Spring / February 2012 Master of Business Administration- MBA Semester 4 MF0018 Insurance and Risk Management- 4 Credits Assignment

Set- 1 (60 Marks) Q1. Discuss the guidelines for settlement of claims by Insurance company. Ans:- General guidelines for claims settlement There are some guidelines that must be followed while settling the claims. These guidelines are general in nature, and are not compiled to be the same always. Therefore, the claim settling authority uses discretion and records reasons. Appointment of surveyor The Insurance Act states that surveyor should survey claims above Rs. 20,000. The surveyors appointment should be based on the following points: The surveyor should have a valid license. The surveyor selected should consider the type of loss and nature of the claims. Depending on the situation, if technical expertise is required, a consultant having technical expertise assists the surveyor. One surveyor can be used for various jobs, if the surveyors compe tence is good for both.

Appointment of investigator Depending on circumstances, it is necessary to appoint an investigator for verifying the claim version of loss. The appointing letter of the investigator o mentions all the reference terms to perform. Q2 What is premium accounting and claim accounting? Ans:- Premium accounting For the businesses that have a fixed rate like that of fire insurance, motor insurance etc., the premium is charged based on the rate. Where as in businesses that do not have fixed rate, the premium is charged based on the guideline rates fixed by the respective technical departments of the insurers Head Office. According to section 64VB of the Insurance Act, 1938; the insurer cannot assume any risk unless the premium is received in advance. Apart from collection of premium by cash, cheque DD etc., the IRDA recently has permitted to collect the premium by other type of receipt like the credit card, debit card, E transfer etc. However, the same has to be collected before assumption of the risk. Service tax of 8% (presently) has to be collected on taxable premium and deposited with the respective excise authorities within prescribed time limit. If the same business is shared among more than one insurer as preferred by the policy holder, then the lead insurer has to collect the full premium along with service tax. But only one share of premium is accounted as premium and the balance is shown as the amount that is due to other co-insurers. As per the Stamp Act, a policy stamp has to be affixed and has to be accounted properly by debiting policy stamp expenses. A premium register is generated in the system on a daily basis. According to the IRDA Regulation, the premium has to be identified as the income over the contract period or the period of risk, whichever is suitable. Most of the general insurance policies are annual contracts and therefore the premium earned is worked out using 1/365 method. In the insurance policies in which the same is not practicable, it is worked out either using 1/24 or 1/12 method. According to the section 64V(1)(ii)(b) of the Insurance Act, 1938, the unearned premium is compared with the reserve for unexpired risks at the end of the financial year and if there is any shortfall it is accounted as unearned premium. Claims accounting: Claims outgo is the major outgo of an insurance company. The respective technical department does the processing of claims and the competent authority approves it. The accounts department does the payment and accounting of the claims. When claim is made for a policy that has more than one insurer the lead insurer pays the full amount of claims. Only own share of claim is accounted as claims cost and the balance is shown as amount recoverable from the other insurers (co-insurers). If a claim is made but not settled by the end of the financial year, then enough provision is made for such outstanding claims. By the end of the financial year the IRDA needs the actuarial valuation of the claims liability of an insurer that the appointed actuary makes and if there is any shortfall, it is provided as Incurred But Not Reported (IBNR) losses. Q.3 Critically evaluate the role of agents in insurance industry

Ans: Insurance agents are people who possess specialized knowledge in the field of finance. They play an important intermediary role between the customer and the insurance company. They are also known as insurance agents. Insurance agents can be either of the following: An individual A commercial business entity

Insurance Brokers: Well Informed and Unbiased : Insurance brokers or agents have a thorough knowledge and extensive experience in the insurance sector and are quite conversant with the contingent risks of life and their possible risk-management. They actually broker the insurance deal between the insurance company and the consumer and in lieu for this, extract a commission.

Insurance brokers are basically financial planners who acquire suitable insurance schemes in accordance with the needs of the insurance clients. Insurance brokers are not tied to any specific insurance companies but to multiple ones. So, there is little chance of them favoring insurances of any specific company/companies. An insurance broker is expected to perform extensive research while choosing the right insurance scheme/policy for the clients requirements without any prior biases.

