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March/2016/P1931(Reprint)
FOREWORD
Our Institute has always been proactive to macro economic changes in the
country by way of building and maintaining core competencies amongst the
members of the Institute so that they can synchronise the economic activities
of various stakeholders of our economy to such macro economic changes.
The Institute has constituted the Committee on Insurance and Pension for
identifying the emerging professional opportunities in the insurance and
pension sectors for the members, both in practice and in service and to train
and equip the members in those sectors through various modes.
I am happy to note that the Committee on Insurance and Pension has taken
the initiative to publish Supplementary Study Material for the Insurance and
Risk Management Course with features like case studies, short answer
questions, objective type question-answers. I am confident, that the format of
this Study Material will help the members to grasp the essence of the
contents.
I would like to place on record my appreciation for CA. Anuj Goyal,
Chairman of the Committee and other members of the Committee, whose
endeavour has culminated in publishing this Supplementary Study Material.
My best wishes are with the members enrolled for the Insurance and Risk
Management course and look forward to their appreciable level of
professional contribution to the booming insurance industry.
MODULE I
PRINCIPLES AND PRACTICE OF INSURANCE
Chapter 1
Introduction to Risk...........................................................................................I-1
Chapter 2
Introduction to Insurance............................................................................... ...I-9
Chapter 3
The Fundamental Legal Principles of General and Life Insurance................... .I-23
Chapter 4
Insurance Contracts..................................................................................................I-34
Chapter 5
Management of Insurance Organisations.................................................................I-47
Chapter 6
General Insurance Policies (Personal).....................................................................I-58
Chapter 7
General Insurance (Commercial).............................................................................I-76
Chapter 8
Life Insurance..........................................................................................................I-89
Chapter 9
Regulation of Investment Funds of Insurance Companies....................................I-102
Chapter 10
Laws Governing Insurance Management and Accounting....................................I-107
Chapter 11
Asset and Liability Management ..........................................................................I-113
MODULE II
TECHNICAL ASPECTS OF INSURANCE
Chapter 1
Underwriting.............................................................................................................II-1
Chapter 2
Fire Insurance ........................................................................................................II-10
Chapter 3
Marine Insurance....................................................................................................II-21
Chapter 4
Motor Insurance .....................................................................................................II-30
Chapter 5
Engineering Insurance ...........................................................................................II-38
Chapter 6
Miscellaneous Insurance ........................................................................................II-44
Chapter 7
Life Insurance Products .........................................................................................II-52
Chapter 8
Life Insurance Pricing Fundamentals ....................................................................II-62
Chapter 9
Social Security Schemes ........................................................................................II-73
Chapter 10
Group Insurance ....................................................................................................II-86
Chapter 11
Financial Gerontology and Super Annuating Policies ..........................................II-96
Chapter 12
Acturarian Valuation ...........................................................................................II-103
MODULE III
RISK MANAGEMENT AND REINSURANCE
Chapter 1
Economics of Insurance .........................................................................................III-1
Chapter 2
Introduction to Risk Management ........................................................................III-11
Chapter 3
Essentials of Risk Management...................................................III-20
Chapter 4
Probability ............................................................................................................III-27
Chapter 5
Decision Making Under Conditions of Uncertainty ............................................III-34
Chapter 6
Risk Management Process....................................................................................III-38
Chapter 7
Risk Management by Business and Enterprise Risk Management (ERM)...........III-47
Chapter 8
Reinsurance Theory ..............................................................................................III-54
Chapter 9
Methods of Reinsurance .......................................................................................III-60
Chapter 10
Treaty Wordings ...................................................................................................III-66
Chapter 11
Reinsurance Accounts and Administration ..........................................................III-73
Chapter 12
Reinsurance Regulations ......................................................................................III-79
Chapter 13
Reinsurance Markets ............................................................................................III-86
Chapter 14
Inward Reinsurance ..............................................................................................III-96
Chapter 15
Reinsurance Practice ............................................................................................III-98
MODULE IV
BUSINESS STRATEGIC PLANNING &
INFORMATION TECHNOLOGY
Chapter 1
Management of Insurance Companies ...................................................................IV-1
Chapter 2
BPO and Insurance ...............................................................................................IV-11
Chapter 3
Exchange Control and Taxation ...........................................................................IV-19
Chapter 4
System Development Process ..............................................................................IV-24
Chapter 5
System Analysis ...................................................................................................IV-35
Chapter 6
System Design ......................................................................................................IV-40
Chapter 7
System Implementation and Operation ............................................................... IV-48
Chapter 8
Computer Software and Configuration ................................................................IV-57
Chapter 9
Data Storage and Processing Methods......................................IV-71
Chapter 10
Information System Controls ...............................................................................IV-84
Chapter 11
Data Security and Integrity ................................................................................IV-100
Chapter 12
Information Technology and Insurance .............................................................IV-116
Chapter 13
Pricing and Marketing of Insurance ...................................................................IV-121
Chapter 14
Case Studies... IV-139
DIRM
MODULE I
Chapter 1
Introduction to Risk...........................................................................................I-1
Chapter 2
Introduction to Insurance............................................................................... ...I-9
Chapter 3
The Fundamental Legal Principles of General and Life Insurance................... .I-23
Chapter 4
Insurance Contracts..................................................................................................I-34
Chapter 5
Management of Insurance Organisations.................................................................I-47
Chapter 6
General Insurance Policies (Personal).....................................................................I-58
Chapter 7
General Insurance (Commercial).............................................................................I-76
Chapter 8
Life Insurance..........................................................................................................I-89
Chapter 9
Regulation of Investment Funds of Insurance Companies....................................I-102
Chapter 10
Laws Governing Insurance Management and Accounting....................................I-107
Chapter 11
Asset and Liability Management ..........................................................................I-113
M O D U LE -I: PRIN CIPLES A N D PRA CTICE O F IN SU RA N CE
C hapter 1
Introduction to R isk
SEC TIO N -A
13. C onsequencesofadverseselection
a. Escalation ofprem ium sand com plete collapse ofan insurance m arketw ith the
w ith-draw alofindividuals
b. Fallin prem ium sand partialcollapseofan insurancem arket
c. Fallin prem ium sand m any individualspurchaseinsurance
d. Fallin prem ium sand com pletecollapseofan insurancem arket
14. Insurancecovers
a. Speculativerisks
b. Investm entrisks
c. Im purerisks
d. Purerisks
15. R isk ofprem aturedeath is
a. Personalrisk
b. Liability risk
c. Property risk
d. Speculativerisk
16. D am ageto theproperty dueto floodsis
a. Personalrisk
b. Liability risk
c. Property risk
d. Speculativerisk
17. Selling defectivem edicinescreate
a. Personalrisk
b. Liability risk
c. Property risk
d. Speculativerisk
SEC TIO N A A N SW ER S
1. a 2. c 3. c 4. a 5. b 6. d
7. d 8. a 9. d 10.c 11.d 12.a
13.a 14.d 15.a 16.c 17.b
SEC TIO N -B
1. W hatarethecharacteristicsofrisk?
A ns:Thefollow ing arethecharacteristicsofrisk :
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6. C lassify differenttypesofrisks
A ns:Therearedifferenttypesofrisks,w hich m ay beclassified asfollow s:
Pureand speculativerisks
Subjectiveand objectiverisks
Fundam entaland particularrisks
Staticand dynam icrisks
7. D istinguish betw een purerisksand speculativerisks
A ns:Pure risks involve situations w here there is a chance ofloss oreven a break-even
situation butno profit.Purerisksdo nothavefavourableoutcom es;atbestw eareleft
in the sam e situation in w hich w e w ere before the eventcausing lossoccurred.Fires
in a go dow n or factory,an injury atthe w orkplace or on the road or a theftor
burglary athom eareallinstancesofpurerisks.
O n the otherhand,speculative risksm ay,in addition to the outcom esofa pure risk
cited above,have happy or favourable outcom es nam ely profit or gain.In other
w ords, speculative risks can have three possible outcom es, viz. loss, breakeven
situation or gain.A com m only cited exam ple of speculative risk is investm entin
sharesin w hich allthethreeoutcom esarepossible.
The difference betw een pure and speculative risks is highlighted to m ake the point
thatpure risks are generally insurable butnotspeculative risks,as the law oflarge
num bersisapplicableto purerisksand notto speculativerisks.
8. D istinguish betw een subjectiverisksand objectiverisks
A ns:Subjective risk arises out of an individuals m ental state. It is the result of
individualsuncertainty abouttheoutcom eofan event.Subjectiverisksoccurdueto
psychologicalfearabouttheoutcom eofan eventw hetheritw illbefavourableornot
to an individual.
O bjective risks,asthe term suggests,can be observed and forthatreason capable of
m easurem entunlike subjective risksw hich are notm easurable.H ere the probability
ofan eventoccurring can bedeterm ined in tw o w ays:oneby deductivereasoning (as
in the case ofa balanced coin being tossed)orby inductive reasoning (asin the case
ofan actuary determ ining theprobability ofdeath ofaperson atacertain age).
9. D istinguish betw een fundam entalrisksand particularrisks
A ns:Fundam entalrisksaregroup risks,w hich occurdueto social,econom icand political
changesin the country.Large num bersofpeople are affected by these fundam ental
risks.Fundam entalrisksalso arisedueto naturalcalam ities.
Exam ples:Crisis in the econom y,w idespread unem ploym ent,sudden w ars,poverty,
dram atic changes in governm ent policies, inflation, floods, earthquakes, fam ine,
volcaniceruptionsand othernaturalcalam itiesarealso described asfundam entalrisks.
Particularrisks on the contrary are personalin nature and affectonly individuals.
Thesearisefrom individualcausesand theconsequencesaffectindividuals.
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the m iddle of the 20th century,itw as custom ary to callthe risk m anager as the
insurance m anagerand hisdepartm entw asreferred to asinsurance departm ent.H is
activities w ere m ainly focussed on insurance buying.Today m ostlarge com panies
have a fulltim e senior executive designated as Risk M anager.H is job is clearly
defined.H eisaspecialistw hosejob isto identify and analysetheriskshiscom pany
isexposed to,selectm ethodsw ith w hich theserisksm ay becontrolled orelim inated
and advise top m anagem enton insurance buying to indem nify the com pany against
insurable losses to reduce the im pactofpotentialfinancialloss.Thus,even though
insurance buying m ay rem ain a m ajor area of his w ork,itis notthe only area of
operation.Risk m anagem entisam uch w iderconceptthan insurancem anagem ent.
InsuranceM anagem entvsR isk M anagem ent
1. Believesexclusively in insurance 1. M akesasystem aticstudy ofallrisksan
astherisk m anagem enttool. organization isexposed to,evaluates
them and identifiesthebestand m ost
econom icalm ethod ofhandling each risk.
2. Expertiseisin theareaofinsurance 2. H asabetterunderstanding ofrisk in the
and tendsto look atrisk solely com pany asaprofessionalin risk
from an insuranceangle m anagem ent
3. Covering allorm ostoftherisk 3. Looksatrisk m anagem entfrom thecost
through insurancew ould bea including insuranceforthem anagem ent
heavy costforthecom pany ofrisks.H encecosteffective
4. Insurancem anagem entisof 4. H andlesrisksforthecom pany by
lim ited useto an enterprisein adopting integrated risk m anagem ent
m anaging risks. orenterpriserisk m anagem entpractices
SEC TIO N C
(C A SE STU D IES)
1. V am siis a college student.H e ow ns a high-m ileage bike thathas a currentm arket
value of Rs.80,000.The currentreplacem entvalue of his clothes,television set,
stereo set,and other personalproperty in a rented apartm enttotalRs.1 lakh.H e
w earsdisposablecontactlenses,w hich costRs.6,000 forasix-m onth supply.H ealso
has a w ater bed in his rented apartm entthathas leaked w ater in the past.A n avid
runner,V am siruns five m iles daily in nearby public park thathas the reputation of
being extrem ely dangerousbecauseofdrug dealers,num erousassaultsand m uggings,
and drive-by shootings.V am sisparentsboth w ork to help him pay histuition.
Foreach ofthefollow ing risksorlossexposures,identify an appropriaterisk m anage-
m enttechniquethatcould beused to dealw ith theexposure.Explain youransw er.
a. Physicaldam ageto thebikebecauseofacollision w ith anotherm otorist
b. Liability law suitagainstV am siarising outof the negligentoperation of his
bike.
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C hapter2
Introduction to Insurance
SEC TIO N A
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M O D U LE -I: PRIN CIPLES A N D PRA CTICE O F IN SU RA N CE
SEC TIO N A A N SW ER S
1. (c) A s per the econom ic principle of life insurance,w ithin a substantially large
population,allthe m em bersare facing the sam e kind ofrisk.A llare likely to suffer
the losses equally butonly a few of them w illhave to face the harsh reality that
cannotbe predicted in advance through hum an intelligence.H ence,the conceptof
insuranceoperatesby pooling resources.
2. (a)Life insurance contractprovides the necessary econom ic supportin case ofthe
occurrenceofprem aturedeath orexcessivelongevity ofan individual,by w hich one
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M O D U LE -I: PRIN CIPLES A N D PRA CTICE O F IN SU RA N CE
can getthe security ofcash flow s forselfas w ellas forthe dependents in case of
disability orexcessivelongevity;and forthedependantsin caseofprem aturedeath.
3. (d)In any insurance contract,the lossesofthe unfortunate few are shared by a large
num berofpersonsfacing sim ilartypesofrisks.Therefore,thefinancialuncertainties
of those unfortunate few are shared by a large num ber of individuals in order to
assurecertainty ofcash com pensation from theinsurer.Butalifeinsurancecom pany
cannotrestoretheinsured to thesam eposition priorto theeventoflosses.
4. (e)In any insurance business,the sm allam ountofprem ium ischarged upfrontfrom
the insuredsw ho m ay suffersim ilartype oflosses.Butfinally,only the unfortunate
few insureds w ill face the harsh reality that is to be indem nified from those
prem ium s.Therefore,the risks are spread.But,the application ofthe law oflarge
num bersfinally leadsto theaccuracy ofestim ation oflosses.Theoriesofprobability
areused to estim atetheam ountofprem ium underactuarialprinciple.
5. (b) The concept of hum an life value is used to evaluate the requirem ent of life
insurancecoverageofan individual.Theobjectiveofsuch estim ation isto ensurethe
sam estandard ofliving to thedependentsofaperson even afterhispre-m aturedeath.
6. (a)A sthediscountrateincreases,thedenom inatorofeach factorw illgo up,w hilethe
num erator w ill rem ain the sam e. Therefore, the ultim ate hum an life value w ill
decrease.
7. (d)Clean up fundsare required to pay offthe debtsand the readjustm entfundsare
used to m aintain thesam estandard ofliving.Incom eto supportthefam ily ism eantto
supportthenecessitiesofthechildren and w ife.Lastly,retirem entneedsconsiderthe
financialrequirem entattheold age.Buttheneed forim provem entofsocialstatusis
notconsidered.
8. (c) U nder Section 38 of the Insurance A ct, 1938, transfer of property in a life
insurance policy can be done sim ply by an endorsem enton the back ofthe policy
docum ent.
9. (e)Lifeinsurancepolicy coveragecan betaken in allsuch casesasm entioned above.
10. (b)Life insurance isa type offorced and com pulsory savingsto the policyholder.In
othertypesofsavings,onem ay w ithdraw theaccum ulated sum atthetim eofeven a
m inorliquidity crisis.Butin case oflife insurance,the policyholderhasto suffera
substantialam ountoffinanciallossto sacrificetheinsurancecoverage.
11. (a) The very nature of the term insurance policies is such that the beneficiary
proceedsarepayableonly on death during theselected term and nothing ispayablein
caseofsurvivaloftheinsured untiltheend ofthecontracted term .
12. (d)In caseofpureendow m entpolicy,thepolicyholderreceivesthepolicy valueonly
on survivaltillthe end ofthe policy term .O therw ise,nothing isreceivable from the
insurer.
13. (a)Term insurancepoliciesonly considertherisk prem ium ,operationalexpensesand
a profitfactor.Therefore,due to the absence of any savings com ponent,they are
relatively cheaper.
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M O D U LE -I: PRIN CIPLES A N D PRA CTICE O F IN SU RA N CE
14. (d)W hole life insurance policy isthe longestterm insurance policy.In thiscase,the
proceedsofthe policy are rem itted by the insurerfollow ing the death ofthe insured,
irrespectiveofitstim ing.
SEC TIO N -B
1. D efineinsurance
A ns.Insurance can be defined both from an econom ic perspective and from a legal
perspective. From an ECO N O M IC PERSPECTIV E, insurance is a financial
interm ediation function by w hich individuals exposed to a specific financial
contingency each contribute to a pool from w hich covered events suffered by
participating individualsarepaid.
From aLEG A L PERSPECTIV E ,insuranceisan agreem entby w hich oneparty,the
policy ow ner,paysastipulated consideration called the prem ium to theotherparty
called the insurerin return forw hich the insureragreesto pay a defined am ountof
m oney orprovide a defined service ifa covered eventoccursduring the currency of
thepolicy.
2. W hatarethebasiccharacteristicsofinsurance?
A ns:Thebasiccharacteristicsofinsuranceare
Pooling oflosses
Thelaw oflargenum bers
Paym entoffortuitouslosses
Risk transfer
Indem nification
1. Pooling oflosses Pooling ofrisksorthesharing oflossesistheheartof
insurance.Pooling is spreading of losses incurred by the few over the
entire group,so that,in the process,average lossissubstituted foractual
loss. It im plies (i) the sharing of losses by the entire group; and (ii)
prediction offuture lossesw ith som e accuracy based on the law oflarge
num bers.
2. The law oflarge num bers M any lines of insurance risk reduction are
based on thelaw oflargenum bers.Itstatesthatthegreaterthenum berof
exposures,the m ore closely w illthe actualresultsapproach the probable
resultsthatareexpected from an infinitenum berofexposures.
3. Paym ent of fortuitous losses Paym ent is m ade for losses that are
unforeseen and unexpected and occursasa resultofchance.Thism eans
thelossm ustbeaccidental.
4. Risk transfer In this,a pure risk is transferred from the insured to the
insurerw ho typically is in a strongerfinancialposition and is w illing to
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M O D U LE -I: PRIN CIPLES A N D PRA CTICE O F IN SU RA N CE
pay the loss than the insured (e.g.risk ofprem ature death,poorhealth,
destruction ortheftofproperty)
5. Indem nification This m eans the insured is restored to his or her
approxim atefinancialposition priorto theoccurrenceoftheloss
3. W ritea briefnoteon theLaw ofLargeN um bers
A ns:M any lines ofinsurance risk reduction are based on the law oflarge num bers.The
law statesthatthe greaterthe num berofexposures,the m ore closely w illthe actual
results approach the probable results thatare expected from an infinite num berof
exposures.
Ifthere are a large num berofexposure units,the actuallossexperience ofthe past
m ay be a good approxim ation of future losses.To charge prem ium that w ill be
adequate for paying all losses, expenses and m argin for profit, this concept is
im portantto insurer because he can predictfuture losses w ith a greater degree of
accuracy asthenum berofexposuresincreases.
4. W hatdo you m ean by R isk Transfer?
A ns.In this,apurerisk istransferred from theinsured to theinsurer,w ho typically isin a
strongerfinancialposition and isw illing to pay forthelossthan theinsured (e.g.risk
ofprem aturedeath,poorhealth,destruction ortheftofproperty).
5. W hatdo you m ean by Indem nification?
A ns.Indem nification m eans the insured is restored to his or her approxim ate financial
position priorto theoccurrenceoftheloss.
6. W hataretherequirem entsofan insurablerisk?
A ns.Insurers norm ally insure only pure risks.H ow ever,allpure risks are notinsurable.
From theview pointoftheinsurer,therequirem entsofan insurablerisk are:
Therem ustbealargenum berofexposureunits
Thelossm ustbeaccidentaland unintentional
Thelossm ustbedeterm inableand m easurable
Thelossshould notbecatastrophic
Thechanceoflossm ustbecalculable
Theprem ium m ustbeeconom ically feasible
7. H ow doesinsurancedifferfrom gam bling?
A ns.Insurance isoften confused w ith gam bling.Butthere are tw o im portantdifferences
betw een them .
1. G am bling creates a new speculative risk,w hile insurance is a technique for
handling an already existing purerisk.
2. G am bling is socially unproductive,because the w inner s gain com es at the
expense of the loser. In contrast, insurance is alw ays socially productive,
becauseneithertheinsurernortheinsured isplaced in aposition w herethegain
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M O D U LE -I: PRIN CIPLES A N D PRA CTICE O F IN SU RA N CE
10. W hatarethetypesofInsurance?
A ns.
TY PES O F IN SU R A N C E
SO CIA L
PRIVATE IN SU RA N CE
IN SU RA N CE
{Em phasison (Focuson individualequity)
socialequity
through
incom e
redistribution}
*O A SD I LIFE H EA LTH N O N -LIFE
*M ED ICA RE
W holelife[death]
D isability incom e
accident,injury.
expensehealth,
* U N EM PT.
Liability loss
Property loss
Endow m ent
com pensation
Long term care
incapacity
M edical
W orkers
A nnuity
Term
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M O D U LE -I: PRIN CIPLES A N D PRA CTICE O F IN SU RA N CE
It can reduce the financial burden on the state of caring for the aged and
destitutes.
Itcan benefittheeconom y by creating asourceoffinancing fornew businesses,
housing and farm ing,etc.
Itgeneratesem ploym ent.
Itcan perm itm ore favourable term sto borrow ers;decrease the risk ofdefault;
and m inim izefinancialdisruption dueto death ofkey em ployeeand ow ner.
It can prom ote better em ployee/em ployer relations and provide low cost
benefitsto abroad spectrum ofpersonsw ho m ay otherw isehavebeen unableto
obtain such protection.
Insurance and Econom ies:A study by the O rganization forEconom ic Cooperation
and D evelopm ent[O ECD ]observesthatinsurance providesatleastthree categories
ofservicesim portantto econom ies.Theseare:
Substituteforgovernm entsecurityprogram m es Thestudy ofO ECD countries
found a significantnegative relationship betw een socialexpenditures and life
insuranceprem ium s.
M obilizes savings Role of savings in econom ic developm ent is crucial.
Insurers actas financialinterm ediaries and reduce transaction costs betw een
saversand borrow ers,createliquidity and facilitateeconom iesofscale.
Fosters a m ore efficient capital allocation. Insurers gather substantial
inform ation to provide funds to the m ostattractive firm s and projects,show
continuing intereston them ,m onitor entrepreneurs and foster m ore efficient
allocation ofacountry sscarcefinancialcapital.
15. Insuranceentailscertain coststo Society Explain
A ns: The Costs of Insurance: A lthough insurance offers societies great social and
econom icbenefits,italso carriescertain costs.Theseare:
Costsofdoing business
Fraudulentclaim s
Inflated claim s
C osts of doing business: O ne im portant cost is the cost of doing business.A n
expense loading [the am ountneeded to pay allexpenses,including com m issions,
generaladm inistrativeexpensesand an allow anceforcontingenciesand profit]m ust
be added to the pure prem ium to coverthe expensesincurred by com paniesin their
daily operations.H ow ever,these additionalcostscan be justified from the insured s
view pointofengaging in a w ide variety oflossprevention activities.A nd from the
industry view point,itprovidesjobsto m illionsofw orkers.
Fraudulentclaim s:A second costofinsuranceencouragesm oralhazardslike
Faked auto accidents
Fakeslip and fallaccidents
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SEC TIO N C
C A SE STU D IES
1. There are num erous definitions ofinsurance.Based on the definition ofinsurance
stated in the text,indicate w hethereach ofthe follow ing guarantees is considered
insurance.
a. A television setisguaranteed by them anufactureragainstdefectsfor90 days.
b. A new setofradialtiresisguaranteed by them anufactureragainstroad defects
for50,000 m iles.
c. A builderofnew hom esgivesaten-yearguaranteeagainststructuraldefectsin
thehom e.
d. A consigner of a note agrees to pay the loan balance if the originaldebtor
defaultson thepaym ents.
e. A largegroup ofhom eow nersagreeto pay forlossesto hom esthatburn during
theyearbecauseoffire.
2. Theexistenceofinsuranceprom ptssom einsuredsto deliberately causealossso asto
profitfrom insurance.Thesesocialcostsfalldirectly on society.G ivesom eexam ples
ofsuch fraud.
3. D oestherisk offirefulfilltherequirem entofan insurablerisk?
4. D oestherisk ofunem ploym entfulfillstherequirem entofan insurablerisk?
SEC TIO N C A N SW ER S
1.(a)-N o (b) N o (c) N o (d) N o (e) Yes
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M O D U LE -I: PRIN CIPLES A N D PRA CTICE O F IN SU RA N CE
4. Yes.
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M O D U LE -I: PRIN CIPLES A N D PRA CTICE O F IN SU RA N CE
C hapter 3
TheFundam entalLegalPrinciplesof
G eneralA nd LifeInsurance
SEC TIO N -A
d. Proponentand hisfriend
e. Em ployerand em ployee.
10. W hich of the follow ing relationships leads to lim ited am ount of insurable
interest?
a. Insurerand Insured.
b. Partnersin abusiness.
c. D ebtorand creditor.
d. Both (b)and (c)above.
e. A llof(a),(b),and (c)above.
11. In a typical case, the proponent of a life insurance contract w rote the age
w rongly w hile the insurer issued a policy other than the applied one.W hatw ill
betheim pactoftheein thecontractbetw een theinsurerand insured?
a. Itisacaseinvolving coercion and hencethecontractw illbenulland void.
b. Itinvolvesundue influence ofthe insureron the insured and hence no contract
isadm issiblebetw een theparties.
c. Itisam atterofm isrepresentation by theinsurerand so voidableatthew ishesof
theinsurer.
d. Theproponentisinvolved in theactoffraud and so theinsurercan suehim .
e. Both the parties have com m itted m istakes and hence the contract is
unenforceable.
SEC TIO N A A N SW ER S
1. (c)Principle ofinsurable interestis the m ostim portantfeature ofa life insurance
contractto m aintain the legality ofthe objectofthe contract.Ifthe existence ofthe
insurableinterestisnotconsidered properly,itw illam ountto gam bling.
2. (e)A llthe given situationsw illplace the insurerin a m ore risky position w hich isa
essentialpartform aking theunderw riting decisionsby theinsurer.
3. (e) These facts are expected to be know n to the insurers ow ing to their levelof
know ledge and understanding as w ell as their underw riting skills. H ence, the
proponentneed notbew orried abouttheirdisclosures.
4. (d) A ny representation m ade by the policyholder can lead to the risk of
m isrepresentation w hile a w arranty m ay lead to a serious contingency to the
policyholder.
5. (b) The principle of indem nity m eans m aking good the losses suffered by an
unfortunate person.Butin a life insurance contract,itis im possible to assess the
valueoflifeofan individualand so theprincipleofindem nity cannotbeapplied.
6. (d)O ne cannotbuy a life insurance policy forany unlim ited am ountatany pointof
tim e. The insurance com pany assesses the prem ium paying capacity and the
insurancecoveragerequirem entoftheproponent.Thisisdonein orderto ensurethat
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M O D U LE -I: PRIN CIPLES A N D PRA CTICE O F IN SU RA N CE
the insurance coverage should notbe cum bersom e to the insured.Sim ultaneously,
the insurance proceedsshould be sufficientenough to m aintain the sam e standard of
living,follow ing thestoppageofincom eoftheinsured.
7. (c)In a life insurance contract,the insurerassessesthe possibility ofthe lossesfrom
the m ortality tables.In a w agering contract,the possibility of losses is estim ated
eitherby em piricaljudgem entoranalytically depending on thesituation.
8. (c)Fraud occursw hen theproposerintentionally suppressesthem aterialinform ation
atthe tim e ofsubm ission ofan offer.In the life insurance business,the disease of
tuberculosis seriously affects the risk profile of the insured and hence itm ay be
considered asm aterialinform ation to theinsured.
9. (c)Exceptthe proponentand his ow n life,as w ellas husband and w ife,no other
em otionalrelationship leadsto any insurableinterest.
10. (e) The relationships in all the given cases lead to lim ited am ount of insurable
interest.In the firstcase,the insureris liable to provide the contracted benefits on
death or disability of the insured as contracted.W hile in the other tw o cases,the
extentofinsurable interestislim ited to the am ountofcapitalbroughtby the partner
to thebusinessand theam ountoutstanding in thebooksofthecreditor.
11. (e)Ifboth the parties to a contractcom m itted m istakes atthe tim e ofm aking the
contract,thecontractw illbetreated asnulland void.A saresultofthat,neitherofthe
party w illbeliableto otherregarding theexecution ofthecontractsincetheessential
ingredientofa contract i.e.consensusad idem ism issing in thiscase due to the
actsofboth theparties.
SEC TIO N -B
1. W hat are the fundam entalprinciples related to G eneraland Life Insurance
C ontracts?
A ns.The m ostim portantfundam entalprinciples related to G eneraland Life Insurance
Contractsare
1. U tm ostgood faith
2. Indem nity
3. Insurable interest
4. Subrogation
5. Contribution
6. Proxim atecause
2. Explain w hy an insurancecontractisconsidered ofutm ostgood faith and notof
caveatem ptor?
A ns.A n insurancecontractisbased on theprincipleofutm ostgood faith.Theprincipleof
utm ostgood faith is supported by three im portantlegaldoctrines:representations
concealm ent[intentionalfailure ofthe applicantforinsurance to reveala m aterial
factto the insurer] and breach of w arranty [prom ise m ade by the insured in the
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M O D U LE -I: PRIN CIPLES A N D PRA CTICE O F IN SU RA N CE
8. W hatisthelegaldoctrineofproxim atecause?
A ns.The legaldoctrine ofproxim ate cause isbased on the principle ofcause and effect.
A nd itdoesnotconcern itselfw ith the cause ofcauses.The law providesthe rule
causa proxim a non rem ota spectatur w hich m eansto beproxim ate,acausem ustbe
im m ediate cause,w hich is effectualin producing thatresultbutnotthe rem ote or
distantone.A nd thiscause hasto be selected by applying com m on sense standards,
i.e.thestandardsofam an in thestreet.
A n insurance policy is designed to provide com pensation only for insured perils
[nam ed in the policy as insured ex. fire, theft, etc.] but not for uninsured [not
m entioned in the policy]and excepted orexcluded [stated in the policy asexcluded]
perils.A nd theliability oftheinsurerarisesonly ifthelossiscaused by an insured.
Theselection ofproxim atecauseisnotan easy and sim pletask becauselossm ay be
caused by severaleventsacting sim ultaneously orone afterthe other.Itisnecessary
to differentiatebetw een theinsured peril,theexcepted periland theuninsured peril.
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M O D U LE -I: PRIN CIPLES A N D PRA CTICE O F IN SU RA N CE
SEC TIO N C
(C A SE STU D IES)
1. M any proponentsfeelthatfilling up ofthe proposalform isa boring and tiresom e
job and theagentoftheinsurancecom pany should takecareofthat.Butactually,that
should notbe the case.The proposerhim selfissupposed to fillup the sam e on his
ow n.D espite that,m any prefer the agentto do the job and m ostof the tim e the
hapless agents do it w ithout asking for any details of the health status of the
proponent.This innocent act m ay run into a nightm are,if the policyholder dies
w ithin tw o yearsfrom the date ofcom m encem entofthe policy.In such a situation,
m andatory investigationsare carried outbefore passing such claim sand the insurer
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M O D U LE -I: PRIN CIPLES A N D PRA CTICE O F IN SU RA N CE
SEC TIO N C A N SW ER S
1. (a) In thiscase,there isa high possibility thatthe agentm ay com m itm istake and
that m ay turn into a m isrepresentation on the part of the policyholder.
M oreover,thepolicyholderhasto provideaw arranty regarding thecorrectness
of allthe facts m entioned therein.Therefore,the contractw illbe treated as
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M O D U LE -I: PRIN CIPLES A N D PRA CTICE O F IN SU RA N CE
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M O D U LE -I: PRIN CIPLES A N D PRA CTICE O F IN SU RA N CE
C hapter4
Insurance C ontracts
SEC TIO N -A
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M O D U LE -I: PRIN CIPLES A N D PRA CTICE O F IN SU RA N CE
e. N oneoftheabove.
5. W hich of the follow ing is not an essential requirem ent of a legally valid
contract?
a. Freeconsentbetw een theparties
b. Com petency to contractby theparties
c. Law fulconsideration
d. Legalobject
e. Expressly declared by theactto bevoid
6. W hich ofthefollow ing leadsto incapacity to contract?
a. M inorageofany party
b. U ndischarged insolvent
c. Citizen ofan enem y country
d. Both (a)and (b)above
e. A llof(a),(b)and (c)above
7. W hich ofthefollow ing considerationsisdeem ed aslaw ful?
a. Theconsideration w hich isforbidden by law
b. Theconsideration w hich w illdefeattheprovision ofany otherlaw oftheland
c. Theconsideration w hich w illim posesom erestrictionson both theparties
d. Theconsideration w hich w illlead to som efraudulentactivity
e. Theconsideration w hich isopposed to thepublicpolicy
8. W hich ofthefollow ing isN O T a partofthepolicy docum ent?
a. Theheading
b. Thepream ble
c. Theobjectiveclause
d. Theoperativeclause
e. Theproviso
9. W hatisthecontentofthepream bleofa lifeinsurancepolicy?
a. Thenam eand addressoftheinsurancecom pany
b. Theintention oftheinsurerand theinsured in briefand in generalterm s
c. Therightsand responsibilitiesoftheinsured and theinsurerundertheinsurance
contract
d. The conditions to be follow ed and privileges ofthe insured forenjoying the
insurancecoverage
e. Stam psand signatureoftheauthorized officeroftheinsurancecom pany
10. W hatisthecontentoftheoperativeclauseoflifeinsurancepolicy?
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M O D U LE -I: PRIN CIPLES A N D PRA CTICE O F IN SU RA N CE
SEC TIO N A A N SW ER S
1. (b)Foralegally valid contract,them inim um num berofpartiesshould beatleasttw o
the prom isorw ho m akesthe prom ise and the prom isee w ho receivesthe prom ise.
Both sidesofthecontractshould beaw areoftheirrespectiveconsiderations.
2. (e)In thiscase,Ram isoffering m oney to theinsurancecom pany and thereby seeking
insurance coverage from it.The contractbetw een Ram and the insurance com pany
w illbeestablished,iftheofferisaccepted by theinsurer.H ow ever,theofferm ay be
revoked by Ram anytim e prior to the com m unication of its acceptance by the
insurancecom pany.
3. (b)A ssoon asthe letterofacceptance isposted by the offeree,the com m unication
w ith respectto theacceptanceoftheoffered isdeem ed to becom pleteasperthelegal
requirem entofacontract.
4. (c)M aking a counterofferby the offeree im pliesanotherofferto the offererand the
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M O D U LE -I: PRIN CIPLES A N D PRA CTICE O F IN SU RA N CE
SEC TIO N -B
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M O D U LE -I: PRIN CIPLES A N D PRA CTICE O F IN SU RA N CE
2. G ivea briefnoteon
A dhesion contract
Valued policy
U nilateralcontract
Conditionalcontract
A leatory contract
Personalcontract
A ns.A dhesion C ontract:A contractofadhesion m eansthatthe insured m ustacceptthe
entire contract,w ith allitsterm sand conditionsw hich are fixed by the insurer.Itis
highly specialized and technicalin nature and prevents itfrom being a bargaining
contract.
Valued Policy:U nlike property insurance,life insurance contractisa valued policy
w hich m eans the insurer agrees to pay a stated sum of m oney irrespective of the
actualeconom ic loss w hich is opposite to the contractof indem nity applicable to
property insurance.
U nilateral C ontract: U nlike com m ercial contracts w hich are bilateral in nature,
insurance contractsare unilateralin nature.Itm eansthatonly one party,the insurer,
givesa legally enforceable prom ise and the insured cannotbe legally forced to pay
the prem ium s. But of course, the insurer is bound to accept them and provide
protection to theinsured w hen they pay prem ium sin tim ely m anner.
C onditionalC ontract:A n insurancecontractisaconditionalcontract.Theinsurer s
obligation to pay aclaim dependsupon theconditionsw hich areinserted in thepolicy
likepaym entofprem ium s,proofofdeath and in thecaseofproperty lossim m ediate
noticeoflossto theinsurer,etc.
A leatory C ontract:U nlikeacom m utativecontract,an insurancecontractisaleatory.
Itm eans thatthe values exchanged m ay notbe equalbutinvolve the elem entof
chance oran uncertain event.In this,one party m ay receive m ore in value than the
other.The insured m ay receive m ore than the am ounthe paid in prem ium sw hen the
lossoccursim m ediately aftertheacceptanceofapolicy.A nd theinsurerm ay receive
m orein valueifthelossdoesnotoccurto theinsured w hen thepolicy w asin force.
PER SO N A L C O N TR A C T:Property insurance is a personalcontractbetw een the
insurerand theinsured.In this,insurerinsurestheow nerofproperty againstlossbut
notthe property.Insured property isindem nified ifthere isany lossand itcannotbe
assigned to another party w ithoutthe insurer s consent.Butlife insurance can be
assigned to any onebecausetheassignm entdoesnotaltertherisk.
3. W hatarethebasicrequirem entsofan InsuranceC ontract?
A ns.Thebasicrequirem entsofan insurancecontractare:
O fferand acceptance.
Consideration.
Com petentparties.
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M O D U LE -I: PRIN CIPLES A N D PRA CTICE O F IN SU RA N CE
Legalpurpose.
O fferand acceptance:A n agentm erely solicitsorinvitestheprospectiveinsured to
m akean offer.Theapplicantforinsurancem akestheoffer,and thecom pany accepts
or rejects the offer. This accepting procedure is different for property, liability
insurance and life insurance.In property insurance,the offerand acceptance can be
oralorw ritten and theagentshavethepow erto bind theircom paniesthrough theuse
ofa binderw hich is a tem porary contract.Butin life insurance,the agentdoes not
have the pow erto bind the insurer.The application forlife insurance is alw ays in
w riting and itshould beapproved by theinsurerbeforeitisin force.
C onsideration:Itrefersto thevaluethateach party givesto theother.Theinsured s
consideration ispaym entoraprom iseto pay theprem ium and an agreem entto abide
by the conditions in the policy.The insurer s consideration is the prom ise to do
certain thingsw hich arespecified in thecontract.
C om petentparties:Insane persons,intoxicated personsand m inorsare notlegally
com petentto enterinto insurancecontracts.
Legalpurpose:A llillegalactivitiesw hich are contrary to the public interestare not
enforceable.A contractshould havealegalpurpose
4. D escribethebasicpartsofan InsuranceC ontract:
A ns.Insurancecontractsgenerally can bedivided into
D eclarations
D efinitions
Insuring agreem ent/O perativeclause
Exclusions
Conditions
M iscellaneousprovisions
G enerally,m ostoftheinsurancecontractscontain theseparts:
D eclarations:In thedeclaration partinform ation regarding property oractivity to be
insured by theinsurerispresented.Itisusefulforunderw riting and rating purposes.It
is generally found on the first page of the policy. In property insurance, the
declaration page contains inform ation regarding the identification of the insurer,
nam e of the insured, location of the property, period of protection, am ount of
insurance, am ount of the prem ium , etc. In life insurance, the declaration page
containstheinsured snam e,age,prem ium am ount,issuedateand policy num ber.
D efinitions:Insurance contractsgenerally contain a page ofdefinitions.They are in
eitherquotation m arksorin bold face type.Forex.The insurerisalw aysreferred to
as w e our or us and the insured is referred to as you and your .These
definitionsm akeeasy to determ inethecoverageunderthepolicy.
Insuring A greem ent:Itisthe m ostim portantpartin the contact.Itsum m arizesthe
m ajorprom isesand conditionsto fulfilthe prom isesby the insurer.In property and
liability insurance there are tw o form sofan agreem ent.1.Nam ed perilpolicy and 2
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M O D U LE -I: PRIN CIPLES A N D PRA CTICE O F IN SU RA N CE
allrisk coverage.In the nam ed perilpolicy the policy covers only the specified
perils,w hereasunderan allrisk coverage policy the policy coversalllossesexcept
those losses specifically excluded.A llrisks coverage is preferable to nam ed perils
coverage because ofitsbroad coverage and also asthe burden ofproofto deny the
paym entis placed on the insurerunlike the insured in the nam ed perilpolicy.Life
insurance isan exam ple ofallriskspolicy itcoversallcausesofdeath w ith som e
exceptionslikesuicide,aviation,w ar,etc.
Exclusions:Therearethreetypesofexclusionsin an insurancecontract:
a. Excluded perils[ex.Theperilofw arisexcluded in disability incom epolicy]
b. Excluded losses [ex.Professionalliability losses are excluded from personal
liability section ofhom eow nerspolicy]
c. Excluded property [ex.Carsand planesin ahom eow nerspolicy]
M ain REA SO N S fortheseexclusionsare:
Som eperilsareuninsurablelikew ars.
Som eperilsarepredictabledeclines[w earand tearand inherentvice]
Som eperilsareextraordinary hazards[in carsand cabs-cabsarem oreproneto
accidentsthan car]
To avoid duplication ofcoverage [ex.A caris excluded underhom e ow ners
policy becausecariscovered underthepersonalauto policy]
To avoid m oralhazard -Ifunlim ited am ountofm oney w ere covered fradulent
claim scould increase.
Finally exclusions are used because the coverage is notneeded by the typical
insured.
C onditions:To m eetprom isesby the insurer,the conditionssection im posescertain
dutieson the insured.Ifthe policy conditionsare notm et,the insurercan refuse to
pay theclaim .
M iscellaneous Provisions: In property and liability insurance, m iscellaneous
provisionsreferto cancellation,subrogation,and assignm entofthe policy;and in life
insurance,graceperiod,reinstatem entofalapsed policy and m isstatem entofage,etc.
M ostof the policy ow ners m ake a com m on m istake of notreading policies and
understanding the contractualprovisions thatappear in the policies w hich lead to
controversies in the settlem ent. To avoid this, study of basic parts of insurance
contractw ould beuseful.
5. Identify the m ajor types of exclusions typically found in insurance contracts.
W hy areexclusionsused by insurers?
A ns.EX CLU SIO N S are basic partof any insurance contract.There are three types of
exclusionsin theinsurancecontract.
a. Excluded perils[ex.Theperilofw arisexcluded in disability incom epolicy]
b. Excluded losses [ex.Professionalliability losses are excluded from personal
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M O D U LE -I: PRIN CIPLES A N D PRA CTICE O F IN SU RA N CE
I-42
M O D U LE -I: PRIN CIPLES A N D PRA CTICE O F IN SU RA N CE
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M O D U LE -I: PRIN CIPLES A N D PRA CTICE O F IN SU RA N CE
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M O D U LE -I: PRIN CIPLES A N D PRA CTICE O F IN SU RA N CE
SEC TIO N C
(C A SE STU D IES)
1. Joshuaow nsam otorboatthatstruck and dam aged anotherboatanchored atam arine.
W hen theaccidentoccurred,Joshua sfriend,Zoe,w asoperating them otorboat.The
ow nerofthe dam aged boathasasked Zoe to pay forthe dam age.Joshua islisted as
thenam ed insured on thedeclarationspageofaboatow nersliability policy.Joshua s
policy included thefollow ing provisions:
W hatiscovered?
W e w illpay allsum s w hich an insured becom es legally obligated to pay as
dam ages due to bodily injury or property dam age arising out of the ow nership,
m aintenance,oruseofthedescribed vessel.
W hatisnotcovered
W e do notcoverliability arising from the ow nership,m aintenance,oruse ofthe
described vessel:
1. thatresultsfrom an intentionalactofan insured
2. to personsw hile they are being tow ed by the described vesselasw aterskiers,
aquaplaners,orsim ilarw atersports.
D efinitions
1. Thew ords you and your m ean thepersonsnam ed on thedeclarations.
2. Thew ords w e , us ,and our m ean thecom pany providing thisinsurance.
3. Bodily Injury m eansbodily harm ,sickness,ordiseaseto aperson.
4. Insured m eans you and:
your spouse;
your relativesifresidentsofyourhousehold;
personsundertheageof21 in your care;
aperson w ho operatesacovered vesselw ith your perm ission.
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M O D U LE -I: PRIN CIPLES A N D PRA CTICE O F IN SU RA N CE
SEC TIO N -C A N SW ER S
1. (a) D eclaration
(b) Joshua s Policy can provide coverage for the claim againstZoe.The policy
provision in thissituation isthatunderthe D efinitions aperson w ho operates
acovered vesselw ith your perm ission isalso included.
(c) Yes, Joshua s policy w ould pay for the lost revenues because under the
provision w hatis covered the dam age arising outof the use of described
vesselisalso covered.
(d) N o,becauseskiersarenotcovered undertheprovision w hatisnotcovered .
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M O D U LE -I: PRIN CIPLES A N D PRA CTICE O F IN SU RA N CE
C hapter5
M anagem entofInsurance O rganizations
SEC TIO N -A
1. Insuranceinstitutionsarebasically
a. Financialinstitutions
b. Investm entinstitutions
c. M utualfundsinstitutions
d. Lending institutions
2. Theregulatorofinsurancecom paniesin India is
a. SEBI
b. IRD A
c. LPA
d. TA C
3. The authority responsible in the redressalofdisputes betw een the insurer and
theinsured isknow n as
a. O m budsm an
b. A rbitrator
c. Judge
d. A dvocate
4. O m budsm an isa
a. G overnm entalbody
b. Sem i-governm entalbody
c. Sem i-quasibody
d. Sem i-judicialbody
5. Theinsuranceom budsm an pronounces
a. Statem ents
b. D ecree
c. Aw ards
d. Rew ards
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M O D U LE -I: PRIN CIPLES A N D PRA CTICE O F IN SU RA N CE
I-48
M O D U LE -I: PRIN CIPLES A N D PRA CTICE O F IN SU RA N CE
b. Retrospectiverating
c. Experiencerating
d. Policy rating
13. The gross prem ium includes besides risk prem ium a percentage of loading
factorfor
a. Expenses
b. Pastlosses
c. A dverseclaim sexperience
d. Profits
14. The process of evaluating risks and fixing rates in an insurance com pany is
called
a. U nderw riting
b. Ratem aking
c. U nderrating
d. Reinsurance
15. W hich ofthefollow ing m easuresareintended to low erfrequency oflosses?
a. Lossprevention m easures
b. Losscontrolm easures
c. Lossreduction m easures
d. Lossm inim ization m easures
16. The processofinsuring lossesfor an entire class,territory ,or book ofbusiness
isknow n as
a. Treaty reinsurance
b. Portfolio reinsurance
c. Facultativereinsurance
d. Proportionalreinsurance
17. Excessoflosstreatiescan beclassified as
a. Peroccurrence
b. Perrisk
c. A ggregateexcess
d. A lltheabove
18. W hich ofthe follow ing is the m osteffective form ofreinsurance for handling
lossfrequency variations?
a. A ggregateexcesstreaty
b. Facultativetreaty
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M O D U LE -I: PRIN CIPLES A N D PRA CTICE O F IN SU RA N CE
c. catastrophetreaty
d. pro ratatreaty
19. W hen a reinsurer shareshislossexposure(s)w ith other reinsurer(s),itiscalled
as
a. Reinsurance
b. Retrocession
c. Retention
d. Re-reinsurance
20. W ho am ong thefollow ing doesnotcom eunderthecategory ofclaim sadjusting
personnel?
a. A ssessor
b. Exam iner
c. Claim ssupervisor
d. A djuster
SEC TIO N A A N SW ER S
1. a 2. b 3. a 4. c 5. c 6. a
7. d 8. d 9. d 10.b 11.c 12.b
13.a 14.b 15.a 16.b 17.d 18.a
19.b 20.a
SEC TIO N -B
ix) Physicalcondition
x) Safety equipm ent
A geofoperators U sually,considerably higherratesarecharged foryoung drivers.
Thisisdueto thegreaterinvolvem entofyoung driversin fatalaccidents.
A ge and type ofautom obile A correlation exists betw een the age ofthe vehicle
and its m echanical condition. The type of autom obile m ay also determ ine
underw riting acceptability.Sportsand luxury carstend to producehigherlossesthan
otherm odels.
U se ofthe autom obile U nderw riting ofautom obiles also takes into accountthe
type ofroadsthe autom obile runson (highw aysorcity roads,)the distance covered
by iton adaily basis,and thepurposeforw hich theautom obileisused (forbusiness
use,forpleasure,etc.)
D riving record The record orpriorlosshistory ofthe driveristaken into account
w hen evaluating aprivatepassengerautom obileapplicant.
Territory or radius of operation A ccidentfrequency depends notonly on the
territory in w hich the autom obile is used butalso on the distance travelled by the
autom obile.
Sex and m aritalstatus Young fem ale drivers are considered to be m ore careful
driversthan young m aledrivers,and arethereforeconsidered betterthan m aledrivers
in term soflossexposure.
O ccupation Som e occupations require extensive driving. This increases the
probability ofloss.
Personalcharacteristics The creditinform ation of applicants is often used by
insurers to evaluate their financial stability. U nderw riters have discovered a
correlation betw een poorcreditrisk and poorinsurancerisk.
2. W hat are the risk dim ensions of underw riting in the insurance business as
opposed to thesecuritiesbusiness?
A ns.Investors seek diversification of risks and com m ensurate m arket rates of return.
O therw ise, it m ay lead to pile up of high price/earnings (P/E) m ultiple stocks.
Therefore,generally,investorstry to m aintain abalancebetw een therealrisk and the
perceived risk and desireto haveabalanceofhigherand low erP/E stocks.P/E ratio
m easure risk adjusted ratesofreturn.They indicate the degree ofrisk asw ellasthe
expectation ofearningsand cash flow sin thenearterm .
Buyersofinsurancew antastableand creditquality m arket,w hich providesthem w ith
a reasonable ability to forecastand budgetrelated costs.The risk involved in the
insurancebusinessistheunexpected orfortuitouscausesoflossdefined in thepolicies.
U nderw riting firm s,on a portfolio basis,focus on m atching assets and liabilities.
H ow ever,they m aintain a reasonable degree of liquidity in order to pay claim s.
Further,in the insurance business,the insurerhas gotthe responsibility tow ards its
policyholdersapartfrom the investm entphilosophy ofm aintaining safe high-credit
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M O D U LE -I: PRIN CIPLES A N D PRA CTICE O F IN SU RA N CE
R isk R etention: This step pertains to the ability of the country or the society in
particular to w ithstand disasters. There are tw o aspects of risk retention
psychologicaland financial.The psychologicalaspects have a lotto do w ith the
involvem entofgovernm entm achinery and voluntary agencies and also to a great
extenton thetenacity ofthepeople.
R isk Transfer:This is a risk financing m ethod and provides a m eans forhandling
risk w hich haveahigh severity oflossesand onecannotafford to retain such risks.
4. W hataretheparam etersto decidew hethera particularrisk isinsurableornot?
A ns.Thekey param etersto decidew hetheraparticularrisk isinsurableornotare:
M utuality:A large num berofpeople exposed to risk m ustcom bine to form a risk
com m unity.
N eed:The occurrence ofthe anticipated eventm ustplace the insured in a condition
offinancialneed.
A ssessability:Theexpected lossburden m ustbeassessable.
R andom ness:The tim e atw hich the eventoccurs m ustnotbe predictable and the
occurrenceoftheeventm ustbeindependentofthew illoftheinsured.
Econom icViability:Thecom m unity organized by theinsured personsm ustbeable
to m eetitsfutureloss-related financialneedson aplanned basis.
Sim ilarity ofthreat:The insured com m unity m ustbe exposed to the sam e threat.
Further,the occurrence ofthe anticipated eventm ustcreate the need forfundsin the
sam ew ay forallthoseaffected.
5. In reinsurance transactions,w hat does retention m ean? W hat are the steps
being considered by the Insurance R egulatory and D evelopm entA uthority to
im provetheretention capacity ofdom esticinsurancecom panies?
A ns.Reinsuranceagreem entsinvolveatransferoflossexposuresassum ed by theprim ary
insurerto the reinsurer.H ow ever,the reinsurerdoesnotassum e allthe exposuresto
w hich the prim ary insurer is exposed.The reinsurance agreem entrequires thata
portion oftheexposure,know n asretention,beretained by theprim ary insurer.
D om esic insurance com panies are facing low retention capacities ow ing to the
increasing outflow of their prem ium incom e from the country. The outflow of
prem ium is a resultofthe large am ounts ofreinsurance taken by private insurance
com panies,eitherw ith theirparentcom pany abroad orw ith otherlarge reinsurance
com panies.Privatesectorinsurancecom panieshaveretained only asm allpartofthe
risk thatthey haveinsured and reinsured am ajorportion oftherisk insured ow ing to
under-capitalization.
Further,reinsurers have hiked their prem ium s to close to one percentof the sum
assured.W ith this,thelow retention capacity oftheprivateinsurancecom paniesw ill
lead to an outflow ofprem ium s to the extentof40 percentofthe gross dom estic
prem ium incom eofallgeneralinsurancecom panies.
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M O D U LE -I: PRIN CIPLES A N D PRA CTICE O F IN SU RA N CE
In contrastto the insurance com paniesin the private sector,insurance com paniesin
the public sector have seldom taken large reinsurance cover. Even in the w orst
cyclicalphase,the reinsurance taken by the fourpublic sectorinsurance com panies
hashardly exceeded 7 percentofthegrossdom esticprem ium incom e.Thishasbeen
possiblebecauseofthehigh retention capacity ofpublicsectorinsurancecom panies
w ith each com pany having an averagecapitalization ofaboutRs.2,500 crore.
Thus,in orderto cap prem ium outflow sfrom the country and im prove the retention
capacity of dom estic insurance com panies, the Insurance Regulatory and
D evelopm entA uthority isconsidering thefollow ing m easures:
Coinsurance Itis an arrangem entbetw een alldom estic insurance com panies
identicalto consortium financing by banks.In coinsurance,therew illbeonelead
insurerw ith severalotherinsurancecom panies.A llthem em bercom paniesin the
arrangem entw illhaveasharein prem ium collections.They w illsharetheclaim s
on aparipassu basis(paripassu fairely;atan equalrateorin an otherw isefair
w ay,w ith no person orgroup taking percentoveranother)
Syndicated insurance This is identicalto coinsurance arrangem ent,except
thatthem em bersofthesyndicatehavetheoption to exittheagreem ent.
Increased Capitalization Increasing the capitalization of the new private
sector com panies in the generalinsurance industry is likely to im prove the
retention capacity ofprivateinsurers.
6. D iscusstheobjectivesofratem aking activitiesin an insuranceorganization.
A ns.Ratem aking isoneofthefunctionsofactuaries.Thebasicobjectiveofratem aking is
to develop a rate structure thatw illenable the insurer to com pete effectively for
businessw hile earning a reasonable profit.A partfrom thisprim ary objective,there
arecertain secondary objectives.They are.
Corporateobjectives
Regulatory objectives
C orporate objectives-Prim ary insurerspreferratesthatare flexible,easy to apply,
prom ote loss controland provide forcontingencies.H ow ever,in reality,this is not
possibleto achieve.
Prim ary insurers prefer stable rates because the process of fixing a rate is very
expensive.In addition,frequentchangesw ould lead to custom erdissatisfaction.
To prom ote loss control, the rating system should provide low er rates to those
policyholders w ho undertake loss prevention m easures.A partfrom this,the rating
system should be understandable to agents,brokers,underw riters and especially
policyholders(w ho havelittleexpertiseregarding insurancem atters).
R egulatory objectives A ccording to regulatory objectives,rates
Should beadequate
Should notbeexcessive
Should notbeunfairly discrim inatory
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M O D U LE -I: PRIN CIPLES A N D PRA CTICE O F IN SU RA N CE
If the rate does notcom ply w ith regulatory norm s,itm ay invite harsh regulatory
actionsand unfavorablelegislation.
