Final project insurance

An Overview of the Life Insurance Industry in India

UNIVERSITY PROJECT

“An Overview of the Life Insurance Industry in India”

Project Guide

PROF. SANDEEP CHOPDE

Project prepared by

Amit Baburao Bidaye

(Master in Financial Management)

MFM- III Year (2010-13), Semister –V

Roll No- 66

MET’S Institute of Management

Bandra (W) – Mumbai

Academic Year: 2012-2013

MET Institute of Management 1


Index

Executive Summary.................................................................3

Overview.................................................................................4

History....................................................................................4

The First Step….......................................................................4

A Brief History of the Life Insurance Sector..............................5

Insurance History in India........................................................6

Risk Management....................................................................7

Definition of Life Insurance......................................................8

Types of Insurance Companies.................................................9

The Transition Of Life Insurance.............................................10

The Insurance Regulatory and Development Authority (IRDA)..11

Life Insurance Market............................................................13

Industry Evolution.................................................................15

Bancassurance......................................................................18

Terminology Used..................................................................20

Law of Large number.............................................................21

Three Principals in Insurance Industry....................................23

Principal of Utmost Good Faith...............................................23

Principal of Insurable interest................................................26

Principal of Indemnity............................................................28

Human Life Value..................................................................29



Life Insurance Products.........................................................30

Term Insurance Plans............................................................33

Whole Life plans....................................................................34

Endowment plans..................................................................35

Joint Life Policies...................................................................36

Unit Linked Plan....................................................................37

Annuity.................................................................................39

Riders...................................................................................41

Premiums..............................................................................45

Underwriting.........................................................................47

Financial Underwriting...........................................................51

Life Insurance Accounting......................................................53

The Role of Portfolio Management:.........................................55

Implications of Cost Management:..........................................57

Organisational Structure........................................................58

Departments in a Life Office...................................................62

The Role of actuary in a Life Office.........................................64

Macro Economic Scenario & Insurance Industry Prospects.......66

Conclusion.............................................................................70

Bibliography..........................................................................72

Executive Summary



In India, insurance has a deep-rooted history. It finds mention in the writings of Manu ( Manusmrithi ), Yagnavalkya ( Dharmasastra ) and Kautilya ( Arthasastra ). The writings talk in terms of pooling of resources that could be re-distributed in times of calamities such as fire, floods, epidemics and famine. This was probably a pre-cursor to modern day insurance. Ancient Indian history has preserved the earliest traces of insurance in the form of marine trade loans and carriers’ contracts. Insurance in India has evolved over time heavily drawing from other countries, England in particular. 1818 saw the advent of life insurance business in India with the establishment of the Oriental Life Insurance Company in Calcutta. This Company however failed in 1834. In 1829, the Madras Equitable had begun transacting life insurance business in the Madras Presidency. 1870 saw the enactment of the British Insurance Act and in the last three decades of the nineteenth century, the Bombay Mutual (1871), Oriental (1874) and Empire of India (1897) were started in the Bombay Residency. This era, however, was dominated by foreign insurance offices which did good business in India, namely Albert Life Assurance, Royal Insurance, Liverpool and London Globe Insurance and the Indian offices were up for hard competition from the foreign companies. In 1914, the Government of India started publishing returns of Insurance Companies in India. The Indian Life Assurance Companies Act, 1912 was the first statutory measure to regulate life business. In 1928, the Indian Insurance Companies Act was enacted to enable the Government to collect statistical information about both life and non-life business transacted in India by Indian and foreign insurers including provident insurance societies. In 1938, with a view to protecting the interest of the Insurance public, the earlier legislation was consolidated and amended by the Insurance Act, 1938 with comprehensive provisions for effective control over the activities of insurers. The Insurance Amendment Act of 1950 abolished Principal Agencies. However, there were a large number of insurance companies and the level of competition was high. There were also allegations of unfair trade practices. The Government of India, therefore, decided to nationalize insurance business. An Ordinance was issued on 19th January, 1956 nationalizing the Life Insurance sector and Life Insurance Corporation came into existence in the same year. The LIC absorbed 154 Indian, 16 non-Indian insurers as also 75 provident societies—245 Indian and foreign insurers in all. The LIC had monopoly till the late 90s when the Insurance sector was reopened to the private sector.



This millennium has seen insurance come a full circle in a journey extending to nearly 200 years. The process of re-opening of the sector had begun in the early 1990s and the last decade and more has seen it been opened up substantially. In 1993, the Government set up a committee under the chairmanship of RN Malhotra, former Governor of RBI, to propose recommendations for reforms in the insurance sector.The objective was to complement the reforms initiated in the financial sector. The committee submitted its report in 1994 wherein , among other things, it recommended that the private sector be permitted to enter the insurance industry. They stated that foreign companies be allowed to enter by floating Indian companies, preferably a joint venture with Indian partners. Following the recommendations of the Malhotra Committee report, in 1999, the Insurance Regulatory and Development Authority (IRDA) was constituted as an autonomous body to regulate and develop the insurance industry. The IRDA was incorporated as a statutory body in April, 2000. The key objectives of the IRDA include promotion of competition so as to enhance customer satisfaction through increased consumer choice and lower premiums, while ensuring the financial security of the insurance market.

The insurance sector is a colossal one and is growing at a speedy rate of 15-20%. Together with banking services, insurance services add about 7% to the country’s GDP. A well-developed and evolved insurance sector is a boon for economic development as it provides long- term funds for infrastructure development at the same time strengthening the risk taking ability of the country

IRDA regulations and norms for the allocation of funds need to have a comprehensive look. In the phase of declining interest rates and rising inflation the funds need to be applied in productive areas so as to generate high returns. Also in terms of clients servicing areas such as premium payments, after sales service, policy dispatch, redressal of grievances has to be amended. In the current scenario, LIC has to provide flexible products suited to the customers requirements. Also a proper and systematic risk management strategy needs to be adopted. After the increase in terrorism and destructive events around the global world such as September 11 attack on World Trade Centre, US – Taliban war, US – Iraq war etc... An alternative to reinsurance such as asset backed securities is emerging out in the developed economies. Catastrophe bonds are one of the alternatives for reinsurance.

Finally some policies such as pure term and pension schemes needs to be addressed massively at both the urban and the rural segment so as



to generate high premium income which will help in the development and growth of the economy.

Overview

The purpose of Insurance is to cover Risk and the means of its existence in turn is Risk Management. All pervasive concepts, Risk Management is the bedrock of growth, survival and stability for organizations where increasing awareness and involvement of top management is evidenced in the process of establishing a "Risk Management Framework".

With the opening up of the insurance industry to the private sector in India, a plethora of opportunities with its attachment of 'Risk and Reward' has come across for all those associated with the insurance industry and more specifically, the insurance companies themselves.

Time and again, history has revealed that major events were bound to happen and should and could have been avoided by means of an effective Risk Management Framework. However, there will always be surprises, for Risk Management is a 'Continuum' where surprises add to the learning process and effectively reinforce the framework. Certain events are beyond organizational control and organizations can only take alternate mitigating steps, but cannot avoid the event.

Risks can be either transferred or retained. Either way, the objective is to minimize the losses expected to arise from the risks. Insurance Companies being the key risk transferees, who in turn retain based on risk appetite, have to exercise extreme due diligence in their risk management practices and establish a strong Risk Management Framework to ensure adequate solvency and their survival.

HistoryAlmost 4500 years ago, in the ancient land of Babylonia, traders used to bear risk of caravan trade by giving loans that had to be later repaid with interest when the goods arrived safely. In 2100 BC, the code of Hammurabi granted legal status to the practice. That, perhaps, was how insurance made its beginning.

Life Insurance had its origins in ancient Rome, where citizenes formed burial clubs that would meet the funeral expense of its members as well as help survivors by making some payments.

In 1347, in Genoa, European maritime nations entered into the earliest known insurance contract and decided to accept marine insurance as a practice.



The First Step…

Insurance as we know it today owes its existance to 17th century England. In fact, it began taking shape in 1688 at a rather interesting place called Lloyd’s Coffe House in London, where merchants, ship owners and underwriters met to discuss and transact business. By the end of the 18th century, Lloyed’s had brewed enough business to become one of the first modern insurance companies.

In IndiaMany may not be aware that the life insurance industry of India is as old as it is in any other part of the world. Insurance in India can be tracked back to Vedas. For instance, yogakshema, the name of Life Insurance Corporation of India’s corporate headquarters, is derived from the Rig Veda. The term suggests that a form of “community insurance “was prevalent around 1000 BC and practiced by the Aryans. The history of life insurance in India dates back to 1818 when it was conceived as a means to provide for English Widows. Interestingly in those days a higher premium was charged for Indian lives than the non-Indian lives, as Indian lives were considered more risky for coverage.

A Brief History of the Life Insurance Sector

The business of life insurance in India in its existing form started in India in the year 1818 with the establishment of the Oriental Life Insurance Company in Calcutta.

Some of the important milestones in the Life Insurance business in India are:

1912: The Indian Life Assurance Companies Act enacted as the first statue to regulate the life insurance business.

1928: The Indian Insurance Companies Act enacted to enable the government to collect satisfied information about both life and non life insurance business.

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 taken over by the central government and nationalized. LIC formed by an Act of parliament, viz. LIC Act, 1956 with a capital contribution of Rs. 5 corer from the Government of India.

