INSURANCE AND RISK MANAGEMENT

UNIT – I
MEANING OF INSURANCE:
Insurance is an arrangement under which people facing common risk come together
and make their small contribution to common fund.
DEFINITION OF INSURANCE:
According to Thomson “Insurance is a provision which a prudent man makes against
fortuitous or inevitable contingencies, loss or misfortunes. It is a form of spreading risks”.
According to Prof.R.S.Sharma, “Insurance is a co-operative device to spread loss
caused by a particular risk over a number of persons who are exposed to it, who agreed to
insure themselves against that risk”.
FEATURES OF INSURANCE OR IMPORTANCE OF INSURANCE
The important feature of insurance is below.
➢ Contract
➢ Consideration
➢ Co-operative device
➢ Protection of financial risks
➢ Payment of contingency
➢ Insurance is not gambling
➢ Insurance is not charity
➢ Regulated by law
➢ Value of risk
➢ Large number of insured persons
➢ Investments
Contract:
Insurance is a contract between the insurance company and the policy holder (insured)
makes offer and the insurance company (insurer) accepts his offer. The contract of insurance
is always written agreement.

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Consideration:
Like other contracts, there must be lawful consideration in insurance also. The
consideration is the form of premium which the insured agrees to pay to the insurer.
Co-operative devices:
“All for one and one for all” is the basis for co-operation. The insurance is a system
where in large numbers of persons, exposed to a similar risk, are covered and risk is spread
over among the larger insurable public. Therefore, insurance is a social or co-operative
method where in losses of one is borne by the society.
Protection of financial risks:
Insurance offer protection to those risks which can be measured in terms of money i.e.
financial risk. As such insurance compensates only financial or monetary loss or risks.
Payment of contingency:
An insurer is liable to pay compensation to insured only when certain contingencies
arise. In life insurance the contingency-the death or the expiry of the certainly occur. In other
insurance contracts, the contingency-a fire accident or the marine perils, May of may not
occur. So, if the contingency occurs, payment is made otherwise no payment need to be
policy holder.
Insurance is not gambling:
The contract of insurance cannot be considered as gambling as the insured is assured
to get his loss indemnity only on the happening of such uncertain events as stipulated in the
contract of insurance, where as the gambling may either result into profit or loss.
Insurance is not charity:
Premium collected from the policy holder under insurance is the cost of risk covered.
Hence, it cannot be taken as charity. Charity lacks the element of contract of indemnity and
compensation of loss to the person who so loss to the who so ever makes it.
Regulated by law:
In India life insurance and general insurance are regulated by Life Insurance
Corporation of India of 1956 and general insurance business (nationalization) act 1972.
Value of risk:
Before insuring the subject matter of the insurance contract, the risk is evaluated in
order to determine the amount of premium to be charged on the insured.

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 Large number of insured persons:
In order to make insurance cheaper and affordable, it is necessary to insure larger
number of persons or property because the lesser would be cost of insurance and so, the
lower would be premium..
Investments
The amount of premium collected from the insured by the insurer is being invested in
different securities.
FUNCTIONS OF INSURANCE:
Insurance provides a variety functions which are beneficial to the common man,
directly or indirectly. As such, functions of insurance can be divided into three categories.
1. Primary functions
2. Secondary functions
3. Other functions

Primary Function:

Provide protection:
Providing protection to the insured against the probable chances of loss is one or the
main functions of insurances. The insurance guarantees the payment of loss and thus protects
insured from losses arising at the happening of risk event.
Provides certainty:
Insurance offers certainty of payment for the risk of loss. There are different types of
uncertainty in a risk. Whether the risk will occur or not, when will it occurs, how much loss
will be there. In other words, there is uncertainty of happening of time and amount of loss.
Insurance removes all these uncertainty and the insured is given certainty of payment loss.
The insurer charges premium for providing the certainty.

Distributes risk:
All business concerns face the problem of risk and if the concern is big enough,
handling risks becomes a specialized function. Risk and insurance are inter related with each
other. Insurance, as a device, is the outcome of the existence of various risks in our day today
life. It does not eliminate risks but it reduces the financial loss caused by risks.