Insurance Brokers: Serving a Large Client Base : The job of an insurance broker varies from firm-to-firm because in such cases, size does matter. In large business entities, they have a wide range of client base along with their wide range of requirements. However, it is impossible for a single broker to meet all these need. So, each broker in a big business house has categorical specializations according to the needs of the clients.

Insurance brokers in small business entities who have comparatively less businesses and a small number of clients are required to do all the associated work themselves.

Insurance Brokers: A Brief Job Description

An insurance broker is involved with the following work:

Acquisition of clients in need of insurance - Even if people don't have the demand for insurance in a specific field, brokers generate this demand through advertisements and other methods. This is known as business development.

Giving proper and adequate service to the client to maintain an ongoing relationship between the insurance company and the client - This is commonly known as servicing of client.

Renewing the policies of the existing clients in a hassle-free manner and with appropriate judgment and guidance.

Giving proper advice to clients in a customized way by gauging their risk profile coupled with extensive research.

Keeping abreast with new policies and schemes of the insurance companies so that they can choose the right policy for their clients personal needs.

Constantly remaining in touch with the clients and catering to their problems by gathering proper information and assessing their risk profile and requirements.

Collecting regular premiums paid by the clients. Processing the accounts of the clients

Q.4 Explain product design and development process in Insurance Industry Ans:- One main issue in the liberalised scenario of the insurance sector is in the area of developing new products. Constant activity in this area is very important for determining the overall profitability, and growth of any insurance company. The main reason for the liberalisation of the insurance sector is that the public sector was not practical in the process of developing products that satisfied the needs of the customer. Product development process is an important process for an insurance company. Developing insurance products include the following steps: Customer requirement analysis - The customer requirements are analyzed. In this phase, the information on the amount to be insured, total income, client biometrics such as age and family size, current purchasing habits, and so on are analysed. Business analysis - In the business analysis stage of product development, different departments of the insurance company have the following responsibilities. 1. 2. 3. 4. 5. 6. 7. Marketing department has to perform the market analysis to know the customer needs, and make a forecast for sales. Underwriting department has to prepare the manuals. Customer service department assesses the procedural requirements of the new products. Actuarial department develops the specifications of the product, and the resulting impact on product portfolios. Accounting department reports the financial requirements of the new product. Information systems department checks whether the insurer has enough operating systems to accommodate the new product or not. Investment department along with the actuarial department determines the investment needs for the new product.

Prototype development - In this step, a prototype of the product is designed and testing is carried out. Pricing the product - The pricing of the insurance products plays an important role in the design and development of the product. The price of the product should include the risk premium that the insurance company needs for accepting the policy, and the cost for distributing and administering the product to the client. The policy price that is charged to the client includes the risk premium and the cost of the distributor. Product release - This stage is called as the technical design stage. It involves creation of drafts for policy documents, commission structure, underwriting, forms and procedures and issue specifications. Before the product is released to the market the insurance companies have to take care of the following: 1. 2. 3. 4. 5. 6. Arrangement of training material. Designing promotional materials for the products. Releasing all the information that is needed to understand the product. Administration of the product after release. Complete policy filing, the process by which the organisation obtains all the regulatory approvals from all the applicable authorities that are needed to release the product. Educating and training the staff and the sales agents on administrative procedures and forms that are needed to sell administer and service the product.

The environment in which the insurer functions inspires its product development. This comprises of the legal framework which the insurance industry has to follow and social and economic factors. Any stage of product development has to be carried out in accordance with the customers interest. Since 1973, the Indian Insurance sector has directed the product development towards meeting this goal. In the last three decades, the General Insurance Company (GIC) together with its four subsidiaries has developed 150 new products, and has met its customer requirements. To control poverty and provide employment in the rural areas, the insurance sector developed the Integrated Rural Development Program (IRDP).

Q.5 What is facultative reinsurance and treaty reinsurance? Ans:- The two different types of reinsurances are: Facultative reinsurance. Treaty reinsurance.