1968: The Insurance Act amended to regulate investment and set minimum solvency margins and the Tariff Advisory Committee set up.

Insurance History in India



Risk Management

Risk Management is a scientific approach to the problem of dealing with the pure risks faced by the individuals and business.

Risk management deals with insurable and uninsurable risk & the choice of the appropriate techniques for dealing with them.

The emphasis in risk management is on reducing the cost of handling risk by whatever means that are considered most appropriate & insurance is one of several alternatives for minimising the pure risk faced by the firm.

The primary objective of risk management effort is to preserve the operating effectiveness of the organisations; to make sure that it is not prevented from attaining its goals by the losses arises from pure risk. The second objective is the humanitarian goal of protecting employees from an accident that might result in death or serious injury.

Risk identification is the first important step in risk management.

The next step is the analysis & measurement of risk to know the severity of risk and its frequency.

The next step is Risk Assessment in terms of frequency, its monetary cost & human cost.

Decision to deal with the risk could be any one of the following To retain the risk To deal with the risk through loss prevention To transfer the risk through insurance

The last step in Risk management is evaluation & review based on experience & business situation.



Definition of Life Insurance

“A contract that provides compensation for specific losses in exchange for a periodic payment.”

“An individual contract is known as an insurance policy, and the periodic payment is known as an insurance premium.”

“A system under which individuals, businesses, and other organizations or entities, in exchange for payment of a sum of money (called a premium), are guaranteed compensation for losses resulting from certain perils under specified conditions in a contract.”

Hence Insurance is

A sharing device

Contribution of many used to share losses suffered by few

Loss should occur as a result of natural calamities

No gains to be made out of insurance.The Insurance Act 1938 does not contain a definition of life insurance contract. But section 2(11) of the Act defines life insurance business as follows.“Life Insurance Business” means the business of effecting contracts of insurance upon human life, including any contract whereby the payment of money is assured on death (except death by accident only) or the happening of any contingency dependent on human life, and any contract which is subject to payment of premiums for a term dependent on human life and shall be deemed to include—The granting of disability and double or triple indemnity accident benefits, if so provided in the contract of insurance.

a) The granting of annuities upon human life, and



b) The granting of Superannuation allowance and annuities payable out of any fund applicable solely to the relief and maintenance of persons engaged or who have been engaged in any particular profession, trade or employment or of the dependents of such person.

Types of Insurance Companies

Insurance companies may be classified as:

Life insurance companies -Sell life insurance, annuities and pensions products.

Non-life or general insurance companies -Sell other types of insurance.

In most countries, life and non-life insurers are subject to different regulatory regimes and different tax and accounting rules. The main reason for the distinction between the two types of company is that life, annuity, and pension business is very long-term in nature — coverage for life assurance or a pension can cover risks over many decades. By contrast, non-life insurance covers usually a shorter period, such as one year.

Reinsurance Companies: Reinsurance companies are companies that sell policies to other companies, so that those companies can protect themselves from huge losses. Companies with a lot of fund have conquered the reinsurance market today.

Captive Insurance Companies- Captive Insurance Companies are the insurance companies that have been established for a particular reason for financing risk. In short these Companies are an in house self insurance vehicle. They provide coverage of risk that is neither available nor offered by usual insurance companies in the market at reasonable price. They are also known as “insurance consultants”. Like the mortgage brokers the insurance consultant companies are paid a fee by the customers to buy the best insurance policy from the best company.



The Transition Of Life Insurance

Effect of introducing competition

* Figures are of FY 07 – 08 Source: Life insurance Council



The Insurance Regulatory and Development Authority (IRDA)

Reforms in insurance sector were initiated with passage of IRDA Bill in parliament in Dec 1999.The IRDA since its incorporation as a statutory body in April 2000 has fastidiously stuck to its schedule of framing regulations and registration private sector insurance companies. The other decision taken simultaneously to support insurance sector and in particular the life insurance companies was the launch of IRDA’s online service for the issue and launch of renewal of licenses to the agents. The approval of institutions for imparting training to the agents has also ensured that insurance companies would have a trained workforce of insurance agents in place to sell their products.

Duties, Powers and Functions of IRDA:

Section 14 of IRDA Act, 1999 lays down the duties, powers and functions of IRDA.

(1) Subject to the provisions of this Act and any other law for the time being in force, the Authority shall have the duty to regulate, promote and ensure orderly growth of the insurance business and re-insurance business.

(2) Without prejudice to the generality of the provisions contained in sub-section 1, the powers and functions of the Authority shall include, -

(a) Issue to the applicant a certificate of registration, renew, modify, withdraw, suspend or cancel such registration.

(b) Protection of the interests of the policy holders in matters concerning assigning of policy, nomination by policy holders, insurable interest, settlement of insurance claim, surrender value of policy and other terms and conditions of contracts of insurance. (c) Specifying requisite qualifications, code of conduct and



practical training for intermediary or insurance intermediaries and agents.

(d) Specifying the code of conduct for surveyors and loss assessors.

(e) Promoting efficiency in the conduct of insurance business.

(f) Promoting & regulating professional organizations connected with insurance & re-insurance business. (g) Levying fees and other charges for carrying out the purposes of this Act. (h)Calling for information from, undertaking inspection of, conducting enquiries and investigations including audit of the insurers, intermediaries, insurance intermediaries and other organizations connected with the insurance business. (i)Control and regulation of the rates, advantages, terms and conditions that may be offered by insurers in respect of general insurance business not so controlled and regulated by the Tariff Advisory Committee under section 64U of the Insurance Act, 1938 (4 of 1938). (j) Specifying the form and manner in which books of account shall be maintained and statement of accounts shall be rendered by insurers and other insurance intermediaries.

(k) Regulating investment of funds by insurance companies.

(l) Regulating maintenance of margin of solvency.

(m) Adjudication of disputes between insurers and intermediaries or insurance intermediaries.

(n) Supervising the functioning of the Tariff Advisory Committee.

(o) Specifying the percentage of premium income of the insurer to finance schemes for promoting and regulating professional organizations referred to in clause (f). (p) Specifying the percentage of life insurance business and general insurance business to be undertaken by the insurer in the rural or social sector and



(q) Exercising such other powers as may be prescribed

Life Insurance Market

Life insurance in India is an underdeveloped market that was only tapped by the LIC before the entry of private insurers. The penetration of life insurance products was 19% of the 400 million insurable populations. LIC sold insurance as a tax instrument, not as a product giving protection. Most customers were under-insured by international standards, with no flexibility or transparency in the products. With the entry of private insurers, the rules of the game have changed.

Innovative products, smart marketing and aggressive distribution have enabled fledgling private insurance companies to sign up Indian customers faster than anyone expected. Indians, who had always seen life insurance as a tax saving device, are now suddenly turning to the private sector and snapping up the new innovative products on offer.

The growing popularity of the private insurers shows in other ways. They are minting money in the new niches that they have introduced. The state-owned companies still dominate segments like endowments and money-back policies. But in the annuity or pension products business, the private insurers have already wrested over 33% of the market. And in the popular unit-linked insurance schemes, they have a virtual monopoly, with over 90% of the customers.

Barriers to buy Life insurance

Unsure about Private Life insurance companies

Lot of paper work formalities

Low rate of returns and High Premium

Unsure whether the family gets the claim after death



Lack of knowledge about life insurance sector

Poor service by insurance agents

Reduction in the policy value due to inflation

Growth Stages of Insurance Industry

As on 1st Oct 2009 the premium collection of the life insurance industry grew by around 44 per cent to Rs 9,044.18 crore in August this

year as against Rs 6,273.57 crore in the same period last year, according to IRDA data.

The private life insurance segment, however, witnessed a negative growth of around 8 per cent, while the Life Insurance Corporation of India (LIC) registered a whopping growth rate of 83 per cent in premium collection in August.

LIC garnered a premium of Rs 6,544.99 crore in August this year as against Rs 3,562.93 crore in the corresponding period of the previous



year, the Insurance Regulatory and Development Authority (IRDA) said.

Premium collection of private life insurers stood at Rs 2,499.20 crore during the month as compared to Rs 2,710.65 crore in August 2008.

Among private life insurers, ICICI Prudential Life registered a negative growth rate of 16 per cent with a premium collection of Rs 524.97 crore in August this year as against Rs 627.91 crore in the corresponding period last year.

Bajaj Allianz Life's premium collection was Rs 289.57 crore during the month under review, down by 25 per cent, as against Rs 389.73 crore in the year-ago period.

Industry Evolution Up to 1999

1999 till 2002

2003 onwards

No. of Players

LIC Monopoly No Private Players allowed

Private Players allowed12 new insurers

12 Private PlayersLIC loses 12% share

Distribution Focus

Agency only800K LIC agents

Agency model replicatedLittle confidence in BA(Bancassurance)

Confidence in BABA takes 20% + share among Private PlayersAlignment of most Banks for exclusive arrangements

Regulatory Environment

LIC of India ActInsurance Act 1938

IRDA Act 1999Primarily Agency driven regulations

BA regulations become clearerMultiple models allowed- CA, Broking

Opportunity in India



The size of the insurance market with only 20 per cent of the insurable population currently insured, presents an immense opportunity to new players. Foreign insurance majors have entered the country in a big way & have started joint ventures in both life and non-life areas.

Opportunities in Rural India

Over 70% of Indian population living in rural areas.

There are 6 lakhs villages in 452 headquarters.