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Secondary Function:
Some functions in insurance are categorized as secondary functions are below
Prevention of loss:
The insurers assists financially to the health originations, fire brigade, educational
institutions and other originations which are involved in prevention of losses of the general
public from death or damage.
Provide capital:
Insurance provides capital to the industries various forms. First, it reduces financial
risks and losses by provided facilities of core capital investments in various big organizations.
Secondly, the amount of premiums collected by the insurance is made available for the
capital, providing long term loans. Thirdly, insurance makes the company or organization to
avail loans on each term by hypothecating the insurance policies.
Increases efficiency:
Insurance increases the efficiency of the business by reducing the risks of fear losses. It
provides a sense of security in the business world, which in turn becomes a source for the
growth and diversification of the industry. Management is relieved of the various risks.
Other Functions:
Encourage savings:
Life insurance is considered as one of the important forms of savings. The premium
paid by the assured is accumulated and is returned to him if he survives till the date of
maturity. Certain tax exemptions given under Sec. 80 C of the income tax act.
Promotes foreign trade:
Foreign trade fully depends on insurance. The banker will not come forward to
discount the marine trade bills unless the cargo is fully insured. In India insurance has been
made mandatory for foreign trade.

Checks inflation:
Insurance plays an important role in controlling inflation. It curbs the circulation of
money and saves it from its ill effects..
Credit facilities:
Business people can borrow loans from banks and other financial institutions by
pledging their insurance policies. In case, the insured trader is unable to return the loan, the
financial institutions can recover their amount out of the policy’s surrender value.

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Social security:
Insurance gives an instrumental force to fight against old age, unemployment, evils of
poverty, fateful accidents of person and property and similar other natural calamities. It has
helped society a lot by designing various types of insurance like Employees State Insurance
Act, Provident Fund Act, and Workers Compensation Act etc.
Types of Insurance
There are two main branches of insurance in our country namely, Life Insurance and
General Insurance. The General insurance is subdivided into three types namely Fire
insurance, Marine insurance and Miscellaneous insurance.

Types of insurance:

Life insurance General Insurance

Fire Insurance Marine Insurance Miscellaneous Insurance

1. Life insurance:
It refers to a contract in which the insurance agrees to pay a specified amount on the
death of the assured or on the expiry of a certain fixed period, where ever is earlier.
In consideration of this, the insurers collect premium, from the insured. Since the sum
for which a policy is taken is assured to be paid whether there is a death or not, Life insurance
is also after referred to as “Life Assurance”.
In India, the life insurance business is being undertaken by Life Insurance Corporation
of India (LIC) and twelve private insurance companies.

2. General insurance:
Expect life insurance all other insurance come under general insurance. The
government of India enacted general insurance business act 1982 to takes over general
insurance business. Under the provision of this act, the General Corporation (GIC) India was
established in Jan 1973 for the purpose of directing controlling and carrying on the general
insurance. For the classified into fire, miscellaneous.
a. Fire insurance:
This insurance covers the risk of fire to property because there is every like hood
factories, houses, shops and ships. The insurance is not only covers the fire but not also the
consequential losses from such loss.
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 b. Marine insurance:
This is the oldest form of insurance and covers all the marine perils, due to marine
perils the ships can be damaged or destroyed, carriage can be cost and consequently there can
be loss of freight. Therefore the marine insurance covers the risk to ship cargo and freight on
the high seas.
c. Miscellaneous insurance:
All other general insurance fall under the miscellaneous category. It includes
 Bhagyashree child welfare policy
 Burglary insurance
 Group mediclaim policy
 Individual mediclaim policy
 Jewelers insurance
 Money insurance
 Motor insurance
 Overseas mediclaim policy
 Personal accidents
 Product liability insurance
 Public liability insurance
 Rajeswari Mahila Kalayan BimaYojna
 Shop keepers insurance
 Workman compensations
GENERAL PRINCIPLES OF INSURANCE:
Insurance contracts are based on certain fundamental principles. These principles are
common to all types of insurance, life, fire, marine and miscellaneous insurance contracts

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with the exception of the principles of indemnity which is not applicable in case of life
insurance.

1. Principles of Utmost good faith:

Utmost good faith requires each party to tell the other, “the truth, the whole truth and
nothing but the truth”. It means that the parties to the contract must take a full disclosure of
all the material facts and information relating to the contract.
(e.g.)
Motor: Details of any young driver.
House hold: Details of any commercial use of private dwelling house.
Life: Details of heart diseases.
2. Principles of Indemnity:
The term “indemnity” means making up the loss or security against damage. All the
contracts of insurance except life & personal life accident & sickness insurance are contracts
are indemnity. According to this principle the insured should be placed on the same, financial
position as for as possible after a loss as he occupied immediately before its occurrence. the
insured will neither gain nor lose