7. A property-liability insurer basically operates tw o kinds of businesses.
C om m enton this statem entand also explain the role ofinvestm entincom e in
ratem aking.
A ns.A property liability insurerbasically operatestw o kindsofbusinesses:
Insurancebusiness
Investm entbusiness
Insurance business Insurance business operations include w riting policies,
collecting prem ium s, and paying claim s. This is the revenue generator for an
insurancecom pany.Thesuccessofan insurerdependson thesuccessofhisinsurance
business.
Investm ent business This business includes the purchase of bonds,stocks and
other investm entvehicles for earning profit.In the investm entbusiness,profitis
derived from threesources:investm entincom e,realized capitalgains,and unrealized
capitalgains.
Roleofinvestm entincom ein ratem aking
Previously, investm ent incom e w as not considered by insurers w hen calculating
insurance rates.But,oflate,in som e countries,itisconsidered in the calculation of
rates.
Investm entprofits can be reflected in ratem aking by firstestim ating the realizable
investm entprofitfrom a particularinsurance line,and laterdeducting thatam ount
from the expense loading used in the rates.The inclusion ofinvestm entprofits in
ratem aking m ay affectliability insurance rates m ore than property insurance rates
because the am ountofinvestm entprofitearned on an insurance line w ould largely
depend on thelossreserveand theunearned prem ium reserves.
SEC TIO N C
C A SE STU D IES
1. RahulK um ar,the CEO ,Ram esh A dhikari,the G eneralM anager(U nderw riting),of
RK Insurance Com pany are discussing the various types of reinsurance options
available in the m arket.A dhikariinform ed K um ar thatthree types of reinsurance
optionsare available:facultative,treaty and financialreinsurance.H e also described
each option briefly to theCEO .A fterlistening to him ,theCEO said that,prim a-facie,
facultativereinsuranceseem sto bem oresuitableforthecom pany than othertypesof
reinsurance.H e asked A dhikari to provide him details on the different types of
facultative reinsurance available. D escribe the different types of facultative
reinsurancecontractsavailableto help A dhikarim akeasuccessfulpresentation.
A ns:In facultative reinsurance,the lossexposure isw ritten separately foreach individual
custom er by the reinsurer. The prim ary insurer provides the reinsurer detailed
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M O D U LE -I: PRIN CIPLES A N D PRA CTICE O F IN SU RA N CE
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M O D U LE -I: PRIN CIPLES A N D PRA CTICE O F IN SU RA N CE
C hapter 6
G eneralInsurancePolicies(Personal)
SEC TIO N -A
1. Personalaccidentpoliciescovertherisk of
a. U nem ploym ent
b. Sickness/illness
c. A ccidentalinjuries
d. N oneoftheabove
2. PersonalA ccidentpoliciesare
a. V alued policies
b. Indem nity policies
c. U nvalued policies
d. O pen policies
e. N oneoftheabove
3. D isability incom epoliciespay for
a. D isability arising outofsickness
b. D isability arising outofsickness/accident
c. D isability arising outofem ploym entinjuries
d. H ospitalization only forinjuries
e. N oneoftheabove
4. Personalliability insurancepoliciescoverdam agesto propertiesand injuriesto
otherpeopledueto
a. N egligence
b. W illfulm isconduct
c. W arlosses
d. Burglary
e. N oneoftheabove
5. The fire insurance policy in India doesnotprovide for com pensation for losses
arising outof
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M O D U LE -I: PRIN CIPLES A N D PRA CTICE O F IN SU RA N CE
a. Theft
b. A ircraftdam age
c. Im plosion orexplosion
d. Lightning
e. N oneoftheabove
6. W orkm en sC om pensation policy indem nifiesthelossesofthe
a. W orker
b. Em ployer
c. G overnm ent
d. Surveyor
e. N oneoftheabove
7. G olfer sindem nity policy providesprotection againstlossesordam agesto the
a. O nly golfplayers
b. G olfplayers& golfequipm ent
c. O nly golfequipm ent
d. G olfplayers& golfequipm ent& liability losses
e. N oneoftheabove
SEC TIO N A A N SW ER S
(1) c (2) a (3) b (4) a (5) a (6) b
(7) d
SEC TIO N -B
PER SO N A L A C C ID EN T PO LIC Y
1. D efineaccidentasgiven in thePersonalA ccidentpolicy.
A ns.A ccidentisdefined asany injury caused by accidental,violent,external,and visible
m eansresulting in death ordisablem ent.
2. Is the PersonalA ccidentinsurance,a contractofindem nity? G ive reasons for
youransw er.
A ns.N o,itisnota contractofindem nity because on som e conditionsbeing fulfilled the
CapitalSum Insured (CSI)is payable to the injured.Forexam ple,ifw ithin tw elve
m onths of its occurrence the injury be the sole cause of death, or of total and
irrecoverablelossofboth theeyes,orlossofuseoftw o handsortw o feet,thecapital
sum insured shallbe payable to the insured.Thus,the contractis based on agreed
value of loss.D ifferentcom pensations for differentclasses of insured negate the
principalofindem nity.
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M O D U LE -I: PRIN CIPLES A N D PRA CTICE O F IN SU RA N CE
H EA LTH IN SU R A N C E
11. D escribethesalientfeaturesoftheIndividualM ediclaim insurancepolicy.
A ns. The individual M ediclaim policy covers reim bursem ent of H ospitalization/
D om iciliary H ospitalization expenses forillness/diseases orinjury sustained.The
com pany w ill pay to the Insured Person the am ount of such expenses as are
reasonably and necessarily incurred butnotexceeding the Sum Insured in any one
period ofinsurance.
12. W hatisthescopeofcoverunderthevariousclausesin a health insurancepolicy?
A ns.In theeventofany claim /sbecom ing adm issibleundertheschem ethecom pany w ill
pay to theinsured such expensesasm entioned below :
Room expenses,boarding expensesasprovided by the hospitalization/nursing
hom e.
N ursing expenses
_ Surgeon,anesthetist,m edicalpractitioner,consultantsand specialistsfees.
O therexpensesrelating to blood,oxygen,surgicalexpenses.
13. W hat Institutions can be considered as H ospital/ N ursing H om e under a
M ediclaim policy?
A ns.H ospital/N ursing H om em eansan institution in Indiaestablished forindoorcareand
treatm ent of sickness and injuries and it should have been registered w ith local
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M O D U LE -I: PRIN CIPLES A N D PRA CTICE O F IN SU RA N CE
PER SO N A L A U TO IN SU R A N C E
23. D iscussthenatureand scopeofthePersonalA uto Insurancecover.
A ns.A policy ofm otorvehicle insurance is,in ordinary course,a com bined insurance.It
insuresthe dam age ofthe m otorvehicle and itsaccessories,liability fordam age for
property,death oforinjury to,the assured him selforspouse and italso insuresthe
m otorvehicle againstthe risk ofliability forinjury to,orthe death ofthird parties
caused by thedriver snegligence.
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M O D U LE -I: PRIN CIPLES A N D PRA CTICE O F IN SU RA N CE
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M O D U LE -I: PRIN CIPLES A N D PRA CTICE O F IN SU RA N CE
contractor to a third party arising outof the faulty design of a structure w as held
covered though therew asno negligence.
Sim ilarly,in a householders com prehensive insurance policy,the w ord accident
covered nuisance liability w hich had occurred w ithoutthe negligence on the partof
theassured.
32. W hatisthedifferentinsurancecoveragesoffered in liability insurance?
A ns.U nderthe liability insurance category thefollow ing liability policiesarecovered:
Publicliability insurance,
Liability arising in connection w ith professionalnegligence,
Com pulsory insurance,
Em ployer sliability insurance,
G uaranteeinsurance.
33. Explain briefly each oftheabovem entioned liability insurancepolicies.
A ns.Liability insurance policiesare generally expressed asproviding indem nity against
liability in law .Thevariousliability insurancepoliciesarediscussed atlength below .
Publicliability insurance: Publicliability doesnotm ean liability ofthestateorits
agencies.Itm eansliability asim posed by law asopposed to self-im posed liability as
in contract. The Public Liability Insurance A ct, 1991, is intended to provide
im m ediate reliefto the persons affected by accidents occurring w hile handling any
hazardous substance and form atters connected therew ith and incidentalthereto.In
Indiathispolicy appearsasasequelto thefam ousBhopalG asLeak case.
ProfessionalN egligence:There are standard policies forprofessionalindem nities
coverforaccountants,insurance agents,solicitors,and law yers.These policiesalso
covertherisk oflossby theirow n negligence.Thelaw hasm adetheseprofessionals
liable in respectofany loss orinjury due to the negligence in the conductoftheir
professionalduties.
C om pulsory Insurance: For the w elfare of the em ployees, social w elfare
legislations have been passed in England and in India m aking itcom pulsory for
em ployersto insureforsafety ofthew orkm en.
The Indian A ctm akes itcom pulsory for the em ployer to insure his w orkm en by
providing certain benefits to them in the event of their sickness, m aternity and
em ploym entinsurance.Theem ployeesinsured undertheA ctareentitled to
(a) Sicknessbenefit
(b) M aternity benefit
(c) D isablem entand D ependentsbenefit.
Em ployer sLiability:Though in olden daysthe liability ofthe em ployerhasbeen
extended in thelaw oftortsby vicariousliability,in regard to hisliability tow ardsthe
em ployees, a num ber of defences w ere recognized, substantially reducing his
liability tow ards his em ployee.Forexam ple,the doctrine ofcom m on em ploym ent,
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M O D U LE -I: PRIN CIPLES A N D PRA CTICE O F IN SU RA N CE
W O R K M EN S C O M PEN SA TIO N IN SU R A N C E
34. D iscuss the rationale for the existence and developm ent of W orker s
C om pensation conceptand program m e.
A ns.W orkerstim eand again areinjured and becom esick becauseofjob-related accidents
and disease.Besidespain and suffering,these disabled w orkersalso dealw ith other
m entaltensionsand agony such aslossofearned incom e,paym entofm edicalbills,
partialorperm anentlossofbodily functionsorlim bsorjob separation.
W orker sC om pensation (W C )isa socialprogram m ethatprovides:
M edicalcare
Cash benefits
Rehabilitation services to disabled w orkers from job related accidents or
disease.Thesebenefitsreducetheeconom icinsecurity thatm ay resultfrom job
related disability.
35. Statebriefly theobjectivesofW orker scom pensation concept.
A ns.Thefollow ing arethebroad objectivesofthew orker scom pensation law s.
Broad coverage of em ployees for job-related accidents and diseases. The
w orker s com pensation covers m ostoccupation or job-related accidents and
diseases.
Substantialprotection againstlossofincom e.Thecash benefitsaredesigned to
restore a substantialproportion ofthe disabled w orker slostearnings,so asto
enablethedisabled w orkerto m aintain thesam estandard ofliving.
Sufficientm edicalcareand rehabilitation services.Thew orker scom pensation
law s require em ployers to pay hospital, surgical, and other m edical costs
incurred by injured w orkers,as w ellas rehabilitation services to restore the
disabled em ployeesto productiveem ploym ent.
Encouragem entofsafety.The w orker scom pensation law sencourage the firm s
to reduce job-related accidents and to develop effective safety program m es.
Experience rating isused to encourage firm sto reduce job-related accidentsand
diseases,becausefirm sw ith superioraccidentrecordspay low erW C prem ium s.
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M O D U LE -I: PRIN CIPLES A N D PRA CTICE O F IN SU RA N CE
TR A V EL A C C ID EN T IN SU R A N C E
46. D iscussthescopeofcoveravailableundertheTravelA ccidentinsurancecover.
A ns.ThescopeoftheTravelA ccidentcoverextendsto alldom estictravellersirrespective
ofthe theirage and incom e group.The benefits underthis policy ofinsurance are
very large and w ide in depth forallthose w ho frequently traveland face the various
unforeseen risksofjourney.
47. W hich m odesoftransportarecovered underthispolicy cover?
A ns.Thiscoverisavailableto travellersby allm odes:Road/Rail/W ater/A ir,including by
theirow n m odeoftransport.
48. W hatisthebasicobjectiveofthisinsurancepolicy cover?
A ns.Thiscoverisvalid fortransitperiod subjectto m axim um of60 days.
Thecoverincludesincidentallocaltravelalso.Thebasicobjectiveofthispolicy isto
provide reliefin case ofaccidentaldeath and loss and /ordam age to accom panied
baggageduring thetravelling w ithin thecountry.
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M O D U LE -I: PRIN CIPLES A N D PRA CTICE O F IN SU RA N CE
49. W ho are the people covered under the policy cover? C an PA also be covered
besidestheavailablecover?
A ns.This policy is designed to provide cover for the insured,spouse,and dependant
children only.Com pensation underthe PersonalA ccidentw illbe in addition to all
otherexisting coversorinsurancecoversinsured m ightbeholding.
50. W hataretheotherC ausesofLossagainstw hich thepolicy extendsitscover?
A ns.The policy covers reasonable and actualem ergency incidentalexpenses upto Rs.
1000/- arising out of an accident resulting in a valid claim under a PA section.
Besides,the loss or dam age to accom panied baggage arising out of fire,storm ,
tem pest, hurricane, flood, inundation, riot, strike, terrorism , m alicious dam age,
accident,theftorburglary.
51. H ow isthelim itofIndem nity fixed forthiscover?
A ns.Thelim itofindem nity underthiscoverdependson thesum insured and otherw iseas
stipulated in the schedule.The sum insured perarticle isRs.500/-unlessotherw ise
declared and claim ofsum insured perarticle above Rs.500/-should be settled on
claim ed valuebasisw ithoutapplying depreciation and average.
52. W hatis the underw riting factors to be taken into consideration for fixing the
price?
A ns.The pricing ofthe policy dependsup on the num berofpersonsasm entioned in the
schedule.In caseofm orethan 8 persons,an additionalprem ium ofRs.40/-perhead
is charged.The service tax is charged extra.The cancellation of journey is to be
intim ated to the concerned authorities w ithin 2 days of the schedule journey.
Som etim es,extension ofthecoverw illbegranted subjectto revised dateschosen by
theinsured,butnotbeyond aperiod of60 days.
53. W hatarethegeneralexclusionsundertheTravelA ccidentcover?
A ns.The generalexclusions under the TravelA ccidentcover m ay be sum m arized as
follow s:
Lossofarticlesofjew ellry
Jew ellery m adeup offully/partially/sem ipreciousm etal/stones/
M oney
Securities
M anuscripts
D eeds
Bonds
BillsofExchange,Prom issory notes
Stocksorsharecertificates
Stam psand travelticketsortravellerscheques
Businessbooksand docum ents
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M O D U LE -I: PRIN CIPLES A N D PRA CTICE O F IN SU RA N CE
SEC TIO N C
C A SE STU D IES
1. M r.D hanrajinsured hisnew Santro carw ith R oyalSundaram C o.in them onth
ofA pril2002,and allow ed hisson to driveit.D hanrajdied in June2002.H isson
continued to drivethecarand caused an accidentin them onth ofJanuary 2003,
and claim ed indem nity underhisfather spolicy.Justify hisclaim .
A ns.Theinsurancecom pany contended thattheperm ission lapsed autom atically w ith the
death of his father.H ence the son is notentitled for any com pensation under the
policy.Thushisclaim isnotsustainable.
2. M r.Suresh,w ho w asthe ow ner ofa car,sold hiscar for itsprice and w hen the
chequecould notbeencashed heclaim ed indem nity from theinsurerfortheloss
ofthecar.Ishisclaim valid?
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M O D U LE -I: PRIN CIPLES A N D PRA CTICE O F IN SU RA N CE
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M O D U LE -I: PRIN CIPLES A N D PRA CTICE O F IN SU RA N CE
C hapter7
G eneralInsurance (C om m ercial)
SEC TIO N -A
1. Firelossesin a FIP iscovered only w hen
(a) thereisactualignition
(b) theignition isaccidentally caused
(c) therem ustbealossofsom eproperty
(d) alltheabove
(e) noneoftheabove
2. C ontractorsallrisk insuranceform spartof
(a) Personalgeneralinsurance
(b) Com m ercialgeneralinsurance
(c) G roup insurance
(d) Socialsecurity insurance
3. Professionalindem nity insurancedoesnotcover
(a) A ctsofcom m ission and om ission
(b) A ctsofnegligence
(c) Liability arising outoffailureofdoctorstreatm ent
(d) Crim inalA ct
4. Thestandard erection allrisk insurancepoliciesdo notcover:
(a) Firerisk
(b) N egligence
(c) Storm caused dam ages
(d) Rem ovalofdebris
5. Im plosion in fireinsurancem eans
(b) Inw ard burst
(c) Sudden burstw ith loud report
(d) D am agecaused by corrosion
(e) D am agecaused by tem pest
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M O D U LE -I: PRIN CIPLES A N D PRA CTICE O F IN SU RA N CE
6. Forcefulentry isthechiefcharacteristicof
(a) Theft
(b) A rson
(c) Larceny
(d) Burglary
SEC TIO N A A N SW ER S
1. d 2. a 3. d 4. d 5. a 6. d
SEC TIO N -B
1. Enum eratetheessentialcharacteristicfeaturesofa FireInsuranceC ontract.
A ns:A contractoffire insurance isa speciesofa contractofinsurance and itexhibitsall
thefollow ing characteristics,nam ely:
(f) Thisisacontractofindem nity
(g) Itisacontractuberrim a fides
(h) Itm ustbedistinguished from w agering contractand acontractofguarantee
(i) Itisapersonalcontractand
(j) Thecauseoffireisim m aterialgenerally.
2. W hatisthe difference betw een subject-m atter ofinsurance from the subject-
m atterofa contractofinsurance?
A ns.Them ain objectofthecontractofinsuranceisto indem nify theassured from theloss
caused by dam ageordestruction by fireoftheproperty oftheassured.Thisphysical
objectiscalled thesubjectm atterofinsurance.O n theotherhand,thesubject-m atter
ofcontractofinsurance is notthe physicalobjectorproperty ofthe assured butis
m oney and m oney alone.Itm ustbe noted thatw hatis insured is notthe physical
property oftheassured butonly lossofitby firebecauseby thiscontractlossby fire
cannotbe prevented.Itis notan insurance againstaccidents butan agreem entto
protectagainstdam ageby afireaccident.
3. Statew hethera FIP isa personal/im personalcontract?
A ns.A contractoffireinsurancethough appearsto beaproperty insuranceisnotso and it
isapersonalcontractbetw een theinsurerand theassured,forthepaym entofm oney,
in case the loss is occasioned to the property ofthe contracting party by fire.The
purposeofthecontractisnotto insurethesafety oftheproperty butonly to savethe
insured from the losscaused by dam age to the property by fire.Therefore,w here a
property insured againstfireisconsum ed by firebutstillthereisno pecuniary lossto
theow neroftheproperty,theinsurerw illnotbeliableto pay any am ount.
4. C an you have a separate consequentialloss policy w ithoutan ordinary FIP?
G ivesom eexam plesofconsequentiallosses.
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M O D U LE -I: PRIN CIPLES A N D PRA CTICE O F IN SU RA N CE
i. Fireand specialperilspolicy.
ii. Burglary insurancepolicy.
iii. M achinery breakdow n/boilerexplosion/electronicequipm entpolicy.
iv. Businessinterruption dueto fireand specialperilspolicy.
Thepolicy excludesthefollow ing:
i. Inherentvice,defects,deteriorationsand norm alw earand tear.
ii. Faulty m aterial/w orkm anship/defectivedesign and m aterial.
iii. Pollution,contam ination,shrinkage,rust,corrosion,scratching and tem perature
changes.
iv. Collapseorcracking ofbuildings.
v. W illfulact,negligence,w arand nuclearrisks.
vi. Larceny,fraud,dishonesty,inventory losses,shortageon delivery.
8. D iscussthecom prehensivecoverundertheC A R policy
A ns.TheCA R policy providesthefollow ing coversforlossesdueto:
(a) Collapse,collusion,im pact.
(b) A lltheaccidentaleventsduring construction likedropping orfalling,defective
w orkm anship and m aterial,lack ofskill,negligence,m aliciousactand hum an
error(handling risks).
(c) Lack of skill, negligence, m alicious and terrorist dam age (risks of hum an
elem ent).
(d) Theftand burglary,fire/lightning (location risks).
(e) Failure of safety devices, leakage of electricity, failure of insulation, short
circuit,explosion,etc.(operationalrisks).
(f) N aturalcalam itieslikeflood and earthquake,inundation,etc.
9. H ow istheprem ium fora C A R policy determ ined?
A ns.The factors that affect the risk associated w ith the project are considered w hile
w orking outtheprem ium .They include:
1. Thenatureoftheproject
2. Theprojectcost
3. Theprojectperiod
4. G eographiclocation
5. Theperiod oftesting
If the sum insured in the projectexceeds Rs.100 crores w ith the option of higher
deductibles,then a discountin prem ium isallow ed.The discountisalso given ifthe
projectsite isprotected againstthe fire.Projectsw ith period ofm ore than one year
areallow ed to pay theprem ium in instalm ents.W hereprojectsgetcom pleted before
the estim ated tim e period,the prem ium forthe balance period ofinsurance m ay be
refunded.
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M O D U LE -I: PRIN CIPLES A N D PRA CTICE O F IN SU RA N CE
(4) Professional liability insurance does not allow the settlem ent of the claim
w ithoutthepriorapprovaloftheinsured.
22. D efinethescopeofcoverageundertheM IP ?
A ns.Thecoverageunderm arineinsurancepolicy includesthefollow ing:
Theship (hulland m achinery)
Theinsurablegoodsand property exposed to m aritim eperils.
O therincidentalearningslikefreight,com m ission,etc.w hich w illbelostalong
w ith theproperty dueto them aritim eperils.
Thethird party liabilitiesincurred by theinsurerorotherperson responsiblefor
orinterested in theproperty.
Expensesincurred to preventand m inim iselosses
M aritim e perilsare the perilsthatare incidentalto the sea journey thatarise in
consequenceoftheseajourney.
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SEC TIO N C
C A SE STU D IES
1. G ovind Rao,adealerin tim ber,supplied tim berto com panieson acontractbasis.H e
insured his business w ith U nity Insurance Com pany. G ovind Rao had different
paym entarrangem entsw ith each ofhisclients.W hilesom eclientsw ereasked to pay
in cash,othersw ereallow ed credit.
G reen Earth PublicLtd w asoneofthecom paniesthatpurchased tim berfrom G ovind
Rao.G ovind Rao received fully paid sharesofthecom pany aspaym entforthetim ber
sold to it.By financing the com pany during its tim e ofneed,G ovind Rao had also
becom ean unsecured creditorofthecom pany.
O n 10 A pril2000,G ovind Rao and G reen Earth signed adealfor1000 teak w ood logs.
Thedeliveryofthetim berw astotakeplacethenextday.U nfortunately,thatnightthere
w as a short circuit at the godow n w here the tim ber w as stored, and the entire
consignm entw as destroyed in the fire.G ovind Rao filed a claim w ith the insurance
com pany forthelosshehad incurred.U nity,how ever,rejected hisclaim and refused to
payfortheloss,allegingthatthetim berw hichw asdestroyedw assoldbytheinsuredto
G reen Earth and,therefore,G ovind Rao no longerhad any claim overit.
Q uestionsfordiscussion:
1. IsG ovind Rao entitled to receive com pensation from the insurance com pany forthe
losscaused by thefire?
2. W hat is insurable interest? W hat are the policy requirem ents for an insurance
interest?
A ns.1.A fterhaving finalized the sale ofthe tim berto G reen Earth Public Ltd.,G ovind
Rao has no insurable interestin the tim bersince ithas becom e the property ofthe
buyer,thatis,G reen Earth.
Insurable interestisthe legalrightofthe ow nerofa property to insure the property.
O ne ofthe conditionsofan insurance policy isthatthe policyholdershould have an
insurableinterestthroughouttheperiod ofthepolicy.Further,during thetenureofthe
policy, the policyholder m ay lose his insurable interest by w ay of transfer of
ow nership,etc.In such a situation,he is no longerentitled to claim forloss to the
insured property asthesold property no longerbelongsto him .
M oreover,a shareholder or creditor of a com pany cannot insure the assets of a
com pany,sincetheassetsbelong to thecom pany.Thecom pany,w hich isan artificial
person,hasan insurableinterestin thecom pany sassets.Thus,in thegiven case,the
tim berhas becom e the property ofG reen Earth and G ovind Rao is notentitled to
receiveany com pensation from theinsurancecom pany forthelossto thetim berdue
to thefire.
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Even after one year of quitting the job,Ram an could notrecover com pletely.H e
approached Ayurvedic doctors and used herbal m edicines. U nfortunately all his
attem ptsw ererendered futile.
Ram an then claim ed com pensation from the railw ays for the ailm ents he had
contracted during the tenure ofhisservice and the financialburden he had to bearin
the process of undergoing treatm ent for these ailm ents. The railw ays forw arded
Ram an sclaim to itsinsurerFairInsuranceCom pany.Theinsurer,in turn,appointed
aclaim sadjusterto carry outthenecessary investigationsand to decideon theclaim s
am ountithad to pay Ram an.
The claim adjuster surveyed the w orkshop prem ises w here Ram an used to w ork,
spoke to Ram an s colleagues and subordinates,and noted dow n a few things to
discusslaterw ith the m anagem ent.The claim sadjustereven obtained the addresses
ofthe doctorsw ho had treated Ram an and had detailed discussionsw ith them about
Ram an shealth problem s.Later,w hilegiving them anagem enthisreporton w hatthe
claim am ount should be, the claim s adjuster stressed on som e vital aspects of
Ram an sjob w hich,ifsuitably m odified w ould notonly help Ram an com e back to
w ork w ithoutcausing any furtherharm to hishealth,butw ould also help therailw ays
low erthedisability expensesthey w ererequired to pay Ram an.
Q uestionsforD iscussion:
1. Claim s adjusters handling w orkers com pensation cases m ust investigate them
diligently.D iscuss,how w elltheadjusterinvestigated Ram an scom pensation case.
2. H ow w ill the com pensation adjuster s report to the railw ays m anagem ent help
controldisability expensesin future?
A ns.1.There isno realinvestigation into w orkers com pensation casesthatonly involve
m edicalexpenses.Theclaim sadjustertakesthepolicyholder sw ord asproofthatthe
accidenthappened on thejob and thattheinjury isw ork-related.
Theadjusterusually conductsan investigation iftheaccidentinvolveslosttim efrom
w ork.In such cases,he obtainsstatem entsfrom the claim ant,the em ployer,and any
w itnesses present.W ith the help ofthese statem ents,the adjustertries to establish
w hetherthe injury is w ork-related ornot,ifthe relationship betw een the em ployee
and the em ployer m ighthave prom pted exaggerated claim s by the claim ant,and
w hether the injury w as preexistent or not. The adjuster m ust also obtain
docum entation ofthe earningsofthe em ployee in orderto calculate the em ployee s
disability com pensation accurately.
2. For com pensation adjusters,controlling disability expenses is probably the m ost
im portantissue.Casesin w hich the claim antreturnsto w ork prom ptly and doesnot
lose any tim e from w ork are relatively sim ple and straightforw ard forthe adjusterto
handle.The biggestproblem thatcom pensation insurers face are from cases w hich
involvedisability extending overalong period oftim e.
Com pensation insurers cannot sim ply stop paying com pensation because they
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C hapter 8
LifeInsurance
SEC TIO N -A
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M O D U LE -I: PRIN CIPLES A N D PRA CTICE O F IN SU RA N CE
e. The liability ofthe insured to pay the prem ium s w illgradually increase butit
w illbelim ited to acertain value.
5. W hich ofthefollow ing policiesby natureconstitutethrifty savings?
a. Term insurance
b. Pureendow m ent
c. Endow m entassurance
d. Term endow m ent
e. Pureinsurance
6. W hich policy do you suggestto m anagetherisk ofexcessivelongevity?
a. Term insurance
b. Pureendow m ent
c. Endow m entassurance
d. Term endow m ent
e. Pureinsurance
7. W hich ofthefollow ing lifeinsurancepoliciesdo notassurethem inim um return
fortheinvestm entcom ponent?
a. U niversallifeinsurancepolicy
b. V ariablelifeinsurancepolicy
c. Endow m entassurancepolicy
d. Both (a)and (c)above
e. Both (b)and (c)above
8. W hataretheadvantagesoftheuniversaland variablelifeinsurancepolicies?
a. Incom etax-deferred cash accum ulation.
b. G uaranteed death benefitand otheroptionalbenefits.
c. Flexibility abouttheam ountofprem ium paym ents.
d. Choiceofthetim ing ofprem ium paym entto thepolicyholder.
e. A lloftheabove.
9. W hatcom ponentsdoesvery paym entin caseofan annuity certain consistof?
a. Principalcom ponent
b. Interestcom ponent
c. Risk prem ium com ponent
d. Both (a)and (b)above
e. A llof(a),(b)and (c)above
10. W hich of the follow ing statem ent(s) captures the sim ilarities betw een a life
insuranceand an annuity contract?
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M O D U LE -I: PRIN CIPLES A N D PRA CTICE O F IN SU RA N CE
SEC TIO N A A N SW ER S
1. (e) Life insurance products offer good savings plans along w ith different risk
coverages thatare related to our life.Life insurance savings also offer som e tax
incentivesto thepolicyholderaspertheincom etax rules.
2. (c)U nderthe conditionsofthe autom atic renew alfeature,the insured can renew the
insurancepolicy attheend ofeach fixed period w ithoutundergoing any m edicaltest
in orderto provehis/herinsurability.
3. (d)A n insurerm ay renew thepolicy on thebasisofany oneofthegiven tw o agesof
the policyholder.If the policy is renew ed on the basis of the attained age of the
insured,higher am ountof prem ium due to the increased age is to be paid by the
insured.If the age atthe com m encem entof the policy is chosen for renew al,the
differencein prem ium am ountisto bepaid along w ith interest.
4. (b) U nder a lim ited paym ent w hole life policy, the insured is liable to pay the
prem ium sup to acertain period oftim e.Butin return ofthoseprem ium s,therisk of
death coverageisavailableatany tim eirrespectiveoftheage.
5. (c) O ne can build up certain am ountof corpus based on the future needs atany
expected pointoftim ein future.D ueto thevery natureofthecontract,oneisforced
to save and the proceeds ofpolicy are payable only on m aturity oron early death
w hich m ay be predeterm ined on the basis ofthe am ountand tim e ofthe expected
fundsrequirem ents.
6. (b) In case of pure endow m entpolicy,the am ountof sum assured is paid to the
policyholderon survivaltillthe end ofthe policy term .D uring old age,funds are
required to m eetthem inim um physiologicalneedsw hilethew orking lifeofaperson
com esto an end.Therefore,such apolicy can offerthebestchoiceto m anagetherisk
oftheexcessivelongevity atalow cost.
7. (b)U nderthevariablelifeinsurancepolicy,thepolicyholderisrequired to choosethe
natureofinstrum entsw heretheinsurercan m aketheinvestm ents.By follow ing that
norm ,the totalproceeds are returned to the policyholderon m aturity,w ithoutany
assuranceofeven them inim um return.
8. (e)A llthegiven featuresareapplicableto both thepolicies
9. (d) In case of an annuity certain,the insurer pays a fixed sum of m oney to the
annuitantforacertain num berofyearsasagreed upon by both theparties.Thisfixed
am ount consists of principal and interest. In the initial years, the percentage of
interestism orew hileitisthereversein lateryears.
10. (e)Inboththecasesofannuityandlifeinsurance,theinsurerprotectsagainstthelossof
incom es to the insured based on the m ortality rate experienced by the insurable
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SEC TIO N B
1. D escribethebasiccharacteristicsofterm lifeinsurance?
A ns.Term insurancehasseveralbasiccharacteristics.
Protection foralim ited num berofyears[tem porary protection]
U nlessthepolicy isrenew ed,theprotection expiresattheend oftheperiod.
Thesepolicieshaveno cash valueorsaving elem ent.
N othing ispaid in caseofsurvival.
Issued forone yearto a setnum berofyearssuch as10 or20 orto a stipulated
age65 or70.
Initialprem ium sarelow .
Prem ium sforterm coverage can escalate rapidly asthe duration ofthe policy
lengthens.
Thesepricesarem oreeasily com pared than arepricesofotherproducts.
H ence this m arketis m ore price com petitive than the m arketfor cash value
policies.
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M O D U LE -I: PRIN CIPLES A N D PRA CTICE O F IN SU RA N CE
TH E N A TU R E O F W H O LE LIFE IN SU R A N C E:
It provides for the paym ent of the face am ount upon the insured s death
regardlessofw hen death occurs
The face am ounts payable under w hole life policies typically rem ain atthe
sam elevelthroughoutthepolicy duration,although dividendsareoften used to
increasethetotalam ountpaid on death
In m ostpoliciesthe grossprem ium also rem ainsatthe sam e levelthroughout
theprem ium paym entperiod w ith som eexceptions.
U niversal life policies can function as w hole life insurance if they have
sufficientcash value
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M O D U LE -I: PRIN CIPLES A N D PRA CTICE O F IN SU RA N CE
W H O LE LIFE C A SH V A LU ES:
A llw holelifepoliciesinvolvesom epre-funding offuturem ortality costs
Cash valuesare available to the policy ow neratany tim e by surrendering the
policy
Facility ofobtaining a loan w ith rate ofinterestupto thatofthe policy s cash
value
Loan isdeducted from thegrosscash valuew hen death claim ispayable
W hole life policies m ay be participating ornon participating w ith som e non
guaranteed elem ent.
5. D escribethelim ited paym entw holelifeinsurance
A ns.LIM ITED PA Y M EN T W H O LE LIFE IN SU RA N CE policy rem ainsin fullforcefor
the w hole oflife butprem ium sare payable fora lim ited num berofyearsonly,after
w hich thepolicy becom espaid up foritsfullfaceam ount.
Itisdifferentfrom vanish pay policy w herethereisno guaranteeofnotrequired
paym entsbeyond thestated prem ium paym entperiod .
The greaterthe num berofprem ium paym ents,the m ore closely the contract
resem blestheordinary lifeform .
A nnual level prem ium s of these policies are larger than ordinary life plan
because the actuarial equivalent of the prem ium s payable for the insured s
entire lifetim e.
Thehighertheprem ium sforapolicy,thegreaterthecash values.
The size ofthe cash value variesinversely w ith the length ofprem ium paying
period.
Itcontainsthesam enon-forfeiture,dividend,settlem entoptionsofordinary life
policy.
The one end extrem e in lim ited paym entlife insurance is the single prem ium
w holelifepolicy and anotherend isordinary lifeinsurance.
Itis notw elladopted to those w hose incom e is sm alland w hose need for
insuranceprotection isgreat.
Thispolicy fitsm any businessinsurancesituations
6. W hatisan endow m entinsurance?
A ns.A n endow m entpolicy paysthe face am ountofinsurance ifthe insured diesw ithin a
specified period;ifthe insured survivesto the end ofthe endow m entperiod,the face
am ount is paid to the policy ow ner at that tim e. The m athem atical concept of
endow m entinsurance = term life insurance + pure endow m ent[to pay the face
am ountifthe insured diesduring the period + to pay the m aturity am ountonly ifthe
insuredislivingattheendofaspecificperiod,w ithnothingpaidincaseofpriordeath.]
The econom ic concept divides endow m entinsurance into tw o parts :decreasing
term insuranceand increasing savings.
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M O D U LE -I: PRIN CIPLES A N D PRA CTICE O F IN SU RA N CE
Policy ow neroften lacksa firm com m itm entto pay prem ium s.A sa resultthe
policy m ay lapsebecauseofnon-paym entofprem ium s.
8. D efinean annuity
A ns.A n annuity can bedefined asaperiodicpaym entthatcontinuesforafixed period or
forthe duration ofa designated life orlives.The person w ho receives the periodic
paym entsorw hoselifegovernstheduration ofpaym entisknow n astheannuitant.
The fundam entalpurpose ofa life annuity isto provide lifetim e incom e thatcannot
beoutlived.
9. C lassify annuities.
A ns.A nnuitiesm ay beclassified in num erousw ays,based on
N um beroflivescovered
M ethod ofprem ium paym ent
Tim ew hen incom ebegins
M ethod ofdisposing ofproceeds
D enom ination in w hich benefitsareexpressed
10. W hatdo you m ean by num beroflivescovered in an annuity?
A ns.W hen annuity paym ents are m ade w ith reference to one life orm ultiple lives itis
know n as num ber of lives covered. W hen annuity covers tw o or m ore lives,
especially w ife and husband,itisknow n asjointand lastsurvivor annuity w hich
continues the sam e incom e untilthe death ofthe lastsurvivor.Jointlife annuity
providesaspecified incom efortw o orm orenam ed persons,w ith theincom eceasing
upon thefirstdeath am ong thecovered lives.
11. H ow do you classify annuitiesbased on them ethod ofprem ium paym ent?
A ns.Them ethod ofprem ium paym entsin an annuity can be
Singlepaym entby beneficiaries
Periodicpaym ents
12. H ow do you classify an annuity based on tim ew hen incom epaym entscom m ence?
A ns.A nnuitiescan beclassified in tw o w aysbased on tim e
A deferred annuity
A n im m ediateannuity
A deferred annuity is an annuity purchased w ith either a single prem ium or
periodic prem ium s.The firstannuity benefitism ade afterthe passage ofm ore
than one paym entinterval.M ore flexibility isperm itted in prem ium paym ents
w ith thelongerdeferralperiod.
A n im m ediate annuity isan annuity purchased w ith a single prem ium and the
first annuity paym ent is due [alm ost] im m ediately, generally one paym ent
interval[am onth orayear]from thedateofpurchase.
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M O D U LE -I: PRIN CIPLES A N D PRA CTICE O F IN SU RA N CE
policy.
M ostgroup plansallow a m odestam ountoflife insurance to be w ritten on the
em ployee sspouseand dependentchildren.
Theinsuranceon thespouse slifecan beconverted to an individualcash-value
policy
G roup term life insurance is used by com m ercial banks and other lending
institutions to insure the lives of debtors.Itprovides the cancellation of any
outstanding debtiftheborrow erdies
D isadvantages:
This insurance is tem porary and term inates w hen the individualis no longer
partofthegroup.
Itis expensive for an older w orker to convertto an individualpolicy after
retirem ent
SEC TIO N C
C A SE STU D IES
Term ,w holelife,endow m ent,annuity policiesorthecom bination ofpoliciesareavailable
in them arket.
Suggestsuitablepoliciesforthegiven situations:
1. Y ou arein 30s.Y ou aretheeldestson in yourfam ily.O nebrotherand sisterare
dependenton you fortheireducation and m arriage.
2. Y ou arein 40s.Y ou juststarted anew business.Y ourentirefam ily isdependent
on you.Tillyou settlein yourbusinessyou cannotcreateacapitalfund foryour
fam ily m aintenance.
3. Y ou purchased acarby taking loan from A uto Finance.Y ou w antto retain that
carto yourfam ily m em berseven in yourabsence.
4. Y ou w antto raiseloanson yourpolicy w hen you arein need.
5. Y ou w antto com bineinsuranceplansw ith som efinancialgoalslikechildren s
education and m arriage
6. Y ou know thatcom pounding factorisim portantforplanning retirem ent.
7. Y ou do notw antto takerisk w ith yourV RS Funds
8. Y ou w antsafeand guaranteed returnsfrom yourV RS Fundsinvestm ent.
9. Y ou w antfixed returnsfrom yourV RS Fundsinvestm ent.
A N SW ER S
1 & 2 :Forthesesituationsthesuggested bestpolicy isTerm InsurancePolicy.Theseplans
offer life insurance cover for specific num ber of years,atleastcost.Since entire
prem ium goestow ardsthe costofinsurance,there isonly risk coverand no saving
elem entisinvolved.
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C hapter9
R egulation ofInvestm entFundsof
Insurance C om panies
SEC TIO N A
1. Sourcesofinvestm entfundsforinsurersinclude
a. Issuanceofpolicies
b. Issuanceofloans
c. Issuanceofshares
d. Issuanceofonly stock
e. N oneoftheabove
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SEC TIO N -A A N SW ER S
(1) a (2) e (3) b (4) d (5) d (6) e
(7) d (8) a (9)b (10) c
SEC TIO N -B
1. D efinetheinvestm entactivitiesofa lifeinsurer.
A ns.The aggregate investm ent activities of any country s life and health insurance
industry aream ajorsourceofcapitalforthenationaleconom icgrow th.Theinsurers
investin the debtand equity issues of alltypes of corporations,shopping m alls,
apartm ents and other real estate. They are the m ajor purchases of G overnm ent
Securities.Thetotalinvestm entportfolio ofalifeinsurancecom pany can bedefined
on thebasisofliabilitiesthatthey support.
2. H ow areassetsclassified foran insurer?
A ssetsareclassified according to thenatureoftheliabilitiesforw hich theassetsare
held and invested.A ssets used to supportcontractualobligations for guaranteed,
fixed benefitpaym ents norm ally are held in generalaccountw hile assets held to
supportotherliabilitiesassociated w ith investm entrisk are held in specialaccounts
called separate accounts e.g.(valuable annuities,pension products,variable life
insurance,etc.).
3. W hy is the perform ance ofinvestm entportfolio so critically im portantfor an
insurer?
A ns.Theinvestm entperform anceofthegeneralaccountofalifecom pany affectsprofits,
dividends,interestcreditson term ,etc.Separateaccountperform anceaffectsvariable
life and annuity productsand pension fundsw hen benefitsby contractdepend upon
investm entresultsthatarepassed directly to contractholders.Thepricesofinsurance
productsaredependenton theinvestm entreturnsan insurerearns,especially theunit
linked insurance products. Insurers that earn above average returns can price
products favourably to retain custom ers in a com petitive m arket.Thus,investm ent
m anagem ent is a process involving asset liability m anagem ent, integration of
investm entm anagem entand productdesign m anagem ent.H ence the perform ance is
so critically essentialforthesustainability ofan insurer.
4. W hat are the factors that influence and constrain the investm ent policy of
insurer?
A ns.Theim portanteconom icconstraintsthatinfluenceoracton theinvestm entpolicy of
an insurerinclude inflation,m onetary and fiscalpolicy ofgovernm entinvestm ent
m arketopportunities,insurer s m arketshare,com petition,tax liabilities,etc.The
regulatory constraints,rating agencies view s,brokers,agents,currency rates,trade
balances,and geographic location ofliabilities are also to be considered in setting
investm entpolicy by internationalinsurers.Further,the investm entpolicy of life
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M O D U LE -I: PRIN CIPLES A N D PRA CTICE O F IN SU RA N CE
insurer establishes a level of risk tolerance for individual assets as w ell as for
m ism atched assets and liabilities.H ence,the prim ary objective of an investm ent
policy should be to create an investm entportfolio w ith cash flow s,thatm atchesan
insurer s expected liability cash flow s and assetliability risk m anagem entstrategy,
and striking abalancebetw een solvency and profitability.
5. H ow can you strikea tradeoff in investm entdecisions?
A ns.Trade off in investm ent decisions necessarily involves understanding the central
conceptofinvestm entrisk and to acknow ledge the relationship ofinvestm entrisk
and expected return.G reaterthe degree ofrisk associated w ith an investm entim ply
greater expected returns.The objective of investm entportfolio m anagem entis to
m axim ize investm entreturn fora given levelofrisk orm inim ize risk fora desired
levelofreturn.Investm entrisk can be defined asthe potentialvariability ofreturns.
The trade offin tw o areasrequiresspecialportfolio m anagem entconsideration than
otherinvestors.The insurance pricing (actuarial)risk is one specialarea,w hich
takesinto accountthe rate ofreturn to calculate prem ium .Itisalso used to discount
the price ofinsurance to policy ow ners.The discounting practice hastw o im portant
im plications nam ely:The asset-liability m atching (system atic)risk is the second
consideration specialto financialinterm ediaries.The changing m arketinterestrate
can affectthe value ofcom pany sassetsand liabilitiesand also the behaviourofits
custom ers.Like otherinvestors,life insurersalso preferhigherreturnsto m inim ize
thecostofinsuranceproductsand to m axim izeprofitability,keeping in m ind theidea
ofinvestm entm arginsorspreads.
6. C ritically exam ine the rationale of governm ent intervention in insurance
m arkets.
A ns.G overnm entsw orldw ide intervene in insurance m arketseitherdirectly orindirectly
through regulation ofoperationsortaxation ofincom e.W hateverm ay be the nature
and degree of intervention the basic purpose is to protectthe consum ers,to raise
revenue to support social program m es and to ensure order and efficiency in the
functioning of insurance m arkets. Insurance regulation is universal but different
approachesare follow ed w orldw ide.The m ain focusofthe State isalw aysto ensure
safety and solvency ofthe insurer.Com petition is encouraged butis alw ays under
check in the areasofpolicy contentand in pricing prem ium s,w here a sem blance of
uniform ity isdesired by thepolicyholders.
Insurersareregulated forseveralreasons,including thefollow ing:
To m aintain insurersolvency,
To com pensateforinadequateconsum erknow ledge,
To ensurereasonableratesand
To m akeinsuranceavailableto thosew ho need it.
7. Identify them ain areasofinsuranceoperationsthatareregulated in India.
A ns.G overnm entalintervention isinevitablein thegeneralinterestofthepublic.Thelaw s
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M O D U LE -I: PRIN CIPLES A N D PRA CTICE O F IN SU RA N CE
thatare in place to regulate the operations of the insurers invariably concern the
follow ing areas:
Form ation ofinsurancecom panies;
Licensing ofagentsand brokers;
Financialrequirem entsform aintaining solvency ;
Insurancerates;
Investm ents
Salesand claim spractices;
Taxation and
Rehabilitation orliquidation ofinsurers.
Thusitisclearthatregulation ofinsurancecom paniesisin theinterestsofthepublic.
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C hapter 10
Law sG overning Insurance
M anagem entand A ccounting
SEC TIO N -A
a. G overnm entgrants,fees,charges
b. Fundsform centralgovernm ent
c. Percentageofprescribed incom efrom theinsurer
d. D onationsfrom charitableand non-governm entalinstitutions
e. A lloftheabove
6. TheIR D A fund cannotbeutilized forthe
a. Salariesofm em bersand em ployees
b. A ny otherexpensesrelated to thefunctionsoftheauthority
c. A llow ancesand perksoftheem ployeesand m em bers
d. A dvertisem entofprivateinsurancecom pany
e. A lloftheabove
7. C apitaladequacy norm sofan insurerspecify the
a. M axim um quantum ofcapital
b. M inim um paid up equity capital
c. M inim um reservecapital
d. M axim um reservecapital
e. N oneoftheabove
8. Solvency m arginsreferto theadequate
a. Excessofassetsoverliabilities
b. Excessofoverliabilitiesoverassets
c. Excessofliabilitiesovercash
d. Totalofassetsand liabilities
e. N oneoftheabove
9. The person engaged in the forecasting and pricing of insurance products is
know n as
a. A uditor
b. A ctuary
c. A dvocate
d. Consultant
e. N oneoftheabove
10. A sperIR D A regulationstheregistration ofan insurerm ay besuspended ifhe
a. Indulgesin m anipulativeinsurancebusiness
b. Failsto provideperiodicalreturns
c. Failsto m akeinvestm entsaspernorm s
d. Failsto furnish inform ation asrequired by theregulator
e. A lltheabove
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M O D U LE -I: PRIN CIPLES A N D PRA CTICE O F IN SU RA N CE
11. The IR D A has m ade it obligatory for the insurance com panies to procure
businessfrom
a. Socialsector
b. U rban sector
c. Tertiary sector
d. Ruralsector
e. N oneoftheabove
12. A ssignm entprovisionsrefersto
a. Thetransferofpolicies
b. Purchaseofpolicies
c. Buying and selling ofpolicies
d. D istribution ofpolicies
13. A bsoluteassignm entim plies
a. Com pletetransferofallrights
b. Transferofsom erights
c. N o transferofany rights
d. Transferofonly obligations
14. C ollateralassignm entim plies
a. Tem porary /conditionaltransfer
b. A bsolutetransfer
c. Transferofonly obligations
d. Transferofallrights
SEC TIO N A A N SW ER S
(1) c (2) c (3) a (4) c (5) d (6) d
(7) b (8) a (9) b (10) e (11)a (12)a
(13)a (14) a
SEC TIO N -B
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M O D U LE -I: PRIN CIPLES A N D PRA CTICE O F IN SU RA N CE
SEC TIO N C
C A SE STU D IES
1. The insurance regulator w ill w ork tow ards creating an environm ent that
generates confidence am ong potentialpolicyholders.W hy is there a need for
creating such an environm ent? W hat m easures has the IR D A taken in this
regard?
A ns.Tillrecently,governm entow ned com paniesoffered insurance servicesin India and
hencetherew aslittledoubtin them indsofthepolicyholdersaboutthesafety oftheir
savings.H ow ever,the sam e levelofconfidence cannotbe expected in the case of
private com panies.To gain thisconfidence,itisessentialthatthere w illbe a fairly
high leveloftransparency in theiroperations.Further,as the risk involved is high,
there should be adequate capitalbase forcom paniesoffering these services.Larger
capital base is also essential to spread the business and increase the volum e of
businessin orderto gain the econom iesofscale.In thisregard,IRD A hasissued the
follow ing guidelines:
M inim um paid-up capitalofRs.100 crore,forlife/generalinsuranceand Rs.200
crore,in caseofreinsurancebusiness.
D epositw ith RBI,the leastof(a)Rs.10 crore,in cash orm arketable approved
securities,or(b)asum of1% (forlifeinsurance),3% (forgeneralinsurance)of
thetotalgrossprem ium w ritten in India.In caseofreinsurerthedepositam ount
isRs.20 crore.
A nnualactuarialinvestigation.
Solvency m argins.
2. W hatstrategiesdo you recom m end to a new privatesectorinsurer?
A ns.Insurance iscom paratively a new businessto the Indian corporate w orld asthe LIC
and G IC and itssubsidiariesw eretheonly playersin thism arket.In thisnew m arket,
thefollow ing strategicissuesareto beidentified:
Tap potentialm arket:Thereisvastuntapped m arketforinsurancein India.
Investm entsin secured assets:Foran insurancecom pany therisk arisesfrom its
liabilitiesside,i.e.due to the policiesunderw ritten.Thus,investing in secured
assetsshould reduceriskson theassetsside.
Custom ized products:A large untapped m arketalso gives scope to custom ize
theproducts.Therew asno properproductinnovation thathasbeen taking place
in thecountry.
M arketresearch: To identify the m arket to research identity the needs of
custom er has to be undertaken. W hile LIC has m ore than 100 types of
policies,the levelof aw areness is very low .H istoricaldata w illenable the
new players identify the depth in the m arketand the scope for developing
variousproducts.
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M O D U LE -I: PRIN CIPLES A N D PRA CTICE O F IN SU RA N CE
I-112
M O D U LE -I: PRIN CIPLES A N D PRA CTICE O F IN SU RA N CE
C hapter 11
A ssetand Liability M anagem ent
SEC TIO N -A
I-113
M O D U LE -I: PRIN CIPLES A N D PRA CTICE O F IN SU RA N CE
I-114
M O D U LE -I: PRIN CIPLES A N D PRA CTICE O F IN SU RA N CE
SEC TIO N A A N SW ER S
(1) a (2) e (3) c (4) d (5) c (6) e
(7) a (8) b (9) a (10) b (11)a (12)b
(13) a
SEC TIO N -B
1. W hat is m eaning of a financialinterm ediary? W hat is the speciality of these
FI s?
A ns.A FinancialInterm ediary (FI) is a firm thatbrings together users and providers of
funds.In theabsenceofFI s,householdsgenerating excesssavingsby consum ing less
than theirincom e w ould have the basic choice ofeitherholding cash as an assetor
investin the securities issued by corporations directly.Financialinterm ediaries help
channelize household savings to the corporate sector.Even sm allhouseholds often
preferto hold financialclaim sissued by FI sratherthan thoseissued by corporations.
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M O D U LE -I: PRIN CIPLES A N D PRA CTICE O F IN SU RA N CE
I-117
M O D U LE -I: PRIN CIPLES A N D PRA CTICE O F IN SU RA N CE
Foreign exchange risk:G lobalFI shave the advantage and the potentialto expand
their operations and investm entactivities abroad directly or to expand a financial
asset portfolio so as to include foreign securities as w ell as dom estic securities.
Foreign exchangerisk isthe risk thatexchange rate changescan affectthe value of
an FI sassetsand liabilitieslocated abroad.
C ountry or Sovereign risk:FI s face a m uch m ore serious creditrisk,in case of
country orsovereign risk.Itisthe risk thatrepaym entsfrom foreign borrow ersm ay
beinterrupted becauseofinterferencefrom foreign governm ents.
Liquidity risk: Liquidity risk arises w henever an FI s liability holders, such as
depositors,policyholders dem and im m ediate cash for their financialclaim s.This
situation m ay forcetheFI seitherto borrow additionalfundsorsellofftheirassetsin
a very shortperiod oftim e and atlow pricesto m eetthe dem and forw ithdraw alof
funds.
Insolvency risk:Insolvency occursw henevertheinternalcapitalorequity resources
ofan FI s ow ners are inadequate to m eetlosses incurred due to one orm ore risks.
Insolvency risk is a consequence or outcom e of excessive interest rate, m arket,
credit,off-balancesheet,and liquidity risks.
O ther risks:These are often called eventrisks.Involving sudden and unexpected
changesin financialm arketconditionsdue to w ar,revolution,orsudden collapse in
stock m arkets,fraud,theft,m alfeasance,breach oftrust,and otherm acroeconom ic
riskssuch asinflation and unem ploym ent.
3. C an insurancereducetheirrisk by diversification?
A ns.D iversification reduces risk, because prices of different securities do not m ove
exactly together.But,insurersfacetw o typesofrisk:
U niqueRisk
System aticorM arketRisk
U nique risk is derived from the uniqueness of each firm ,from its unique
environm ent.Theuniquerisk ofeach stock iscountered by uniquerisk ofother
stocksthusreducing overallrisk.
System atic or m arket risk is the unavoidable risk thatstem s from factors
w hich influenceallbusinessesalikesuch associetalinfluencesand factors.The
num berofsecuritiesdeterm ine the risk profile.Ifa portfolio consistsofa few
securities,the firm s face greater unique risk and diversification ofportfolio
elim inatesagreaterpartofuniquerisk.Them inim um rateofreturn required by
investors to hold a security depends upon the opportunity costoffunds,i.e.
thereturnsavailablefrom alternativeassetinvestm ents.
4. D iscussA LM asa m ultidisciplinary exercise.
A ns.A sset-liability M anagem ent(A LM )isam ultidisciplinary undertaking.Itinvolves
Productcontractdesigning
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M O D U LE -I: PRIN CIPLES A N D PRA CTICE O F IN SU RA N CE
I-119
M O D U LE -I: PRIN CIPLES A N D PRA CTICE O F IN SU RA N CE
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M O D U LE -I: PRIN CIPLES A N D PRA CTICE O F IN SU RA N CE
SEC TIO N C
C A SE STU D IES
G iven below is a table thatshow s the relative assetrisk w eights for Life and Property
Casualty insurers.
R isk Based C apital(R BC )FactorsforSelected A ssets
A ssets Lifeinsurers Property insurers
Bonds
G overnm ent 0.0% 0.0%
A A A -A * 0.3% 0.3%
BBB 1.0% 1.0%
BB 4.0% 2.0%
B 9.0% 4.5%
CCC 20.0% 10.0%
In orneardefault 30.0% 30.0%
Residentialm ortgages 0.5% 5.0%
Com m ercialm ortgages 3.0% 5.0%
Com m on stock 30.0% 15.0%
Preferred stock 2.0% 2.0%
1. Interpretthegiven table.
2. H ow istherisk based capitaldecided foran insurancecom pany?
A ns.