54% of the GDP comes from rural areas

Rural people have a higher propensity to save and Good income levels in upper rural segments

The compelling need to address in Rural segment-India’s vulnerability to natural disasters makes insurance coverage to rural areas an urgent necessity

About 60% of Indian landmass is prone to earthquakes

Over 40 million hectors is prone to floods

About 8% of the total area is prone to cyclones

Over 68% of the area is susceptible to drought

In the decade 1990-2000, an average of about 4344 people lost their lives and about 30 million people were affected by disaster every year

Road blocks to rural markets

Lack of adequate communication and transport facilities Absence of adequate distribution facilities and Low literacy level Dispersed and thickly populated markets Low per capita income and poor standard of living Religious and language diversity



Cultural and social diversity Insurance specific concern Low insurance awareness Non availability of distribution channels Infrastructure deficiencies

Challenges to Life Insurance Sector

The awareness regarding insurance is strong among people, but there are problems. The peculiarity of this market is that people tend to buy policies to save tax, which is why the three months prior to the end of financial year are when most of life insurance business is conducted; this is followed by ‘nothing’ periods. But insurance also offers protection against death and disability, besides being a savings instrument.

The challenge is to change the mindsets of people through education about the need-based sale of life insurance. We have to convince people to park their hard-earned money in long-term insurance & savings. But this will take time. Companies need to use trained agents & advisors to bring about this change in perception. Also, consumers were accustomed to having a single, dominant player for too long. With privatization, plenty of companies have entered the fray & they are offering too much choice. This has resulted in the consumer getting


Phase III

Insurance Penetration (Premiums /

GDP)

Economic Development of Country(GDP / Capita)

Phase I Phase II

INDIA INDIA

BrazilChina

BrazilChina

USJapanUK

USJapanUK

S-Curve of Insurance

Market Development

Nascent Market

Fully Mature Market

Transitional Market


confused and either making wrong decisions or making none at all. Hence we need to focus on insurance education.

Bancassurance

Bancassurance is the term used to describe the sale of insurance products in a bank. The word is a combination of "bank" and "assurance" signifying that both banking & insurance is provided by same corporate entity. The usage of word picked up as banks & insurance companies merged and banks sought to provide insurance, especially in markets that have been liberalized recently. It is a controversial idea, and many feel it gives banks too great a control over the financial industry.

In the short term, regulations will have a pivotal role on the nature of alignments, sales models and resources deployed by either partner. Over the next 3-5 yrs, we may see a stage of BA realignment, with current arrangements being reviewed as they come up for renewal. This would impact players who are in relatively shorter term partnerships.

The long term should see clear winners with long term integration between partners, and having achieved a high degree of comfort in insurance selling, the take up to Broking models, which require investments and entail product choice to the customer.

Bancassurance- Indian Opportunity



Banks are major players in the Indian Financial system:

Command over 40% of household investments Extensive coverage:

66000 branches (32000 rural and 14700 semi urban)Enormous retail account base of 440 mn deposit accountsTotal deposit base of Rs. 11,23,393 Cr

It is widely recognized that banks and life insurers can build a mutually beneficial relationship and offer their customers a great deal of value-add in the process. Banks give life insurance companies an opportunity to increase their distribution presence, and they also earn a fee income from the arrangement.


Future trends in Bancassurance

Early 2000

Insurers partnered with Select Banks under Corp

Agency

Some Banks yet to firm up

partnerships

Change in regulations has impact current arrangements

2002-05

Most Banks have short-term

agreements; a stage of

realignments may occur

2005-08

Stage of Polarization:

Emergence of winnersStrong

alignments with Banks with cross

investments and exclusivity

Broking arrangements

2010 onwards

Mergers and Acquisitions could impact the industry


Terminology Used

Annuity-A contract sold by a life insurance company that provides fixed or variable payments to an annuitant, either immediately or at a future date.

Beneficiary-The person(s) named in the policy to receive the life insurance proceeds upon the death of the insured.

Nominee - The person(s) nominated by the policyholder to receive the policy benefits in the event of his death.

Sum assured - The amount of cover taken under a life insurance policy, it is the minimum amount that will be paid on death of the policyholder during the policy term.

Surrender value - The amount payable by the insurer to the owner of an investment-based plan in case he opts to terminate the policy after three years (the mandatory lock-in period) but before its maturity date. The surrender value will be the premia paid till date minus surrender charges and any outstanding loans due.

Cumulative Premium- The total amount paid over the course of a specified amount of years.

Effective Date-The date on which the insurance under a policy begins

Expiration date or expiry - The date on which the insurance policy ceases to protect the policy owner.

Net asset value (NAV) - The simplest measure of how a scheme is performing, it tells how much each unit of it is worth at any point in time. A scheme’s NAV is its net assets (the market value of the financial securities it owns minus whatever it owes) divided by the number of units it has issued.

Face Amount-The amount stated on the policy that will be paid in case of death. It does not include additional amounts payable under accidental death or other special provisions or acquired through the application of policy dividends, and can be reduced by loans or withdrawals.



Lapse - The termination or discontinuance of an insurance policy due to non-payment of a premium.

Payor - The person making premium payments on a policy.

Policy holder - The person who owns a life insurance policy. This is usually the insured person, but it may also be a relative of the insured, a partnership or a corporation

Multi-year premium mode - A premium payment option where future annual premiums are paid in advance at a discount.

Rider-A special provision attached to a policy that expands or restricts the benefits otherwise payable or excludes certain conditions from coverage.

Waiver of Premium (WP)-An optional policy provision that continues the coverage without further premium payments if the insured becomes totally disabled

Peril-The cause of a loss insured against in a policy.



Law of Large number

Since in insurance many persons exposed to similar kind of risk share the loss suffered by a few, we need a sufficiently large number of persons to be insured. And since risk depends on the probability of the insured event happening, again it is only in large number that the theory of probability will really be operative.

Once the probability of an insured event happening is reasonably estimated, the likely quantum of loss to be compensated can be found out and this is shared amongst the group of policyholders. Their share of contribution to the pool is called premium. It represents assets against the liability, i.e. likely loss. Without large number & ‘Sufficient data’ insurance will be akin to gambling.

Probability Theory And Law of Large Numbers

Probability theory is concerned with measuring the likelihood that something will happen and making the estimates on the basis of likelihood. It deals with random events and is based on the premises that, while some events appear to be a matter of chance, they actually occur with regularity over a large number of trials revealing a measurable pattern as it were. The likelihood of an event is assigned a numerical value between 0 & 1, with those that are impossible assigned a value of 0 and those that are inevitable assigned a value of 1.Events that may or may not happen are assigned a value between 0 & 1, with higher values assigned to those estimated to have a greater likelihood or probability of occurring. In reality events assigned 0 probability may in rare circumstance actually happen and even assigned 1 probability may vary rarely fail to happen. The commonsense notion that the probability is meaningful over a large number of trials[happenings] is an intuitive recognized of the law of large number, which in its simplest form states:

The frequency with which an event happens reflects the actual probability of the event occurring more closely if the cases involved are larger.

Dual Application of the Law of Large Numbers

The requirement of a large number has dual application:



a) To estimate the underlying probability accurately, the insurance company must have a sufficiently large volume of data. The larger the sample the more accurate will be the estimate of the probability.

b) Once the estimates of probability have been worked out sufficiently large number of insurance contracts must be entered into to avoid possible losses as a result of small volume.

Three Principals in Insurance Industry

Principal of Utmost Good Faith

Commercial contracts are subject to the principals of ‘Cavet Emptor’ i.e. let the buyers beware. It means each party can examine the terms or service, can ask for proof to verify the correctness. No need to take the statements ‘on trust’. In insurance contract the Cavet Emptor principal does not apply. In life insurance contract most of the facts relating to health, habits, personal history, which form the basis of life insurance contract is known to the proposer. Insurer cannot know these facts, if proposer does not disclose. Medical examination reports may not bring certain facts i.e. ‘Blood Pressure’ or Diabetes if controlled through medicines. History of last illness, operations and injuries can be suppressed. These facts may affect life expectancy of the proposer. This is material information from the point of view of the Underwriter. The non disclosure of such facts would put the ‘insurer’ and the community policyholder to disadvantage. When insurer and community of policyholders are disadvantaged, it is called ‘adverse selection’. Contract is unfair because one of the party to the contract is in a more advantageous position. The doctrine of utmost good faith means ‘full disclosure without being asked of all material circumstances’. Law imposes the duty of full disclosure of relevant information by the proposer, to the underwriter. This duty is one of the utmost good faith or ‘Uberrimae fides’. Any failure would render the contract ‘void ab initio’.

What is material fact?

A fact/circumstance is said to be material if it affects the judgment of prudent insurer in fixing the premium or accepting the proposal for insurance. Therefore facts regarding age, height, weight, occupation, habits, medical history, surgeries, earlier insurance policies must be disclosed. The proposer can’t that he did not think that they were ‘material’.

Facts which need not be disclosed:-



o Facts of common knowledge which everyone is supposed to know

o Facts of Law

o Facts which a survey would have revealed

o Facts which could reasonably be discovered by reference to previous policies and records available with insurer.

Duty to disclose continues:-

o In life insurance contract ‘Duty to disclose’ facts continues till risk is accepted.

o Risk commences when underwriter accepts the risk & First Premium Receipt is issued.

o Circumstances arising after risk commencement do not affect the validity of contract unless the conditions of the contract requires so. For example a policy could be issued with a condition that a change of occupation after risk commencement must be notified to the insurer who can reassess occupation risk.

o Duty of disclosure of material facts arises again at the time of

a) Alteration to the contract

b) Revival of lapsed policy.

c) Reinstatement of surrender policy since what follows is a new contract.

