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Ans 1: Insurance basically means protection against future losses arising from unexpected

possible risks. Insurance is a course of action through which an individual manages the potential
risk and transfers it efficiently to the structure that is capable of handling it. Though insurance
neither reduces the severity of risk for an individual or organisation nor does it reduce the
probability of an occurrence of an event in the future, it definitely compensates the financial loss
related to the event. An individual can get protection in exchange for a particular amount called
premium. The minimum amount promised by the insurer at the time of maturity of the policy is
called sum assured. An organisation that provides insurance policies to people is called insurer
and a customer who buys these policies from the insurer is known as insured or policyholder.

Life insurance covers the risk of life. A life insurance policy is a contract between the insured
person and the life insurance company to provide a pre-determined sum of insurance to the
nominee’s in case of injury or death of the policyholder. Life insurance is expected to provide
financial security to the dependents of the policyholder. The insured amount should be sufficient
to replace the income of the policyholder.

The cost of insurance is not determined on the basis of the cost of production and distribution or
demand and supply, but by assessing the risk in an apt manner. The costing of life insurance
process is as follows:

 Mortality Table: Insurers deal with the probability of risk or death under the life
insurance segment. The probability of risk is estimated on the basis historical data. To
understand the probability of death, insurers look at the mortality table of a particular
period. A mortality table can be either census mortality table or insured lives mortality
table. The census mortality table provides information on the general population and it is
constructed on the basis of births and deaths of insured people. The matrix of the
mortality table is based on the selected group. Grouping can be done on the basis of
standard lives and substandard or impaired lives. An individual added to the group should
have similar risk as the risk of other listed individuals. Insurers generally like to qualify
for standard lives as the risk involved is lesser than the risk of substandard lives. To
determine whether it is a standard life proposal or substandard one, the following points
are noted:
a) The life to be insured is healthy.
b) It does not have any physical impairment.
c) It is not addicted to anything.
d) It is not involved in a risky occupation.
e) It does not engaged in risky activities as a hobby.
f) It does not have any unfavorable medical history, surgery, operations or critical
disease.
g) It does not reside at a location which can be hazardous to health.
h) It carries a normal physical structure.

If the life to be insured does not adhere to the abovementioned points, it may be
called impaired or substandard life.

 Proposal Form: It is the main source of pricing insurance as it contains the details of the
applicant with key risk areas. The form helps the insurer to ascertain possible events of
risk and the severity of those risks.
 Insurable Interest: the insurer should have the insurable interest in the life he/she wants to
insure. If the insurable interest is missing, the proposal cannot proceed and it is rejected.
Insurable interest signifies that the proposer would be in the state of financial loss if
something unfortunate happens to the life insured. The amount of insurance sought
should also be appropriate as the cost of insurance would be determined on the basis of
this amount.
 Medical reports: Reports pertaining to the health conditions of the applicant from the
authorised medical examiner are attached to the proposal form. These reports are
necessary to record particulars like age, weight and other measurements to verify the
identity of the person. These records are required to ascertain possible health issues the
applicant might be suffering from. Any difference in the details provided by the applicant
and the medical reports can call for further investigation through laboratory tests to
remove any kinds of doubts. Any pre- existing disease or possibility of a disease is
counted as significant risk and taken into consideration to ascertain the cost of insurance.
 Confidential reports from other sources: Other sources can include agents and third
parties that can help to find information about the applicant. Given that the insurer has to
follow the principles of insurance, he/she calls for confidential reports of the applicant
through other sources. The insurer has to ensure that the funds are managed efficiently
and when the sum assured is high enough, he/she may investigate even the minute details
of the case.
 Financial Status: Even if all other aspects are acceptable, the financial status of the
applicant cannot be ignored in the pricing of insurance. The applicant would only be able
to avail any insurance service if he/she is able to pay the cost of insurance. To ascertain
this, not only the information about the income of the applicant is required but his/her
need for the insurance, the proposed nominee, estimated human value and the sources of
income are also taken into account.

