Introduction to Insurance

INTRODUCTION TO INSURANCE

 DEFINITION
 REQUIREMENTS OF AN INSURANCE RISK
 ISSUES IN INSURANCE
 TYPES OF INSURANCE
 BENEFITS OF INSURANCE TO SOCIETY
 COSTS OF INSURANCE
 INSURANCE FRAUD
Insurance
• Risks
Why? • Risk Averter

• Economic
Cooperation
• Sharing of Risk
What? • Synallagmatic
contract
• Aleatory Contract

• Pool of Funds
How? • Law of Large
Numbers
DEFINITION
Insurance is the pooling of fortuitous losses
by transfer of such risks to insurers, who
agree to indemnify insured for such
losses, to provide other pecuniary
benefits on their occurrence, or to render
services connected with the risk.
 DEFINITION EXPLAINED
 POOLING OF LOSSES
◦ Spreading of losses
◦ Law of large numbers
 ACCIDENTAL LOSSES
◦ Unforeseen and unexpected and happens due to
chance
 RISK TRANSFER
◦ Pure risk transferred from the insured to insurer
 INDEMNIFICATION
◦ Insured restored to approximately his previous
financial position
The Law of the large numbers
 Greater the number of events that have a given or
observed probability, the less the observed
frequency deviates from the expected frequency.
 A statistical axiom that states that
the larger the number of exposure units
independently exposed to loss, the greater the
probability that actual loss experience will equal
expected loss experience
 Chance of head and tails is 50/50.
 10 times coin tossed.
 Expected frequency 5/5
 Observed frequency will deviate from the
expected.
Example
 For example, an auto insurance company may record and study the
number of accidents caused by a very large population of 18-year-
old males.
 They will be able to predict how many 18-year-old males will cause
an accident in a given year.
 They will know that in a given year there is a high probability that
X number of 18-year-old males will cause an accident.
 Knowing this, they partially can determine how much an 18-year-
old male should pay for auto insurance (excluding other factors,
such as the type of vehicle, region where the driver resides, etc.)
 This is how the law of large numbers helps insurance providers
determine their rates, and why the rates vary from one type of
individual to another.
REQUIREMENTS OF AN INSURABLE
RISK
 Large number of exposure units
◦ Large number of units similar exposed to
same peril (s)
 Loss is accidental and unintentional
◦ Fortuitous and outside insured control
 Loss must be determinable and
measurable
◦ Loss must be definite in terms of cause, time,
place and amount.
 REQUIREMENTS OF AN INSURABLE
RISK..
 Loss should not be catastrophic
◦ Exposure units should not incur loss at the same
time
 The chance of loss must be calculable
◦ Must be able to calculate average frequency and
average severity of loss
 The premium must be economically feasible
◦ Insured must be able to afford to pay premium.
ISSUES IN INSURANCE
1. ADVERSE SELECTION
- Tendency of persons with a higher-than-
average chance of loss seek insurance at
average rates
2. INSURANCE vs. GAMBLING
- Pure risk and speculative risk
- Socially productive and unproductive
- Los of one is gain of other, win-win if no loss
to either parties in insurance.
3. INSURANCE vs. HEDGING
- Transferable risks and un transferable risks
- In insurance, Law of large numbers reduces
risk and in hedging, the transfer of risk and
no reduction takes place between parties.
TYPES OF INSURANCE
 Private Insurance
◦ Life Insurance
 Insurance against Death
 Insurance against Life
TYPES OF INSURANCE

