person who lost will be compensated for the loss.

Unfortunate Few

The loss of the unfortunate few is shared by the fortunate many.

Fortunate Many

Larger Impact reduced to smaller manageable impacts

Insurance is a business of sharing

If a Jumbo Jet with more than 350 passengers crashes, the loss would run into several crores of rupees. No airline would be able to bear such a loss. How can insurance help in mitigating the financial loss?

Risk Sharing

100 airline companies come together to form an insurance pool

Insurance Pool

Risk Sharing

Risk of 1 airline

Basic Principles
There are certain principles which make it possible for insurance to remain a fair arrangement: The occurrence has to be random The occurrence has to Accidental Not the deliberate creation of the Insured person.

How is the loss determined?

The manner in which the loss is to be shared can be determined beforehand. It would be proportional to the risk that each person in the group is exposed to. This would be indicative of the risk that he is exposed to. Each persons share may be collected from the members after the loss has occurred or in advance.

The Human Asset

Human life is also an income generating asset. This can also be affected by death or sickness or accidents leading to disability. Accidents may or may not happen, but death is certain. Only the time of death is not certain.

Insuring Human Life

There are two major concerns when it comes to insuring human life Living too Long Dying too soon Life Insurance helps to take care of both these concerns. The risks in the case of a human being are related to: Early death Living too long Disabilities Sickness, unemployment, etc.

Human Life Value (HLV)

The income generating capacity of a human being depends on his/ her skills:
manual professional problem solving entrepreneurial, etc

These skills are assets. The value of these assets can be measured by considering the amount of income that is generated by the person concerned.

HLV provides scientific ways to determine the asset value of the human life and therefore, the amount of life insurance required

Insurance of Intangibles
The concept of insurance has been extended beyond the coverage of tangible assets.
Exporters may suffer losses, due to defaults from importers from other countries. They may suffer heavily due to sudden changes in currency exchange rates, economic policies or political disturbances in the other country. Doctors and other professionals run the risk of being charged with negligence and subsequent liability for damages.

All these are dynamic risks and can be insured

Insurance of Intangibles
In some countries, the voice of a singer or the legs of a dancer may be insured. These are assets which produce the income and provide living to the owners. The object insured is intangible, but it is linked to a financial loss, and therefore becomes insurable. Indian non-life insurers are perhaps, considering the feasibility to insure such risks.

The business of insurance

Insurance companies are called the insurers. They bring together persons with common interests (sharing the same risks) Collect the share of contribution (called premium) Pay out compensation (called claims)

Insurer

Insured

Trustee
The insurer is in the position of a trustee because: It is managing the common fund, for and on behalf of the community of policyholders. It has to ensure that nobody is allowed to take undue advantage of the arrangement. The management of the insurance business requires care to prevent entry of people whose risks are not of the same kind. The management also has to ensure that no payments are made for claims on losses that are not accidental.

Underwriting of Risks
Underwriting includes assessing the risk- making an evaluation of how much is the exposure to risk. The premium to be charged depends on this assessment of the risk. Both underwriting and claim settlements have to be done with great care.

Reinsurance
Insurance companies are taking risks and have to pay claims as and when they occur. They cannot be sure when the claim will occur and how big the claim may be. Insurers normally are financially sound enough to be able to pay claims. However a catastrophic event like the tsunami or a hurricane may generate claims amounting to crores of rupees, which may put a very heavy strain on the reserves of the insurer. To protect themselves from such situations, they reinsure the risk with other insurers. If there is a claim, the burden is shared by the primary insurer and the reinsurers.

Classification of Insurance business- India

Insurance Business

Life Insurance

Non- Life Insurance

Covers death and disability

fire

Marine

Miscellaneous Covers liability, fidelity, motor, crop, personal accident, etc.

Covers Fire Related Risks

Covers transport related risks and ships

The law of large numbers

The premiums payable by an individual for insurance is based on expectations of the losses. These expectations are based on studies of occurrences in the past, and the use of statistical principles. In statistics there is a Law of Large Numbers. If a coin is tossed, the chance of it coming down as a head or tail is half. If the same coin is tossed 10 times, we cannot say for sure that heads will come 5 times. If the coin is tossed 1 million times, the number of heads will be closer to half a million. The variation will also be less as a percentage.

So, the larger the number of risks included in the pool, the better the chances that the assumptions regarding the probability of the risk will be accurate.

Business of Insurance
Insurance is nothing but the business of sharing of risk. It spreads the losses of an individual over the group of individuals who are exposed to similar risks. People who suffer loss get relief because the loss is made good. People who do not suffer the loss are relieved because they were spared the loss.

Insurance as a social security tool

When a breadwinner of the family dies, the income of the family dies as well. The economic condition of the family is thus affected. The family may be pushed into the lower strata of society, which creates a cost for the society. Insurance prevents this by stepping in and providing the family with the sum assured. It is the responsibility of the state to provide social security to its members. Insurance is one of the instruments provided for this purpose.

Thus, insurance helps provide social security.

Role of Insurance in Economic Development

It relieves the worry of the insured there by increasing the individuals productivity It mobilizes money from people's homes for nation building Acts as an Anti-inflationary Force-inflation happens when lot of spending takes place from income

Difference between Life Insurance and Hire purchase

In a hire purchase scheme, the product is purchased immediately, but payments are made in installments. In the event of death, the installments are not excused, they are still payable. In Life insurance, premium payments cease on death, there is nothing outstanding.

THERE IS NO FINANCIAL ARRANGEMENT THAT CAN EQUAL THE BENEFITS OF LIFE INSURANCE.

Advantages of Life Insurance

Life insurance has no competition from any other business. It offers quick settlement of claims in the event of death. It encourages financial discipline, as premiums are required to be paid regularly. Creditors cannot claim life insurance money. The money can be protected against attachment by courts. Marketability and liquidity are better. A life insurance policy is property and can be transferred or mortgaged. Loan can be taken against it.

A Recap
Insurance helps to reduce the adverse effects that perils have on assets. Insurance can be taken on assets and human life. Insurance is based on the concept of sharing of risks. Insurance is of two main types- Life Insurance and General Insurance It is based on the law of large numbers. It plays an important role in economic development and is a very good way to provide social security.

Thank You!