Cost to be paid by an applicant for purchasing a life insurance policy is determined by the level
of risk the applicant carries. Insurers generally use the numerical rating system to estimate the
cost in an efficient and timely manner. The numerical rating system originated when medical
experts from various countries engaged in investigation with actuaries and developed valuable
data. They worked on various factors like insurability, life expectancy and mortality rates.

Conclusion: You will probably invest a significant amount of money in insurance over the course
of your lifetime and buy several policies. You must be aware of what each form of insurance
covers and how it functions in order to make the best purchasing decision. Consider the benefits
as well as the price before making a choice.

Ans 2: Risk Management is the process of identifying, evaluating and prioritizing risks defined
on various parameters. It also involves mitigating and monitoring the causes of risks to achieve
the risk management objectives. Risk management is a systematic process of pre-empting the
possible risks, problems or disasters even before they occur. It also involves taking precautionary
measures to ward off the risk, or at least minimize its impact, or prepare the organization to deal
with its impact. Risk management also involves a realistic evaluation of the severity level of risk.

The various instrumental techniques the risk manager should consider are as follows:

(1) Risk Avoidance: The objective here is to either eliminate the risk or withdraw from
business activity. In other words, it means that the organisation decides not to perform an
activity that carries a risk. It is the easiest method to get rid of the risk. Nonetheless,
eliminating the task will also eliminate the chances of accomplishing the attainable goals.
For example, an organisation contemplating to venture into the supply chain business
may decide to avoid it due to the risk involved in road accidents of commercial vehicles.
Though it appears that avoidance is the answer to all risks, it also means that a business
opportunity is lost. This lost opportunity could have enabled the company to achieve
profits had it accepted the risk.

However, business operations cannot be implemented without any risk element in them
and this is not a practicable solution for any business entity.

(2) Risk reduction: The process of risk reduction or optimization is meant to reduce either the
severity or the possibility of the loss from happening. For example, in case of a fire
hazard, it may be impossible to eliminate all causes of fire and make the building 100%
fireproof. However; methods are designed to put off a fire so as to decrease the risk of
loss arising out of fire. This includes the use of water sprinklers, fire alarms etc. Risks
can have positive or negative outcomes. Hence, optimizing risks means to strike a
balance between the loss due to negative risk and the benefit of business; and the risk
reduction and effort applied.

Outsourcing its non – core activities by an organisation is an example of risk reduction if


it is evident that the organisation to which the activity is being outsourced, possesses
superior management capabilities for managing or reducing risks. For instance, insurers
often outsource many activities, such as call centre, claims management, etc., to other
organisations while handling the business management itself. In this way, an insurer can
focus on business development and sales without having to worry about the claims
process or finding a location for the call centre.

However, risk reduction approach needs to be evaluated in terms of returns. If the returns
are not high enough and the cost of risk reduction is more, it is not prudent to move
forward with the method. Moreover, if limiting the activity does not ensure sensible
returns, the use of this method needs to be reconsidered.
(3) Risk Transfer: Transferring or sharing of risk is the best possible way to manage the risk.
This also means insurance. Transferring risk is the method of passing on the risk or
sharing it with the other entity. However, transferring or sharing is possible if the other
entity is willing to accept it and is able to deal with it. One thing that cannot be ignored is
that in case the insurer or contractor go bankrupt, the risk is likely to revert to the first
party. Though in financial or economic parlance, purchase of an insurance policy is
called as transfer of risk, when seen technically, loss responsibility still lies with the
insured in legal terms. The meaning of transferred, in insurance necessarily means a post
– event compensatory mechanism. For example, a person who owns a car and takes a
personal accident insurance policy does not transfer the risk of a car accident to the
insurer. The risk lies with the insured who is involved in the accident. The liability of the
insurer is only to the extent of compensation for the expenses incurred on treatment or
damage repair due to the accident.
(4) Risk retention: Not transferring or sharing the risk is called retention of risk. This
approach is acceptable when the loss sustained is minimal and does not have any
hazardous effects. This method is adopted when the cost of transferring or reducing the
risk is excessive and goes beyond the returns expected. When an organisation decides to
retain risk, it is prepared to bear the loss, or benefit of gain in business arising due to a
risk as and when it occurs. Catastrophic events, such as man –made or natural disasters,
such as war, terrorist attack, earthquake, etc., are not covered by insurers. Thus, any loss
arising out of this shall have to be borne by the business or individual.

