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									   Risk Management

       Meaning of Risk

       “There is nothing certain in the world except death and tax: yet death and tax are uncertain as
   no body knows when he will die or when the tax will change” – Benjamin Franklin

       We live in a risky world. Forces that threaten our Financial well being constantly surround us
   and are largely outside our direct control. Some people experience the pre-mature death of their
   near and dear ones, loss and destruction of their property from both manmade and natural

        Majority of Insurance authors have defined Risk in terms of uncertainty. Based on this theory,
   risk is defined as “Uncertainty concerning the occurrence of a loss.” Risk therefore arises out of
   uncertainty. It is measured in terms of the likelihood of it happening and, the consequences that
   will arise if it does happen. Chance of loss is the likelihood of the occurrence of an event causing
   a loss. It is the relative frequency of occurrence of an event resulting in loss. It is calculated as the
   number of expected losses to a total number of actual losses that actually occur.
        Chances of loss = Number of likely losses / Total number of possible losses.

       From the above discussion, we can conclude that Risk has the following characteristics:-

         Risk is unpredictable.
         Risk is uncertainty about the future.
         Risk is the possibility of an adverse deviation from expected outcomes.
         Risk is an outcome that is not favorable.

   All above characteristics of risk highlight one element, namely, the presence of uncertainty with
   regard to the outcome. Uncertainty is subjective as it depends on the individual’s perception of
   risks. It is obvious that no two persons exposed to the same risk will perceive it in the same
   manner. The level of uncertainty will also depend on the information available on the risk.

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   Risk Definition
   Risk is the possibility of harm, injury, loss, danger, or destruction.

   Basic Categories of Risk

    Static                                                                  Fundamental
    and                                                                     and
    Dynamic Risk                                                            Particular Risk


   Financial                                                                Pure
   and                                                                      and
   Non-financial Risk                                                       Speculative Risk

                                     Objective Risk

   An evolutionary process of Pure Risk

       From the beginning of civilization, human have faced possibility of loss. The ancestors faced
   enormous amount of risk from their own habital. The earliest perils giving rise to risk were the
   nature and the predators (both beasts as well as human predators). The human slowly adapted to
   the system, and created the machinery called society. The society created shelter and collectively
   blocked the ancient risks but in effect brought in new and more complex set of risks. Thus as new
   ways of risk control are discovered; new risks appear, often as a result of progress.

      The era of industrialization saw steam energy replacing muscle muscle power. Large machines
   were developed to boost the production process. However, the early machines were highly
   hazardous and explosions were common destroying human life. Like steam (mechanical energy).

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   The introduction of electrical energy and more sophisticated nuclear energy brought with it new
   sources of risk.
        Society Information Technology (IT) revolution has brought its own share of risk inventory.
   Terms which were unheard of to our older generation are floating around. A hacker can sweep an
   entire bank / or steal secret information worth hundreds of crores of rupees. Without firing a single
   gunshot. These information pirates are more dangerous than our physical dacoits: as their cryptic
   method of operations cannot be understood with traditional policing methods. These thieves not
   only steal assets but sometimes the whole identity of an individual and then leverage the
   information to gain access to his accounts at bank, credit – cards or brokerages.

       The net effect of the above discussion is the multiplication of risks faced by today’s society.
   The ancient perils from natural disaster (Tsunami) co-habits with the nuclear age peril like
   erstwhile. Soviet Union’s Chernobyl Plant accident. It is of no help to know that society is also
   regularly attacked by terrorist activity.

       What we have discussed so far are only collective risks. However, there are other risks, which
   affect an individual or firm at a micro level. For a person or firm, who suffers from such peril: the
   consequences are no less destructive.

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   Risk and Insurance (LIFE & GENERAL INSURANCE)

       Basic Characteristics of Insurance Pooling of Losses.

        Insurance is the most common method used for transferring risks. It shifts the risk from an
   individual to a group. It also provides a means for paying for losses. Insurance provides an
   important means of preventing risk from interfering with a client’s achieving financial objectives.

