Module-2

Risk Management Techniques: Risk avoidance - Risk retention - Risk

reduction and control - Risk financing, Difference between Insurance
and Assurance, Roll of the actuary. Different types of risks – actual and
consequential losses – management of risks – loss minimization
techniques-Management of risk by individuals –management of risk by
insurers – fixing of premiums. Reinsurance: foundation of reinsurance –
forms of reinsurance.
RISK
• Risk means exposure to danger.
• Risk may means that there is a possibility of loss or damage.
• It may or may not happen.
• In business the risk may be defined as the danger of loss from
unforeseen circumstances.
Meaning of Risk
• Risk is defined as uncertainty of loss.

• Examples: premature death of a family head, car accident,

sickness or injury, unemployment, destruction of a home
and personal property.
• According to LIC of India, risk may be defined as “ a condition where
there is a possibility of an adverse deviation from a desired outcome
that is expected or hoped for; there is no requirement that the
possibility be unmeasurable, only that it must exist”.

• The concept of risk may be distinguished from peril and hazard

• Peril is the cause of loss .for example fire, wind, storm, hail or theft.
• Hazard is a condition that may create or increase the chance of loss
Objective Risk vs. Subjective Risk

Objective risk (degree of risk) is defined as

the relative variation of actual loss from
expected loss
• It can be statistically calculated using a
measure of dispersion, such as the
standard deviation
Eg. Assume that a property insurer has 10000 houses
insured over a long period and on an average, 1% or
100 houses burn each year. However it would be rare
for exactly 100 in some years 90 or 110 houses may
burn. Thus there is a variation of 10 houses from the
expected number of 100. This relative variation of
actual loss from expected loss is known as objective
risk.
Subjective Risk

Subjective risk is defined as uncertainty based on a person’s

mental condition or state of mind .
Eg . A drunken person attempts to drive home. He
may be uncertain whether he will arrive home safely
without being arrested by police for drunk driving.
This mental uncertainty is called subjective risk.
Peril and Hazard
A peril is defined as the cause of the loss

• In an auto accident, the collision is the

peril

• If the house burns because of a fire the

peril or cause of loss is fire
• Hazards can be classified into following three categories
1. Physical hazard
2. Moral hazard
3. Morale hazard
• Physical hazards are physical conditions that increase the
chance of loss
(icy roads- chance of accidents, defective wiring-chance of fire,
defective lock-chance of theft)

Moral hazard is dishonesty or character defects in an

individual, that increase the chance of loss (faking
accidents, inflating claim amounts)
Attitudinal Hazard (Morale Hazard) is carelessness or
indifference to a loss, which increases the frequency or
severity of a loss (leaving keys in an unlocked car) related
to mental condition of the person

• Legal Hazard refers to characteristics of the legal system or

regulatory environment that increase the chance of loss
(large damage awards in liability lawsuits)
Classification of risk
• From practical point of view, the risk can be classified into:

a) Financial and Non-financial risks

b) Static and Dynamic risks
c) Fundamental and Particular risk
d) Pure and speculative risk
Financial vs non-financial
• Financial risks
If any risk is concerned with financial loss it is termed as a financial risk.
For example, the presence of borrowed money or debt in the capital
structure
Non-financial risk
Financial risk is avoidable risk to the extent that managements have the
freedom to decide to borrow or not borrow funds. A firm with no debt
has no financial risk.
Other than financial consequences(only incidental)those risks are
referred to as non-financial risks.
Static vs dynamic
• Static risk
Static risk involve losses resulting from the destruction of an asset or
changes in its possession as a result of dishonesty or human failure.
For example: dishonesty, carelessness, incompetence, death pf responsible
officer
Dynamic Risk
Dynamic risk involves losses mainly concerned with financial loss. It also
effect the public.
Changes in price level, Foreign exchange losses, bad publicity, worker
compensation claims, loss of production and assets are the few examples
Particular Risk and Fundamental Risk /
Diversifiable Risk and Non-diversifiable Risk

A Particular /diversifiable risk affects only individuals or

small groups eg -car theft. It is also called nonsystematic
or particular risk.

A Fundamental/non diversifiable risk affects the entire

economy or large numbers of persons or groups within
the economy (hurricane). It is also called systematic risk .
Pure and Speculative Risk

• Pure and Speculative Risk

A pure risk is one in which there are only the possibilities of

loss or no loss (earthquake, fire, flood)

A speculative risk is one in which both profit or loss are

possible (gambling)
Types of pure risk
• Personal risk-Some uncertainities arise out of human element
Premature death, Dependent old age ,Sickness or disability, Unemployment
• Property risk- refers to direct lossess/consequential losses
Loss of property, Loss of use of property and additional overhead expenses
occasioned by loss of property.
• Liability risk –is concerned with the losses which result from
unintensional injury to other persons or damages to their property
through negligence or carelssness
• Other risks-Any loss that occurs resulting from failure of another person
to meet an obligation is considered in this category.
Major Personal Risks
• Personal risks involve the possibility of a loss or reduction in income,
extra expenses or depletion of financial assets:

• Risk of Premature death of family head

• Risk of Insufficient income during retirement

 Most workers are not saving enough for a comfortable
retirement

• Risk of Poor health (catastrophic medical bills and loss of

earned income)

• Risk of unemployment
Property risks

Property risks

Risk that property may be damaged, destroyed or stolen .

