PRINCIPLES & PRACTICE OF LIFE INSURANCE

Terminology of Insurance 1. Insurance 2. Insurer 3. Proposer 4. Insured 5. Life Assured 6. Proposal 7. Policy 8. Plan 9. Term 10. Sum Proposed

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11. Sum Assured 12. Premium 13. Mode 14. Lapsation 15. Revival 16. Date of Maturity 17. Participating Policies 18. Non Participating Policies 19. Days of Grace 20. Gross Premium

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21. Net Premium 22. Tabular Premium 23. Loading 24. FPR / Renewal Receipt 25. Notice for Renewal Premium 26. Nomination 27. Assignment 28. Actuaries 29. Mortality Tables / Morbidity Tables 30. Mortality Experience

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31. Policy Reserve 32. Underwriting 33. Alteration in Policy 34. Claim 35. IRDA 36. Risk Speculation 37. Group Insurance 38. Reinsurance 39. Survival Benefit 40. Annuity 41. Loan 42. Surrender

Life Insurance History 1. Life Insurance in modern form based on England 2. Oriental Life Insurance Company (1818) 3. 285 Companies by 1868 4. 174 Companies ceased to exist by 1870 on passing Insurance Act, 1870 by British Parliament 5. Mainly for Europeans 6. Indian lives treated sub-standard-Extra 15%0 to 20%0 7. First Indian Company Bombay Life Assurance Society in 1870
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8. Oriental Govt. Securities Life Assurance Company 1874 9. 44 Indian Company by 1914 10. 95 Indian Company by 1940 11. Insurance Act, 1938 was passed to regulate the sector 12. 209 insurers in 1948 with 713 crores business in force under 30,16,000 policies. Life Fund 150.39 crores 13. 250 Life Companies in 1956 14. Nationalization of life business in 1956

Life Insurance Industry -Major role in economy -Insurance Companies as business organizations -Structure Sole Proprietorship Partnership A Company/Corporation
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- Insurance Companies-part of financial service industry - Most important financial intermediaries - Make significant contribution to economic growth: as long-term investors as very large employers - Financial service industry fast changing

Life Insurance Company Operations - Forming and organizing Insurance Co. - Assessing Customer needs - Developing products - Distributing Products - Administering Products - Integration among functional areas - Ensuring Corporate Success

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Typical Life Insurer Functional Areas - Accounting - Legal - Compliance - HR - Information Systems - Marketing

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- Underwriting - Actuarial - Customer Service - Claims Administration - Investments

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Organizational Structure Functional Areas - Effective Organizational Structure - Responsibility - Authority - Line Authority - Staff Authority - Functional Authority - Accountability - Delegation

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Organizational Chart - Visual display of various job positions - Chain of command - Unity of command

Typical Ways Insurers organize work - By Function - By Product - By Terminology - By Profit Centre

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Concept of Risk - What is risk - Risk Types Pure Risk Outcome Loss No Loss Speculative Risk Outcome

Loss

Gain

No Loss

Only Pure Risks are insurable risks

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Peril Cause of Loss Hazard - a condition that increases the chance of loss arising from a given peril or under a given condition.

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Type of Hazards

Physical Hazard Moral Hazard Morale Hazard

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Risk Management - Identification of Risk - Assessment of Risk - Handling the Risk

Avoid Risk

Control Risk

Accept Risk

Transfer Risk

Last option leads us to Insurance

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Operational Risks Risks faced by insurer - Product Design and Pricing Risk - Underwriting Risk - Credit Risk - Market Risk - Operational Risk - Liquidity Risk - Legal or Regulatory Risk - Strategic Risk
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What is Insurance - Protection of economic value of assets - Contract between the life assured and the insurance company - A Social Security Untimely death Living too long Law of large numbers is fundamental to insurance

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What is Contract? Contract is an agreement enforceable at law between two or more parties Essentials of Contract - Offer acceptance - Consideration - Capacity to contract - Consensus-ad-idem - Legality of object - Intention to create legal relationship

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Distinguishing Features of Life Insurance Contract - Formal and Informal Contracts. - Bilateral and Unilateral Contracts - Commutative and Aleatory Contracts - Bargaining Contracts and Contracts of Adhesion - Contracts of Utmost Good Faith and contracts Governed by Caveat Emtor. - Existence of Insurable Interest