Facultative reinsurance It is a type of reinsurance that is optional; it is a case-by-case method that is used when the ceding company receives an application for insurance that exceeds its retention limit. It is based on the individual agreements that help to cover specific losses. When any primary insurer wants reinsurance for a specific coverage, it enters the market, and bargains with different reinsurance companies for the amount of coverage and premium, looking out for a better value. According to most of the contracts, the reinsurer pays a ceding commission to the insurer to pay for purchase expenses. Before issuing the insurance policy the insurer looks for reinsurance and speaks to many reinsurers. The insurance company does not have any commitments to cede insurance and also the reinsurer has no commitments to accept the insurance. However if the insurance company find a reinsurer who is willing to take the insurance policy then they can enter into a contract. Facultative reinsurance is used when a huge amount of insurance is preferred and while considering a specific risk involved in an individual contract. Facultative reinsurance is the reinsurance of a part of a single policy or the entire policy after negotiating the terms and conditions. It reduces the risk exposure of the ceding company against a particular policy. Facultative reinsurance is not mandatory. Treaty reinsurance: Treaty reinsurance is one in which the primary insurer agrees to cede the insurance policy to the reinsurer and the reinsurer has to accept it. It includes a standing agreement with a specific reinsurer. The amount of insurance that the primary insurer sells and those policies where both the parties provide the service is specified in the contract. All the business that comes under the contract is automatically reinsured according to the conditions of the treaty. Treaty reinsurance needs the reinsurer to assume the entire responsibility of the ceding company or a part of it for some particular sections of the business with respect to the terms of the policy. The contract is a compulsory contract because according to the treaty the ceding company has to cede the business and the reinsurer is compelled to assume the business. It is a type of reinsurance that is preferred while considering the groups of homogenous risks. The treaty reinsurance provides many advantages to the primary insurance company. It is automatic, more reliable, and there is no delay in issuing the policy. It is also more cost effective as there is no need to shop around for reinsurers before writing the policy. The treaty reinsurance is not advantageous to the reinsurer. Usually the reinsure does not know about the individual applicant of the policy and has to depend on the underwriting judgment that the primary insurer gives. It may be so that the primary insurer can show bad business like more losses and get reinsured for it as the reinsurer does not know the real fact. The primary insurer may pay insufficient premium to the reinsurer. Therefore the reinsurer undergoes a loss if the risk selection of the primary insurer is not good and they charge insufficient rates. There are different types of treaty reinsurance arrangements which may differ according to the liability of the reinsurer. They are: Quotashare treaty. Surplusshare treaty. Excessofloss treaty. Reinsurance pool.

Q.6 What is the role of information technology in promoting insurance products.

