Principles and Practice of Insurance

And Theory of Rate Making

Lajpat Ray ChandnaniSr Branch Manager, DAB, Jaipur

PURPOSE AND NEED OF INSURANCE

Assets may be destroyed or made non functional due to an accidental occurrence. Such possible occurrences are called perils. Fire, floods, breakdowns, earthquakes, road accidents etc are perils.

Loss : is an unplanned decrease in a property (or other) value which can be measured in rupee terms.

Actual Total / Partial

Constructive Total

Sentimental Losses

Losses inherent to trade - seepage through bags, evaporation of liquid cargoes, natural weight loss through drying out of seeds, grain etc.

LOSSES DEFINEDPROPERTY LOSSES : (FIXED / MOVABLE ASSETS)

•PHYSICAL DAMAGE

•LOSS OF USE OF PROPERTY

•CRIMINAL ACTIVITY

•EXTRA EXPENSES : an additional cost beyond normal business expenses, made necessary because of a loss.

LIABILITY LOSSES : Legal responsibility to pay others for

losses or injuries they have suffered. NEGLIGENCE : failure to exercise the necessary care under the circumstances, to protect others from unreasonable risk of harm growing out of one’s actions or failure to act.

•Liability to General Public

•Liability to Employees

•Directors & Officers Liability

LOSSES DEFINED

Business interruption loss : the temporary shutdown of a firm

Actual / Anticipated (ALOP)

Loss of Revenue

Extra Expenses

Loss of / to Persons : (Key persons – an officer, employee or other person in a firm who possesses skills, knowledge, or other qualities difficult to replace – key employees – key owners)

Accidental Death / PTD / PPD/ TTD

Illness / Sickness

Key Person Losses

Unemployment

Dependent old age

LOSSES DEFINED

Pecuniary Losses : (Due to failure of another person to meet an obligation)

•Loss due to Infidelity of Employees

•Court Bonds

•Government Bonds

PURPOSE AND NEED OF INSURANCE

Risk is the possibility of a peril giving risk to a loss.

Risk is only a possibility of loss or damage, it may or may not happen. Therefore, there is an uncertainty about the risk. INSURANCE IS RELEVANT ONLY IF THERE IS AN UNCERTAINTY. Insurance is done against the contingency that the risk may happen. If there is no uncertainty about the occurrence of an event, it cannot be insured.

It is essential in insurance that

A risk can be assessed

Insurance does not avoid risks rather it covers it.

THE PURPOSE OF INSURANCE IS TO GIVE THE ASSET OWNER THE FINANCIAL SECURITY FROM THE RISK OF LOSS DUE TO THE OPERATION OF A PERIL.

Insurable / Non-Insurable Risks

Financial (insurable) / Non Financial Risks (not insurable)

Dynamic (changes in price level, consumer tastes, income and output and

technology – Non predictable – not insurable) and Static (perils of nature, fraud, dishonesty – predictable – insurable) Physical hazard

Pure (chance of loss or no loss – insurable) Speculative (where there is possibility of gain – not insurable)

The business of insurance is related to the protection of the economic value of assets, belonging to an individual or concern. There is a normally expected life time for the asset. If however it gets lost, destroyed or made non-functional because of an accident or unfortunate event before its expected life time, the owner of those deriving benefit from the asset suffer loss. INSURANCE IS A MECHANISM THAT HELPS TO REDUCE THE ADVERSE CONSEQUENCES OF SUCH A LOSS.

Insurance does not protect the asset. It does not prevent its loss due to the perils of fire, earthquake, flood, theft, breakdown, etc. These perils cannot be avoided through insurance. Insurance only compensates the loss, if not fully but at least to a great extent. INSURANCE COMPENSATES ONLY ECONOMIC OR FINANCIAL LOSSES.

It is not the house, ship, machinery, potential liability or life that is insured but it is the financial interest of the insured in that house, ship, machinery etc which is insured. It is an economical method by which the losses of the unfortunate few is shared by those fortunate many who did not suffer losses.

MECHANISM OF INSURANCE

Many persons seeking protection from similar perils contribute small amounts to a common pool. Their contribution to the pool is in proportion to the extent of their exposure to the peril and to the quantum of loss they are seeking protection against. THIS POOL IS MANAGED BY THE INSURED AND THE PERSONS SEEKING PROTECTION ARE THE INSURED. The unfortunate few insured persons who suffer loss in the event of the operation of the peril, are compensated from this pool.