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Besides - Life Insurance Contracts are Valued Contracts and not contracts of Indemnity - Contracts are conditional upon: Performance of certain acts by the insured Subsistence of insurable interest

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Characteristics of Insurable Risks - The loss must occur by chance (fortuitous) - The loss must be definite - The loss must be significant - The loss must be predictable - The loss must not be catastrophic These form the foundation of business of insurance

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Essentials of Insurable Risks - Capable of financial measurement. - There must of sufficient number of similar risks - They must be pure and particular risks - Occurrence of event not against public policy - Premium must be reasonable - Existence of insurable interest

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Subject Matter of Insurance Any type of property or any event that may result in a loss of a legal right or creation of a legal liability. Subject Matter of Contract

Is the pecuniary interest of the insured in that subject of matter insurance.

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Insurable Interest - Defined

The Legal right to insure arising out of a financial relationship recognized under law, between the insured and the subject matter of insurance

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Purpose of Insurable Interest - To Prevent gambling - To reduce moral hazard - To measure the amount of insureds loss - Obliquity apply principle of indemnity to life insurance

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Insurance v/s Gambling Common Features : Promise of payment on happening of certain event.

Amount receivable not commensurate with amount paid.

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The differentiating features are:

Insurance - Risk already exists - No total loss. Entire group provides - Based on sound mathematical foundation

Gambling - Risk not existent. It is created - One gains at the cost of the other - It is highly speculative

Absence of insurable interest makes the contract a wagering agreement.

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LIFE INSURANCE

Life Insurance is called life insurance because it insures the future living of those whom you leave behind Life Insurance is the only way that people can make their wills before they make money. If you die, the bank Pays what you saved, the insurance co. pays what you meant to save

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He, who does not insure, gambles with greatest of all the values and if he loses, makes those dearest to him pay the price (Prof. Huebner)

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General Principles of Insurable Interest in Life Insurance - Person effecting insurance to have an insurable interest in the life to be assured. - Policy must clearly state on whose behalf it is effected. - Sum insured not to exceed the extent of the interest - Interest must subsist when the contract is made - Not necessary to prove interest at death

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Recognized Examples - Own Life - Unlimited - On Spouses - Life Unlimited - Surety Principal - Trustee Trust Property - Insurance company the lives assured - Employer - employee - Partner on the lives of other partners
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Utmost Good Faith Definition A voluntary, positive duty to disclose fully and accurately all facts material to the risk being proposed whether requested or not Duration of application of Principle Till the conclusion of the contract Breach of Principle

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Principle of Utmost Good Faith (UBERRIMAE FIDES) Principle of Utmost Good Faith is supported by three important legal doctrines: 1. Representations-Statements made by the applicant for insurance Legal Implication-Insurance Contract is voidable if - the representation is material - the representation is false and - it is relied on by the insurer A statement of opinion or belief must also be fraudulent Innocent mis-representation (that is unintentional) of a material fact, if relied on, also makes the contract voidable.
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2. Concealment is intentional failure of the applicant to reveal a material fact It is same as non-disclosure deliberately withholding material information Legal Implication-same as mis-representation Insurer to prove: - Concealed fact was known to the insured to be material - Insured intended to defraud the insurer

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3. Warranty a harsh legal doctrine Legal implication Any breach even if minor or not material allows the insurer to deny the claim However the legislation has sofened and modified the harsh common law doctrine of warranty. The statements made by the applicant for insurance are considered as representations.

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Declaration Under the Proposal Proposer for Life Insurance declares that: - statements in the proposal are true and complete - he has not withheld any information - he agrees and declares that these statements and the declaration shall be the basis of the contract - if any untrue averment be contained herein, the said contract shall be absolutely null & void
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he authorizes any doctor/hospital/employer to divulge any information concerning his health / employment to the insurer. he declares to inform any changes in his personal health / financial position / health of family members after submission of proposal and before issue of receipt. he also agrees that any omission to do so will render the contract invalid. Strict construction of term warranty is however subjected to the provisions of Section 45 of Insurance Act, 1938