Breach of utmost good faith through Non disclosure or misrepresentation.

Conditions for breach are that misrepresentation or non disclosure should be

a) Substantially false & known to the proposer as false.

b) Not known to the second party.



c) Concerned with the facts material to assessment/ acceptance of risk or material to benefits obtained by the proposer.

d) Calculated to induce the other party to enter into contract on terms beneficial to the party.

The Declaration

In life insurance the proposer makes a declaration as under:-

All the statements in the proposal form are true & complete in every respect.

The proposal form shall form the basis of contract.

If any statement is found untrue, the insurer can treat the contract as null & void & can forfeit all the premium paid

Contract of warranty:-

The above ‘declaration’ turns ‘representations’ made in the proposal form into ‘warranties’ which must be wholly true. Insurance contract therefore is a contract of warranty & any untrue statement or non disclosure whether material or not can vitiate the contract.

Section 45 of Insurance Act:-

While an insurer can cancel contract based upon above ‘declaration’ still his right to cancel the contract are limited by Section 45. Section 45 states that a policy can not be called in question after 2 years.

o On the ground of inaccurate or false statement.

o Unless it is proved by the insurer that non disclosure/misrepresentation was made deliberately, was material to the risk and the intention of the party was to play ‘fraud’ with the insurance company. It makes Life insurance contract as indisputable.

Utmost good faith principal applies to both the party to the contract.

Duty of full disclosure applies to the ‘Proposer’ & ‘Insurer’



Examples of untrue statement by the insurer or his agent could be

i. Making untrue statement about features & benefits of product during sale.

ii. Not informing the policyholder that loans are not available under some plans

Principal of Insurable interest

Insurable interest is not defined in Insurance Act 1938 but based upon Court judgments we can define as under:

- Insurable interest is a financial interest in the subject matter of insurance which is recognised in law and gives a legal right to insure.

- What is insured is not ‘Life’ but the financial interest of the insured in the subject matter of insurance.

- The relationship should be such that the insured benefits from the safety of the subject matter and would be prejudiced by its loss or damage.



- In simple words, insurable interest means that the insured is interested in the continuance of subject matter of insurance and could suffer a loss due to its discontinuance.

The question of insurable interest will arise when a Life Insurance policy is taken by one person on the life of another person.

When should insurable interest exist?

In Life Insurance contract insurable interest must exist at the time of start of contract and it may not exist thereafter i.e. at the time of claim.

Who all have insurable interest?

1. A person has unlimited insurable interest in himself.(it does not mean that insurer will grant unlimited amount of insurance cover)

2. A husband or wife has unlimited insurable interest in the life of spouse. (Law presumes the existence of insurable interest between the spouses)

3. An employer has insurable interest in the life of his employee to the limited extent of value of his services.

4. An employee has insurable interest in the life of his employer to the extent of his salary for the notice period.

5. A creditor has insurable interest in the life of a debtor to the extent of the debt(principal and outstanding interest)

6. A surety has insurable interest in the life of Co-surety to the extent of debt and also in the life of the principal debtor.

7. Partners have insurable interest in the lives of each other to an extent

8. A company has insurable interest in the life of key employees.

Who do not have insurable interest?

1. Insurable interest does not exist because of family relationship. Parents, children, brothers, sisters have no



insurable interest in the life of each other because of blood relationship.

2. It is not legally established that parents have insurable interest in the life of child. Children policies are issued in India because ‘child’ can’t enter into contract. There is ‘automatic vesting’ clause on the attainment of age of maturity by the child.

3. A debtor has no insurable interest on the life of a creditor since he would be more interested in the death of creditor than his living so that he can avoid repayment of loan.

Proof of Insurable Interest

Not required if insurance is on

- Own life- Husband & Wife

Required in all other cases (When the proposal is on the life of another except Husband & Wife)

Principal of Indemnity

Insurance is meant to compensate losses. By implication it means, insurance cannot be used to make a profit. The claim amount cannot exceed the amount of loss. The principal of indemnity is that insurance should place the insured in the same financial position after a loss as he enjoyed before it & not better.

Linkage between ‘Indemnity’ & ‘Insurable interest’

Insurer insures the interest of the insured in the subject matter of insurance.

Therefore amount of claim is limited to the amount of interest.



The principal of indemnity applies to all insurance contracts except ‘Accident Insurance’ & ‘Life Insurance’ because insurable interest on own life is unlimited.

Life insurance is not a contract of indemnity.

Life insurance is an ‘Assurance’ for Sum Assured.

Non Life Insurance is insurance where maximum amount of Indemnity is sum assured.

Human Life Value

When a property is insured against the risk of loss, it is insured on the basis of it’s appraised value

What method should be used to estimate the economic value or money value of a human life?

Human life value concept is one of the methods of determining the amount of life insurance cover for an individual to preserve his economic value. Human life value concept is based upon the economic value of an individual to his family & dependents.



If an individual earns say Rs 10000/- P.M and spares Rs 7000/- P.M for his family after spending Rs 2000/- on himself and paying Rs 1000/- as taxes to government, his human life value will be a sum of money which provides monthly income of Rs 70000/- to his family.

If an individual earns say Rs 10000/- P.M and spend everything on himself and spares nothing for his family, his human life value will be zero.

Human life value is therefore the present value of family’s share of deceased breadwinner’s future earning.

Suppose a person aged 40 has an annual post tax earning of Rs 130000/- and he has another 25 years to earn. Assuming he spends Rs 30000/- annually on personal expenses, the income meant for the family comes to Rs 100000/- P.A. Assuming the earning to be constant, the total loss of income to the family for 25 years will be Rs 2500000/-. The discounted value of the same say 5% interest works out to Rs 1400000/- This much amount would be required to protect the loss of income to the family. So he will require insurance cover of Rs 1400000/- to protect his family against the loss of income in the event of his untimely death.

Just as appraised value of property undergoes changes, the human life value also changes and insurance cover should be reviewed periodically. Human life fluctuates with the changes in the income. It also increases or decreases if the rate of interest decreases or increases. If the rate of interest goes down Human Life Value goes up and vice versa.

Human life value of two persons both supporting family with same level of income in the future years of the individual and present value of future earnings has to be arrived at by applying discount factor. Human Life Value with 5% discount factor will be much higher as compared to Human Life Value with 10% discount factor.

Life Insurance Products

The Life Insurance products are broadly classified as PIPS -Pension, Investment, Protection, Savings and the addition to this is Health. These products cater to needs of the person depending on the age groups. A person can select the right combination thereby making him financially secured

Young & Single > Savings & Health Just Married > Savings & Protection



Married with children > Savings, Investments & Pension

Nearing Retirement > Investments, Health & Pension

Life Insurance products are called ‘Plans’ of Insurance. There are two basic elements in almost all ‘plans’ of insurance.

One element is Death Cover which provides for benefit to be paid only if death of the insured person occurs within specified period.

The other element is survival benefit which provides for benefit to be paid only if the insured person survives a specified period.

- Plans which provide death cover only are called ‘Term Insurance Plan’

- Plans which provide only survival benefit are called Pure Endowment Plan

Both the above plans are like Fire Insurance Policies. If specified contingency does not happen, the policyholder is not paid any benefit.

All Plans a combination of two basic elements:-

All life insurance plans are a combination of above two elements.

A term insurance with an ‘unspecified period’ is called ‘Whole Life Plan’ under which sum assured is paid on death whenever it occurs.

A term insurance combined with pure endowment & offered as single product is ‘Endowment Plan’ where under sum assured is paid on survival for specified period or on earlier death.

Double Endowment Plan is one with the Term Insurance plus two times the Pure Endowment. Under this plan on survival till maturity, Double Sum Assured is paid and on earlier death basic Sum Assured is paid.

Money Back Plan is the one where 20% of the sum assured is paid as survival benefit each time on survival at the end of 5th year, 10th

year, 15th year & 40% on maturity date for 20 years policy & full sum assured on death at any time during 20 years. It is in fact a combination of Term insurance plan for 20 years for full sum



assured & four different Pure Endowment Plans for 20% sum assured for 5 years, 20% sum assured for 10 years, 20% sum assured for 15 years & 40% sum assured for 20 years.

With profit and Without profit plans

A life insurance plan can be ‘with profit plan’ or ‘without profit plan’

With profit plan is also called as ‘Participating Plan’ and without profit plan is called as ‘Non Participating Plan’

With Profit policyholder gets right to participate in Bonuses, declared by Life Insurance Company whereas no bonuses are paid to without profit policyholder.

With profit plan has more premium than without profit plan.

Policyholder prefer with profit plan because bonuses are expected to be higher than more premium paid.

In a limited premium payment policy right to participate in bonuses continues throughout the period of policy even after premium payment stops

Features of life Insurance plans-

Any number of plans can be developed by adding/combining these features:-

1 Who can be Insured? A Individual Adult

B Children (minor)

C Two or more persons jointly under one policy

2 What can be the Sum Assured?

A There may be minimum Sum Assured stipulation say Rs 50000/-



B There is maximum Sum Assured limit for accident benefit say Rs 2500000/-

3 On which contingency Sum Assured payable

Could be ‘Death’ or ‘Survival’

4 When Sum Assured payable

A On the contingency happening or

B On some other date

5 How Sum Assured payable

A Could be one lump sum or

B In installment

6 Term of the policy A Period during which specified contingency should happen

B Some plans provide benefit even beyond the term.

