CHAPTER 1

INSURANCE PRODUCT
Chapter Introduction

This chapter aims to provide you with an understanding of history of insurance,

insurance products, the various characteristics of an insurance product (such as
physical attributes, legal aspects, utility and financial aspects), the different
parties associated with an insurance product and their relationship with each
other.

Learning Outcomes

A. History of Insurance
B. Definition and characteristics of insurance products
C. Parties involved in insurance product transactions

IC-92 Actuarial Aspects of Product Development 1

Look at this scenario

If risk is like a smoldering coal that may start a fire at any moment, then
insurance is our fire extinguisher.

Insurance is a method of distributing the risk. The Chinese were among the first
ones to employ methods of risk distribution. The Chinese traders would
redistribute their wares across many ships to limit the losses caused as a result
of a single ship capsizing.

The first written insurance policy was found on a Babylonian obelisk monument
along with the code of King Hammurabi carved on it. The insurance product
then was basic in nature, and offered that for a small additional payment on the
loan, the debtor did not have to pay back his loan(s) if some personal
catastrophe made it impossible.

Insurance products have evolved a great deal since then, and we will be
examining the nature and attributes of modern insurance products.

2 IC-92 Actuarial Aspects of Product Development

A. History of Insurance

The story of insurance is probably as old as the story of mankind. The same
instinct that prompts modern businessmen today to secure themselves against
loss and disaster existed in primitive men also. They too sought to avert the evil
consequences of fire and flood and loss of life and were willing to make some
sort of sacrifice in order to achieve security. Though the concept of insurance is
largely a development of the recent past, particularly after the industrial era –
past few centuries – yet its beginnings date back almost 6000 years.

Life Insurance in its modern form came to India from England in the year 1818.
Oriental Life Insurance Company started by Europeans in Calcutta was the first
life insurance company on Indian Soil. All the insurance companies established
during that period were brought up with the purpose of looking after the needs
of European community and Indian natives were not being insured by these
companies. However, later with the efforts of eminent people like Babu
Muttylal Seal, the foreign life insurance companies started insuring Indian lives.

But Indian lives were being treated as sub-standard lives and heavy extra
premiums were being charged on them. Bombay Mutual Life Assurance Society
heralded the birth of first Indian life insurance company in the year 1870, and
covered Indian lives at normal rates. Starting as Indian enterprise with highly
patriotic motives, insurance companies came into existence to carry the
message of insurance and social security through insurance to various sectors of
society. Bharat Insurance Company (1896) was also one of such companies
inspired by nationalism. The Swadeshi movement of 1905-1907 gave rise to
more insurance companies. The United India in Madras, National Indian and
National Insurance in Calcutta and the Co-operative Assurance at Lahore were
established in 1906. In 1907, Hindustan Co-operative Insurance Company took its
birth in one of the rooms of the Jorasanko, house of the great poet
Rabindranath Tagore, in Calcutta. The Indian Mercantile, General Assurance and
Swadeshi Life (later Bombay Life) were some of the companies established
during the same period. Prior to 1912 India had no legislation to regulate
insurance business. In the year 1912, the Life Insurance Companies Act, and the
Provident Fund Act were passed. The Life Insurance Companies Act, 1912 made
it necessary that the premium rate tables and periodical valuations of
companies should be certified by an actuary. But the Act discriminated between
foreign and Indian companies on many accounts, putting the Indian companies
at a disadvantage.

The first two decades of the twentieth century saw lot of growth in insurance
business. From 44 companies with total business-in-force as Rs.22.44 crore, it
rose to 176 companies with total business-in-force as Rs.298 crore in 1938.
During the mushrooming of insurance companies many financially unsound
concerns were also floated which failed miserably.

The Insurance Act 1938 was the first legislation governing not only life insurance
but also non-life insurance to provide strict state control over insurance
IC-92 Actuarial Aspects of Product Development 3
business. The demand for nationalization of life insurance industry was made
repeatedly in the past but it gathered momentum in 1944 when a bill to amend
the Life Insurance Act 1938 was introduced in the Legislative Assembly.
However, it was much later on the 19th of January, 1956, that life insurance in
India was nationalized. About 154 Indian insurance companies, 16 non-Indian
companies and 75 provident were operating in India at the time of
nationalization. Nationalization was accomplished in two stages; initially the
management of the companies was taken over by means of an Ordinance, and
later, the ownership too by means of a comprehensive bill. The Parliament of
India passed the Life Insurance Corporation Act on the 19th of June 1956, and
the Life Insurance Corporation of India was created on 1st September, 1956,
with the objective of spreading life insurance much more widely and in
particular to the rural areas with a view to reach all insurable persons in the
country, providing them adequate financial cover at a reasonable cost.