For example, lightning, tornadoes, hurricanes,

explosions, riots, collisions, floods, earthquakes, etc.
Liability risks
• Liability risks

Legal judgments may result in payments made to

compensate injured parties as well as to punish those
responsible for the injuries.
Liability risk is concerned with those lossess which result
from unintentional injury to the other persons or damages
to their property through negligence or carelessness
• Government assistance may be necessary to insure non
diversifiable risks.

• Enterprise risk encompasses all major risks faced by a business firm,

which include: pure risk, speculative risk, strategic risk, operational
risk, and financial risk
Difference between insurance
and assurance
• Definition of Insurance
• The term ‘insurance’ is defined as a contract between two parties,
whereby one party (insurer or insurance company) promises to
indemnify the specified loss or damage incurred to the other party
(insured) for an adequate consideration, i.e. premium.
• Insurance is a risk transfer mechanism, which
guarantees monetary compensation, for the loss or
damage, as a result of an event beyond the control of
the insured party. The types of insurance are:
• Life insurance: The insurance that covers the life risk
of the person is known as life insurance. This type of
insurance is considered as assurance. Here the
total sum assured is paid to the insured on the maturity
of the policy or the family of the insured after his/her
demise.
• General Insurance: Any insurance other than the life
insurance is known as general insurance. It includes fire
insurance, marine insurance or miscellaneous
insurance. Here the compensation paid is equivalent to
the loss incurred to the insured.
Definition of Assurance

• A form of financial coverage, which provides

reimbursement, for an event that is sure to happen
(sooner or later), is known as assurance.
• One of the best examples of assurance is life insurance,
which covers the risk of the life of the policyholder.
• On the demise of the insured, the nominee will get the
sum assured.
• In life insurance, insurance policy amount is payable
only the occurrence of the event, i.e. death.
• Although, the life insurance also provides for payment
of the policy amount at the maturity of the policy by
 Life insurance is classified into three types:
• Whole life assurance: When the sum assured is payable only on the
event of the death of the insured is the whole life assurance.
• Term life assurance: When the sum assured is paid in lump sum on
the maturity of the policy term is called term life assurance.
• Annuity: When the sum assured is disbursed in the installment on
the maturity, rather than one shot payment is called annuity.
 The two main types of life insurance are temporary
and permanent.

Temporary life insurance, or term life insurance,

provides insurance for a certain period of time
specified at purchase,
whereas permanent insurance, or whole life
insurance, is used to provide lifetime coverage,
assuming the premiums are paid over the entire
period.
Fixed annuities provide a benefit that is fixed (or
known) for life,
whereas variable annuities have a benefit that can
change over time and that is generally based on the
performance of some underlying portfolio or
investment.
When selecting between fixed and variable annuities,
there are a number of important considerations, such
as the volatility of the benefit, flexibility, future
market expectations, fees, and inflation concerns.
MEANING OF RISK MANAGEMENT
• Risk management is a systematic process of identifying and assessing
company risks and taking actions to protect a company against them
RISK MANAGEMENT
• Risk management is the identification, assessment and prioritization
of risks followed by coordinated and economical application of
resources to minimize, monitor and control the probability and/or
impact of unfortunate events or to maximize the realization of
opportunities.
• Risks can come from uncertainty in financial markets, project failures,
legal liabilities, credit risk, accidents, natural causes and disasters as
well as deliberate attack from an adversary or events of uncertain
root-cause
THE EVOLUTION OF RISK
MANAGEMENT
• The field of risk management emerged in the mid-1970s, evolving
from the older field of insurance management.
• The term risk management was adopted because the new field has a
much wider focus than simply insurance management.
• In the 1980s and 1990s, risk management grew into vital part of
company planning and strategy and risk management became
integrated with more and more company functions as the field
evolved
Methods of Handling Pure Risk
(Risk treatment)
• There are five major methods for managing
risk

a. Avoidance of Risk
b. Loss control
c. Risk Retention
d. Non Insurance Transfers
e. Insurance
a. Avoidance of Risk
• Avoidance is one method of handling risk. Avoiding
certain situations in which losses might occur.

• Examples: To not get injured riding a

motorcycle, avoid riding a motorcycle.

• To escape injury from falling off a mountain,

avoid mountain climbing.
• Proactive avoidance
• Abandonment avoidance
One is owning a car and having driven it for sometimes meet with a
minor accident, that cause panic in him,ultimately forcing him to sell it
off.
 b. Loss control
Loss control consists of certain activities
that reduce the frequency and severity of
losses. Thus loss control has two major
objectives :-

• Loss prevention

• Loss reduction
Loss prevention
Loss prevention refers activities to
prevent or reduce the probability of loss so
that frequency of losses is reduced.

