Insurance Basics

INTRODUCTION TO INSURANCE WHAT IS INSURANCE ? • Insurance Indemnifies Assets & Income. Every Asset has a value and generates Income to its Owner. There is a normally expected Life-time for the Asset during which time it is expected to perform. If the Asset gets lost earlier, being destroyed or made Non-functional through an Accident or other unfortunate event the Owner is Prejudiced. Insurance helps to reduce CONSEQUENCES of such Adverse Circumstances which are called Risks WHAT IS INSURANCE (Contd.) • Insurance is the SCIENCE OF SPREADING OF THE RISK. It is the system of spreading the losses of an Individual over a group of Individuals • Insurance is a Method of sharing of financial losses of a FEW from a COMMON FUND formed out of Contribution of the MANY who are equally exposed to the same loss WHAT IS INSURANCE Contd.. • What is UNCERTAIN for an Individual becomes a CERTAINTY for a Group. This is the basis of All Insurance Operations. Thus INSURANCE CONVERTS UNCERTAINTY TO CERTAINTY THE CONCEPT OF RISK • The object of Insurance is to provide protection against Financial Losses caused by Fortuitous Events. Thus Insurance is a protection against the Consequences of RISK. • RISK is defined for Insurance Purpose as the UNCERTAINTY OF A FINANCIAL LOSS. THE CONCEPT OF RISK • Element of RISK is Inherent in Life. Risk Means that there is a possibility of loss or damage. • To the common Man, Risk means Exposure to Danger. • In Insurance, the word Risk may be used interchangeably with Peril-which means the Event or Occurrence which CAUSES the Loss. THE CONCEPT OF RISK • In Insurance, the word Risk may also refer to the Property or Subject Matter of Insurance • The Subject Matter of Insurance can be Life, Limb, Property, Interest & Liability PURPOSE AND NEED OF INSURANCE • The Problem of Risk in Economic and Commercial Activities can be dealt with in FOUR WAYS. 1. Risk Avoidance 2. Risk Retention 3. Risk Transfer 4. Risk Minimisation Insurance is ONE of the most Import method of Risk Transfer PURPOSE AND NEED OF INSURANCE • Insurance spreads the Risk among the Community and the likely Big Impact on ONE is reduced to Smaller Manageable Impacts on ALL. Thus Insurance acts as a SHOCK ABSORBER. • A RISK OF TRADE is Insurable but a Trade Risk is not Insurable. In a Risk of Trade there can only be a LOSS whereas in a Trade Risk, there can be LOSS OR GAIN Risks of Trade are called PURE RISKS. PURPOSE AND NEED OF INSURANCE • Only Economic or Financial Losses can be compensated by Insurance. • The Business of Insurance is the Pooling of RISK and RESOURCES. It is a technique which provides for collection of small amounts of PREMIUM from many Individuals and Firms out of which losses suffered by the FEW are paid. Insurers act as TRUSTEES of the Common Pool. PURPOSE AND NEED OF INSURANCE • • • • INSURANCE ACTS AS A SOCIAL SECURITY Social Shock Absorber Solarium Fund for Hit & Run Victims of Road Accidents. PASS (Personal Accident & Social Security) scheme launched by the Govt. of India Crop Insurance Schemes and other Rural Insurance covers for the Rural Masses. PURPOSE AND NEED OF INSURANCE INSURANCE CONTRIBUTES TO NATIONAL WEALTH • It contributes to a vigorous Economy and National Productivity. LIC & GIC funds formed out of the savings of People are channelled into Investments for Economic Growth. HUDCO, IDBI, IFCI, use funds siphoned from Insurance Money for lending to Entrepreneurs. PURPOSE AND NEED OF INSURANCE • INSURANCE PROTECTS THE CAPITAL IN INDUSTRY - It helps release the same for further Expansion • Insurance is the HAND MADE to Commerce and Trade. THEORY AND PRACTICE OF RATING • RATE OF PREMIUM WILL BE DIRECTLY PROPORTIONAL TO THE DEGREE OF HAZARD • TO ASSESS VARIATIONS IN THE DEGREE OF HAZARD,RISKS MUST BE CLASSIFIED INTO HOMOGENEOUS CATEGORIES WITH SIMILARITY OF EXPOSURE • IN EACH SUB-CLASS,PAST LOSS EXPERIENCE WILL BE THE CRITERIA APPLIED TO DECIDE THE PREMIUM RATE DEGREE OF HAZARD • GREATER THE RISK,HIGHER WILL BE THE PREMIUM RATE • THE MORE PROBABLE THE LOSS AND THE MORE SEVERE IT IS LIKELY TO BE,THE HIGHER WILL BE THE PREMIUM RATE • Eg.