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Section 45 of Insurance Act, 1938 Indisputability No policy of Life Insurance can be called into question by the insurer after expiry of two years from the date on which it was effected on the grounds of: - any misrepresentation - any non-disclosure Unless Insurer proves: - such statement was material - such statement was made fraudulently - that the policyholder knew that the statement was false
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Nomination As per Section 39 of the Insurance Act, 1938 the holder of a policy on his own Life may either at the time of taking the policy Or Any time during the term of the Policy Nominate a person or persons to whom the moneys secured by the policy shall be paid in the event of his death during the policy term

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Implications -A person having a policy on anothers life cannot nominate - If assignee is not the life assured S/he cannot nominate - There may be more than one nominee - Nomination can be incorporated in the text of the policy Or It can be made by an endorsement - The nominee becomes defunct on the maturity of Policy

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Nomination gives the nominee only the right to give a valid discharge Nominee does not get any right, title or interest in the policy before the claim arises

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- When nominee is minor - Multiple nominee - Change of nomination - Registration of nomination - Effect of Assignment on nomination

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Assignment Life Insurance Policy: - is a property - represents rights - forms part of estate of the assured. He can sell mortgage charge gift or bequeath the property under Transfer of Property Act.
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Features - assignments of Life Insurance policies regulated by Section 38 of Insurance Act 1938 - assignor must be major and competent to contract - should not be subject to legal disqualification - must have absolute right or interest in the policy - assignment must be supported by lawful consideration - must be in writing - assignors signature must be witnessed

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Features Continued - assignment can be made by an endorsement or on a separate deed - notice of assignment is necessary - date of receipt of notice by the insurer decides priority of claims - insurer has to give written acknowledgment of receipt of such notice and record the fact of assignment - assignment involving part of policy moneys is bad at law - assignment once made cannot be cancelled or altered by the assignor

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Types of Assignment - Absolute Assignment - Conditional Assignment Minor Assignee - A testamentary guardian should be appointed - Father of the Child by WILL can appoint a guardian/s - Appointer of guardian must affix his signatures to the appointment before at least two witnesses who must sign in the presence of each other. - No stamp duty requires - Guardian appointed for all assets vesting in the Child
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Developing New Products Need - Select target markets - Identify Insurance needs - Insurer develops new / modifies existing products to meet the recognized needs of target consumers - Insurers attempt to differentiate the same basic products by varying such factors as: - Price - Features - Benefits - Customer Service - Policy Values etc.
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Finished Products to meet following norms: - Products should be actuarially sound - Easy to administer - Compliant with applicable insurance laws - Consistent with the insurers strategic objectives

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Process of Product Development - Originates at the top management level - As part of strategic plans, sr. executives develop strategic marketing objectives for the next several years. Say Within next two years, the company will expand its Ulips portfolio With in next two years, the company will increase its term insurance market by developing a new tine of term products and so on. These objectives become the basis for the product development decisions.

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Three Step Process

Strategie Plans (Entire Company)

Strategie Marketing Objectives

Product Development Plans

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- Competition requires insurance companies to be flexible to respond quickly to marketing opportunities - Ability to quickly develop the product - Process requires involvement of virtually all functional areas - Actuarial- Cost & benefit structure, expected experience (mortality, lapse rates, investment performance, sales volume), tax implications, reinsurance, policy wording, break-even point, etc. - Marketing-Resolves issues related to products name, consumer appeal, its competitiveness & complexity, promotion etc.
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Sales Force: Develop and review the best sales approaches, its competitiveness, products pricing, compensation schedule for sales force Legal/Compliance: Whets the policy wording, compliance ensures that the policy from / provisions comply with applicable laws / regulations Investment: Advise on types of investments to provide adequate return, earnings needed, timing and amount of cash flows produced by product design Accounting: Development/introduction cost intensive, establish a separate budget, whether requires and special financial reporting procedures Administration: Underwriting, Customer Service, Policy Issue, Claims Staff finalize procedures to accommodate new product and plan for hiring/training staff Information Systems: Upgrading/modifying or enhancing the existing information systems to support the product, determining the hardware / Software requirements, modifying systems to process transactions, developing 55 new systems & mis.