The loss of a few persons is spread among the community of the insured persons. The big loss of a few persons is reduced in small manageable portions. The INSURERS collect the contributions (premium) in advance to create a fund from which the losses can be paid.

Insurance covers tangible (physically visible) properties like house, car, belongings, shop, human body etc as well as intangibles (physically not visible) like loss due to negligence, error, legal liability etc.

NATURE OF INSURANCE CONTRACT

It is an agreement between the insurer and insured.

The insurer having received premium undertakes to make good the loss suffered by the insured.

The loss is made good subject to :

The loss resulting from the insured risk/peril

The property damaged / person died/injured / liability incurred is covered under the policy

The loss has occurred during the policy period

NATURE OF INSURANCE CONTRACT

Offer and acceptance Proposal

Acceptance and their communication

Parties to the contract and their capacity to contract

Indian Majority Act

Minor’s contracts – void – by a guardian for the benefit of the minor will be valid.

Sound Mind

Married Women : Pardanashin lady

Corporations / Government Agencies

NATURE OF INSURANCE CONTRACT

Lawful consideration and Lawful Object Acts forbidden by Law

Agreements defeating the provisions of any law

Fraudulent

When it involves injury to the person or property of another

When it is immoral or opposed to public policy – Trading with enemy, Interference with course of justice, sale of public offices, restraint of trade

NATURE OF INSURANCE CONTRACT

Consensus ad idem (There mjust be free consent of the parties concerned)

Coercion

Undue influence

Fraud

Misrepresentation

Mistake : as to the person with whom the contract is made, as to the subject matter of the contract, mistake of law

NATURE OF INSURANCE CONTRACT

The agreement is not declared to be void under the Act :

Agreements in restraint of legal proceedings

Agreements contingent on events – insurance – condition precedent – subsequent

Agreements to do an act impossible in itself.

Agreement to do an act which subsequently becomes impossible or unlawful

To do illegal things

Assignment (a) the policy itself (b) the subject matter of insurance, or ( c) the proceeds of the policy

Transfer by Operation of Law

NATURE OF INSURANCE CONTRACT

Consideration :

Premium – 64VB

Promise to pay, compensate or indemnify

BASIC PRINCIPLESINSURABLE INTERESTSUBJECT MATTER OF INSURANCE – WHAT IS INSURED IN A FIRE POLICY ? NOT THE BRICKS AND MATERIALS USED IN THE BUILDING THE HOUSE BUT THE INTEREST OF THE INSURED IN THE SUBJECT MATTER OF INSURANCE.

SUBJECT MATTER OF THE CONTRACT

THERE MUST BE SOME PROPERTY, RIGHT, INTEREST, LIFE OR POTENTIAL LIABILITY CAPABLE OF BEING INSURED

IT IS THIS PROPERTY, RIGHT, INTEREST WHICH MUST BE THE SUBJECT MATTER OF INSURANCE

BENEFITS FROM SAFETY, FREEDOM FROM LIABILITY

RELATIONSHIP BETWEEN INSURED AND SUBJECT MATTER MUST BE RECOGNIZED AT LAW

CREATION OF INSURABLE INTEREST : BY COMMON LAW, BY CONTRACT, BY STATUE

APPLICATION : PART OR JT VENTURES / MORTGAGEES AND MORTGAGORS / EXECUTORS AND TRUSTEES / BAILEES / AGENTS / HUSBAND AND WIFE

LIFE – AT INCEPTION

PROPERTY –AT INCEPTION / TIME OF LOSS

MARINE – TIME OF LOSS

BASIC PRINCIPLES

INSURABLE INTERESTLEGALLY ENFORCEABLE

POSSESSION

CRIMINAL ACTS

FINANCIAL VALUE

ASSIGNMENT

OPERATION OF LAW – DEATH / INSOLVENCY

MARINE POLICIES

ABSOLUTE ASSIGNMENT

CONDITIONS ASSIGNMENT

ASSIGNMENT OF POLICY PROCEEDS

BASIC PRINCIPLESINDEMNITYLINK WITH INSURABLE INTEREST

HOW INDEMNITY IS PROVIDED

CASH PAYMENT

REPAIR

REPLACEMENT

REINSTATEMENT

MEASUREMENT OF INDEMNITY

MARINE

PROPERTY – BUILDINGS – MACHINE AND CONTENTS OTHER THAN STOCKS – MANUFACTURERS’ STOCK IN TRADE – WHOLESALERS’ AND RETAILERS’ STOCK IN TRADE – HOUSEHOLD GOODS –