◦ General Insurance
 Fire and allied perils (Fire accident,
riots and strikes, malicious damage,
earth quake, storm, tempest,
inundation)
 Marine (inland transit road, rail,
water; ocean cargo, voyage, marine
hull, ocean going vessels)
 Motor (own damage, act cover
motor vehicle act 1939, third party,
earth quake, fire cover)
TYPES OF INSURANCE
 Miscellaneous (breakdown,
health, burglary, personal
accident, loss of profits due to
fire, theft, accidents, contractor’
all risks, professional indemnity
insurance, workmen’s
compensation Act)
 Umbrella cover (multiple-line
insurance)
 Credit Insurance (Hire-
purchase guarantee policy)
BENEFITS OF INSURANCE TO THE
SOCIETY
 Indemnification for Loss
 Less Worry and Fear
 Source of Investment Funds
 Loss Prevention
 Enhancement of credit
COSTS OF INSURANCE TO
SOCIETY
 Cost of doing business
 Expense loading (above pure premium, covers all
expenses)
 Fraudulent Claims
 They increase the premium for the insured
 Inflated claims
 Legal claims
 General inflation
 Disability claims
TYPES OF FRAUD
 Creating fraudulent claim
 Overstating amount of loss
 Misrepresenting facts to receive payments
 Misrepresenting for lower premium or
policy
 Insider and internal fraud
Insurance Principles
In this Presentation
1. Legal Principles in Insurance Contracts
* Principle of Indemnity
* Principle of insurable interest
* Principle of Subrogation
* Principle of utmost good faith
2. Supporters of Utmost Good Faith
*Concept of representations,
concealment and warranty
3. Requirements of a Valid Insurance Contract
4. Difference between Insurance Contracts and
other contracts
PRINCIPLE OF INDEMNITY
1. Insurer agrees to pay no more than the
actual amount of loss (insured should not
profit from a loss)

2. The second purpose is to reduce moral

hazard. (dishonest insured might cause
deliberate loss)
Moral Hazard
 Moral hazard is the risk that a party to a transaction has
not entered into the contract in good faith, has
provided misleading information about its
assets, liabilities or credit capacity, or has an incentive to
take unusual risks in a desperate attempt to earn a
profit before the contract settles.
 Moral hazards can be present any time two parties
come into agreement with one another.
 Each party in a contract may have the opportunity to
gain from acting contrary to the principles laid out by
the agreement.
Concept of Actual cash value
 Replacement cost less depreciation
 Fair market value (price a willing buyer
will pay for a willing seller)
 Broad evidence rule means that the
determination of actual cash value should
include all relevant factors an expert
would use to determine the value of the
property.
Example
 A 3 year old car is completely
demolished. If a new car costs 200,000
and the car has a useful age of 8 years.
What is the amount of indemnification?
 Depreciation = replacement cost * age of
insured property / useful age of property
 Dep = 200,000*3/8 = 75,000
 Actual cash value = replacement cost –
depreciation = 125,000
PRINCIPLE OF INSURABLE INTEREST
 The insured must be in a position to lose
financially if a loss occurs, or to incur
some other kind of harm if the loss takes
place.
 To be legally enforceable, all insurance
contracts must be supported by an
insurable interest.
 It prevents gambling, reduce moral hazard
and measures insured’s loss in property
insurance.
Insurable interest Definition
Insurable interest is the legally recognized
relationship to the subject matter that gives
a person the right to effect an insurance on
it.
It is important to note that the relationship
must be a legal one.
A thief in possession of stolen goods, for
example, does not have the right to insure
them.
Its Essential Criteria
 For insurable interest to exist, the following criteria
must be satisfied:
 (a) there must be some person, property (thing), liability
or other legal right capable of being insured;
 (b) that person, thing etc. must be the subject matter of
the insurance;
 (c) the person wishing to have insurance must have the
legally recognized relationship to the subject matter, so
that financial loss may result to him if the insured event
happens.
How It Arises
 (a) Insurance of Persons: everyone has an insurable
interest in himself. One also has an insurable interest in
one's spouse. Further, one may insure one's child or ward
(in guardianship), if they are under 18 years of age.
 (b) Insurance of Property (physical things): the most
obvious example arises in ownership, but sometimes
property belonging to other people may also be insured.
For example, legal personal representatives (executors,
trustees, etc.) may insure property under their care.
How It Arises Contd..
 (c) Insurance of Liability (legal responsibility): everyone
facing potential legal liability for their acts or omissions
may effect insurance to cover this risk (sometimes
insurance is compulsory). for example, employers insure
against their liability arising from negligence etc. of their
employees.
PRINCIPLE OF INSURABLE INTEREST..
 Property or liability insurance
 Potential Legal liability (dry cleaning firm)
 Contractual right (business contract for
procuring from overseas)
 Insurable interest at the time of loss
 Life Insurance
 Own life
 Life of a close relative
 Pecuniary interest (partner, top sales
executive)
 Insurable interest at the time of
inception of the policy
Examples
 You have sold the house which you got
insured and now there is a fire accident.
Can you ask insurance company for
compensation?
 Can you insure your favorite Bollywood
star?
 Can you sell your insurance policy to
someone interested in benefitting after
your death?
Principle of Subrogation
 Substitution of the insurer in place of the
insured for the purpose of claiming
indemnity from a third person for a loss
covered by insurance.
 Prevents insured from collecting the same
amount twice.
 Holds guilty person responsible for loss
 Helps in holding down rates.
 Not applicable to life insurance.
 Definition