Staff for Product Development - Large companies have formal product development department. - staffed with employees with diverse technical backgrounds - Others may form product development teams or adhoc product development committees - Important functionaries -The Project Sponsor -The Project Coordinator

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Phases of Development Process Idea Generation and Screening Comprehensive Business Analysis Technical Design Product Implementation Introduction and Sales Monitoring
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Feedback

Idea Generation & Screening - To generate ideas for product concepts - Quick evaluation for detailed examination - Sources of new product ideas: Policyholders Filed Personnel Product Development team members Company management/executives Market research reports of various environmental factors Competitors products and activities Consultants Business and Insurance Periodicals Changes in insurance laws or regulations
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Typical Screening Queries - Compatibility with Corporate Goals - Fulfilling need in the target market - Can modification off existing product address the same needs? - Whether company's current staff and systems be able to handle products technical and service requirements - Will the product generate new sales or displace sales of an existing product - Can the product be marketed through companys existing distribution systems etc.

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Comprehensive Business Analysis - Ideas accepted post screening are subjected to comprehensive business analysis - Product team develops initial product specifications - Examination of market potential - Assess the merits of the product idea in greater detail

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If comprehensive business analysis indicates good market potentialDevelopment team writes a Product Proposal/Initial Business Plan Contents of Product Proposal - Statement of Product Strategy & purpose - Product description - Cost benefit analysis - Market research data - List of key features - Preliminary pricing

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- Expected Sales Volume - Statement of regulatory and tax environment - Compliance considerations - Information system requirements - Underwriting and Claim Considerations - Policy Service and other administrative considerations - Probable distribution channels - & Selling strategies - Sales Projections
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- Product proposal may recommend test marketing or conducting a pilot program Test marketing is the process of selling a product in a limited number of locations to evaluate its success. This helps insurer to identify and correct any problems with the marketing or operations before full product rollout.

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Technical Design Approved products proceed to Technical Design phase which includes: - Drafting of policy - Product provisions - Pricing - Dividend Structures - Benefit & Commission structures - Underwriting guidelines In this phase, the product takes shape based on preliminary product specifications
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- This phase also involves most of the functional areas - Collaboration across functional areas is critical to successful technical design - Design team drafts a project schedule & budget - Many activities are undertaken concurrently to reduce the total design time - Final design document submitted to project sponsor for approval

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Implementation This phase includes establishing all structures & processes necessary to market the product involving: Designing promotional and training material Policy Filing Educating & training staff & filed force Launching information systems necessary to market and administer the product

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Product Introduction & Sales Monitoring - All necessary marketing and support elements to be in place before introduction - Sales monitoring to watch expected level of sales to ensure profitability - Comparisons yield potentially meaningful information - Launch team also gathers information to find product performance

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- Early Sales indicate effectiveness of new products marketing mix strategy - Marketers also monitor: the average premium size, policy face amount age-mix of insureds etc. to see that the same are on expected lines. If not, investigation becomes necessary.

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Incase product does not take off as expected, planners recommend corrective actions as: - Redesigning underwriting guidelines - Reintroducing the product to field force - Repackaging the sales Kit - Introducing a sales promotion program

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Characteristics of Effective Product Development - Precise Process - Excellent Communication - Skilled Management - Successful Assessment

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Pricing Aspects of Technical Design Role of the Actuary - Key members of design teams - Product Pricing has to be competitive to generate enough money to pay benefits - Calculation of policy reserves - Declaration of bonus

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- Conduct research on long-term and short-term trends of: Interest rates Inflation Mortality rates Company expenses Policy lapses Policy loans

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Pricing any insurance product-a four-step process

Managing pricing results Setting and Testing rates Making actuarial assumptions Outlining a pricing strategy
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Pricing Strategy - To achieve desired goals or pricing objectives - Objectives could be: desired level of profits earned by the product desired level of sales desired level of market share - Different pricing objectives for different products Pricing strategies are general guidelines to achieve pricing objectives Pricing objectives and strategies to be consistent with companys overall goals
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Whatever be companys pricing objectives, pricing strategy must ensure: - that premiums are adequate - that premiums are equitable - that premiums are reasonable In setting rates actuaries are subject to several competing influences.

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Determining Appropriate Distribution System - Multiple distribution channels - Choice dependent on many factors such as: Consumer buying preferences Consumer demographics Economic conditions Regulatory environment etc.
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Insurer's Choice of Channel is critical because it affects: the design of product the product pricing product promotion

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Insurers takes into account factors associated with distribution such as: costs associated with each system Degree of control the insurer intends to exercise over distribution Characteristics of the buyers in the insurers target markets Characteristics of the products the insurer sells Insurers business environment Characteristic of the insurer
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