PECUNIARY INSURANCES

LIABILITY INSURANCES

SALVAGE

ABANDONMENT – MARINE ONLY

INDEMNITYFACTORS LIMITING THE PAYMENT

AVERAGE

EXCESS – COMPULSORY/VOLUNTARY

LIMITS – 5% OF TOTAL SUM INSURED ON CONTENTS UNLESS OTHERWISE DECLARED

DEDUCTIBLE (VERY LARGE EXCESS)

EXTENSION IN THE OPERATION OF INDEMNITY :

REINSTATEMENT : (A) INDEMNITY (B) WEAR, TEAR AND DEPRECIATION (C) EFFECT OF INFLATION BETWEEN THE DATE OF LOSS AND EVENTUAL DATE OF REPLACEMENT

AGREED ADDITIONAL COSTS

VALUED POLICIES

BASIC PRINCIPLES

SUBROGATION – MEANING, WHEN

CONTRIBUTION – TWO OR MORE POLICIES OF INDEMNITY MUST EXIST

POLICIES MUST COVER COMMON INTEREST

POLICIES MUST COVER A COMMON PERIL WHICH GIVES RISE TO THE LOSS

COMMON SUBJECT MATTER

EACH POLICY MUST BE LIABLE FOR LOSS.

PROXIMATE CAUSETHE ACTIVE EFFICIENT CAUSE THAT SETS IN MOTION A TRAIN OF EVENTS WHICH BRING ABOUT A RESULT, WITHOUT THE INTERVENTION OF ANY FORCE STARTED AND WORKING ACTIVELY FROM A NEW AND INDEPENDENT SOURCE.

SINGLE CAUSE

CONCURRENT CAUSE

DIRECT CHAIN OF EVENTS- UNBROKEN SEQUENCE (SUCCESSIVE CAUSE) – BOMB – FIRE (WAR – FIRE NOT PAYABLE)

INTERRUPTED CHAIN OF EVENTS – BROKEN SEQUENCE – ACCIDENT, HOSPITAL, INFECTION FROM NEXT BED PATIENT, NOT PAYABLE

Insurance of Property :

FireBurglary

Cash

Engineering

Motor

Marine (Transit

Insurance of Liability :

Employer’s Liability (WC)

Product Liability

Public Liability

Public Liability Insurance Act

Insurance of Persons :

Personal Accident

Mediclaim

Universal Health Insurance

Overseas Mediclaim

Insurance of Pecuniary Losses :

Fidelity Guarantee

Loss of Profits – Fire, MBD

Advance Loss of Profit

THE PROPOSAL FORM

FOR PERSONAL INSURANCES : Name, Address, Occupation, Age

Past Insurance / Claims history

Basis upon which the premium will be calculated

FOR BUSINESS INSURANCES : Name of the Proposer – Corporate/Business name

Business Address + various locations

Trade, business or profession

Past Insurance / Claims history

Basis upon which the premium will be calculated

THE POLICY

HEADING

PREAMBLE

THE SIGNATURE

OPERATIVE CLAUSE

EXCEPTIONS

DEFINITIONS

CONDITIONS – EXPRESS – IMPLIED – CONDITIONS PRECEDENT TO THE CONTRACT – CONDITIONS SUBSEQUENT TO THE CONTRACT – CONDITIONS PRECEDENT TO THE LIABILITY

OTHER RISK COVERING DOCUMENTS

COVER NOTES

RENEWALS

NON PAYMENT OF PREMIUMS

LONG TERM AGREEMENTS

DECLARATIONS

Checklist for Sum Insured

Buildings Land value : should be excluded Foundation/Plinth : can be excluded Underground Assets : may be included Assets embedded in walls & roofs: should be included Road & Pavement : should be included Boundary Walls & Fences : should be included Utility Buildings : should be included

Basis of Valuation

Original Cost Book Value Market Value Reinstatement Value : Value of Similar New Property

Plant and Machinery All Plants and Machinery including Electrical Items to be

included

Standby Machinery (not in use at the moment)

Tools and Spares

Transformers and Distribution Systems

Basis of Valuation

Original Cost Book Value Market Value Reinstatement Value : Value of Similar New Property

Contd………………Next Page

Checklist for Sum Insured

Stocks and Stock in Process Raw Materials

In Godowns In Open On the Shop Floor In Bonded Warehouse

Finished Goods In Factory In Finishing/Packing Department In Godowns In Open In Bonded Warehouse

Stocks in Process (Care may be taken to estimate maximum value at each location)

Wastes

Basis of Valuation Original Cost Book Value Market Value Reinstatement Value : Value of Similar New Property