Some of the important milestones in the life insurance business in India are:

1818: Oriental Life Insurance Company, the first life insurance company on
Indian soil started functioning.
1870: Bombay Mutual Life Assurance Society, the first Indian life insurance
company started its business.
1912: The Indian Life Assurance Companies Act enacted as the first statute to
regulate the life insurance business.
1928: The Indian Insurance Companies Act enacted to enable the government to
collect statistical information about both life and non-life insurance businesses.
1938: Earlier legislation consolidated and amended to by the Insurance Act with
the objective of protecting the interests of the insuring public.

1956: 245 Indian and foreign insurers and provident societies are taken over by
the central government and nationalised. LIC formed by an Act of Parliament,
viz. LIC Act, 1956, with a capital contribution of Rs. 5 crore from the
Government of India.

2000: Indian insurance industry privatised and several private players including
banks came into life insurance sector. E.g. ICICI prudential, HDFC Standard life,
Birla Sun life etc. 26% of foreign stake was allowed.

4 IC-92 Actuarial Aspects of Product Development

B. Definition and attributes of insurance products

1. Concept of an insurance product

Definition

An insurance product is a ‘promise’ sold by an insurer to a policyholder either

through an agent/broker or through his direct sales force which sets terms and
conditions between the insurer and the policyholder with regard to payment of
specified benefits on the happening of specified event(s) such as death.

An insurance product is a finished good (or service) designed to meet the needs
of a customer. Mobile, for instance, is a consumable product, because it meets
the communication needs of a customer.

2. General product categories

We observe that certain products are consumed for day-to-day use, such as
tooth brush, tooth paste, bath soap, water, food, etc. Certain products are used
to produce some utility such as happiness, entertainment, security (financial or
otherwise), travel, etc. Some are used temporarily to satisfy a specific need and
are of perishable nature, such as a banana, apple, cooked food items, petrol,
diesel, kerosene, etc.

All products are designed to meet the need and/or wants of a person. Thus,
every product has some utility.

While nature produces certain products (plants, trees, animals, etc.), some
products are made by man for consumption, to meet the necessities of life.
Manufactured products require some resources, which are either from nature or
made from nature. For instance, ‘cement’ is a product used in constructions of
buildings. For manufacture of cement, raw materials are needed such as water,
stone, etc.

3. Attributes of a product

The primary attributes of a product are as follows:

a) Shape (physical form) of product

An insurance product is not seen physically, unlike a bar of soap or a TV

set, which one can see and feel. An insurance product is only a piece of
paper (legal document with insurance stamps). It looks similar to a paper
ticket for travel in a train or an aeroplane.

Just like a bus ticket gives the holder right to do the particular journey on
that bus, an insurance product is a legal document which gives the holder of

IC-92 Actuarial Aspects of Product Development 5

 the document legal rights with certain conditions. The document enables
one to get compensation or fixed sum under specified circumstances. If such
document is lost, it can be replaced with a duplicate one subject to certain
conditions imposed by the insurer.

b) Term of the product

Most of the products start giving benefit as soon as they are purchased. For
example, Television, which can be used to satisfy entertainment needs can
be used from the day it is purchased. However, the price can be paid in
lumpsum or as EMI every month if available. These products can have a long
life like fixed assets or short life such as orange.

Life insurance products are just opposite to this. Price or premiums start
much before the payment of actual benefit. Even it is not known when the
benefit will be paid for e.g death benefit. It is a very long term contract
which requires commitment to pay the premiums on time to get the benefit.

One exception to this is the immediate annuity contracts, where the benefit
starts as soon as the single premium is paid.

In general insurance products, even the premium is paid every year, there is
no certainty of benefit payment. E.g. motor insurance paying on accident.

c) Utility of product

Every insurance product has utility, similar to any goods, such as pizza,
which is useful to satisfy hunger. People buy insurance products to meet
their need for financial security of their family or of themselves in their old
age. Money is needed to meet basic needs of life, even while a person is
unable to earn it.

A man feels financially secure if he could satisfy his basic and other needs of
life. A person earns income (money) not only to satisfy his needs/wants, but
also to meet the needs of his dependants who cannot earn or do not have
any resource.