 Again in simple terms, subrogation

provides that an insurer who provides an
indemnity is entitled to take over and
use for his own benefit any recovery rights
the insured may possess against third
parties.
Example
 for example, that the insured is covered
by a motor insurance and his car is
damaged by the negligence of a building
contractor when faulty scaffolding falls on
to the car. The motor insurer must pay for
any insured damage to the car, but the
insured also has rights against the
contractor. These rights become
subrogated (transferred) to the motor
insurer.
Principle of Utmost good Faith
 A higher degree of honesty is imposed on
both parties to an insurance contract
than is imposed on parties to other
contracts.
 Three important legal doctrines:
representations, concealment and
warranty.
Utmost good Faith
 Utmost good faith means that each
party is under the positive duty of revealing
all vital information (called material
facts), whether the other party asks for
this information or no
SUPPORTERS OF PRINCIPLE OF
UTMOST GOOD FAITH
 Insurance contract is void at the
insurer’s option if the
representation is : material, false
and relied on by the insurer
 Concealment is intentional
failure of the applicant for
insurance to reveal a material fact to
the insurer.
SUPPORTERS OF PRINCIPLE OF
UTMOST GOOD FAITH ..
A warranty is a statement of fact
or a promise made by the
insured, which is part of the
insurance contract and must be true
if the insurer is to be liable under the
contract.
REQUIREMENTS OF A VALID
INSURANCE CONTRACT

1.Offer and acceptance

2. Consideration
3. Competent parties
4. Legal purpose
Development of Insurance &
Life Insurance
INSURANCE
 DEVELOPMENT OF INSURANCE
Indian scenario
Global
Recommendations of R.N.Malhotra Committee
Introduction to IRDA
Health Insurance
Insurance Intermediaries
Life Insurance
Players in Life Insurance
Life Insurance Products
Benefits of Life Insurance
Changing Trends in life Insurance
 DEVELOPMENT OF INSURANCE - GLOBAL

 4,500 years before - Babylonia Traders

 1347 - European Maritime Nations
(marine insurance accepted as a practice)
 1688 - Lloyd’s coffee House, London
 1693 - Mortality table by Edmund Haley
 1756 - Joseph Dodson, Reworked tables
and linked insurance premium with age.
 1756 - Oldest insurance company in
existence today was formed. Society for the
Equitable Assurance of lives & Survivorship
also known as ‘Old Equitable’.
DEVELOPMENT OF INSURANCE - INDIA
 Rig Veda - Yogakshema (well being)
 1000 BC- Community Insurance by Aryans
 1818 - England brought Insurance
 1818-1869- Insurance companies were set up.
 Oriental Insurance Co. – First in India,
objective is welfare of European Widows.
Charged 15-20% extra from Indians
(subnormal lives)
DEVELOPMENT OF INSURANCE - INDIA
 1912 - LIC Act, 1912.
 1938 - The Insurance Act, 1938
 1950s - 154 Indian Insurance Co.s, 16
Foreign Co.s, 75 provident societies.
 1956 - LIC (254 life companies)
 1973 - GIC
 1994 - R.N.Malhotra Committee
recommendations(1993 formation)
 August 2000 – Opening of the sector and
formation of IRDA
RECOMMENDATIONS OF R.N.MALHOTRA
COMMITTEE
 Reduce Govt. stake to 50%
 Rs. 100 crore capital for private
companies
 No Company to take life and general
both
 Foreign Co.s through collaborations
only
 Postal life insurance in rural areas
 LIC investment in G- Secs from 75%
to 50%
RECOMMENDATIONS OF R.N.MALHOTRA
COMMITTEE..