Checklist for Sum Insured

Marine : Agreed Value Contracts

Cost Cost + Insurance Cost + Insurance + Freight Cost + Insurance + Freight + Custom

Duty

Profit Margin say +10%

Checklist for Sum Insured

PERSONAL ACCIDENT :

DEATH : 120 MONTHS TABLE II : 60/72 MONTHS TABLE III : 1% OF CSI MAX RS. 5,000 PER WEEK.-mthly

income to justify

Checklist for Sum Insured

Never, never allow a person to be more worth dead than alive to family or business

LIABILITY

LIMIT ANY ONE EVENT / LOSS LIMIT ANY ONE YEAR

THEORY OF RATING

DETERMINATION OF PREMIUM RATES :BROADLY A PREMIUM RATE HAS TO PROVIDE

FOR:

1. Loss Cost i.e., amount required to pay claims (pure cost)

2. Administrative Expenses3. Provision of Profit4. Margin for contingencies / catastrophic

losses

THEORY OF RATING

UNDERWRITING POLICY :

Whether each product should stand alone on its own or cross-subsidy among products sold to one client will be applicable.

Whether the insurer will underwriting any business on a planned underwriting loss basis – how the Insurer will control the effect of such underwriting on the insurer’s solvency margin and the aggregate exposure to such losses.

The margins that will be built into the rates to cover acquisition costs, promotional expenses, expenses of management, catastrophe reserve and profit margin and the credit that will be taken for investment income.

THEORY OF RATINGCLASSIFICATION OF PRODUCTS:

A. CLASS RATES PRODUCTS

(i) Internal tariff rates products – standard products – can be sold by any office with the rates, terms and conditions of cover including choice of deductibles. RULE BASED : variation from listed rates for factors linked to experience / hazard features / size of sum insured / deductible / competition. (ii) Packages or customized Products: specially designed for an individual client or class of clients in terms of scope of cover, basis of insurance, deductibles, rates and terms and conditions of cover.

THEORY OF RATING

CLASSIFICATION OF PRODUCTS:

B. INDIVIDUAL RATES PRODUCTS

(iii) Individual experience rates products : rates, terms and conditions of cover are determined by reference to the requirements of and the actual claims experience of the insured concerned. These will typically be insurances with a high frequency but low intensity of loss occurrence. (iv) Exposure rates products : Where the rates, terms and conditions of cover are determined by evaluation of the exposure to loss in respect of the risk concerned, independent of the actual claims experience of that risk. Where occurrence of loss is an uncomment event or where there are very few risks of that class to develop a statistically supported rating basis.

THEORY OF RATING

CLASSIFICATION OF PRODUCTS:

B. INDIVIDUAL RATES PRODUCTS (v) Insurance of large risks : Typical insurances for individual large clients where the rates, terms and conditions of cover may be determined by reference to the international markets. (a) Total sum insured of Rs. 2500 crores or more at one location for property insurance, material damage and business interruption combined.(b) Rs. 100 crore or more per event for liability insurance.

THEORY OF RATING

FIRE : %-o per mille MOTOR : Type of vehicle, type of cover, zone MARINE : % BURGLARY & OTHER MISCELLANEOUS : % CERTAIN POLICIES : ADJUSTABLE – CASH, WC SHORT PERIOD SCALE – DECLARATION

POLICIES MINIMUM PREMIUM RETURN OF PREMIUM FAILURE OF CONSIDERATION HEALTH INSURANCE SCHEMES :

INSTALLMENTS ENGINEERING +12 MONTHS : INSTALLMENTS LONG TERM : ADVANCE

THEORY OF RATING

HAZARD : a condition that may create or increase the chance of a loss arising from a given condition.

Physical hazard –

Fire : Construction, height, nature of flooring, occupancy, process of manufacture, situation

Marine : age and condition of vessel, voyage/journey to be undertaken, nature of stocks, the method of packing

Motor : age and condition, type of vehicle, use of vehicle

Burglary : nature of stocks, situation, constructional hazard, openings, security arrangements

PA : Age, occupation, health and physical condition

Moral Hazard – Dishonesty, Carelessness, Industrial Relations, General Economic conditions

Morale hazard – Difficult insured

THEORY OF RATING

Rating of Physical Hazard :

Measures to improve risk

Imposition of warranties

Incorporation of Clauses

Survey before Acceptance

Loading of premium

Restriction of Cover

Imposition of Excess/Franchise

Rating of Physical Hazard : Uninsurable

Any Questions?

39

Thanks.