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 (E.G):- If a person has insured a cargo for Rs 40,000 & if a part of the goods of
Rs 7000 is destroyed the insurer will pay only Rs 7000 & not Rs 40,000. This principle
ensures that “NO ONE MAKES A PROFIT OUT OF INSURANCE”.
3. Principles of Contribution:
This principle applies where there is more than one policy covering the same subject matter
against the same peril for the same period and for the same insured. In such cases the insured
used can makes claims under all policies with different insurers and recovers pro rata from
each.
(EX) :- MR .X has insured his house against fire with A,B,C and D insurance companies
for Rs 4,00,000, Rs 8,00,000 ,Rs 12,00,000 & 16,00,000 respectively. Mr. X has suffered
loss of Rs 4,00,000 in all, due to fire and recovered the entire loss from the insurance
company A. In such a case, company ‘A’ has the right to call upon, the other insurers to
contribute to the loss.
4. Principles of Subrogation:
Subrogation means inheriting the rights available to an individual. The insurers after
making good the loss, is entitled to all the rights of the insured against third party as regards
the subject matter of insurance. Thus, when the right of the insured over the subject matter of
insurance is transferred to the insurer by way of this inheritance, it is known as “the doctrine
of subrogation.
5. Principle of Causa Proxima:
The maxim “Causa proxima non remota speculature” means that proximate
(nearest) cause and not the remote one is to be taken note of act the time of determining the
liability of the insurer. The insurer is not liable for remote cause even if it one of the insured
perils.
Example:
Fireman removes undamaged stock from a burning building to avoid its involvement in
the fire. It is stocked in the open yard & subsequently damaged by rain was the proximate
cause of the damage the fire or the rain? If the rain damage occurred before the insured had
an opportunity to protect if then the proximate cause of the damage world be the fire.
6. Principles of Warranty:
There are certain conditions and promises in the insurance contract which are called
“warranties”. A warranty is that by which the insured under takes that same particulars thing
shall or shall not be done or that some conditions shall be fulfilled or where by the terms or
negative the existence of particulars state of faults.

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7. Principles of Mitigation of loss:
This principle emphasis the duty of the insured to take all the possible steps to
minimize the loss or damage to the property covered by the insurance policy in case the
mishap happens.
REINSURANCE
The term reinsurance also termed as insurance of insurance means that an insurer
who has assumed a large risk may arrange with another insurer to insure a portion of the
insured risk.

Importance of reinsurance
• Direct insurer: the insurer who accepts the risk from the proposer and who, so far as
the policy holders is concerned, is alone responsible for the obligation undertaken
• Re –Insurer: The insurer who grants a guarantee (or accepts a reinsurance)from the
direct insurer
• Ceding Insurer: The insurer who obtains a guarantee (or places reinsurance )
• Cession : The amount given off by way of reinsurance and therefore the amount
accepted by the reinsurer
• Re insurance policy: the contract of reinsurance, except in the practice where it is
termed as guarantee, or guarantee
• Retention or holding : The proportion of the risk which the direct insurer holds on
his own account
• Line : the amount of retention of the direct insurance reinsurer may accept one or
more lines (or a fraction of a line)
• Retrocession: A reinsurance of a reinsurance i.e., where the reinsurer desires to
reduce the limit of his liability in respect of business accepted
• Reinsurance commission: the amount paid by the reinsurer to the ceding company
as a contribution to the acquisition and administration costs. It is calculated as a
percentage of premium received by the reinsurer
• Profit commission: it is a percentage of the earned profits which the reinsurer
agrees to return because the profit earned on the business passing under a
reinsurance treaty is deemed to be due to skill and care in the conduct of the
business by the direct insurer
• Underwriter: the person who agrees to compensate the loss arising from the risk is
called the insurer. Assurer or underwriter
• Facultative: Facultative reinsurance is the direct reinsurance of individual risks
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 through the medium of a broker in precisely the same way original insurances are
placed

TYPES OF REINSURANCE
`Depending on the nature and scope, the methods or forms of reinsurance are broadly
classified as follows;
I Proportional form of reinsurance
(1)Quota methods of reinsurance
(2) share surplus form of reinsurance
II. Non-proportional form of reinsurance
(1) Excess of loss method
(2) Excess of loss ratio method
(3) Pools method of reinsurance
(4) Treaty method of reinsurance
The following chart can explain this more clearly:

Reinsurance

Proportional Reinsurance Non-proportional Reinsurance

Quota share excess Excess Treaty pools

methods surples of loss of loss method method
methods Ratio Methods Method

The following methods or forms of reinsurance have been discussed here briefly
(1) Proportional Reinsurance
Use this method, the amount retained and the amount ceded will represent the
fixed share of risk covered by the direct insurer, which places reinsurance with a
reinsurance company (ceding officer), Irrespective of the size of the claim, the liability of
the claim will be shared by the ceding office and the reinsurers within the scope of treaty.
reinsurance is further classified as

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 • Quota method of reinsurance: under this method, the ceding office is bound
to reinsurance such proportion of every risk as stated in the agreement.
• Share surplus method of reinsurance: Under this form, surplus reinsurance
treaty refers to the reinsurance, the surplus of risk over the retention of the
ceding office. amount. If the sum insured is less than its normal retention level for
that class of risk it need not take reinsurance at i.e., it will retain all.

(2) non-proportional reinsurance: the ceding office and the reinsurers not share each loss
in fixed proportions and may not share some losses at all. The ceding office will underwrite
its retention as form of first loss insurance, i.e., it will bear all the losses up to the certain
figure, and usually the reinsurers deal with the balance of any loss above this figure,with a
upper limit.
he non-proportional insurance can be classified into four

• Excess of loss method: this is the another form of reinsurance which sometimes
used. This method assumes that an insurer decides the maximum amount he can
bear on any one loss and seeks insurance under a treaty where by the reinsurers will
be responsible for the amount of losses and the amount retained by the direct
insurer.
• Excess of loss ratio method: it does not deal with individual risk or individual event,
but it is designed to prevent the wide fluctuations of the net claims ratio of a
particular account over one financial year compared with the other.
• Pools method of reinsurance: the method provides against hazardous risk or where
the happening of an insured event may incur heavy loss, damage ,etc under this
method the member company agree to pool together all their business to a leading
office and tle insurance he payment is made by the leading office
• Treaty method of insurance: treaty is referred to an agreement between the ceding
office and the reinsurer or a number of reinsurers where by the reinsurers bound to
accept the fixed share of every risk coming within the scope of agreement

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Double insurance
It implies that it is insured with two or more insurers and the total sum insured
exceeds the actual value of the subject matter. It is called as double insurance. In the other
words the subject matter of insurance is insured with different insurers. If the actual value of
the subject matter is more than the sum insured, it is not treated s double insurance .
Difference between reinsurance and double insurance

Reinsurance Double insurance

1. When the risk is considered as too When the same risk is insured with more
great, get a part reinsured with another than one insurer
insurance company
2. The insurer has the insurable interest If insurer doubts the security of his
in the risk which he may reinsure underwriters insurers, the same risk with
other underwriters no return of premium
can be recovered

3. The reinsurance does not affect the Total amount of all the policies is more
position of the original insured. The than the actual value of the subject-matter
reinsured has to pay reinsurance
premium for the risk shifted
4. The original insurer is able to transfer Here, underwriters can adjust the risk and
a part of the risk to the reinsurer contributions among themselves
5. Reinsurance terminates when once the The termination is not possible
original insurance lapses for any
reason

6. In the event of loss, the original Assured cannot recover more than the
insurer has to pay the assured amount amount of actual loss. If loss occurs, the
to the insured assured may claim payment from the
insurer in such order as he chooses
7. Original insurer will recover from the The assured can recover the full value on
reinsurer his share of liability the original policies till his total loss is
made up.

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INFORMATION TECHNOLOGY IN INSURANCE

The rapid innovations in the field of information and communication

technology have posed serious challenges for the insurance industry in India. The use
and application of information technology in wide variety of insurers operations has
now become strategic in the sense that it has direct impact on the productivity resources
and sweepening impact on reducing the cost of various activities

• Database management system : To find out the profitable combination of

households or clients ,products and agents, a database with five to ten years
history is immense importance.
• Data warehouse :data warehousing technology is based on the integration a
number of information systems into a one shopping data base to achieve vision
of making company national in scope but regional in focus
• Decision supporting system: companies need to utilise decision support
system by implementing data warehouses that pull information from existing
legacy systems into a customer information database.
• Group linking software: it enables sharing of information and particularly
suits the documents heavy insurance business
• Imaging and work-flow technologies: the proposal forms may be scanned into
an imaging system data may be extracted for update to computer and for
automated under writing overflow may be implemented
• Mapping : insurers to meet different needs such as identifying the loss prone
areas or geographic claim analysis can use mapping technology
• Call centre technology :good computer service
• Video linking
• Cat models
• Intranet, Extranet and internet

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