 GIC and subsidiaries not to invest

more than 5% in a company
 Promoters stake in private companies
26% to 40%
 Develop regulatory and prudential
norms & small man and rural areas not
neglected
 Technology up gradation in
nationalized insurance co.s
RECOMMENDATIONS OF R.N.MALHOTRA
COMMITTEE…
 As an interim measure, set up Controller of
Insurance.
 LIC & GIC ‘s exemptions from provisions of
Insurance Act, to be withdrawn.
 Set up Insurance regulatory authority
 State level cooperatives (one per state) for
transacting life insurance may be set up.
 GIC should cease to be a holding company and
become reinsurer.
 GIC stake acquired by Govt. maintain 50% in
subsidiaries.
IRDA
 Objectives : Policy holder protection and
healthy growth of insurance sector.
 Structure: Chairman + 4 whole time
members and 4 part-time members.
 Committees – Insurance Advisory,
Consumer advisory, surveyors and loss
assessors and tariff advisory.
 IRDA Act, 1999 – duties, powers and
functions of IRDA
 IRDA DUTIES, FUNCTIONS AND POWERS

1. Applicant registration
2. Protection of interest of policy
holders
3. Intermediary qualification,
experience & training
4. Code of conduct for surveyors
and loss assessors
IRDA DUTIES, FUNCTIONS AND
POWERS
5. Promote efficiency
6. Promote and regulate professional
organizations
7. Levying fees
8. Calling for information
9. Control & regulation of rates,
advantages, terms & conditions
IRDA DUTIES, FUNCTIONS AND POWERS..

10. Format & Inspection of books

and accounts
11. Regulation of investment of
funds
12. Regulation of management of
solvency
13. Adjudication of disputes between
insurer and insured
IRDA DUTIES, FUNCTIONS AND
POWERS..
14. Specifying the functions of Tariff advisory
functions
15. Specifying the percentage of life /
general business to be undertaken in rural
or social sector
16. Specifying the percentage of premium
income of the insurer to finance schemes
for promotion & regulation.
HEALTH INSURANCE
 3 types of insurance in India – Health,
Life and General.
 Schemes – medical, surgical or hospital
expense benefits
 No one offers Health as a stand alone
business
 Rs. 100 crore min. requirement
 Rider policies offer health care
 TPAs are distributors of Health
insurance products
 INTERMEDIARIES IN INSURANCE
 Agents (retailer of insurance products)
◦ 100 hr. training + test
◦ License granted by IRDA
 Surveyors / Loss Assessors (Back Draft)
◦ Assess loss / damage independently and
appointed by insurance companies.
◦ Licensed by IRDA
◦ Classification based on skills and
experience (A,B and C)
◦ Activities involve assessing cause of loss,
quantum of loss, liability of insurer, steps
insured to take to contain the loss
 INTERMEDIARIES IN INSURANCE..
Category Type of Min cap
 Brokers broker (Rs. Lacs)
◦ They are free to source best
product, price and service I Direct 50
general
◦ A broker provides technical Insurance
advice, advice on
development of insurance II Direct Life 50
market and law, providing insurance
acknowledgements, progress
reports and assist in
negotiation of claims. III Reinsurance 200
◦ Brokers to take professional
indemnity insurance IV Composite 250
 INTERMEDIARIES IN INSURANCE…
 TPAs – Third Party Administrators
 Regional TPAs
 Mediclaim Policies serviced by TPAs