1. RBC orrisk based capitalrequirem entshavebecom eessentialareaofconcern in the
financialm anagem entof insurance com pany.This strategy ensures both solvency
and liquidity requirem entsofthese com panies.A sperthe above given inform ation,
an insurerw ith Rs.100 m illion in com m on stock w ould have a risk-based capital
requirem entofRs.30 m illion,w hile forone w ith Rs.100 m illion in BBB corporate
bondsonly Rs.1 m illion w ould berequired.
2. Thefollow ing factorsareconsidered forcom puting Risk Based Capital(RBC):
(i) Risk characteristics ofthe com pany based on its size,nature ofbusiness (say
life,m otor,fire,etc.),quality ofinvestm entsm ade,etc.
(ii) Risk w eightage for each class of assets.For exam ple,differentw eights are
applied to investm ent in governm ent securities,private loans,equities,real
estateand otherinvestm ents.
(iii) Total adjusted capital w hich consists of statutory capital, asset valuation
reserveand any othervoluntary reserves
(iv) Capitalderived from risk-w eighted form ulaasperpoint(ii)above.
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M O D U LE -I: PRIN CIPLES A N D PRA CTICE O F IN SU RA N CE
I-122
DIRM
MODULE II
TECHNICAL ASPECTS OF
INSURANCE
MODULE II
TECHNICAL ASPECTS OF INSURANCE
Chapter 1
Underwriting.............................................................................................................II-1
Chapter 2
Fire Insurance ........................................................................................................II-10
Chapter 3
Marine Insurance....................................................................................................II-21
Chapter 4
Motor Insurance .....................................................................................................II-30
Chapter 5
Engineering Insurance ...........................................................................................II-38
Chapter 6
Miscellaneous Insurance ........................................................................................II-44
Chapter 7
Life Insurance Products .........................................................................................II-52
Chapter 8
Life Insurance Pricing Fundamentals ....................................................................II-62
Chapter 9
Social Security Schemes ........................................................................................II-73
Chapter 10
Group Insurance ....................................................................................................II-86
Chapter 11
Financial Gerontology and Super Annuating Policies ..........................................II-96
Chapter 12
Acturarian Valuation ...........................................................................................II-103
C hapter 1
U nderw riting
SEC TIO N -A
c. diversification
d. investm entin shares
e. noneoftheabove
6. W hich ofthefollow ing statem entsdescribetheprinciplesof underw riting?
(i) selection and classification ofpolicyholders
(ii) charging equitableprices
a. (i)only
b. (ii)only
c. Both (i)& (ii)
d. N either(i)& (ii)
7. Theprocessofunderw riting involvesessentially
(i) A cceptanceof risk atstandard rates/loaded rates
(ii) Rejection ofrisk
a. (i)only
b. (ii)only
c. Both (i)& (ii)
d. N either(i)& (ii)
8. Sourcesofinform ation forunderw ritersforrisk evaluation include
a. proposalform
b. new spapers
c. censusrecords
d. financialrecords
e. noneoftheabove
9. Stringentunderw riting standardsarea safeguard for
a. A dverseselection
b. Selectiveselection
c. Preferred selection
d. G roup selection
e. N oneoftheabove
10. Im plem entation oftheunderw riting guidelinesisdoneon a daily basisby the
a. Staffunderw riters
b. Lineunderw riters
c. G roup underw riters
d. Board underw riters
e. N oneoftheabove
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M O D U LE -II:TECH N ICA L A SPECTS O F IN SU RA N CE
II-3
M O D U LE -II:TECH N ICA L A SPECTS O F IN SU RA N CE
SEC TIO N A A N SW ER S
(1) c (2) a (3) a (4) a (5) b (6) c
(7) c (8) a (9) a (10) b (11) b (12) b
(13) c (14) b (15) c (16) b (17) a (18) a
(19) b (20) b (21) c (22) b
SEC TIO N -B
C lassrating m ethod
U nderthism ethod,exposuresw ith sim ilarcharacteristicsare grouped together
and charged the sam e rate.Som e ofthe m ajorfactorsin life insurance are age,
health,genderetc.This m ethod is also called m anualrating because the rates
are published in a rating m anual.There are tw o w aysofdeterm ining the class
rates:
* Thepureprem ium m ethod:pureprem ium isthatpartofthegrossrate,w hich
isutilized to pay lossesand adjustm entexpenses.
* The lossratio m ethod:underthism ethod,the actuallossratio w hich isthe
ratio ofincurred lossesand loss-adjustm entexpensesto theearned prem ium s
is com pared to the loss ratio that w as expected and the rate is adjusted
accordingly.
M eritR ating m ethod:
M eritrating is a rating plan by w hich class rates (m anualrates)are adjusted
upw ard ordow nw ard based on individualloss experience.Som e ofthe m erit
rating plansinclude:
* Schedule rating:underthisplan,each exposure isindividually rated.A basis
rate isfixed foreach exposure and thisisthen m odified by debitsorcreditsfor
undesirableordesirablephysicalfeatures.
* Experience rating:underthisrating plan,the classorm anualrate isadjusted
upw ard or dow nw ard based on pastloss experience.The insured s pastloss
experienceisthebasisforfixing theprem ium forthenextpolicy period.
* R etrospective rating: in retrospective rating,the insured s loss experience
during the currentpolicy period determ ines the actualprem ium paid forthat
period.
3. D iscussthevarioushazardsencountered in theprocessofunderw riting.
A ns: The process of underw riting inherently has the danger of adverse selection and
hazards.Theseare:
Physicalhazards
M oralhazardsand
M oralehazards.
Physicalhazards: include hazards thataffectthe physicalcharacteristics of
w hatever is being insured.A ny harm to the tangible qualities of the subject
m atterofinsurance can be called a physicalhazard,e.g.a building m ade of
w ood represents a higherlevelofphysicalhazard than one m ade ofbrick;an
untrained driver, and faulty fire- safety equipm ent are both exam ples of a
physicalhazard.
M oral hazards: these hazards refer to the defects that exist in a person s
character that m ay increase the frequency or the severity of loss. Such a
characterm ay tend to increase the lossforthe com pany,e.g.a w eak financial
II-6
M O D U LE -II:TECH N ICA L A SPECTS O F IN SU RA N CE
condition that m ay lead certain people to w ilfully cause loss and secure
insurancem oney.
M orale hazards:include a situation ofa w ilfulcarelessnesson the partofthe
policyholder because of the existence of insurance.By such negligence and
indifference the possibility ofloss is increased,e.g.careless acts like keeping
thedoorofone shouseopen and going out,thereby increasing thepossibility of
a burglary,orleaving the carkeysin the carand increasing the risk oftheftare
instancesofm oralehazard.
4. O utlinetheunderw riting process.
A ns:The underw riting processessentially involvesa seriesofstages,atthe end ofw hich
the status of a risk is decided.Itis only after the risk has been w eighed and all
possible alternativesevaluated thatthe finalunderw riting isdone.W hen a proposal
forinsuranceisreceived,theunderw riterhasfourpossiblecoursesofaction:
A ccepttherisk atstandard rates
Chargeextraprem ium depending on therisk factor
Im posespecialconditions
Rejecttherisk
The underw riting process involves the follow ing steps w hen evaluating a
potentialrisk.Theseareasfollow s:
* A ssim ilating inform ation abouttheapplicantfrom aw idevariety ofsourcessuch
as application or the proposalform ,the agents* report,governm entrecords,
physicalinspection reportofthesurveyor,in caseofproperty underw riting and in
the case oflife insurance,a physician sreporton the applicantsblood pressure,
heartcondition,urinary system ,etc.areconsidered claim files.
* Evaluating and m aking a decision,w hether to accepta proposal,rejectitor
acceptitw ith certain m odifications,such as changing rating plans and policy
term s.
* Executing thedecision afterperusing allthealternativesand m aking adecision.
If the proposal is accepted,then the applicant should be briefed about the
decision along w ith allthe m odifications m ade.If rejected,the underw riter
m ustconvey this decision to the agentw ith clear,valid and sound reasons
explaining w hy theparticularapplication hasbeen rejected.
* Preparing thedocum entsw hich includesthew ork sheetto besentto thepolicy
w riting departm entand also issueofcertificatesofinsurance.
* Recording inform ation about the applicant and the policy for accounting,
statistical and m onitoring purposes, specially the details like the location,
coverages,lim its,and risk features.
* M onitoring theactivitiesasto any changesin thelossexposuresoftheinsureds,
through regularprem ium auditsand auditreports.
* M aintaining the recordsofbusinessw hich involvesevaluating the profitability
II-7
M O D U LE -II:TECH N ICA L A SPECTS O F IN SU RA N CE
SEC TIO N C
(C A SE STU D IES)
1. A top equestrian,V ijay M allay,insured hisprize show horse,K arishm a,forRs.2.5
lakhs.A ftera seriesoflack lustre perform ances,K arism a died suddenly from w hat
appeared to be colic,a com m on killerdisease ofhorses.H ow ever,the underw riters
settled theclaim ofRs.2.5 lakhsalthough m any observersfeltthatthesettlem entw as
m ore than the horse w as w orth alive due to its poor perform ance justprior to its
death.
D uring the sam e tim e,the CBI w as involved in an investigation regarding horse
killingsand related insurancefraud.They arrested oneM r.A bu Salim ,w ho said that
he w aspaid to killhorsesso thattheirow nerscould collectany insurance proceeds.
Further,A bu Salim also revealed the nam esofhisclientsw herein V ijay M allay w as
also m entioned.D uring thetrial,theow nertestified thatK arishm ahad notdied outof
naturalcause,butinstead died ofelectrocution w hich can be easily be disguised as
colic.
From theinform ation provided answ erthefollow ing questions:
1. A saresponsibleunderw riterhow w ould you evaluatetherisk factorsw hileissuance
ofsuch apolicy?
2. Ism oralhazard presentin thecase?
3. Can thecom pany callback theinsurancesettlem entforRs.2.5 lakhs?
4. Identify thedam agecom pensation liability oftheow ner.
A ns:1.A sa prudentunderw riter,atthe tim e ofissuance ofthe policy,besidesthe costof
thehorse,thecharacteroftheow ner,and hispastlossrecord aresom eofthefactors
to beconsidered.
2. The m oralhazard in the presentcase isevidentin the factthatthe ow nerkilled the
horseto gettheinsurancebenefits.
II-8
M O D U LE -II:TECH N ICA L A SPECTS O F IN SU RA N CE
3. The insurer has every rightto order the restitution of the Rs.2.5 lakhs insurance
settlem entand also to pay forthecostofhisincarceration.
4. The ow ner can be convicted for a clear case of fraud,w ith a liability of fine and
im prisonm entaspertherulesofthecrim inalcodeprocedure.Furtherheisalso guilty
ofm anipulating thecauseofdeath w ith aw illfulintention to cheatthecom pany.
II-9
C hapter 2
FireInsurance
SEC TIO N -A
1. A firePolicy isa
a. valued policy
b. unvalued policy
c. indem nity policy
d. agreed valuepolicy
e. noneoftheabove
2. Insurableinterestin a FIP m ustbepresent
a. attheinception ofthepolicy
b. during thecontinuanceofthepolicy
c. on thedateofloss
d. atthetim eofloss
e. alloftheabove
3. C auseoffiregenerally in caseofa lossis
a. m aterial
b. im m aterial
c. intentional
d. unintentional
e. noneoftheabove
4. thedoctrineofsubrogation and contribution is
a. applicablein afirepolicy
b. notapplicablein afirepolicy
c. applicableonly in caseoffloaterpolicies
d. notapplicablein floaterfirepolicy
e. noneoftheabove
5. To w hich ofthefollow ing assetsa reinstatem entpolicy isnotapplicable?
a. building
b. land
II-10
M O D U LE -II:TECH N ICA L A SPECTS O F IN SU RA N CE
c. furniture
d. plant& m achinery
e. noneoftheabove
6. Excessin a firepolicy im plies
a. adiscount
b. am alus
c. adeductible
d. abonus
7. Fire floater and declaration policies are issued to those com panies w hose
turnoveris
a. very high
b. very low
c. hugeand fluctuating values
d. perm anentvalues
SEC TIO N A A N SW ER S
1. c 2. e 3. b 4. a 5. b 6. c
7. c
SEC TIO N B
II-11
M O D U LE -II:TECH N ICA L A SPECTS O F IN SU RA N CE
a. Thereisactualignition.
b. The fire is purely accidentalor fortuitous in origin so far as the insured is
concerned.
c. Thefirehasburnt/dam aged theproperty oftheinsured.
3. Enum eratetheessentialcharacteristicfeaturesofa FireInsuranceC ontract.
A ns:A contractoffire insurance isa speciesofa contractofinsurance and itexhibitsall
thefollow ing characteristics,nam ely:
a. Thisisacontractofindem nity
b. Itisacontractuberrim a fides
c. Itm ustbedistinguished from w agering contractand acontractofguarantee
d. Itisapersonalcontractand
e. Thecauseoffireisim m aterialgenerally.
4. W hatis the difference betw een subject-m atter ofinsurance from the subject-
m atterofa contractofinsurance?
A ns:Them ain objectofthecontractofinsuranceisto indem nify theassured from theloss
caused by dam ageordestruction by fireoftheproperty oftheassured.Thisphysical
objectiscalled thesubjectm atterofinsurance.O n theotherhand,thesubject-m atter
ofcontractofinsurance is notthe physicalobjectorproperty ofthe assured butis
m oney and m oney alone.Itm ustbe noted thatw hatis insured is notthe physical
property oftheassured butonly lossofitby firebecauseby thiscontractlossby fire
cannotbe prevented.Itis notan insurance againstaccidents butan agreem entto
protectagainstdam ageby afireaccident.
5. Statew hetheran FIP isa personal/im personalcontract?
A ns:A contractoffireinsurance,though appearsto beaproperty insurance,isnotso and
itis a personalcontractbetw een the insurer and the assured,for the paym entof
m oney,in casethelossisoccasioned to theproperty ofthecontracting party by fire.
Thepurposeofthecontractisnotto insurethesafety oftheproperty butonly to save
theinsured from thelosscaused by dam ageto theproperty by fire.Therefore,w here
aproperty insured againstfireisconsum ed by firebutstillthereisno pecuniary loss
to theow neroftheproperty,theinsurerw illnotbeliableto pay any am ount.
6. W hatisthecoverageoffered in a standard fireand specialperilpolicy?
A ns:U nderastandard firepolicy,theinsurancecom pany agreesforaspecified prem ium ,
to pay theam ountofsuch dam ageorreinstateorreplacesuch property,iftheinsured
property bedam aged ordestroyed by any oftheperilsspecified asunder:
Fire
Lightning
Explosion /Im plosion
A ircraftD am age
II-12
M O D U LE -II:TECH N ICA L A SPECTS O F IN SU RA N CE
recoverable underan ordinary fire insurance policy.Exam ples ofrem ote causes of
lossby fireare:
anticipated profits
continuing expenditure
increased expenditure
depreciation
liability
11. W hatism eantby Lossby Fire?
A ns: For a loss covered by an FIP,there m ustbe an actualfire or ignition.A ny loss
attributed to the fire w hetherby actualburning orby cracking orscorching orby
sm okeorotherw isew illalso haveto beborneby theinsurer.
12. W hatisa covernote? D iscussitsvalidity.
A ns:A covernoteisnotapolicy ofinsurance.Itisonly an interim protection note.Itisa
tem porary and lim ited agreem ent.Theeffectofthecovernoteisthatifthefiretakes
place betw een the date ofthe receiptofthe covernote and the date ofintim ation by
the insurance com pany regarding the acceptance or refusal of the policy, the
insurancecom pany w illberesponsible.
13. W hataresalvageexpenses? W ho incurstheseexpenses? W hatistheim plication
of sueand labor clausein an FIP policy?
A ns:Salvage expensesare those expensesincurred by the assured in salvaging orsaving
theproperty.Itistheduty oftheassured to m inim izethelossby saving theproperty
and preventing the spread offire,because a fire insurance contractis a contractof
indem nity.In m odern firepoliciesw ith aview to encouragetheassured to takesteps
to save the property a clause is inserted know n as the sue and labor clause under
w hich the insurance com pany w illbe liable to pay the expenses incurred by the
assured in salvaging theproperty even though nothing hasbeen saved.
14. State the significance of the doctrine of Proxim ate C ause w ith respect to fire
insuranceclaim s.
A ns:Thedoctrineof Proxim ateCause holdsavery significantplacein thedeterm ination
offire related claim s.Proxim ate cause m eans the active efficientcause thatsets in
m otion achain ofeventsw hich bringsaboutaresultw ithoutintervention ofany force
and w orking actively from anew and independentsource e.g.w hereinsured object
isburnt,cause isplainly fire and insured isentitled to recoverunlessthe insurercan
show thatthe fire w ascaused by exem pted perilorw illfully by insured orw ith his
consentsuch as:
1. W here there isan explosion during a fire,the concussion dam age fallsw ithin
exception and theinsured cannotrecover.
2. W here subjectm atter is burntbutfire,w hich burned it,w as due to natural
consequencesofexcepted peril,insured cannotrecover.
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M O D U LE -II:TECH N ICA L A SPECTS O F IN SU RA N CE
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M O D U LE -II:TECH N ICA L A SPECTS O F IN SU RA N CE
II-16
M O D U LE -II:TECH N ICA L A SPECTS O F IN SU RA N CE
17. C an an insurance com pany be com pelled to replace/reinstate the dam aged
property? Isitoptional?
A ns:Reinstatem entliterally m eansreplacem entofw hatislostorrepairing the dam aged
property and bringing to itsoriginalvalueand utility.Thew ord reinstate in apolicy
offire insurance refers to buildings orchattels,w hich have been dam aged,and the
w ord replacerefersto thosew hich havebeen totally destroyed.
U nder an insurance policy, the norm al liability of the insurer is generally to
indem nify theassured,by paying thevalueofthething lostortheexpensesincurred
by theassured in repairing thedam ageoccurred by an eventinsured against.Though
usually theinsurer,in certain cases,m akespaym entofm oney w ith theconsentofthe
assured,itm ay dischargetheirliability by reinstatem ent.
The rightof reinstatem ent is usually stipulated as an option to the insurerin the
sense thaton the happening ofthe loss,the insurerw illhave rightto electeitherto
pay theassured in m oney orto reinstatetheproperty.
The assured w illnothave the rightto com pelthe insurerto reinstate,northe insurer
hasa rightto com pelthe assured on paym entofm oney to apply the proceedsofthe
policy in reinstatem ent.The assured has alw ays an unbridled rightto utilize the
policy proceedsashepleasesw ithoutany interferencefrom theinsurers.
The rightofthe insurerto reinstate the property instead ofpaying the m oney m ay
spring up:
Eitherfrom acontractin theform ofaclauseunderthepolicy,or
U nderastatute.
Thistypeofclauseisnotinserted in allbranchesofinsurances,e.g.itisnotand
cannotbeincluded in lifepolicies.
O nly in indem nity insurances, in appropriate branches of insurance, like fire,
burglary, steam boilers, or m otor vehicles insurances, this clause called the
reinstatem entclause ,entitling theinsurersto exercisean option,on thehappening
of the insured event, either to reinstate or to pay the insured m oney can be
incorporated.This only em pow ers the insured to exercise the option and underno
circum stances the assured can com pelthe insurerto reinstate.The insurers on the
otherhand,can exercise thisoption by expressly giving a m otive to the assured orit
m ay beinferred from theirconduct.
18. W hataretherightsofco-insurersto com binein reinstatem ent?
A ns:W hen tw o orm ore insurersgrantinsuranceson the sam e subject-m atterand ifthey
com binetogetherto reinstate,theassured cannotpreventthem from joining to do the
w ork and w hen once they com plete reinstatem entthey are discharged from their
liability.This rightof com bination som etim es m ay be a valuable rightw here the
policies relate to separate intereston the sam e subject-m atter because the costof
reinstatem entm ay then bevery m uch lessand m oreeconom icalthan them easureof
loss.
II-17
M O D U LE -II:TECH N ICA L A SPECTS O F IN SU RA N CE
II-18
M O D U LE -II:TECH N ICA L A SPECTS O F IN SU RA N CE
Construction ofthe covered property is ofprim ary concern to the underw riter.The
building construction is directly related to its com bustibility w hen exposed and its
construction as fuel once ignited. The Insurance Services O ffice (ISO ) divides
building construction into six classifications:
i. Fireresistive
ii. M odified fireresistive
iii. M asonry noncom bustible
iv. N oncom bustible
v. Joisted m asonry
vi. Fram e
O ccupancy factors affectthe frequency and severity oflosses.These factors w hich
vary from oneoccupancy to anothercan begrouped into threeheadings:
i. Ignition sourcesorfirecauses
ii. Com bustibility
iii. D am ageability
Fireprotection can beoftw o types:publicorm unicipalprotection provided by tow ns
and cities,and privateprotection provided by theproperty ow neroroccupant.
Externalexposures are those outside the area ow ned orcontrolled by the insured.
Theseexposuresfallinto categories:
i. Single-O ccupancy Exposures
ii. M ultiple-occupancy Exposures
W hen the property being underw ritten consistsofa single building,fire division,or
group of buildings ow ned and controlled by the sam e policyholder, a single-
occupancy exposure exists.A m ultiple-occupancy exposure occurs w heneverother
portionsofthesam efiredivision areow ned and controlled by personsotherthan the
policyholder.
SEC TIO N C
(C A SE STU D IES)
1. RelianceG eneralInsuranceCom pany Ltd.deliversafirepolicy to M r.A jay on A pril
15.H ow ever,theinsured paid theprem ium atalatterdate.U nfortunately therew asa
firein theprem isesresulting in lossofproperty insured.Thecom pany laterdenied its
responsibility on the basis ofthe factthatthe prem ium w as overdue atthe tim e of
loss.D iscuss.
A ns:N o, the com pany cannot now deny its claim . For w hen an insurance com pany
delivers a policy w ithoutrequiring im m ediate paym entofthe prem ium ,they incur
responsibility fortherisk,becausehaving delivered thepolicy,they areheld to have
given creditforthe prem ium .M oreover,w hen once the contractis concluded w ith
the prem ium and otherparticularsfixed,the policy draw n and delivered,the insurer
becom es liable for loss by fire,and itis im m aterialw hether the prem ium is paid
beforeorafterthefire.
II-19
M O D U LE -II:TECH N ICA L A SPECTS O F IN SU RA N CE
2. M r.A m ar losthisfactory furniture valued atR s.200,000 ason the date offire.
H e w anted to recover a claim ofR s2,50,000 for he had a policy ofR s500,000.
O n enquiry hefound thatfornew furniturethecostw ould beR s1,75,000.Ifthe
principleofindem nity isto beapplied how m uch ofhisclaim isto beaccepted?
A ns:Since the m arket value of the furniture lost w as Rs 2,00,000 and the cost of
reinstatem entw ould costthe insurers only Rs 1,75,000,the insurers w ould optfor
reinstatem entand accepttheclaim ofRs1,75,000.
3. M r.Shetty,ow ner ofan inn,took outan FIP w ith BajajA lianz Ltd.A fire took
place and his inn w as destroyed.The assured included in his claim the sum
w hich he had to pay by w ay of rent, the cost of hiring alternative
accom m odation,and loss caused by custom ers notfrequenting the inn during
theperiod ofrepair.Justify hisclaim .
A ns:N o,hisclaim isnotjustified.W here a fire destroysproperty,from the use ofw hich
the insured expects to earn a profitin the ordinary course ofbusiness,he does not
m erely lose hisproperty.H e also losesin addition the chance ofearning the profit,
w hich hem ighthaveearned iftheproperty had notbeen destroyed.
Butthisanticipated lossofprofitisregarded asvery rem ote and isnotrecoverable
under an ordinary fire policy on the property lostby fire.A ccordingly,insurance
upon a hotel,shop orfactory coversonly the value ofthe hotel,shop orfactory but
does notcoverthe loss ofbusiness.In the above case,none ofthe above item s is
covered by the policy. A nticipated profit is to be distinguished from the profit
ascertained atthedateoflossto ascertain thevalueofthesubject-m atterand in fixing
theam ountrecoverableunderthepolicy.[W rightvPole]
4. M r.K ishore insured his m achinery and stock of goods stored in the factory
prem isesagainstdam ageby fireand a protection note w asgiven,subjectto the
usualconditionsofthe com pany spolicy,one w arranty clause being sm oking
and cooking be strictly prohibited in or aboutthe prem ises .The stocks w ere
dam aged by fire said to be of accidentalnature.But the insurance com pany
claim ed thatsm oking a cigaretteorbidicarelessly by som eem ployeeoccasioned
thefire.Isthedenialjustified?
A ns:In the above case,the com pany denied the claim on the ground thatthere w as a
breach of w arranty as the fire w as occasioned by sm oking w hich is strictly
prohibited.Butastherew asno eye-w itnessto theorigin ofthefire,thecourtheld that
the cause of fire w as a m atter of conjecture. [Bhattacharjee v Sentinal
InsuranceCo.]
In thefam ouscase D ekhariTea Co vAssam BengalRoadwaysCo,itw asalso held
thatfires cannotalw ays be explained,and itm ustbe a m atter of conjecture.A s
regardsthe w arranty,asthe plaintiffhad putnoticesstrictly prohibiting sm oking in
and around theplaces,in factthereisno breach ofw arranty.H ence,thedenialon the
partoftheinsurancecom pany isnotjustified.O n theotherhand,thecom pany should
m akegood theloss.
II-20
C hapter 3
M arine Insurance
SEC TIO N -A
1. Them arineinsurancehasitsorigin in
a. England
b. U SA
c. India
d. France
e. N oneoftheabove
2. A m arinecargo insurancepolicy isa
a. open policy
b. valued policy
c. unvalued policy
d. indem nity policy
e. noneoftheabove
3. Insurableinterestisnecessary in a m arineinsurancecontracton
a. thepolicy issuedate
b. on thepolicy term ination date
c. atthetim eofloss
d. aftertheloss
e. noneoftheabove
4. Theprofitm adeby theship ow nerby transporting hisow n cargo orthecargo of
anotherperson isknow n as
a. carriage
b. franchise
c. excess
d. freight
e. noneoftheabove
5. A ny expenditurevoluntarily incurred forthecom m on safety oftheship iscalled
as
II-21
M O D U LE -II:TECH N ICA L A SPECTS O F IN SU RA N CE
a. particularaverage
b. generalaverage
c. totalloss
d. constructiveloss
e. noneoftheabove
6. C argo insuranceiscodified underthe
a. ITC clauses
b. ICC clauses
c. IIC clauses
d. IH C clauses
e. N oneoftheabove
7. W hich ofthefollow ing perilsareuninsurablein a m arinepolicy
a. fire
b. barratry
c. delay
d. collision
e. noneoftheabove
8. A clauseaim ed to bring aboutcooperation betw een theassured and theinsurer
such thattherightsofneitherparty isaffected w ith regard to thegoodsis
a. inchm areeclause
b. w aiverclause
c. collision clause
d. proxim atecauseclause
e. noneoftheabove
9. U nseaw orthinessand unfitnessclauseis
a. an im plied w arranty
b. an expressw arranty
c. an im plied condition
d. an expresscondition
e. noneoftheabove
10. Salvagecharges generally form
a. apartofthem arinecontract
b. arenotapartofthecontract
c. apartofthegeneralaverageclause
d. apartoftheparticularclause
II-22
M O D U LE -II:TECH N ICA L A SPECTS O F IN SU RA N CE
e. noneoftheabove
11. W illfulm isconductcom m itted by them asterand thecrew oftheship iscalled as
a. jettison
b. barratry
c. collision
d. m aritim e adventure
e. noneoftheabove
SEC TIO N A A N SW ER S
1. a 2. c 3. c 4. d 5. b 6. b
7. c 8. b 9. a 10.b 11.b
SEC TIO N -B
II-23
M O D U LE -II:TECH N ICA L A SPECTS O F IN SU RA N CE
II-24
M O D U LE -II:TECH N ICA L A SPECTS O F IN SU RA N CE
II-25
M O D U LE -II:TECH N ICA L A SPECTS O F IN SU RA N CE
Experienceoftheoperators
Susceptibility ofthecargo
Packaging standards
Sizeand valueofindividualitem sofequipm ent
Financialstatusofthepolicyholder
Pastlosshistory
Labourrelations
The underw riters should properly evaluate the conditions that m ay increase the
hazardsofafirelossand so should check theinstallationsofsuch equipm ent.
8. D iscussthevarioustypesofm arinelossclaim s.
A ns:A m arine claim upon a policy of m arine insurance goods m ay arise upon the
happening,asaresultofinsured perilsofany ofthefollow ing:
i. TotalLoss actualorconstructive
ii. Particularaverage partialloss
iii. G eneralaverageloss
iv. Expensesw hich are:
Sueand labourchargesand particularcharges
Salvagecharges
Forw arding expenses
Extracharges
A ctualTotalLoss
A ctualtotallossofthesubjectm atterm ay occur
w here it is destroyed by an insured peril (sinking of the ship,collision,or
destruction by fire,enem y in tim esofw ar)
w hereitlosesitsspecies,unfitforhum an consum ption
lossisirretrievable
itisphysicaltotallossand itisabsolute
M easureofindem nity foractualtotallossistheinsured valueunderthepolicy.
ConstructiveTotalLoss
Thisarisesshould allorany ofthefollow ing occur:
actualtotallossisunavoidable
w herethepreservation costofthegoodsexceedstheirvalue
w herethepossession ofthegoodsisunlikely
w here the costof repairing,and forw arding to the destination exceeds their
value
w herethereisalossofvoyage
itisacom m ercialtotalloss
to claim a CTL,the assured m ustgive a notice ofhisintention to abandon the
II-26
M O D U LE -II:TECH N ICA L A SPECTS O F IN SU RA N CE
goods
M easure of indem nity for CTL is the sum insured less any proceeds of sale
w hich aredueto theinsurers.
Particularaverage/Partialloss
itisapartialloss/dam agecaused fortuitously by an insured peril
m easureofindem nity forPA to cargo dependsupon
w hetheritistotallossofpartofcargo
dam aged cargo
salvageloss
G eneralA verageLoss
Section 66 ofM IA ,1963 definesG A asfollow s:
A G A loss m aybe either a sacrifice or an expenditure,extraordinary in nature,
voluntarily and reasonably incurred,in tim eofgeneralperilforthecom m on safety of
them aritim eadventure .
allinterests atrisk nam ely the ship,cargo and freightw hich have been saved
from loss by G A m easures are liable to contribute rateably to m ake good the
sacrificeand expenditure
thesevaluesareknow n as contributing values
the sum necessary to reim burse the interestw hich have suffered the G A lossis
called A m ountM adeG ood or A llow ance
Sueand LabourC harges
A llreasonableexpensesincurred in averting orm inim izing aloss
Therem usthavebeen an operation ofan insured peril
Thechargesarepayablein fullirrespectiveofthevalueofthegoods
Thesechargesareincurred shortofdestination
Thesechargesfollow upon lossordam age
ParticularC harges
Section 64 (2)oftheM IA ,1963 statesthatexpensesincurred by oron behalfof
the assured forthe safety orpreservation ofthe subjectm atterinsured,other
than G A and Salvagechargesarecalled Particularcharges
Particularchargesareincurred atdestination
These chargesare conditionalon the attainm entofthe franchise percentage of
loss
Theseexpensesareincurred w herelossisthreatening orim m inentbutavoided
by expenseforthatpurpose(reconditioning expenses)
Salvagecharges
Third parties w ho voluntarily and independently of contract render services to
II-27
M O D U LE -II:TECH N ICA L A SPECTS O F IN SU RA N CE
SEC TIO N C
(C A SE STU D IES)
Three friends A shok Jadhav,LalitK apoor,and G ovid hadari team ed up to starta
lobsterexportbusiness.Jadav ow ned a ship w hich w asused in the businessforfishing as
w ellasfortransporting the processed lobstersto foreign shores.They insured theirship,
the cargo,freight,profitsand com m ission,fora totalofRs.80 lakhs.Expecting to obtain
enorm ousprofitson theircargo,itw asovervalued by theinsured.
A few m onthslater,the ship sank in m id-ocean asithad a hole.Consequently the cargo
w as also lost. The insured approached the insurance com pany to file a claim for
com pensation forthelostcargo.H ow ever,theinsurancecom pany refused paym entofthe
entire claim am ount.Itonly m ade partialpaym entofthe claim stating thatthe cargo w as
II-28
M O D U LE -II:TECH N ICA L A SPECTS O F IN SU RA N CE
insured foran am ountm ore than its actualm arketvalue.M oreover,investigation by the
insurancecom pany surveyorrevealed thattheinsured had intentionsto sink theship.
The vesselw as retrieved by the insurance com pany and w as offered forsale as salvage.
Theinsured approached thecourtto preventthesaleoftheship.
Q uestions
1. W asthe insurance com pany violating the insurance contractby refusing paym entto
theinsured?Justify youransw er.
2. D iscusstheduty ofan insurerpertaining to salvage.
A ns:1.A n insurance contractlegally binds an insurer to pay the policyholder for the
dam ages orlosses caused by the perils againstw hich the policyholderhas insured
him self.In thegiven case,thesinking oftheship and thelossincurred by theinsured
w asdueto w illfulorfraudulentactoftheinsured and notby theperilsagainstw hich
theship w asinsured.A n insurerisnotliableforrefusing to acceptaclaim pertaining
to a losscaused by the fraudulentactofthe insured.Such lossesare notcovered by
insurancepolicies.
H ow ever,in taking over the ship to sellas salvage,the insurer w as violating the
insurance contractbecause salvage belongsto the insureronly afterhe hasm ade the
paym entof the loss suffered to the insured.In this case,the insurer should have
rejected any furtherdealings w ith the insured once itw as apparentthatthe insured
had involved in fraudulentactby intentionally causing the ship to sink to claim the
insurance am ount.Instead,the insurance com pany took overthe insured sproperty
forsalvagew ithoutthelatter sapproval.
Thus,the insurerw asnotacting w ithin the fram ew ork ofthe insurance contractand
w asliableto belegally penalized.
2. The term salvage refers to partially dam aged property.Salvage belongs to the
insurerafterthe insurerhaspaid the insured forthe lossincurred.Thus,insurersare
entitled to any m aterialthatrem ainsafterdam age provided they pay the fullam ount
fortheloss.H ence,an insurercan claim hisrighton thesalvageonly afterhem akes
thepaym entforitto theinsured.
The insureris also entitled to the salvage afterpaying the claim am ountw hen the
insured isunw illing to retain itorunableto disposeit.
II-29
C hapter 4
M otor Insurance
SEC TIO N -A
1. O riginally them otorinsurancepoliciesw ereissued to coveronly
a. ow n dam agelosses
b. only accidentallosses
c. third party liability losses
d. w arlosses
e. noneoftheabove
2. Besidestheow ner,insurableinterestin a m otorinsurancefora financed vehicle
ispresentw ith the
a. Financier
b. M ortgager
c. Bailor
d. G arageow ner
e. N oneoftheabove
3. W hich ofthefollow ing vehiclesareexem pted from com pulsory insurance
a. vehiclesow ned by thegovernm ent
b. vehiclesow ned by film stars
c. vehiclesow ned by thebanks
d. vehiclesow ned by thepoliticians
e. noneoftheabove
4. A covernoteisvalid only for
a. 15 days
b. 25 days
c. 60 days
d. 90 days
e. noneoftheabove
5. A ssessm entofm otorlossesaredoneby the
a. underw riter
b. agent
II-30
M O D U LE -II:TECH N ICA L A SPECTS O F IN SU RA N CE
c. surveyor
d. om budsm an
e. noneoftheabove
6. Forspeedy settlem entofthethird party claim s,thecasesarereferred to
a. M A CT
b. Consum erforum s
c. Sessionscourt
d. Fam ily courts
e. N oneoftheabove
7. K nock-for-knock agreem entappliesto a situation involving collision betw een
a. m any vehicles
b. tw o vehicles
c. only oneinsured vehicle
d. uninsured vehicles
e. noneoftheabove
8. Settlem entoflossesin a m otoraccidentclaim isusually arrived on thebasisof
a. O m budsm an report
b. FIR report
c. Survey report
d. Lossnotice
e. N oneoftheabove
9. O n saleofa m otorvehicletheinsurancepolicy isalso
a. autom atically transferred
b. nottransferable
c. conditionally transferable
d. transferableonly on application to theinsurer
e. noneoftheabove
10. W hich ofthefollow ing giveriseto adverseclaim sexperience
a. traffic density
b. high costoflabour
c. inflated claim s
d. costofspareparts
e. alltheabove
SEC TIO N A A N SW ER S
1. c 2. a 3. a 4. c 5. c 6. a
7. b 8. c 9. d 10.e
II-31
M O D U LE -II:TECH N ICA L A SPECTS O F IN SU RA N CE
SEC TIO N -B
1. D iscussthenatureand scopeoftheM otorInsurancecover.
A ns:A policy ofm otorvehicle insurance is,in ordinary course,a com bined insurance.It
insuresthe dam age ofthe m otorvehicle and itsaccessories,liability fordam age for
property,death oforinjury to,the assured him selforspouse and italso insuresthe
m otorvehicle againstthe risk ofliability forinjury to,orthe death ofthird parties
caused by thedriver snegligence.
2. W hat are the different types of policies available and w hat is the lim it of
indem nity underthosepolicies?
A ns:The term softhe policiesdefine the nature and extentofthe indem nity provided by
thepolicy.Therearetw o typesofpoliciesnam ely:
(i) Thethird party liability policy
(ii) A com prehensivepolicy
The third party liability insurance iscom pulsory underthe M otorV ehiclesA ct.Itis
often said that am otorcarpolicy isauniquecom bination ofseveraltypesofG eneral
Insurance .
Forexam ple,aprivatem otorcarcom prehensivepolicy indem nifiestheassured against
lossordam age to the insured carby accidentalexternalm eans,by fire,selfignition,
externalexplosion,lightning,frost,burglary,house-breaking ortheft,and by m alicious
act.Thusitisvery clearthattheinsurerisliableto m akegood thelossofam otorcarto
theow nerofthecar,forlossofcarm eanslossto theow nerofthecar.
3. M ention theconditionsin a m otorvehiclepolicy to m aketheinsurerliable.
A ns:Som eoftheconditionsin am otorvehiclepolicy to m aketheinsurerliableare:
a. The insured w illm aintain the vehicle in a good state of repair and efficient
condition;
b. H e takes allreasonable steps and precautions to avoid accidents and to select
com petentand soberdrivers;
c. H etakesallreasonablestepsto safeguard thecarfrom lossordam age.
4. Explain thefollow ing:
K nock forknock agreem ents
N o faultliability
A ns:K nock for knock agreem ents are agreem ents betw een the insurers, to avoid
confusionsand com plicationsatthe tim e ofsettlem entofclaim s.Suppose there are
otherinsurances on the sam e vehicle,the insurers are liable to pay only a rateable
proportion.
Sim ilarly,w hen tw o m otorists,insured undercom prehensive policies,are involved
in a m otoraccident,both m ay be liable.Both casesinvolve doctrinesofsubrogation
and contribution involving costs and m ultifarious litigation. To avoid this
com plication,insurersenterinto agreem entsknow n as knock forknock .
II-32
M O D U LE -II:TECH N ICA L A SPECTS O F IN SU RA N CE
It is an agreem ent betw een both the insurers that irrespective of w hoever w as
responsible forthe accident,provided the liability iscovered underthe policy,each
insurerw illindem nify hisinsured in respectofthe dam age to the vehicle insured by
itand w illnotenforcesubrogation rights.
O n sim ilarlines, third party sharing agreem ents are entered into underw hich each
w illshareequally thethird party costsand dam ages.
N o Faultliability also know n as liability w ithoutfault isto m aketheow nerof
the vehicle liable unconditionally.Thisclause statesthatw here death orperm anent
disablem entofany person hasresulted from an accidentarising outofthe use ofa
m otor vehicle or m otor vehicles, the ow ners of the vehicles shall, jointly and
severally,beliableto pay com pensation provided in theA ctin respectofsuch death
ordisablem ent,w hich isgenerally Rs.25,000 in caseofdeath and Rs.12,000 in case
ofperm anentdisablem ent.
Thissection ofthe A ctm akesthe liability absolute;w hetheratfaultorno fault,the
ow nerofthe vehicle ism ade liable to pay thisam ount.Further,the liability isalso
m ade jointand several w hereby theassured m ay dem and from any oneorsom eor
allofthem w here there are m ore than one vehicle ow nerinvolved.The paym entof
com pensation is m ade certain,expedientand expeditious by dispensing w ith the
necessity ofproving any faulton the partofthe payerand by providing im m unity
debarring any defencesagainstthereceiverofthecom pensation.
5. D iscussthe nature and scope ofthe third party or com pulsory insurance ofthe
m otorvehicles.
A ns:In law oftorts,ifaperson negligently driveshisvehicleand causesinjury ordeath to
a third party the driverw hose negligence caused the dam age is liable to the third
party.U nderthevicariousliability clauseofthecom m on law ,theow neron behalfof
thedriverisliableto thethird party.
The objectofthistype ofpolicy isto protectthe insured againsthisliability to third
parties arising outofan accidentcaused by the use ofa m otorvehicle on a public
road and itisalso m adecom pulsory.Thepersonsrequired to beinsured are:
a. W ho usesthevehicleexceptasapassenger,i.e.adriver.
b. O ne w ho causes orallow s any otherperson to use the vehicle,otherthan an
ow ner,onew ho isin possession ofthevehicleunderacontractofloan orhiring.
6. M ention the provisions and conditions to be adhered to, under the M otor
V ehiclesA ctin respectofthird party insurance.
A ns:The M otor V ehicles A ct has m ade it statutory and obligatory for a third party
insurance coverto be taken by every ow nerofa vehicle.The A ctspecifically states
thatno person shalluse exceptasa passengerorcause orallow any otherperson to
use a m otorvehicle in a public place,unlessthere isin force in relation to the use of
the vehicle by thatperson orotherperson,asthe case m ay be,a policy ofinsurance
com plying w ith therequirem entsoftheA ct.Thus,third party insuranceisam ustfor
II-33
M O D U LE -II:TECH N ICA L A SPECTS O F IN SU RA N CE
running a m otorvehicle in a public place.The follow ing are som e ofthe im portant
provisionsto beadhered to in caseofthird party insurance,nam ely:
(i) Itappliesto any otherperson otherthan apassenger;
(ii) W hatisprohibited istheuserby him selforallow ing anotherperson to use;
(iii) Such useshould beam otorvehicle;
(iv) Such vehiclesshould beused in apublicplace;
(v) The using orcausing ofuse by the otherperson should be w ithouta policy of
insurance.
(vi) Thepolicy ofinsuranceshould com ply w ith theprovisionsoftheA ct.
7. Istherea statutory contractbetw een an Insurerand D river?
A ns:A ccording to section 147 (5)oftheM otorV ehiclesA ct,theA ctstatesthat,aperson
issuing a policy of insurance under this section,shallbe liable to indem nify the
person orclassesofpersonsspecified in the policy in respectofany liability w hich
the policy purportsto coverin the case ofthatperson orthose classesofpersons.In
factby virtue ofthe provision ofthis section the insureris liable to indem nify any
specified classofdriver,butisnotthereby liableto theinjured third party him self.
This section gives statutory recognition to the practice ofextensions ofthe policy.
Theeffectofthisprovision isto createacontract,betw een theinsurersand any driver
ofthevehiclew ho isofaclasscovered by thepolicy.
A satisfactory form of policy therefore not only covers the liability of the
policyholderw hiledriving hisow n carbutalso extendsto indem nify:
(a) Thepolicy holderw hiledriving another scar;
(b) O therpersonsw hiledriving thepolicy holder scar.
In fact,itisa second statutory contract,w hich runssubsidiary to the m ain contract,
and itstandsorfallsw ith the m ain contract.Ifthe ow nersellsaw ay hisvehicle,his
contractcom esto an end and along w ith itthesecond contractalso disappears.
8. D iscusstheeffectofthefollow ing on claim s:
Insolvency;
D eath.
A ns:Insolvency
U nder the provisions of section 154,the A ctprotects the rights of the third party
againstinsolvency oftheassured.Thebroad effectofthesection isthatallrightsand
liabilities arising betw een the insured and the insurers in the case of com pulsory
m otorinsuranceshallrem ain unaffected,notw ithstanding thatathird party hasbeen
given largerrightsagainsttheinsurersthan theassured him selfhad.
D eath ofparties
The generalprinciple ofactio personalis m oritur cum persona does notapply to
accidentsunderthisact.U nderthe provisionsofthe A ct,ifthe death ofa person in
w hosefavouracertificateofinsurancehad been issued,occursafterhappening ofan
II-34
M O D U LE -II:TECH N ICA L A SPECTS O F IN SU RA N CE
A ns:M r. Rahul cannot claim any am ount by w ay of com pensation from the insurer
becausethepolicy ceased to haveeffecton thesaleoftheinsured carand so hecould
no longergetany benefitofinsuranceunderthepolicy.
3. M s.Payalm etw ith an accidentw hiledriving hercar,and itw asdueto defective
brakes.Sheclaim ed com pensation from theinsurersforthedam ages.D ecide.
A ns:M s.Payalcannotclaim any com pensation in theabovesituation becausetheInsurers
are notheld liable w here there isinherentdefectin the vehicle.M oreover,w hen the
vehicle isnotroadw orthy and in a dangerouscondition the insurerisabsolved from
his liability to indem nify such an insured,w heneverany condition ofthe policy is
breached by theinsured.Theinsurerw illnotm akethelossgood,sim ilarly w herethe
lossisdueto w antoffootbrakes.
4. M r.R anjitSingh had engaged a driver for hiscar,w ho had negligently driven
thevehicleand caused dam ageto a third party.IsM r.R anjitresponsiblein the
abovesituation?
A ns:A s per the com m on Law ,the m aster is liable for the tortious acts of the servant
provided theservantdoessuch actin thecourseofhisem ploym ent.Thecom m on law
also recognizes the vicarious liability ofthe ow nerofthe m otorcar.In the law of
torts,ifaperson negligently driveshisvehicleand causesinjury ordeath to thethird
party,thedriverw hosenegligencecaused thedam ageisliableto thethird party.The
driveristheservantoftheow ner,and sinceheisaperson ofno m eans,theow neris
liableforallhisactsso farthathehasdonesuch actsin thecourseofhisem ploym ent.
In theabovecasebased on theprovisionsofthecom m on law M r.Ranjitisheld liable
forthedam agecaused to thethird party.[PushpabaiSudershin vRanjitG and P Co].
5. ParulA garw alreceived a brand new M arutiZen from herhusband on herbirthday.
The carw asinsured againstdam age orlossw ith W heelsInsurance Com pany foran
am ountofRs5 lakhsw ith adeductibleofRs75,000 from hercoverage.
O ne day,Parul,w ho w asan experienced driver,took the caroutto visitherfriend.
O n the w ay to herfriend s place,she had to stop ata traffic signal.A lthough she
stopped hercarto avoid jum ping the signal,a speeding driverfrom behind ram m ed
into hercar.The im pactofthe collision w assuch thatParulsuffered severe injuries
and she had to be hospitalized.H er car w as reduced to a w reck.Investigations
revealed thatthecarthathitParulscarw asbeing driven by oneM r.RanjitG arg.
Parulfiled a claim forlossw ith herinsurance com pany and received Rs4,25,000 as
dam age claim . The insurance com pany, in turn, sued Ranjit on behalf of its
policyholder,Parulforthe sam e am ountthatithad paid her.Ranjitapproached the
courtchallenging thevalidity oftheinsurancecom pany ssuit.
Q uestionsforD iscussion:
1. W hatisthe principle on the basisofw hich the insurance com pany accepted Paruls
claim and laterfiled asuitagainstRanjit?
II-36
M O D U LE -II:TECH N ICA L A SPECTS O F IN SU RA N CE
II-37
C hapter 5
Engineering insurance
SEC TIO N -A
II-38
M O D U LE -II:TECH N ICA L A SPECTS O F IN SU RA N CE
a. Totallosses
b. D eny theclaim
c. Pay rateableshareofloss
d. Pay only halftheloss
e. N oneoftheabove
6. TheBoilerexplosion policy cannotbeissued on
a. A greed valuebasis
b. M arketvaluebasis
c. Book valuebasis
d. Replacem entvaluebasis
e. N oneoftheabove
7. R efund ofprem ium during thestandstillperiod isnotpayablew hen caused by
a. Shortageofraw -m aterials
b. Breakdow n ofplantand m achinery
c. W orkersstrike
d. Lack ofprovision ofstandby equipm ent
e. N oneoftheabove
8. TheM achinery breakdow n policy coversany dam agecaused to m achinery
a. A tw ork
b. A trest
c. W hiledism antling forrepairs
d. Shifting orre-erection
e. A lltheabove
9. M B policiescannotbeissued on the
a. Firstlossbasis
b. W ith abonusclause
c. W ithoutexcessclause
d. Forplantslocated outsideIndia
e. A lltheabove
10. D eductibleFranchise/Excessistheam ountoutofeach claim by the
a. Insured
b. A gent
c. Broker
d. Insurer
e. N oneoftheabove
II-39
M O D U LE -II:TECH N ICA L A SPECTS O F IN SU RA N CE
11. R efund ofprem ium isnotperm issiblein a M achinery breakdow n policy in case
of
a. Lockoutperiod
b. W hileatw ork
c. W hileatrest
d. Standstillperiod dueto shortageoffuel& raw m aterial
e. N oneoftheabove
12. TheM achinery lossofprofitspolicy coverslossofgrossprofitonly dueto
a. Increasein output
b. D ecreasein output
c. D ecreasein costofw orking
d. Lockoutperiod
e. N oneoftheabove
13. Them inim um tim eexclusion period forLO P policiesin caseofpow erplantsis
a. 15 days
b. 14 days
c. 30 days
d. 45 days
e. N oneoftheabove
14. Thebasisoftotallosssettlem entin an EA R policy ispayableon thebasisof
a. A ctualvaluelesssalvage
b. M arketvalueplussalvage
c. Reinstatem entvalue
d. V aluedecided by IRD A
e. N oneoftheabove
15. W hich ofthefollow ing isnotA ctofG od perils
a. Earthquake
b. Flood
c. N egligence
d. Storm /Tem pest
e. N oneoftheabove
SEC TIO N -A A N SW ER S
1. b 2. b 3. e 4. e 5. c 6. a
7. c 8. e 9. e 10.a 11.a 12.b
13.b 14.a 15.c
II-40
M O D U LE -II:TECH N ICA L A SPECTS O F IN SU RA N CE
SEC TIO N -B
1. D efinethescopeand aim of engineering insurance
A ns:Engineering Insuranceschem esaim atprotecting businesshousesfrom eventualities
thatcould give rise to a loss and disrupttheirday-to-day functioning.Such losses
arise due to the failure of m achineries, explosion of boilers and breakdow n of
com puters and sophisticated electronic equipm ent. A m ajor breakdow n due to
m echanicalfailure could also resultin consequentialloss ofprofits.A llthese risks
can becovered undervariousengineering policies.
Engineering Insurance coversare available atthe tim e ofputting up ofa factory or
even during an expansion. These insurance covers are the Storage-cum -erection
policies forindustrialrisks,the Contractors allrisk policy forcivilw orks and the
Contractors plant & m achinery policy,w hich takes of the Contractors Insurance
requirem ents.The A dvance lossofprofitspolicy isa sophisticated insurance cover,
w hich takescareoflossesarising outofdelay in com pletion ofaprojectw ellbeyond
thestipulated period w herethedelay iscaused by an insured peril.
2. D efine the term explosion and explain the scope of coverage in a Boiler
explosion policy
A ns:The term Explosion refersto the sudden and violentrending ortearing apartofthe
perm anentstructureofaboilerorpressureplantorany partorpartsthereofby force
of internal steam gas or fluid pressure causing bodily displacem ent of the said
structureand accom panied by theforcibleejection ofitscontents.
TheBP policy explicitly coversthefollow ing:
1. D am age (other than by fire) to the boilers and/or other pressure plant or
surrounding property described in theschedule.
2. Liability arising dueto death oforbodily injury to any person provided heisnot
em ployed orunderapprenticeship w ith theinsured.
3. Liability arising from dam age to any property w hether the insured is
responsibleforitornot
3. StatethegeneralexceptionsofBoilerExplosion policy.
A ns:Thefollw ing lossesarenotcovered underthepolicy:
dam agesarising directly orindirectly from fire orexplosion orcollapse orany
othercause.
D am ages caused by w ar,hostilities orw arlike operations,naturalcalam ities,
etc.Sim ilarly,dam agesfrom nuclearreaction,nuclearradiation orradioactive
contam ination areexcluded.
Loss resulting from any experim ent requiring overloading or abnorm al
conditions.
D efectsthatare gradually developing and w ould require repairsatsom e future
datearenotcovered underthispolicy.
II-41
M O D U LE -II:TECH N ICA L A SPECTS O F IN SU RA N CE
II-42
M O D U LE -II:TECH N ICA L A SPECTS O F IN SU RA N CE
the purpose ofeffecting the repairs as w ellas ordinary freightto and from a
repair shop, custom s duties if any, to the extent such expenses have been
included in thesum insured.
N o deduction shallbem adefordepreciation in respectofpartsreplaced except
for(i)w earand tearpartsand (ii)partsforw hich m anufacturershavespecified
a fixed life foruse and the like butthe value ofany salvage w illbe taken into
account.
In cases w here an insured item is destroyed,the com pany w illpay the actual
value ofthe item im m ediately before the occurrence ofthe lossincluding costs
forordinary freighterection and custom sdutiesifany,provided such expenses
havebeen included in thesum insured,and such actualvalueisto becalculated
by deducting properdepreciation from thereplacem entvalueoftheitem .
A ny extra chargesincurred forovertim e,night-w ork,w ork on public holidays,
express freightare covered by this insurance only if especially agreed to in
w riting.
Thecostofany provisionalrepairsw illbeborneby thecom pany ifsuch repairs
constitutepartofthefinalrepairsand do notincreasethetotalrepairexpenses.
8. W hatisthem ain aim ofa Lossofprofitsinsurancepolicy?
A ns:U nderthis policy the com pany m akes good the losses arising from unforeseen and
sudden dam ages to any m achinery described in the schedule,during the period of
policy,on thebasisofthefollow ing requirem ents:
The liability ofcom pany forclaim s rem ains w ithin the lim itspecified in the
schedule.
Theaccidentshould happen during period specified in thepolicy and should be
covered by standard m achinery insurance policy or boiler & pressure plant
insurancepolicy.
Theterm sand conditionsofthepolicy havebeen fulfilled.
Thestatem entsand answ ersin theproposalform aretrue.
Thecoverprovided underthispolicy shallbelim ited to lossofgrossprofitdueto
(a) Reduction in outputand
(b) Increase in costofw orking and the am ountpayable as indem nity thereunder
shallbe
(a) In respectofreduction in output
(b) In respectofincreasein costofw orking
Thereduction in fixed chargesifany during theperiod ofbusinessisdisrupted,shall
bededucted from thecom pensation am ount.