Ans:-The rapid developments in information technology are posing serious challenges for insurance organisations. The use of information technology in insurance industry has an impact on the efficiency of the organisation as it reduces the operational costs. After many private players entered the insurance industry, the competition in the insurance sector has become immense. Information technology has helped in enhancing the insurance business. Insurance industry uses information technology for internal administration, accounting, financial management, reports, and so on. Indian insurance organisations are rapidly growing as technology-driven organisations, by replacing billions of files with folders of information. Insurers are heading towards the technological enhancements, in order to focus on the key areas of insurance business. The role of IT in different fields of insurance like: Actuarial investigation - Insurers depend on the rates of actuarial models to decide the quantity of risks which create loss. Insurance organisations are using new technologies, to analyse the claims and policyholders data for providing connection between risk characteristics and claims. Developments in technology allow actuaries to examine risks more precisely. Policy management - Most of the insurance policies are printed and conveyed to policy owners through mail every year. The method of creating documents is accomplished by technicians and typists. In most of the cases, this task is generally completed by using new technology. Customer data is accessed by computer systems, and maintained in huge folders, in order to renew each policy. To assemble the policies, complex software packages are used, and to print the policies high speed printers are utilised. Underwriting Underwriters can use knowledge based expert systems to make underwriting decisions. By using automated systems, underwriters can compare an individuals risk profile with their data and customise policies according to the individuals risk profile. Front end operations: CRM (Customer Relationship Management) packages are used to integrate the different functional processes of the insurance company and provide information to the personnel dealing with the front end operations. CRM facilitates easy retrieval of customer data. LIC is using CRM packages to handle its front end operations. Assignment Set- 2 (60 Marks) Q1. What is the procedure to determine the value of various investments? Answer: - According to this sub clause of the Regulations, a detailed procedure has been prescribed for determining value of various investments like real estate, debt securities and equity securities. Real estate Investment property The investment property can be valued at a historical cost after deducting the accumulated depreciation and impairment loss. Residual value is considered zero and no re-evaluation is allowed. The change in the carrying amount of the investment property shall be taken to Revaluation Reserve. The insurers can asses at every balance sheet date to check whether an impairment of the investment property has occurred. All impairment losses are recognised as expense in the Revenue/Profit and Loss account. Debt securities : - Debt securities that include the government securities and the redeemable preference share must be considered as held to maturity securities and can be measured at an historical cost that is subjected to amortisation. Equity securities and derivative instruments that are traded in active markets Limited equity securities and derivative instruments that are traded in active markets must be measured at a fair value according to the balance sheet date. The lowest of the last estimated closing price of the stock exchanges where securities are listed can be considered for estimating the fair value. The insurer can assess the balance sheet date to check whether an impairment of the listed equity security instruments has occurred. An active market means the market where the securities that are traded are homogenous, it has normal willing buyers and sellers and the prices are available publicly. Unrealised gains or losses that arise due to the change in the fair value of listed equity shares and derivative instruments can be considered under the heading Fair Value Change Account and reported in Profit or Loss account. The profit or loss on sale of such investments can include the accumulated changes of the fair value that was previously recognised under the heading Fair Value Change Account with respect to a particular security and recycled to Profit and Loss Account on actual sale of that listed security. The balance in Fair Value Change Account or any part thereof cannot be distributed as dividends. In addition to this, while declaring dividends, any debit balance in the Fair Value Change Account can be reduced from the profits or free reserves. Q.2 Explain chance of loss and degree of risk with examples.

Ans:- Chance of loss Loss is the injury or damage borne by the insured in consequence of the happening of one or more of the accidents or misfortunes against which the insurer, in consideration of the premium, has undertaken to assure the insured. Chance of loss is defined as the probability that an event that causes a loss will occur. The chance of loss is a result of two factors, namely peril and hazard. Hazards are further classified into the following four types: Physical hazard This is a danger likely to happen due to the physical characteristics of an object, which increases the chance of loss. Moral hazard It is an increase in the probability of loss due to dishonesty or character defects of an insured person. For example, Burning of unsold goods that are insured in order to increase the amount of claim is a moral hazard. Morale hazard It is an attitude of carelessness or indifference to losses, because the losses were insured. For example, careless acts like leaving a door unlocked which makes it easy for a burglar to enter, or leaving car keys in an unlocked car increase the chance of loss. Legal hazard It is the severity of loss which is increased because of the regulatory framework or the legal system. For example actions by government departments restricting the ability of insurers to withdraw due to poor underwriting results or a new environment law that alters the risk liability of an organisation.

Degree of risk Degree of risk refers to the intensity of objective risk, which is the amount of uncertainty in a given situation. It can be assessed by finding the difference between expected loss and actual loss. The formula used is Degree of risk =Difference between the expected and actual loss /expected loss Degree of risk is measured by the probability of adverse deviation. If the probability of the occurrence of an event is high, then greater is the likelihood of deviation from the outcome that is hoped for and greater the risk, as long as the probability of loss is less than one. In the case of exposures in large numbers, estimates are made based on the likelihood of the number of losses that will occur. With regard to aggregate exposures the degree of risk is not the probability of a single occurrence but it is the probability of an outcome which is different from that expected or predicted. Therefore insurance companies make predictions about the losses that are expected to occur and formulate a premium based on that. Q.3 Explain in detail Malhotra Committee recommendations. Ans:- Recommendations of Malhotra committee The major reforms in Indian industry started when the Malhotra committee was formed in 1993 headed by R. N. Malhotra. This was formed to analyse the Indian insurance industry and propose the future course of the industry. It modified the financial sector to design a system appropriate for the changing economical structures in India. The committee 6omputeriz the importance of insurance in financial systems and designed suitable insurance programs. The report submitted by the committee in 1994 is given below: Structure Government risk in the insurance Companies to be decreased to 50%. GIC must be taken under the government so that the GIC subsidiaries can work independently. Better freedom of operation for insurance companies.