Eg 1 -Accidents can be reduced if motorist

take a safe riding course and drive
defensively.
Eg2 -The number of heart attacks can be
reduced if individuals controls their
weight, stop smoking, and eat healthy
diets
Loss reduction
• Loss reduction refers to activities to reduce
the severity of losses.

• Eg – A department store can install a sprinkler

system so that fire can be promptly
extinguished thereby severity of loss can be
reduced.

• Eg – A community warning system can reduce

the number of injuries and deaths from an
approaching tornado.
Risk Retention
An individual or a business firm retains all or part of a
given risk, is retains the obligations to pay for part or
all of the losses.

It is the easiest and cheapest way of dealing with

relatively small losses by paying out of one’s own
resources whenever they occur or by creating some
fund to meet such losses if their magnitude is some
what large.
The retention may be two types :

• Active retention means that an individual is

consciously aware of the risk and deliberately
plans to retain all or part of it.

Eg. a person riding motor cycle without

renewing insurance.
Passive retention means risks may be
unknowingly retained because of
ignorance, indifference, or laziness.

Eg:- An employer not insuring his workers,

against total or partial disability. If he
retain that risk it is very dangerous if the
workers met industrial accidents.
d. Non-insurance Transfers
A risk may be transferred to another party
by several methods:

 Transfer of risk by contracts

 Hedging price risks
 Incorporation of business firm
 Transfer of risk by contracts
• Unwanted risks can be transferred by contracts.
• A transfer of risk by contract, such as through a
service contract or a hold-harmless clause in a
contracts
Eg :- The risk of defective computer can be transferred
to service provider through annual maintenance
contract. The contractor is responsible for all repairs
and maintenances.
Hedging price risks
This is a technique for transferring the risk of
unfavorable price fluctuations to a speculator
by purchasing and selling forward contracts on
an organized exchange.

These contracts can be used to hedge risk ,i.e,

they may be used to offset losses that can
occur from changes in interest rates,
commodity prices, foreign exchange rates etc.
 Hedging price risks is a technique for
transferring the risk of unfavorable price
fluctuations through futures contracts.

A financial contract obligating the buyer to

purchase an asset (or the seller to sell an
asset), such as a physical commodity or a
financial instrument, at a
predetermined future date and price.
Incorporation of a business firm

• Incorporation of a business firm transfers to the creditors the risk of having

insufficient assets to pay business debts
e. Insurance
For most people, insurance is the most practical
method for handling a major risk
 Risk Management Process

Risk management is an integrated process of

delineating specific areas or risk, developing a
comprehensive plan, integrating plan and conducting
ongoing evaluation.
Risk management include mainly three aspects:-

1. Risk Analysis
2. Risk Control
3. Risk Financing
 I. Risk Analysis
Risk analysis divided in to two:-

a. Risk identification
b. Risk evaluation
Risk Identification
The first step in the process is to analyze the risk to
which an organization may be exposed.

It requires knowledge of the organization, legal,

social, economic ,political and climatic environment in
which it does it’s business, financial strength and
weakness, manufacturing process, management
system and business mechanism by which it operates.
 Any failure at this stage to identify risk may cause a
major loss for the organization.
Risk identification provides the foundation for risk
management.
The various methods of risk identification are:
Financial statement method
Flowchart method
Checklist method
Statistical records of losses
Interaction with others
Risk Evaluation

Risk evaluation breaks down into two parts, the

assessment of:-

1. The probability of loss occurring, and

2. Its severity

In order to quantify risk, value at risk is the most

popular measure.
Value at Risk

Value is measurable variable that depicts one’s desire

or state of affairs in a given set of circumstances.

Since circumstances never remain same for any

identity, what ever value is perceived or created is
always at risk.
VaR measures the worst expected loss over a given
horizon under the normal market conditions at a
given confidence level.

VaR measures the potential loss in value of a risky

asset or portfolio over a defined period for a given
confidence interval.
It is used by commercial and investment banks to
capture the potential loss in value of their traded
portfolios from adverse market movements over a
specified period, this can be compared to their
available capital and cash reserves to ensure that the
losses can be covered without putting the firms at
risk.
 II. Risk Control

It can be divided into two :-

a. Avoidance
b. Loss control
Avoidance

Risk control covers all those measures aimed at

avoiding, eliminating or reducing the chances of loss.
Limiting the severity of the losses that do happen.

Here, one is seeking to change the conditions that

bring about loss-producing events or increases their
severity.
Though some measures call for little more than
common sense, often considerable technical
knowledge is required, for which the risk manager will
need to turn experts in the particular field.
Loss control can be exercised in two ways:

a. One way is to enhance and monitor the level of

precautions taken to minimize the losses due to
exposures.
b. Another is to control and minimize the risk
operations, internal risk control techniques include
diversification and / or investments in getting
information of loss exposures so as to control them.
 III. Risk Financing

It can be mainly divided into two:-

a. Risk Retention
b. Risk Transfer
Risk Financing

When the risk exposure for an organization exceeds

the maximum limit that the organization can bear, it
becomes necessary to either transfer or reduce risk.