II-43
C hapter 6
M iscellaneousInsurance
SEC TIO N A
1. M iscellaneousinsurancepoliciescoverlossesconcerning
a. person
b. property
c. pecuniary risks
d. liabilities
e. alltheabove
2. W orkm en scom pensation policy takescareoftheliability ofthe
a. Em ployer
b. O w ner
c. Tenant
d. M ortgagee
e. N oneoftheabove
3. C rop insurancein India to allloaneefarm ersis
a. com pulsory
b. notobligatory
c. optional
d. voluntary
e. noneoftheabove
4. W hich ofthefollow ing lossesarenotcovered by thepersonalaccidentpolicy
a. naturaldeath
b. disability
c. accidentaldeath
d. suicide
e. noneoftheabove
5. Foritem sofhigh sentim entalvalue,a burglary policy can beissued asa
a. floaterpolicy
b. declaration policy
II-44
M O D U LE -II:TECH N ICA L A SPECTS O F IN SU RA N CE
c. valued policy
d. open policy
e. noneoftheabove
6. W hich ofthefollow ing doesconstitute m oney
a. bank notes
b. coins/currency
c. stam p papers
d. jew elry & ornam ents
e. alltheabove
7. W hich ofthe follow ing lossesare notcovered by the Plate and G lassinsurance
policy?
a. w illfulbreakage
b. superficialdam ages
c. scratches
d. cracked orim perfectglass
e. alltheabove
8. Fidelity G uaranteepolicy coverstheem ployeragainstpecuniary lossescaused by
a. naturalcalam ities
b. servants
c. dishonestem ployees
d. custom ers
e. noneoftheabove
9. TheD & O insurancepolicy isaim ed to protecttheinterestsofthe
a. policyholders
b. shareholders
c. custom ers
d. em ployeesand creditors
e. alloftheabove
10. W hich statem entregarding the liability ofthe insurance com pany for a D & O
policy istrue
(i)Theunderw riterisliablew hen thepolicy isin force
(ii) Theunderw riterisliableeven afterthepolicy iscancelled orlapsed.
a. only (i)
b. only (b)
c. both (a)& (b)
II-45
M O D U LE -II:TECH N ICA L A SPECTS O F IN SU RA N CE
d. neither(a)or(b)
e. noneoftheabove
SEC TIO N -A A N SW ER S
1. e 2. a 3. a 4. a 5. c 6. e
7. e 8. c 9. e 10.c
SEC TIO N -B
based on Crop Cutting Experim ents (CCEs) is available for adequate num ber of
years,and (ii) requisite num ber of CCEs are conducted for estim ating the yield
during theproposed season:
a. Food crops(Cereals,m illets& pulses)
b. O ilseeds
c. Sugarcane,cotton & potato (annualcom m ercial/annualhorticulturalcrops)
O therannualcom m ercial/horticulturalcropssubjectto availability ofpastyield data
w illbe covered in a period ofthree years.H ow ever,the crops,w hich are covered
nextyear,w illhaveto bespecified beforethecloseofpreceding year.
A ll farm ers including sharecroppers, tenant farm ers grow ing notified crops in
notified areasareeligibleforcoverage.
Theschem ecoversthefollow ing groupsoffarm ers:
a. O n a com pulsory basis: A ll farm ers grow ing notified crops and availing
SeasonalA griculturalO perations (SA O )loans from financialinstitutions,i.e.
loaneefarm ers.
b. O n a voluntary basis:A llnon-loanee farm ers grow ing notified crops w ho opt
fortheschem e.
4. D efinethescopeofA viation insurancepolicy?
A ns:Them ostcom m on coveragesofaviation insuranceare:
A ircraftliability insurance
H ullcoverage
Personalaccident
A ircraftLiability Insurance:
Theliability in caseofaviation insuranceisdivided into tw o categories:
Passengerliability
D eath and injury to third parties
There are som e policies thatcover both these categories as w ellas property
dam age w ith a single lim itto coverallthree ofthem (like floating policies in
fidelity guarantee).The aircraft liability insurance also provides coverage of
m edical paym ents for injuries sustained w hile travelling in or entering or
alighting from the aircraft.This policy coverage is available only ifthe policy
includes passengerbodily injury liability.Som e policies also provide forH ull
coveragew hichincludecoverageofthebodyandm achineryoftheaircraft.Som e
policiesprovideopen perilscoverageboth on ground and in flightw hereasothers
restrictthe open perils coverage to ground only.In-flightpolicies do notcover
crash orcollision.They coverperilsoffire,lightning orexplosion in air.
5. H ow is insuranceofa person policy differentforlifeinsurancepolicy?
A ns:W hile in life insurance a claim can be m ade only on the death ofa person orthe
attainm entofa specific age, insurance ofperson policy providescoveragainstany
personalaccidentorspecified diseases.Secondly,the Life Insurance Corporation of
II-47
M O D U LE -II:TECH N ICA L A SPECTS O F IN SU RA N CE
India provides the form er policy, w hile the latter is provided by the G eneral
InsuranceCorporation ofIndia.Likelifeinsurancetheam ountto beaw arded in case
ofaccidentispre-decided in thepolicy.Personalaccidentinsuranceisnotacontract
ofindem nity.The coverage is linked to the incom e ofthe insured.G enerally,sum
insured isrestricted to 5/6 tim esofannualincom eor50/60 tim esofm onthly incom e
in case ofsalaried em ployees.The schedule ofthe policy specifiesthe am ountto be
paid in case ofdeath ofthe insured,totalorpartialloss ofeyesight,am putation or
irrecoverablelossoflim bsw ithoutphysicalseparation.
Personalinsurance also covers m any insurances like personalaccidentinsurance,
disability insurance,baggage,m edical,individualliability covers forprofessionals
likedoctors,architects,etc.
6. H ow is Burglary defined in a Burglary insurancepolicy?
A ns:Burglary is defined as forcefuland illegalentry into the business prem ises forthe
purposeofstealing. Forcefulentry istheprerequisiteforburglary.Itisnecessary to
differentiate it from theft, robbery or housebreaking. W hile Robbery requires a
forcefulpersonalcontact.Itis an aggravated form ofburglary w here force is used
againstaperson.
7. W hatisthecoveravailableforlossin a burglary policy?
A ns:Burglary insurance is notonly forthe goods ow ned by the person butalso forthe
goodsheisresponsibleforlikethoseheld in histrust.Italso includestherelationship
ofbailm entoragency regarding thegoods.Thepolicy w ith w idercoverexcludesthe
item sthatarespecifically covered underotherpolicies.
Them ain policiesavailableundertheburglary insuranceare:
(i) Burglary businessprem isesinsurancepolicies.
(ii) Burglary privatedw ellingsinsurancepolicies.
(iii) Com bined fireand burglary insurancepolicies.
(iv) A llrisk insurancepolicies.
(v) Baggageinsurancepolicies.
(vi) Jew ellery and valuablesinsurancepolicies.
8. D iscussthescopeofcoveravailableundera Bankers Indem nity Insurance
A ns:A bankers blanketcover provides insurance againstfire perils,burglary,cash in
transit,fidelity guaranteeand m arineinsurance.Thispolicy providescom prehensive
insurancecoverto thebanking sector.
C overage: This policy covers the directlosses ofm oney and/orsecurities discovered
during the period specified in the policy.M ore specifically,itcovers the
follow ing losses:
Prem ises - By fire,riotand strike,burglary orhouse breaking orhold up resulting in
lossto m oney/securitiesattheprem ises.
Transit Lost, stolen, m islaid, m isappropriated or m ade aw ay either due to
II-48
M O D U LE -II:TECH N ICA L A SPECTS O F IN SU RA N CE
II-49
M O D U LE -II:TECH N ICA L A SPECTS O F IN SU RA N CE
SEC TIO N C
(C A SE STU D IES)
H em antPatel,areal-estatebroker,lived in D elhiw ith hisw ifeand tw o children.H eow ned
a bungalow in K arolBagh w hich w asinsured w ith Elite Insurance Com pany,N ew D elhi,
forRs35 lakhs.
O n D ec 31st1999,H em antw entto the localclub w ith his fam ily to attend a N ew Y ear
II-50
M O D U LE -II:TECH N ICA L A SPECTS O F IN SU RA N CE
party.W hen they returned hom e in the early hoursofthe nextday,they found thattheir
househad been burgled and m any valuableshad been taken.
W hile the police investigation w asgoing on,the insurersenthissurveyorto look into the
cause of the loss,the com pliance of the insured w ith the term s of the policy,and the
am ountoflosssuffered by thepolicyholder.
D uring the course ofinvestigation,the surveyorobserved significantdiscrepanciesin the
statem entsgiven by theinsured.Thesediscrepanciespertained to thelistofitem sreported
to havebeen stolen by theinsured and them ism atch betw een thetruevalueoftheseitem s
and the am ountsupposedly involved in the burglary.W hen the surveyor subm itted his
reportto the insurance com pany,he m entioned thatthe financialcondition ofthe insured
w asnotgood beforetheburglary and hehad increased theinsurancecoverageon hishouse
justafew daysbeforetheburglary took place.
H em ants claim form w as therefore rejected by the insurance com pany on grounds of
fraud.H em antfiled alaw suitagainsttheinsurancecom pany.
Q uestionsforD iscussion:
1. W as H em anteligible to receive the claim am ountforthe reported loss thathe had
suffered?W hy do insurersm akepaym entsforsuspiciousclaim s?
2. W hatare the precautions thata loss adjusterhas to take w hile handling claim s for
losscaused by theft?
A ns:1.H em antfailed to give convincing repliesto the questionsposed by the surveyor.
Even theinform ation hesupplied w asfullofdiscrepancies.Further,heincreased the
valueoftheinsurancecoverageon thehouse,w hich provesthattheinsured sm otive
behind obtaining insurancew aspurely to obtain financialgain ratherthan protection
againstrisk.Therefore,H em antis noteligible to receive the claim am ountforthe
reported loss.
Insurersoften m akepaym entstow ardssuspiciousclaim sforfearofbeing blam ed for
tardinessin claim settlem ent.The fearoflossofgoodw ill,and the need to m aintain
good standing w ith the insurance regulators is also responsible for the insurers
m aking hasty settlem entsofsuspiciousclaim s.
2. A n adjuster should thoroughly review relevantpolicy provisions w hile handling a
claim for loss due to theft.If the policyholder has theftcoverage for the type and
locationofpropertyconcerned,thentheverificationofthelossbecom esaverydifficult
task forthe adjuster.W hile verifying a theftclaim ,both the lossitselfasw ellasthe
am ountoflossdueto thefthasto beverified.Sincelittleorno evidencerem ainsaftera
theft,itis easy fora dishonestinsured to fabricate claim s.Even ifa thefthas truly
occurred,thereisno evidenceto provethattherew asathiefinvolved in theincident,or
to prove the existence ofthe property involved in the theft,oreven to prove the true
value orquantity ofthe property involved.The statem ents ofthe insured aboutthe
nature,quantity and valueoftheproperty thathasbeen allegedly stolen areaccepted as
evidence in courts.The failure ofthe insured to provide receiptsto validate hisclaim
cannotform thebasisfordenialoftheclaim by theadjuster.
II-51
M O D U LE -II:TECH N ICA L A SPECTS O F IN SU RA N CE
C hapter 7
LifeInsuranceProducts
SEC TIO N -A
d. Either(a)or(c).
e. Either(b)or(c)aschosen by theannuitant.
11. H ow isthepurchasepriceforan im m ediateannuity paid?
a. By installm entsoveraperiod oftim e.
b. By alum psum am ount
c. Eitherthrough installm entorby alum psum am ountaschosen by theannuitant.
d. From thesalary oftheannuitant.
e. N oneoftheabove
12. W hy isthew ord profitredundantin lifeinsurancebusinessused?
a. Theinsurancecom paniescannotearn any profit.
b. Theinsurancecom paniesarenotcarrying outthebusinessthey arew orking for
thecharitableinterestoftheirpolicyholders.
c. Theinsurancecom panies com m itm entsarecontingentliabilitiesonly.
d. Theinsurancecom paniescannotm eetalltheliabilitiesatatim e.
e. Theinsurancecom panieshonourtheunlim ited volum eofliabilities.
13. W hich ofthefollow ing isan investm entplan ofLIC ?
a. Bim aPlus
b. Jeevan A sha
c. A shaD eep
d. Jeevan dhara
e. N oneoftheabove
14. W hich ofthefollow ing isnota children splan?
a. Jeevan Balya
b. Jeevan K ishore
c. Jeevan Sukanya
d. Jeevan A kshya
e. N oneoftheabove
15. TheW holelifeplansin India,
a. Pay death benefitsafterapersonsexpiry
b. Pay death benefitsafterretirem ent
c. Pay policy benefitsaftertheperson attainsacertain age,say 80-85 years.
d. N oneoftheabove
16. Term assuranceprovidesthefollow ing benefits
a. D eath benefitsiftheperson dies
b. D eath and survivalbenefits
II-54
M O D U LE -II:TECH N ICA L A SPECTS O F IN SU RA N CE
c. Periodicpaym entsatpredictableintervals
d. D eath benefitsw ith bonus.
17. Endow m entplans
a. A lw aysparticipatein profits
b. A renoteligibleforloans
c. A rem ostpopularin India
d. N on oftheabove
18.W hich ofthefollow ing isa children spolicy?
a. Jeevan Sneha
b. Jeevan V ishw as
c. Jeevan D hara
d. Jeevan Sukanya
19.V aristha Pension Y ojana
a. Isan LIC plan
b. Providesan effectiveyield of9% p.a.
c. Surrendervaluecan bepaid on m eritsiftheperson iscritically ill
d. A lloftheabove
20.W hich ofthefollow ing isa health insuranceschem e?
a. N ew Jeevan D hara
b. Jeevan A adhar
c. Jeevan Chayya
d. A shaD eep
SEC TIO N A A N SW ER S
1. (d)A policyholdercan availthe conversion feature in a policy and m ay shiftto a
w hole life policy oran endow m entpolicy asperthe requirem ent.There isno such
policy called long-term assurancepolicy.
2. (c) Term insurance and pure endow m ent are the tw o building blocks of the life
insurance products. Every product incorporates these tw o features in varying
proportionsto suitthespecificrequirem entsofaparticularclassofcustom ers.
3. (c)The endow m entassurance policiesconsiderthe tw o com ponents risk coverage
and m aturity benefits in the sam e policy.In orderto take both the features,the
insurerneedsto chargem oretow ardsthecoverageofboth.
4. (b)Thecapitalm arketlinked variablelifeinsurancepoliciescontain tw o com ponents
risk prem ium and investm ent prem ium . Since the hard earned m oney of the
policyholderis invested in various types offinancialinstrum ents,the choice ofthe
policyholder,depending upon his/herreturn requirem ents and risk taking abilities,
II-55
M O D U LE -II:TECH N ICA L A SPECTS O F IN SU RA N CE
SEC TIO N -B
II-56
M O D U LE -II:TECH N ICA L A SPECTS O F IN SU RA N CE
II-57
M O D U LE -II:TECH N ICA L A SPECTS O F IN SU RA N CE
Som eoftheICICIPrudentialplansare
ICICIPru saven product
ICICIPru A ssureInvest
H D FC Standard endow m entplansare
Endow m entA ssurancePlan
TA TA A IG endow m entplansare
A ssureSecurity and grow th plan
A llianzaBazazendow m entplansare
SaveCareeconom y plan
3. D escribe briefly the nature ofterm plans.M ention som e ofthe plansw hich are
availablein them arket.
A ns:Term insurancehasseveralbasiccharacteristics.
Protection foralim ited num berofyears.[tem porary protection]
U nlessthepolicy isrenew ed,theprotection expiresattheend oftheperiod.
Thesepolicieshaveno cash valueorsaving elem ent.
N othing ispaid in caseofsurvival.
Issued forone yearto a setnum berofyearssuch as10 or20 orto a stipulated
age65 or70.
Initialprem ium sarelow .
Prem ium sforterm coverage can escalate rapidly asthe duration ofthe policy
lengthens.
Thesepricesarem oreeasily com pared than arepricesofotherproducts.
H ence this m arketis m ore price com petitive than the m arketfor cash value
policies.
These policieshave no cash values,no dividends-so easy to com pare on the
basisofprem ium s.
Term lapse ratesare higherthan otherpolicies[because ofsensitivity in price
and low profitm argin.]
M ostterm insurance policies are renew able,for additionalperiods w ithout
evidence of insurability w ith increased prem ium at each renew al based on
insured sattained age.
M ostterm insurance policies are convertible fora cash value policy w ithout
evidence ofinsurability.Thisconversion m ay be perm itted on an attained age
ororiginalagebasis.
Traditionalterm prem ium soften arebased on aggregatem ortality experience.
R eentry term prem ium sarebased on aselect\ultim atem ortality split.
H encethescaleofprem ium ratesvariesnotonly by agebutalso by theduration
sincetheinsured lastdem onstrated insurability.
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M O D U LE -II:TECH N ICA L A SPECTS O F IN SU RA N CE
Term insurance is appropriate w hen incom e is lim ited,orthere are tem porary high
insuranceneeds.Itcannotbeused forretirem entorsaving purposesbecauseithasno
cash values.
Som eoftheLIC Term Plansare
Bim aSandesh plan 94
Convertibleplan plan 58
Som eoftheICICIPrudentialplansare
LifeG uard [term levelassurance singleprem ium ]
LifeG uard [term levelassurance instalm entprem ium plan]
LifeG uard Term A ssurancew ith Return ofPrem ium
Som eoftheH D FC Standard plansare
Loan coverterm assurance
Term assuranceplan
Som eoftheA llianzBazazTerm Plansare
Risk care
Term careplan
4. W hatarethefeaturesand benefitsofinvestm entplans?
A ns:Basically itw asa type ofw hole life insurance w hose valuesm ay vary directly w ith
the perform ance ofa setofearm arked investm ents.N ow m any m arketsare offering
these U LIPsin children plans[ICICISm artK id policy]endow m entand retirem ent
plans [LIC S Forty Plus policy]also.These plans give an option to the investorto
choose betw een three fund options debt,equity,and balanced.In these products,
prem ium scan be paid quarterly,halfyearly oryearly.O utofthe prem ium am ounts,
deductionsw illbem adetow ards
Initialadm inistrative charges
Investm ent m anagem ent charges [ there w ill be an extra charge if the
policyholderutilizes the sw itch over(from equity to debtordebtto balance)
option]
A nnualadm inistration charges
Risk cover
and thebalancew illbeinvested in aselected fund [debtorequity orbalance].
Insurance Com panies charge anyw here betw een 20 -35 percentas upfrontcharges
fortheirunit-linked plans.So,every tim eyou m akeyourprem ium paym ent,only
a partofitisactually invested in thefund ofyourchoice.
In case ofdeath during the prem ium paying term orthe term ofthe policy,the sum
assured [Rs.1 Lakh in exam ple]orvalue ofpolicy fund,w hicheverishigher,ispaid
to the beneficiaries.In case ofsurvivalup to m aturity,the value ofthe fund ispaid
out.The returns on thatday [m aturity or death]on the plan depend upon the
perform ance ofthe m arket,be itequity or debt.So ifthe fund value fallsbelow
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M O D U LE -II:TECH N ICA L A SPECTS O F IN SU RA N CE
SEC TIO N C
(C A SE STU D IES)
1. Term ,w hole life,endow m ent,annuity policies or the com bination of policies are
available in the m arket.The bestpolicy is the one thatbestm eets your financial
needs.Y ou haveto selectthepolicy according to yourneeds.
Suggestsuitablepoliciesforthegiven situations:
1. Y ou are in the age of 25.Y ou justjoined an organization.Y ou are recently
m arried.N ow you cannotspend m oreon lifeinsurance.
2. Y ou arein 50s;both ofyourchildren arein them iddleoftheireducation.
3. Y ou aretheonly earning m em berin yourfam ily.Y ou purchased aflatby taking
loan from housing finance.A slong asyou arethereyou can pay EM Is regularly.
Y ou w antto retain thehouseforyourfam ily m em berseven in yourabsence.
4. Y ou are in the beginning ofcareer;you w antto com bine both insurance and
saving.Butthe com bination ofthissaving and insurance iscostly.Rightnow
you cannotinvestm uch,having dependentsand you w antto investlaterafter
settling in thecareer.
5. Y ou w antto getlifetim eprotection.
6. Y ou believethatyou cannotsavem oney w ithoutbeing forced to do so.
7. Y ou w antto leave an estate to yourfam ily afteryou.Butyou cannotpay the
prem ium safterretirem ent.Y ou areundisciplined in yoursaving habitsand you
arenotfinancially savvy.
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M O D U LE -II:TECH N ICA L A SPECTS O F IN SU RA N CE
C hapter 8
LifeInsurancePricing
Fundam entals
SEC TIO N -A
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M O D U LE -II:TECH N ICA L A SPECTS O F IN SU RA N CE
SEC TIO N A A N SW ER S
1. (c )In any insurance business,a large volum e ofresources is pooled form a large
num berofpersonsforthe benefitofthe unfortunate few .The prem ium sare decided
on thebasisoftherisk profileoftheinsured.
2. (a) The levelof accuracy of the m ortality statistics depends on the source of the
required data.The source m ay be prim ary orsecondary.O theroptionsdo nothave
any rolein determ ining theaccuracy ofthecollected data.
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M O D U LE -II:TECH N ICA L A SPECTS O F IN SU RA N CE
3. (d) A ccording to the law of large num bers,as the num ber of trials increases,the
variation ofthe resultsdecreases.Proceeding on the sam e line,ifan infinite num ber
oftrialsarem ade,theactualand expected resultsw illcoincide.
4. (e)A llthethreegiven optionscan givethem ortality rateexperienced by agroup of
people in a country and any of these three m ay be used to prepare the m ortality
statistics.
5. (e)M ortality investigations are carried outby the life insurance com panies forthe
reasons m entioned in the given options. W ith the im provem ent in m edical
technology,alow errateofm ortality isbeing experienced.
6. (c )The risk ofdeath ofthe insured increasesalong w ith hisage.A sa resultofthat,
the am ount of risk prem ium should be higher for a higher age. But this is not
convenientforthe needsofthe insured.A sa result,the conceptoflevelprem ium is
follow ed to enable the insured to pay an equalam ountofprem ium throughoutthe
term .Initialprem ium sexceed the costsofrisk thatultim ately subsidize them during
thelateryears.
7. (d)Theam ountofnetprem ium isrequired to coverjusttherisk ofoccurrenceofthe
insurable event.Life insurance is a long-term contractand prem ium s are collected
from a large num berofinsureds.Thislarge poolofresourcesisinvested in safe and
secured financialinstrum entsforitsappreciation.Benefitsoftheseappreciationsare
passed on to the policyholders up to the extentofinterestexpected to be earned in
future.
8. (e)A llthegiven threeexpensesareconsidered asprem ium related expensesasthese
vary w ith theam ountofprem ium .
9. (e) First year expenses are the expenses incurred by an insurer for procuring a
proposal,assessing therisk,decision m aking aboutunderw riting,insuranceofpolicy
docum ent,etc.M ostoftheseexpensesareonetim eexpensesand so aresignificantly
high com pared to subsequentyears.Butunderthe Insurance A ct,1938,an insurer
should notspend m orethan 90% ofprem ium earningsasfirstyearexpensesand 15%
oftherenew alprem ium .
10. (c ) Life Insurance prem ium s are decided on the basis of the rate of m ortality
experienced by agroup ofindividuals.Butvariouseventslike,occurrenceofnatural
calam itiese.g.flood,earth quake,and breaking outofepidem ic,etc.m ay lead to a
higherlevelofm ortality.Itm ay ultim ately resultin asubstantially higheram ountof
outflow from theexchequeroftheinsurer.H ence,am argin isrequired.
11. (e)H ere,allthegiven stepsareexpected to befollow ed by an insurerto keep asound
financialhealth.If the expenses (claim s settlem entas w ellas operational) of the
insurerarem orethan theearnings,theprem ium am ountsarerequired to berevised to
achieve consistency.The prem ium rates should be com patible w ith the level of
benefits.Policies ofsim ilarduration are expected to serve equitable risk profile,to
earn equalinterestand costthesam eam ountofadm inistrativecharges.
12. (e) Savings from a low er level of m ortality w ill finally lead to low er expenses
II-66
M O D U LE -II:TECH N ICA L A SPECTS O F IN SU RA N CE
tow ards claim s settlem ents and thus increases the volum e of life funds. Excess
interestearningsw illenableabetterlevelofsurpluses.Savingsfrom alow erlevelof
contingencieshelp theinsurerto facelow ervolum eofclaim sin em ergency situation
than thatw asexpected.
13. (b)D ifferentlevelsofm ortality experienced by theinsured livesism ainly dueto the
factthatthe livesto be insured are selected w ith utm ostcare againstthe inclusion of
any extra risk ofm ortality than thatofthe norm alone.Therefore,the inferiorlives
areleftbehind w hilethenorm allivesareconsidered.
14. (a) From the m ortality tables,one m ay easily find outthe probability of death or
survivalofan individualofacertain age.N aturalprem ium isobtained by m ultiplying
theam ountoffinancialbenefitsw ith thatoftheprobability asestim ated above.
15. (a)N etprem ium considersthe conceptofrisk prem ium and the expected am ountof
interest to be earned by investing the proceeds of the prem ium s. W hile office
prem ium considers the operationalexpenses required to be m ade by the insurerto
servethepolicyholdersand contingentsituations,sum ofthesetw o ischarged by the
insurerfrom anorm alinsured asinsuranceprem ium .
16. (d)O ffice prem ium consistsofprem ium related expenseslike,com m ission payable
to the agentand policy related expenses like stam p duty to be paid by the insurer,
adm inistrative expenses,etc.Butthe risk related expensesare considered aspartof
thenaturalprem ium .
17.a 18.d 19.d 20.a 21.a
SEC TIO N -B
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M O D U LE -II:TECH N ICA L A SPECTS O F IN SU RA N CE
N ET A N N U A L LEV EL PR EM IU M :
Consum ersfind itm ore convenientto pay insurance in installm entsthan netsingle
prem ium dueto largeam ountofcash required forit.
If prem ium s are paid annually,the netannuallevelprem ium (N A LP) cannotbe
determ ined by sim ply dividing thenetsingleprem ium (N SP)by thenum berofyears
overw hich the prem ium sare to be paid.Itproducesan insufficientprem ium due to
the loss ofintereston the sm alleram ounts ofinvestm entand the risk ofprem ature
deaths.So the m athem atical adjustm ent for the loss of prem ium s and interest is
accom plished by dividing the net single prem ium by the present value of a life
annuity due[PV LA D ]ofRs.1 fortheprem ium paying period.
N SP
N A LP =
PV LA D O F Rs.1 fortheprem ium paying period
The seriesofprem ium paym entsare refered to aslife annuity due.Ifitispaid in an
ordinary lifepolicy,thatiscalled aw holelifeannuity due.
Ifitispaid fortem porary period [term insurance]itiscalled tem porary life annuity
due.Even for ordinary life insurance,the sam e procedure is used exceptthatthe
calculationsareextended to theend ofthem ortality table.
G RO SS PREM IU M : The gross prem ium is determ ined by adding a loading
allow ance to the net annual level prem ium w hich includes operating expenses
[production,distribution,m aintenance],a m argin forcontingenciesand contribution
to profits.
SEC TIO N -C
(C A SE STU D IES)
1. A ssum e thatyou are asked to explain how prem ium s in a life insurance policy are
calculated.Based on thefollow ing inform ation,answ erthequestionsbelow :
a. Com pute the netsingle prem ium fora five-yearterm insurance policy in the
am ountof$1000 issued atage40.
b. Com putethenetannuallevelprem ium forthesam epolicy asin part(a)
c. Isthe netannuallevelprem ium the actualprem ium paid by the policyow ner?
Explain youransw er.
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M O D U LE -II:TECH N ICA L A SPECTS O F IN SU RA N CE
A N S.(a)
Age No.of Prob. Costof
beginning lives D ies deaths P.V. insurance
ofyear
40 9,377,225 28319 .0030 1000 .9524 2.8572
41 9,348906 30758 .0033 1000 .9070 2.9931
42 9,318,148 33173 .0035 1000 .8638 3.0233
43 9,284,975 85933 .0038 1000 .8227 3.1263
44 9,249,042 38753 .0041 1000 .7835 3,2124
15.2123
N SP
N etannuallevelprem ium =
PV LA D of$1
15.2123
= = 3.3673
4.5176
(c) The netsingle prem ium m ustbe converted into a netannuallevelprem ium ,w hich
m ustbethem athem aticalequivalentofthenetsingleprem ium .
The netsingle prem ium cannotbe determ ined by sim ply deciding the netsingle
prem ium by the no.ofyearsoverw hich the prem ium sare to be paid.Such division
w ould producean insufficientprem ium ,i.e.for2 reasosns:
(i) the netsingle prem ium based on the assum ption thatthe entire prem ium is paid in
advanceatthebeginning oftheperiod.Ifprem ium sarepaid in instalm ents,and som e
personsdieprem aturely,theinsurersuffersthelossoffutureprem ium s.
(ii) Installm entpaym ents resultin the loss of interestincom e because of the sm aller
am ountsthatareinvested.
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M O D U LE -II:TECH N ICA L A SPECTS O F IN SU RA N CE
C hapter 9
SocialSecurity Schem es
SEC TIO N -A
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M O D U LE -II:TECH N ICA L A SPECTS O F IN SU RA N CE
d. N oneoftheabove
6. TheG ram in personalaccidentpolicy doesnotcover
a. naturaldeath
b. accidentaldeath
c. disability
d. accidentalinjuries
e. noneoftheabove
7. W hich ofthefollow ing perilsarenotcovered underthehutinsurancepolicy?
a. earthquakes
b. w ar
c. terrorism
d. flood
e. noneoftheabove
8. W ho am ongstthe follow ing do notcontribute in the Em ployeesFam ily pension
schem ein India?
a. em ployer
b. em ployee
c. governm ent
d. unions
e. noneoftheabove
9. TheG ratuity A ctprovidesforpaym entto theem ployeeatthetim eof
a. retirem ent
b. resignation
c. death
d. disability
e. noneoftheabove
10. TheED LIschem ew asprim arily aim ed to protectthefam ily in caseof
a. untim ely death
b. retirem ent
c. oldage
d. disability oftheem ployee
e. noneoftheabove
11. W hich outofthefollow ing isnota SocialSecurity insuranceschem esin U S?
a. M edicare& M edicaid schem es
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M O D U LE -II:TECH N ICA L A SPECTS O F IN SU RA N CE
b. Fidelity guaranteeinsurance
c. D isability insurance
d. U nem ploym entinsurance
e. N oneoftheabove
SEC TIO N A A N SW ER S
1. (c) 2. (d) 3. (c) 4. (b) 5. (a) 6. (a)
7. (b) 8. (d) 9. (a) 10.(a) 11.(b)
SEC TIO N -B
Prem aturedeath
O ld age
Poorhealth
Inflation
Substandard w age
N aturaldisasters
* Personalfactors
Letsdiscussthem briefly:
U nem ploym ent: This is one of the vital factors that cause econom ic insecurity.
People lose theirjob due to restructuring oforganisation and technologicalchanges.
Thisresultsin:
Lossofincom e
M orepeopleareforced to go in forparttim ejobs(leading to reduced incom e)
U ncertainty aboutincom e
N o jobs
Prem ature death:Itoccursw hen the head ofthe fam ily expiresw ithoutfulfilling his
obligations.Itcouldbehischild seducation,m arriageofhissonordaughter,paym ents
ofbills,instalm ents,etc.A gain the levelofinsecurity is m ore w hen the head ofthe
fam ily has notinsured his life orhealth orhas previously saved very little.Butifa
person w ho dieshasa very little by w ay ofcom m itm entsto fulfilw ith regard to the
otherfam ily m em bers,itisnotconsidered aprem aturedeath in insuranceparlance.
O ld age:A fterthe retirem entage,people no longerhave a steady incom e and even if
they seek re-em ploym ent,they earn less.People in thiscategory often develop heath
problem sand poorhealth leadsto m oreexpenditure.Theseexpensescan befaced only
ifthereisreasonablesavingsorfinancialassetsorannuitiesand health insurance.
Poor health and disability: It can be due to illness or injury,w hich affects the
earning capacity.The inability to pursue gainfulem ploym entasa resultcan be long
term orshort-term .From thefam ily spointofview itisam ajorm edicalexpenditure.
Ifthe head ofthe fam ily is the victim ,the insecurity increases allthe m ore as the
sourceofincom eitselfisblocked.
Inflation:Ifthere isan increase in pricesw ithouta com parable increase in incom e,
inflation occurs.This is a problem especially for salaried people and pensioners.
They find itdifficultto m anagetheincreasein pricelevel.
Substandard wage: The governm entshould fix up a m inim um w age to alleviate
poverty and exploitation by the em ployer.A m inim um levelofincom e isneeded to
m eet the basic expenses. By substandard w age w e m ean w age low er than the
m inim um subsistencew agelevel.
N aturaldisasters:The m ostunavoidable are the naturaldisasters like earthquakes,
fam ines,floodsand hurricanes.They causehugelosses.N othing can bedoneaboutit
as m ost of the properties are uninsured or underinsured.The level of econom ic
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M O D U LE -II:TECH N ICA L A SPECTS O F IN SU RA N CE
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M O D U LE -II:TECH N ICA L A SPECTS O F IN SU RA N CE
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M O D U LE -II:TECH N ICA L A SPECTS O F IN SU RA N CE
SEC TIO N C
(C A SE STU D IES)
W hatistheliability oftheem ployerin thefollow ing cases?
1. A w orkm an suffered an injury by an accidentarising outofand in thecourseof
em ploym entand w as perm anently disabled.Butthe accidenthad been caused
by his w illfuldisobedience to an order issued for the purpose ofsecuring the
safety ofw orkm en.
A ns:N o,theem ployerisnotliableforany com pensation becausethelaw doesnotprovide
forw illfuldisobedienceasaground forcom pensation.H ow evertheinsurancepolicy
coverseven theinjuriesand death resulting from thenegligenceofthew orker.
2. A w orker in X Y Z Ltd.a plastics m anufacturing unit,broke his leg and w as
totally disabled for 3 m onths. W hat is the benefit under the W orkers
C om pensation law s?
A ns:A fteraone-w eek w aiting period,thedisabled w orkerw ould receivetw o-thirdsofhis
w eekly w age up to a m axim um of qualified num ber of w eeks according to the
disability.
3. A w orker lost his m entalbalance as a result of an injury by accident w hile
w orking in thefactory and com m itted suicide.
A ns:Y es,thew orkerisentitled to w orkerscom pensation becausetheinjury w ascaused to
thew orkm an in thecourseofem ploym ent.
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M O D U LE -II:TECH N ICA L A SPECTS O F IN SU RA N CE
C hapter 10
G roup Insurance
SEC TIO N A
1. Em ployeebenefitschem esareplanssponsored by
a. em ployers
b. em ployees
c. governm ent
d. noneoftheabove
2. Em ployeebenefitschem esincludebenefitscovering therisksof
a. salariesand w ages
b. prem aturedeath,disability,superannuation and unem ploym ent.
c. fringebenefits
d. noneoftheabove
3. Em ployeebenefitsarem oreclear
a. in theunorganized sector
b. in theagriculturalsector
c. in theorganized sector
d. in thesem iorganized sector
e. noneoftheabove
4. Em ployeebenefitschem esim prove
a. em ployer-em ployee relations
b. em ployeeloyalty
c. industrialrelationsclim ate
d. alloftheabove
e. noneoftheabove
5. Fortheintroduction ofa group schem ew eneed a
a. H om ogeneousgroup
b. Insured group
c. A sm allgroup ofpersons
d. A largegroup
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M O D U LE -II:TECH N ICA L A SPECTS O F IN SU RA N CE
6. The group schem e specially designed to discharge the gratuity liability ofthe
em ployeriscalled
a. G roup superannuation schem e
b. G roup gratuity insuranceschem e
c. G roup insuranceschem e
d. ED LIschem e
7. G roup superannuating schem e in conjunction w ith group insurance schem e is
taken
a. To m eetstatutory requirem ents
b. To offergroup insuranceprotection
c. To ensurethateven in thecaseofprem aturedeath,theem ployee sw idow gets
areasonablepension
d. N oneoftheabove
8. G roup savingslinked insuranceisa
a. G roup insuranceschem ew ith asurvivalbenefit
b. Schem eoffered in lieu ofED LIschem e
c. Schem eform eeting em ployer sliabilitiesunderPaym entofG ratuity A ct,1972
d. Schem eoffered by N ationalSavingsO rganisation
9. In India, m ost group insurance schem es are m arketed by the insurance
com paniesthrough
a. A gents
b. Brokers
c. D irectly by thecom pany
d. Banks
SEC TIO N -A A N SW ER S
1. a 2. b 3. c 4. d 5. a 6. b
7. c 8. a 9. c
SEC TIO N -B
1. W hatarethecharacteristicsofgroup insurance?
A ns:G roup insurance isa m eansthrough w hich a group ofpersons,w ho usually have a
business orprofessionalrelationship to the contractow ner,are provided insurance
coverageunderasinglecontract.
D istinguishing characteristics:
G roup underw riting The prem ium to be collected and m axim um sum
II-87
M O D U LE -II:TECH N ICA L A SPECTS O F IN SU RA N CE
assuredtobegrantedforagroupw illbedecidedon:1.Thenatureofthegroup.2.
The size ofthe group.3.The age distribution in the group.4.The type ofgroup
schem esoughtfor.N o individualevidenceofinsurability isusually required,and
benefitlevelscan besubstantial,w ith few ,ifany,im portantlim itations.
A num berofcontrolling factorsofgroup underw riting are:
1. H om ogenous lives - Itaim s atobtaining a group of hom ogeneous lives,to
predictthe m ortality orm orbidity rate.Itaim satcontrolling adverse selection
by individualsw ithin agiven group.
2. Theinsuranceshould beincidentalto thegroup -Thatis,them em bersofthe
group should have com e together for som e purpose other than to obtain
insurance.
3. There should be a steady flow ofpersonsthrough the group -Thatis,there
m ustbeinflux ofnew young livesinto thegroup and an outflow from thegroup
oftheolderand im paired livesto assum ethatthey arein averagehealth.
4. There should be an autom atic basisfor determ ining the am ountofbenefits
on individuallivesto avoid adverseselection.
5. C ontributory plansand non-contributory plans-Forcontributory plans[an
em ployee pays a portion ofthe prem ium ],generally atleast75 percentofthe
eligible em ployeesm ustjoin the plan ifcoverage isto be effective.In the case
ofnon-contributory plans [em ployer-pay-allplan],100 percentparticipation
is required.By covering a large proportion of a given group,the insurance
com pany gainsasafeguard againstan undueproportion ofsubstandard lives.
The use of a m aster contract The m aster contract is a detailed
docum ent setting forth the contractual relationship betw een the group
contractow nerand theinsurancecom pany.Theinsured personsunderthe
contract, usually em ployees and their beneficiaries, are not actually
parties to the contract,although they m ay enforce their rights as third-
party beneficiaries. The four-party relationship [em ployer, insurer,
em ployee,and dependents]found in a group insurance plan can create a
num ber of interesting and unusual problem s that are com m on only to
group insurance.
Low er adm inistrative cost The nature ofthe group approach perm its
the use ofm ass-distribution and m ass-adm inistration m ethodsthatafford
econom ies of operation not available in individual insurance. Sm all
proportions of com m ission, sim plified accounting techniques and
adm inistrative procedures,m inim um costof m edicalexam inations and
inspection reportsetc.help to low eradm inistrativecosts.
Flexibility in contractdesign Thegroup insuranceprogram m eusually
isan integralpartofan em ployee benefitprogram m e.In m ostcases,the
contractcan bem oulded to m eettheobjectivesofthecontractow ner,and
as long as the requests do not entail com plicated adm inistrative
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M O D U LE -II:TECH N ICA L A SPECTS O F IN SU RA N CE
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M O D U LE -II:TECH N ICA L A SPECTS O F IN SU RA N CE
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M O D U LE -II:TECH N ICA L A SPECTS O F IN SU RA N CE
SEC TIO N C
(C A SE STU D IES)
1. V asundhara is president of a consulting firm that has ten em ployees. The only
em ployee benefitprovided by the firm is a paid tw o-w eek vacation forem ployees
w ith one orm ore years ofservice.The firm s profits have substantially increased,
and V asundhara w ould like to provide som e additionalbenefits to the em ployees.
N ancy w ould likeadviceconcerning thetypesofbenefitsto provide.A ssum eyou are
an em ployee benefitsconsultant.Based on the follow ing considerations,answ erthe
follow ing questions:
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M O D U LE -II:TECH N ICA L A SPECTS O F IN SU RA N CE
Benefits
1. In the eventofdeath ofthe em ployee,the nom inee gets an assured sum w ith
accum ulated savingsand intereston thesam e.
2. O n retirem ent/resignation/term ination,only the accum ulated savings portion
w ith interestispayable.M onthly contribution ofem ployeesisexem pted under
Section 88 ofIT A ct1961.
R equirem ents
Thenum berofm em bersjoining theschem ehasto beatleast75% ofthetotalnum ber
ofem ployees.Theschem ehasto bem adecom pulsory forallthenew em ployees.
Theprem ium payableisbased on thew eighted m ean oftheagesofthem em bers.
Contribution isuniform foreach category.
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M O D U LE -II:TECH N ICA L A SPECTS O F IN SU RA N CE
C hapter 11
FinancialG erontology and
SuperA nnuating Policies
SEC TIO N -A
SEC TIO N -A A N SW ER S
1. a 2. b 3. a 4. a 5. c 6. b
7. a 8. a 9. b
SEC TIO N B
1. W hataretheproblem sofageing?
A ns:There are tw o processes in the ageing ofpopulation;one is ageing atthe base and
second ageing atthe apex ofthe population.(the form erisdue to the decline in the
fertility and latterbecauseofreduction in m ortality am ong theolderpersons.) W hen
thepopulation ages,theshareofolderpeoplein population increasesw hiletheshare
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M O D U LE -II:TECH N ICA L A SPECTS O F IN SU RA N CE
ofchildren and youth decrease resulting in a rise in the m edian age (Conception,
1996).M edian agesum m arisestheagestructureofthepopulation.
These people becom e m ore vulnerable to health problem s. This leads to
physical disabilities such as blindness, deafness and other health related
problem s.
Theneedsoftheaged areno longerm etby theyoungerm em bersofthefam ily.
Em erging changesin technology havem inim ised theroleoftheelderly people,
as their know ledge and skills are outdated. A nd nuclear fam ilies are also
grow ing atam uch fasterrate.In thissituation,w ho w illtakecareoftheelderly.
Therehasalso been avastim provem entin thefield ofm edicineand health care,
w hich hasextended thelifespan ofm any.
2. D escribe O A SIS
A ns:G overnm ent of India launched the project called O A SIS (O ld A ge Social and
Incom e Security).Thisstudy indicated thatbetw een 1991 and 2016,the population
ofold aged,i.e.60 years and above w ould increase by 107% to 113.0 m illion and
w ould continueto grow rapidly in theyear2026 to 179 m illion w hich w illbe13.3%
ofthepopulation.
3. D escribethedifferentattributesto understand theproblem sofageing
A ns:Theaged population refersto peoplew ho havecrossed atleast60 years.They arenot
ahom ogeneousgroup.A nd theattributesarealso notsim ilar.To actually understand
theproblem sofageing,thediversity m ustbeunderstood.
Som eofthecharacteristicsofaged personsaregiven below :
Sex com position:A geand sex arethebasictoolsforany dem ographicanalysis.For
elderly population itisan indication ofdifferentialm ortality thattook place during
theirlife.M alesw hen com pared to fem aleshave higherm ortality rate.Thisleadsto
sex im balance w hen they becom e old.A ccording to the Censusso far,unlike other
countries,India has m ore num berofm ales.The sam e w as also true forthe elderly
population till1991.Itisinteresting to noteaccording to U N projections,thenum ber
ofw om en population (80+)islikely to increase.
A gecom position:A lm osttw o-thirdsoftheaged population,i.e.60 to 69 isdeclining
by each decade w hile others are increasing.Butin absolute term s,population is
increasing in alm ostallagegroup categories.In 1961 therew asan increasein theage
group category of70-79 w hen com pared to othercategories.
Place ofR esidence:Itisseen thatthree outoffourelderly are found in ruralareas.
Thisisexpected sincethree-fourthsoftheIndian population livesin ruralareas.
M aritalStatus:The distribution ofm aritalstatusam ong the elderly isvital.Itisan
age w herein everyone requires a partner.Children and grandchildren tend to spend
lessand lesstim ew ith theelderly people,asthey arebusy w ith theirow n activities.A
study show s thatthe percentage ofw idow ed w om en w as m ore w hen com pared to
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M O D U LE -II:TECH N ICA L A SPECTS O F IN SU RA N CE
SEC TIO N -C
(C A SE STU D IES)
1. In our country,m ostpeople are conditioned to think thatpost-retirem entliving
m eansscaling dow n thestandard ofliving.Butin reality,thatissom ething ofam yth.
A little planning,som e forethoughtand a clearunderstanding ofoptionsm ay be all
thatisneeded to live a retired life like a prince,albeitofa sm allnation.Savingsfor
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M O D U LE -II:TECH N ICA L A SPECTS O F IN SU RA N CE
them ,the am ountofannuity installm entw illbe reduced by 50% ofthe norm al
annuity.The annuity plan forthe surviving spouse w illcontinue aslong ashe/
she survives.In case ofa deferred annuity program m e,the annuitantm ay also
prefer a cash option,if required,to w ithdraw a lum psum am ount from the
accum ulated fund.
b. N o such option should be given to the insured.Ifthe option is available,one
m ay notbe able to resistthe tem ptation ofw ithdraw ing thatm oney assoon as
any need arises,how everm inoritm ay be.This m ay also resultin em ptiness
during the very old age of the annuitantw hen allother sources of earnings
m ightdry up.In thatcase,the very econom ic purpose (to provide a regular
incom e to the annuitantduring old age)ofannuity w illnotserve itspurpose at
all.Since the basic objective has failed,no such option should be allow ed
during the lifetim e ofthe annuitant.H ow ever,considering the interestofthe
survivors (successors)ofthe annuitant,thatoption m ay be allow ed only after
thedeath oftheannuitant.
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M O D U LE -II:TECH N ICA L A SPECTS O F IN SU RA N CE
C hapter 12
A ctuarialV aluation
SEC TIO N -A
1. Lifefund isdefined as:
(a) Theprem ium balanceaccum ulated afteradding theexpenses.
(b) Theprem ium balanceaccum ulated beforeadding theexpenses.
(c) Theprem ium balanceaccum ulated afterdeducting theexpenses.
(d) Theprem ium balanceaccum ulated afterm ultiplying theexpenses.
2. Theform ula forthecalculation ofprospectivereserve:
(a) tV x = A x+t Px x+t
(b) t+1V X = A x+t Px+tax+t
(c) tV x+t= A x Px+t x+t
(d) tV x = A x+t Px+t x+t
3. V aluation surplusisdefined as:
(a) [Lifefund presentvalueoffuturepreview s]+ [presentvalueoffutureclaim s]
(b) [Lifefund + presentvalueoffuturepreview s]x [presentvalueoffutureclaim s]
(c) [Lifefund x presentvalueoffuturepreview s] [presentvalueoffutureclaim s]
(d) [Lifefund + presentvalueoffuturepreview s] [presentvalueoffutureclaim s]
4. D eath strain isdefined as:
(a) Sum insured (s)+ policy value
(b) Sum insured (s)% policy value
(c) Sum insured (s) policy value
(d) Sum insured m ultiplied by policy value
5. Expected death strain isequalto:
(a) Q x (s+v)
(b) Q x (s+v)
(c) Q x (s-v)
(d) Q x (s-v)
6. M ortality surplusisequalto:
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M O D U LE -II:TECH N ICA L A SPECTS O F IN SU RA N CE
(e) [Q x qx][S V ]
(f) [Q x S Q x V qx S + qx V ]
(g) [Q x qx][S V ]
(h) a& b
7. G iven thatA = principal;I= interest;n isno ofyears.W hatisthe form ula for
accum ulated valueof1:
(a) S = A [1+i]
(b) S= A + [1+i]n
(c) S = A [1+i]n
(d) none
8. Presentvalueisequalto (un)=
(a) 1/(1+i)
(b) 1/(1+i)n
(c) [1+i] n
(d) b & c
9. A ccum ulated valueofseriesofpaym entsissym bolized by w holepaym ent m ade
attheend ofyear:
(a) Sn+(1+i)
(b) Sn+
(c) (1+i)+ (1+i)2 + (1+i)3 + + (1+i)n
(d) b & c
10. Presentvalueofseriesofpaym entsofallim m ediateannuity:
(a) n+ (b)an+ (c)a& b (d)none
11. Theprocessofvaluation in a lifeinsurancecom pany istaken up by:
(a)A n A ctuary
(b)Chartered A ccountant
(c)A financialanalyst
(d)A surveyor
12. V aluation in lifeinsurancem eans:
(a) Theprocessofarriving attheprojectofalifeinsurancecom pany
(b) Theprocessby w hich thevalueofalltheexisting policiesisascertained in alife
insurancecom pany
(c) Theprocessofdeterm ining thenetprem ium foralifeinsurancepolicy
(d) Theprocessofarriving atthe bonus in alifeinsurancecom pany
13. Them athem aticalestim ation oftherisksinvolved in lifeinsuranceisbased on:
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M O D U LE -II:TECH N ICA L A SPECTS O F IN SU RA N CE
SEC TIO N A A N SW ER S
(1) c (2) a (3) d (4) c (5) c (6) d
(7) c (8) d (9) d (10) b (11) a (12) b
(13)a (14) d (15) b
SEC TIO N B
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M O D U LE -II:TECH N ICA L A SPECTS O F IN SU RA N CE
SEC TIO N C
(C A SE STU D IES)
1. Iam paying R s.100 yearly attheend oftheyearfrom 2006 to end of2010,atthe
rateof6% regularly,W hatisthepresentvalueoftheannuity paym ents.
Sol: G iven thatn= 5:i= 6 % ,paym entsRs.100 peryear
=> presentvalue= a5+= 100 v+100v2 + 100v3 + 100v4 + 100v5
=> a5+= 100 [v+v2+v3+v4+v5].@ 6%
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M O D U LE -II:TECH N ICA L A SPECTS O F IN SU RA N CE
II-108
DIRM
MODULE III
Chapter 1
Economics of Insurance .........................................................................................III-1
Chapter 2
Introduction to Risk Management ........................................................................III-11
Chapter 3
Essentials of Risk Management...................................................III-20
Chapter 4
Probability ............................................................................................................III-27
Chapter 5
Decision Making Under Conditions of Uncertainty ............................................III-34
Chapter 6
Risk Management Process....................................................................................III-38
Chapter 7
Risk Management by Business and Enterprise Risk Management (ERM)...........III-47
Chapter 8
Reinsurance Theory ..............................................................................................III-54
Chapter 9
Methods of Reinsurance .......................................................................................III-60
Chapter 10
Treaty Wordings ...................................................................................................III-66
Chapter 11
Reinsurance Accounts and Administration ..........................................................III-73
Chapter 12
Reinsurance Regulations ......................................................................................III-79
Chapter 13
Reinsurance Markets ............................................................................................III-86
Chapter 14
Inward Reinsurance ..............................................................................................III-96
Chapter 15
Reinsurance Practice ............................................................................................III-98
M O D U LE-III:RISK M A N A G EM EN T A N D REIN SU RA N CE
C hapter1
Econom icsofInsurance
SEC TIO N A
1. N extbestuseofresourceiscalled:
a. W isdom
b. Expected cost.
c. O pportunity cost.
d. M arginalcost.
e. N oneoftheabove.
2. Econom ic theory states that prices exactly m easure opportunity costs if all
m arketsare:
a. Com petitive
b. Im perfect
c. Perfectly com petitive
d. O pen m arkets
e. N oneoftheabove.
3. O neofthefollow ing isnotessentialforcom petitiveinsurancem arket:
a. Econom icefficiency isachieved by m arketcom petition.
b. Each firm and supplier in a com petitive m arketm akes continuous efforts to
innovate.
c. Ifthe m arketdoes notsufferfrom significantim perfections,there w illbe no
need forgovernm entregulations.
d. N ot only product and factor m arkets but also financial m arkets including
insurancem arketssufferfrom asubstantialdoseofim perfections.
e. N oneoftheabove.
4. M arketfailureiscom m only discussed in term softhesegeneralproblem s:
a. M arketstructure.
b. M arketinform ation.
c. Publicgoods.
d. A lltheabove.
e. N oneoftheabove.
III-1
M O D U LE-III:RISK M A N A G EM EN T A N D REIN SU RA N CE
c. Com petitiveadvantage.
d. A lloftheabove.
e. N oneoftheabove.
11. The tendency ofindividualsto alter their behaviour because ofthe presence of
insuranceisreferred to as:
a. Lem onsproblem .
b. Principal-A gentproblem .
c. M oralH azard problem .
d. Info-gapproblem .
e. N oneoftheabove.
12. O neofthefollow ing doesnotform partofPublicG oods;
a. Publiceducation.
b. Publicparks.
c. Fireprotection services.
d. H otelsand Restaurants.
e. N oneoftheabove.
13. O neofthefollow ing isnottrue:
a. Externalitiesoccurw hen actualcostsofproducing a good /service are greater
than accounting costs.
b. Externalities occur w hen a firm s production or an individuals consum ption
has directand uncom pensated effectson others.
c. Positiveexternality occursifothersbenefit;negativeexternality occursifcosts
areim posed on others.
d. M ost environm ental problem s involve externalities and m ost of them are a
consequenceofshifting costs.
e. N oneoftheabove.
14. W hen a failure of a financial institution leads to failures of other financial
institutionsin them arket,itisa caseof:
a. M arketfailure.
b. Cascading failure.
c. Rippleeffect.
d. O rchestrated failure.
e. N oneoftheabove.
15. O ccurrenceofrunsin India isnorm ally notpossible,becauseof:
a. Regulators.
b. M onopoly m arketstructure.
III-3
M O D U LE-III:RISK M A N A G EM EN T A N D REIN SU RA N CE
c. G overnm entintervention.
d. W eak publicresponse.
e. N oneoftheabove.
SEC TIO N -A A N SW ER S
1. c 2. c 3. e 4. d 5. a 6. c
7. d 8. c 9. d 10.b 11.c 12.d
13.e 14.b 15.b
SEC TIO N -B
III-5
M O D U LE-III:RISK M A N A G EM EN T A N D REIN SU RA N CE
III-6
M O D U LE-III:RISK M A N A G EM EN T A N D REIN SU RA N CE
III-7
M O D U LE-III:RISK M A N A G EM EN T A N D REIN SU RA N CE
environm ent) direct costs of production (input costs) do not reflect fully true
econom ic costsofproduction,because ofim position ofuncom pensated costson the
neighborhood.A stheproducerisableto shiftapartofthetrueproduction costs,costs
of production are understated,and the firm s product prices are low er than they
should truly be.A saresult,thefirm w illproduceoutputlargerthan w hatisoptim alor
socially desirable,thereby further contributing to pollution.Thus,w here negative
externalitiesarepresentin theproduction ofagood orservice,too m uch ofthegood,
orservicew illbeproduced orconsum ed,thepricew illbelow and too littleresources
and effortw illbe devoted to m itigate orelim inate the externality.In contrast,w here
positive externalities are present,too little ofthe good orservice w illbe produced,
price w illbe high in the m arketand notm uch effortand resourcesw illbe deployed
forthepurposeofenhancing thepositiveexternality.
Itis observed thatlife and health insurance industries w itness both negative and
positive externalities. O ne striking exam ple of negative externality existing in
insurance relates to fraudulent claim s m ade by insured w hich lead to higher
prem ium s for everyone.Black and Skipper cite an extrem e exam ple of negative
externality som etim es associated w ith life insurance the designated beneficiary
com m itting m urderw ith aview to collecting death claim proceeds.
SEC TIO N -C
(C A SE STU D IES)
III-9
M O D U LE-III:RISK M A N A G EM EN T A N D REIN SU RA N CE
III-10
M O D U LE-III:RISK M A N A G EM EN T A N D REIN SU RA N CE
C hapter2
Introduction to R isk M anagem ent
SEC TIO N -A
c. Society risk.
d. A & B.
e. N oneoftheabove.