Conclusion: A comprehensive management requirement that considers every aspect of


risk exposure is risk management for an entity. In addition, in today's constantly changing
environment, when even thinking that one is above a particular danger could be foolish, the
traditional methods of controlling risks as they develop are no longer effective. The preferred
approach is to foresee the risks well in advance and prepare oneself to handle the undesirable
outcomes. The senior management must make sure that these practises have filtered down into
the organization's culture in this regard.
Ans 3(A): Ratemaking is a process of deciding the amount of premium of insurance. Thus, it is
also known as insurance pricing. As an insurance company is a profit business, the rate of
premium charged for insurance must be sufficient enough to provide for losses and expenses
while at the same time earning profit for the company. The main objectives of determining the
rate of premium are to:

 Ensure the profitability of an insurer.


 Maintain competitive prices in relation to other insurers.
 Create a corpus that allows the insurer to pay claims and expenses as they occur.

However, the rate of premium differs across insurance companies depending on the laws of the
state in which it operates and various other factors related to the proposer. Rates and premiums
in insurance are determined by an actuary. An actuary is a skilled mathematician who is a part of
the different phases of an insurance company, such as operations planning, research and pricing.
Apart from deciding the rate of premium, an actuary also helps in determining annuities and
legal reserves, which are needed by an insurance company for the payment of future obligations.
This is achieved by studying vital statistical data related to birth, marriages, deaths, disease,
retirement, employment and accidents.

Methods for calculating premium rate:

In the insurance sector, underwriters or actuaries use various methods to determine the rates of
premium. The following are the methods:

1. Class or manual method: In this method, rates set apply uniformly to each exposure unit
that belongs to the same class or group. In simple words, the same rate of premium is
charged from individuals under the same situation. Such groups are usually
predetermined so as to collect and manage claims data in an organized manner. This
method is commonly used in determining the rate of premium for life insurance, workers
compensation insurance, automobile insurance, health insurance etc. For example, in case
of motor insurance, the rate of premium is decided on the basis of the type of vehicle, age
of driver, gender of driver, and category of the vehicle used like commercial, personal,
etc.
2. Loss ratio method: Loss ratio is calculated by adding losses and loss-adjusted expenses
over the premium charged from the insured. Thus, this method is applied to adjust the
premium on the basis of the actual loss happened rather than deciding the rate of
premium.
3. Merit Rating/individual method: This method identifies the unique features of a particular
risk and a rate that reflects the severity of the risk. Moreover, in this method, actuaries
develop special rating classes based on the individual attributes of proposers. The merit
rating method is based on a class rating; however, the rate of premium is calculated as per
the individual customers and the actual losses suffered by them.
4. Schedule rating: This method is used frequently by commercial fire insurance companies.
A building proposed to be covered under the insurance is considered to be a unique
identity, and a rate is established for it. The representative of the insurer does
infrastructure audit, and the building is rated. Rate credits are given based on the good
features of the structure.
5. Experience rating: This method takes into consideration the amount of actual loss in
previous policy periods, generally in the past 3 years, for deciding the rate of premium in
the next policy period. In situations wherein the exposure that affects policy
administration of the insurer is reasonably within the span of control of the policyholder,
the individual risk may be given a special consideration through experience rating. In
such situations, one can expect a reduction of losses through special interventions. Often,
once a loss reduction is demonstrated through past experience, the policyholder may be
passed on the benefit of reduced cost of insurance on the pretext that the policyholder
promises to demonstrate his/her ability to keep the loss low.
6. Retrospective rating: In the retrospective rating method, the premium is adjusted
according to the losses suffered by the insurance company instead of the whole insurance
industry itself. It helps an insurance company to keep control of its losses due to limiting
risk exposure of the insured.