However, there is cost involved in both of these

exercises. If the method adopted is Insurance.
Risk financing therefore, refers to the manner in
which the risk control measures that have been
implemented shall be financed.

The primary objective of risk financing is to spread

more evenly over time cost of risk in order to reduce
the financial strain and possible insolvency which
random concurrency of large losses may cause.

The secondary objective is to minimize risk costs.

Risk Financing includes the following alternatives:-

Risk Retention
Risk retention implies that the losses arising due to a
risk exposure shall be retained or assumed by the
party or the organization.
• Self-insurance
It’s a form of planned retention by which the part or full of the
exposure arising due to a risk factor is retained by firm.
It act as a alternative to buying insurance in the market.
It may be done by keeping aside funds to meet insurable lossess.
• Captive insurance
• Pure captive company is a insurance company established by parent
company to provide insurance cover to itself and its subsidiaries
Risk Transfer
The two methods used are
• Insurance
• Non- insurance transfers
which includes hedging, incorporation, Diversification etc
What is an Actuary?
• An actuary is a professional who specialises in the
field of analysing financial risks by implementing
statistical, financial and mathematical theories.
• In insurance, actuaries aid in assessing risks which
help companies in the estimation of premiums for
their policies.
Role of an Actuary in an Insurance Company
• It is ideal for insurance companies to create policies that bear minimal
risk and can generate stable returns.
• Estimating risk and return from each proposal also in turn aids in
assuring policyholders that their claims will be settled.
• With regards to insurance, actuarial practices involve analysing factors
related to a customer’s life expectancy, construction of mortality
tables that help one to have a measurement of predictability and
offering insight to brokers.
• Actuarial science mostly finds its application in the life insurance
mortality analysis.
• However, they can also be applied in case of other general insurance
fields like property and liability insurance.
• Sometimes recommendations for the determination of premium for
insurance policies made by actuaries can also have a positive impact
on the behaviour of policyholders
• . For instance, premium payable by non-smokers for life insurance
policies is often significantly lesser than that for smokers.
• This might push individuals to quit smoking to avail their life
insurance policies at a lower premium.
• Who can be Appointed as Actuaries for Insurance Companies?
• As per the Appointed Actuary regulations put forth by the Insurance
Regulatory and Development Authority of India, any insurer or
insurance company should mandatorily appoint an actuary to manage
financial risks and uncertainty of the insurance business.
• To be appointed as an actuary with any insurance company, an
individual has to fulfil the following criteria, as put forth under
regulations:
• He/she should be a resident of India.
• Should be a fellow member as per the Actuaries Act, 2006.
• In the case of life insurance:

• He/she should have passed a specialisation subject related to life

insurance. Currently, specialisation refers to a Specialist Application
subject as put forth by the Institute of Actuaries in India.
• A prospective candidate should have at least 3 years of post-
fellowship experience pertaining to the annual statutory value of life
insurers.
• A minimum of 10 years’ experience in the life insurance industry, out
of which, at least 5 years should be that of the post-fellowship
experience.
• In the case of general insurance:
• He/she should have passed a specialisation subject related to general
insurance. As per the Institute of Actuaries in India, currently,
specialisation refers to a Specialist Application subject.
• He/she should have at least 1 year of post-fellowship experience
pertaining to the annual statutory value of a general insurer.
• A minimum of 7 years’ experience in the general insurance industry,
out of which, at least 2 years should be that of the post-fellowship
experience.
• in the case of health insurance:
• He/she should have passed a specialisation subject related to health
or general insurance. Similar to the above two categories, as per the
Institute of Actuaries of India, currently, specialisation refers to the
Specialist Application subject.
• He/she should have at least 1 year of post-fellowship experience
pertaining to the annual statutory value of a health or general insurer.
• A minimum of 7 years of experience in the general or health
insurance industry, out of which, there must be at least 2 years of
post-fellowship experience.
• Apart from these, an individual can be eligible for the position of
Appointed Actuary with any insurance company if they comply with
the following criteria:
• Should be an employee of an insurance company.
• Is not already appointed as an actuary with any other insurance
company in India.
• Is not over the age of 65 years.
• Possesses a Certificate of Practice from the Institute of Actuaries in
India.
• Has not committed any professional breach or is not guilty of any
other misconduct.
• Individuals satisfying the above criteria can be appointed as an
actuary for insurance companies by the IRDA.
Definition: Premium is an amount paid periodically to the insurer
by the insured for covering his risk.
Description: In an insurance contract, the risk is transferred from
the insured to the insurer. For taking this risk, the insurer charges
an amount called the premium
Life Insurance Premium
Life insurance premium is the recurring or one-time
payment you make towards your life insurance policy.