       How Insurance works?

      To understand the concept of insurance, let us imagine a small town with 100 houses. The
   town is located in an area where storms of great severity occur frequently.

        Each family in the town faces the risk that a storm will destroy their house completely. If the
   house is destroyed, the family will have to spend Rs. 50,000/- to reconstruct the house. However,
   at the same time, it is unlikely that a storm will destroy all the 100 houses simultaneously.

       Let’s suppose all the citizens of the town agree to share the losses (if and when they occur)
   equally, so that no single family will be forced to bear the entire loss of Rs. 50,000/-. This means
   that whenever any house is destroyed, every family will pay a sum of Rs.500/- to the affected
   family to rebuild their house. While the cost of Rs. 50,000/- would have been crippling for a single
   family, the expense of Rs.500/- is easily affordable.

      Thus the risk is transferred from a single family to the entire village and the loss (when it
   occurs) is shared.

      In our example, the risk sharing and risk transfer is dependent is dependent upon the town
   people successfully agreeing to bear the expenses of reconstruction of houses. In the real world it
   would be very difficult to arrive at such an agreement and even more difficult to enforce it, because:

               Some people might not agree to be part of such an agreement, making it difficult to be
               part of such an agreement, making it difficult to reach the large numbers of
               participants, necessary for the scheme to work.
               Some people might not pay their share, even though they were part of the agreement.

               Someone would need to perform the task of collecting money from the people and
               providing it to the affected family.

       In the real world, insurance companies act as facilitators and remove the obstacles to risk
   transfer and risk sharing. They perform the functions of making agreements, collecting money,
   calculating losses and providing payments to affected persons.

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       Insurance is defined as an economic device whereby the individual can substitute a small
   definite cost (the premium) for a large uncertain financial loss (the risk).

       Law of large numbers: The frequency with which an event occurs reflects the actual
   probability of the event occurring more closely if the number of cases involved is larger.

        Insurable Risks
        Insurance thus appears to be an elegant solution for the transfer of all risks. With relative ease
   an individual can be free of all risks that can cause financial insecurity. However, not all risks are
   insurable. Insurance companies do not cover speculative risks. They cannot be expected to absorb
   risk that a person creates willfully in expectation of a profit. Essentially, commercially insurable
   risks typically share seven common characteristics.

               A large number of homogeneous exposure units

         The vast majority of insurance policies are provided for individual members of very large
   classes. The existence of a large number of homogeneous exposure units allow insurers to benefit
   from the so- called “law of large numbers,” which, in effect, states that as the number of exposure
   units increases, the actual results are increasingly likely to become close to expected results.
   There are exceptions to this criterion such as taking out an insurance policy for a soccer star’s feet
   or insurance for a heritage property for which there are no ‘homogeneous’ exposure units. Despite
   failing on this criterion, many exposures like these are generally considered to be insurable.

               The Loss must be definite

        The event that gives rise to the loss that is subject to insurance should, at least in principle,
   take place at a known cause. The classic example is death of an insured on a life insurance policy.
   Fire, automobile accidents, and worker injuries may all easily meet this criterion. Other types of
   losses may only be definite in theory. Occupational disease, for instance, may involve prolonged
   exposure to injurious conditions where no specific time, place or cause is identifiable. Ideally, the
   time, place and cause of a loss should be clear enough, so that a reasonable person, with
   sufficient information, could objectively verify all three elements.

               The loss should not be Large / Catastrophic

        The size of the loss must be meaningful from the perspective of the insured. Insurance
   premiums need to cover both the expected cost of losses, plus the cost of issuing and
   administering the policy, adjusting losses, and supplying the capital needed to reasonably assure
   that the insurer will be able to pay claims. For small losses, these latter costs may be several times
   the size of the expected cost of losses. There is little point in paying such costs unless the
   protection offered has real value to a buyer.