7 How long premium payable

A Could be ‘Single’ or

B For ‘limited period’ or

C For ‘Term of Policy’

8 Frequency of Premium payment

Could be yearly, half yearly, quarterly, monthly

9 When premium payable Payable in advance on due date of premium

1 Does the Sum assured increase

A Could be because of ‘Bonus additions’

B Or ‘Guaranteed additions’

1 Does the Sum assured reduce

Can be for meeting reducing liabilities like mortgage loan.



1 Are there additional benefits

Also called ‘supplementary benefit’, can be provided as additional benefits by way of ‘riders’ to the basic cover

Term Insurance Plans

Term Insurance is cheapest form of insurance plan. Under Term Insurance plan sum assured is payable on death within specified period & no benefit is payable on survival. There are no ‘paid up’ or ‘surrender benefit’

Under decreasing term insurance plan (also called Mortgage Redemption Plan) sum assured decreases. Premium does not decrease. It is suitable to cover the outstanding loan amount under mortgage transaction.

Under increasing term insurance plan sum assured increase at periodical intervals as per policy contract & premium also increases. This is suitable to overcome the effect of inflation.

Under Renewable term insurance plan you have the option to renew the contract without underwriting and premium at renewal will increase based upon then attained age.



Under convertible term insurance plan you have the privilege to convert the policy into Endowment or Whole life plan without fresh underwriting. Premium will be recalculated at attained age under converted plan. Conversion option is to be exercised within the period specified in the contract, which is generally 2 years before expiry of term. Sum assured under converted plan will remain the same. Conversion may be allowed anytime but before age 60.

Another variation of term insurance plan is Term Insurance with return of premium. Under this plan survival benefit is total of premium paid without any interest. This in fact is an Endowment plan where death benefit is sum assured & maturity benefit is total premium paid or higher amount but not sum assured.

Another variation of term insurance is that on maturity date premium paid are refunded but life insurance cover for sum assured continues till death. It is not free cover. Here premium is so calculated that interest accumulated on the premium during the term is enough to meet the single premium cost of the extended cover.

Term Insurance plan are not popular in India because surviving policyholder feel that they get nothing under the policy.

Whole Life plans

Whole life plan is a plan without any fixed term & its for whole of life.

Death claim is always payable whenever death occurs which is not the case in term insurance.

Some insurance pays claim when life to be assured completes certain age say 100 years.

Premiums can be paid for whole life or for limited period or one time single premium.

Premium under such plans are higher than term insurance plan because such policies have ‘paid up value’, ‘surrender value’, ‘loan value benefits’.



Whole life plans can be positioned for persons who would like to accumulate money and leave an estate for their wife, children & grand children.

Endowment plans

Under this plan sum assured is payable on maturity or on earlier death. Premiums may be payable throughout the term or for limited period on single. Performing activities, people working abroad, armed force personnel can opt for limited payment policy. Death benefits can be more than Maturity benefits or vice versa. Money back plan is an endowment plan where under survival benefits are paid at periodical intervals. Death benefit is paid without deducting survival benefits already paid. On maturity only balance sum assured is paid.

Another combination can be Endowment plan with whole life benefits under which maturity claim is paid on maturity date & one more sum assured is paid if death occurs after maturity date.

Marriage Endowment is name of an Endowment plans which has nothing to do with the marriage.



- It is a policy taken in the life of either parent stipulating a fixed date on which sum assured under the policy is paid even if the Life assured dies earlier.

- The fix date can be chosen to coincide with the likely date of marriage of son or daughter.

- Sum assured under the policy can be used to facilitate marriage or for any other purpose.

- Such policy can be taken to meet any other likely future liability likely to arise on a future date. Policy is taken on the life of parent & not on life of the child.

Education Annuity plan is name of a plan, which is not an ‘Annuity’ but a fixed maturity ‘Endowment Plan’ where under sum assured is paid in installment starting from a date as chosen by the policyholder.

It may coincide with child going for higher education. The policy is taken in the life of ‘parent’ & not on the life of ‘child’.

Joint Life Policies

When two or more lives are covered under single policy, it is called joint life plan.

Such policies generally cover married couples or partners of a firm.

Sum assured is paid on death of one of the insured live during the term or on maturity date.

Joint life plans are also designed to provide for payment of sum assured on death of one life & policy is continued to cover the second life till maturity date without paying any further premium. Such plans provide more death benefits & less maturity benefits.

Joint life plan of HDFC Standard Life is designed on First claim basis aim at providing better maturity benefits.

Procedure for Joint Life Policy



For partnership insurance, partnership deed is required to examine the nature of financial interest of each partner.

Each life is underwritten separately.

Bonuses accrue on single basic sum assured only.

Unit Linked Plan

In Unit Linked plan you can achieve short medium and long term financial goals through a single insurance cum investment product which offer you the choice to control your changing risk return profiles through seven fund options with varying risk cover options & flexible premium payment choices

You get the benefit of systematic investment plan over a number of years thereby accruing fund units at lower average cost

You also get the benefit of Tax shield on withdrawals, switches, Death Benefit, Maturity Benefit, Surrender Benefit, Critical Illness Benefit

Features

A regular premium Unit linked Contract

Regular premium increase allowed



Single premium Top up allowed

Yearly, Half Yearly, Quarterly and Monthly frequencies allowed

Decrease in the premium allowed

Risk cover options-Life, Extra Life, Life and Health, Extra Life Health

Risk cover level 5 to 40 times the annual premium

Seven Fund option

Fund Switching and Premium Redirection option

Premium Holiday Option

Market Linked Death Benefit with minimum guarantee of Sum Assured

Market Linked Maturity, paid up, surrender value benefit

Investment content Rates linked with size of premium & year of premium

Fund Management charge same for all the funds

Fixed administration fee, irrespective of size of policy

Risk charge varies with age and sum at risk

No surrender charge after 3 years



Annuity

Annuities are same as pensions. Annuity provides regular periodical payments monthly, quarterly, half yearly or annual. These payment continues so long as the Annuitant is alive & sometimes for dependents spouse) after death of the annuitant.

Annuity & Life Insurance

Annuities are reverse of Life Insurance.

In annuity an individual pay lump sum amount or build capital fund and get periodical payment from the insurer so long as you live.

In life insurance an individual make a periodical payment to insurer in return for a promise of lump sum payment on death.

In life insurance contracts insurer starts paying on death of insured whereas under annuity contract the insurer stops paying on the death of annuitants.

Variation of basic contract

You can build a fund for annuity by paying in installments and with the fund so built annuity can be purchased.



Annuity may not stop with ‘death’ & may continue thereafter.

No underwriting

Annuitants exercise Self Selection

No medical tests & no underwriting are involved.

Risk covered under annuity is risk of ‘Living too long’

Types of Annuity

Immediate Annuity:- Under this annuity the person has to make one lumpsum payment & annuity starts immediately say after 1 month if payment is monthly & after 1 year if frequency chosen is yearly.

Deferred Annuity:- Such an annuity has Two periods

Deferment period during which period purchase price is paid by making either one lumpsum payment or regular periodical payments.

Annuity payment period during which annuity is paid to the Annuitant.

Annuity Option:-

1 Life AnnuityAnnuity is paid so long as annuitant is alive &

no amount is paid after his death

2 Joint Life AnnuityAnnuity payable during the life time of

Annuitant or spouse whichever is longer.

3 Annuity guaranteed for 5 or 10 or 15 or 20 or 25 years

Under this Annuity option annuity is paid for the selected period. If annuitant lives beyond the selected period, he gets annuity so long as he lives. If he dies before the selected period annuity for the balance period is paid to the nominee.



4 Life Annuity with return of capital

Annuity paid during life time and full or percentage of capital returned to nominee on death.

Riders

A rider is an add-on benefit that can be added to a basic policy at a nominal extra cost. They provide protection against specific risks. Riders not only cover contingencies that may cause death but also those which might incapacitate the individual from earning a regular income required to maintain his life style or contracting critical illness or for undergoing surgical procedure etc.

These are optional benefits which may be offered on proper assessment of the proposers risk, needs, paying capacity etc. Some of the riders like critical illness Rider and major surgical Assistance Rider can generally be availed at the time of purchase of the policy. Others like Accidental Death Benefit and Permanent Disability Riders, Waiver of Premium benefit can generally be added later, on policy anniversary date.According to IRDA regulations, aggregate premium on riders shall not exceed 30% of basic policy premium, except health insurance rider where premium could be upto 100% of the basic policy premium.

The popular riders available in the Indian Insurance Market are as below- Accidental Death Benefit Rider- This rider provides cover

against death due to accident as defined as a result of accident.



BenefitsOn death due to accident within 90 days of the date of

accident, 100% of rider sum assured is payable in addition to basic plan sum assured some insurers provide for payment of 200% rider sum assured (in addition to basic plans sum assured) in the event of accidental death while traveling as a fare paying passengers in a land surface on a public transport system. Maximum sum assured for this rider is the maximum sum assured under the base policy and may further be limited to 10 Lacs to Rs 1crore.