A life insurance policy is valid only if your pay the

premiums on time and according to the insurer’s
guidelines.
 In general, you have the option to choose the
frequency of premium payments such as monthly,
quarterly, half-yearly, yearly or single premium.
A factor of this premium is paid out as sum assured
when the benefits of the policy get activated.
The premium for life insurance policies varies
according to chosen plans as well as the credentials of
the applicant.
Usually, a younger, healthier individual will likely be
quoted lower premium than a person touching
his/her 50s.
Similarly, a non-smoker will get preferential premium
rates whereas a smoker is likely to be quoted a higher
amount.
There are various variables that play a part in
determining your premium amount and making your
own calculations can only take you so far.

This is where life insurance premium calculators

come into play.
Life Insurance Premium Calculator

A life insurance premium calculator is a tool that gives

you an estimated amount of premium according to
your chosen policy and technicalities such as tenure,
age, sum assured, premium frequency etc.
These calculators are available from the official
insurance providers for their exclusive list of products.
For instance, the Life Insurance Corporation of India
(LIC) has its own premium calculator for life insurance
policies.
Typically, a life insurance premium calculator includes
the following fields where information has to be
provided by you:
• Plan name
• Age of applicant
• Sum assured
• Premium frequency
• Tenure
• Riders, if any
The whole form takes less than a minute to fill up, and
once you have input all the required data and
preferences, an estimated figure of premium will be
displayed as result.

The result is an estimate as the insurer may go for

further details about your background that can affect
the premium calculations.
What’s an insurance premium?
An insurance premium is the money charged by
insurance companies for coverage.

The cost of an insurance policy depends on risk, which

in turn reflects the likelihood of the insurer making a
claim.

The lower the risk, the lower your premium will

generally be.
[Link] your lifestyle
The first step is to evaluate your lifestyle: whether you
indulge in too much drinking or smoking, or if you’re a
spendthrift, and so on.

This, in conjunction with your current income, will

help you determine how much life cover you will
need.
[Link] for inflation

It is imperative to consider the rate of inflation when

figuring out how much insurance you need to
purchase, as it can impact your premium rate.
Use a calculator
An insurance premium calculator is specially designed
to help you determine the actual premium you will
need to pay the insurer.
HDFC Life has a range of interactive tools and
calculators to compute the premium.
Depending on the insurance plan desired, you just
have to fill out information in the calculator and the
tool will present recommended plans.
 There are various factors that affect the cost of term
insurance premium rates, such as:
• Age of the applicant
• Current health history
• Intake habits
• Sum assured
• Tenure of the policy
Underwriting process

The amount of insurance premiums charged is

determined by calculations done by the underwriting
department of the insurance company. It depends on
their life history, age and health.
The information is gathered and analyzed to predict
how likely the insurance applicant will make a claim
on their policy.

The higher the probability of a claim, the higher the

premiums usually are.
For example, for health insurance, the process
involves investigation into familial diseases, analysis of
reports from the medical information bureau.

The company studies the data and uses it to predict

prospective losses due to death or sicknesses.
Factors affecting Health Insurance Premium

1. Pre-existing medical conditions: The policyholder

or applicant will need to provide your own health
records to ensure there aren’t any pre-existing
medical conditions.
But if, you do have any pre -existing conditions, then
the company can choose to allow it in their policies or
can even decide not to cover it, and if the insurance
company cannot cover it under the health insurance
then the policyholder will need to bear the costs.
Thereby increasing and affecting the premium.
2. Family medical history: If the policyholder’s family
have certain medical ailments their premiums may be
higher than others. No one can do anything with their
genes.

If the policyholder’s family has a medical history of

illnesses such as heart diseases, cancer or any other,
that puts you at a risk and it increases the individual’s
rate of premium.
3. Body Mass Index (BMI): People with high BMI have a
significantly higher rate of premium than people with
normal BMI.
The reason again being this can lead to various
ailments such as heart problems, joint problems,
diabetes, to name a few.
People with higher BMI may even need specialized
treatment, for normal procedures like pregnancy.

Thereby making even simple process a little tedious

and affects the premium rates.
4. Injurious substances: Most insurance companies
increase their rates of premium for their insurance
plans and at times even refuse to insure people who
have the habit of smoking, chewing tobacco .

Since they are most prone to getting life threatening

diseases like cancer. Thereby affecting the rates of
premium.
If you are a regular smoker you will be required to pay
a higher premium for your medical insurance due to
significantly higher health risks for smokers.

Insurer’s worldwide charge a higher premium to

diversify the higher risks associated with insuring a
smoker.
Regular smokers are more likely to be vulnerable to
issues such as lung cancer, stroke, heart disease,
asthma, chronic obstructive pulmonary disease
(COPD), and hypertension.
5. Gender: Many policies have a difference in premium
rates for men and women, the 3 reasons for this
experts say are - Women are more likely to visit
doctors, take prescriptions, and be subject to chronic
diseases.
6. Age: Most young individuals have premiums at
much lower rates since they have fewer identified and
unidentified diseases than older individuals.