Insurer Insured
1
3
Float funds

Information 2
about client Hospitals

TPA
Hospital claims settled

1-identity card +guide book, 2- ailment, 3- hospital information

 BANCASSURANCE
 20 Banks have tie-ups Country % of total sale
with public & private through Banc
assurance
sector insurance
companies. France 50%
 3 routes of participation
◦ Fee based insurance HK 25%
services
◦ Investment in
insurance company UK 18%
◦ Setting up joint venture
with a company Singapore 15%
 Other Countries
 LIFE INSURANCE

 Contract between assured and assurer

 Assured pays premium
 Assurer at the end of the period /
premature death pays amount
 Security to the assured and his family
 Insurance for premature death and
living to old age without financial
support
NEW ENTRANTS SINCE 2000
 Allianz bajaj Life Insurance
 Birla Sun Life
 HDFC Standard Life
 ICICI Prudential Life
 ING Vysya
 Max New York
 Metlife Insurance
 OM Kotak Mahindra
 SBI Life
 TATA AIG Life
 AMP Sanmar Life
 Dabur CGU Life Insurance (Now AVIVA Life)
 LIFE INSURANCE PRODUCTS
1. ENDOWMENT PLAN
1. Insurance Cover for a specific period
or term
2. Most popular world over
3. Perceived as savings instrument
4. Sum assured + bonus, on date of
maturity / event of death
2. MONEY BACK PLAN
1. Sum assured returned in lump sum
after definite intervals of time
2. Expensive just like endowment
 LIFE INSURANCE PRODUCTS..
3. WHOLE LIFE PLAN
1. Covers risk for whole life
2. Pays premium throughout life and on death money
handed over to family
4. TERM INSURANCE PLAN
1. Pure risk product
2. Like whole life but for defined periods
3. Small premium and high risk cover as no
payments made on survival.

Insurance Companies now offer money back options, pension

plans, unit linked insurance etc. with health insurance riders,
premium collected in lump sum or installments.
BENEFITS OF LIFE INSURANCE
 Safeguards the insured’s family
 Means of compulsory savings
 Source of income during old age
 Helps in meeting periodic financial
needs, education, marriage etc.
 Improves the life style of the insured
and family
 Takes care of disabilities and uncertain
future adversities
 Tax benefits under Section 88 of the IT
Act.
CHANGING TRENDS IN LIFE
INSURANCE
 Savings to risk
 Endowment & Money back to whole
life & term plans
 Risk cover is a requisite
 Policy size need to increase with age,
income and profile
 Provision of riders
 Product innovation
In Summary
 Insurance existed in prehistoric times also.
 After liberalization the sector opened and the
competition has increased.
 IRDA was formed in 1999 to develop and
regulate insurance market and also protect
policyholder interest.
 Life Insurance products focus on products for
premature death as well as longer life without
adequate financial support.
 The changing trends in this sector is affecting the
perceptions of the policy holders and is forcing
life insurance companies to develop and market
innovative products.
General Insurance
In this Presentation
Introduction to General Insurance
Products
Tariff Advisory Committee
Patterns of investments
Reinsurance
GIC & Distribution system
GENERAL INSURANCE -
INTRODUCTION
 Triton Insurance Co. Ltd., Calcutta, 1850.
 Nationalization in 1972, 107 insurers earlier.
 Formed 4 subsidiaries.
 GIC is reinsurer since November, 2000 under sec
101A of Insurance Act 1938
 4 subsidiaries Cap increased from Rs. 40 to Rs. 60
crores.
 General Insurance (19%) as compared to life (81%)
 Concentrated in urban areas.
 Lack of product innovation & lack of quality data on
risks and associated parameters.
 National Insurance Company LTd., The New India
Assurance Company Ltd., The Oriental Insurance
Company Ltd., The United India Assurance Company
Ltd., head offie at Kolkata, Mumbai, Delhi and Chennai.
 PRIVATE SECTOR PLAYERS
 Royal Sundaram Alliance Insurance
 Reliance General Insurance
 IFFCO Tokio General Insurance
 TATA AIG general Insurance
 Bajaj Allianz General Insurance
 ICICI Lombard General Insurance
 Cholamandalam General Insurance
 Export Credit Guarantee Corporation
 HDFC Chubb General Insurance
GENERAL INSURANCE PRODUCTS