Competition Private companies who have initial capital of Rs 1 billion must be permitted to work in the insurance industry. Companies should not use a single entity to deal with life and general Insurance. Foreign companies may be permitted to work in the Indian insurance industry only as partners of some domestic company. Postal life insurance must be permitted to work in the rural market. Every state must have only one state level life insurance company.

Regulatory body The Insurance Act must be changed. An Insurance Regulatory body must be formed. Insurance controller, which was a part of finance ministry, should be allowed to work independently.

Investments The mandatory investments given to government securities from the LIC Life Fund must be reduced from 75% to 50%. GIC and its subsidiaries should not be allowed to hold more than 5% in any company.

Customer service LIC must pay interest if it delays any payments beyond 30 days. All insurance companies should be encouraged to create unit linked pension plans. The insurance industry should be 7omputerized and the technologies must be updated. The insurance companies should promote and fulfil customer services. They should also extend the insurance coverage areas to various sectors.

The committee allowed only a limited competition in this sector as any failure on the part of new players could ruin the confidence of the public to associate with this industry. Every insurance company with an initial capital of Rs.100 crores can act as an independent company with economic motives. Since then there is a competition between the private and public sectors of insurance, the Insurance Regulatory and Development Authority Act, 1999 (IRDA Act) was formed to control, support and ensure a structured growth of the insurance industry. The private sector insurance companies were allowed to work along with the public sector, but had to follow the conditions given below: The company must be registered under the Companies Act, 1956. The total capital share by a foreign company held by itself or by through sub sectors of the company should not exceed 26% of the capital paid to the Indian insurance industry. The company should only provide life, general insurance or reinsurance. The company should have an initial paid capital of at least Rs.100 crores to provide life insurance. The company should have an initial paid capital of at least Rs.200 crores to provide reinsurance.

Later in 2008, further reforms were made by introducing the plan for Insurance (Laws) Amendment Bill 2008 and The LIC (Amendment) Bill 2009. These amendments influenced the Indian insurance industry in a huge way. The Insurance (Laws) Amendment Bill 2008 amended three other acts namely, Insurance Act 1938, General Insurance Business (Nationalisation) Act 1972 (GIBNA) and Insurance Regulatory and Development Authority Act 1999. Q4. List and explain briefly the organisations of insurers in India. Answer: - Organisations of Insurers: - The professionals involved in the insurance industry unite and organize themselves into different insurer organisations. In India, there are such organisations, which help the professionals to study and discuss their insurance related functions. These organisations are as given below: Insurance Regulatory and Development Association (IRDA) The Insurance Regulatory and Development Authority (IRDA) was formed in the year 1999, when the Indian parliament passed the IRDA bill. This organisation was developed to control and enhance the insurance industry standards. It aimed to protect Indian policyholders from different types of risks faced by them. Details of IRDA were discussed in previous units. Life Insurance Council The Life insurance council of India connects a variety of stakeholders in the insurance sector. It was formed in 1938 under the Insurance act. All the life insurance companies in India and some other committees are the members of this council. It was formed to coordinate the discussions between the Government, Regulatory Board and the Public. Some of its functions are listed below: Generate trust and confidence among the customers towards the insurance industry. Preserve the ethics of the insurance industry. Promote awareness about the benefits of life insurance. Conduct structured and effective discussions with Government, insurers and regulators. Conduct research in life insurance. Develop the life insurance sector.