An insurance product is useful to the customer because it secures monetary

compensation for the customer on the occurrence of certain untoward
events. The monetary compensation can be used by the customer or his
legal heirs to somewhat restore the financial status to the position that
existed before the event occurred.

6 IC-92 Actuarial Aspects of Product Development

The following table explains how certain events can cause financial concerns for
a secure life:

Table 1.1

Occurrence of event in the case of a life assured – and the financial problem

Event Financial Problem

a) Funeral Expenses – to bury or cremate the dead body and
meet the expenses for ceremonies which ensue after
death.
b) Flow of regular income to family gets stopped, but the
Death family requires money to live. (Family could be spouse
and children who are dependent on the life assured’s
income).
c) There can be loans which need to be honoured leading to
sale of estates of died person, leaving family in distress.
Accident which a) Hospital expenses for treatment.
causes injuries b) Flow of regular income to the family gets stopped
to body temporarily.

Accident which a) As in item 1, but there could be legal expenses too since
causes death accident may involve litigation.
a) Flow of regular income gets stopped - it is necessary to
have financial support to take care of old age needs.
Old Age b) Funeral expenses to be paid in case of death due to old
age.
c) Higher chances of falling ill needing money for treatment
Sickness As in item (2)

Such events are not covered per se, but provided by insurers
by offering monetary benefits at certain intervals during the
period of contract (called Survival Benefits, Partial
Other Financial
Withdrawals/ Surrenders to provide some liquidity to a
Needs
customer) so that these could meet certain needs such as (a)
Education Expenses for children (b) Marriage Expenses (c)
Purchase of certain capital items needed for family, etc.

Note: Utility expected is referred to as ‘economic value’ - usefulness to the

individual/person in terms of money.

d) Types of Product Utilities

Every product has five types of utility. Insurance product also provides all
these utilities.

IC-92 Actuarial Aspects of Product Development 7

 i. Political utility

The social power granted by a product refers to its political utility e.g. a
costly car may improve the social acceptance of the owner.

ii. Economic utility

The financial power granted by a product refers to its economic utility

e.g. gold ornaments and diamonds increase the financial stability of an
individual.

iii. Social utility

The social benefit granted by a product refers to its social utility e.g. a
solar panel providing electricity to an entire village is of great social
utility.

iv. Philosophical utility

The social morality decides the philosophical utility of the product e.g. a
bottle of wine has less philosophical utility as compared to a religious
book.

v. Aesthetic utility

The sensory appeal of a product decides its aesthetic utility e.g. a

colourful vase with a beautiful shape is of greater aesthetic utility
compared to a black vase.

e) Legal aspects of a product

Insurance products are legal contracts. A legal contract is a stamped paper

duly signed by the insurer, setting out terms and conditions. This is referred
to as ‘policy bond’, ‘insurance contract’, or ‘insurance policy’.

i. Issues related to the policy document

 The policy document is legally negotiable.

 Language used in the contract is not easily understood by a
layman. Many terms such as non-forfeiture conditions, definition
of accident, etc. are complex in nature.
 Font size is small, and one would find it difficult to read.
 If there is any dispute over settlement of claim, courts interpret
the terms mentioned in the contract.
 In some countries, standard text/wording is used in insurance
contracts but in many other countries, the insurance contract
language is written by the insurer, and rarely gets vetted by
insurance regulators.

8 IC-92 Actuarial Aspects of Product Development

  Efforts are being made by consumer associations, insurers’
associations and regulator to make such contracts as simple and
understandable as possible.

ii. Appellate authorities for insurance disputes

Not all beneficiaries of insurance policies would go to court. Many prefer

to go to consumer grievance cells in the offices of insurers, and knock on
the doors of the insurance regulator and insurance ombudsmen for
justice. Some approach consumer forums. Very rarely, beneficiaries go
to courts for justice.

Throughout the world, consumer grievances are predominant. Hence it is

necessary to have a serious look at the design of insurance contracts
with comprehensive terms and conditions. This is, however, easier said
than done.

iii. Documents related to insurance products

 In most countries, the application for insurance (called the

proposal form) is part and parcel of an insurance contract.
 This is the basis on which insurance would be granted.
 In the case of lives assured that are subject to medical
examination, the medical examiner’s reports and medical reports
would be part of the proposal form along with the insurance
contract.

iv. Commencement of an insurance contract

 An insurance contract is a concluded contract if the first

premium is realised by the insurer.
 Risk is not assumed by the insurer unless the insurer receives
premium which is realised into cash.
 Some insurers issue insurance contracts with a condition that, in
case of payment by cheque, the contract is valid only if the
cheque is realized.
 When a cheque is dishonoured after the date of policy but before
the death of the life assured, such insurance contracts are in
dispute.
 Even though many precautions are taken by insurers, they face
problems with regards to ‘unconcluded’ contracts.