—HAZARDOUS GOODS AND HAZARDOUS PROFESSIONS WILL ATTRACT A HIGHER PREMIUM AS COMPARED TO NON-HAZARDOUS GOODS OR PROFESSIONS CLASSIFICATION OF RISKS • RATES OF PREMIUM SHOULD BE EQUITABLE AND FAIR AS BETWEEN DIFFERENT INDIVIDUAL INSUREDS • HENCE,A SYSTEM OF CLASSIFICATION OF RISKS INTO BROAD CATEGORIES IS ADOPTED. • THESE MAY BE FURTHER CLASSIFED INTO GROUPS AND SUB-GROUPS DEPENDING UPON THE HAZARDS INVOLVED AND THEIR SIMILARITY • Eg.CLASSIFICATION IN MOTOR/FIRE/W.C. PAST LOSS EXPERIENCE • IN EACH SUB-GROUP,THE PAST LOSS EXPERIENCE IS WORKED OUT AND FUTURE FORECASTS ARE MADE ON THIS BASIS • FORMULA FOR PURE PREMIUM L X100 L=SUM TOTAL OF LOSSES ---------V V=SUM TOTAL OF VALUES • PURE PREMIUM WILL BE JUST SUFFICIENT TO PAY THE LOSSES,HENCE LOADING IS REQUIRED FOR OTHER FACTORS LIKE-COMMISSIONS/MANAGEMENT EXPENSES/RESERVES FOR UNEXPIRED RISKS/PROVISION FOR UNEXPECTED HEAVY LOSSES/MARGIN OF PROFITS • FINAL RATE=LOADED RATE LAW OF LARGE NUMBERS • LAW OF LARGE NUMBERS IS FUNDAMENTAL TO ALL INSURANCE OPERATIONS • THIS IS A MATHEMATICAL PRINCIPAL AND STIPULATES THAT• The greater the number of cases studied and longer the duration of study, the more accurate will be the future forecast … PROVIDED THE CONDITIONS REMAIN THE SAME • AS THE No. OF CASES INCREASES,THE GAP BETWEEN THE ESTIMATED FUTURE LOSSES AND ACTUAL FUTURE LOSSES BECOMES LESS AND LESS • APPLYING THIS PRINCIPLE,INSURERS ARE ABLE TO ANTICIPATE FUTURE LOSSES MORE ACCURATELY AND FIX PREMIUM RATES ACCORDINGLY (SUBJECT TO TREND ADJUSTMENTS LEGISLATIVE AN REGULATORY MATTERS MERCHANT SHIPPING ACT-1958 COGSA-1925 MARINE INSURANCE ACT-1963 BILL OF LADING ACT-1963 INDIAN CARRIERS ACT-1865 INDIAN RAILWAYS ACT-1890 INDIAN POST OFFICE ACT--1898 W.C.ACT 1923 INSURANCE OPERATIONS ARE DIRECTLY AFFECTED BY IRDA-ACT—2000 INSURANCE ACT—1938 LIBNA—1956---LIFE OPERATIONS GIBNA—1972---NON-LIFE OPERATIONS M.V.ACT1988 C.P.ACT 1986 PLI ACT-1991 SALE OF GOODS ACT-1930 INDIAN STAMP ACT FERA-1973 REINSURANCE The ultimate underwriting objectives are • The production of large volume of premium income sufficient to maintain and progressively enlarge the insurers business. • The earning of a reasonable profit on the operations • The important underwriting factors are - Well spread out and Large Volume of business - Retention limits - Reinsurance of the surplus • Reinsurance is insurance of insurance . The ceding company retains a part of the risk / premium and cedes the balance to the reinsurer. There are two main methods of reinsurance a) Facultative b) Treaty REINSURANCE…contd • Facultative Reinsurance : In facultative reinsurance, the choice / faculty to accept or reject a risk is with the reinsurer. This method involves considerable amount of clerical work and ceding company cannot go on risk unless confirmation is received from the reinsurer about the acceptance of the risk and premium rate / terms conditions of insurance. REINSURANCE …. Contd. • Treaty :There are two types of treaty reinsurance – Proportional and Non-proportional. • Proportional : Proportional treaties are risk based & can be divided into – • a) Quota Share b) Surplus c) Pools d) Auto Facultative (Facultative obligatory) • Non Proportional : Non proportional treaties are not risk based but loss based. The insurer limits the amount of loss as per the underlying limit and the reinsurer agrees to pay the loss over and above the underlying limit. Examples of non proportional treaties are a) Excess of loss – for event losses b) Stop loss – for portfolio losses REINSURANCE…contd • Retrocession---Reinsurance of a Reinsured Risk • Purpose of Reinsurance— • • • • • • • Creation of additional capacity Achieves Global Spread of risk Best protection against Catastrophic Risks Facilitates acceptance of Mega/Jumbo Risks Works on the Principle of: No Cession without Retention Follow the Fortune of the Ceding Company GENERAL INSURANCE—BUSINESS PORTFOLIO • The Major Portfolios are as follows: • • • • • • • Fire Insurance—20% Marine Insurance---15% Motor Insurance---35% Engineering Insurance—10% Aviation---5% Miscellaneous Traditional—10% Miscellaneous Non-Traditional—5%