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               The loss must be Accidental / Fortuitous

       The event that constitutes the trigger of a claim, should be fortuitous, or at least outside the
   control of the beneficiary of the insurance. The loss should be ‘pure,’ in the sense that it results
   from an event for which there is only the opportunity for cost. Events that contain speculative
   elements, such as ordinary business risks, are generally not considered insurable.

               Affordable Premium

        If the likelihood of an insured event is so high or the cost of the event so large, that the
   resulting premium is large relative to the amount of protection offered, it is not likely that anyone
   will buy insurance, even if it is on offer.

Risk Management Process

       Meaning and Objectives of Risk Management

        Risk management is the human activity which integrates recognition of risk, assessment of
   risk, development of strategies to manage it, and the mitigation of risk, using available resources.
   The strategies include transferring the risk to another party, avoiding the risk, reducing the negative
   effect of the risk, and accepting some or all of the consequences of a particular risk.

        The objective of risk management is to reduce different risks related to a pre-selected domain
   to the level accepted by society. In an ideal risk management, situation a prioritization process is
   followed whereby the risks with the greatest loss and the greatest probability of occurring are
   handled first, and risks with lower probability of occurrence and lower loss are handled in
   descending order.

       In practice the process can be very difficult, and balancing between risks with a high probability
   of occurrence but lower loss versus a risk with high loss but lower probability of occurrence can
   often be mishandled / mismanaged.

       Risk management also faces difficulties allocating resources. This is the idea of opportunity
   cost. Resources spent on risk management could have been spent on more profitable activities.
   Again, ideal risk management minimizes spending while maximizing the reduction of the negative
   effects of risks.

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       Steps in Risk Management Process

               Identify potential risks.
               Evaluate potential losses.
               Select appropriate techniques for treating loss exposures.
               Implement and administer the program.
               Review the risk management decision.

                   Risk Transfer                           Risk Avoidance
                   Low Frequency                           High Frequency
                   High Severity                           High Severity

                   Risk Retention                          Risk Reduction
                   Low Frequency                           High Frequency
                   Low Severity                            Low Severity

   The Principles of Insurance

       What is Insurance?
       In its simplest aspect, the term has two fundamental connotations.
       o Transferring or shifting risk from one individual to a group.
       o Sharing of losses, on some equitable basis, by all members of the group.

       Utmost Good Faith therefore, is defined as a positive duty to voluntarily disclose, accurately
   and fully, all facts material to the risk being proposed, whether requested or not.

         A Material Fact is any fact which would influence the insurer in accepting or declining a risk or
   in fixing the premium or terms and conditions of the contract are referred to as material facts.

       Insurable interest is the financial interest of the proposer in such a manner that the proposer
   stands benefited by the safety or continuous existence of an asset, the absence of liability and
   prejudiced by the destruction or damage of assets or existence of liability.

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   Subject Matter of Insurance
       The subject matter of insurance can be any type of property or any event that may cause a
   loss or create a liability. Insurance is taken to offset the loss incurred or to pay for the liability
       Examples of subject matter of Insurance under different types of policies are:

    Type of insurance          Example of subject matter of Insurance
    Fire Insurance             Building, Stock or Machinery
    Liability Insurance        A person’s legal liability to third part for injury or damage
    Life Assurance             Life of insured person

   The Insurance Contract

        • Offer and acceptance :
        As with all legal contracts, in insurance contracts, there must be an offer and     acceptance of
   its terms. It should be remembered that in insurance contracts, the person seeking insurance
   makes the offer. Therefore, he is also referred to as the “ Proposer”. It is the insurance company or
   the insurer or the insurer which accepts or declines the offer.

        • Consideration :
        ‘Consideration’ is the value that each party to the contract provides to the other. Without
   consideration there cannot be any contract. In case of insurance contracts, the consideration for
   the insured is the premium payments and the agreement to abide by the terms by the terms of the
   policy. For the insurer, the consideration is the promise to make payment of the sum insured on
   occurrence of a specified event.