11. D ynam icrisksarem oreclosely related to:
a. Purerisk
b. Speculativerisk.
c. D ynam icrisk.
d. Staticrisk.
e. N oneoftheabove.
12. R isksw hich affectthew holesociety likenaturalcatastrophesareexam plesof:
a. D ynam icrisk.
b. Fundam entalrisk
c. Particularrisk
d. N aturerisk
e. N oneoftheabove.
13. W hen thereisrobbery in H orizon Bank and itlostR s1 crore,itisa caseof:
a. Fundam entalrisk.
b. Particularrisk
c. Bank risk
d. D ynam icrisk
e. N oneoftheabove.
14. W hen there isa failure ofa system ,hum an errors,inadequate proceduresand
controls,w ecallitas .
a. O bjectiverisk.
b. O perationalrisk.
c. H um an risk.
d. System srisk.
e. N oneoftheabove.
15. Thebasisofm odern insurancetheory is:
a. Law ofLargeN um bers.
b. Theory ofProbability.
c. U tility Theory.
d. A lltheabove
e. N oneoftheabove.
III-13
M O D U LE-III:RISK M A N A G EM EN T A N D REIN SU RA N CE
SEC TIO N -A A N SW ER S
1. e 2. a 3. c 4. c 5. d 6. b
7. a 8. a 9. b 10.a 11.b 12.b
13.b 14.b 15.d
SEC TIO N -B
1. D ifferentiatebetw een R isk and U ncertainty .
A ns.W e often find the term s risk and uncertainty used interchangeably.H ow ever,a
distinction needsto be draw n betw een the tw o.Risk isoften thoughtofin term sof
chance(orprobability)ofloss.U ncertainty fallsinto tw o broad categories.Thereare
those forw hich the probability ofoccurrence iscalculable eitheron a priorigrounds
orthrough the statisticalanalysisofa seriesofsim ilareventsthathave occurred in
the past.The rem ainderdo notlend them selvesto such m easurem enteitherbecause
theiroccurrence follow s no discernable pattern orbecause they are unique events.
The im portance ofuncertainty arises from its influence on the process ofdecision-
m aking ofindividuals,businessesasalso society.
W hilerisk isastateofnature,uncertainty isastateofhum an m ind.Itistherefore
possible to considera situation risky ifa num berofoutcom es is possible and the
actualoutcom ethatm aterializesisnotknow n in advance.Thus,risk isdefined asthe
relative variation ofthe actualoutcom e from the anticipated orexpected outcom e.
Forinstance,fora m anufacturing firm ,the developm entofa new productisrisky as
the profitsfrom the sale ofthe productin the m arketare uncertain before the actual
sale.Likew ise,the developm entof a new drug by a pharm aceuticalcom pany is
characterized by risk because ofthe range ofpossible outcom es w ith regard to the
m arketreception forthedrug.
2. W hatishazard? Explain differenthazards.
A ns.A condition thatcreatesthechanceoflossorincreasesthechanceofalossisterm ed
a hazard .Threem ajortypesofhazardsareusually distinguished.
a. Physicalhazard
b. M oralhazard and
c. M oralehazard
Physicalhazard:A physicalcondition thatheightens the chance of loss is called
physicalhazard.A large num berofexam plesofphysicalhazard from ourdaily life
can be cited,such asdefective electricalw iring in a cinem a hallw hich increasesthe
chance offire,bad and poorly m aintained roads thatincrease the chance ofm otor
accidents and defective locking system on the m ain door of an apartm ent that
increasesthechanceoftheft.
M oralH azard :M oralhazard isacondition characterized by defectsin thecharacter
ofan individualsuch asdishonesty thatincreasesthefrequency oflossorseverity of
loss orboth.M oralhazard is a com m on occurrence in insurance and is noteasy to
III-14
M O D U LE-III:RISK M A N A G EM EN T A N D REIN SU RA N CE
III-17
M O D U LE-III:RISK M A N A G EM EN T A N D REIN SU RA N CE
SEC TIO N -C
(C A SE STU D IES)
III-19
M O D U LE-III:RISK M A N A G EM EN T A N D REIN SU RA N CE
C hapter3
EssentialsofR isk M anagem ent
SEC TIO N -A
III-20
M O D U LE-III:RISK M A N A G EM EN T A N D REIN SU RA N CE
d. A nalysisoffinancialstatem ent.
e. N oneoftheabove.
5. A ccording to R ejda, A ccountsR eceivables ,can beclassified as;
a. Property lossexposure.
b. Liability lossexposure.
c. Businessincom elossexposure.
d. Crim elossexposure.
e. N oneoftheabove.
6. A ccording to R ejda, K idnapping ofkey personnel ,can beclassified as;
a. Foreign Lossexposure
b. Crim eLossexposure.
c. H um an ResourcesLossexposure.
d. BusinessIncom elossexposure.
e. N oneoftheabove.
7. O neofthefollow ing isnottrue.
a. Frequency oflossrelatesto the probable num berofparticularlossesthatm ay
occurduring som egiven period oftim e.
b. Severity ofloss refers to the probable m agnitude oflosses thatm ay occur,if
they occur.
c. A loss potentialthatis sm alleven though frequent,is m uch less im portantas
com pared to potentiallossexposuresthatare infrequentbuthasa potentialfor
bankruptcy.
d. Both frequency and severity have to be considered in the risk m anagem ent
process.
e. N oneoftheabove.
8. O neofthefollow ing isnota techniquefortreating lossexposures:
a. H edging.
b. Risk Financing.
c. Risk retention.
d. Insurance.
e. N oneoftheabove.
9. O neofthefollow ing isnottrue:
a. Com m ercialinsurance is a technique of transferring risk from one party to
anotherforaprice.
b. O necan com binealargenum berofindependentexposureunitsin oneportfolio;
an insurancecom pany isableto reducetherisk ofitsaggregatelosses.
c. Firm sthatenterinto contractsto supply goodsatafixed pricein thefutureface
III-21
M O D U LE-III:RISK M A N A G EM EN T A N D REIN SU RA N CE
the risk thata rise in pricesbetw een entering into the contractand the delivery
datem ay involvethem in aloss.
d. Retention refersto thefinancing oflossesinternally.
e. N oneoftheabove.
10. Insuranceissuggested in thefollow ing case:
a. Frequency ofloss low and severity ofloss low
b. Frequency ofloss high and severity ofloss low
c. Frequency ofloss low and severity ofhigh low
d. Frequency ofloss high and severity ofloss high
e. N oneoftheabove.
SEC TIO N -A -A N SW ER S
1. a. 2. d 3. d. 4. e. 5. a. 6. a.
7. e 8. e. 9. e. 10.c.
SEC TIO N -B
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M O D U LE-III:RISK M A N A G EM EN T A N D REIN SU RA N CE
III-23
M O D U LE-III:RISK M A N A G EM EN T A N D REIN SU RA N CE
III-24
M O D U LE-III:RISK M A N A G EM EN T A N D REIN SU RA N CE
SEC TIO N -C
(C A SE STU D IES)
You aretheRisk M anagerforalargem ultinationalenterpriseinvolved in them anufacture
of products through a hazardous process prone to pollute.Your m ain operations are in
Finland, a country know n for its rigorous and costly pollution, m anufacturing and
em ployeesafety standards.M oreover,Finnish w orkersarehighly paid by w orld standards.
O ne ofyourem ployeeshassuggested the relocation ofthe m osthazardousaspectsofthe
m anufacturing processto adeveloping country in A frica.Theem ployeearguesthatsuch a
m ovew ould besound risk m anagem entbecausethecostsofcom pliancew ould below erin
the A frican country,w hich haslessrigorouspollution,m anufacturing,and w orkersafety
law s.M oreover,because w orker w ages w ould be low er,the costs of w orker disability
paym entsand otherjob-related injuriesand illnessesw ould be less.Finally,the em ployee
notesthatunem ploym entisram pantintheA fricancountry,andthegovernm entandpeople
w ould w elcom etheopportunity to w ork forthecom pany.
A stheRisk M anageroftheM ultinational,yourgoalisto m inim izevolatility in corporate
cash flow and to do so atthelow estcostconsistentw ith ethicalbehaviour.Ifyou m aintain
the hazardous operations in Finland,costs w illrem ain high.Ifyou relocate them to the
developing country,costsw illdecreaseand peoplew illhavem orejobs.
W hatisyourrecom m endation? D iscuss.
A ns.Them anagem entofrisk isaprocessw ith theobjectiveofidentifying risk exposures
III-25
M O D U LE-III:RISK M A N A G EM EN T A N D REIN SU RA N CE
III-26
M O D U LE-III:RISK M A N A G EM EN T A N D REIN SU RA N CE
C hapter4
Probability
SEC TIO N -A
1. Probability can takevalues
(a) - to
(b) - to 1
(c) -1 to 1
(d) 0 to 1
2. Probability can expressed as:
(a) ratio
(b) Proportion
(c) percentage
(d) alltheabove
3. W hen rolling a dietheprobability that3 occursisequalto
(a) 1/2
(b) 1/3
(c) 1/6
(d) 1/5
4. M ean isa m easureof
(a) location (centralvalue)
(b) dispersion
(c) correlation
(d) none
5. W hich ofthefollow ing ism easureofcentralvalue
(a) M edian
(b) Standard deviation
(c) M ean deviation
(d) Q uartiledeviation
III-27
M O D U LE-III:RISK M A N A G EM EN T A N D REIN SU RA N CE
(b)
(c)
(d)
(b)
(c)
(d)
(a) =
(b) =
(c) =
(d) =
III-28
M O D U LE-III:RISK M A N A G EM EN T A N D REIN SU RA N CE
(a) =
(b) =
(c) =
(b) x =
III-29
M O D U LE-III:RISK M A N A G EM EN T A N D REIN SU RA N CE
SEC TIO N -A A N SW ER S
1. (d) 2. (d) 3. (c) 4. (a) 5. (a) 6. (c)
7. (a) 8. (c) 9. (d) 10.(a) 11.(b) 12.(c)
13.(d) 14.(b) 15.(c)
SEC TIO N -B
1. G ivebriefly theconceptofprobability?
2. W hatarethestepsincluded in thecalculation ofstandard deviation?
3. Find m ean,m edian,& m odeforthefollow ing data
42,53,71,63,82,91,48,53,67,98,53
4. W rite briefly about theoretical probability distributions w hich are used in risk
m anagem ent?
A N SW ER S
1. There are no.ofeventsin day to day life aboutw hich one isnotsure w hetheritw ill
occur (or) not. But one is alw ays curious to know w hat chance is there for a
happening (or) event to occur. For instance, one m ay be interested to estim ate
w hetheritw illrain today ornot.O ne w ould like to evaluate thischance ofw inning
forhead in a definite no.oftosses.W hatisthe chance thatthere are fouracesin one
hand in agam eofcardsam ong fourplays,etc.i.e.thenum ericalevoluation ofchance
factorofan eventisknow n asprobability.
2. (i) Find them ean
(ii) Subtractthem ean from each individualvalue
(iii) Squaretheindividualdifferencesfrom them ean
(iv) Totalthesquareofdifferences
(v) Thesum ofthesquared deviation isdivided by thetotalno.ofm easurem ents
(vi) Theresulting num beristhem ean ofthesquared deviation,i.e.variance
(vii) Standard deviation isobtained by taking thesquarerootofthevariance
3. M ean (x ) = xi
n
42+53+71+63+82+91+48+53+67+98+53
=x
11
721
= = 65.55
11
M edian = A rrangein increasing ordecreasing orderand in w hich m id valueism edian
= x M edian = 42,48,53,53,53 63,67,71,82,91,98
= 63
III-30
M O D U LE-III:RISK M A N A G EM EN T A N D REIN SU RA N CE
O
m ean x
III-31
M O D U LE-III:RISK M A N A G EM EN T A N D REIN SU RA N CE
SEC TIO N -C
(C A SE STU D IES)
1. In acultivating land,thelossoccurrenceyearly,in rupees,and theprobability ofloss
occurrence also are given.Find the m ean am ountoflossand expected value ofloss
for5 years.
A N SW ER S
1. A ns.
Year Lossin Probability Am ount (lossx
rupees ofloss ofloss Prob.ofloss)
1 6 lakhs 0.05 0.3 0.3
2 28 lakhs 0.18 5.04
3 30 lakhs 0.28 8.4
4 15 lakhs 0.35 5.25
5 58 lakhs 0.14 8.12
137 lakhs 1 27.11
M ean am ountofloss= =
III-32
M O D U LE-III:RISK M A N A G EM EN T A N D REIN SU RA N CE
2. A ns.
D eviation Squared
Scores M ean score from m ean score deviation
27 55.2 -28.2 795.24
53 55.2 -2.2 4.84
48 55.2 -7.2 51.84
98 55.2 42.8 1331.84
61 55.2 5.8 33.64
52 55.2 -3.2 10.24
72 55.2 16.8 282.24
40 55.2 -15.2 231.04
20 55.2 -35.2 1239.04
81 55.2 25.8 665.64
552 0 5145.6
M ean score: =
variance( )= =
S.D .( )= = 22.68
III-33
M O D U LE-III:RISK M A N A G EM EN T A N D REIN SU RA N CE
C hapter5
D ecision M aking U nder
C onditionsofU ncertainty
SEC TIO N -A
III-34
M O D U LE-III:RISK M A N A G EM EN T A N D REIN SU RA N CE
a. current
b. futureexpected
c. pre-existing
d. noneoftheabove.
6. W hatistheform ula forexpected valueofan event?
a. EV = PiX i
b. EU = PiU (X i)
c. Pi X i
d. N one
7. G iven thatP1 = 0.25,P2 = 0.55,P3 = 0.20 and X 1 =15,000 ,X 2 =20,000 and X 3 =
8,000 respectively,w hatistheexpected valueoftheabovevalues?
a. 17,350
b. 18,750
c. 16,350
d. noneoftheabove
8. Iftheindividualisrisk neutral:
a. helikesrisk
b. hedislikesrisk
c. heisneitheraverseto risk nordoeshelikerisk
d. noneoftheabove
SEC TIO N -A A N SW ER S
1. d 2. b 3. c 4. d 5. c 6. a
7. c 8. c
SEC TIO N -B
1. W hatisexpected utility rulein insurance?
2. N am ethevariouseconom ictheoriesofconsum ption and briefly explain.
3. D escribebehaviouralpattern ofhum an shortcom ingsaccording to D anielK ahnem an
andA m osTversky?
4. W hatisthe endow m enteffect according to behaviouraleconom ists?
5. N am ethetw o characteristicsofutility function forarisk averseindividualexhibit?
A N SW ER S
1. The application of the expected utility rule relates to individuals choice am ong
investm entalternatives.The sam e rule is also applicable to determ ine w hether an
III-35
M O D U LE-III:RISK M A N A G EM EN T A N D REIN SU RA N CE
SEC TIO N -C
(C A SE STU D Y )
If you invested sum of m oney 2,00,000 in a private bank thatw illearn 20% on your
investm entforoneyearw ith probability of0.35 and alossof15% w ith probability of0.65,
w hatisyourexpected utility?
III-36
M O D U LE-III:RISK M A N A G EM EN T A N D REIN SU RA N CE
A N SW ER S
G iven thatC = 2,00,000
Earn 20% w ith probability -0.35
Loss15% w ith probability -0.65
theexpected utility = Pi U (X i)
earn = 2,00,000 X 0.20 = 40,000
loss= 2,00,000 X 0.15 = 30,0000
(X i)= 2,00,000 + 40,000 = 2,40,000
(X 2)= 2,00,000 -30,0000 = 1,70,0000
E.U = 0.35 X U (2,40,000)+ 0.65 X U (1,70,000)
= 0.35 X ln (2,40,000)+0.65 X ln (1,70,000)
= 4.3359 + 7.8283
= 12.1642
III-37
M O D U LE-III:RISK M A N A G EM EN T A N D REIN SU RA N CE
C hapter6
R isk M anagem entProcess
SEC TIO N -A
1. Thejob ofrisk m anagem entcan bebroken dow n into follow ing elem ent/s.
a. RiskA ssessm ent
b. Risk Control.
c. Risk Financing
d. A lloftheabove
e. N oneoftheabove.
2. com prisesofidentification and analysisofpotentiallossexposures
a. Risk Control
b. RiskD ynam ics
c. RiskA ssessm ent
d. Risk Initiation.
e. N oneoftheabove.
3. M aking useofa m atrix plotting in lossfrequency and lossseverity,isknow n as
a. RiskA nalysis
b. Risk G rid
c. Risk M apping
d. Risk Convergence
e. N oneoftheabove.
4. Lossfrequency can becategorized underthis/thesehead /s.
a. Rare LossEventsuch asa personshouse located in an earthquake zone thatis
likely to sufferlossrarely
b. LossEventthatoccursoccasionally likeadam ageto aperson scar
c. FrequentLossEventsuch asm ild illness
d. A lloftheabove
e. N oneoftheabove.
5. O neofthefollow ing isnottrue:
a. Financialconsequencesofrelatively cheap utensilofafam ily m ay bequitelow.
III-38
M O D U LE-III:RISK M A N A G EM EN T A N D REIN SU RA N CE
c. LossReduction
d. LossU nderstanding.
e. N oneoftheabove.
11. Individualsinvesting in equity sharesand m utualfundsfor purposesofw ealth
accum ulation and retirem entneedsare invariably subjectto investm entrisk.A
risk reduction techniquethatisappropriateform itigating theinvestm entrisk is
portfolio diversification.Itis
a. LossPrevention.
b. LossAvoidance
c. LossReduction
d. LossU nderstanding.
e. N oneoftheabove.
12. Individuals m ight have got num erous risk-financing options w hich, m ay
how everbeclassified as
a. N oneofthese.
b. Risk Retention.
c. Risk Sharing
d. Risk Transfer
e. A lloftheabove.
13. O neofthefollow ing isnota form ofrisk transfer:
a. H oldH arm lessA greem ents
b. Incorporation.
c. Partnership
d. Insurance
e. N oneoftheabove.
14. A num ber of factor/s is /are considered by individuals before m aking risk-
financing decisions.
a. Expected cost
b. Financialposition
c. D egreeofrisk aversion
d. A lloftheabove
e. N oneoftheabove.
15. A house ow ner includes in the lease agreem ent a clause m aking the tenant
responsibleforallinjuriestheguestsm ay sufferw hileon theleased prem ises.It
is .form ofrisk transfer.
a. H edging
III-40
M O D U LE-III:RISK M A N A G EM EN T A N D REIN SU RA N CE
b. Insurance
c. H oldH arm lessA greem ent
d. D iversification
e. N oneoftheabove.
SEC TIO N -A A N SW ER S
1. d. 2. c. 3. c. 4. d. 5. e. 6. d
7. d 8. d. 9. b. 10.a. 11.c. 12.e.
13.c. 14.d. 15.c.
SEC TIO N -B
1. O utlinetheprocessofR isk A ssessm ent.
A ns.The first step in the process of risk m anagem ent by individuals,businesses and
society is the assessm ent of risk. Risk assessm ent com prises identification and
analysis of potential loss exposures. Such assessm ent has to be continuous and
com prehensive.Individualsasw ellastheirenvironm entare notstatic butdynam ic
and do change,and so risk assessm enthasto be an ongoing activity.A person srisk
profile undergoes significant change w hen he or she m arries and has children.
Likew ise,a person sinventory ofassetsgrow sw ith fresh acquisition ofassetsover
tim e and,as a result,his property risk profile changes overhis life tim e.The legal
environm enta person faces is altered by enactm entofnew statutes and changes in
case law.Because ofthese and otherchanges,individualsw illhave to continuously
and suitably adjusttheirrisk m anagem entefforts.
A business organization s exposure to loss is now m anaged by using a new risk
m anagem enttechnique called risk m apping m aking use ofa m atrix plotting in loss
frequency and loss severity.The risk m apping technique m ightnotbe particularly
usefulform anaging risk exposuresofindividualsand fam ilies.H ow ever,itm ightbe
instructiveto understand thetechniquew ith aview to applying itw hilediscussing the
techniques of risk control and risk financing for individuals and fam ilies. Loss
frequency m easures the likelihood of occurrence of a loss eventand loss severity
indicatesthepotentialfinancialim plication oftheevent.
2. W hatarethetechniquesofrisk controlavailableforindividualsand others?
A ns.The techniques of risk control available for individuals and others are classified
underthreeheads:
a. LossAvoidance
b. LossPrevention,and
c. Lossreduction
(i) LossAvoidance:
By refraining to expose oneselfto certain types oflosses,one can avoid loss.
III-41
M O D U LE-III:RISK M A N A G EM EN T A N D REIN SU RA N CE
SEC TIO N -C
(C A SE STU D IES)
D as and A ssociates is a m anagem entconsulting firm w ith headquarters atM um baiand
operationsspread alloverthe country.The com pany w asform ed in 2000 by itsprom oter
directorA nup D as.D aspresently m aintains150 consultantsand 100 em ployeesw orking in
supporting roles.The firm has developed a reputation for being especially helpful in
solving personneland financialm anagem entproblem s.A sD asand hism anagem entteam
plan forthefuture,they w antto bevery system aticin identifying key issues,opportunities,
and potentialproblem sthatm ay confrontthecom pany in theyearsahead.
O ne area thathasnotreceived m uch attention to date isthatofpure risk exposures.Thus,
D as has recently assigned one of his top consultants to take on the responsibility for
identifying allofthe potentialrisks confronting his firm .A fterthe exposures have been
identified,D asw antsto know therelativeim portanceofeach one.Forexam ple,istherisk
oflossdueto firepotentially m oredam aging than therisk ofadverseliability judgm ents?
W hatlossesare m ostlikely to happen in a given year,and how m uch w ould probably be
lostin each case?Can consistency beexpected from oneyearto thenext?D asbelievesthat
itisim possible to m ake good risk m anagem entdecisionsw ithoutfirsthaving answ ersto
theseand sim ilarquestions.D iscuss.
A ns.H um an nature isfundam entally adolescent(e.g., bad thingsw on thappen to m e )
and short-sighted (e.g.,tends tow ard im m ediate gratification instead of long-term
gratification).D isasterpreparation and m ostothercom ponentsofrisk m anagem ent
require leadership that is m ature (e.g., bad things happen all the tim e and can
happen to m e as easily as to anyone else) and far-sighted (e.g., able to delay
gratification and m ake long-term investm ents for a greater good). To achieve
m aturity and far-sightedness,m any thingsarerequired overm any years.K ey am ong
thosethingsareacadem iceducation and lifeexperiencethatincludetheform ation of
positive values, ethics, and know ledge of the political, econom ic, and business
conditionsm ostlikely to producepositiveresultsfrom hum an nature.
The first step in the process of risk m anagem ent by individuals,businesses and
society is the assessm ent of risk. Risk assessm ent com prises identification and
analysis of potential loss exposures. Such assessm ent has to be continuous and
com prehensive. A s individuals as w ell as their environm ent are not static but
dynam ic and do change,risk assessm enthas to be an ongoing activity.A business
III-45
M O D U LE-III:RISK M A N A G EM EN T A N D REIN SU RA N CE
organizations exposures to loss is now m anaged by using a new risk m anagem ent
technique called risk m apping m aking use ofa m atrix plotting in lossfrequency and
lossseverity.
The second step in the risk m anagem entprocess is to controlthe risk by selecting
thosetechniquesthatw illreducethefrequency oflossand reducetheseverity ofloss.
Beforedeciding upon thespecificrisk controlm easureto beadopted itisnecessary to
conducta cost-benefitexercise.Thatis an evaluation ofthe expected benefits and
costsinvolved to determ inew hetherthedecision taken iseconom ically sound ornot.
D espiteone sbestefforts,lossexposurescan neverbeelim inated;onehasto think of
financing losses,w hen losseshappen.The question ofsourcesoffundsforrepairing
lossesisaddressed to techniquesoflossfinancing.Lossfinancing (and the various
sourcesoffundsavailable forthispurpose)isrequired to repairorreplace dam aged
property,to m eetexpensesinvolved in legaldefence and any advance judgm entsor
aw ard in casesoflegalliability,to pay m edicalbillsand otherhealth care expenses
and to replacelostw agesand taking careofthefinancialconsequencesofprem ature
death orlossoflife.
W hileoneend oftherisk-financing continuum ,isrisk retention,theotherend ofthe
continuum is risk transfer.In risk transfer,the financialim pactofloss is shifted to
anotherparty.Risk transferinvolvesagreem entby thetransfereeto assum ethelossor
risk thatthetransferorisdesirousofescaping.Theprocessofrisk transferinvolvesa
paym entby thetransferorto therisk bearerortransferee.Itisnorm ally donethrough
insurance.
Basing on the above analysis the consultants need to look atalldim ensions and
estim ateprobablecausesofrisks,how to m anagethem ,and how to fund them in case
itreally occurs.
III-46
M O D U LE-III:RISK M A N A G EM EN T A N D REIN SU RA N CE
C hapter7
R isk M anagem entby Businesses
and EnterpriseR isk M anagem ent(ER M )
SEC TIO N -A
III-47
M O D U LE-III:RISK M A N A G EM EN T A N D REIN SU RA N CE
III-49
M O D U LE-III:RISK M A N A G EM EN T A N D REIN SU RA N CE
SEC TIO N -A A N SW ER S
1. e 2. e 3. d 4. e 5. c 6. d
7. e 8. d 9. e 10.b 11.d 12.c
13.a 14.a 15.a
SEC TIO N -B
III-51
M O D U LE-III:RISK M A N A G EM EN T A N D REIN SU RA N CE
Finite risk insurance. U nlike traditional insurance contracts w hich are based on
spreading acrossa poolofsim ilarrisk exposures,finite risk insurance contractsare
risk transfercontractsbased on theconceptofspreading risk overtim e.In thistypeof
contracts,the insured transfers lim ited extentof risk.The m ain objective of such
contractsissm oothing thelossesduring thecontractperiod.
M ulti-live/m ulti-yearinsurance contracts generally com bine a num berofrisks and
the policy period extends overm ultiple years.The risks thatare com bined m ay be
pure riskssuch asproperty,liability and auto risksorcom bination ofpure risksw ith
financialrisks.
M ultiple Triggercontractspoolrisksw hich togethercould seriously affectthevalue
ofthe firm .Forthe shareholders ofa com pany,the effectofthe risk on the firm s
earnings is im portant,not the source of the risk.M ulti-trigger policies generally
com bine a pure risk w ith a financialrisk.The policy is "triggered" and paym entis
effected only,w hen therisky eventin each category occurs.Forexam ple,an electric
pow ergeneration com pany m ightbuy a policy thatis"triggered"ifone ofthe firm s
pow ergeneration plantsbreaksdow n (thefirstrisk),during aperiod w hen thepow er
ratesarem arked by considerablevolatility (thesecond risk).
SEC TIO N -C
(C A SE STU D IES)
The globaleconom y has becom e a reality for m any firm s.A s internationaloperations
expand,itisim portantform anagem entto recognize thatthe sam e risk m ay resultin very
differentestim atesforthem axim um probablelossand m axim um possiblelossin different
countries.W ith differing lossfrequency and severity estim ates,the m ostappropriate risk
m anagem enttechniquesare also likely to vary from country to country.Severalexam ples
illustratethispoint.
In the U nited States,risk m anagersoften concentrate m uch tim e and effortin identifying,
evaluating and m anaging liability exposures.H ow ever,the restof the w orld is notas
litigious,thusm aking liability lossesoutside ofthe U nited Stateslessproblem atical.The
analysisofpotentialproperty lossesm ay also vary.Forinstance,the proliferation ofvery
old buildingsthrough outEurope presentsunique problem s.In Pacific Rim countries,the
potentialfor catastrophic loss due to typhoons or other w indstorm s is very real.Risk
evaluation in countries experiencing frequentcurrency devaluation (such as Brazil)can
also bechallenging,becauseproperty valuationsbecom eobsoleteso quickly.
Risks of loss due to crim e also vary considerably from one country to the next.For
exam ple,in Eastern Europe and the form er SovietU nion,deficiencies in the com puter
infrastructurem akesitnearly im possibleto track stolen vehiclesin thesam ew ay thatitis
possiblein m ostW estern countries.A nd therisk oflossto em ployeesdueto kidnapping or
otherviolenceisw ellknow n in m any Latin A m erican countries.O ften,thedynam icrisk of
political unrest m erely exacerbates such problem s, m aking the risk m anagers job
continually challenging.
III-52
M O D U LE-III:RISK M A N A G EM EN T A N D REIN SU RA N CE
D iscuss the challenges of Risk M anagers in the lightof changing globalscenario and
EnterpriseRisk M anagem entpractices.
A ns.The optim alRM D epartm entreporting structure is difficultto define and can vary
w ith thesizeand scopeofthebusinessoperation.W hileIagreein general,thew rong
reporting relationship can certainly underm inetheRM departm entseffectiveness.In
sm allerorganizations,theRM m ay need to reportto thepresidentorow ner,because
as w as said, every silo of an organization is touched by risk m anagem ent and
therefore there exists the potentialforspecialinterests and conflicts by individual
departm ents. Risk m anagem ent affects the overall business operations, therefore
having itreportthrough H R,treasury,finance,orthegeneralcounselisin m ostcases
aform ulaforfailure.
Risk m anagerm ust,above all,be a tough-m inded individualable to com m unicate
because the task athand is,in large part,selling the conceptofrisk m anagem entto
V P-levelpeers.The V Psare paid to grow revenue,w hile the risk m anagerispaid to
prevent/lim it loss.There is a healthy tension here w hich,in the end,serves the
organization best.Ifthe risk m anagerisnotgetting results,then find a risk m anager
tough enough forthejob.Investing m oreauthority in an essentially w eak playerw ill
only fosterthew rong kind ofstressw ithin theorganization,and m akelifeeven m ore
difficultfortherisk m anager.
Businessenterprisesface a num beroftypesofrisks-som e called pure riskssuch as
property and liability risksand som eotherrisksthatarecalled financialriskssuch as
interestraterisk,foreign exchangerisk and com m odity pricerisk.Theform erthatis
pure risksare often insurable and are characterized by only a dow nside potential,
i.e. chance of loss. Insurable risks can be m anaged by insuring them . The
com partm entalization ofrisk m anagem entactivitiesw ithin afirm m ay beillustrated:
pure orhazard risk ism anaged by the traditionalrisk m anager;creditand m onetary
risk is handled by the corporate treasurer; m arketing and public relationship
personnelfocuson reputationalrisks;Forhandling operationaland com m odity risk,
strategic business units develop appropriate controls. N ew financial products
futures, options, sw aps and other derivative contracts are used for m anaging
financialrisks,such asinterestrate risk,com m odity price risk and foreign exchange
risk.
D uring the lastdecade or so,there is a proliferation of a num ber of tools of risk
transfer,(asan alternative to insurance).Itistrue thatthey have notbecom e w idely
used.They include creation ofcaptive insurance com panies,finite risk orfinancial
insurance,m ulti-line/m ulti-year insurance,m ulti-trigger policies and securitization
techniques.
A m ong the risk m anagem entinstrum ents com m only used by enterprises,hedging
tools orinsurance are the m ostim portant.These devices perm itthe party holding
som erisky assetto transferthatrisk to another,called counter-party.Theassetvalue
can be separate from risk and the lattersold separately fora price.Risk is a traded
com m odity and issold in them arketforrisk.
III-53
M O D U LE-III:RISK M A N A G EM EN T A N D REIN SU RA N CE
C hapter8
R einsuranceTheory
SEC TIO N -A
a. Stabilizing oflossexperience.
b. M inim izing theeffectsofcatastrophe.
c. Increasing thecapacity.
d. A lloftheabove
e. N oneoftheabove.
6. The process of reinsuring all losses for an entire class,territory or book of
businessisknow n as
a. CatastropheReinsurance
b. D isasterinsurance
c. Portfolio Reinsurance
d. Large-linecapacity
e. N oneoftheabove.
7. A tlaw,the policy holdersdo nothave directaccessto the reinsurers.H ow ever,
thereisan exception and itis
a. Provision ofSubrogation
b. Cut-through Endorsem ent
c. Pre-em ptiveClause
d. A lloftheabove
e. N oneoftheabove.
8. R einsurance contractunder w hich the ceding com pany has the option to cede
and reinsurer has the option to accept a risk of a specific business line is
called .
a. FacultativeReinsurance
b. Treaty Reinsurance
c. ProporionalReinsurance
d. O ptionalReinsurance
e. N oneoftheabove.
9. W hatdoesthew ord " treaty" m ean in Treaty R einsurance
a. A n agreem entbetw een tw o parties
b. Bulk Insurancepolicy
c. SingleInsurancepolicy
d. Ceding
e. N oneoftheabove
10. U nderthistheprim ary insurercedesa fixed,predeterm ined percentageofevery
risk to thereinsurerw ithin theclassorclassessubjectto thetreaty.
a. SurplusShareTreaty
b. ExcessofLossTreaty
III-55
M O D U LE-III:RISK M A N A G EM EN T A N D REIN SU RA N CE
c. Q uotaShareTreaty
d. Stop LossTreaty
e. N oneoftheabove.
11. In surplusreinsurance,theretained businessiscalled
a. M argin
b. Line
c. Treaty
d. LossRatio
e. N oneoftheabove
12. The form ofexcessoflossreinsurance w hich indem nifiesthe reinsured against
the am ount by w hich the reinsured losses incurred during a specific period
exceed eitheran agreed am ountoragreed percentageiscalled
a. Stop-LossReinsurance
b. ExcessofLossreinsurance
c. Q uotaShareReinsurance
d. ProportionalReinsurance
e. N oneoftheabove.
13. Thisisthesim ilarity betw een insuranceand reinsurance
a. Liability ofreinsurersisseveraland notjoint
b. Principleofutm ostgood faith
c. PrincipleofIndem nity
d. Both B & C
e. BothA & B
14. The sum ofallindividuallossesdirectly occasioned by any one disaster,accident
orlossorseriesofdisastersarisingoutofoneevent,w hich occursw ithin oneState.
a. CatastropheLoss
b. D isastersyndrom e
c. LossO ccurrence
d. H urricaneclause
e. N oneoftheabove.
15. Theprim ary insurersendsa reportofreinsured businessevery m onth /quarter
know n asbordereauxto reinsurer.Such bordereauxcontains
a. Prem ium details.
b. D etailsofpolicies
c. D etailsofclaim s
d. A & B
e. A ,B & C.
III-56
M O D U LE-III:RISK M A N A G EM EN T A N D REIN SU RA N CE
SEC TIO N -A A N SW ER S
1. d 2. c 3. e 4. c 5. d. 6. c
7. b 8. a 9. a 10.c 11.b. 12.a
13.d 14.c 15.d
SEC TIO N -B
III-57
M O D U LE-III:RISK M A N A G EM EN T A N D REIN SU RA N CE
SEC TIO N -C
(C A SE STU D IES)
1. N ew Starinsurance com pany has purchased from M um Re Reinsurance com pany a
Q uota Share Treaty w ith a Rs 250,000 lim itand a retention of 25 percentand a
cessionof75percent.N ew Starhasw rittenthreepolicies.PolicyA insuresbuildingA
forRs10,000 foraprem ium ofRs100,w ith onelossofRs8000.
Policy B insuresbuilding B forRs100,000 foraprem ium ofRs.1000,w ith oneloss
ofRs10,000.Policy C insuresbuilding C forRs150,000 foraprem ium ofRs1500,
w ith onelossofRs60,000.
RahulK hanna,the new Reinsurance M anager,feels thatSurplus Share Treaty is
betterthan Q uota Share Treaty asitw illbe lim iting the claim exposure ofN ew Star
Insuranceand thereism oreliability in thecourtofM um Re.A ssum ing thatN ew Star
haspurchased aSurplusShareTreaty w ith aretention ofRs25,000 and alim itofRs
250,000 (a ten-line surplus treaty),show your calculations under tw o reinsurance
arrangem ents.
III-58
M O D U LE-III:RISK M A N A G EM EN T A N D REIN SU RA N CE
SO LU TIO N :
Q U O TA SH A R E TR EATY
D ivision ofInsurance,Prem ium and Losses
New Star M um Re Total
Rs Insurance(25% ) (75% )
PolicyA
Insurance 2500 7500 10,000
Prem ium 25 75 100
Loss 2000 6000 8,000
PolicyB
Insurance 25,000 75,000 100,000
Prem ium 250 750 1000
Loss2500 7500 10,000
PolicyC
Insurance 37,500 112,500 150,000
Prem ium 375 1125 1500
Loss 15000 45000 60,000
SU R PLU S SH A R E TR EATY
D ivision ofInsurance,Prem ium and LossesR etention
R s.25,000 and Lim itR s.250,000
New Star M um Re Total
Rs Insurance(% ) (% )
PolicyA
Insurance 10,000(100% ) 0 (0% ) 10,000
Prem ium 100 0 100
Loss 8000 0 8,000
PolicyB
Insurance 25,000 (25% ) 75,000(75% ) 100,000
Prem ium 250 750 1000
Loss 2500 7500 10,000
PolicyC
Insurance 25,000(16.67% ) 125,000(83.33% ) 150,000
Prem ium 250 1250 1500
Loss 10,000 50,000 60,000
III-59
M O D U LE-III:RISK M A N A G EM EN T A N D REIN SU RA N CE
C hapter9
M ethodsofR einsurance
SEC TIO N -A
5. U nder this agreem ent the reinsurer indem nifies the reinsured against the
am ountby w hich thereinsured lossincurred during a particularperiod exceeds
eitheran agreed am ountoran agreed percentageorsom eotherpercentage.
a. ExcessofLossTreaty
b. Stop LossReinsurance
c. Q uotaShareTreaty
d. SurplusTreaty
e. N oneoftheabove.
6. The reinsurance in w hich the reinsurance lim it and the reinsurers loss lim it
apply perriskiscalled
a. Peroccurrencereinsurance
b. Perrisk reinsurance
c. Catastrophereinsurance
d. A ggregatereinsurance
e. N oneoftheabove.
7. O neofthefollow ing isnota characteristicofQ uota ShareTreaty
a. Sharing ofpercentageisfixed.
b. N o individualcessions
c. Prem ium sand lossesaresettled by account.
d. Individualcessions
e. N oneoftheabove.
8. O neofthefollow ing isnota characteristicofPro-rata reinsurance.
a. Liability isbased on predeterm ined percentage
b. Itisproportionaltreaty
c. Thereissharing ofrisks.
d. Itisnon-proportionaltreaty
e. N oneoftheabove.
9. It offers the insurer protection against the accum ulations resulting from
num erouslossescaused by thesam eevent(cyclone,earthquake)
a. Pro ratareinsurance
b. Perilreinsurance
c. Coverperevent
d. BothA & B
e. N oneoftheabove.
10. A line isequalto theceding com panysretention.W here,a ceding insurerhasa
ten line surplus treaty on the basis of a m axim um retention of R s 5000,the
III-61
M O D U LE-III:RISK M A N A G EM EN T A N D REIN SU RA N CE
SEC TIO N -A A N SW ER S
1. d 2. d 3. c 4. a 5. b 6. b
7. d 8. d 9. c 10.a
SEC TIO N -B
4. Reinsurance prem ium is w orked outon the basis of exposure and pastloss
experience.
3. D ifferentiatebetw een SurplusShareTreaty and Q uota ShareTreaty
A ns.
Surplussharetreaty Q uota sharetreaty
1. O ften property only. 1. Both property and casualty.
2. Sharing ofpercentageisvariable. 2. Sharing ofpercentageisfixed.
3. Individualcessions. 3. N o individualcessions.
4. Reinsurersprem ium isthepercentage 4. Reinsurersprem ium isthe
oftheoriginalprem ium lessa percentageoftheoriginal
negotiated ceding com m ission. prem ium lessanegotiated
ceding com m ission.
5. Prem ium sand lossesaresettled by 5. Prem ium sand lossesaresettled
account. by account.
5. O utlinethecharacteristicsofN on-proportionaltreaties.
III-63
M O D U LE-III:RISK M A N A G EM EN T A N D REIN SU RA N CE
A ns.
Perrisk PerO ccurrence Aggregate(stop loss)
1. Itisnegotiated on rate 1. Itisnegotiated on rate 1. Itisnegotiated on rate
exposurebasisand there exposurebasisand there exposurebasisand
isno com m ission. isno com m ission. thereisno com m ission.
2. Prem ium saresettled by 2. Prem ium saresettled by 2. Prem ium saresettled by
annualadjustm entof annualadjustm entof annualadjustm entof
depositprem ium . depositprem ium . depositprem ium .
3. Prem ium ism inim um . 3. Prem ium ism inim um . 3. Prem ium ism inim um .
4. Lossesaresettled 4. Lossessettled by 4. Lossesaresettled
individually. catastropheorevent. annually
5. Retention isforeach 5. Retention isusually 5. Retention and thelim it
risk orbuilding or aboveam inim um of stated asalossratio.
location. tw o full-losses.
6. Ithasperoccurrence 6. Ithasaco-insurance 6. Ithasaco-insurance
lim itation. provision w hen the provision w hen the
reinsured sharestheloss reinsured sharesthe
above retention. lossaboveretention.
SEC TIO N -C
(C A SE STU D IES)
1. M unich insurance com pany entered into tw o surplus treaty contracts w ith the
reinsurers.Thefirstsurplustreaty consisted 10 linesw ith am axim um liability ofRs.
30,00,000.Thesecond surplustreaty consistsof20 linesw ith am axim um liability of
50,00,000.Theclaim sfiled areasunder:Show calculationsofprem ium aspersurplus
treaty.
Risk G rosssum insured Retention applicable
1 Rs.2,00,000 Rs.2,00,000
2 Rs.3,00,000 Rs.1,00,000
3 Rs.12,00,000 Rs.2,00,000
4 Rs.30,00,000 Rs.4,00,000
5 Rs.65,00,000 Rs.2,00,000
SO LU TIO N :
Risk G rosssum Retention [Rs] Cessionsto 1st Cessionsto 2nd
insured [Rs] surplustreaty surplustreaty
1 Rs.2,00,000 Rs.2,00,000 N il
2 Rs.3,00,000 Rs.1,00,000 Rs.2 ,00,000 N il
3 Rs.12,00,000 Rs.2,00,000 Rs.10,00,000 N il
4 Rs.30,00,000 Rs.4,00,000 Rs.26,00,000 N il
5 Rs.65,00,000 Rs.2,00,000 Rs.20,00,000 Rs.40,00,000
Balance3,00,000 hasto bearranged facultatively.
III-64
M O D U LE-III:RISK M A N A G EM EN T A N D REIN SU RA N CE
III-65
M O D U LE-III:RISK M A N A G EM EN T A N D REIN SU RA N CE
C hapter10
Treaty W ordings
SEC TIO N -A
c. Exclusionsclause
d. Reservesclause
e. N oneoftheabove.
9. Ifduring the currency ofthisagreem entany balancesunder any other treaty
ortreatiesbetw een thecom pany and thereinsurerrem ain unpaid by oneparty,
the other shall be entitled to: retain the balance due hereunder until full
paym ent has been m ade under the other treaty or treaties: or adjust such
balanceagainsttheam ountduefrom theotherparty.
a. ReservesClause
b. A djustm entClause
c. Set-offClause
d. A lterationsClause
e. N oneoftheabove.
10. A rbitration clausefordisputesprovidesforappointm entofarbitrator/s.
a. 1
b. 2
c. 3
d. 4
e. 5
SEC TIO N -A A N SW ER S
1. e 2. c 3. b 4. b 5. c 6. d
7. d 8. b 9. c 10.b
SEC TIO N -B
1. U nderw hatcircum stancesw illthereinsuranceagreem entgetterm inated?
Eitherparty shallbeatliberty to term inateitasat31stD ecem berin any yearby
giving notless than 90 days previous notice in w riting.U nless the parties
otherw ise agree,the Reinsurers w illrem ain liable for allreinsurances ceded
underthisagreem entuntiltheirnaturalexpiry.
In the eventof W ar (w hether declared or not) arising betw een India and the
country in w hich theReinsurersresideorcarry on businessorareincorporated,
thisagreem entshallbeautom atically term inated forthw ith.
If during the period of this agreem ent, postal and/or telegraphic
com m unications should be rendered im possible as a consequence of W ar,
w arlike operations,blockade,revolution,civilw arorothersim ilareventfora
period exceeding thirty (30)days,the com pany shallbe entitled to term inate
thisagreem entforthw ith w ithoutgiving notice.
III-68
M O D U LE-III:RISK M A N A G EM EN T A N D REIN SU RA N CE
Eitherparty shallhave the rightto term inate this A greem entim m ediately by
giving theotherparty notice:
Ifthe perform ance ofthe w hole orany partofthisA greem entbe prohibited or
rendered im possible de jure orde facto in particularand w ithoutprejudice to
the generality ofthe preceding w ordsin consequence ofany law orregulation
w hich is or shall be in force in any country or territory or if any law or
regulation shallpreventdirectly orindirectly therem ittanceofany orallorany
partofthebalanceorpaym entsdueto orfrom eitherparty.
Iftheotherparty hasbecom einsolventorunableto pay itsdebtsorhaslostthe
w hole orany partofitspaid up capitalorhashad any authority to transactany
classofinsurancew ithdraw n orcanceled orsuspended orm adeconditional.
Ifthereisany m aterialchangein theow nership orcontroloftheotherparty.
Ifthecountry ortheterritory in w hich theotherparty resideshasitshead officeor
is incorporated shallbe involved in arm ed hostilities w ith any other country
w hetherw arbedeclared ornotorispartly orw holly occupied by anotherpow er.
If the other party shall have failed to com ply w ith any of the term s and
conditionsofthisagreem ent.
2. Explain theA ccounting ofLosses:
A ns.Prelim inary lossadvicesshallbe sentby the Com pany to the Reinsurerin respectof
alllossesw heretheproportion ofthereinsurerssharing in theagreem entisestim ated
to exceed theam ountstated in theSchedule.Furtherm ore,theCom pany shallfurnish
theReinsureran estim ateofoutstanding lossesasat31stD ecem berofeach year.
W hen theproportion ofalossand orexpensesfalling upon allthereinsurerssharing
in thisA greem entam ountsto orexceedsthe am ountspecified in the Schedule,the
reinsurers shall be liable to pay its proportion w ithin 21 days of dem and. The
Com pany shalldebitallother losses and/or loss expenses in the accounts of the
quartersin w hich thelossesand/orlossexpensesaresettled.
A ny loss or claim or com prom ise thereof and all expenses including fire
extinguishing expenses shallbe settled by the Com pany w ithoutreference to the
reinsurer and such settlem ents including ex gratia paym ents shallin allcases be
unconditionally binding upon the reinsurer.The Com pany atitssole discretion m ay
com m ence,continue,defend,com prom ise,settleorw ithdraw from any actions,suits
and prosecutionsand generally do allsuch m attersrelating to any lossorclaim w hich
in itsjudgm entm ay beadvantageousand thepaym entofallexpensesand allow ances
in connection therew ith shall be shared by the reinsurer in proportion to its
participation.
TheReinsurershallsharein proportion to itsparticipation in allam ountsw hich m ay
berecovered by theCom pany in respectofany lossorclaim .
3. W hatdo you understand by Insuring clause?
A ns. TheReinsurershereby agreeto indem nify theCom pany forthatpartoftheultim ate
III-69
M O D U LE-III:RISK M A N A G EM EN T A N D REIN SU RA N CE
III-70
M O D U LE-III:RISK M A N A G EM EN T A N D REIN SU RA N CE
SEC TIO N -C
(C A SE STU D IES)
D unhill,a subsidiary ofa bank,em ployed a consultancy firm to advise investors about
sw itching from corporateto pension plans.D unhillw asinsured underabankerscom posite
insurancepolicy issued by thedefendantinsurers.U nderthispolicy,theinsurersagreed to
indem nify the com pany in respectofitslegalliability from any third party claim .O vera
period ofyears,therew eresubstantialclaim sby investorsw ho had changed theirpensions
and w ho had suffered losses as a result.Itw as alleged thatthe consultancy firm had
provided incorrectadvice.Forthe purpose ofa claim on insurers,the com pany subm itted
thatthe claim s by investors w ere a series of claim s thatresulted from a single actor
om ission,nam ely,a failure on the partof their ow n m anagem entto train properly the
consultancy firm so asto be able to give investorsbestadvice.Insurersargued thatitw as
the failure on the partofthe consultancy firm in each case to give properadvice to the
investor,ratherthan thefailureon thepartofm anagem entto providepropertraining to the
consultancy firm .D iscuss.
SO LU TIO N :
The aggregation clause requires one to ask a m atterofcom m on sense w hetherthe
seriesofclaim sand questionsw ere the resultofan actorom ission ofthatkind.In
com m on senseterm s,allofthethird party claim sresulted from afailureon thepartof
m anagem entto provide the training required to enable the consultancy firm to give
proper advice to investors.The proper course w ould be to identify the dom inant,
efficient,orrealcause ofthe loss.In the absence ofagreem entto the contrary,the
presum ption w ould bethatthepolicy w asintended to providecoverw herean insured
perilw asthedom inant,efficient,orrealcauseoftheloss,butnototherw ise.
H ere, the policy provided cover against losses caused by a range of acts and
om issionscom m itted by officersand em ployeesoftheinsured.Itw asnotdifficultto
envisagecircum stancesin w hich asingleactorom ission on thepartofoneofficeror
em ployeem ightgiveriseto claim sofasufficientsizeto exceed thedeductiblew hen
aggregated.W hetherthatfailureshould beregarded asasingleactorom ission on the
partoftheinsured orasarelated seriesofactsorom issionsdoesnotm atter.In either
case,theinsured isentitled to theclaim s.
2. Carona Insurance entered into a reinsurance contract w ith Law son reinsurance
com pany.The definition of loss in the treaties provide that a disaster and / or
casualty included allloss resulting from aseriesofaccidents,occurrencesand /or
causative incidents having a com m on origin and /or being traceable to the sam e
act .. shall be considered as having resulted from a single accident... Carona
insurance settled claim s, w hich covered m ultiple sites in m ultiple geographic
jurisdictions,by allocating the sites as separate occurrences under its underlying
III-71
M O D U LE-III:RISK M A N A G EM EN T A N D REIN SU RA N CE
III-72
M O D U LE-III:RISK M A N A G EM EN T A N D REIN SU RA N CE
C hapter11
R einsuranceA ccountsand
A dm inistration
SEC TIO N -A
III-73
M O D U LE-III:RISK M A N A G EM EN T A N D REIN SU RA N CE
d. A& B
e. N oneoftheabove.
5. O neofthefollow ing isnottrue:
a. D irect prem ium data to calculate the reinsurance prem ium payable to the
reinsurer.
b. D ataforindividuallossesneeded to apply treaty lim itsand excessretentions;
c. Codesforidentifying occurrencesundercasualty clashcoverage;
d. Inform ation on risks included in the treaty but not ceded for preserving
profitability ofthetreaty.
e. N oneoftheabove.*
6. N ow adaystheprim ary insurersaresending inform ation through thisstatem ent
to reinsurersinstead ofbordereaux.
a. Statem entofStatistics
b. CurrentA ccountStatem ent
c. Ceding statem ent
d. Scrip
e. N oneoftheabove.
7. D isputesbetw een prim ary insurerand reinsurerarenorm ally settled through
a. D irectnegotiations
b. A rbitration
c. Courts
d. A lloftheabove*
e. N oneoftheabove
8. O neofthefollow ing isnottrue:
a. Reinsurershavevery littleto do exceptcollecting reinsuranceprem ium ;*
b. Som e reinsurers m inim ize their w ork by preferring large retentions w ith the
possibility ofno claim sbeing presented atall.
c. Reinsurersm ay beengaged in auditing theunderw riting and claim spracticesof
theprim ary insurers.
d. A & B
e. N oneoftheabove.
9. W hat is the purpose of collecting and analyzing a large am ount of data by
reinsurers?
a. O btain betterterm s
b. Balancecessions.
c. Solidify relationship.
III-74
M O D U LE-III:RISK M A N A G EM EN T A N D REIN SU RA N CE
d. A& B
e. A lloftheabove*
10. ProbableM axim um Loss isan assessm entby
a. Thecedent
b. The reinsurer
c. Thesurveyor*
d. Thebroker
e. N oneoftheabove.
SEC TIO N -A A N SW ER S
1. e 2. d 3. b 4. b 5. e 6. b
7. d 8. a 9. e 10.c
SEC TIO N -B
1. O utlinetheroleofPrim ary Insurerin reinsuranceadm inistration.
A ns.The prim ary insurerm ustconducthis underw riting operations satisfactorily w ithin
the guidelines and expectations ofthe treaty so thatthe reinsurerhas no surprises
com ing in theform oflargelosses.M ore,theprim ary insurerm ustnotify prom ptly all
large losses and the reinsurer m ust be given the opportunity to participate in
investigation ofsuch losses.
The prim ary insurer has the freedom to underw rite individual risks and adjust
individual claim s once clear-cut underw riting policies are contem plated under a
treaty.W e conventionally use a phrase "FO LLO W TH E FO RTU N ES".Itm eansthe
reinsurerisnorm ally bound by the prim ary insurersactionsin the underw riting and
claim sm atters.
Theprim ary insurerm usthaveagood orw elldesigned inform ation system to beable
to furnish allnecessary inform ation in tim e forthe reinsurerto be able to control
losses w herever possible and to discharge their obligations under the treaty
professionally.
2. Them oreim portantdata thatshould becapableofbeing m adeavailablefrom a
good inform ation system used by the prim ary insurer should include certain
elem ents.H ighlightthem .
A ns.a. D irect prem ium data to calculate the reinsurance prem ium payable to the
reinsurers;
b. D ataforindividuallossesneeded to apply treaty lim itsand excessretentions;
c. Theabovedataforaccounting purposes;
d. Codesgenerated forcatastrophelosses;
e. Codesforidentifying occurrencesundercasualty clashcoverage;
III-75
M O D U LE-III:RISK M A N A G EM EN T A N D REIN SU RA N CE
f. D ata to determ ine the portion of policy/ies ceded to each surplus share
reinsurer;
g. Separate data on retention,lim its,rates,and the reinsurer involved for each
facultativeplacem ent;
h. Inform ation on risks included in the treaty but not ceded for preserving
profitability ofthetreaty;
i. D ataon risksexcluded underthetreaty butunderw ritten by theprim ary insurer
so asnotto includethesam ein thereinsurancebordereau;
A n accurate and efficient inform ation system helps the credibility of the
prim ary insurer and helps the renew alof treaties.The prim ary insurer m ust
m akeavailablehisbooksofaccountforinspection by thereinsurer.
3. O utlinetheroleofreinsurerin thecontextofreinsuranceadm inistration.
A ns.O ne w ould think that the reinsurers have very little to do except collecting
reinsurance prem ium ,and paying claim s and brokerage com m ission to brokers and
cedingcom m issiontotheprim aryinsurer.M aybethisisso w hen thetreaty relationship
issm ooth.In fact,som e reinsurersm inim ize theirw ork by preferring large retentions
w ith thepossibility ofno claim sbeing presented atall.
O n thecontrary,thereinsurersm ay beengaged in auditing theunderw riting and claim s
practicesoftheprim ary insurerso asto ensurethatthesearedonesatisfactorily and as
expected.A gain,w heneverthelossesarelarge,thereinsurersm ay liketo participatein
theinvestigation ofthesam e,both to seethatproperproceduresarein placeand to find
out the underw riting im plications. M any a tim e, the prim ary insurers, both on
underw riting and claim sissues,openly consultthereinsurers.
Thereinsurersnotonly help in stabilizing lossexposuresbutalso positively assistthe
prim ary underw riters in underw riting on accountof their superior experience and
expertise.