Young policyholders are less likely to have health

problems and are more likely not to visit a doctor.
[Link]/occupation
Since your occupation plays a key role in your health
condition, it also plays a key role in how much health
insurance premium you are required to pay.
If you have a very stressful job or if you work in a
hazardous environment t, you are more likely to suffer
from significant medical issues and hence, you may be
charged a higher premium.
Policyholders working in environments with
hazardous substances, radiation, chemicals, and jobs
with high risk of injuries like constructions have to end
up paying higher premiums as per insurance
companies since they’re prone to risk of
cardiovascular diseases.
8. Marital status: It’s still unclear if married people live
longer and healthier lives, but the insurance
premiums generally lower in rates. The men generally
reap better benefits with this status change.
9. No insurance yet: If you’re not previously insured,
the insurance companies generally charge a higher
rate of premium.
The insurers believe that previously uninsured
individuals would make frequent trips to doctors and
hospitals to start reaping benefits of the health
insurance policy.
Therefore they increase the premium rates to cover
all expenses.
10. Location of stay: There are many insurance
companies who base their premiums on the location
in which the individual stays.
Many companies feel that shared climate, lack of
healthy food options, cultural aversion to exercise etc.
often come from same areas. And therefore the
similarities have lead companies to charge higher.
Loss Minimization
According to the Principle of Loss Minimization,
the insured must always try their level best
to minimize the loss of his insured property, in case of
sudden events like fire etc.
Hence, it is the responsibility of the insured to
protect his insured property and avoid further losses.
According to the Principle of Loss Minimization,
insured must always try his level best to minimize the
loss of his insured property, in case of uncertain
events like a fire outbreak or blast, etc.

The insured must take all possible measures and

necessary steps to control and reduce the losses in
such a scenario.
The insured must not neglect and behave
irresponsibly during such events just because the
property is insured.

Hence it is a responsibility of the insured to protect

his insured property and avoid further losses.
For example :- Assume, Mr. John's house is set on fire
due to an electric short-circuit. In this tragic scenario,
Mr. John try his level best to stop fire by all possible
means, like first calling nearest fire department office,
asking
neighbors for emergency fire extinguishers, etc.
He must not remain inactive and watch his house
burning hoping, "Why should I worry? I've insured my
house."
 What are the steps that an insurer can take for loss
minimization

• To appoint the right surveyor for the right job as per

IRDA guidelines and the only merit should be the
criterion for deputation of a surveyor by rotation.
[Link] surveyors are expected to take photographs of
damages to the vehicle from all angles and for all
parts.

Therefore the insurers should pay to the surveyor for

at least 24 photographs (without any duplications) for
major losses so that the surveyor may justify the
assessment.
The insurers should settle the surveyor’s professional
fee bills promptly and properly (strictly as per GIPSA
approved norms) so that the surveyors reciprocate
this good gesture by rendering high-quality service to
the clients of the insurance company.
3. To refuse renewal of policy to the insured who makes
unreasonable demands, lodges false claims or is an
expert habitual claimant.

All insurance companies should jointly form a data

bank where the claim history of such clients should be
stored and shared for future reference.
4. To dispose of off undisputed claims of clients
promptly with complete transparency and without
wasting the insured’s time in follow-ups.
If insurers save insured time, he would reciprocate by
accepting the justified assessment.
5. There should be specific guidelines for fixing IDV
( insured declared value) of a vehicle more than five
years old. Sometime down the line, IDV is fixed higher
than the actual market value resulting in loss to
insurers in case of Total Loss Assessment.

There should be a uniform system of applying excess

without any rebate in premium over and above the
compulsory excess for a vehicle of age beyond five
years.
6. Pre-insurance inspection and photography of the
vehicle by a surveyor should be made compulsory
whenever this is break-in insurance.
7. Insurance Policy copy must mention vehicle Engine
No., Chassis No., Registration No., type of vehicle,
model variants, year of manufacture & compulsory
excess/voluntary excess/imposed excess on OD claims
clearly for proper assessment.
Any activity in loss control can be more effective if
surveyors are taken into confidence.
Surveyor is a very important link between insurers
and the insured.
A healthy relationship of mutual trust and interest
will help in reducing the motor claim ratio.
Anything that goes wrong anywhere during the claim
process, the surveyor is not always responsible for it.
There is no job guarantee but he must sign an
affidavit that he is not engaged in any other
occupation.
He has to waste a lot of time and energy to secure a
job and for survey fee settlement.
 This infuses a sense of insecurity which adversely
affects the quality of reporting.

Unless the surveyor devotes his major time on the job

in hand, he cants deliver quality service in time.
Spot surveyors and final surveyors must mention the
identification number of major assemblies in their
report to verify the genuine replacements and try to
improve the quality of the survey report.