ExclusionsThis benefit is not paid under the following circumstances:-

Attempted suicide, under the influence of drug or intoxicating liquor, engaging in aviation other than fare paying passenger, breach of law, hazardous sports, civil riots, war

Premium:

Some companies charge same premium irrespective of age.

Some companies relate premium per thousand sum assured with age.

Some companies relate premium to Risk class & occupation.

Disability Benefit Rider

Disability Benefit may be paid only when there is total & permanent disability as defined. Disability benefit may be payable for partial permanent or disability as defined. Disability benefit is also called ‘Dismemberment Benefit’ when disability is due to ‘severance of limb’, ‘loss of limb’ due to accident. Disability can be due to ‘loss of limb’, ‘loss of sight’ or ‘loss of use’

Disability must be such that Life Assured becomes incapable of engaging in any gainful activity or carrying out any work occupation or profession to obtain any wages, compensation, remuneration or profit.

Disability must be caused within 180 days of accident. Partial permanent disability benefit (50% of rider sum



assured) is generally paid in the lumpsum. Total permanent disability benefit is either paid in the lumpsum i.e. 100% of rider sum assured or in installment spread over 10 years or 5 years (10% or 20% every year)

In the event of death/maturity of the policy within 10 years or 5 years some companies do not pay balance unpaid installment, some pay unpaid installment, some pay present value of unpaid installment.

Intimation of disability to the insurer has to be made within 90 days of the occurrence and proof of disability has to be produced within 60 days from the date of claim, otherwise claim is not payable.

Waiver of Premium Rider

Under this rider future premium payable under the policy upto the Rider sum assured are waived and policy holder is not required to pay any future premiums and the policy continues in full force. For sum assured in excess of rider sum assured, premium has to be paid by the policyholder.

The waiver is applicable during the period of total disability (may be accidental only or both accidental and/or due to disease) or after contracting critical illness.

The life assured should not be able to pursue any occupation. Some companies allow this rider as part of disability benefit rider, whereas some companies allow it as a separate rider and charge separate premium and some companies do not have the rider.

Future premiums are not immediately waived. They are waived only after a waiting period of 26 weeks of continuous disability and only after a total disability is proved. This benefit is not paid during the first 12 months of the policy.

When premium are waived, basic policy & other rider continues without payment of premium. In fact insurer pays the premium under the policy.

Critical Illness Rider



With the opening of the insurance sector, the major innovation in the area of ‘Critical Illness Rider’. Some companies call it ‘Dreaded Disease Rider’

As the medical expense increase day by day, this rider provides the benefit in the event of Life assured being diagnosed as suffering from any of the specified critical illness. The rider improves the financial condition when the policyholder and his family need it most.

Number of diseases/illness covered under this benefit varies from 6 to 17 for different insurers. Diseases generally covered are-1)Cancer 2)Heart Attacks 3)stroke 4)Kidney failure 5)Major organ transplant 6)Paralysis 7)By pass surgery 8)Heart valve replacement 9)Aorta 10)coma.

There is waiting period of 6 months from the date of risk before the rider cover starts. In other words no claim is payable if critical illness is diagnosed during first 6 months of the policy. The benefit is payable only if the policyholder survives a period of one month from the date of diagnosis of critical illness. Intimation of the critical illness has to be given to the company within 60 days of diagnosis.

Exclusions for the benefit are Aids, war, failure to follow medical advice, pregnancy, aviation other than fare paying passenger, breach of law, hazardous sports.

Maximum sum assured for this benefit varies from company to company between Rs 5 lacs to 50 lacs.

This benefit is not payable generally after the life assured attaining age 60/65 years. This rider is given between age 20 to 50 years depending upon the term.

When the claim for this rider is paid as additional benefit or as portion of sum assured the premium for this rider benefit also ceases. Policyholder can’t claim this benefit for subsequent disease.



Premiums

What is premium?

Premium is the consideration paid by the policyholder to the insurance company for an ‘insurance contract’, in order to get benefits offered by an insurance policy. Premium is price for insurance policy. Premium can be paid once i.e. one time. Often premium is paid regularly over the period of policy or for a limited period.

Default in premium payment:-

A default in premium payment will result in to discontinuance of contract. The policy will be treated as ‘lapsed’ & expected benefits will not be available.

No claim will be settled for the lapsed policy due to default in premium payment.

Key factors for determining premium rates



- Premium rates are determined based upon actuarial & statistical principals.

- Only trained professional called ‘Actuary’ can do it.

- Different plans of insurance offering different benefits have different premium rates.

- Tables of premium rates for each plan of insurance are made by the Actuary.

- These tables are made available to agents to quote rates to the prospects.

- Agents should know the rationale behind premium calculation.

- Premium used by Life Insurance Company are called office premium determined by an Actuary. The key factors or assumptions regarding

Mortality rates

Interest rates Expense factor

Contingency factor

General Principals:-

- Higher the rate of mortality assumed, higher will be the rate of premium

- Higher the rate of interest assumed, the lower will be the rate of premium.

- Higher the expense assumed, higher will be premium rate

- Higher the contingency provided for, higher will be the rate of premium



Underwriting

A proposal form is an application for insurance cover. When a proposal is received, insurer does not grant cover automatically. Insurer decides about the admissibility of the proposer into the ‘pool of policyholders.’ Insurer has to play the role of trustee to ensure that members of the pool are exposed to similar risk.

“Process of verifying and assessing the level of risk of new entrants is called ‘selection’ or underwriting”.

Implication of underwriting going wrong

If risk is not assessed properly, premium charged will not be appropriate.

A lower premium would affect solvency of the insurer/fund.

Cost of additional risk, if not recovered from the policyholder will be borne by the rest of policyholder.



If premium charged is more, it will be unfair to the proposer and violate the principal of Utmost Good Faith.

Section has implication of fairness to the insurer and to the policyholder individually and collectively.

Standard Risk

If the underwriter finds that the ‘life proposed’ has no adverse features affecting mortality, such a risk is called ‘Standard’ and life is classified ‘normal’ or ‘standard’ or ‘average’ or ‘first class’. He will be charged premium as per tabular rates.

Factors affecting Risk

Factors affecting risk on the life of an individual are called ‘Hazards’Hazards are of three types:

a)Physical b) Occupational c)Moral

A. Physical Hazards

1. Age

- Higher the age, higher the probability of death- Premium rates are linked with age- Certain risk increases with age while other decrease with

age- Overweight at younger age is not unfavorable factor while

it increases other risks at higher ages- Underweight at younger age is an adverse factor and not

at higher ages

2. Sex

- Mortality rate of female lives at younger ages( child bearing age) is higher than males among poor and uneducated sections.

- Female in general live longer than male

3. Build



- Height, weight, chest and abdomen measurement affect longevity

- Girth of abdomen more than chest and overweight as compared to standard weights may suggest greater chances of diabetes or cardiac ailment. The combined effect of two adverse factors is much more on risk to life.

4. Physical Conditions

- Medical examination of reflexes, B.P., pulse rate, urine etc. provides data with regard to important system of the body.

5. Physical impairments

- Blindness, loss of limb, deafness are not illness but pose extra hazard increasing the probability of death.

6. Personal history

- Past history of the diseases, operations provides useful data for ‘nature of risk’

7. Habits and Lifestyle

- Addiction to drinking, smoking, drugs, stressful life poses greater hazards.

8. Family history

- Family history of early death of parents, brothers, sisters due to heart attack, cancer etc. indicate chances of premature death]

- If parents have lived long, it is a ‘favorable factor’

B. Occupational Hazard

- Certain occupation increases ‘Health Hazard’ or ‘Accidental Hazard’

- People working in chemical industries are exposed to the risk of respiratory diseases



- People working on heights, with high speed machines, with high voltage electricity are exposed to risk of accident, electrocution, burns

- Underwriters charge extra premium for occupation hazard

C. Moral Hazard

- Moral hazard refers to the intention of the proposer to make gain out of insurance i.e. to get insurance at lower premium or to make some monetary gains

- Moral hazard is a matter of opinion based upon circumstantial evidence.

- Moral hazard can be environmental e.g. living in Nexalite or Terrorist areas.

- Moral hazard is suspected it cannot be established.- If moral hazard is suspected, proposal are declined and not

accepted even with extra premium.

Examples of Moral Hazard

First time insurance for large sum assured at advanced age

Large amount of insurance with low income Large amount of insurance for non earning

member while earning members of family are insured for very small amount.

Taking insurance while under threat from terrorist group.



Financial Underwriting

Insurance cover can not be disproportionate to the current level of income of the proposer otherwise it may give rise to moral hazard. Though insurable interest of an individual is unlimited yet underwriter will link insurance cover amount to current income since premium has to be paid regularly. If someone else is financing policy, question of insurable interest/gamble will arise. Financial underwriting is making judgment in these financial aspects.

Thumb rule is ‘Insurance amount not more than 10 years income’ or 10 times of the annual income.

Data for underwriting (assessing risk)

Proposal form provides data about the proposer and person to be insured with regard to health, habits, family history, personal history of the person to be insured.

Confidential report of the Medical examiner.



Confidential report of the agent.

Special Examination report called for large sum assured at advanced age or some past history of ailment.

Moral Hazard Report of Senior Official.

Who underwrites Risk?

Underwriter interprets the data and decides about ‘level of risk’ in each case. Underwriter need not be an actuary. Underwriter may use the services of doctors called ‘Medical Referees’ who are in the panel of insurance companies for medical opinion or mortality of certain diseases. For large sum assured cases, reference could be made to the specialist in the panel of reinsurers.