        • Competent Parties :
        Each party to the insurance contract must be legally competent to enter into contract. For the
   insured this means that the proposer should be an adult of sound mind. For the insurer this means
   that the proposer should be an adult of sound mind. For the insurer this means that the insurer
   must have a valid license to do insurance business.

       • Common Intention :
       Parties to a contract are said to have a common intention when they understand the same
   thing in the same manner at the same time.
       For example if the proposer intends to take a policy for theft, then it should not be
   misconstrued with burglary. Burglary entails forced entry into the premises, which is not the same
   in case of theft.

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        • Legality of Purpose :
        The purpose of the insurance contract should be legal. A terrorist cannot insure his weapons
   against theft because the object of the contract is not legal and is contrary to the greater public

       Basic Parts of an Insurance Contract :

     1) Preamble
     2) Days of grace
     3) Revival if Policies
     4) Surrender and Paid up Value
     5) Policy Loans
     6) Non-Forfeiture Regulations
     7) Riders
     8) Suicide Clause
     9)Pregnancy Clauses
   10) Specific clauses on female lives
   11) Occupation related clauses
   12) Lien Clause

   Life Insurance
                Life insurance is designed mainly to protect the beneficiaries’ standard of living in the
   event of the untimely death of wage earner. Through life insurance, the beneficiaries will have the
   financial resources to protect their future income and pay for immediate and future financial
   obligation. We need life insurance if our financial obligations at the time of death exceed our
   financial assets.
   For example, life insurance is required in all of the following cases, where the individual:
            Is married and has a dependent spouse
            Has dependent children
            Has aging parent(s) and/or dependent siblings
            Has low retirement savings and pension which won’t be enough for the surviving spouse in
            Owns a business which is a partnership
            Has a substantial debt/financial obligation for which another person would be legally
            responsible after death

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    Types of life insurance policies

     Life insurance may be divided into two basic classes – temporary and permanent.
     Temporary life insurance
                  This type of insurance is characterized by its defined time period that is named when
     the contract is initially put into force.
     Term life insurance
                  Term Insurance is the simplest from of life insurance. Term life insurance provides for
     life insurance coverage for a specified term of years for a specified premium. It pays only if death
     occurs during the term of the policy, which is usually from one to 30 years. Term life policies cover
     risk only during the selected term period. If the policyholder survives the term, the risk cover comes
     to an end.
                  Most term policies have no other benefit provisions. The policy does not accumulate
     cash value. Term is generally considered “pure” insurance, where the premium buys protection in
     the event of death and nothing else.
     The three key factors to be considered in term insurance are:
           • face amount (protection or death benefit),
           • premium to be paid (cost to the insured), and
           • length of coverage (term)
                  Various insurance companies sell term insurance with many different combinations of
these three parameters. The face amount can remain constant or decline. The term can be for one or
more years. The premium can remain level or increase.
                  A term plan is designed to meet the needs of people who are initially unable to pay the
larger premium required for a whole life or an endowment assurance policy, but hope to be able to pay
for such a policy in the near future. Hence, they may leave the final decision regarding the plan to a
later date, when a better choice can be made. No surrender, loan or paid-up values are granted under
these policies because reserves are not accumulated. If the premium is not paid within the grace
period, the policy will lapse without acquiring any paid-u value.
                  However, a lapsed policy may be revived during the lifetime of the life assured but
before the expiry of the period of two years from the due date of the first unpaid premium, on the usual
terms. Accident and/or disability benefits are not granted on policies under the term plan.
                  Generally, the premium for the policy is based on the insured person’s age and health
at the policy’s start, and the premium remains the same (level) for the length of the term. So premiums
for 5-year renewable term can be level for 5 years, then to a new rate reflecting the new age of the
insured, and
So on every five years. Some longer term policies will guarantee that the premium will not increase
during the term; others don’t give that guarantee, enabling the insurance company to raise the rate
during the policy’s term.
                  Most companies will not sell term insurance to an applicant for a term that ends past
past his or her 80th birthday.