Reinspection surveyor must take the photograph of

salvage parts and note identification No. of newly
replaced parts or assembly.
• RISK MANAGEMENT FOR INSURERS

The Indian Insurance Industry has been seeing various

changes, some of which are very significant for the
overall development of a dynamic industry.
The success of insurance companies will be measured
not just in terms of profits earned or rates of return,
but equally by the quality of corporate governance
and risk management.
The issue of corporate governance assumes added
significance in insurance on account of the following
factors:

(1) since large public funds are involved, there is a

greater need for transparency of financial
management.
(2) worldwide, there is a move towards securing strict
adherence to high standards of disclosure and
compliance;

(3) universally accepted accounting standards are

emerging, imposing considerable discipline among
the players;
(4) operations such as pricing, risk management,
marketing, investment decisions need to be more
prudent and open.
The basic objective of management of an insurance
company is to ensure safety, security and growth of
policyholder's fund, and the primary objective of
Corporate Governance in an insurance company is to
protect the policyholders against insolvency by
efficient management of financial, accounting and
technical functions.
The major risks which need to be addressed by an
insurance company are basically of two types,
namely technical/insurance risk and investment risk.
Technical Risk : Risk of miscalculating premiums and
miscalculating technical provisions, and growth risk
arising out of excessive growth not matched by
sufficient resources or due to wrong selection or
wrong practicing of product.
Investment Risk: Investment Risk is considered to be
an important factor contributing to the insolvency of
an insurance company.
The major sources to investment risk are:
Depreciation. Risk arising out of depreciation value of
investment; Liquidity Risk arising out of inability of
timely encashment of investment; Matching Risk
arising out of insufficient cover of liability.
Derivative Risk arising out of off- balance sheet
operation, thin market, wrong pricing and Credit Risk
arising out of Reinsurance.
MANAGING FINANCIAL RISKS

Financial Risks in an Insurance Company can be

minimized through well-designed Corporate
Governance practices supported by regulatory and
voluntary initiatives, promoting sound financial
management practices. The major initiatives are:
[Link] Restrictions : Quantitative limits of
investments in various instruments and some features
are locations, prudent sound good management
quality and integrity-internal control, portfolio
diversification and locational dispersal of investment.
 Provisioning for probable investment risk, Accurate
Valuation and Asset Accounting for determining the
real value of actual liability of insurance company.

However, governance of investment strategy can also

play an important role in efficiency improvement and
risk minimization.
2. Active Investment Strategy : Stock selection and
marketing timing irrespective of trading costs form
the basis of this strategy.
The funds managers aim at beating the market by
taking the advantages of market movement.

Very often, there is over diversification, which adds

disproportionate cost to the fund thereon causing
strain on the performance of the funds.
Active investing requires reasonable knowledge in
market forecasting, macro economic and interest rate
forecasting etc. Very often, fund managers are
incapable of that and they may be unable to get out
of the market at an appropriate time and land up in
trouble with illiquid stocks.
3. Strategy Indexation : Indexation is a passive
investment strategy aimed at market return by
investing in stocks under a particular index. Indexation
strategy is cheaper and less technical and selection is
comparatively easy.
But the initial selection of stocks may be done easily
to avoid chronic under performing and stocks with
inflated premium.

Future potential for growth liquidity, must be taken

into account.

It is often thought that long term investment goal can

be achieved through indexing and the fund managers
remain totally passive about the internal dynamics of
the stocks.
[Link] of Value Investing : Value investing is a
painstaking strategy to discover future value of the
stocks by analyzing companies.

The in depth analysis of companies is undertaken to

discover long-term business value and the value of
the management.
Therefore, a close tie is established between the
company and fund managers, which enables the fund
to keep itself informed of the developments in the
long term perspective.
Value investing is thus developed on the relationship.
This relationship enables the fund managers to aim at
medium to long- term investment growth instead of
short-term speculative gain.
Management of Risk By Individuals
The risk management process for individuals is
complex given the variety of potential risks that may
be experienced over the life cycle and the differences
that exist across households.
The two primary asset types for most individuals can
be described broadly as human capital and financial
capital.
Human capital is the net present value of the
individual’s future expected labor income, whereas
financial capital consists of assets currently owned
by the individual and can include such items as a bank
account, individual securities, pooled funds, a
retirement account, and a home.
 There are typically four key steps in the risk
management process for individuals:

1. Specify the objective,

2. identify risks,
3. evaluate risks and
4. select appropriate methods to manage the risks,
and monitor outcomes and risk exposures and make
appropriate adjustments in methods.
 The financial stages of life for adults can be
categorized in the following seven periods:
• education phase,
• early career,
• career development,
• peak accumulation,
• pre-retirement,
• early retirement, and
• late retirement.
 The primary goal of an economic (holistic) balance
sheet is
• to arrive at an accurate depiction of an individual’s
overall financial health by accounting for the present
value of all available marketable and non-
marketable assets, as well as all liabilities.
 An economic (holistic) balance sheet includes

• traditional assets and liabilities,

• as well as human capital and pension value,
• as assets and includes consumption and bequests as
liabilities.
The total economic wealth of an individual changes
throughout his or her lifetime, as do the underlying
assets that make up that wealth.
The total economic wealth of younger individuals is
typically dominated by the value of their human
capital.