Underwriting decisions

Underwriting decisions could be one of the following types.

1. Accept at original terms:-which means life is assessed as standard and tabular premium can be charged.

2. Accept with rated up premium of Rs per thousand for health or for occupation or both which means premium charges will be increased by ‘rated up premium’

3. Accept with modified terms i.e. offer lower risk plan or lower term of the policy. Risk of insurance varies from plan to plan. Whole life is more risky than Endowment. Term Insurance is most risky. A shorter period policy has lower risk.

4. Postpone for a certain period which means risk cover be assessed again after expiry of postponement period with fresh medical report.

5. Decline which means risk is uninsurable too high to be insured.

Non Medical Underwriting

It is Underwriting risk without medical examination report. Experience shows that 90% of the proposals are accepted at standard rates. Medical exam from qualified doctors is not easy at all places. Even at urban centers proposers have to wait at doctor’s clinics. Medical exam for insurance is not high priority for doctors. Non medical underwriting



means deciding the risk based upon proposer’s declarations and personal statement. Non medical proposals considered subject to certain conditions. E.g.

Age not more than 45 years.

Sum assured not more than 5 Lacks

More risky plans are not allowed

Condition for non medical underwriting vary across insurers.

Female Lives Underwriting

Insurers in India were cautious about insuring ladies because of pregnancy related death and history of frauds. Working women and educated are now treated at par with men. Women who are not earning are considered for insurance if husband is adequately insured. Women in purdah are not considered for insurance.

Life Insurance Accounting

The principal source of income for Life Insurance Company is the Premium. The other source of income are dividend, interest etc. on investments made by the company. The main expenses for Life Insurance Company are Management Expense in the form of commission and salaries. The outgoes are by way of payment of benefits on death or maturity including surrenders.

1. Premium Accounting:-

a. First Premium-: When a proposal is received along with first premium amount, it is kept in Proposal Deposit A/c. The deposit is adjusted towards First Premium Account after acceptance of risk. Proposal deposits under Annuities are credited to Single Premium A/c or consideration for Annuities Granted.

b. First Year Renewal Premium A/c-: Where the premium frequency is other than yearly i.e. half yearly or quarterly the premium installments, falling due after the first premium in the first year are credited to First Year Renewal Premium A/c.



c. Renewal Premium A/c-: Remittance towards Renewal premium are credited to Renewal Premium A/c.

d. Outstanding Premium-: At the end of the financial year provision for outstanding premiums is made in the Revenue A/c & the Balance sheet in respect of policies where premiums have fallen due but have not been paid and the days of grace have not expired.

2. Outgoes- Benefit Payments-:Accounting entries for claim payments in respect of Death benefits, Maturity benefits & Survival benefits are made at two stages.

a. While creating liability for benefits-: Claims by Death Maturity/Survival benefit (Gross amount)………………………….DrLess-:To unpaid premiums (if any)……………………………...CrTo policy loans (if any)……………………………………CrTo interest on policy loans (if any)………………………...CrTo outstanding Death/Maturity/Survival benefit Claims(net amount)………………………Cr

b. While making payment of benefits-:

Outstanding Death/Maturity/Survival benefit claims……………………………………...DrTo Bank A/c…………………………………………………Cr

3. Expenses of Management-: Expense of management means all charges whenever incurred whether directly or indirectly & includes

i. Commission payments of all kinds-: Commission payment is classified as First Year Commission, Renewal commission & Bonus Commission

ii. Other Expense of Management-: Such as salaries, rents, stationery, policy stamps, telephones etc as permitted u/s 40B of the Insurance Act 1938

Final Accounts-: As per Insurance Act 1938 & IRDA Regulation 2002 a Life Insurance Company has to prepare, Final Accounts in the format prescribed.



Audited accounts & statements are to be printed & four copies thereof are to be furnished as Returns to IRDA by 30th September every year after incorporating Valuation Results.

Financial statements, Auditors report have to be submitted together with Management Report. Life Insurance Companies have to follow Accounting Standards as issued by ICAI except Standards relating to segment reporting and method of cash flow statement.

Financial Statements would include

Revenue A/c (Policyholder’s A/c)Profit & Loss A/c (Shareholder’s A/c)

The Role of Portfolio Management:

Portfolio and asset liability management are important for both life and property liability insurance companies. However, the latter face the problem that their liabilities are far more unpredictable than the liabilities of the life insurance companies. For example, given a stable mortality table and other historical data, it is easier to predict the approximate number of death claims, than the approximate number of claims on account of car accidents and fire.

As a consequence of such uncertainty, and perhaps also moral hazard stemming from reinsurance facilities, asset liability management of property liability companies in the US has left much to be desired. Hence, a meaningful discussion about the changing nature and role of portfolio management for US's insurance companies is possible only in the context of the experience of its life insurance companies. Although the role of an insurance policy is significantly different from that of investments, economic agents like households have increasingly viewed insurance contracts as a part of their investment portfolio. This change in perception has not affected much the status of the property-liability or non life insurance policies, which are still viewed as plain vanilla insurance contracts that can be used to hedge against unforeseen



calamities. However, the perception about life insurance contracts has perhaps been irrevocably altered, and it has changed the nature of fund management of insurance companies significantly, forcing them to move away from passive portfolio management to active asset liability management. The change in perception of the households became apparent during the 1950s, when stock prices rose sharply in the US. Given the steep increase in the opportunity cost of funds, households shied away from whole life insurance products and opted for term life insurance policies!

During the earlier part of a policyholder's life, the premium for a term insurance policy is lower than the premium for a whole life policy. Hence it was in a (young) household's interest to opt for term insurance, and invest the difference between the whole life premium and term life premium in the equity market. As a consequence, the life insurance companies were forced to think about development of new products that could give the investors returns commensurate with the pins in the stock market. The immediate impact of the financial volatility on portfolio or asset liability management came by way of a change in the design of the life insurance products.

The insurance companies started offering universal life, variable life, and flexible premium variable life products. These policies bundled insurance coverage with investment opportunities, and allowed policy holders to choose the amount of their annual premium and/ or the nature of the portfolio into which the premium would be invested. Most of these contracts carried guaranteed Minim urn death benefits, but returns over and above that were determined by the inflow of premia and the subsequent investment experience. Some of the policies could also be forced into expiration if the afore mentioned inflow and experience fell below some critical minimum levels.

Further, policy loans were offered only at variable rates of interest. In other words, the policyholders were increasingly co-opted into sharing market and interest rate risks with the insurance companies. As a consequence of these changes, which brought about a bundling of insurance and investment products, portfolio management of life insur-ance companies today is similar to that of a bank or non bank financial company. They have tolook out for arbitrage opportunities in the market place both across markets and over time use value at risk modeling to ensure that their reserves are adequate to absorb market related shocks, ensure that there is no mismatch of duration between their assets and liabilities, and ensure that the risk return trade off of their portfolios remain at an acceptable level.



During the 1980s, the life insurance companies gradually reduced the duration of the fixed income securities in their portfolio, thereby ensuring greater liquidity for their assets. They also moved away from long term and privately placed debt instruments and increasingly invested in exchange traded financial paper, including mortgage backed securities. However, while the increased liquidity of their portfolios reduced their risk profiles, they also required active management of these portfolios in accordance with the changing liability structures and market conditions. Today, while life insurance companies compete for market share by changing the nature and structure of their products, their viability is critically dependent on the quality of their portfolio and asset liability management.

Implications of Cost Management:

As is the case with most competitive industries, profitability and viability of a firm in the insurance industry significantly depends on its market share, and its ability to minimise its cost of operations without compromising the quality of its service and risk management. Perhaps the easiest way to reduce cost is to reduce the cost of processing and underwriting policy applications.

In the US, the average cost of processing and underwriting an application has been estimated to be in excess of US $250. As a consequence, insurance companies have increasingly resorted to replacement of personnel by computer based "expert" systems which apply the vetting models used by the companies' (human) experts to a wide range of problems." However, the US companies have found it



more difficult to reduce their cost of marketing and distribution. A significant part of these expenses accrue on account of the commissions paid to exclusive and/or independent agents, the usual rate of commission being 15 to 30 per cent, depending on the line of business. As such, independent agents have greater bargaining power than the exclusive agents because they "own" the insurance contracts held by the policyholders, and can switch from one insurance company to another at will. These agents also benefit from the perception that, as outsiders having bargaining power vis a vis the insurance companies, they will be able to ensure better service for the policyholders. In order to mitigate the cost related problem, insurance companies in the US are increasingly looking at alternative ways to market and distribute their products.

Direct marketing has gained popularity, as has marketing by way of selling insurance products through other financial organizations like banks and brokers. These actions might lead to significant reduction of cost of operations of insurance companies, but it is not obvious as yet as to how the small policyholders will fare in the absence of powerful intermediaries with bargaining power vis a vis the insurance companies.

Organisational Structure

Life Office Organisation

An organisation has offices, departments, sections. Revenue generating activities and customer service related activities are more important than other activities. An organisation has ‘positions’, ‘people’, ‘responsibilities’

Important activities in a Life Office:

Procuring proposals from prospective buyers of insurance



Underwriting of proposals

Issuing policy documents, inserting terms and conditions and endorsements.