 FIRE INSURANCE
◦ Building / flat,
◦ Furniture fixtures and other
contents
◦ Loss of profit
◦ Comprehensive covers fire, earth
quake, riots, floods, strikes and
malicious intent.
 GENERAL INSURANCE PRODUCTS

 MOTOR INSURANCE
◦ Cars, trucks, 2 wheelers and three
wheelers.
◦ Third party insurance,
comprehensive insurance.
◦ High cost of repairs and third party
claims
 GENERAL INSURANCE PRODUCTS..

 MARINE CARGO INSURANCE

◦ Cargo in transit
 MARINE HULL INSUANCE
◦ Inland vessels, sea going vessels, fishing and
scaling vessels, freight at risk, construction of
ships, voyage insurance of various vessels, ship
breaking, oil & energy, On shore and off shore,
construction risk (on shore, off shore)
 GENERAL INSURANCE PRODUCTS..

 NON TRADITIONAL / RURAL

INSURANCE
◦ Cattle / hens, water pump for agriculture, hut,
other live stock.
 TARIFF ADVISORY COMMITTEE

 Advisory body, Insurance Act, 1938

 Provides tariff for all lines except
marine cargo and personal lines.
 TAC controls and regulates rates,
advantages, terms and conditions
offered by insurers.
 TARIFF ADVISORY COMMITTEE..

 Probable Max. Loss (PML) Rs. 1054

crores or Insurance of Rs. 10,000
crores and above de-tariffed.
 Tariffs will be gradually phased out.
 Future role – collection & analysis of
data to help in pricing and rating of
insurance products.
 PATTERNS OF INVESTMENTS
 Central Govt. Securities – min 20%
 State Govt. Securities – min 30%
 Housing loans to state Govt. & loans for
purchase of fire fighting equipment – min 5%
 Investments in approved investments
 Infrastructure and social sector - min
10%
 Approved investments - max 55%
 PATTERNS OF INVESTMENTS..
 Approved Investments
◦ Secured loans, deposits, debentures,
bonds, debt instruments, shares and
preference shares with very strong
rating
◦ Deposits with banks
◦ Commercial Paper with strong rating
◦ Treasury bills
◦ Venture capital funds
REINSURANCE
1
Insurer Ceding company
Insured
2
3
4
Part or
full

Reinsurer
1 & 3. Risk and premium
2 & 4. Compensation on loss
Cession – reinsurance premium
Ceding co. – part retention and part transfer
Retention depends on – assets, investment income,
premiums, inflation, reinsurance market conditions etc.
 REASONS FOR USING REINSURACE

 Increase underwriting capacity

 Spread the risks
 Obtain advice and assistance
 Stabilize profits (peak losses are balanced)
 Protection against catastrophic risks
 Retire from a particular business /
territory
 TYPES OF REINSURANCE
 Facultative
◦ Reinsurer can accept or reject risk
presented by ceding company
 Treaty
◦ Ceding company is obliged to cede
and reinsurer is obliged to reinsure
within the scope of the agreement.
 Distribution System of GIC
 Head office – General managers (underwriting,
reinsurance, investments and other functions)
 Regional Office – Regional managers &
administrative support. (90 ROs)
 Divisional Office – Divisional manager &
administrative officers( underwriting, claims),
development officers and agents (1300 DOs)
 Branch office – branch manager, development
officers and agents.(2800 BOs)
In Summary
 General Insurance also opened in 2000
and number of players have entered this
market.
 The market is more urbanized and there
is a need to increase the reach.
 Tariff Advisory committee decides on the
premiums and other advantages offered
by insurers.
 The role of GIC has become more of a
reinsurer post liberalization of this sector.
Thank You