As individuals age, earnings will accumulate,

increasing financial capital.
Earnings risk refers to the risks associated with the
earnings potential of an individual—that is, events
that could negatively affect someone’s human and
financial capital.
Premature death risk relates to the death of an
individual, such as a family member, whose future
earnings (human capital) were expected to help pay
for the financial needs and aspirations of the family.
Property risk relates to the possibility that one’s
property may be damaged, destroyed, stolen, or lost.

There are different types of property insurance,

depending on the asset, such as automobile insurance
and homeowner’s insurance.
Liability risk refers to the possibility that an individual
or other entity may be held legally liable for the
financial costs of property damage or physical injury.
Health risk refers to the risks and implications
associated with illness or injury.

Health risks manifest themselves in different ways

over the life cycle and can have significant
implications for human capital.
The primary purpose of life insurance is to help
replace the economic value of an individual to a
family or a business in the event of that individual’s
death.

The family’s need for life insurance is related to the

potential loss associated with the future earnings
power of that individual.
 The two main types of life insurance are temporary
and permanent.

Temporary life insurance, or term life insurance,

provides insurance for a certain period of time
specified at purchase,
whereas permanent insurance, or whole life
insurance, is used to provide lifetime coverage,
assuming the premiums are paid over the entire
period.
Fixed annuities provide a benefit that is fixed (or
known) for life,
whereas variable annuities have a benefit that can
change over time and that is generally based on the
performance of some underlying portfolio or
investment.
When selecting between fixed and variable annuities,
there are a number of important considerations, such
as the volatility of the benefit, flexibility, future
market expectations, fees, and inflation concerns.
Techniques for managing a risk include risk
avoidance, risk reduction, risk transfer, and risk
retention.

The most appropriate choice among these

techniques often is related to consideration of the
frequency and severity of losses associated with the
risk.
An individual’s total economic wealth affects portfolio
construction through asset allocation, which includes
the overall allocation to risky assets, as well as the
underlying asset classes, such as stocks and bonds,
selected by the individual.
Definition - Reinsurance
Reinsurance is a transaction in which one insurer
agrees, for a premium, to indemnify another insure
against all or part of the loss that insurer may sustain
under its policy or policies of insurance.

The company purchasing reinsurance is known as the

ceding insurer, the company selling reinsurance is
known as the reinsurer.
It can also be described as “ insurance of
Insurance companies “

Reinsurance may be defined as the shifting by a

primary insurer (ceding company) of a part of the risk
it assumes to another company (reinsurer).

• That portion of the risk kept by the ceding

company is called the line, or retention.

• That portion shifted to the reinsurer is called

the cession.
• A method created to divide the task of handling risk
among several insurers.

• Often accomplished through cooperative

arrangements, called treaties.

• Also accomplished by using the services of specific

companies and agents organized for that purpose.
Retrocession

The process by which a reinsurer passes on

risks to another reinsurer is known as
retrocession
Objectives of Re-Insurance

1. To limit liability on specific risks

2. To stabilize loss experience
3. To protect against catastrophes
4. To increase capacity
Limiting Liability

By providing a mechanism in which companies limit

loss exposure to levels commensurate with net assets,
reinsurance allows reinsurance companies to offer
coverage limits considerably higher than they could
otherwise provide.
This function of reinsurance is crucial because it
allows all companies, large and small , to offer
coverage limits to meet their policyholders needs.
 Stabilization

Insures often seek to reduce the wide swings in profit

and loss margins inherent to the insurance business.

These fluctuations result, which involves pricing a

product whose actual cost will not be known until
sometime in the future.
Though reinsurance, insurers can reduce these
fluctuations in loss experience, thus stabilizing the
company’s overall operating results.
Uses and Advantages of Reinsurance

• Enlarges the ceding insurer’s financial capacity to

accept risk
• Stabilizes profits and evens out loss ratios
• Reduces the ceding insurer’s unearned premium
reserve requirement
• Offers a way for the an insurer to retire from
underwriting a given segment of its insurance
business.
TYPES OF REINSURANCE

There are two types of reinsurance:

1. Facultative Insurance

2. Treaty Insurance
 Facultative Reinsurance

Facultative reinsurance applies to an

individual risk

i.e., one commercial fire policy or even only one location.

Insurer and reinsurer agree to the reinsurance terms
on each individual agreement.
Treaty Reinsurance
Applies to an insurance company’s entire
book of business and the reinsurer is
required to accept them.

Some of these include all commercial fire

polices, all automobile policies, all workers’
compensation policies, all homeowners
policies, or, more generally, any combination
of the above.
• Treaty reinsurance is the one in which both pro-data
and excess of loss forms are

• Two basic types of treaties have been recognized

• Pro-rata treaties
• Premiums and losses are shared in some
proportion
• Excess-of-loss treaties
• Losses are paid by the reinsurer in excess of
some predetermined deductible or retention
• No directly proportional relationship exists
between their original premium and the
amount of loss assumed by the reinsurer