Keeping record of premium payments and other benefits paid

Policy servicing like nomination, assignment, alterations, loans, surrenders, claim payments

Investments of funds

Maintenance of Accounts

Management of Personnel

Data processing

Compliance with laws

Depending upon size of operations all activities can be centralized or distributed across various offices.

Organisational Set Up

LIC of India

Board of Directors

LIC has a Board of Directors with maximum 16 members, appointed by Government of India, including Chairman who is full time employee and CEO

LIC has two MDs appointed by Government of India and both are members of the Board.

Four tier structure of LIC



LIC has central office at Mumbai, 7 zonal offices, 100 divisional offices and over 2000 branch offices in India.

Over 90% of policy servicing is done at branch office. Investments are done at central office.

LIC branch office

In LIC branch report to Division who reports to Zone and Zone reports to Central office.

LIC branch office has the responsibility to develop business in its area. It is basic unit of growth and profit.

Agents

Agents and development officers are a part of branch office and act as distribution channel. Insurance is rarely bought, it is sold. Agent persuade people to buy insurance benefits

LIC has 9 ½ lac agents on its role- some are whole time, some are part time. New companies are increasing their agency force and they are called ‘Advisors’ or ‘Consultants’

There are courses for agents to make them better professionals.

Brokers

Broker does business with more than one insurer. He gets commission from the ‘insurer’ and does not charge the prospect. Brokers were not allowed to market insurance business and they have been allowed to do so IRDA vide their regulations issued in October 2002. Brokers are issued ‘license’ by IRDA to procure business and receive commission thereof.

Direct Selling

With a view to reduce costs, direct marketing is also being tried as a channel of distribution where ‘prospect’ approaches to the ‘insurer’

Internet Selling

Internet selling is also being used for some insurance products where no underwriting is involved. Full information about the product is available on ‘Internet’. It will take time



before results can be expected through this channel of marketing.

Structure of New Companies

New companies have Board of Directors, one of whom is a representative of customers.

They have two tire structure-Head office and branch office

Branch office of a new companies are either in their own premises or they have tied up with their own Associates who have large network of offices e.g. banks

Branch offices of these companies concentrate on production of business and building up clientele.

The technical work e.g. underwriting, policy issue, administration of policy is done at Head Office. Gradually the structure will change as they have more experienced staff and more work.

Structure of Postal Insurance

Postal Life Insurance is part of Central Govt.

There is separate directorate looking after this business.

It is headed by CGM reporting to Postal Service Board

Every district postal head office has an officer to look after Postal Life Insurance sells and claim payments.

Premiums are collected by all post offices, but accounting is centralized with Director of Accounts at Kolkata.



Departments in a Life Office

The following departments are likely to exist in an insurance office either at Head Office or Regional Offices or Branch Offices as the case may be. Names of the departments may differ but activities will be the same.

Business Development or Marketing- concerned with agency force, market development and business growth.

New business Department- which will receive proposals, scrutinize, underwrite, issue First Premium Receipt and policy.

Policy Holders Servicing Department- which will administer policy, monitor premium payments, deal with lapses, revivals and



alterations, nomination, assignment, surrender, loan, claim payment

Accounts Department-to maintain accounts books

Following departments at Head Office

Actuarial Department-is unique in a Life Office & plays vital role which inter alia include:-

i. Studies mortality, interest, expense experience

ii. Does valuation

iii. Determines surplus and bonus

iv. Monitor adequacy of premium rates

v. Sets underwriting standards

vi. Studies mortality rates ets.

Investment Department will invest funds as per law and regulations to get optimum returns

Advertisement, publicity and public relations department

Other departments

i. Personnel

ii. HRD

iii. Training

iv. Purchase

v. Administration for office upkeep will exist in all organisations catering either to the entire organisation or that office.



The Role of actuary in a Life Office

No Life Insurance can start Life Insurance Business in India without an “Appointed Actuary”. Actuary is a specialized person in an insurance organisation who is Fellow of Institute of Actuary, London or Actuary Society of India

The role of Actuary covers the following

- He is a technical expert on insurance matters

- Studies the mortality of insuring public

- Evaluates the financial condition of the Insurance Company

- Evolves insurance product



- Decides premium rates for each product at different ages

- Sets underwriting policies and standards

- Decides bonus rates

- A good Actuary is good economist, good statistician, good security analyst

- Actuarial valuation done at annual intervals is the responsibility of actuary

- Premium to be charged is certified by the actuary before the product is submitted to IRDA for approval

IRDA regulations on duties of Appointed Actuary

Every life insurer has to have an “Appointed Actuary”. The duties of Actuary include:

- Advise the management on product design, pricing, wording of insurance contract, investment of funds, reinsurance arrangements

- Ensure solvency of the insurer at all times- Comply with the Act in regard to premium, valuation of

assets and liabilities

- Certify actuarial report and other returns

- Certify the determination of mathematical reserves



Macro Economic Scenario & Insurance Industry Prospects

Indian Scenario

Robust GDP Growth FY 2008 - 09 (Provisional) : 6.1%

Increasing per Capita Income FY 2008 - 09 : Rs. 39,000

Increasing per Capita Income FY 2008 - 09 : Rs. 39,000

Demographics: Population Growth & Profile

India’s population growth (as per UN Population Division ) - Population to increase from 1029 Mn to 1400 Mn between 2001-26

This demographic transition Will raise the proportion of working-age people Favorable implications for savings, investment, and overall GDP

growth



With the fall in youth dependency ratio - GDS will rise & participation of women in the workforce likely to improve.

Demographics: Income Levels

As per NCAER market information survey of households (August 2005) Economic growth will push household incomes higher

Demography – Life Expectancy & Health Indicators



Better penetration – Another avenue for growth

India constitutes 16% of world population but only 1.97% of the world life insurance market (2008)

India’s household savings rate at 34.6% in 2008. Out of every 100 persons in India, only 3 are covered by

insurance or pension. Mere 20% of the insurable population ( age group 20 to 60)

covered by life insurance. Potential to cover remaining 80% which is without life insurance

protection or pension provision Huge potential to tap the rural population

Insurance Industry : contribution to Nation Building

As per the Life Insurance Council Insurance industry is the largest investor in the Indian equity

market Life insurance industry also participates significantly in

government borrowingso In FY 2007 – Rs. 2751 billiono In FY 2008 – Rs. 2975 billion

New Business Market Share

Based on weighted first year premium figures derived from IRDA Report below is the market share distribution



New Business - Trends

First Year Premiums (Rs. Billion)



The IRDA report shows growing market share for private players indicates their acceptance

Key Changes – Regulations

FY 2008-09 Changes in unit linked product guidelines – premium reduction

capped at 25% Investment norms tightened (Process and risk management

related) Reduction in solvency norms Change in service tax from 12% to 10% Insurers instructed to separate out assets backing the required

Solvency Margin, from the other shareholder assets and hold it in a separate

account New requirement to disclose payouts to non individual distributors

FY 2009-10 PFRDA launches pension solutions for unorganised sector Committee set up for review of multi-ties for banking companies Corporate governance framework in process Changes in investment and accounting regulations likely Disclosure & EV framework Circular for cap on ULIP charges

Conclusion



Insurance offer a very high growth potential in India. Insurance penetration in India is one of the lowest among all emerging markets. Rising income levels and awareness about insurance products would lead to many years of explosive growth in this sector.

In 2004, Indian insurance companies mobilized over $21 billion, nearly three times as much as in 1999 ($8 billion). The marketplace is getting competitive, but the market share of private insurance companies remains very low in 10-15 percent range. The heavy hand of government still dominates the market, with price controls, limits on ownership, & other restraints.

Over the past five years, life insurance industry has witnessed a sea change in terms of product offerings, service, risk management, fund options and others. Customers are now much more aware about life insurance and its benefits. Competition from private players has shaken up market leader LIC, which has become very aggressive of late. New entrants, attracted by the growth potential, are also queuing up to enter the market. What is more, in just a short period of time, life insurance has also become amongst the most exciting sectors to work in or partner with, demonstrating the immense job opportunity it has created.

Life insurance policies are sold in this country mostly as savings and investment products rather than as an essential tool to protect living standards of the family in the event of untimely death of an earning member. The proportion of pure life insurance policies, or term policies, is still very low. As awareness improves, this situation would change dramatically. There is also significant scope for increased insurance penetration in semi-urban and rural areas where very few lives are insured.

Insurance is a capital-intensive industry. It is also a long-gestation business. India's insurance industry needs capital, and a major source of capital would be from foreign investors, who are now limited to 26 percent ownership. India needs to raise the cap on Foreign Direct Investment (FDI) to attract capital for the industry.

India's insurance market remains very small compared with some of the major emerging markets. South Africa and South Korea, with a fraction (one-twentieth) of India's population, do at least twice as much insurance business as Indian companies did in 2004. This is a major missed opportunity for India's economy. A vibrant insurance market can support the economy by providing long-term capital - equity and debt, to the private sector.



Life Insurance…Better to have it and not need it….Than need it and not have it !!!!

Bibliography



Internet

www.irdaindia.org

www.google.com

www.worlsinsurance.com

www.licindia.com

www.hdfcstandardlifeinsurance.com

www.rncos.com

Newspaper Article and Magazines

Business World

Economic Times


http://www.rncos.com/

http://www.hdfcstandardlifeinsurance.com/

http://www.licofindia.com/

http://www.worlsinsurance.com/

http://www.google.com/

http://www.irdaindia.org/

Final project insurance

Economy & Finance

Transcript of Final project insurance