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    There are two basic term life insurance policies-level term and decreasing term. Level tern means
that the death benefit stays the same throughout the duration of the policy. Decreasing term means
that the death benefit drops usually is one-year increments, over the course of the policy’s term.

Common types of level term are:
     yearly-(or annually-) renewable term
     5-year term
     10-year term
     20-year term
     25-year term
     30-year term
     Term to a specified age (say 65)

                  If a policy is “renewable,” that means it continues in force for an additional terms, up to
a specified age, even if the health of the insured (or other factors) would cause him or her to be
rejected if he or she applied for a new life insurance police.

                   A common type of term is called annual renewable term. It is a one year policy but
the insurance company guarantees that it will reissue a policy of equal or lesser amount without regard
to the insurability of the insured and with a premium set for the insured’s age at that time.

Permanent life insurance:

               Permanent life insurance is life insurance that remains in force until the policy matures,
unless the owner fails to pay the premium when due.

                 The policy cannot be cancelled by the insurer for any reason except fraud in the
application, and that cancellation must occur within a period of time defined by law (usually two years).
Permanent insurance builds a cash value that reduces the amount at risk to the insurance company
and thus the insurance expense over time. This means that a policy with rupees one lakh face value
van be relatively inexpensive to a 70 year old because the actual amount of insurance purchased is
much less than one lakh rupees. The owner can access the money in the cash value by withdrawing
money, borrowing the cash value, of surrendering the policy and receiving the surrender value.

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       Endowment Assurance
       Whole Life Policies with Profits
       Whole Life Limited Payment Plan
       Whole Life Single Premium Plan
       Limited Pay Life Insurance
       Money Bank with Profit Scheme
       Joint Life Policies
       Children’s deferred Assurance Plan
       Pension Plan
       Group Insurance
       Women’s Policy
       Special Plans
       Family Policy
       Single Premium Life
       Unit Linked Insurance Plans(ULIP)

General Insurance

                    Householders Insurance
                    Motor vehicles insurance
                    Liability insurance
                          i. Doctor’s Protection Policy
                    Package// Umbrella Policy
                          i. Personal Package Insurance Policy for Executives / Businessmen
                    Travel insurance

                 Motor Vehicles Insurance
                 Motor insurance is compulsory in India. It is essential for all motor vehicle owners
   since it protects them from legal liabilities that might arise during their vehicle operation.
                 There are two types of policies available for motor vehicles-third-party liability
   insurance and comprehensive insurance policy.
   Policy A              to cover Act liability.
   Policy B              to cover both own damage losses and Act liability.

                Other liability insurance :
                Even if the personal property of an individual is protected through insurance, financial
   insecurity can arise if the person commits a legal wrong against a third party and is directed to pay
   damages or fines to compensate the aggrieved party. The liability arising from such a situation is
   covered through liability insurance.

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    Package / Umbrella Policy
                 Personal Package Insurance Policy for Executives / Businessmen
                 This package policy is designed keeping in mind the specific insurance needs of an
    executive / businessmen.

                 Travel Insurance
                 A traveler is exposed to risk factors in the course of his travel.

                Travel Insurance Policy
                This policy provides risk coverage, against accident, emergency expenses which are
    incurred on account of events happening during the course of travels.

Health Insurance

Why does one need health insurance?

                 All people are exposed to risk of both mortality and morbidity. It is surprising that in
India insurance is thought only to be a means of saving tax. Out of a population of over 100 crore only
around 8 crore have covered against the risk of mortality for a very small amount. When we come to
the cover for health risk or medical cost the figure is alarmingly low. Reasons for this situation are many
but two major reasons to mention are:
          Low family income
          Unawareness about the health insurance.
                 If we see the reality today, health care costs are high, and getting higher by the day. In
case of a medical emergency, the cost of treatment cannot be predicted, and thus can be well beyond
what one can afford. In a particular year the cost of medical treatment might be low, but in some other
year it could be prohibitively high. Thus medical insurance is required to protect oneself against such
emergencies as well as uncertainties.