Life Insurance Agents Federation of India (LIAFI) The Life Insurance Agents Federation of India (LIAFI) was formed on 2nd of October, 1964. This association was formed by Life Insurance Corporation of India with all its agents as the members. This non political federation addresses all the issues of the LIC agents in India. It has an Agents Consultative Forum meeting every six months where the LIAFI discusses these issues with the L.I.C. management. LIAFI promotes life insurance education through many institutions. It is concerned about the problems of the LIC policy holders also. It has a larger association i.e., Life Insurance Agents Association (LIAA) which connects all the LIC agents worldwide. Institute of Actuaries of India (IAI) The Institute of Actuaries of India (IAI), formerly known as the Actuarial Society of India (ASI) was shaped in September,1944 to organise and unite the actuarial professionals of India. It is the Indian equivalent of the Institute of Actuaries, London. It was formed to prepare and educate the actuaries of India. Its basic objectives are: Progress of the actuarial profession in India. Provide better opportunities for communication among professional actuaries. Develop actuarial research. Provide guidance for actuarial exams. Insurance Brokers Association of India (IBAI) Insurance Brokers Association of India (IBAI) was formed in 1956 under the Section 25 of the Companies Act. It is the only IRDA recognised insurance association of brokers in India. Only IRDA licensed brokers can be members of this association. The objectives of IBAI include: Promote interaction among brokers in India. Support and carry out interests of the IBAI members. Train and educate brokers. Q6. Explain different types of pricing objectives and methods. Answer: - Pricing Objective: -The marketing manager has to decide the objectives of pricing. Pricing objectives guides the decision makers to make price policies, to plan pricing strategies and to set actual prices. Pricing objectives are the overall goals that describe the role of price in the long-range plans of organisations. The pricing objectives guide the marketing manager in developing marketing plans. The insurance pricing has the following general objectives: 1) The rating system must create adequate premium income for the insurance corporation to be able to settle its claims and expenses; to provide a realistic return rate to the sponsors of funds and to finance continuing growth and expansion. 2) The rate must not be excessively high and allow unusual gains for the insurer. The rate must be justifiable. 3) The rates must not be discriminatory, in the sense that it must not be the same for heterogeneous buyers and must not be different for homogeneous buyers. Basic Pricing Methods: - The previous section described different types of pricing objectives. This section will describe the basic pricing methods. Basically, the pricing method gives us an idea on how to set the product price. The price value that is set for the product in the insurance company will change over time for many reasons. The company can decide to change the pricing method only when it finds out the customers needs and competition in the market. The pricing methods allow companies to think about their business, industry and customer. The vendors must understand the variety of options available along with the merits and demerits of the pricing methods, before selecting any one of them. They may also merge a number of pricing methods to suit their business and the type of products they sell. There are three basic pricing methods, which are: Cost-based pricing In this method, the price includes the cost of ingredients and cost of operating the business. This method is based on product cost subtotal, which includes the costs of operating the business such as costs of reserves, transportation, advertisement, rent and other costs involved in manufacturing the products. The cost-based pricing comprise of three methods, which are: Mark-up pricing Mark-up pricing includes a profit percentage with product cost. All businesses with many products use this type of pricing because it is simple to calculate. The profit level must be specified in terms of percentage. This is added to the production cost to set product price. This type of pricing is common in retail business as they have many types of products and purchases from many vendors. Cost-plus pricing In a cost-plus pricing, a percentage is added to an unknown product cost. This type of pricing works properly when production costs are not known. The only difference between markup and cost-plus pricing is that, in cost-plus pricing both consumer and vendor settle on the profit percentage and believe that product cost is unknown whereas in mark-up pricing product cost is known. The cost-plus pricing reduces your risk if you produce custom order products for other firms or individuals. Planned-profit pricing Planned profit pricing method enables you to earn a total profit for the business. It is different from the first two types of cost-based pricing. The first two pricing methods focus on per unit price. In planned-profit pricing, the product price is calculated by combining per unit costs with output projections. Planned-profit pricing uses break-even analysis to calculate product price. This method is suitable for manufacturing businesses since the manufacturer has the ability to increase or decrease the production depending upon the available demand or profit.