4. Explain how claim saresettled underdifferentm ethodsofreinsurance.
A ns.Theprocedurediffersfrom treaty to treaty based on individualagreem ents.
If it is a pro rata treaty,the prim ary insurer sends a m onthly bordereaux to the
reinsurer, detailing the prem ium s due to the reinsurer and claim s due from the
reinsurer.The prim ary insurer w illrem itthe difference to the reinsurer w hen the
prem ium s exceed the losses and if the losses exceed the prem ium s,the reinsurer
rem its the difference to the prim ary insurer. If at any tim e, there are som e
exceptionally large losses,then itis the convention for the reinsurer to rem itthe
lossesto theprim ary insurerbeforetheend ofthereporting period.
In thecaseofexcesstreaties,assoon aslossesexceed theretention,intim ation isgiven
and thereinsurerpayson being given proofofsettlem ent,w hich issim ply astatem ent
oflossespaid by theprim ary insurer,togetherw ith estim atesofcurrentreserves.
In the case of aggregate excess treaties,the reinsurers are know n to m ake initial
paym ents say sixty days afterthe end ofthe accounting year.Ifitis clearthatthe
III-76
M O D U LE-III:RISK M A N A G EM EN T A N D REIN SU RA N CE
losses w illexceed the retention,then paym ents m ay be m ade before the end ofthe
year.
5. Explain C losing ofA ccountsin caseofa reinsurancecom pany.
A ns.Every insurance com pany w hile closing its annualaccounts atthe end ofthe year,
exam inesallclaim soutstanding w ith respectto inw ard treatiesin the booksin order
to m ake a reasonable estim ate forprovisionsto be m ade in the revenue accounts,so
thatitcan presentasaccurate a picture aspossible.Based on the estim atesm ade for
grossclaim s,thecom pany w illw ork outtheoutstanding claim sposition in respectof
itsvariousoutgoing treaties,w hich w illbeincluded in theannualaccountsasw ellas
adviceto therespectivereinsurers.
Profitand lossaccountasw ellasBalance SheetisasperInsurance A ctand IRD A
regulations.
SEC TIO N -C
(C A SE STU D IES)
1. U tkal Insurance com pany has reinsurance arrangem ents w ith G reat Eastern
reinsurance com pany,K olkata.The prem ium s to be paid by cedentto reinsureris
based on the rate specified in the contractand the rate w illbe applied to the ceding
insurerstotalnetprem ium afterceding to proportionalreinsurances.
M arketFirePool Rs.
Profitasat31/03/2004 207,161,000
Prem ium 767,898,000
PC Term s 15% PC on Profit
U p to 10% ofPrem ium
& 75% ofbalance
CalculateProfitCom m ission
SO LU TIO N :
15% PC up to 10% on Prem ium
10% on Prem ium 76,789,800
@ 15% on above 11,518,470(A )
75% ofBalance
Profit 207,161,000
Less10% Prem ium 76,789,800
Balance 130,371,200
@ 75% on Balance 97,778,400(B)
Com m ission (A +B) 109,296,870
III-77
M O D U LE-III:RISK M A N A G EM EN T A N D REIN SU RA N CE
III-78
M O D U LE-III:RISK M A N A G EM EN T A N D REIN SU RA N CE
C hapter12
R einsurance R egulations
SEC TIO N -A
c. 10*
d. 12
e. N oneoftheabove
5. In India thefollow ing authority adm inistersregulationson insuranceindustry.
a. M inistry ofFinance,U nion G ovt.
b. RBI
c. IRD A *
d. PFRD A
e. SEBI
6. O neofthefollow ing isnotan objectiveofreinsuranceregulationsin India.
a. to m axim izetheretention w ithin thecountry.
b. D evelop adequatecapacity
c. Securethebestpossibleprotection forthereinsurancecostsincurred;
d. Sim plify theadm inistration ofbusiness
e. N oneoftheabove.*
7. R egulationsrelating to placem entofreinsurancebusinessoutsideIndia:
a. Those reinsurers w ho have a period ofthe past5 years enjoyed a rating ofat
leastBBB (w ith S& P)
b. Rating ofany internationalagency equivalentofS& P
c. Placem entcan bedonew ith reinsuranceagency in U SA .
d. Priorperm ission ofIRD A should beobtained.*
e. N oneoftheabove.
8. W hich ofthefollow ing A ctsarerelevantto reinsurancecases?
i. IndianContractA ct.
ii. IndianA rbitrationA ct.
iii. InsuranceA ct.
a. only (i)
b. only (ii)
c. Both (i)and (ii)
d. Both (ii)and (iii)
e. A lloftheabove.*
9. Every insurer shallcede such percentage ofthe sum insured on each policy for
differentclasses ofinsurance w ritten in India to the Indian reinsurer.W hatis
thatpercentage?
a. 15.
b. 20.*
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c. 30.
d. 40.
e. N oneoftheabove.
10. TheIndian reinsuranceagency is:
a. EX IM bank.
b. ECG C.
c. G IC.*
d. LIC.
e. IRD A .
SEC TIO N -A A N SW ER S
1. e 2. d 3. e 4. c 5. c 6. e
7. d 8. e 9. b 10.c
SEC TIO N -B
1. Exam inereinsuranceregulation scenario in U K and U SA briefly.
A ns.In theU .K .,theD epartm entofTraderequirestheprim ary insurersto annually report
on thefollow ing:
a. The nam es and addresses ofallreinsurers to w hom business has been ceded
during theyear;
b. A ny connection (other than the reported reinsurance) betw een the prim ary
insurerand any ofitsreinsurers;
c. Theam ountofprem ium payableto each reinsurer;and
d. A ny indebtednessofareinsurerto theprim ary insurerattheend oftheyear.
In theU nited States,reinsurersasw ellaslicensed alien reinsurershaveto keep
solvency m argin alm ostalong thelinesprescribed forprim ary insurersand m ust
follow reserves,investm ent,capitaland surplus requirem ents and annually or
som etim es every quarter file financial statem ents w ith State regulatory
authorities.
2. R einsuranceinterm ediariesactin a fiduciary capacity forallfundsreceived in
theirprofessionalcapacity and m ustnotm inglethem w ith otherfundsin U SA .
Explain theroleofinterm ediaries.
A ns.Reinsurance interm ediaries shallhave w ritten authorization from the insurers and
reinsurersthey represent,spelling outtheextentand lim itationsoftheirauthority;
The w ritten authority above m ust be m ade available to the prim ary insurers or
reinsurersw ith w hich theinterm ediary deals;
N o licensed interm ediary shall procure reinsurance from an unlicensed reinsurer
unlessthereinsurerhasappointed an agentfortheserviceofprocessin N ew York;
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including the Indian reinsurer to participate in its facultative and treaty surpluses
beforeplacem entofsuch cessionsoutsideIndia.
SEC TIO N -C
(C A SE STU D IES)
1. G eneralInsuranceCorporation ofIndiahasbeen w elladapting itselfto thechanging
reform s scenario. To focus itself on the reinsurance m arket both dom estic and
international,ithastaken variousdecisionsto supportitsnew corporatevision.In Jan
2004,G IC hasdecided to exititsm utualfund arm ,G IC M utualFund,so asto focus
on core reinsurance operations.The fund had been constantly underperform ing for
thelastfew years.In 2002-03 therehasbeen w hopping increasein theforeign inw ard
reinsurance prem ia atRs600 crores.Thisincrease haspushed the totalreinsurance
prem ium to overRs3800 crores.The Indian reinsurer,isw illing to w rite m ore risks
in the dom estic m arket.The underw riting losses fellbelow the Rs 500 core-m ark.
Though the severe drought,took its toll on G ICs underw riting w ith agricultural
losseszoom ing to Rs400 croresin 2002-03.theclaim sratio reduced during theyear
from 94 to 86% .Though the quantum offoreign inw ard prem ium islow in the total
prem ium incom e,the increase in its share over the lastone year is significant.In
2002-3,the share offoreign prem ium hasbeen over15% ascom pared to just6% in
thepreviousyear.
InternationalCreditrating agency,A M Best,hasgiven A (Excellent) rating to the
corporation indicating its financial strength. The rating reflects not only the
Corporationsexcellentfinancialposition and conservative investm entportfolio but
also recognizesitsleading position in theglobalm arket.
D iscuss the grow th opportunities and business ofG IC in the lightoflatestglobal
changes.
SO LU TIO N :
Today,India stands as a country w hose econom y is getting increasingly integrated
w ith the w orld econom y.The large and grow ing m arket,developing infrastructure,
sophisticated financialsector,stable polity and strong econom ic outlook m ake India
an attractivedestination,both,forbusinesstravellersand tourists.
G IC of India (G IC),the Indian Reinsurer caters to the reinsurance needs of the
country and also underw ritesrisksglobally.G ICssupportto theIndian m arketcom es
in the form ofobligatory cessions,com pany surplustreaties,m arketsurplustreaties,
Excess of Loss (X O L) protection to direct w riting com panies and facultative
acceptances. G IC is one of the reputed underw riters for treaty and facultative
reinsurancein theA fro-A sian region.
A sa sole reinsurerin the dom estic reinsurance m arket,G IC providesreinsurance to
the directgeneralinsurance com paniesin the Indian m arket.G IC receivesstatutory
cession of20% on each and every policy subjectto certain lim its.Itleadsm any of
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M O D U LE-III:RISK M A N A G EM EN T A N D REIN SU RA N CE
dom estic com paniestreaty program m esand facultative placem ents.G ICscapacity
foreach class ofbusiness on Treaty and Facultative basis fordom estic business is
given in thefollow ing table.
C lass
C apacity
Property
IN R 15000 m ln.A ny onerisk
M arine
H ull-IN R 2000 m ln.any onevessel
Cargo IN R 2500 m ln.A ny onepolicy/sending
CrudeO ilIN R 3500 m ln.any onepolicy/sending
Engineering
IN R 15000 m ln.Sum Insured
M iscellaneous
IN R 3500 m ln.Sum Insured
M otor
U nlim ited
C lass
C apacity
Aviation-H ull/Spares RotorW ing
IN R 20.50 m ln.peraircraft
Aviation-H ull/Spares Fixed W ing
IN R 50 m ln.peraircraft
Liability
IN R 100 m ln.peroccurrence
Aviation Treaty H ull
IN R 500 m ln.
Spares
IN R 250 m ln.
Liability
IN R 1000 m ln.
G IC declared a bonusin the ratio of1:1 and the equity capitalhasgrow n to Rs.430
crores.D ividend @ 15% am ounting to Rs.64.50 croresw asdeclared on theenhanced
capital.The incom e from investm ents am ounted to Rs.1398.61 crores in 2004-05.
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C hapter13
R einsurance M arkets
SEC TIO N -A
1. It is an association of reinsurers banded together to underw rite reinsurance
jointly.
a. LloydsClub.
b. ReinsurancePool
c. Society ofReinsurers
d. W orld ReFederation.
e. N oneoftheabove.
2. O neofthefollow ing isnottrue;
a. Som ereinsurancepoolsw ritereinsuranceforonly m em bers.
b. Industrialinsurersm ay form apoolto w ritespecificrisks.
c. Specialized poolsarealso form ed forenergy insurance.
d. A & B
e. N oneoftheabove
3. Lloydsw asoriginally developed as
a. CenterforM arineinsurance.
b. CenterforAviation insurance.
c. CenterforG eneralinsurance.
d. CenterforLifeinsurance.
e. N oneoftheabove.
4. Thisisthelargestreinsurancecom pany ofthew orld.
a. M unich Re
b. Sw issRe
c. Em ployersRe
d. A m erican Re
e. N oneoftheabove.
5. M ostofthetop reinsurersarelocated in;
a. Sw itzerland
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M O D U LE-III:RISK M A N A G EM EN T A N D REIN SU RA N CE
b. G erm any
c. U nited StatesofA m erica
d. Britain
e. Japan.
6. O neofthefollow ing isnottrue:
a. In them odern daysreciprocalreinsuranceisnotw idely practised
b. Thereinsurancem arketin London isconstituted ofLloyds.
c. Thepercentagecom m ission paid by thereinsurersto thereinsurancebrokersis
relatively high.
d. B& C
e. N oneoftheabove.
7. A X A R eisassociated w ith w hich country?
a. N etherlands.
b. G erm any
c. U SA .
d. France.
e. Japan
8. G enerally reinsurancebrokerspreferthism ethod ofreinsurance.
a. Facultativereinsurance
b. ExcessofLossReinsurance.
c. Treaty Reinsurance
d. Q uotasharecover.
e. N oneoftheabove.
9. Identify the factor w hich is not contributing to the success of reinsurance
m arket:
a. Availability ofknow ledgecapital.
b. M atured financialm arkets.
c. Infrastructurefacilities.
d. D om esticm arkets.
e. Interestrates.
10. A fter nationalization ofthe insurance industry,five com panieshave taken care
ofgeneralinsuranceneeds.Identify theodd m an out.
a. G eneralInsuranceCorporation ofIndia.
b. LifeInsuranceCorporation ofIndia
c. O rientalInsuranceCom pany.
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M O D U LE-III:RISK M A N A G EM EN T A N D REIN SU RA N CE
SEC TIO N -A A N SW ER S
1. b 2. e 3. a. 4. a 5. c 6. c
7. d 8. c. 9. e 10.b 11.c 12.c
13.c 14.a 15.e
SEC TIO N B
2. Explain theroleofreinsurancebrokers.
A ns.Justasthere m ay be brokersforprim ary insurersw ho actasinterm ediariesbetw een
the insured and the insurer,there are reinsurance brokers w ho are go-betw eens to
prim ary and reinsurers.The percentage com m ission paid by the reinsurers to the
reinsurance brokers is relatively sm all,as com pared to the com m ission paid to the
insurance brokers and is som etim es as low as one percent of the reinsurance
prem ium .
W hen there are reinsurance brokers,the prem ium paym ents and loss paym ents as
w ellas prem ium refunds pass through them .W hen prim ary insurers do nothave
expertise to place reinsurance directly,they need the services of the reinsurance
brokers. Large reinsurers also use reinsurance brokers as a m atter of course.
H ow ever,ifprim ary insurersgo directto reinsurers,they m ay be able to reduce the
reinsurancecostto som eextent.
A lthough reinsurancebrokersobtain theircom m ission from thereinsurers,they have
aduty to observetheprincipleofutm ostgood faith,w hich m eansthey m ustrevealto
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the reinsurers allm aterialfacts concerning the risks,w hich they obtained from the
prim ary insurers.Them arketshareofthereinsurerscom bined in theU nited Statesis
estim ated at75% ,w hich show sthe predom inance ofthe reinsurance brokersin the
reinsurance m arket. G enerally, reinsurance brokers handle treaty reinsurances in
preferenceto facultativereinsurance.
3. O utlinethefeaturesofa successfulreinsurancem arket:
A ns.Thefeaturesthatexem plify thereinsurancem arketareasfollow s:
1. Stability factor.
2. Availability ofK now ledgeCapital.
3. M atured FinancialM arkets.
4. TheRoleofEconom y.
5. TheA rbitration Factor.
6. Infrastructure Facilities.
7. D om esticM arkets.
8. TheLocation A dvantage.
9. TheRoleofForeign Reinsurers.
4. W hatistheR egionalR einsuranceC orporation? O utlinetheirrole.
A ns.G enerally,a regionalreinsurance corporation caters to the needs arising am ong a
group ofneighboring countries.Thesecorporationsw ereproposed to besetup across
thedifferentdeveloping nationsofthew orld.
The setting up ofregionalreinsurance m ainly dependson certain com m on features,
w hich the m em bercountriesare bound to have due to the binding proxim ity w ith or
to each other.
The regionalreinsurance corporations have the liberty to choose theirow n m arket
place to locate theirheadquarters.The headquartersm ay be setup depending on the
factorssuch asw ell-developed accessibility,excellentcom m unication facility,w ell-
established com m ercialbackup,etc.Thebacking ofgood banking system w illenable
thecorporation to haveasm ooth functioning.
The regional reinsurance corporations end up w ith a good business in hand by
involving com pulsory cessions from its m em bers. The corporation can also get
exposed to the risks arising from the m em ber nations. In order to avoid such
happeningsthey getprotection through retrocession coversfrom otherm arkets.The
regional reinsurance corporations m anage their portfolio, w hich is spread over
differentcountriesthrough variousretrocession coversthey are:
Proportionalcovers
N on-proportionalcovers
By trading outw ard coversthrough tradersand generating inw ard covers.
N on-reciprocalinw ard reinsuranceaccounts,apartofw hich m ay beretroceded
back to them em bernations.
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M O D U LE-III:RISK M A N A G EM EN T A N D REIN SU RA N CE
m ightnotprovide.
Enablesto retain theprem ium sw ithin thegroup by theparentcom pany.
O perating costsarereduced.
Thereisan im proved cash flow.
Thereisan increasein coverageand capacity.
Betterinvestm entasw ellasinvestm entincom e.
Thereisadirectreach to w holesalereinsurancem arkets.
Thereisflexibility in underw riting and funding.
Thereisagreatercontroloverclaim s.
Availability ofsm allerdeductiblesforoperating units.
Thereisan additionalnegotiating leveragew ith underw riters.
Availability ofincentivesforlosscontrol.
SEC TIO N -C
(C A SE STU D IES)
1. The w eatherhas a substantialinfluence on the econom y from the risk ofa rainy
sum m er for beer garden proprietors to the dependency of energy suppliers on the
w eather.W eather derivatives offer a range of tools for these industries to hedge
againstpreviously uninsurablew eatherrisks.
H edging againsta cold sum m er
W hen thetem peraturein Britain risesby 3 C,daily beerconsum ption increasesby
10% ,saysthe U K M etO ffice in a study a very telling exam ple thatshow show
m uch aparticularindustrysturnovercan beaffected by thew eather.
M eteorological research institutes estim ate that m ore than 80% of all econom ic
activities are w eather-dependent.In other w ords,a huge variety of industries are
involved fashion com panies,brew eries,construction firm s,ice-cream producers
and especially energy suppliers.
W hen nationalutility m onopolies in the U SA w ere turned into independentenergy
com panies, dem and increased for protection against the im pact of the w eather.
Instrum entsforhedging w eatherrisksw eresought,and w hatm oreobviousideathan
to use the tools ofthe capitalm arket? Explain how M unich Re is offering w eather
derivatives.
SO LU TIO N :
O bjectiveofw eatherderivatives
A w eatherderivative differs from a custom ary derivative in thatitis notbased on
tradable reference item ssuch asshares,share price indices,bondsorexchange rates
buton predeterm ined index data,such asthetem perature.Itfollow sthatthepurpose
ofaw eatherderivativeisto hedgevolum erisksratherthan pricerisks,sincearising
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M O D U LE-III:RISK M A N A G EM EN T A N D REIN SU RA N CE
strengthening.
C urrentstateofthem arket
Financial results for the reinsurance m arket are sim ilar to those of the general
insurance m arket.Forexam ple,financialresultsforthe firstquarterof2004 show a
m arked im provem entin profitability.Thecom bined ratio forthereinsuranceindustry
asreported by the Reinsurance A ssociation ofA m erica is94,betterthan lastyears
healthy 96.4.Thiscontinuesa trend ofsteadily im proving resultsoverthe pastfew
years.D espitethisrosy present,m any expertsarestillconcerned aboutthelong-term
prospectsforthereinsuranceindustry.
Standard & Poors is one of the m ore vocalcritics of reinsurersfuture financial
conditions.Itcontinuesto reportthattheoutlook forthereinsuranceindustry rem ains
negative. This basically m eans that ratings dow ngrades for U .S. reinsurers are
expected to exceed upgradesin thecurrentyear.D iscuss.
SO LU TIO N :
Poorfinancialresultsoverthe pastfew yearshave required a num berofchangesin
thew ay reinsurersapproach theircorebusiness,asw ellasoperationalaspectsin their
underw riting.Follow ing isareview ofsom eofthem oreinteresting changes,asw ell
asa reporton severalkey trendsthatw illhave a profound im pacton the industry in
thefuture.
R isk securitization
Itisobviousthatthereinsurancem arketisundergoing rapid changesin thenatureof
itscorebusinesspractices.Forthem ostpart,thishasbeen caused by theconvergence
of the financial m arkets. Leading the change in core business practices is the
securitization ofrisk.
A recentstudy by G uy Carpenterfound thatin 2003 thecatastrophebond (CAT bond)
m arkethad significantgrow th.The prim ary purpose ofCAT bonds is to provide a
m echanism forreinsurersto raise capitalto covercatastrophic claim s.A n additional
purpose, how ever, is to offer a portfolio diversification strategy to institutional
investors. U p to this point, the m ost popular CAT bonds w ere associated w ith
property risk such asw indstorm and earthquake exposuresin the U nited States,but
now there is grow ing interestin other types of applications.Currentpossibilities
include such diverse areasassecuritizing life insurance portfoliosand non-property
exposuressuchasw orkerscom pensationandterrorism .A num berofotherinnovative
applicationsarealso being review ed forfinancialviability.
W hile m any in the insurance com m unity see the value ofthe CAT bond approach,
m uch ofthe currentm ovem entisbeing driven by investorslooking forhigheryield
investm entvehicles.A m ong otherreasonsfortheincreasing attention are:
* Investorsarebecom ing m orecom fortablew ith thesecuritization approach.
* Thestructureofsecuritizationsisbecom ing m orestandardized.
* Tim e and cost involved in com pleting a securitization have been greatly
III-94
M O D U LE-III:RISK M A N A G EM EN T A N D REIN SU RA N CE
reduced.
Both G uy Carpenterand Sw issRe predictsignificantgrow th in securitizationsnear
term .A sinnovation and consum eracceptancecontinuesin thism arketsegm ent,one
w ould expect to see this trend of the gradual blending of the financial service
productsto accelerate.
A tthis point,m ostindustry experts and rating agencies are painfully aw are ofthe
potentialproblem associated w ith questionable recoverables and are im plem enting
reductions in theirlistings offuture recoverables.A s a result,som e com panies are
taking m ore ofthe risk internally,w hile seeking to place businessw ith higherrated
reinsurancecom paniesw hen they do chooseto usethatm arket.A n additionalfailsafe
m echanism isaN ationalA ssociation ofInsuranceCom m issioners(N A IC)-U SA rule
thatrequires insurers to reduce reinsurance recoverables by 20% forthose thatare
overdueby m orethan 90 days.A ccordingly,therehasbeen an overalltrend to m ove
the reinsurance business to m ore highly rated reinsurers.This,of course,has the
predictable effectofplacing prem ium pricing on financially sound reinsurers.Itis
expected thatthistrend w illpersistoverthenextfew yearsastheindustry continues
to strugglew ith adequateam ountsofcapital.
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C hapter14
Inw ard R einsurance
SEC TIO N -A
1. O neofthefollow ing isnottrue:
a. Reinsurancebusinessaccepted by an insurerisinw ard reinsurancebusiness
b. Reinsurancebusinessaccepted by areinsurer,isinw ard reinsurancebusiness
c. Itisopposed to insurancebusinessceded to anotherinsurer.
d. A & B
e. N oneoftheabove.
2. W hy com paniesgo forinw ard reinsurancebusiness?
a. To increasethegrossprem ium and netretained prem ium
b. To achieve a low er expense ratio by m aintaining the volum e of prem ium
incom easceding reducestheprem ium incom e.
c. To obtain abetterand w iderspread ofbusiness
d. A lloftheabove.
e. N oneoftheabove.
3. O neofthefollow ing isnottrue:
a. A com pany hasto deviseitscorporatestrategy foritsunderw riting policy.
b. Itcan w ritelinesforitsnetaccount.
c. Itcan w ritelargershares.
d. Itcan createaretrocession treaty to takecareofsurplusoveritsnetretention.
e. N oneoftheabove.
4. Thisconsideration need notbekeptin m ind w hilefinalizing inw ard reinsurance;
a. Treaty orFacultativereinsurance
b. Territorialscope.
c. D irectorBrokers.
d. Classofbusiness
e. N oneoftheabove
5. O neofthefollow ing isnottrue:
a. Facultativereinsuranceinvolvesm oreadm inistrativew ork.
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M O D U LE-III:RISK M A N A G EM EN T A N D REIN SU RA N CE
SEC TIO N -A A N SW ER S
1. e 2. d 3. e 4. e 5. e
SEC TIO N -B
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C hapter15
R einsurance Practice
SEC TIO N -A
1. W hich ofthefollow ing statem entsistrue?
a. A good reinsurance program m e can be executed w ith assistance from
reinsurers,brokersand consultants.
b. A reinsuranceplan m usttakeinto accounttheprim ary insurersneeds.
c. Theprim ary insurersm ustcontinueto besolvent.
d. A & B
e. A ,B & C.
2. O neofthefollow ing isnota factordeterm ining thereinsuranceneeds.
a. K indsofinsurancew ritten
b. Volum eofinsurancew ritten
c. Availablefinancialresources.
d. Businessvolum eofclient
e. N oneoftheabove
3. Law oflargenum bersisnotapplicablein oneofthefollow ing cases.
a. M otorreinsurance
b. Catastrophes
c. M arineinsurance
d. Lifeinsurance
e. N oneoftheabove.
4. Theim portantfactorin setting oftheretention
a. Stability
b. Liquidity ofinvestm ent
c. A m ountofreliefneeded
d. G row th plans.
e. N oneoftheabove.
5. Theprincipalpurposeofan excessoflosstreaty is
a. stabilizelossexposures
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b. providing largelinecapacity
c. stabilizeearnings
d. A& B
e. A ,B& C
6. Setting reinsurancelim itsdependson
a. Com pany considerations
b. Costconsiderations
c. Financialstrength ofthereinsurer
d. Financialstrength oftheclient
e. N oneoftheabove.
7. W hilesetting thereinsurancelim itsthisfactorisnotconsidered
a. Volum eoftheprem ium
b. Prem ium loading
c. Reinsurancecost
d. A lltheabove.
e. N oneoftheabove
8. O neofthefollow ing ism orevulnerableto lossratio fluctuation.
a. N ationallevelprim ary insurer
b. Regionalinsurer
c. M arineinsurer
d. LifeInsurer
e. N oneoftheabove.
9. Thereinsurancecostincludes
a. O perating expenses
b. Prem ium paid to reinsurer
c. Lossesrecovered /to berecovered
d. A & B
e. B& C
10. O neofthefollow ing isnottrue:
a. Transferofassetsresultsin lossofinvestm entincom eto theprim ary insurer.
b. Such alossofinvestm entincom em ay begreaterunderpro-ratatreaty.
c. Reinsuranceprem ium forapro-ratatreaty isusually low er.
d. Lossofinvestm entincom em ay also becom ean additionalcostofreinsurance.
e. N oneoftheabove.
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M O D U LE-III:RISK M A N A G EM EN T A N D REIN SU RA N CE
SEC TIO N -A A N SW ER S
1. e 2. d 3. b 4. c 5. d 6. b
7. b 8. b 9. e 10.c 11.d 12.c
13.d 14.e 15.c
SEC TIO N -B
SEC TIO N -C
(C A SE STU D IES)
H im alayan Insurance com pany is a large insurance com pany.Itspecializes in personal
lines insurance, m otor insurance and m ortgage insurance. Its annual direct prem ium
volum eisRs2000 crores.Itsbusinessisspread alloverthecountry,w ith theproportion of
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M O D U LE-III:RISK M A N A G EM EN T A N D REIN SU RA N CE
itsbusinessin any one state being approxim ately the sam e asthatstatesproportion ofthe
nations population.Its policy holders surplus is Rs 1200 crores.Its investm entportfolio
consists m ostly of G overnm entBonds and high-grade industrialand utility bonds.The
insurance com pany norm ally holds about Rs 500 crores in treasury bills, high rated
Com m ercialPaperand othershortterm assets.Investm entin equity stocks accountfor
only 5 percentofitsinvested assetsand lessthan 10 percentofpolicy holderssurplus.The
insurance com pany hasshow n an operating profitevery yearforthe lastone decade.A n
analysisofthe geographic spread ofitsbusinessexposuresindicatesthatlossesin excess
ofRs500 croresin any onecatastrophearevery unlikely.
Exam inethereinsuranceplanning processofH im alayan InsuranceCom pany.
SO LU TIO N :
A fterreview ing alloftheavailabledata,itissuggested thattheH im alayan Insurance
Com pany does notrequire any reinsurance.Its large prem ium volum e,w idespread
sm allindividualrisks,strong surplusposition and stable,liquid investm entportfolio
w ould enable itto cope w ith any loss ratio variation itm ightreasonably expectto
occur,including catastrophes.
2. D harm aInsurancecom pany hasannualdirectw ritten prem ium sofRs100 croresand
policy holderssurplusofRs50 crores.Ithasaveraged 10 percentannualgrow th over
thepastdecadeand expectsto continueto grow ataboutthesam erate.Itscom bined
ratio hasexceeded 100 percenteach yearforthe lastdecade,averaging 102 percent
fortheperiod.Ithasreported an operating profiteach yearforthelastdecade,butthe
profithasbeen sm allin som e years.A high rated portfolio ofbondsand otherfixed-
incom e securitiesaccountsforabout95 percentofitsinvested assets.The balance
consistsofcarefully selected preferred and equity stocks.
D harm a w ritescom m ercialm otorinsurance,generalliability,fire and allied linesof
insurance.Itw ritessm allto m edium -sized com m ercialand industrialrisks.A survey
ofits outstanding policies show ed thatabout95 percentofits liability policies had
occurrence lim its of Rs1.0 crore and less,and about95 percentof other policies
proved coverage ofRs 1.5 crore orless.M anagem enthas decided to setits treaty
lim its to cover those am ounts and to depend on facultative reinsurance for the
policiesw ith greaterlim its.D harm a doesnotneed surplusrelief,and so no pro rata
reinsurancew illbepurchased.D iscuss.
SO LU TIO N :
Perrisk orperpolicy excesstreatiesw illbepurchased forboth liability and property
insurance.M anagem entm ay decide thatthe insurercan afford to assum e individual
lossesupto 0.5 percentofdirectw ritten prem ium ,or1.0 percentofpolicy holders
surplus.Consequently,theretention underboth theliability and othertreatiesw illbe
setatRs50 lacsperloss.Treaty lim itsw illbeRs50 lacsforliability and Rs1.0 crore
form ortgage losses.Thus,the prim ary insurers retention and the treaty lim its w ill
fully coverabout95 percentofallpoliciesissued.
III-103
M O D U LE-III:RISK M A N A G EM EN T A N D REIN SU RA N CE
The propertiesinsured by the prim ary insurerare spread w idely acrossthe country,
butseveralareas have high concentrations ofvalues subjectto catastrophe losses.
Thew orsttragedycanoccurincoastalareasw herelossescouldgouptoRs5crore.A
catastrophe treaty w ith a lim itofRs 5 crore and a retention ofRs 50 lacs w illbe
purchased to covertheexposure.
III-104
DIRM
MODULE IV
BUSINESS STRATEGIC
PLANNING & INFORMATION
TECHNOLOGY
MODULE IV
BUSINESS STRATEGIC PLANNING &
INFORMATION TECHNOLOGY
Chapter 1
Management of Insurance Companies ...................................................................IV-1
Chapter 2
BPO and Insurance ...............................................................................................IV-11
Chapter 3
Exchange Control and Taxation ...........................................................................IV-19
Chapter 4
System Development Process ..............................................................................IV-24
Chapter 5
System Analysis ...................................................................................................IV-35
Chapter 6
System Design ......................................................................................................IV-40
Chapter 7
System Implementation and Operation ............................................................... IV-48
Chapter 8
Computer Software and Configuration ................................................................IV-57
Chapter 9
Data Storage and Processing Methods......................................IV-71
Chapter 10
Information System Controls ...............................................................................IV-84
Chapter 11
Data Security and Integrity ................................................................................IV-100
Chapter 12
Information Technology and Insurance .............................................................IV-116
Chapter 13
Pricing and Marketing of Insurance ...................................................................IV-121
Chapter 14
Case Studies... IV-139
C hapter 1
M anagem entof
Insurance C om panies
IV-1
M O D U LE-IV :BU SIN ESS STRA TEG IC PLA N N IN G
12. Insurance m arkets in the industrial countries do not offer the sam e
opportunitiesfor grow th in thenext10 yearsastheem erging econom ies. This
trend hascontributed tow ards
(a) D e-tariffing
(b) G lobalisation
(c) Increasein tradebarriers
(d) Entry ofM N C (insurers)into developing econom ies
SEC TIO N -A :A N SW ER S
1. d 2. c 3. a 4. b 5. d 6. c
7. a 8. a 9. c 10.d 11.a 12.d
1. W hatarethedifferentbasesofclassification ofinsurance?
A ns:D ifferentyardsticks like tim e period of insurance policy,nature of risk coverage,
nature ofsubjectm atterorinsurable interest,purpose ofinsurance can be applied to
classify insurancein India.Som eofthepopularbasesofclassification include:
Personal,Property and Liability Insurance
G overnm ent(orsocial)and PrivateInsurance
V oluntary and Involuntary Insurance
Long-term and Short-term Insurance
Lifeand G eneralInsurance
Firstand Third Party Insurance
Itm ay benoted thattheseareoverlapping classifications.Forexam ple,lifeinsurance
isform ofpersonalinsurancew hich isusually long-term in nature.
IV-3
M O D U LE-IV :BU SIN ESS STRA TEG IC PLA N N IN G
3. Listoutthevariousfunctionsofinsurers.
Thefunctionsperform ed by any insurernecessarily depend on thetypeofbusinessit
w rites,thedegreeto w hich ithasoutsourced certain functions,thefinancialresources
available,the size and nature ofthe insurerand a hostofotherfactors.H ow ever,a
broad rangeoffunctionsarecom m on to alm ostallinsurers.Thesefunctionsare:
1. Production (Selling and M arketing)
2. U nderw riting
IV-4
M O D U LE-IV :BU SIN ESS STRA TEG IC PLA N N IN G
3. RateM aking
4. Claim sM anagem ent
5. Investing and Financing
6. Record keeping and A ccounting
7. M iscellaneousfunctions
4. W hatisProduction in insuranceand briefly discussitsuniquecharacteristics.
Insurance is an intangible item and thus does notexistuntila policy is sold.In the
insurance industry,therefore,the actofselling isproduction in the truestsense and
the function thatcorresponds to selling orm arketing in otherbusinesses is usually
referred to asproduction in theinsuranceindustry.
The production (or sales) m anagem ent team coordinates and m anages the
relationships w ith agents in the field.W here an insurance com pany has exclusive
agents,ithasto m aintain ahigh degreeofcontrolovertheactivitiesoftheagent.The
function encom passes the recruitm ent,training and supervision of such agents.In
India,the IRD A (Insurance Regulatory and D evelopm entA uthority)haslaid dow n
the qualification and training necessary forsuch agents.Som e insurance com panies
havedesignated theiragentsas Certified FinancialPlanner .Them ain task ofthese
agentsisto reach outto custom ersand sellthepolicy.They areoften thepublicface
of the insurance com pany.A n insurance com pany needs a sufficient num ber of
applicants(policyholders)foritto beaviableentity.
5. Selection and classification of risks is a very vital function in insurance
business. D iscuss.
U nderw riting is the process ofselection ofrisks.The insurance com panies need to
selecttherisksto insurein accordancew ith thecom panies policies.Theobjectiveof
underw riting isto ensure thatthe applicantw illnotsuffera lossthatism uch greater
than w hatw asassum ed atthe tim e the prem ium sare fixed.The insurance com pany
establishes certain standards ofselection,w hen the prem ium rates are form ulated,
keeping in m ind the physicaland m oralhazards.For exam ple,the com pany m ay
decidethatitw illnotinsureagainsttheftand burglary,ifthenearestpolicestation is
m orethan 16 km aw ay.A lifeinsurancecom pany m ay sim ilarly decidenotto insure
the life ofsom eone w ho w orks in a hazardous environm ent,say,a stuntm an in the
film industry.
W hen considering an application fortheftand burglary insuranceofapieceofproperty
w herethenearestpolicestation is17 km aw ay orw hileconsidering an application for
lifeinsuranceofafilm stuntm an,theunderw riterneedtoconsiderw hetherhecanm ake
an exception to the com pany policy.The underw riterneeds to evaluate w hatw ould
happen ifa large num berofsuch policiesw ere w ritten and ifa significantnum berof
claim sarose.U nderw ritershaveto strikeabalancew ith RateM aking.RateM aking is
an extrem e balancing actbetw een being very liberaland taking m ore risk than is
w arranted and being very strictand losing too m any custom ers.
IV-5
M O D U LE-IV :BU SIN ESS STRA TEG IC PLA N N IN G
The field agentis also expected to do som e prelim inary screening ofthe applicant
before forw arding it to the insurance com pany s underw riter. In m any fields of
insurance,the agentcan m ake binding decision on behalfofthe insurance com pany,
butthesedecisionsaresubjectto postunderw riting by theinsurancecom pany and the
contractiscancelableon giving duenoticeto theinsured.
There are som e functions that are allied to underw riting or provide support to
underw riters.In lifeinsurance,forexam ple,aphysician m ay providem edicalreports
on prospective applicants. The physicians m ay be appointed or licensed by the
insurance com pany. Sim ilarly in property and m arine insurance, inspectors w ho
inspectvalue and assess the risks involved in insuring the property m ay assistthe
underw riter.
A notherfunction oftheunderw riting departm entispolicy w riting.In m ostcases,the
agentissuesthepolicies,buttheunderw riterhasto check w hethertherateshavebeen
accurately charged,w hetherornotthe agenthastaken a prohibited risk and w hether
theapplicanthasfollow ed alltheterm sand conditions.
6. W hatisratem aking? Stateitssignificance.
RateM aking isan extrem ely technicalfunction,w hich involvesselection ofclassesof
insurableunitson w hich statisticsiscollected regarding probability ofloss.In thecase
oflife insurance,itusually involvesestim ating m ortality ratesaccording to age,sex,
occupation and otherfactors including lifestyle habits and choices such as sm oking/
drinking,etc.In otherfields,like property and liability insurance,ratem aking is an
extrem ely com plicated and a large num berofvariablesneedsto be factored in before
ratesarefixed.Ratem aking isaspecialised field thatisusually overseen by actuaries.
A ccurate rate m aking requires huge am ounts of inform ation collected over long
periods oftim e in orderto predictthe potentialloss from each class ofassets.The
prem ium charged by an insurance com pany isthe am ountofanticipated loss(called
pureprem ium )plusthecostofdoing business(called loading).
Forexam ple,ifan insurance com pany expects to pay Rs.600,000 by w ay ofm otor
vehicle insurance claim s fora particularclass ofinsured (say truck operators)and
there are a totalof1000 trucks am ong the insured,the pure prem ium w orks outto
Rs.600 pertruck.Thispureprem ium hasto beincreased by thecostofdoing business
w hich includes expenses such as agents com m issions,generalcom pany expenses,
prem ium s,taxes and fees,and the profitm argin.The sum of pure prem ium and
loading is w hatthe custom eractually pays the insurance com pany and this sum is
called grossprem ium .G uidelinesforratem aking arefixed by theIRD A .
7. C laim s m anagem ent is crucial to the success of an insurance com pany.
D iscuss.
Settling claim s under insurance contracts is the function of claim s m anagem ent,
w hich is often perform ed or supervised by risk m anagers. This activity usually
requires field w ork,and use ofoutside expertise in the form ofloss assessors and
IV-6
M O D U LE-IV :BU SIN ESS STRA TEG IC PLA N N IN G
IV-8
M O D U LE-IV :BU SIN ESS STRA TEG IC PLA N N IN G
IV-9
M O D U LE-IV :BU SIN ESS STRA TEG IC PLA N N IN G
IV-10
C hapter 2
BPO and Insurance
SEC TIO N -A :A N SW ER S
1 c 2 c 3 d 4 d 5 d 6 a
7 a 8 a 9 d
IV-12
M O D U LE-IV :BU SIN ESS STRA TEG IC PLA N N IN G
IV-13
M O D U LE-IV :BU SIN ESS STRA TEG IC PLA N N IN G
IV-14
M O D U LE-IV :BU SIN ESS STRA TEG IC PLA N N IN G
the organization does not understand its ow n requirem ents,it w ill not be able to
com m unicate them to an outside provider.H ow ever,ifthe organization understands
thereasonsthatm akeaparticularnon-corefunction difficultto m anage,then itm ay be
in aposition to evaluatew hetheroutsourcing m ay beabetteralternative.
M akecapitalfundsavailable
There is trem endous com petition w ithin m ost organizations for capital funds.
D eciding w here to investthese funds is one of the m ostim portantdecisions that
seniorm anagem entm akes.Itisoften hard to justify non-corecapitalinvestm entsw hen
areasm ore directly related to producing a productorproviding a service com pete for
the sam e m oney.O utsourcing can reduce the need to investcapitalfundsin non-core
business functions.Instead of acquiring the resources through capitalexpenditures,
they arecontracted foron an asused operationalexpensebasis.O utsourcing can also
im prove certain financialm easurem ents ofthe firm by elim inating the need to show
return on equity from capitalinvestm entsin non-coreareas.
ShareRisk
Trem endousrisksareassociated w ith theinvestm entsan organization m akes.M arkets,
com petition,governm entregulations,financialconditionsand technologiesallchange
extrem ely quickly.K eeping up w ith these changes,especially those in w hich the next
generation requiresasignificantinvestm ent,isvery risky.O utsourcing providersm ake
investm ents on behalfofm any clients,notjustone.Shared investm entspreads risk,
and significantly reducestherisk borneby asinglecom pany.
Cash Infusion
O utsourcing often involvesthe transferofassetsfrom the custom erto the provider.
Equipm ent,facilities,vehiclesand licensesused in thecurrentoperationshavevalue
and aresold to thevendor.Thevendorthen usestheseassetsto provideservicesback
to the client.D epending on the value ofthe assetsinvolved,thissale m ay resultin a
significantcash paym entto the custom er.W hen these assetsare sold to the vendor,
they are typically sold atbook value.The book value can be higherthan the m arket
value.In these cases,the difference betw een the tw o actually representsa loan from
thevendorto theclient,w hich m ay berepaid by thepriceoftheservicesoverthelife
ofthecontract.
3. Identify theareasin w hich outsourcing isfeasiblein insurancecom panies.
Traditionally,com panies have outsourced supportfunctions thatallow ed them to
concentrate their focus on activities that contribute to grow th. The scope of
outsourcing hasdram atically increased.Presently,thefollow ing classesofprocesses
arebeing outsourced:
Field-based Services
Services perform ed over a large geographicalarea,including loss prevention and
prem ium auditing.
IV-15
M O D U LE-IV :BU SIN ESS STRA TEG IC PLA N N IN G
FinancialRecoveries
Thisincludessubrogation and prem ium (and overdueprem ium )collection.
D ata M anagem entand Analysis
Insurance com paniesneed to have the ability to turn volum esofdata into actionable
inform ation.This data m ay pertain to theircustom ers,agents,claim s and policies,
and even com petitors.It is necessary for an insurance com pany to analyse their
custom er sneedsand tailorallthebusinessprocessesto effectively m eetcustom er s
requirem ents.H erebusinessintelligencetoolslikedataw arehousing and datam ining
can be of trem endous help. H ow ever, since these specialised skills m ay not be
availableto insurancecom panies,they often outsourceit.
4. D iscuss the m ethodology of outsourcing and also the factors influencing
successfuloutsourcing.
There are asm any m ethodologiesforoutsourcing asthere are consultants.A broad
m ethodology foran outsourcing agreem entw ould be:
D eterm inetheactivity to outsource.
Evaluatethefinancialim pactofoutsourcing.
A ssessthenon-financialcostsand advantagesofoutsourcing.
Choosean outsourcing partnerand contracttherelationship.
D eterm inewhatto outsource
O utsourcing initiativesm ustcom e from the top.U pperm anagem entm ustarticulate
the goals and objectives of the outsourcing initiative and com m unicate how the
process w ill benefit the organisation. In m ost cases, it is unw ise to outsource
som ething thatprovidesunique com petitive advantage.Thus,core com petenciesare
neveroutsourced.
Evaluatethefinancialim pactofoutsourcing
O utsourcing likely offerscostadvantagesifavendorcan realizeeconom iesofscale.
A com plete financialanalysisshould include the im pactofincreased flexibility and
productivity ordecreased tim eto m arket.
Assessthenon-financialcostsand advantages
O utsourcing m ay also bring expertise or innovation available only in a firm
specialized in itschosen field.Even ifan activity iskeptinhouse,the evaluation of
externalresourcesm ay im proveinternalperform ance.
Choosean outsourcing partner
Candidates should be qualified and selected according to both their dem onstrated
effectiveness and theirability to w ork collaboratively.The contractshould include
clearly established perform anceguidelinesand m easures.
The em phasisfrom the outsetshould notbe on w ho w insthe bestdeal,butratheron
IV-16
M O D U LE-IV :BU SIN ESS STRA TEG IC PLA N N IN G
IV-17
M O D U LE-IV :BU SIN ESS STRA TEG IC PLA N N IN G
IV-18
C hapter 3
ExchangeC ontroland Taxation
1. Follow ing institutions and/or regulations have dealt or deal w ith Foreign
Exchangem anagem entin India EX C EPT:
(a) ReserveBank ofIndia
(b) FERA ,1973
(c) IRD A
(d) FEM A ,1999
2. C urrently foreign insurerscan operatein India in oneofthefollow ing w ays:
(a) 26% directinvestm entorsetting up ofabranch office
(b) 26% directinvestm entand setting up abranch office
(c) 100% ow ned subsidiary
(d) N oneoftheabove
3. Insurance com panies registered w ith IR D A are perm itted to issue general
insurancepoliciesdenom inated in foreign currency only in caseofthefollow ing:
(i) M arine insurance for vessels ow ned by foreign shipping com panies and
chartered by Indian com panies
(ii) A viation insurance foraircraftsim ported from outside India on lease basisfor
thepurposeofairtaxioperations,etc.
(a) O nly i
(b) O nly ii
(c) Both i& ii
(d) N one
4. The incom e of a Life Insurance C om pany w ill not be com puted under the
______ heads,but w illbetaxed asa ________item .
(a) V arious Single
(b) Single V arious
(c) V arious D ouble
(d) D ouble V arious
IV-19
M O D U LE-IV :BU SIN ESS STRA TEG IC PLA N N IN G
5. The absence ofa policy duly stam ped does notaffectthe ___________ ofthe
contract, butan unstam ped policy cannotbeadm itted as___________.
(a) validity .evidence
(b) evidence .proof
(c) eitheroftheabove
(d) noneoftheabove
SEC TIO N -A :A N SW ER S
1. c 2. a 3. c 4. a 5. a
IV-22
M O D U LE-IV :BU SIN ESS STRA TEG IC PLA N N IN G
profits as disclosed in the annualaccounts as com puted under the Insurance A ct.
Though the profitsoflife insurance businessare to be com puted separately from the
profits ofnon-life insurance business orotherbusiness carried on by the assessee,
any lossincurred in life insurance businesscan be setoffagainstprofitsofnon-life
insurancebusinessorotherbusiness.
Non-ResidentInsurers
TheIncom eTax A ctlaysdow n provisionsw ith respectto theincom ereceived by an
assessee from the businessofinsurance,w hetherthe com pany w hich receivessuch
businessincom eisresidentin Indiaornot.In theabsenceofreliabledata,theprofits
and gainsofanon-residentinsureristaken to bethatproportion ofthew orld incom e
w hich correspondsto the proportion w hich the prem ium incom e derived from India
bearsto thetotalprem ium .
4. D iscuss how the provisions of the Indian Stam p A ct,1899 are applicable to
insurancecontracts.
Stam p D uty
W hen a contract of insurance is effected, it is necessary to get it stam ped in
accordance w ith the stam p duty prescribed foreach kind ofpolicy underthe Indian
Stam p A ct,1899 (Stam p A ct).The ratesofstam p duty on insurance policiesare the
sam e throughoutIndia.The absence of a policy duly stam ped does notaffectthe
validity ofthecontract,butan unstam ped policy cannotbeadm itted asevidence.
The insurance policy is an actionable claim and is therefore treated as im m ovable
property.TheprovisionsoftheStam p A ctapplicableto im m ovableproperty arealso
applicable to insurance policies. A n assignm ent executed on the reverse of an
insurance policy isnotrequired to be stam ped.H ow ever,an assignm entm ade on a
separate piece of paper does require stam ping.Issuing a policy that is not duly
stam ped is a punishable offence w ith a fine w hich m ay extend up to Rs. 200.
G enerally,the stam p duty on a life insurance policy orgroup insurance isborne by
theperson effecting theinsurance.In thecaseofafireinsurancepolicy,theinsureris
liableto bearthestam p duty.
IV-23
C hapter 4
System D evelopm entProcess
SEC TIO N -A :O BJEC TIV E TY PE Q U ESTIO N S
(b) Review and approve the IS departm ents w ork program m e and determ ine
prioritiesforprojects.
(c) Review periodicprogressreportson activesystem sprojects.
(d) Review and rejectproposed plansforsystem im plem entation.
6. The various w ays in w hich different accountants can becom e involved in the
system developm entprocessareasfollow s:
(i) System specialist
(ii) Consultant
(iii) Staffaccountant
(iv) Internalauditor
(v) Independentauditor
(a) i,ii,iiionly
(b) ii,iii,iv only
(c) iii,iv,v only
(d) alloftheabove
7. C om ponentsoftheSystem D evelopm entLifeC ycleincludes:
(a) System planning
(b) System analysis& System D esign
(c) System im plem entation
(d) A lloftheabove
8. C A SE toolsstand for
(a) Com puterA ided Softw areEngineering
(b) Com puterA nd Softw areEngineering
(c) Com puterA ided System Engineering
(d) N oneoftheabove
9. _______________ isan iterative processthatavoidsthe structure and periodic
form al approval process of the traditional approaches. It relies on the
developm entofa w orking m odelofthenew system .
(a) Prototyping
(b) Photo typing
(c) X ero typing
(d) N oneoftheabove
10. O bjectoriented developm entisa m ethod for creating system sthatthink ofthe
w orld as a set of ________________ that are related to one another and that
com m unicatew ith oneanother.
(a) classes
(b) objects
IV-25
M O D U LE-IV :BU SIN ESS STRA TEG IC PLA N N IN G
SEC TIO N -A :A N SW ER S
1 b 2 c 3 b 4 b 5 d 6 d
7 d 8 a 9 a 10 b
IV-27
M O D U LE-IV :BU SIN ESS STRA TEG IC PLA N N IN G
IV-30
M O D U LE-IV :BU SIN ESS STRA TEG IC PLA N N IN G
from varied backgrounds,and each contributes unique skills to the design process.
A ccountants usually participate in the design of an accounting system ,and so do
personnelfrom the affected operating departm ents.Forexam ple,the design ofan
orderentry system requiressom eone from salesorm arketing.The design ofa cost
accounting system requires inputfrom production.Frequently these personnelare
tem porarily relieved oftheirnorm aldutiesand assigned full-tim eto theproject.A ny
projectteam also has people from the IS departm entw ho are experienced in the
design and developm ent process. These include system s analysts, program m ers,
docum entation specialists,and technicalconsultants.
4. D iscussthe role and responsibility ofInform ation System sSteering C om m ittee
in system developm ent.
Theauthority forapprovalofprojectisusually vested w ith an IS steering com m ittee
to ensurethat:
Existing IT resourcesareused efficiently and effectively.
O rganizationalobjectivesareachieved.
System s developm entresources are allocated consistently across allbusiness
functions.
TheresponsibilitiesoftheISSC include:
1. Review and approve for further study all projects requested by operating
departm entsortheIS departm ent.
2. Review and approve the IS departm ents w ork program m e and determ ine
prioritiesforprojects.
3. Review periodicprogressreportson activesystem sprojects.
4. Review and approveproposed plansforsystem im plem entation.
5. Review periodically theIS departm entsbudget.
The projectteam should provide userinputto the developm entprocessthroughout.
U serrepresentativesshould beinvolved notonly in developing specificationsforthe
system butalso in coordinating the project,in perform ing costbenefitanalyses,and
in planning thefinalim plem entation ofanew system .
5. C om bining the know ledge ofIT,business,accounting,auditing and internal
controlw illensurethatthenew system m eetstheneedsoftheuserand possesses
adequate internalcontrols. D iscuss how this is achieved and w ho can play a
uniquely qualified rolein thisprocess.
M ost accountants play a uniquely qualified role in the process of system s
developm entbecausethey:
M ay beam ong thefew peoplein an organization w ho can com bineknow ledge
of IT,business,accounting,and internal control,as w ell as behaviour and
com m unications,to ensure thatnew system s m eetthe needs of the user and
possessadequateinternalcontrols.
IV-31
M O D U LE-IV :BU SIN ESS STRA TEG IC PLA N N IN G
accounting system s follow s a distinct cyclical pattern com m only called the
System D evelopm entLifeCycle(SD LC).
The System D evelopm ent Life Cycle describes how an inform ation system
progressesfrom itsconception asan idea,through thedevelopm entprocess,and into
routine operation.Typically,the cycle begins as a m anagerrecognizes a need that
existing inform ation system sdo notsatisfy.Thism anagerm ay proposeasolution or
m ay w anta problem studied by som eone else w ho can suggestpossible solutions.
M anagem entappointsastudy team to apply thesystem study processto theproblem .
The study team m ay increase in size and m ay im plem enta new inform ation system
asasolution to theproblem .Thissolution m ay beused form any yearsbeforeanother
m anagerrecognizessom eotherneed forinform ation thatthesystem doesnotsatisfy.
Then thecyclebeginsagain.
C om ponentsoftheSD LC
SD LC com ponentsinclude
System splanning,
System sanalysis,
System sdesign,
System sim plem entation,and
System soperation.
Three of the com ponents analysis, design, and im plem entation com pose the
system developm entprocessand m ay require a few m onthsto a few years.The fifth
com ponent,operation,m ay lastfordecades.Forexam ple,onem ajoroilcom pany has
used the sam e payrollsystem forover30 years.D eveloped in the m id 1970s,this
system required approxim ately tw o yearsto develop.
7. W hatisa system sdevelopm entm ethodology? D escribeitscharacteristics.
A system sdevelopm entm ethodology (also know n assystem sdevelopm entlifecycle
[SD LC] m ethodology) is a form alized,standardized,docum ented setof activities
used to m anage a system s developm ent project. It should be used w henever
inform ation system s are developed,acquired,or m aintained.The m ethodology is
characterized by thefollow ing:
Theprojectisdivided into anum berofidentifiableprocesses,and each process
has a starting point and an ending point. Each process com prises several
activities,one or m ore deliverables,and severalm anagem entcontrolpoints.
The division ofthe projectinto these sm all,m anageable steps facilitates both
projectplanning and projectcontrol.
Specific reports and other docum entation, called deliverables, m ust be
produced periodically during system s developm ent to m ake developm ent
personnelaccountable forfaithfulexecution ofsystem sdevelopm enttasks.A n
organization m onitors the developm entprocess by review ing the deliverables
thatare prepared atthe end ofeach key step.M any organizationsrely on this
IV-33
M O D U LE-IV :BU SIN ESS STRA TEG IC PLA N N IN G
docum entation for training new em ployees; it also provides users w ith a
referencew hilethey areoperating thesystem .
U sers,m anagers,and auditorsare required to participate in the project.These
people generally provide approvals,often called signoffs,atpre-established
m anagem ent control points. Signoffs signify approval of the developm ent
processand thesystem being developed.
The system m ustbe tested thoroughly priorto im plem entation to ensure thatit
m eetsusers needs.
A training plan isdeveloped forthosew ho w illoperateand usethenew system
Form alprogram m e change controls are established to preclude unauthorized
changes to com puter program m es.Lack of controlover program m e changes
jeopardizes the security of the entire system . Program m e change controls
provideassurancethatallm odificationsto program m esStructured System sare
authorised, and ensure that changes are com pleted, tested and properly
im plem ented. Changes in program m e should be also be reflected in the
docum entation.