Who can avail health Insurance?

                 Medical insurance can be availed by anyone be anyone between the age of 5 years
and 75 years. The lower and upper age limits may vary depending on the policy. One can avail of
medical insurance for himself only (individual cover) or for himself and family members like spouse,
children and dependant parents (group cover).
Benefits of Health Insurance
                 Provides cover against sudden illness or accidents that one may encounter.
                 Adequate coverage can prevent sudden cash outflow and can sometimes help by
providing capital for immediate surgeries

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Different Types of Medical Expenses
    • Hospitalization
    • Surgery
    • Medicines
    • Diagnostic
                  Various types of medical expenses can be incurred by a person. Medical Insurance
Policies usually tend to cover the expenses only on and after hospitalization. So this means that once
the hospitalization of the consumer has taken place, then rest of the expenses like medicine, diagnostic
etc are taken care of.

    •   Hospitalization
                 This broad category of expenses covers the daily hospital charges as well as the
services that might be utilised, during the hospital stay. Typically hospitalisation expenses are the most
expensive from of medical expenses that one incurs.
    • Surgery
                 This category of expense, one would have to incur in case of accidents or any other
major ailments that would require him/her to be operated on. Pre and Post hospitalization is usually
required, when one needs to undergo a surgery and this increase the cost of the treatment. Cost of a
surgery can vary from a few thousand rupees to well over a lac, depending on the kind of ailment.

    •   Medicines
                Any form of disease, would require one to take medicines for treatment purpose. Thus,
expenses on medicine are the most common expense that one would have to bear. The cost of
medicines that one has to take on a daily basis, depending on his/her illness.
    • Diagnostic
                The treatment of any illness would begin with diagnosis of the disease. There are
many common symptoms of disease, and it is not possible to accurately determine the disease, without
proper diagnosis being done. In today’s time, the cost of diagnoses has increased manifold and can
sometimes exceed the cost of other expenses. Also, now-a-days a lot of different tests are needed, for
cored assessment of the disease.

Mediclaim Policy
                Medical expenses have become prohibitive, injury on disease do not come with prior
notice. The requirement of quality medical care has generated the market for health care insurance

Group Mediclaim Insurance Policy
               Group mediclaim policy provides health insurance coverage for a group at an
economical premium value.

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Overseas Mediclaim Policy
                 The Overseas Mediclaim policy provides coverage against personal accident, medical
expenses arising from sudden illness or accident, repatriation, total loss of checked baggage, loss of
passport during travel abroad.

Personal Accident Insurance Policy
                   Accidents don’t come with prior intimation. It is a known fact that despite all possible
precautions, accidents do occur. Accident may occur while walking, driving or even in the house due to
fall from stairs. This may result into disablement or loss of limbs or sometimes even death. Knowing
this fact it should be one’s endeavor that he or his dependants get adequate compensation in the event
of his disablement or death.
                   To cater to this need the general insurance industry has devised an insurance cover,
known as the personal accident insurance policy. The policy covers the risks of accidental death and/or
disablement. The cover has worldwide territorial jurisdiction. This is a non-tariff business. The Policy
provides compensation in the event of insured sustaining injuries, solely and directly from an accident
caused by violence, visible and external means, resulting into death, permanent total disablement,
permanent partial disablement or temporary total disablement.

Shopkeeper’s Insurance Policy
                 Shopkeepers’ insurance policy is designed to cover various risk and contingencies
faced by small shopkeepers under a single policy. It provides protection for property and interests of
the insured and his partners in the shop. The shop premises must conform to specification of class A
construction as per fire tariff.
Workmen’s Compensation Insurance
                 The employer’ legal liability under the Workmen’s Compensation Act, 1923 to pay-
compensation to employees not covered under Employees State Insurance Act for bodily injury or
disease sustained/contracted out of and in the course of employment is covered by this policy. Liability
to employees under Indian Fatal Accident Act 1855 and at Common Law are also covered under the

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