IC-92 Actuarial Aspects of Product Development 9

 v. Persons competent to contract

A proposer (the applicant or the prospect who wants to buy an

insurance product) can enter into a contract if he/she:

 Is a legal person – i.e. an individual whose age is at least 18 years

at the date of proposal (application for insurance product) and
mentally sound, or a corporate entity who can enter into a
contract by law (as per the Contract Act).
 A major – i.e. a minor person cannot enter into a contract as a
proposer. A minor can be life assured – life insurance cover can
be obtained for him. A minor can be a beneficiary under the
contract, provided a legal guardian is appointed.
 An illiterate person - who is also a legal person provided a
declaration is obtained from a person known to the illiterate
person that he has understood the consequences of entering into
the contract.
 Is an individual who is mentally stable. A mentally unstable
person cannot enter into a contract. He can be a beneficiary
under the contract, provided a legal guardian is appointed.
 A person who cannot sign in view of a physical deformity - (e.g.
one who lost both hands or whose hands do not permit him to
sign due to health grounds) can also enter into a contract,
provided that he holds a power of attorney granted by a court as
per the Contract Act.

Test Yourself 1

Who among the below is not allowed to buy an insurance product?

I. A senior citizen
II. A person above 18 years of age
III. A person below 18 years of age
IV. An unmarried woman

10 IC-92 Actuarial Aspects of Product Development

C. Parties involved in insurance product transactions

1. Parties to a life insurance contract

A life insurance contract is a contract between the proposer and the insurer
over the life of the assured. The insurer, proposer and life assured are all bound
by certain conditions as per the contract of insurance.

Relationship between proposer and life assured

When the proposer and the insurer enter into a life insurance contract, the
following scenarios can occur:

 The proposer and life assured are two different persons

 The proposer and life assured are the same.

A proposer is usually referred to as ‘policyholder’, and ‘policy-owner’ indicating

that the he/she/they entered into a contract with an insurer to own the
contract (policy).

Life assured can be an individual on whose life insurance cover is being granted.

Life (lives) assured can be of a group of individuals. There can be more than one
life assured – e.g. two lives – husband and wife, individual A and individual B, a
family consisting of husband, wife and children, employees of an employer.

An insurer would ensure ‘insurable interest’ between proposer and life assured,
otherwise, he might end up dealing with financial frauds and disputes.

2. Concept of insurable interest

Insurable interest means that the proposer (or the life assureds’ family
members - could be referred to as ‘beneficiary’) could face financial problems
in the event of death of the life assured since the beneficiary is dependent on
the earning of life assured.

A wife has insurable interest in her husband and vice versa. An employer has an
insurable interest in his employees. A lender has an insurable interest in his
borrowers to the extent of outstanding loan amount. An individual has insurable
interest in his/her life to the extent of financial support to his/her family or to
himself/herself in old age.

Insurable interest stresses financial dependence earnings, but not unearned

income such as rents, interest, etc. which might be received with certainty.
Earned income such as daily wages, salary, etc. could only be received if earner
discharges certain functions; otherwise, he does not receive income. Therefore,
there is no certainty of flow of income in the case of earned income in the
event of sickness/death.
IC-92 Actuarial Aspects of Product Development 11
Therefore, insurable interest has properties of:

 Definite relationship between two parties

 Financial commitments if future earnings cease

Most insurance contracts are individual contracts (only one life assured is
involved) and group contracts (where more than one life assured is involved.

Example

Mr. George is aged 40 and gets a salary of Rs.10 lakhs p.a. He has dependents
i.e. his wife and two children. He takes a policy on his life to protect his family
from the financial hardships arising in the event of his death.

Let us try and understand the above situation carefully.

Mr. George has insurable interest in his life so he can buy a policy on his life. If
he dies, insurance proceeds go to his wife who would take care of the family. If
he survives the maturity date, insurance proceeds go to him which would take
care of his old age.

3. Rights of Nominees, Assignors and Legal Heirs

a) In the case of contracts where policyholder and life assured are the
same, the beneficiary is usually the policyholder on maturity, and in
case of death before the expiry of the contract, it is the nominee or
legal heir.

b) ‘Nominee’ is created in law for the purpose of discharging the insurer’s

liability, so that the nominee could pass the policy money to the legal
heirs who have a right over the estate of the policyholder.

c) An assignor has a right over the policy monies to the extent of his/her
interest [assignors would be usually banks, housing loan companies,
insurers, and lenders who wish to have security against the loan granted
to the policyholder] and this right can be exercised only if assignment is
registered as endorsement in the insurance contract.