A postim plem entation review ofalldeveloped system sm ustbe perform ed to
assess the effectiveness and efficiency of the new system and of the
developm entprocess.
A n organization ssystem sdevelopm entm ethodology isusually docum ented in
theform ofasystem sdevelopm entstandardsm anual.A m ong otheritem s,such
m anualsoften indicate:
M ethodsofrequesting system sdevelopm ent.
Procedures to be follow ed,techniques to be used,and docum entation to be
prepared during system sdevelopm ent.
Review sto beperform ed and signoffsto beobtained.
Theseproceduresensurethatdevelopm enteffortsareefficientand consistently
lead to inform ation system sthatm eetorganization needs.
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M O D U LE-IV :BU SIN ESS STRA TEG IC PLA N N IN G
C hapter 5
System A nalysis
4. V arious system tools used during prelim inary survey include w hich of the
follow ing:
(i) D ocum entation review
(ii) U sing interview s
(iii) D atam odeling
(iv) W ork m easurem ent
(v) Procedurem odeling
(vi) A uditreports
(a) i,ii,iii,iv
(b) i,ii,iii,iv,vi
(c) ii,iii,iv,v,vi
(d) iii,iv,v,vi,
(e) i,iii,iv,v,vi
5.-8.In a data flow diagram ,m atch thefollow ing correctcom binations:
(W ritethecorrectalphabetin the[]box)
(i)Circles [] (a)Externaldestinationsfordata
(ii)Squares [] (b)Processes
(iii)Rectangles [ ] (c)D ataflow
(iv)A rrow s [] (d)D atastore
9. Processm odeling isused forw hich ofthefollow ing purposes?
(a) Sum m arising
(b) D ocum enting
(c) A nalysing
(d) A lloftheabove
10. Feasibility study includesw hich ofthefollow ing?
(i) TechnicalFeasibility
(ii) O perating Feasibility
(iii) Tim e Feasibility
(iv) Econom ic Feasibility
(a) i,iionly
(b) ii,iiionly
(c) iii,iv only
(d) alloftheabove
11. Follow ing could betheoutcom eofsystem analysis:
(a) D o nothing
(b) M odify existing system
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SEC TIO N -A :A N SW ER S
1. d 2. a 3. d 4. b 5. b 6. a
7. d 8. c 9. d 10.d 11.d
SEC TIO N -A
(a) i,iionly
(b) ii,iii,iv only
(c) iii,iv,v only
(d) alloftheabove
5. O nce the design team identifiesthe necessary featuresfor the system ,w hich of
thefollow ing arechosen:
(a) InhouseD evelopm ent
(b) Softw areD evelopm entCom panies
(c) Com puterm anufacturers
(d) A ny oneoftheabove
6. W hat are the considerations in choosing betw een inhouse developm ent or an
externalsoftw arepackage:
(i) U serA cceptance
(ii) Required M odifications
(iii) V irusprotection
(iv) Q uality ofInstruction M anuals
(v) Installation Costs
(vi) Installation Tim e
(a) i,ii,iiionly
(b) ii,iii,iv only
(c) i,ii,iii,iv,v
(d) i,ii,iv,v,vi
7. W hatarethew aysin w hich an organisation can acquirecom puterequipm ent?
(i) Purchase
(ii) LeaseorRental
(iii) Servicebureau
(iv) Rem otebatch
(v) Tim esharing
(a) ionly
(b) iionly
(c) ii,iii,iv only
(d) any oneoftheabove
8. ___________________ isan inform allanguagethatusesEnglish likestatem ents
representing theactionsperform ed by com puterlanguageinstructionsafterthe
m oduleisprogram m ed.
(a) N ano code
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SEC TIO N -A :A N SW ER S
1. a 2. a 3. d 4. d 5. d 6. d
7. d 8. b 9. d 10.d
for it during preliminary system design. The five alternative ways in which an
organisation can acquire computer equipment follow.
PURCHASE
Organizations frequently choose to purchase the additional equipment required by a
new system. An organisation with existing equipment may have a preferred
manufacturer and may be knowledgeable about equipment that is available.
Because of this knowledge and experience, the firm is willing to make the
investment required by a purchase. Purchasing may provide tax benefits to profit
making businesses. However, this alternative requires a large initial cash outlay.
Furthermore, in later years the equipment may become obsolete, and the organisation
may have difficulty selling it.
LEASE OR RENTAL
Many organizations choose to rent or lease computer equipment. A lease is a rental
of the equipment for a length of time fixed by a lease contract. The acquiring
organisation contracts with a bank or leasing company that provides the equipment
in return for a monthly rental fee. Computer equipment leases commonly extend
from two to five years. By leasing or renting, the acquiring organisation avoids the
initial large cash outlay of a purchase. However, the total of the lease or rental
payments over several years exceeds the purchase cost of the same equipment.
Leasing or renting allows the organisation to avoid many risks of technological
obsolescence that purchaser incurs.
SERVICE BUREAU
A service bureau is a business that provides computer services to other organizations
for a fee. The service bureau owns its computer equipment and provides programs
for many processing applications. An organisation records events on its own source
documents and then delivers them to the service bureau. The service bureau converts
the transactions into computer readable form, processes them, and returns them
along with reports to the organisation. A service bureau is a good alternative for an
organisation that has no experience with computerized data processing. It can obtain
many of the advantages of computerization without establishing an IS department.
However, the organisation is restricted to only those applications that the service
bureau provides. And if the number of transactions is large, using a service bureau is
an expensive alternative.
REMOTE BATCH
Remote batch processing results from a modification of the procedures used by a
service bureau. With remote batch, the organisation installs at its own location
equipment that converts transactions into computer readable form. Its employees
accumulate transactions into batches, convert them into computer files, and transmit
these files over telephone lines to a computer at another location. The company that
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M O D U LE-IV :BU SIN ESS STRA TEG IC PLA N N IN G
A uditM odules
M any m odern system sdo notcontain thekind ofaudittrailthatauditorsprefer.Som e
of these system s enter a transaction into the system and im m ediately postitto a
ledger,w ith no record on paper of interm ediate processing steps.Thus,auditors
cannotestablish thereliability ofthesystem by sim ply exam ining evidenceprovided
in itsreportsby theaudittrail.To determ inethatsuch asystem isproducing accurate
data,auditorsintroduceauditm odulesinto thesystem sprogram m es.
A n auditm odule isa segm entofan application program m e thatenablesauditorsto
exam ine transactions in digitalform as they are processed by the program m e.A n
audit m odule m ay, for exam ple, allow for exam ining transactions for a special
characteristic such asa high m onetary value.Transacting thathasthischaracteristic
aresum m arized in afileforlaterreview by an auditor.
A uditm odules are difficultto add to program m es in existing system s.H ow ever,if
created during system design they can beim plem ented atreasonablecost.D uring the
review of design docum entation, auditors look for opportunities to em bed audit
m odulesinto thesystem sprogram m es.
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C hapter7
System Im plem entation
and O peration
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SEC TIO N -A :A N SW ER S
1. a 2. d 3. c 4. b 5. d 6. d
7. c 8. d 9. b
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1. W hatis System Im plem entation? W hatare the various activities taking place
during thesystem im plem entation.
The im plem entation phase is the period oftim e during w hich a w orking system is
produced and placed in operation. Im plem entation begins w hen the inform ation
system s steering com m ittee accepts the detailed specifications produced during
system design.It ends w ith the acceptance of the system by m anagem ent as an
operationalsuccess.The inform ation system ssteering com m ittee appointsa project
team to com pleteim plem entation.Thisprojectteam consistsofm em bersofthedesign
team ,program m ers,docum entation specialists,and dataentry clerks.
Five m ajor activities take place during the im plem entation phase: equipm ent
installation,coding,training,testing,and conversion.U nlikethosein thesystem design
phase, som e of these activities m ay occur sim ultaneously. A uditors participate in
im plem entation by review ing tw o oftheactivities,testing and conversion.
2. D iscusstheA uditor sInvolvem entin Im plem entation.
A uditorsdevotem oretim eto im plem entation phasethan to system sanalysis,butless
than to system design. They perform critical tasks during tw o im plem entation
activities.
D uring system testing,auditorsreview theadequacy ofthetestdataand theresultsof
the tests.Theirprim ary concern isthatthe testdata adequately evaluate the internal
controls in the system .If system test docum entation does not show that control
m easures are functioning properly, auditors m ay produce their ow n test data to
evaluate these controls. If the controls are not functioning, auditors insist on
m odificationsto thesystem beforeproceeding w ith conversion.
In theconversion activity,auditorsensuretheadequacy ofdataconversion procedures.
They review the plans forconversion priorto its start,and they determ ine thatthese
plansw illm aintainaccuratedataduringchangeover.A fterdataconversioniscom plete,
auditors satisfy them selves thatdata in the new records are com plete and consistent
w ith data contained in the old ones.Because accurate data conversion isso criticalto
theaccuracyofm anagem ent,financialandoperationalreports,theprojectteam usually
appreciatesthisindependentcheck on theiractivities.
This review of the data conversion procedures and results does notterm inate the
auditors involvem entin a new system .A uditors are again involved during review s
thatthey m akein theoperationsphaseoftheSD LC.
3. W hatisPostIm plem entation R eview and w hy isitim portant?
The postim plem entation review follow s the com pletion ofa system developm ent
project.This analysis and appraisal of the new system usually occurs about six
m onths after conversion.Its purpose is to determ ine if the new system m eets the
objectivesestablished foritduring system sanalysis.
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M O D U LE-IV :BU SIN ESS STRA TEG IC PLA N N IN G
ResponsibilityfortheReview
The inform ation system ssteering com m ittee appointsa review team to conductthe
post im plem entation review. The review team norm ally consists of one or tw o
system sanalystsw ho participated in thedevelopm entprocessfrom system sanalysis
through im plem entation.Itshould also includesom eoneim partial,w ho did notw ork
on thedevelopm entproject.Som etim esthecom m itteeappointsan internalauditorto
thereview team forthisreason.
The system s analysts on the review team know the assum ptions m ade w hen the
system w as designed and understand how the system w as intended to w ork.Thus,
during the review they centre theirattention on appraising the system ratherthan on
learning aboutitsdesign.The auditorbringsexpertise in auditability and controlsto
the review team .The review providesthe auditorw ith an opportunity to learn about
the system from analysts w ho designed it.This know ledge is valuable w hen the
auditorconductsperiodicoperationalauditsthroughouttheoperationsphases.
Proceduresin theReview
In itsreview,theteam evaluatestheoutcom eofthesystem design project.Itsm em bers
estim ate the costs and benefits of the system and com pare them to those predicted
during developm ent. They identify the source of differences betw een actual and
predicted costs.They determ ine the adequacy ofthe docum entation provided by the
design team and theim plem entation projectteam .Thereview team also evaluatesuser
satisfaction w ith thesystem ,and theadequacy ofitsinternalcontrols.
Evaluating Costsand Benefits
The firststep in the review is to estim ate the costs and benefits ofthe system .The
review team calculatesthe initialcostsofdeveloping the system .Because the system
hasoperated forseveralm onths,italso developsaccurate estim atesofongoing costs
and savings.The review team calculatesthese and com paresthem w ith the costsand
benefitsprojected during system sanalysis.Thisprovidestheanalystson theteam w ith
feedback concerning theaccuracy ofthecost-benefitanalysis.Thisfeedback aidsthem
w hen perform ing anotherfeasibility analysisforalaterproject.
The review team then determ ines w hy actual costs differ from predicted costs.
D ifferences som etim es arise from uncontrollable sources such as unexpected price
changes,policy changes,orchangesin theeconom icenvironm entoftheorganization.
In othercases,differencesoriginate from controllable sourcesthatinclude inaccurate
estim ates or inefficiencies in the developm entprocess.The review team learns by
identifying thesesourcesand isableto correctthem in futureprojects.
Evaluating D ocum entation
D uring the post-im plem entation review,the review team evaluates the adequacy of
the docum entation forthe new system .Preparing adequate docum entation during a
projectisim portantbecause auditorsreview docum entation asa partofoperational
and financialaudits.A dequate docum entation also aidssystem sanalystsw hen they
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M O D U LE-IV :BU SIN ESS STRA TEG IC PLA N N IN G
investigate future problem s w ith the system . Furtherm ore, an exam ination of
docum entation is an efficient w ay to begin the other procedures in the post-
im plem entation review.
In studying the phases of the SD LC,w e have seen three types of docum entation:
D esign docum entation includes the w orking papers produced by the design team
w hen developing detailed specifications for the system ; user docum entation
describesthefeaturesofthesystem thatuserpersonnelneed to know to perform their
jobs;operationsdocum entation providessim ilarinform ation forpersonnelin the IS
departm ent.
Evaluating U serSatisfaction
Theobjectiveofapostim plem entation review isto determ inew hetheranew system
m eetsitsobjectives.A n effective w ay ofdoing thisisto find outusers reactionsto
the system .In m any cases,users initiate the developm entprocess.Such a system
cannotbe considered a success unless these users think thatthe objectives of the
system havebeen m et.
Com m only the review team determ ines usersatisfaction by conducting interview s
w ith key usersorsupervisorsw ithin theuserdepartm ents.Iftherearem any users,the
team m ay develop questionnairesforthispurpose.
Inputfrom usersduring the review identifiesshortcom ingsin the system design that
areto beavoided in laterprojects.A dditionally,theteam m ay identify problem sthat
can becorrected easily by changesto thesystem sprogram m esorprocedures.
Evaluating InternalControls
Frequently,the review team includes an auditor to evaluate the effectiveness of
internalcontrolin thenew system .A uditorsevaluatecontrolsasapartoftheirroutine
operational and financial audits. H ow ever, by exam ining them during the post
im plem entation review,an auditoridentifiesm aterialcontrolw eaknessesbeforethey
haveaw idespread effecton theaccuracy oftheinform ation system .
The review team paysspecialattention to the errorcorrection proceduresin the new
system . Errors m ay be introduced into data either on input, as transactions are
recorded in com puterreadableform ,orduring processing by com puterprogram m es.
M any control m easures, called detective controls, are included in inform ation
system s to identify these erroneous transactions before they are posted to a ledger.
Error correction procedures provide a m ethod of correcting these erroneous
transactionsand re-entering them into com puterprocessing.
In review ing errorcorrection procedures,the team looks foreitheroftw o possible
occurrences. Som etim es these procedures m ay identify excessive erroneous
transactions,w hich indicate to the auditor thatadditionalpreventive controls are
needed in thesystem to stop theseerrors.O n theotherhand,thesystem m ay identify
few errors,w hich m ay indicate thatadditionaldetective controls are needed.Error
correction proceduresprovidetheauditorw ith an accurateindicatoroftheadequacy
ofinternalcontrol.
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M O D U LE-IV :BU SIN ESS STRA TEG IC PLA N N IN G
Program m ing
D eveloping Program m eLogic
Coding theprogram m e
D ebuging theProgram m e
Training
In som e system developm ent projects, training begins as soon as a prelim inary
system design is com pleted,and itm ay continue into the operations phase.M ost
training,how ever,occursafterthecom pletion ofthedesign phaseand priorto testing
ofthe system .The tw o groupsofem ployeesw ho benefitfrom training are the users
and thecom puteroperationspersonnel.
Testing
A nother activity during the im plem entation phase is testing.This activity follow s
program m ing and m ustprecede conversion,butitm ay proceed atthe sam e tim e as
som e training tasks.Program m er team s test individual program m es as a part of
program m ing;during the testing activity tw o othertestsoccur:interface and system
testing.
Conversion
Conversion istheprocessofchanging from theold system to thenew one.D uring the
conversion activity,the projectteam tests the new system under actualoperating
conditions. Conversion provides the team w ith the opportunity to m ake final
m odifications to the system before the organization relies on it for processing
transactions. The project team com pletes three tasks during conversion: data
conversion,volum etesting,and system changeover.
IV-56
C hapter8
C om puterSoftw areand C onfigurations
SEC TIO N -A :O BJEC TIV E TY PE Q U ESTIO N S
(c) Eitheraorb
(d) Procedurallanguage
5. ______________________ are used to translate a program m e from a
procedurallanguageinto m achinelanguage.
(a) Com pilers
(b) Translators
(c) Triggers
(d) A ny oneoftheabove
6. Thecom ponentsoftheexpertsystem includew hich ofthefollow ing
(i) K now ledgebase
(ii) Inferenceengine
(iii) U serinterface
(iv) Explanation facility
(a) ionly
(b) i,iionly
(c) i,ii,iiionly
(d) i,ii,iii,iv
7. W hatisW O R M ?
(a) W riteonceread m em ory
(b) Com putervirus
(c) W rong O verRightM ethod
(d) N oneoftheabove
8. _____________________________ netw orks connect peripheral devices at
rem otelocationsw ith a singlecentralprocessor,usually a m ainfram ecom puter.
(a) D istributed system s
(b) Teleprocessing netw orks
(c) LocalA reaN etw ork
(d) D istributed A reaN etw ork
9. W hen distributed processing isapplied w ithin a lim ited geographicarea,such as
w ithin a singlebuilding oroffice,thesystem iscalled ______________________
(a) LocalA reaN etw ork
(b) W ideA reaN etw ork
(c) D istributed A reaN etw ork
(d) Sim pleA reaN etw ork
10. ___________________ is a private netw ork that is established by an
organisation and thatbehaveslikean internalinternet.
(a) Intranet
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M O D U LE-IV :BU SIN ESS STRA TEG IC PLA N N IN G
(b) O rganet
(c) LA N
(d) W A N
11. ___________________ is the com puter to com puter transm ission of the data
contained on standard businessdocum entssuch asinvoicesorpurchaseorders.
(a) E Com m erce
(b) E D I
(c) D atatransm ission
(d) N oneoftheabove
SEC TIO N -A :A N SW ER S
1. a 2. c 3. a 4. c 5. a 6. d
7. a 8. b 9. a 10.a 11.b
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M O D U LE-IV :BU SIN ESS STRA TEG IC PLA N N IN G
operating system softw are from a secondary storage device into m ain storage.The
operating system then takescontrolofthecom puter.Som etim estheoperating system
allow s otherprogram m es to controlthe centralprocessing unit(CPU )tem porarily,
butcontrolalw ays returns to the operating system .The five basic functions ofan
operating system areasfollow s:
Job control. K eeping U tility Program m es track of jobs subm itted for
processing.
Job scheduling. A ssessing the priority of jobs aw aiting processing and
assigning them to aqueue.
Library m anagem ent. M aking available various application and system s
program m esneeded in executing individualjobs.
M em ory m anagem ent.K eeping track ofm ain m em ory usageand allocating itto
individualjobsforstoring theirinstructionsand data.
Peripheralm anagem ent.K eeping track ofinputand outputdevicesin use and
assigning outputto them asitisproduced by theCPU .
Exam plesofO perating System sincludeD O S,W indow s,U nix,Linux,etc.
(b) U tility Program m es
Com puter m anufacturers or program m es developers norm ally provide utility
softw are.A utility program m e perform sa specialized function such assorting data,
printing outthe contentsofm ain storage orofa com puterfile,orrestoring data that
hasbeen deleted from acom puterdisk.
Exam ples ofU tility Program m es in D O S/W indow s include Copy,Form at,D ebug,
Find,etc.
(c) LanguageTranslation Program m es
Languagetranslation program m esconvertapplication program m esw ritten in aform
understood by hum ansinto aform thatthecentralprocessorcan interpret.
M ostpeople prefer com puter languages thatresem ble either English sentences or
m athem aticalequations,Procedurallanguages,such asCO BO L orBA SIC,havethis
characteristic. The Central Processing U nit (CPU ), how ever, requires instructions
w ritteninabinaryform orm achinelanguage.Theseinstructionsaredifficultforpeople
to interpret,so w eusually w ritethem in asym bolicform called assem bly languages.
Program m ers use softw are packages called com pilers to translate a program m e
from a procedurallanguage into m achine language.The proceduralversion ofthe
program m e is the source program m e;the m achine language version is the object
program m e.Som e languages,such asBA SIC,also have interpreters.A n interpreter
translatesprocedurallanguage instructionsone ata tim e,ratherthan translating the
entireprogram m eatonce.A lthough avoiding com pilation m akesiteasierforusersto
debug a program m e,itslow sthe program sexecution.Forthisreason,professional
program m ers norm ally use com pilers rather than interpreters in developing
system s.
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M O D U LE-IV :BU SIN ESS STRA TEG IC PLA N N IN G
Expertsystem sforcom plex decisionsaretim econsum ing and difficultto develop and
m ay be expensive. Furtherm ore, the developer m ust anticipate every possible
occurrence w hen creating the system and program m e the system to handle it.W hen a
new orunforeseen situation develops,theexpertsystem doesnotm akegood decisions.
2. W hatdo you understand by objectoriented system s? D iscuss.
N ew erkindsoftranslation program m es,called object-oriented program m ing system
(O O PS)languages,are m ore flexible than traditionallanguages.A n objectoriented
system can processvery generaldata form scalled objects.A n objectisa com puter
representation ofaperson,place,orthing.A n objectm ay includenotonly traditional
data such as nam es,addresses,and accountbalances,butalso binary data of any
form .These include the visualim agesand audio sound trackscurrently recorded on
laserdisks.They also includeexecutablecom puterprogram m es.
W hen storing visualim ages,organizations use a specialkind ofdata m anagem ent
softw are called im aging system s.Im aging system sscan docum ents,convertthem to
binary form ,and storethem in com puterm em ory orexternalstoragedevices. W rite
onceread m em ory (W O RM )system srecord im ageson disksthatareindestructible
and can be read w ith laserbeam .Thisavoidsthe tim e-consum ing data entry process
using akeyboard.
O O PSsm akeitpossibleto storethecom putercodeforprocessing dataalong w ith the
data itself.This feature,called encapsulation,is an im portantadvantage of object
oriented system s.
D eveloping O bject-O riented System s
Traditionalsystem developm entprocessesfocuson identifying w hatthesystem does.
U sing them ,developm entteam sidentify w hatpeople orm achinesdo and figure out
w aysto do itbetter.O bjectoriented developm ent,in contrast,focuseson theobjects,
or elem ents of the system .D evelopm ent team s identify the relevant objects,the
know ledgeassociated w ith each elem ent(itsrelated data,called attributes ),and the
functions it m ust provide (its m ethods that m ust be program m ed). In object
oriented system s,theseareallstored togetherin thecom puterso thatanotherperson
orprogram m ecannotobtain thisknow ledgew ithoutusing theobjectsow n m ethods.
This radically different approach requires the use of appropriate softw are
developm ental tools. It is intended to shorten developm ental tim e, increase the
reliability oftheresulting system s,and m akeeasierthem aintenanceofthesystem .
3. W hat is com puter system configuration? D iscuss different types of
configurations.
Softw are and hardw are com ponentsm ake up a com putersystem .H ardw are consists
ofthe centralprocessing unit(CPU )and itsperipheraldevices.Softw are consistsof
theinstructionsthat,w hen converted to m achinelanguageand stored in m ain storage,
directtheactivitiesofthehardw are.A llcom putersystem scontain thesecom ponents,
butnotallsystem scom bine them in the sam e w ay.H ow they are com bined depends
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M O D U LE-IV :BU SIN ESS STRA TEG IC PLA N N IN G
on the configuration of the com puter system .A project team determ ines system
configuration during thesystem design process.
The configuration describeshow a specific organization com bineshardw are devices
to support the applications required by its com puter system .A large num ber of
differentconfigurationsarepossible.
Teleprocessing Networks
Teleprocessing netw orksconnectperipheraldevicesatrem otelocationsw ith asingle
centralprocessor,usually a m ainfram e com puter.They allow data entry atrem ote
locations,such asin a differentbuilding orata branch office in a differentcity.This
data m oves across a com m unication link to the centralprocessorata data centre,
w herean application program m eprocessesit.O utputsfrom processing,such asCRT
(Cathode Ray Tube)displaysorreportsforprinting,m ay m ove from the CPU to the
rem ote site.O utputs also m ay be printed orstored in secondary storage files atthe
datacentre.
M ainfram esare also know n aslarge scale com putersorgeneralpurpose com puters.
They are large,fast,pow erful,and flexible in w hatthey can do.M ainfram es are
usefulnotonly foraccounting and m anagem entpurposesbutalso forscientific and
engineering applications.The costof a m ainfram e system usually totals crores of
rupees.
A configurationbuiltaroundam ainfram em ayincludedozensoftapeanddiskdrives,
hundredsofterm inals,and severalhigh speed printers.A teleprocessing netw ork also
includes a com m unications processor. This sm aller processor controls
com m unication by thecentralprocessorw ith rem oteterm inals.
M any com panies use the telephone lines intended for carrying voice signals as
com m unication linksin a teleprocessing netw ork.W hen they do this,they m ustadd
m odem s to the netw ork to translate digitalsingles com ing from the rem ote device
into an audiblesignalappropriateforthetelephoneline.They add anotherm odem at
the centralprocessorto translate from the audible signalback to digital.Technical
peoplesay thatthem odem m odulatesand then dem odulatesthesignalateach end of
thetelephonelinethus-theorigin ofthenam e.
D istributed System s
A distributed system contains tw o or m ore processors connected by data
com m unications links. Thus, the processing done by the system is distributed
betw een tw o or m ore rem ote locations. The com m unication links m ay utilize
telephone lines, m icrow ave radio relay tow ers, com m unications satellites, or a
com bination ofthese.
Som e system s use a single large m ainfram e com puter connected to several
m inicom puters or m icrocom puters. O thers utilize several processors of
approxim ately equalsize and speed.Each processor m ay have its ow n peripheral
equipm ent,orprocessors m ay share peripherals.A decentralized netw ork in w hich
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C hapter9
D ata Storageand
Processing M ethods
1. The devices in a com puter system record data by changing the state of
___________ and _____________________ constituting theperipherals.
(a) Circuits& m agneticdevices
(b) m agneticdevices& transistors
(c) ICs& electro m agnets
(d) A ny oneoftheabove
2. Thetw o popularm ethodsforencoding inform ation arecalled
(a) EBCD IC andA SCI
(b) EBCCD IandA SCI
(c) EBCD IC andA SCII
(d) EBCD CC andA SCII
3. Follow ing aretheapproachesto data organisation:
(a) Traditionaldatafileorganisation
(b) D ataBaseM anagem entO rganisation
(c) Eitheraorb
(d) Both a& b
4. ____________________ is a set of com puter program m es that m aintain
centralized controlofthedatabase.
(a) D ataBaseM anagem entSystem
(b) D ataFileM anagem entSystem
(c) D ataD ictionary
(d) Q uery Language
5. C om paniesim plem ent_________________ w hen itisim portantthatclerksand
m anagershaveaccessto data thatiscurrentorrelevant.
(a) O nlinerealtim esystem s
(b) Batch sequentialprocessing system s
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(c) O fflinesystem s
(d) N etw orkedsystem s
6. A ______________________________ isa non procedurallanguage sim ilar to a
fourth generation language com posed ofhigh levelcom m ands thatthe D BM S
softw areinterpretsand executes.
(a) D ataQ uery Language
(b) D ataQ uestion Language
(c) D ataD ictionary
(d) D atabaselanguage
7. A com puter file containing standardized nam es and form ats for alldata item s
included in thedatabaseiscalled________________________.
(a) D ataQ uery Language
(b) D ataLog
(c) D ataD ictionary
(d) N oneoftheabove
8. Thedata structure(s)com m on am ong inform ation system sis(are):
(a) Tree
(b) N etw ork
(c) Relational
(d) A lloftheabove
9. Follow ing aretheapproachesto data processing:
(i) M anualsystem s
(ii) Batch sequentialprocessing system s
(iii) Batch system sw ith onlineenquiry
(iv) O nlinerealtim esystem s
(a) i,iionly
(b) ii,iiionly
(c) iii,iv only
(d) A lloftheabove
SEC TIO N -A :A N SW ER S
1. a 2. c 3. d 4. a 5. a 6. a
7. c 8. d 9. d
1. D efine D ata representation and discuss the sam e from the view point of the
com puter and theuser.
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Characters com bine to form data fields and fields com bine to form records. A
collection ofsim ilardatarecordsform sadatafile.H um anscom m only m aintain data
files in filing cabinets;these collections ofsim ilardocum ents m ay be a file orold
card bills,a file ofold accounting records,orthe like.Each docum entisa record in
thesem anually processed files.
A com puterfileisacollection ofsim ilarcom puterrecords.Com putersm aintain their
fileson secondary storagedevices.Forexam ple,acom puterised inventory filem ight
contain thousandsofcom puterrecords,one foreach item in inventory.Each record
containsthedataitem sidentified earlier.
A ll the data used by an organisation and stored on secondary storage devices
constitute the organisation s database.In older system s,the database is sim ply a
collection of com puter data files.N ow adays,data records are m aintained in the
database by a system softw are package,the data base m anagem entsystem (D BM S).
In allsystem s,the com puterand itshum an usershave tw o alternative view sofhow
dataarestored in acom puter.
W henevera D BM S is used,the application softw are designeris unconcerned w ith
how the data fields are arranged on secondary storage. The D BM S allow s the
com puterapplication to access the data item s in needs regardless ofhow they are
stored.
2. W hat are the approaches to data organisation? D iscuss the features and
lim itationsofolderapproaches.
Tw o approaches exist for organizing data in a database. The first represents a
m odification ofearly m anualprocedures.The second w as developed to overcom e
deficienciesofthefirst.H ow ever,both arecom m on in today sbusinessenvironm ent.
In this text,w e referto them as the traditionaldata file approach and the database
m anagem entapproach.
TraditionalD ata FileO rganisation
From the perspective of a com puter user,data (particularly transaction data) are
stored in groups of logically related files called records. In non-com puterized
system s,theserecordsaredocum ents.
W hen businessesfirstcom puterised the accounting process,they created a com puter
file for each m anualfile and a com puter record for each docum ent.Com puterized
proceduresreplacedm anualproceduresw henprocessingtheserecordsandfiles.Inthis
w ay a com puterapplication created and m aintained itsow n data filesindependentof
otherapplications.Even though these applicationshave expanded and im proved over
theyears,m any businessesstillusethistraditionalapproach to organizing data.
Characteristics
W ith traditionaldata file organization,each application m aintainsitsow n data files.
Each file consists of a collection of data records.O ther applications m ay process
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records containing sim ilardata item s,butthose applications store these records in
differentfiles.Thus the com pany s database contains m any differentdata files and
each isprocessed independently.
The three com m on m ethods ofarranging records w ithin a data file use sequential,
directaccess,and indexed sequentialfiles.
SEQ U ENTIAL
A sequentialfilecontainsrecordsthatarephysically arranged in sequenceby thekey
field of the record.Thus,in a sequentialcustom er file,the record containing the
balance for custom er num ber of 12034 is located im m ediately prior to that for
custom ernum ber12035.
A com puterprogram m elocatesarecord in asequentialfileby searching through the
entirefile,record by record,from thefirstoneuntilitfindsthedesired key field.A ll
m agnetictapefilesaresequential,butm agneticdisksallow thism ethod asw ell.
D IRECT ACCESS
W ith directaccess,datam anagem entsoftw areaccessesarecord directly;itcom putes
aphysicallocation on asecondary storagedevicefrom thekey field ofarecord.The
softw arethen storestherecord atthatlocation.W heneveraprogram m em ustusethe
record,thedatam anagem entsoftw areagain com putesthelocation and copiesitfrom
thedeviceinto m ain storage.Them ostcom m on deviceused fordirectaccessfilesisa
m agnetic disk,an exam ple ofa directaccessstorage device.M agnetic tapescannot
beused w ith thism ethod.
IND EXED SEQ U ENTIAL
Indexed sequentialfilesareso nam ed becausethey contain an index to recordsin the
file.The index show sthe key field and the location ofthe record forsom e (butnot
all)records.Therecordsthem selvesarephysically located in sequenceby key field.
A program m e reads a record from an indexed sequential file by either sim ply
searching sequentially throughoutthefileuntilitfindsthedesired key,orlooking up
thekey field in theindex.Ifthekey field isnotthere,itfindsthenextlow estkey field
in the index and locates this record on the secondary storage device.The softw are
then searchessequentially from thelocation ofthisrecord untiltherecord containing
thedesired key field isfound.Indexed sequentialfilem ustbestored on directaccess
devices,such asm agneticdisks.
Thew ay datam anagem entsoftw areusesafileindex issim ilarto thew ay areaderuses
an index to a book.The readerlooks up a topic in the book s index and then reads
sequentially from thepagenum bershow n untilheorshefindstheinform ation needed.
D eficiencies
Com paniesadoptedtraditionaldatafileorganisationastheirm anualsystem sevolvedto
com puter-based ones.A fterusing traditionalm ethodsforseveralyears,how ever,they
recognised deficiency w ith thisw ay ofstructuring theirdatabases.These deficiencies
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exist because of data redundancy.D ifferent com puter files,m aintained by several
applicationsinthesam ecom puter-basedsystem ,storerecordscontainingthesam edata
item s. Three deficiencies result from data redundancy: inefficient use of storage,
conflicting data,and thedifficulty ofm aking changesto theapplicationssoftw are.
INEFFICIENT U SE O F STO RAG E
W hen a com putersystem storesthe sam e item in m ultiple locationson a secondary
storage device,the system w astesstorage capacity.The system requireslessstorage
capacity ifitrecordseach dataitem only once.
Forexam ple,both billing and inventory system s m aintain files containing data on
quantities ofproducts sold.Billing system s use this data to calculate am ounts due
from custom ers.Inventory system s subtractquantities sold from the Q U A N TITY -
O N -H A N D dataitem in thefilecontaining perpetualinventory records.A record in a
file ofbilling transactionsand a record in a file ofinventory transactionscontain the
sam edataitem .
A lthough thisispossibly them ostobviousdeficiency oftraditionalfileprocessing,it
istheleastserious.M ostcom putersystem shaveadequatesecondary storagecapacity
and this usually can be increased by adding devices. The storage capacity
inefficienciesintroduced by duplicatedatafieldsaresm all.
CO NFLICTING D ATA
A m ore serious problem arising from duplicate data fields is the possibility of
conflicting data.W hen thesam edataitem existsin tw o orm orefiles,thecontentsof
thesedatafieldsm ay differ.Reportsprinted from theseshow conflicting inform ation
and cause m anagers to question the validity ofallreports produced by the system .
Conflicting data m ay indicate errors. O r a conflict m ay occur sim ply because
differentapplicationsm ay follow differentprocessing schedules.
Supposethatthebilling system executesdaily buttheinventory system executesonly
once a w eek,on Friday.A nd suppose thateach system produces on W ednesday a
reportshow ing quantities sold by inventory item .These tw o reports w illcontain
conflicting inform ation:The reportproduced by the inventory system containsdata
threedaysolderthan thatofthebilling system .
W hen conflicting data occurin system susing traditionalfile organisation,asin the
above exam ple,there isusually a valid explanation.Furtherm ore,by carefulsystem
designing a project team can avoid producing reports that contain conflicting
inform ation.In thisexam ple,both thebilling and theinventory system scan produce
reportsusing them ostcurrentdataitem ,than from thebilling system .H ow ever,this
solution to the problem ofconflicting data creates anotherdeficiency oftraditional
datafileorganisation.
D IFFICU LTY O F SYSTEM CH ANG E
M any organisations have corrected the problem s arising from duplicate and
conflicting data by allow ing differentapplication system s to share data files.W ith
shared files,each data item is recorded once in a file.This file is used by several
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Inform ation System C ontrols
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5. In case ofa catastrophe,a data centre can be protected by taking the follow ing
m easuresEX C EPT:
(a) Ignoreinsurancecoverage
(b) Identify vitalapplication
(c) D esignatean alternativeprocessing location
(d) D esignatean offsitestoragelocation
6. Proper segregation of duties requires thatcriticalfunctions perform ed atthe
data centrebeseparated.Thesefunctionsinclude:
(a) System analysisand program m ing
(b) M achineoperations
(c) D atam aintenance
(d) A lloftheabove
7. O rganisations w ith good generalcontrols ensure thatm achine operators have
no accessto thefollow ing:
(a) Program m edocum entation
(b) Sourcecode
(c) A lltheabove
(d) N oneoftheabove
8. By properly assigning duties in the data centre,m anagem ent m inim izes the
opportunitiesfor em ployeesto alter com puter program m esor recordsto cover
thetheftofan asset.Thisisachieved through ______________ ofduties.
(a) D ivision
(b) Segregation
(c) Subrogation
(d) Integration
9. Follow ing are the w ays in w hich m anagem ent lim its access to data and
equipm ent:
(a) Physicalsecurity
(b) System access
(c) D ataaccess
(d) A lltheabove
10. System auditors have identified three w ays in w hich applications controls
preventordetecterrorsand irregularities;they are:
(i) Inputcontrols
(ii) Processing controls
(iii) O utputcontrols
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SEC TIO N -A :A N SW ER S
1. c 2. c 3. c 4. d 5. a 6. d
7. c 8. b 9. d 10.c 11.c
1. W hat do you understand by inform ation system controls? W hat are the
differentcategoriesofsuch controls?
A n organization s internalcontrolincludes the m easures adopted by m anagem entto
achievetheorganization sobjectives.Theserelatetotheeffectivenessandefficiencyof
operations, the reliability of financial reporting, and com pliance w ith law s and
regulations.Thesepolicies,practices,and proceduresdirected tow ard theseobjectives
are called internalcontrols.Those internalcontrolsim plem ented in a com puter-based
accounting system are inform ation system controls.M anagem entselects from these
and im plem entsthem to providereasonableassuranceso thatobjectivesareachieved.
Because accountantsare responsible forproviding financialinform ation,they have a
professionalinterestin m aintaining adequate system controls.A uditorsevaluate these
controls to determ ine their effects on the accuracy of accounting inform ation.A n
understanding ofinform ation system controlsisvitalforaccountantsand auditors.
ViewsofInform ation System Controls
A norganization sinform ation system controlscan beview ed in differentw ays.Som e
preferto categorizethem by function;otherscategorizethem by scope.Each view is
correct;each representsadifferentperspectiveon thesam esetofpolicies,practices,
and procedures.
2. D escribehow inform ation system controlsarecategorized by function.
M anagem entim plem ents internalcontrols eitherto preventorto detecterrors and
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system softw are m ay lack adequate controls and produce erroneous inform ation.
Inadequateapplication controlsin asystem arefrequently ajustification forinitiating
thesystem developm entprocess.
W ithin any transaction cycle,the com bination ofgeneralcontrols and applications
controls determ ines w hetherornorinform ation system controls are effective.Both
categoriesaffecttheability oftheapplicationssystem sto preventordetecterrorsand
irregularities.A strength in applicationscontrolsm ay com pensate fora w eaknessin
generalcontrols.
Forexam ple,acreditcard chargesystem m ay haveterm inalsin thousandsoflocations
in retailstores alloverthe country.Security forthese term inals m ay be quite w eak,
allow ing easy access to them by unauthorized users.Yetan application controlthat
verifiesthevalidity ofan accountnum bereffectively com pensatesforthisw eaknessin
generalcontrols.Itpreventschargesto fraudulentcreditcard accounts.
G eneralControls
G eneralcontrolsaretheinform ation system controlsthataffectallapplicationsofthe
com puterin theorganization.Thefourcategoriesofgeneralcontrolsare:
D ataCentreO perationsControls
System Softw areA cquisition and M aintenanceControls
A ccessSecurity Controls
A pplicationsSystem D evelopm entand M aintenanceControls
4. H ow is D ata back up m aintained in Local A rea N etw orks? D escribe the
proceduresinvolved in m aking data backups.
Local area netw orks (LA N s) store data on w orkstations and file servers. The
com putersin a LA N em ploy devicessuch asm agnetic disks,m agnetic diskettes,or
opticaldisksforstoring data.M aking regularbackupsisim portantin these system s
becausethesedatadevicesarelessprotected than thosein adatacentre.
A file server frequently has attached to ita backup disk or tape drive.The LA N
adm inistratorperiodically (perhapseach evening)copiesthecontentsofallfilesto a
m agneticdisk ortapem ounted in thisdrive.Thesam edrivem ay contain anotherdisk
ortapeused asatransaction log w hiletheLA N isin operation.Proceduresforroutine
backups at the file server are im portant because users of individual w orkstation
frequently neglectto m akebackup copies.
W orkstation users, like operators of all personal com puters, should m ake regular
backup copies offiles stored attheirlocations.M any use m agnetic diskettes forthis
purpose,although individualw orkstationsm ay also includebackup drives.Procedures
form aking databackupsw ith w orkstationsand personalcom putersystem sinclude:
M ake fullbackups.M ostbackup system scan,ifthe userw ishes,backup only
files thathave changed since the lastbackup.H ow ever,backing up allfiles
(including thosethathavenotchanged)m akestheprocessofrestoring dam aged
filesm uch easier.
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the organization should identify another com puter that it can use during
reconstruction. A s an alternative processing site, m any com panies designate
another of their data centres at a different location.Sm aller organizations m ay
reach a reciprocalalternative processing agreem entw ith others thathave sim ilar
equipm ent.O rthey m ay arrange to use a service bureau ortim e-sharing service.
The alternative site m usthave enough unused processing capacity to process all
vitalapplications.
IdentifyVitalApplication
Vitalapplicationsare those the organization requiresto continue operating.Ifa data
centre isdestroyed,the IS departm entm ustim plem entthese applicationsfirstatan
alternative processing location.M anagem ent m ust identify vital applications and
ensure thatthey can be im plem ented quickly atthe alternative site in the eventofa
disaster.
A ccounts receivable and accounts payable are vital applications to m ost
organizations.O ther applications are vitalin specific industries.For exam ple,an
airline reservations system is vital to an airline,and a com puterized typesetting
system isvitalto anew spaper.Thesecom paniescannotfunction ifm anagem entfails
to re-im plem entthem prom ptly.Vitalapplicationsrequirean off-sitestoragelocation.
D esignatean O ff-siteStorageLocation
M anagem ent should designate a place,aw ay from the data centre,to store item
necessary to continueoperating thevitalapplications.Theseincludecopiesofsystem
softw are,program m es,backup datafiles,docum entation,and operating instructions.
M anagem entshould establish policies ensuring thatthese item s are current.Som e
organizations use the alternative processing site for this purpose. O thers use a
w arehouse thatisconvenient,secure,and safe from environm entalhazards,and has
controlled access.
Assign Responsibility
M anagem ent should assign responsibility to an individual for m aintaining and
im plem enting an up-to-date contingency plan.This includes acquiring an adequate
alterative processing site,selecting a satisfactory off-site storage location,keeping
current backup files at that location, and testing the plan. Som eone should be
designated in advance as responsible for beginning recovery procedures if a
catastrophe occurs.The plan should also identify and assign otherresponsibilities
necessary to begin operation at the alternative site. A ssigning responsibility in
advancem inim izesdelaysatatim ew hen top m anagem entispreoccupied w ith things
otherthan theinform ation system .
A contingency plan preventsthe sizable financiallossesan organization could incur
ifan inform ation system w eredestroyed.Becauseacontingency plan affectsseveral
vitalapplications,itisageneralcontrol.
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changes to them .The database adm inistrator (D BA ) determ ines w hich users gain
access to accounting records and m onitors the database to detect attem pts at
unauthorized access.Thelibrarian orD BA hasaccessto recordsregarding assets.A n
organization w ith good generalcontrolspreventstheiraccessto thecom puterw hileit
executes production program m es. This m inim izes their opportunities to com m it
irregularities.
7. System softw are im plem ents identification and authentication procedures.
D iscussthesignificanceoftheseprocedures.
System softw are im plem ents identification and authentication procedures. This
system softw are m ay be the operating system softw are,or itm ay be a com puter
security softw arepackageused in conjunction w ith theoperating system .
System Access
Before allow ing people to use a com puter system ,the softw are requires users to
identify them selves to the system .M anagem entassigns them accountnum bers or
user-ID sforthispurpose.Thesoftw arethen consultsan authorization filecontaining
authentication inform ation for that individual. A fter requesting authentication
inform ation,the system com pares the inform ation provided by the user w ith that
recorded in the com puterfile.Forexam ple,the system m ay ask the userto provide a
passw ord foraccessto thesystem .Thesoftw arethen looksup in theauthorization file
thatuserspassw ord.Ifthepassw ord and theauthorization fileagree,theuserislogged
on thesystem .Ifthey differ,thesoftw aredoesnotallow theuseraccessto thesystem .
Som e system s thatallow dial-up access by telephone use an autom atic call-back
procedure. A user calls the telephone num ber of the com puter s autom atic
sw itchboard.The com puteransw ers the call,accepts the user s passw ord,and then
disconnects.The com puterlooksup in a file the telephone num berofthe userlisted
forthis passw ord,and calls the userback atthatnum ber.This m akes unauthorized
accessby telephonem oredifficult.
Passw ords are effective in preventing unauthorized system access only if used
properly.A llpass-w ordsshould bechanged periodically and selected from arandom
com bination of letters and digits. Too often, em ployees select as a passw ord a
fam iliarnam ethatiseasy foran unauthorized userto guess.Som epeopleeven w rite
dow n theirpassw ordsand tapethem to desksorPCs.Theseactionsm akepassw ords
lesseffectiveascontrolprocedures.
U serID sand passw ordsknow n by the use are com m on form sofidentification and
authentication.Som e system suse otherform s,such asbadges,keys,fingerprints,or
voiceprints.Softw areusesalloftheseasm ethodsofidentification and authentication
to preventunauthorized system access.
D ata Access
The authorization file identifies notonly system passw ords butalso passw ords for
individualfiles stored by the system .Itshow s allthe files a useris authorized to
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D ata Security and Integrity
(a) Illusive
(b) Collusive
(c) Pervasive
(d) Invasive
6. The data centre m inim izes the risk ofaccidentaldestruction by the follow ing
w ays:
(a) em ploying trained com puteroperators
(b) by having a com puter operations m anual that describes procedures for
safeguarding data
(c) by follow ing standard databackup policies.
(d) A lloftheabove
7. W hatkey inform ation can be used by com petitors by procuring data through
espionage?
(a) listsofcustom erscan beusefulto acom petitor ssalesforce.
(b) proprietary m anufacturing processes can be learnt by accessing certain
production data.
(c) pricing strategies can be learntby accessing sales orcostaccounting records.
Budgetdatadiscloseplansforfutureoperationsand capitalexpenditures.
(d) A lloftheabove
8. Thefraud triangleincludethefollow ing EX C EPT:
(a) Pressure
(b) Rationalisation
(c) Proxim ity
(d) O pportunity
9. Them ostcom m on em ployeefraudsconsistofw hich ofthefollow ing acts?
(i) theftofassets
(ii) conversion ofthoseassets
(iii) concealm entofthetheft
(iv) violenceand hostility
(a) i,ii,iv
(b) ii,iiionly
(c) i,iv only
(d) i,ii,iiionly
10. Passw ord D os doesnotinclude!
(a) D o notchangeyourpassw ord often.
(b) D o usean acronym foran easy-to-rem em berphrase.
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1. a 2. d 3. d 4. a 5. b 6. d
7. d 8. c 9. d 10.a 11.a 12.b
W hen the organization im plem ents good segregation of duties,no one has both
custody ofan assetand accessto the recordsconcerning thatasset.Thisseparation
restrictsthe ability ofoperations-levelem ployeesto both stealthe assetand conceal
thetheftby altering com puterized records.
M ANAG ERS
M anagerial and supervisory em ployees have greater access to records but few er
opportunitiesto stealassets.A lthough they can m oreeasily falsify recordsto covera
theft,itisdifficultform anagersto stealan assetw ithoutthe know ledge ofothersin
the organization.They m ay,how ever,bypass restrictions by threatening to dism iss
operations-levelem ployeesw ho know oftheirthefts.
ExternalSources
Externalsourcesofrisk include businesscontactsand potentialcrim inalsw ho have
opportunitiesto stealtheorganization sassets.
BU SINESS CO NTACTS
Severalkindsofbusinesscontactshavetheopportunity to com m itacom puter-related
crim e.The m ajorsources ofrisk are custom ers and vendors.Because they process
transactions w ith the organization,the em ployees of custom ers and vendors have
indirect access to assets and to records. The greatest risk occurs w hen their
em ployees act in conjunction w ith one of the organization s em ployees. A cting
together,they m ay com m ita theftand concealitby entering fraudulenttransactions
in thecom puter-based system .
Form erem ployees also constitute a risk to an inform ation system .Frequently they
have intim ate know ledge ofthe system and its controlw eaknesses.Ifthey hold a
grudge againsttheir form er em ployer,they m ay attem ptto exploitw eaknesses to
com m itcom puter-related crim es.
A nothersourceofrisk isbusinesscom petitorsw ho m ay seek com petitiveadvantage
by gaining accessto confidentialdatastored in com puterfiles.
U NKNO W N CRIM INALS
O thercrim inalsm ay also becom e sourcesofrisk to com puterized records.H ackers
attem ptto bypasssystem security featuresusing accessby telephone.O therunknow n
crim inals w rite program m es (called viruses) that m aliciously destroy data, erase
program m es,oruse up system resources.U sually the challenge,ratherthan theft,is
the m otive for these crim inals.N evertheless,they can do extensive dam age to an
organization s database. O rganized crim e m ay also exploit w eaknesses in data
security to defraud an organization ofitsassets.
CollusiveSources
Collusive sourcesofrisk existw hen tw o orm ore individualsconspire to defraud an
organization and conceal the theft by altering com puterized records. A ll
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Espionage
M anagers are continually concerned about the action and plans of com peting
com panies.They can acquirem uch usefulinform ation aboutcom petitorsby granting
access to com puterized data. For exam ple, lists of custom ers are useful to a
com petitor ssalesforce.Com petitorscan learn proprietary m anufacturing processes
by accessing certain production data.They m ay learn pricing strategiesby accessing
salesorcostaccounting records.Budgetdatadiscloseplansforfutureoperationsand
capitalexpenditures.Payrolldata revealinform ation on pay ratesa com petitorm ay
useto lureaw ay key em ployees.
Espionage is prim arily an external threat.H ow ever,a com petitor m ay also gain
accessto sensitivedataby collusion w ith an em ployee.
Invasion ofPrivacy
Com puterized data files contain m uch personal inform ation about individuals.
D isclosure of this inform ation is an invasion of privacy. For exam ple, m any
em ployeesobjectto releaseofdataconcerning theirpay rates,ages,pension records,
or hom e addresses.Custom ers expectconfidentiality concerning currentbalances,
creditratings,and paym enthistories.In m any countries,law s protectindividuals
from release of personal inform ation contained in data files.These law s require
organizationsto m aintain adequatesecurity forpersonaldata.
Threatsto privacy com efrom hackersand from em ployees.H ackersenjoy exam ining
the contentsofcom puterfilessim ply to learn aboutotherpeople orto dem onstrate
theirability to bypasssecurity.Em ployeesm ay gain unauthorized accessto pay rates,
forexam ple,w hen dissatisfied w ith theirow n pay.
Em ployeeFraud
Fraud istherisk thataffectstheaccuracy ofthefinancialrecordsand resultsin lossof
assets. Frauds result in m isstatem ents of assets and expenses in the financial
statem ents.M ajorfraudsalso endangerthe ability ofan organization to continue its
operations.M any controlpolicies and procedures protectagainstfraud by low er-
levelem ployees.Em ployeesata m anageriallevel,how ever,m ay be in a position to
override these controls. A nd w hen em ployees collude w ith other people, either
internalorexternalto theorganization,controlsm ay failto preventordetectfraud.
3. D iscusssecurity and integrity aspectsin C om puterN etw orks.
In a com puter netw ork, com puters transfer data and instructions across data
com m unications links. The links m ay be w ire, cable, or satellites. The netw ork
configuration m ay beateleprocessing system w ith onlineterm inalsand w orkstations
or a distributed system such as a localarea netw ork or w ide area netw ork.Each
createsrisksfordatasecurity and integrity.
Risksin Teleprocessing System s
O rganizations frequently use teleprocessing netw orks as a w ay of im plem enting
onlinereal-tim e(O LRT)system s.U sersatterm inalsand w orkstationsenterdata,and
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data or see com puterized processes, they cannot determ ine w hether m any
com puterized controls function properly by observing them .A s a result,they use
com puter-assisted techniquesto evaluatecontrols.
A uditors em ploy com puter-assisted audit techniques (CA ATs) w henever they
exam ine online realtim e system s.They also m ay use them w hen auditing batch
processing system s because they are an efficientw ay to obtain reliable evidence.
There are m any kindsofCA ATs;fourthatauditorsuse to evaluate data integrity are
testdata,parallelsim ulation,an integrated testfacility,and em bedded auditm odules.
TestD ata
The use of test data using parallel sim ulation in auditing is sim ilar to its use in
program m eand system testing.A uditorsdevelop afileofsim ulated inputtransactions
forthe program m e to be tested.They also prepare w orking papersshow ing how each
transaction should beprocessed iftheprogram m efunctionsproperly.
A uditors execute the program m e using these testdata and exam ine the output.If
actualoutputdiffersfrom thatexpected,auditorsidentify thesourceofthedifference.
Thism ay occurbecauseofprogram m elogicerrorsorbecauseaprogram m ed control
isineffective.
The file oftestdata containsboth valid and invalid transactions.A uditorscreate an
invalid transaction to test each application control procedure of interest. Such
transactionsshould be detected by inputorprocessing controls;ifthey are,auditors
know thatthese controls function as intended.U sing valid testtransactions show s
thattheprogram m eproducesdesired reportsaccurately.
A uditorsencountertw o problem sw hen using testdata.First,they m ustensure that
the application program m e they testis the one used during norm alprocessing of
transactions. Second, the azuditors m ust take steps to avoid recording the test
transactions in the live system .Parallelsim ulation is a technique thatlacks these
problem s.
ParallelSim ulation
U sing parallelsim ulation,auditors w rite a com puterprogram m e thatperform s the
m ajor functions of a clients application program m e. The auditors execute this
sim ulation program m e fora representative tim e period using the clients data.The
auditors then com pare the output of the sim ulation program m e w ith the output
produced by the clients application program m e during the sam e tim e period.
D ifferencesm ay indicatethattheapplication program m eprocessesdataerroneously.
Parallelsim ulation allow s auditors to avoid the lim itations of testdata;how ever,
developing an adequate sim ulation program m e requiressignificantcom puterskills.
Theauditorsm ustunderstand theapplication program m eand beproficientenough in
acom puterlanguageto program m easim ulation ofit.Becausetheauditorsnevertest
the application program m e directly,they obtain no assurance abouthow itprocesses
erroneousorunusualtransactions.
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1. D iscusstheinfluenceofI.T.on Insuranceindustry.
There has been a revolution in the w ay insurance com panies do business.The new
em erging businessm odeldependsheavily on inform ation technology.
Itis often referred to as the new business m odel.Itis prim arily custom er-oriented.
That is, all processes are designed to satisfy custom er needs, rather than the
com pany sneeds.Thenew m odelisalso decentralized;w ith m oreresponsibility and
pow ergiven to the people w ho are on the frontlines w ith the custom ers w hether
they areindependentagents,brokers,captiveagents,orcom pany em ployees.
G iving these people the autom ated toolsthey need to handle allcustom errequests,
often in a single session,letsinsurerssatisfy custom erneedsfasterand better.A sa
result,thenew businessm odelisflexible,responsive,and cost-efficient.
M any established com panies, especially those w ith a keen eye on the strategic
advantages ofleading-edge autom ation,have already adopted the new technology-
driven business m odel either com prehensively or in specific niches, such as a
specialty line ora residualm arket.A nd forw ard-thinking start-upsare now running
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theirentire com pany on the new business m odeland pow ering w ith a netw ork of
personalcom puters.