Ans 3(B): Many individuals still use the noun "risk" to refer to the business, asset, person, or
activity that will be at risk of losses. Contrarily, the majority of insurance sector contracts,
educational materials, and training programmes refer to the entity, asset, individual, or activity
that is at risk of loss as an exposure. A house constructed on the coast close to Galveston, Texas,
is therefore referred to as an "exposure unit" for the possibility of loss brought on by a hurricane.
To identify those units that are vulnerable to losses, we'll utilise the phrases "exposure" and
"risk" throughout this article.

The different types of risk exposures a grocery store are as follows:

1. Property Loss exposures: Any condition or situation that creates some kind of damage or
loss to a property. Property loss exposures include the following:
 Building, plants and other structures.
 Furniture, equipment and supplies
 Computers, data inventory.
 Accounts receivable and records
 Company vehicles, planes, mobile equipment.

A property is exposed to losses because of accidents or catastrophes, such as floods or


hurricanes. There are 2 types of loss in property loss exposure: Direct Loss: It is the upfront
damage caused to the asset. Indirect loss: It is a complete loss of revenue or an increase in
expenses, which is commonly known as net income loss. Insurers also offer cover for net income
loss.

For example: In a fire accident, a shop gets destroyed. In such case, the direct loss is the money
spent by the owner on re-establishing the building. The indirect loss in this case is the expense
for an alternative place that is used for continuing the business. Therefore, net income loss =
Amount used to restore the building + Amount spent on alternative shop during renovation +
Business income loss

Property owners face the possibility of both direct and indirect losses. Indirect losses are
intangible losses, such as loss of business.

2. Liability loss exposures: Liability loss exposures relate to the following: Defective
Products, Environmental pollution, Liability arising from company vehicles and
discrimination against employees.

Liability loss exposure is an event that creates the possibility of a claim by a person or
business for injury or damage suffered by another person or party. This claim is generally
made for financial damages because of injury to another party or damage to another party’s
property.

3. Business income loss exposures: Organisations that depend on specific type of buildings
or specialized equipment are typically subject to income loss exposure. In the event of
disaster, such organisations would probably have to shut down their operations until the
buildings/equipment get repaired. Such shutdown would cause a further loss of income.
Manufacturers of a product are classic example of businesses in this category because of
their dependence on specialized production equipment and factory. The insurance that
addresses loss of exposure is called business income coverage. This plan promises to
replace the income that would otherwise have been earned by the business during the
time when repairs are being made. The business income loss exposures relate to: Loss of
income, Extra expenses and Continuing expenses after loss.
4. Human Resource Loss exposures: These include losses related to worker injuries,
disabilities, death, retirement and employee turnover etc. These include the losses related
to: Death of employees, Retirement of employees and Job-related injuries.
Organisations mostly take insurance to compensate the employees or beneficiaries in this
case.
5. Crime loss exposure: This loss exposure results from criminal acts. It is related to
robberies and employee threat, Fraud, Internet crimes, Intellectual property theft.
Organizations purchase crime insurance that help in filing claims for employee theft or
other offenses.
6. Employee –Benefit loss exposure: This involves loss of an employee mistakenly or
deliberately makes an error or omission in the administration of an employee benefit
programme. These include failure to advise employees of benefit programmes. This
relates to the following: Failure to comply with government regulations, Violation of
fiduciary responsibilities, failure to pay the promised benefits.

Coverage of this exposure is usually provided by a fiduciary liability insurance policy. All these
exposures can be identified with the help of questionnaires, inspection, financial statements,
historical data, etc.

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