4. Who would buy insurance products?

Insurance products are rarely purchased...these are sold in the market through
soliciting by distributors (agents, brokers, insurer’s sales men). Distributors
need to convince customers to purchase insurance products by explaining the
importance of ‘protection’ as well as saving.

This is different from other basic products which are needed every day for
consumption, such as tooth-paste, soap, cloth, houses, milk, transport, etc. An
individual is forced to come to a shop or a store to purchase the basic product.
12 IC-92 Actuarial Aspects of Product Development
Life insurance products are generally not given priority by individuals. Reasons
for this could be:

a) Lack of awareness: Customers are unaware of such products and their

utility. People are not aware of their need for insurance.

b) Even though they are aware, priorities are different in view of limited
savings and financial capabilities.

c) Complexity of insurance products: Insurance products are complex;

language in the insurance documents - sales literature, proposal form,
insurance contract etc. - is full of technical jargon, and not easily
understood and also not explained.

d) Service rendered by distributors and insurers (including settlement of

claims) after sales is not as expected.

e) Unavailability of right products to meet the needs of the customers.

f) People may not have trust in insurers and the products designed by
insurers.

g) Alternative savings instruments: Other instruments of savings may be

through to be more attractive such as mutual funds (expected high
return), fixed deposits (liquidity), government bonds or public provident
funds (security).

h) Facilities for purchase of contract not easily available– [no sales counters
in the offices of insurers, no distribution person (agent) available to
render advice etc. However, this not the major issue now because of
plenty of information and sale on internet.

It is necessary to have a wide range of insurance products to meet the insurance

needs of all types and segments of people - children, youth, old, married,
single, men, women, fixed income groups, self-employed groups, un-organized
groups, farmers, casual workers, etc.

IC-92 Actuarial Aspects of Product Development 13

 Normally, we expect the following persons to buy insurance products:

Table 1.2

Type of persons Type of products Reasons

To get payments on vesting to
Children Deferred Assurances meet education expenses,
marriage expenses etc.
To get payments (periodic
Deferred Assurances, payments) on vesting to meet
Students
Money Back Plans education expenses, marriage
expenses etc.
Employees with
Endowment Assurances,
fixed incomes, To provide savings for family
Money Back Plans, Unit
self-employed (dependants), for old age or to
Linked Plans, Deferred
persons with meet funeral expenses.
Annuity contracts
regular incomes
Retired
employees Immediate Annuity As old age income and also to
(retiring Contracts meet funeral expenses.
employees also)

Casual workers, Term Insurance To get lump sum payments for

Unorganised Contracts with Accident dependants or to meet funeral
workers Benefits expenses.

Deferred Annuity
Old age income or to meet funeral
Single Persons Contracts, Immediate
expenses.
Annuity Contracts

Term Insurance Lenders need security for the

/Decreasing Term outstanding loan in case of death
Borrowers
Insurance (Mortgage or permanent disability of the
insurance policies) borrower.

Test Yourself 2

Which of the below statement is false?

I. A person can buy insurance for himself

II. A husband can buy insurance for his wife
III. A wife can buy insurance for her husband
IV. A person can buy insurance for his friend

14 IC-92 Actuarial Aspects of Product Development

Summary

a) Insurance is a promise given by the insurer that grants protection to the

insured against a specific loss under certain conditions.

b) Insurance contracts are legal contracts designed to meet the customer’s

need of a secure financial future.

c) Only persons of sound mind, majority age and those permitted by law can
enter into an insurance contract.

d) Insurable interest ensures that the proposer does not gain undue financial
advantage by effecting a contract of insurance.

e) Insurance products are mostly sold and rarely purchased mainly because of
lack of awareness and several other factors.

Answers to Test Yourself

Answer 1

The correct option is III.

A minor cannot enter into a contract of insurance. He can only be the

beneficiary.

Answer 2

The correct option is IV.

A person has no direct insurable interest in his friend and hence cannot buy
insurance for his friend.

Self-Examination Questions

Question 1

Insurance is purchased to ______________.

I. Obtain financial security

II. Invest money
III. Place a bet
IV. Lower tax liability

IC-92 Actuarial Aspects of Product Development 15