2. W hatarethefeaturesofI.T.w hich arebeneficialto insuranceindustry?
FeaturesofInform ation Technology
Client/ServerTechnology
Thisisthetechnology footing thatpow ersthenew businessm odel.Itistheengineof
changethatisbreaking thestranglehold ofthem ainfram em odel.
Client/Serverisa system in w hich m ostofthe active com puting,orprocessing,can
be done on inexpensive but pow erful personal com puter w orkstations of the
clients .M eanw hile,the serverstores a centraldatabase.Servers can be lined to
clientsby a localarea netw ork (LA N );a w ide area netw ork (W A N )using dedicated
lines, or even ordinary dial-up lines. U ltim ately, the link can be the Internet or
com pany intranets.
Today sserversare pow erful,fast,and reliable.M any have m ultiple processorsand
hard disks that allow scalability and autom atic backups in the form of data
redundancy.The clientsand the servercom bine to becom e a virtualsupercom puter
w ith enorm ousprocessing pow er.A client/serversystem thuscan supporta sizable
insurancecom pany sprocessing environm ent.
Com puting PoweratthePointofSaleorService
To be effective,autom ation m ustbe available anyw here itisneeded,w ith consistent
results.U nderthenew businessm odel,theservicerepresentativeoragentcan takecare
ofallthe custom er s requirem ents in one transaction.The client/serversystem puts
processing pow erw hereitisneeded on thecom pany servicerepresentative soragents
desktop,orevenonalaptoptheagentcantaketoam eetingattheclientshom eorplace
ofbusiness.(TheInternetw illonedaybecom eanim portantpointofsaleandserviceas
w ell.)A n integrated client/serversystem can provide the userw ith properprocessing
rules atthe desktop,resulting in consistententerprise-w ide processing.This offers
m any advantages,including quotesthatm atch theactualprem ium .
Flexibility
In today s com petitive environm ent,insurers do nothave the luxury oftim e.They
m ust respond quickly to take advantage of m arket opportunities. Softw are that
pow ers the new autom ation m odel is tool-based. Instead of having to rely on
program m ing,the user/analystsim ply selectsa tool:to quickly change a rate,add a
field,orm odify an endorsem ent.In businessterm s,insurersgeta m uch m ore cost-
effectiveand tim ely w ay to addressnew orchanging m arketconditions.
Scalability
N ew styleautom ation can beused anyw herebecauseitisscalable.Thefullversion of
aprocessing system isused forcom pany-w idefunctions.
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The sam e softw are can be scaled dow n to fiton a laptop.Thism eanslow ercosts,
flexibility; m ore focused access to inform ation,and im proved service across the
insurer sorganization.
3. D iscusstheadvantagesofI.T.in insurancebusinessapplications.
A dvantagesofInform ation Technology
First,costsarelow er.In part,thisstem sfrom low erhardw arecosts;forexam ple,disk
storage on a personalcom puter (PC) is aboutone-tw entieth the costof the sam e
am ountofm ainfram e storage.A pow erfulPC clientnow coststhe sam e asa dum b
term inaloncedid.
M oreim portantly,hardw aresavingsareultim ately dw arfed by personnelsavingsand
increased business opportunities. Since users are em pow ered; program m ers and
system analysts can be freed from m aintenance and developm ent and redirected
tow ard providing m ore im m ediate business services to the consum ers and the
com pany.
Extendibility is another key advantage of the new environm ent.Creating a new
productorrevising an existing one isnotasm onum entala task asitisw ith the old
autom ation m odel. Insurers can easily adjust both their business tactics and
strategies.They can testnew m arket-placesquickly and inexpensively.Ifa specific
plan does notw ork out,they do notlose m onths of tim e and lakhs of rupees in
program m ing and m anagem entexpenses.
TheInternetalong w ith thecom pany orindustry specificintranetsw illultim ately put
significant insurance inform ation directly in the hands of the consum er at a
reasonablecost.Custom ersw illbeableto inquireabouttheirpoliciesand coverages,
m akechanges,and getquotesallfrom theconvenienceoftheirhom ecom puter.
Betteraccessto criticalinform ation isanotherbenefitofthe new autom ation m odel.
Integrated new -m odel system s put inform ation about losses, expenses, m arket
penetration,and agencies atm anagem ents fingertips instantaneously.W ith vastly
superiordata,com pany executivescan takestepsto low eroperating costsw ith m ore
confidenceand craftbettershortand long term strategies.
Finally,the new IT driven m odelalso letsinsurersgive better,m ore focused service
to theinsured sand itsagents.W ith an integrated system ,servicerepresentativescan
answ eralm ostany question posed by a policyholderoragent.They can readily go
into the system and prepare a quote,find the costofa policy change,orcheck the
statusofaclaim paym ent.
4. W hatisBusinessIntelligence?
BusinessIntelligence(BI)ism orethan decision supporttoolsordataw arehouses.BI
involvesallthesystem sprocesses,applications,and inform ation structuresnecessary
to havean effectiveinform ation m anagem entenvironm entand supporttheanalytical
processoftheentireorganization.
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C hapter13
Pricing and M arketing
ofInsurance
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7. a 8. b 9. d 10.a
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1. Insurance in m ost countries is regulated and prices are subject to com plex
regulations. D iscusspricing and ratem aking in insurance.
A ccurate rate m aking requires huge am ounts of inform ation collected over long
periods oftim e in orderto predictthe potentialloss from each class ofassets.The
prem ium charged by an insurance com pany isthe am ountofanticipated loss(called
pure prem ium )plus the costofdoing business (called loading).Forexam ple,ifan
insurance com pany expects to pay Rs.600,000 by w ay ofm otorvehicle insurance
claim sfora particularclassofinsured (say truck operators)and there are a totalof
1000 trucksam ong theinsured,thepureprem ium w orksoutto Rs.600 pertruck.This
pure prem ium has to be increased by the costof doing business w hich includes
expensessuch asagents com m issions,generalcom pany expenses,prem ium s,taxes
and fees,and the profitm argin.The sum ofpure prem ium and loading is w hatthe
custom eractually paystheinsurancecom pany and thissum iscalled grossprem ium .
G uidelinesforratem aking arefixed by theIRD A .
U sually the loading isexpressed asa percentage ofthe expected grossprem ium ;in
property-liability insurance,forexam ple,atypicalloading m ightbe25 percent.The
Relationship betw een prem ium and loading m ay be expressed by the follow ing
equation:
G P=PP+LP (G P)
W hereG P = G rossPrem ium
PP = PurePrem ium
LP = Loading Percentage
Itiscom m on to rearrangetheterm softheaboveform ulaasfollow s:
G P-LP (G P)=PP
G P(1-LP)=PP
G P= PP/(1-LP)= 600/(1-0.25)=800
Thusin thiscasetheprem ium w orksoutto Rs.800 pertruck.
M odifying the exam ple above so that the pure prem ium is again assum ed to be
Rs.600 percarbuttheloading is30 percentm eansthatthegrossprem ium w ould be
calculated asfollow s:
G P=600/(1-.30)
G P=Rs.857
The pure prem ium is the estim ate ofloss cost,and the ratio ofthe loss costto the
grossprem ium iscalled the lossratio,w hich isrepresented by the term (I-LP)in the
form ulaabove.A scan beseen,thelossratio in thefirstexam pleis75 percent.
A nother w ay to explain rate m aking in insurance is by analogy w ith retailstore
pricing.Ifa grocerbuysa loafofbread forRs.10 and sellsitatretailforRs.15,the
grocer sgrossm argin (orm arkup)isRs.5.Thegrocer scostofbread correspondsto
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possible contingencies. This problem arises from the fact noted above that the
insurance rate m ustbe setbefore allthe costsare know n.In m any linesofbusiness,
the entrepreneurm ay ascertain allornearly allcostbefore setting a price.Ifcosts
cannotbe determ ined,the entrepreneurw illusually insistthatthe contractofsale be
subjectto lateradjustm entto reflectthe actualcostsorw illinsiston a costplustype
ofcontract.In insurance,how ever,adefiniteestim atem ustoften bem adein advance,
w ith no possibility of later negotiation if the estim ation of loss w as incorrect.
Frequently, these estim ates are inaccurate because they are derived from past
experience;the insurance contractm ay involve a substantialfuture period during
w hich conditionschange drastically.Itiseasy to see thatopinionsasto the future of
insurancecostscan vary w idely.
The problem ofpreventing rates from becom ing excessive has been the subjectof
m uch legislation,yetunrestricted com petition som etim es leads to rates thatare too
low forthelong-term solvency ofinsurancecom panies.H aving ratesthataretoo low
is justas bad as,if notw orse than,having ones thatare too high.A bove all,the
insured isseeking assurancethatpersonallossesw illbepaid ifand w hen they occur.
FairAllocation ofCostBurden
Justhow farshould theunderw ritergo in developing aratethatcom pletely reflectsthe
truequalityoftheindividualhazard,thusm akingtheratefair?Theissueisofparticular
concern to risk m anagers of businesses as they selectappropriate risk m anagem ent
toolsforvarioussituations.Theoretically,forlifeinsurancepurposesthereshouldbean
attem ptto setindividualprem ium son the basisofoccupation,incom e,m aritalstatus,
drug oralcoholconsum ption,sm oking record,and longevity ofparents.In practice,
noneofthesefactorsaffectstheprem ium individually becauseage,and sex arealm ost
the sole discrim inants.Ifthe criterion offairnessiscarried to an extrem e,itm ightbe
said thateach person should receive a slightly differentrate to reflectthatperson s
particularsituation.This,ofcourse,w ouldbeim possibletoadm inisterandw ouldm ake
the rate-m aking task hopelessly com plex. H ow ever, a decision m ust be m ade
concerning w hereto draw thelineand w hatcriteriaoffairnessto use.
3. W hatarethedifferentratem aking m ethods? D iscussthesam ein detail.
O ne ofthe m ostdifficultproblem s in insurance is thatofdeveloping rate-m aking
m ethod thatm eetthe criteria discussed above.The m ethods em ployed can seldom
m eetthese criteria,and underw riting judgm ent,unsupported by statisticalevidence,
often playsa m ajorrole in rate m aking.The calculation ofan insurance rate isin no
sense absolute or com pletely scientific in nature.A s in m ost areas of the social
sciences, the scientific m ethod in insurance m akes its greatest contribution in
narrow ing the area w ithin w hich executive judgm ent m ust operate. The basic
approachesto ratem aking follow.
M ANU AL O R CLASS RATING (PU RE)M ETH O D
TheM anual,orclassrating,m ethod setsratesthatapply uniform ly to each exposure
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pastexperience.This w ould be the case ifthe insured has a very large num berof
hom ogeneousexposureunitsatrisk and is,in effect,largeenough to beself-rated.It
should benoted,furtherm ore,thatasZ increases,theterm 1 Z decreases,and w ith it
thew eightgiven to thelossexperienceofthepopulation.
Forconvenience,thevaluesgiven to Z areexpressed aspercentages.Theratem aker
generally developsa scale ofcredibility fordifferentline ofinsurance,running from
0 to 100 percent. A s an exam ple, let us assum e that an em ployer s w orkers
com pensation policy isfound to producealossratio of0.70,ascom pared to w ith an
expected loss ratio of0.60 forem ployers in this occupationalgroup.H ow ever,the
num berofclaim son w hich the 0.70 lossratio w ascalculated w asofsuch size and
type thatonly 60 percentcredibility can be attached to this ratio.In the form ula,
Z=0.60,PPi= 0.70,and PPp = 0.60.The pure prem ium for the em ployer in the
forthcom ing period w ould bebased on alossratio of0.66 ratherthan 0.70;thatis,PP
= 0.70 (0.60) + 0.60 (1-0.60) = 0.42 + 0.24 = 0.66. Because the em ployer s
experience is notfully credible,the rate w ould be increased only 10 percent(0.66/
0.60)ratherthan 16.7 percent(0.70/0.60).
4. D iscussthem arketing and distribution aspectsofinsurance.
M any kindsofarrangem entsm ay bem adeto distributetheinsurancecontract.These
arrangem entsare com parable to the channelstaken by physicalgoods.Forexam ple,
life insurance generally takes a short,directchannel,w hereas property insurance
norm ally usesa long,indirectchannelw ith one orm ore independentinterm ediaries
involved.In som e fieldsofproperty insurance in recentyears,increasing em phasis
has been placed on the use ofm ore directchannels.Som e ofthe reasons forthese
developm entsw illbeexplained here.
D irectD istribution in LifeInsurance
Life insurance is distributed in tw o m ain w ays:through salaried group insurance
representatives and through individual insurance agents, w ho usually w ork on
com m ission.Life insurance isalso sold by directcontactw ith the consum erthrough
advertising or m ail order som etim es called direct reasons.U nder each of these
m ethods,thecontactbetw een theinsurerand thecustom erisadirectonein w hich the
insurer m aintains a one-on-one relationship w ith the insured and in w hich
independentinterm ediariesusually arenotinvolved.
G roup Insurance
Life insurers offerm any oftheirproducts on a group basis,thatis,undercontracts
covering groups of persons rather than individuals.Exam ples include group life
insurance,group health insurance,and group pensions.
Thecustom ersforgroup coveragearegenerally businessfirm s.Personsem ployed to
sell and service this business usually receive a salary and bonus. The group
representativeoften w orksclosely w ith com m issioned agents,w ho m ay firstlocatea
potentialcustom erforgroup insurance and w ho receive a com m ission ifthe group
representativesucceedsin m aking thesale.
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IndividualAgents
Personsknow n asagents,underw riters,orfinancialplannersusually handle policies
sold to individuals.The agentor underw riter contacts the ultim ate consum er and
reportsdirectly to theinsurerorto an interm ediary,com m only called ageneralagent,
w ho in turn reportsto theinsurer.Theauthority oftheunderw riteroragentislim ited;
the agentcannotbe called an independentinterm ediary because he orshe isactually
w orking undercontractw ith theinsureroftheinsurer srepresentative.
The generalagentsom etim es collects prem ium s and rem its them to the insurer s
hom e office.The generalagentdoesnotexercise finalcontroloverthe issuance and
theterm softhecontract.Thecom pany norm ally isnotbound by thegeneralagentin
putting acontractin force.Thegeneralagentexercisesno controlovertheam ountof
theprem ium ,hasno investm entin inventory,doesnotow n any businessw ritten,and
hasno legalrightto exerciseany controloverpolicyholdersonceheorsheleavesthe
em ploym entofthecom pany.
ReasonsforD istribution in LifeInsurance:
The system ofdirect,orshortchannel,distribution has grow n up in life insurance
becauseofseveralbasicfactors:
1. Theinsurer sneed to m aintain closecontroloverthepolicy Product .
2. Theinsurer sneed to exercisecontroloversalesprom otion and com petition.
3. Theinfrequentpurchaseoflifeinsurance.
4. Theagentsability to m akeabetterliving through specialization.
NEED FO R CLO SE CO NTRO L O VER PRO D U CT
The insurerneeds to m aintain close controloverthe policy productbecause ofits
com plicated nature,itslong duration,and thefiduciary relationship required betw een
theinsurerand theinsured.A shortchannelisappropriatew heresuch closecontrolis
desired.
NEED FO R CO NTRO L O VER SALES PRO M O TIO N AND CO M PETITIO N
Life Insurance is becom ing very com petitive.The policies ofthe m any com panies
vying forbusinessare sim ilarin nature.H ence,extra prom otion and com petition on
thebasisofsuperiorsalestechniquesofagentsoften representthedifferencebetw een
rapid and m ediocre ratesofgrow th fora life insurer.The insurercan exercise m uch
greatercontroloverthesefactorsby em ploying ashortchannelofdistribution.
INFREQ U ENT PU RCH ASE O F LIFE INSU RANCE
There are no com pelling reasonsforlife insurance to be offered asone ofthe m any
contracts available from a given agent,as is true in property insurance.A buyer
usually purchaseslifeinsuranceinfrequently,hasinfrequentneed forclaim sservice,
and haslittle day-to-day contactw ith the agentregarding endorsem entson policies,
requestsforinform ation,and thelike.
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Thisisnottoim plythatthelifeinsuranceagentrendersnoserviceoncethecontracthas
been putin force.The agentstands ready as the localrepresentative to the insured,
answ ers questions,and w rites letters to the insureron behalfofthe insured.Butthis
serviceisnotso dem anding oftheagentstim ethatalargebusinessoperation w ould be
required to provideit.A n agentstim eisbestspentin securing new sales.
BETTER LIVING TH RO U G H SPECIALIZATIO N
A n agentcan generally m akeahigherincom eifheorshespecializes.Becauseofits
technicalnature,the m ostsuccessfullife insurance agentspecializes in life,health,
and disability insurance,as w ellas pension planning.Fitting life insurance to an
individualsparticularneedsrequiresthe professionalservice supplied by the agent.
A dvanced know ledge ofthe subjectisneeded to renderthe quality ofsalesservice
usually expected.A n agent generally does not becom e an expert in all lines of
insurance butratherconcentratesin one area.W ith the frequentchangesin tax law s
during thepastseveralyears,thisstatem entism oretruethan ever.
The latestdevelopm entin m arketing insurance is ecom m erce.Insurers are selling
insuranceovertheInternet.Potentialbuyerscan surfthenet and seek theinsurance
they desire.A ctually,one com pletes an application and subm its itto the insurance
com pany.The com pany underw rites the policy,and if everything is correct and
acceptable to the insurer,the policy is issued through the m ail.This approach has
greatpotentialto reduce adm inistrative and m arketing costs.O nly tim e w illtellifit
w illbe a valid distribution m ethod.M ostpeople believe itw illbe easierfora new
com pany to use this approach versus existing ones because of relationships w ith
agentsand existing em ployees.
D irectW riting in Property-LiabilityInsurance
In som e lines ofproperty and liability insurance,independentinterm ediaries have
been elim inated,and thecontractism arketed directly from theinsurerto theinsured
through eitherexclusive agentsorem ployeesw ho w ork on salary and com m ission.
The exclusive agent (or salaried em ployee) solicits prospects, takes care of
paperw ork,and in generalserves as the insurers directcontactw ith the insured.
Insurersw ho em ploy thistypeofdistribution arecalled directw riters.
In general,directw ritershave been able to sellinsurance ata low ercostto the final
consum er,and this,plusa vigorousadvertising cam paign,hascontributed greatly to
theirsuccess.Thelow ercosthasbeen achieved by theinsurerlargely through stricter
underw riting and sm allerallow ancesto theagentfortheproduction and servicing of
business.
A n explanation of the grow th of property-liability com panies em ploying direct
channels of distribution m ay be found in som e observations about the nature of
consum erbuying habitsin insuranceand otherfields.Channelsofdistribution tend to
be fixed in a free-enterprise system according to w hetherornotthey are asefficient
asalternativem ethods.
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U sesand AdvantagesofReinsurance
W hy w ould an insurer, despite the expense and difficulty of securing business
voluntarily,transfersom eofitto athird party?Therearefourm ain reasonsto do so :
1. Reinsuranceenlargestheceding insurer sfinancialcapacity to acceptrisk.
2. Reinsurancestabilizesprofitsand evensoutlossratios.
3. Reinsurance reduces the ceding insurer s unearned prem ium reserve
requirem ent.
4. Reinsurance offers a w ay for an insurer to retire from underw riting a given
segm entofitsinsurancebusiness.
6. W hatarethedifferenttypesofre-insurancearrangem ents?
TypesofReinsuranceAgreem ents
O rganization for reinsurance is found in m any form s,from individualcontractual
arrangem entsw ith reinsurersto poolsw hereby anum berofprim ary insurersagreeto
acceptcertain typesofinsuranceon som eprearranged basis.
FacultativeReinsurance
The sim plesttype of reinsurance is an inform alfacultative agreem ent,or specific
reinsurance on an optional basis. U nder this arrangem ent a prim ary insurer, in
considering theacceptanceofacertain risk,shopsaround forreinsurance,attem pting
to negotiate coverage specifically on this particular contract. A life insurer, for
exam ple,m ay receive an application forRs.10 m illion oflife insurance on a single
life and approached anotherinsurerforreinsurance.The reinsurance com pany m ay
notw ish to rejectthisbusinessbutstillunw illing to acceptthe reinsurance business
from a particular insurer w ith w hom it has done business in the past,Then the
reinsurerm ay agreeto assum e40 percentofany lossforacorresponding percentage
oftheprem ium .Theprim ary insurerthen putsthecontractin force.
Thereinsuranceagreem entdoesnotaffecttheinsured in any w ay.Inform alfacultative
reinsuranceisusually satisfactory w hen reinsuranceisofan unusualnatureorw hen it
is negotiated only occasionally. Such an arrangem ent becom es cum bersom e and
unsatisfactory,how ever,ifreinsuranceagreem entsm ustbenegotiated regularly.
O ccasionally,an insurerw illhave an agreem entw hereby the reinsureris bound to
take certain types of risks if offered by the ceding com pany,butthe decision of
w hetherornotto reinsurerem ainsw ith theceding com pany.Such an arrangem entis
called a form alfacultative contractorobligatory facultative treaty.Itisused w here
the ceding com pany isbound on certain typesofrisksby itsagentsbefore ithasan
opportunity to exam ine the applications.Ifthe exposure is such thatreinsurance is
notneeded ordesired,the ceding com pany m ay retain the entire liability.In other
cases,itw illsubm itthe business to the reinsurer because of the tendency for the
ceding com pany to keep betterbusinessforitselfand passon the m ore questionable
linesto thereinsurer.
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Autom aticTreaty
To protectallparties concerned from the tendency described above,to speed up
transactions, and to elim inate the expense and uncertainties of individual
negotiations,reinsurance m ay be provided w hereby the ceding com pany isrequired
to cedesom ecertain am ountsofbusinessand thereinsurerisrequired to acceptthem .
Such an agreem entisdescribed asan autom atictreaty.
Tw o basic typesoftreaty have been recognized:prorata treaties,underw hich losses
are paid by the reinsurerin excess ofsom e predeterm ined deducitable orretention
and excess-of-loss treaties, w here there is no directly proportional relationship
betw een theoriginalprem ium and theam ountoflossassum ed by thereinsurer.
PRO -RATA TREATIES
There are m any varietiesofpro-rata treaties,butperhapsthe tw o m ostcom m on are
the surplus treaty and the quota share treaty.Surplus treaties cover only specific
exposures policies covering individuals or business firm s w hereas quota share
treatiescoverapercentageofan insurer sbusiness,eitheritsentirebusinessorsom e
definiteportion thereof.
A n exam ple ofa surplus treaty is the excess line,orfirstsurplus,treaty.H ere the
ceding com pany decidesw hatitsnetretention w illbeforeach classofbusiness.The
reinsurerdoesnotparticipateunlessthepolicy am ountexceedsthisnetretention.The
largerthe netretention,the m ore the orderm em bersofthe treaty w illbe w illing to
accept.Thus,if the ceding com pany w illretain Rs.100,000 on each hom eow ner
exposure,theagreem entm ay callforcession ofup to fivelines, orRs.500,000,for
reinsurance.Theprim ary insurercould then takeahom eow ners risk ofRs.600,000 -
Rs.100,000 to beretained and Rs.500,000 to beceded to thereinsurer.
Firstsurplustreatiescallforthesharing oflossesand prem ium sup to astated lim itin
proportion to the liabilities assum ed.Som etim es a second surplus or even a third
surplustreaty arranged to take overbusinessthatisbeyond the lim itssetby the first
surplustreaty.Thesurplustreaty isprobably them ostcom m on typeofreinsurancein
usetoday.
To illustrate how surplus treaties w ork,assum e thata prim ary insurerhas issued a
hom eow ners insurance policy in the am ountofRs.1,000,000 subjectto a four-line
firstsurplustreaty,Rs.100,000 oftherisk.Therisk isdivided asfollow s:
O riginalpolicy lim its Rs.1,000,000
Retention by prim ary insurer 100,000
O riginalpolicy lim its Rs.1,000,000
Surplus 900,000
Firstsurplusretention (4 lines) 400,000
Second surplusretention (3 lines) 300,000
Third surplusretention (2 lines) 200,000
Totalcession Rs.900,000
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Each reinsurerdivides the prem ium and any losses in proportion to its share ofthe
totallim itof coverage.Thus,the prim ary insurer and the first,second and third
surplus reinsurers w ould divide prem ium s and losses on the basis 1/10,4/10,3/10,
and 2/10,respectively.Ifthere w ere a Rs.100,000 loss,these fourpartiesw ould pay
Rs.10,000,Rs.40,000,Rs.30,000,and Rs.20,000 respectively.Prem ium sand losses
on polices w ritten forless than Rs.1 m illion w ould be divided on the basis ofthe
insurersinvolved.Forexam ple,aRs.500,000 policy w ould bedivided by theprim ary
insurerand the firstsurplusreinsureron a 1/5,4/5 basis.In thiscase,the capacity of
theprim ary insurerand thefirstsurplusreinsurerissufficientto covertheRs.500,000
exposure. The second and third surplus retention policies are not needed. The
reinsureralso paystheprim ary insureraceding com m ission to help pay forthefirst-
yearacquisition expensepaid by theprim ary insurer.
U nderthe quota share treaties,each insurertakesa proportionate share ofalllosses
and prem ium s ofa line ofbusiness.A n illustration ofthe quota share treaty is the
reinsurance pool or reinsurance exchange. Pools are usually form ed to provide
reinsurance in given classes ofbusiness,such as cotton,lum ber,oroil,forw hich
hazards are of a special nature and for w hich the m utual use of engineering or
inspection facilitiesprovidesan econom y forparticipating m em bers.Each m em ber
ofthepoolagreesto placealldescribed businessitobtainsinto thepool,butitshares
som e agreed proportion,such as 10 percentor16.67 percent,ofthe totalprem ium
and losses.Q uota share treaties are especially suitable for new,sm allfirm s w ith
lim ited underw riting capacity thatw ould be unable to getstarted w ithoutsuch an
arrangem entbecauseoftheunearned prem ium reserverequirem ents.
EXCESS-O F-LO SS TREATIES
Itisnotuncom m on fora prim ary insurerto find that,although itisw illing to accept
up to Rs.100,000 on each exposure insured in a given class,itisunable to stand an
accum ulation oflossesthatexceedsRs.500,000.To im posealim iton such losses,the
excess-of-loss treaty has been developed,w hereby the reinsureragrees to be liable
for all losses exceeding a certain am ount on a given class of business during a
specific period.Such a contractis sim ple to adm inister,because the reinsurers are
liableonly aftertheceding com pany hasactually suffered theagreed am ountofloss.
Because the probability oflarge losses is sm all,prem ium s forthis reinsurance are
likew isesm all.
A variation of the excess-of-loss type of reinsurance is the spread-of-loss treaty.
U nderaspread oflosstreaty,theprim ary insurerdecidesw hatlossratio itisprepared
to stand on a given kind ofinsurance and agreesw ith a reinsurerto bearany losses
thatw ould raise the losssratio above the agreed levelfora period ofyears(e.g.five
years).Thus,theceding com pany hasspread itslossesoverareasonabletim eperiod
and,in effect,has guaranteed an underw riting m argin through reinsurance.In this
w ay,an unusually high lossratio in apoorunderw riting yearisaveraged in w ith other
years.
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Insurers are perm itted to place their reinsurance business outside India w ith only
thosereinsurersw ho haveoveraperiod ofthepastfiveyearscounting from theyear
preceding forw hich the businesshasto be placed,enjoyed a rating ofatleastBBB
(w ith Standard and Poor) or equivalent rating of any other international rating
agency.Itisobligatory forallinsurersto offeran opportunity to otherIndian insurers
including the Indian reinsurer to participate in its facultative and treaty surpluses
beforeplacem entofsuch cessionsoutsideIndia.
A ny surplusoverand above the dom estic reinsurance arrangem entsclassw ise m ay
beplaced by theinsurerindependently w ith any ofthereinsurers,subjectto alim itof
ten percentofthe totalreinsurance prem ium ceded outside India being placed w ith
any one reinsurer.In the eventthatthe insurerw ould like to cede a share exceeding
such lim itto any particularreinsurer,in respectofspecialized insurance,the insurer
should seek thespecificapprovaloftheIRD A in thisregard.
Every insurershould also m akean outstanding claim sprovision forevery reinsurance
arrangem entaccepted on the basisoflossinform ation advicesreceived from brokers/
cedants and in cases w here such advices are notreceived,on an actuarialestim ation
basis.In addition,every insurershould also m ake an appropriate provision forclaim s
on itsreinsuranceaccepted portfolio on actuarialestim ation basis.
TheIndian reinsurerisrequired to organizedom esticpoolsforreinsurancesurpluses
in fire,m arinehulland otherclassesin consultation w ith allinsurersand should also
assistin m aintaining the retention ofbusiness w ithin India.Such arrangem ents are
required to be subm itted to the IRD A forapproval.Further,the Indian reinsureris
required to retrocedeatleastfifty percentoftheobligatory cessionsreceived by itto
theceding insurersafterprotecting theportfolio by suitableexcessoflosscovers.
Every insurer w anting to w rite inw ard reinsurance business should have an
underw riting policy for underw riting reinsurance business,w hich should be filed
w ith the IRD A stating the classes of business,geographical scope,underw riting
lim itsand profitobjective.
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Chapter 14
Case Studies
CASE STUDY - 1
Sonata Life Insurance company has been set up in India after the privatization of the
insurance business. The company had set up the following departments and started
its operations.
(a) Production
(b) Underwriting
(g) Miscellaneous
The company recruited around thirty thousand agents and five thousand unit
managers to start its marketing activities. With much focus on marketing soon,
thousands of proposals were brought into the offices around the country. The heavy
rush led to delay in issue of policies and suddenly there was pressure from the agents
and customers about the aid-back attitude of the company, and agents were worried
that their payments were unduly deferred.
Company management did not want to keep the marketing people unhappy and
therefore decided to speed up the issue of policies. Thus the company could sell
about one hundred thousand policies in the first six months of operations, which is a
record of sorts.
However, the joy of achievements in marketing did not last long because by the end
of the first year, the following cases were reported.
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Solution:
The next step after the marketing activity is the underwriting which involves the
process of selection of risks. Because of the pressure from the marketing department
and eagerness to capture the market, the company seems to have missed its focus on
underwriting which resulted in the above complaints.
The insurance companies need to select the risks to insure in accordance with the
company's policies. The objective of underwriting is to ensure that the applicant will
not suffer a loss that is much greater than what was assumed at the time the
premiums were fixed. The insurance company establishes certain standards of
selection, when the premium rates are formulated, keeping in mind the physical and
moral hazards.
A life insurance company may decide not to insure the life of someone who works in
a hazardous environment, say, a stuntman in the film industry. While considering an
application for life insurance of a film stuntman, the underwriter needs to consider
whether he can make an exception to the company policy. The underwriter needs to
evaluate what would happen if a large number of such policies were written and if a
significant number of claims arose. Underwriters have to strike a balanced rate
making.
The field agent is also expected to do some preliminary screening of the applicant
before forwarding it to the insurance company's underwriter. In many fields of
insurance, the agent can make binding decision on behalf of the insurance company,
but these decisions can be subject to post underwriting by the insurance company
and the contract is cancelable on giving due notice to the insured.
There are some functions that are allied to underwriting or provide support to
underwriters. In life insurance, for example, a physician may provide medical reports
on prospective applicants. The physicians must be appointed or licensed by the
insurance company to avoid unethical practices in issue of certificates.
Another function of the underwriting department is policy writing. In most cases, the
agent issues the policies, but the underwriter has to check whether the rates have
been accurately charged, whether or not the agent has taken a prohibited risk and
whether the applicant has followed all the terms and conditions.
CASE STUDY - 2
Fountain Life Insurance company, a leading life insurance company has perfected
the art and science of insurance and has excelled in providing the best of services to
its customers. It has achieved this objective by continuous efforts by staying
customer centric and has put in lots of efforts and investments to develop various
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Of late the company management sensed some reduction in profits and so has set up
a committee to look into the issues relating to changes in the business environment.
The committee has made the following observations:
(b) The claims rates are increasing because of growing uncertainty in the law
and order situation in the country, catastrophic events and also some
malpractices in some areas of operations.
(c) Business partners and stakeholders are waiting for greater consistency in
earnings and profits from the company.
(d) Regulator is contemplating increase in capital requirements
(e) The investments made by the company are not yielding as much profits as it
used to a few years ago.
(f) Coordination among the departments is also becoming difficult because of
attrition from the company.
(g) Few irregularities are also detected in certain processes of claims
settlement.
(h) Certain deficits are also surfacing in the underwriting department, which is
the core competency of the company, because of the above factors and a
sense of instability.
In order to face the situation the management decided to outsource its activities and
engaged ContraFin, a BPO firm to look after its underwriting and claims
departments. After the outsourcing arrangement the company restricted itself to the
marketing activity and focused on it.
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Solution:
BPO is fast becoming a strategic initiative that is driving the course of the enterprise
and the global economy. Insurance firms are also pushing to outsource non-core
functions to reduce losses and to focus more on their core competencies. The
mismanagement in claims departments, workers' compensation costs, increased
liabilities and risks around the world, etc. can be handled well by the outsourcing
initiatives.
CASE STUDY - 3
Fin Man Life Insurance is a leading insurance company headquartered in Australia
and has also set up its operation in other parts of the world as part of expansion
activities. The company never believed in partnerships or joint ventures and it holds
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hundred percent stake in all the countries where it has set up the companies. The
company is excited to learn about opportunities in the Indian insurance market where
there is the second largest population in the world and the insurance penetration is
very less which is in single digits. The company has forwarded its application to set
up a life insurance company in India to the Ministry of Finance and has expressed
interest to invest to the tune of Rs.5000 crore in India. The proposal also gives
details about its competency and achievement in the life insurance business. The
company also submitted the quality assurance certificates awarded to it by various
agencies in support of its application.
To its surprise the company has not received any information from the Ministry of
Finance and is awaiting response.
Q. State the reasons for such delay and also the prospects of getting license in
Indian insurance market.
Solution:
The case relates to the aspects about exchange control and their relation with
Insurance. The Exchange Control Department within the Reserve Bank of India
(RBI) is responsible for the regulation and enforcement of exchange controls. The
Foreign Direct Investment (FDI) regime in India has been progressively liberalized
in the nineties with the passage of the Foreign Exchange Management Act, 1999
(FEMA).
Direct Investment
The aggregate equity participation of a foreign company either by itself or through
its subsidiary companies or its nominees in an insurance company cannot not exceed
twenty six per cent of the paid up capital of the insurance company. The Insurance
Act and the regulations there under provide for the manner of computation of such
twenty six percent.
Hence, for the above reason "FinMan" could not be given permission to invest
hundred percent in insurance business in India. Only twenty six percent is the
permissible limit for FDI in Indian insurance sector.
FDI is permitted in India either under the 'automatic route', or with prior government
approval. If the investment is not eligible for the 'automatic route', the investors
would require approval from the Foreign Investment Promotion Board (FIPB).
Indian companies are generally permitted to accept FDI without prior approval,
subject to certain sectoral policies and investment limits. In other words, only if
"FinMan" wishes to invest through joint venture it can be permitted to invest in
India, and it need not await any approvals upto twenty six percent joint venture FDI.
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CASE STUDY 4
Infinity Life insurance company was set up in the year 2001 in Chennai, with a
limited number of dedicated customers. The company has since then grown by leaps
and bounds to more than one hundred thousand customers. Initially, the company
could look after the needs of the customers on a case to case basis; however, as the
number of customers increased, monitoring each individual transaction become
manually impossible. Slowly there were complaints from the customers about
deficiencies in service regarding delays in issue of policy, policy servicing, billing,
loans, claims settlement, etc. The existing workforce was not able to track even the
complaints efficiently because of the increasing number of customers. Hence the
management initiated steps to put in place a computerized system to get feedback
from the customers about their suggestions and grievances. It was codenamed:
"Customer Feedback System"
Management intended to get the feedback from the customers through internet and
various computer terminals set up at the offices into a centralized database. The
feedback would be used to address the gaps in underwriting, policy servicing,
billing, loans and claims departments. A new development wing was put in place,
with a project manager and his four-member team, keeping in view the present and
future requirements of the insurance company.
During the system development process, the senior managers, office staff,
development staff, and users were all involved and ultimately the system was put in
place. However, during the phase of development of the system, the managers
insisted on getting through their pet projects and the users had many more options
before them by way of entry of many other insurance companies, and some office
staff were not keen about encouraging customer complaints fearing loss of jobs. The
system development process was dragged beyond the said time frame because of
which many more changes have happened. Ultimately the "Customer Feedback
System" was found to be not useful to implement and it was discarded.
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x New technologies. The delay in development process has seen the evolution of
new technologies which are more competent to handle such feedback from
customers. When an organization tries to gain a competitive advantage by
using the latest information technology, it generally finds that attaining
systems development objectives is far more difficult because development
personnel are not as familiar with the technology.
x Resistance to change. People have a natural tendency to resist change, and
information systems development projects signal changes often radical in the
workplace. When personnel perceive that the project will result in personnel
cutbacks, threatened personnel will dig in their heels, and the development
project is often a casualty. The staff also feared that complaints could be
registered against them also if the system is implemented and hence were
showing resistance to change.
x Changing user needs. Users in this case are the customers. User requirements
for information technology are constantly shifting. However, when users
request a change during the development process, the development team may
be faced with the difficult challenge of developing systems whose very
purposes have changed since the development process began.
Users may not be keen to cooperate because they have other options from the
competitors and may just keep quiet and ignore the requests.
Most users do not realise that when a change is requested for, late in the
development process, the entire process has to be started afresh. Sometimes the
changes suggested by the users may not be incorporated as they desired because of
the gaps in communication.
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CASE STUDY 5
"KaasiAds" is an advertisement agency based in Mumbai and regularly takes
feedback from its customers to improve its performance from time to time. The
methodology for taking feedback included sending questionnaires to the customers
as email attachments and taking the completed sheets back in the same format. This
system was more effective than the earlier manual system but as the amount of
business grew even this seemed to be time taking because it still involved final
printing and storage of the filled sheets to do data analysis. Currently, "KaasiAds"
has only a computer terminal, printer, modem to look after this work and one person
attached to doing this job.
Citing the advent of new technology and increase in business "Winlad Soft" a
software company came up with a proposal to set up a new system to take customer
feedback. The new system involved online filling up of questionnaires and
submitting the data into a database which shall do the required data analysis and sum
it up in report format. The proposal of the "Winlad Soft" says that it will take care of
the system development and maintenance work and give the final report to the
agency. The time required would be greatly reduced because all the data is centrally
stored in a database and can be easily analysed in any required format to generate
report.
Q. Briefly discuss the technical, operational and time feasibility aspects in the
above case as part of system analysis.
Solution:
During the feasibility study the system study team examines alternatives that are
potential changes to existing systems. In the feasibility study, the objectives and
scope of the new system under consideration are specified. Then they examine each
alternative in detail and eliminate from consideration those clearly infeasible.
Technical Feasibility
A problem has a technically feasible solution if it can be solved using available
(already possessed or obtainable) hardware and software technology. This feasibility
criterion concerns the state of technology in the computer industry and the
technological capabilities of the organization. In evaluating technical feasibility, the
study team determines whether computer software and equipment that allow
implementation are available from manufacturers or already available. In this case,
the required hardware and software are available with the software company and are
much more effective in nature. In the changed system the client company need not
maintain any equipment as it used to do earlier.
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Operating Feasibility
A problem has an operationally feasible solution if it can be solved given the
organization's available personnel and procedures. In considering the operating
feasibility of an alternative, the study team determines if a proposed system change
could enable the system to meet its operating objectives. An alternative that fails to
do so is discarded.
The person currently operating the computer and modem set up could be employed
in some other location in the organisation or relocated.
A significant factor in determining operating feasibility is user satisfaction. If users
are dissatisfied with a system, it does not meet its objectives. The new system of
taking customer feedback is much more effective than the earlier system because the
user can finish the job by click of button and need not send any reply emails with
attachments. So operating feasibility is good enough to the new system.
Time Feasibility
The software delivery time is very less because it is readily available and should only
be customized to the advertising agency requirement. Also the new software enables
early generation of reports in all possible formats.
Thus technically, operationally and time-wise the new system seems to be feasible.
CASE STUDY 6
The design team creates user interfaces for the system. User interfaces are the
conversations that occur between the user and the system and usually result in a data
input, output, or both. They are products of the project team's decisions concerning
outputs, inputs, computerized processes, and manual ones. In many systems, a user
interface is a series of display screens.
The system prompts users for data attributes on these screens, and the user responds
by entering them.
Amazing.com is a web-based bookseller, which registers the enquiring customers
online and provides details about various books, and it also takes the order after
taking details about the name of the book, author, number of copies, address of
delivery of the book, and enlists payment particulars in a safe format. The user
interface has the following features.
1. There are continuous data boxes against the column of which the customer
should type in the details.
2. The user can enter all the information about the address in a text box.
3. The customer can select any state from India from a menu box.
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Q. From the above case identify the guidelines followed while designing user
interfaces.
Solution:
The following guidelines have been incorporated in designing the above user
interface.
1. The system is not prompting the user what to do next, as only plain text
boxes seem to have been given. It is suggested that a menu or note should be
displayed near the text box or options link should be given to give more
ideas to the customer in case there is scope for doubt.
2. All the address can be entered in a single text box. This is not the right
approach. In fact, a display should be used to communicate only idea, i.e one
box for only house number, another box for street name etc.,
3. The third point seems to be okay as a menu is given in the box through
which only one item (state name) can be selected.
4. Prompting was given to enter data in a particular format. This meets another
guideline which says that where data must be entered, default values should
be specified in the design.
5. A chance is given to the user to look at the preview of data entered by him or
edit it before it is submitted. This is in keeping with the guideline that the
system should anticipate the errors a user is likely to make and suggest
change.
CASE STUDY 7
"MegaNet Insurance Services", a brokerage firm has embarked on a massive
exercise to computerize its services and has reached the system implementation and
operation phase. The new information system has been designed and in the
implementation stage, hardware and software acquisition, software development,
testing of programmes and procedures, development of documentation, and a variety
of installation activities were carried out. At this stage, the company management
realized that the systems should be in place immediately, otherwise the company
should be losing the market to the competitors. Hence a decision was taken to go
ahead with the conversion process, which involves shifting from the use of the
present system to the operation of a new application.
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Solution:
From the above discussion it is very clear that out of the five major activities that
take place during the system implementation phase, viz.:
the training and testing activities were disregarded. Training the people concerned
and testing the interface and system is essential before the conversion process. The
following text describes training & testing activities in system implementation phase
and their significance.
Training
Most training occurs after the completion of the design phase and prior to testing of
the system. The two groups of employees who benefit from training are the users and
the computer operations personnel.
User Training
Users include the managers, supervisors, and clerks who receive outputs from the
system or provide inputs to it. Members of the system design team have primary
responsibility for user training, although they may receive help from supervisors or
outside consultants. User training relies heavily on the descriptions contained in the
Procedures Manual. Members of the design team teach users the non-computerized
tasks required by the new system. They describe procedures for data entry and give
instruction on the use of outputs from the system.
Improper training or lack of training hence could lead to errors in data entry. This
naturally leads to mistakes in the system output, faulty reports, and loss of data also.
Another key aspect is that, as the managers, supervisors, clerks are devoid of training
the administration can face difficulties.
Operations Training
The project manager provides operations training to employees directly involved in
running the computer equipment. They include data entry clerks, computer
operators, technical support personnel, and data control clerks. Data entry clerks are
the people who convert transactions into a magnetic form readable by the computer;
computer operators work at a data centre and physically operate the computer and its
data storage devices; technical support personnel make repairs to equipment or
software when it malfunctions; data control clerks distribute to users the reports
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produced. During operations training, these employees learn how to use the
equipment and software included in the system.
Lack of training would affect the functioning of clerks, computer operators, technical
support personnel and data control clerks as they are the employees receiving
training at this stage. Improper storage of data may lead to loss of data or damage to
storage devices, which is detrimental to the functioning of the system in the long run.
Testing
Another activity which was ignored in this case is testing. This activity must precede
conversion, but it may proceed at the same time as some training tasks. Programmer
teams test individual programmes as a part of programming; during the testing
activity, two other tests occur: interface and system testing.
Interface Testing
In many applications, the output of one programme provides an immediate input to
another programme. for example, one programme may resequence a batch of
transactions. This sorted batch of transactions is then an input to another programme
that prints a report listing them. Next, another programme posts each transaction to a
ledger. In systems terminology, these programmes are tightly coupled. It is not
enough to know that each programme works properly; the project team must also
determine that the entire series of programmes functions as intended.
During interface testing, the project team produces test data for the first of a series of
programmes. Team members then execute each programme in the series and
examine the validity of the last programme's output. Interface testing should ensure
that the outputs produced by each programme are consistent with the input
requirement of the programme that follows it. When this testing is not done, the
likely mistakes cannot be identified after the conversion process.
System Testing
In contrast to interface testing which evaluates only computerized procedures,
system testing allows the project team to evaluate non computerized ones as well.
System testing includes tests of procedures used to capture data, covert data into
computer readable form, and produce the outputs of the system. It concerns user and
operations personnel involved in the system's routine operations.
The project team creates sample transactions representing a full range of both valid
and invalid data. User and data entry personnel enter these transactions into the
system. Computer operators execute on the actual equipment the computer
programmes to process the transactions. The project team then compares the outputs
from processing with those expected.
During system testing, the project team's main concern is the system's capabilities.
Team members determine whether the system has the capacity to process
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transactions correctly without creating backlogs. They also test to make sure that it
does not produce excessive erroneous transactions or allow erroneous data to enter
data records. System testing sometimes alerts the project team against errors made
during system design. Such errors must be corrected before conversion, when the
project team uses the system to process actual transactions. The importance of
system testing is thus quite evident from the above lines. Disregarding it may well
prove to be desperate to the organisation discussed in the case.
CASE STUDY 8
"An EDI transaction contains the same data found on a paper document in a
traditional system. Companies using a traditional system produce paper purchase
orders, order acknowledgements, shipping notices, invoices, and cheques. The
equivalent EDI transactions contain the same data as these paper documents but are
encoded electronically. EDI is an alternative way of recording transaction data."
Mr.Vikram. a Mumbai based importer, was impressed by the latest he read about
Electronic Data Processing and wanted to place his purchase order to the exporter
through electronic wire transfer. All the data entry work about the filling up of
forms, amount of data to be transferred is completed and the submit button was also
pressed, but then suddenly there was a total black out and he could not receive the
acknowledgement of the huge amount he paid, that too for the first time. The
Mumbai floods have kept the city dark for four days and the entire system got
submerged in water.
Q. What do you think is the position of the transaction and how safe are the
funds in the above case?
Solution:
In EDI terminology, the EDI transaction is a transaction set. The transaction set
contains not only the purchase data but also a header and a trailer. These are data
fields marking the start and the end of the transaction. They show the type of
transaction (for example, a purchase) and some control information (for example, the
total amount of the purchase), and they assign a unique identifying number of the
transaction set.
The EDI software combines several transaction sets of the same kind into a
functional group. It assigns to the group its own header (marking the group's start)
and trailer (marking the group's end). For example, a customer may initiate several
purchase orders to a supplier at one time. The customer's EDI software combines
them into a single functional group and sends it to the supplier. The supplier's
software knows when it reads the functional group header, how many transactions it
is receiving and what type they are.
The software combines several functional groups intended for the same company
into an EDI envelope. An EDI envelope may contain several functional groups of
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different kinds of transactions. The envelope also has its own header and trailer,
which shows the recipient and the sender of the envelope. For example, a supplier's
translation software may combine order acknowledgement, shipping notice, and
invoice transactions in an envelope addressed to a single customer.
Thus the data is secure in EDI and everything is properly recorded which can be
retrieved for verification purposes. Besides, controlling procedures ensure accuracy
and reliability of data.
When exchanging data electronically, developers implement other control
procedures that are appropriate for computer networks. EDI systems record control
data in the headers and trailers used with transaction sets, functional groups and
envelopes. This control data enables the translation software to determine if data has
been accidentally lost or altered on the communications link.
Another control issue is the form of the audit trail. An audit trail provides the ability
to trace a transaction from its initial record into the financial statements, and also in
the reverse direction. With transactional systems, document numbers provide the
audit trail. An EDI system also identifies electronic transactions with numbers. But it
stores the data and thus the audit trail, on magnetic media rather than paper.
Although this makes the audit trail invisible to people, it becomes accessible much
faster and more easily when a computer is used.
CASE STUDY 9
The Indian Railways seems to be the most sought after way of transport for the
common man in India. Surprisingly enough we find that almost all the trains run full
and the last minute efforts to get reservation always have long lines of passengers
eagerly waiting to get their tickets.
Till a few years back, the waiting period is what made the things really disappointing
because until the last minute the reservation clerk was not revealing the position.
People who wanted to make a long distance travel involving two or more trains too
had nightmares because a confirmed reservation ticket was being issued from the
originating station to the changing point from where another reserved ticket should
be availed. A telegram used to be sent to the station at the changing point requesting
to book the reserved ticket. However, in most of the cases, the passenger used to hear
from the reservation clerks at the station at changing point that they have not
received any communication at all or there is no availability of reservation. This
naturally puts many passengers to difficulty not knowing how to proceed further as
their entire plan gets upset.
Thanks to the modern technology of computers and networking, the times have
changed and railways have taken many initiatives to help the customers. Now the
customers need not wait in the lines to know the reservation position, they can
enquire about the latest position through more effective telephone lines or computer
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terminals set up outside the reservation counters, which provide minute to minute
details.
Passengers have the convenience to reserve their tickets from any place to any place
in India sitting at any single location. They can themselves see the reservation
position on the Internet and book their tickets on line. They can even cancel any
ticket at any place in India, without bothering about the place of purchase of the
ticket.
Online systems are invaluable for management purpose such as recording rail travel
reservations. Online real time systems frequently provide no printed record of
transactions. For this reason, magnetic records are obtained on a transaction log. This
allows reconstruction of the computer file containing the receivables records should
the file accidentally be erased or destroyed.
Online real-time system provides current data because the results of processing are
immediately available. They are frequently used with database management system
so that users can easily produce ad hoc reports from the database. They are more
complex to develop and maintain than the other approaches, however, and more
expensive to implement.
CASE STUDY 10
A disaster is a great or sudden misfortune, where usually there is a complete failure.
A disaster could be a natural one like a cyclone, tsunami, floods, earthquake or
manmade like terrorist attacks, war, etc. Businesses have to be prepared to face the
unexpected and plan in advance.
The recent floods in Mumbai, tsunami and the 9/11 have severly affected several
business houses. Mumbai is the financial capital of India and the place where many
companies from financial sector, IT, and BPOs have set up their facilities. The floods
have caused havoc in the city, with meteorologists recording 949mm of rain on 26
July 2005. Government officials estimated the disaster resulted in losses exceeding a
few thousand crores.
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Experts commented that "The city was unprepared. The local trains were cut off and
most of the roads were under water. The emergency services were not able to
respond and the administration has failed to anticipate and respond."
"Many of the bigger businesses, especially outsourcing centres, have been affected.
Many of the financial centres... have been affected and their business continuity has
come under pressure. Even though the damage is not that high, some people cannot
turn up to work."
In addition to the general chaos that surrounds natural disasters, some companies
have failed to prepare for flood scenarios and this was, indeed testing their disaster
recovery plans. Many of the control systems were set up in basements of the
buildings which were all flooded with water and it took almost three days for the
water to recede in some low lying areas. Employees were unable to report to their
duties because of lack of transport, some employees were either stuck in their offices
or on the streets and could not go home for two days.
All the newspapers reported that mobile networks were affected and large parts of
landlines too were under repair. Internet backbone services went down for three
days. Even people in other parts of India have reported being unable to withdraw
cash from ATMs as a result of systems failures in Mumbai. The CitiBank, ICICI,
HSBC and the Reserve Bank of India are all reported to have experienced problems
with ATM networks.
Solution:
A contingency plan, which is also called a Business Continuity Plan or a Disaster
Recovery Plan is a formal document that describes procedures to be used, should a
catastrophe occur at the data centre. Catastrophes such as fires, explosions, floods, or
tornadoes are unlikely, yet when one occurs, it can completely destroy a facility.
The contingency plan suggests any one or combination of the following initiatives:
adequate insurance coverage, designate alternative locations for processing and data
storage, identify vital applications, and assign responsibility for recovery procedures.
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Assign Responsibility
Management should assign responsibility to an individual for maintaining and
implementing an up-to-date contingency plan. This includes acquiring an adequate
alterative processing site, selecting a satisfactory off-site storage location, keeping
current backup files at that location, and testing the plan. Someone should be
designated in advance as responsible for beginning recovery procedures if a
catastrophe occurs. The plan should also identify and assign other responsibilities
necessary to begin operation at the alternative site. Assigning responsibility in
advance minimizes delays at a time when top management is preoccupied with
things other than the information system.
A contingency plan prevents the sizable financial losses an organization could incur
if an information system were destroyed.
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CASE STUDY 11
A leading financial services provider has initiated steps to set up systems in the
entire organisation and its branches. The management has ensured that all the
activities are computerized to improve the functioning of the organisation. All the
employees were trained on the relevant computer skills.
To it's great surprise the management realized after six months of commencement of
online operations that it has lost its business to the competitors and some of the
records are manipulated in the systems. This resulted in customer grievances and
sometimes court cases. Some customers have complained that their credit card
numbers were misused once the details are given to the company, while others
noticed minor thefts from their accounts.
Some managers also complained that important data with respect to the contract
tender rates were leaked from the systems and passed on to the competitors.
Q. Discuss the reasons for the loss of data in the above case in the backdrop of
setting up computerized systems.
Solution:
Fraud is the risk that affects the accuracy of the financial records and results in loss
of assets. Frauds result in misstatements of assets and expenses in the financial
statements. Major frauds also endanger the ability of an organization to continue its
operations. Many control policies and procedures protect against fraud by lower-
level employees. Employees at a managerial level, however, may be in a position to
override these controls. And when employees collude with other people, either
internal or external to the organization, controls may fail to prevent or detect fraud.
A good system of internal control limits the opportunities to commit fraud. When an
organization has proper segregation of duties, it separates custody, record keeping,
and authorization of transactions in an asset. Thus, if an employee commits a fraud,
another employee is in a position to discover it. Whenever employee fraud occurs,
the three circumstances of the fraud triangle are present. The employee must have an
opportunity, must feel pressure from some sources to commit the crime, and must be
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able to rationalize the behaviour. Management can prevent many employee frauds by
recognizing when these circumstances occur for its employees.
Just as recognizing the fraud triangle aids in preventing frauds, knowing the
components of any fraud aids in detecting them.
Components of Fraud
The most common employee frauds consist of three acts: theft of assets, conversion
of those assets and concealment of the theft.
THEFT
An organization entrusts its employees with its assets so they can perform their
duties. A fraud begins when someone steals assets. This causes the overstatement of
the asset in the financial records.
Because of its liquidity, the most desirable asset to a thief is currency. Most
organizations implement controls making a theft of currency difficult to commit and
conceal. Therefore, most frauds involve stealing other assets such as cheques,
inventory, or equipment. These require a second fraudulent act, viz., conversion of
the assets.
CONVERSION
When a criminal steals an asset other than currency, usually the asset itself is not
valuable to the criminal. So the criminal attempts to convert the asset into currency.
This occurs, for example, when a thief sells stolen inventory or equipment or cashes
a stolen cheque.
Conversion does not affect the accuracy of the financial records, but it does provide
opportunities to detect a theft. Furthermore, making conversion difficult is an
effective way to discourage theft.
CONCEALMENT
A thief who has an ongoing relationship with an organization, such as an employee
or business contact, usually attempts to conceal the theft. This either prevents or
delays recognition of it or prevents identification of the thief. Concealment provides
additional opportunities to steal and can result in an ongoing fraud.
To conceal a theft, the criminal must alter the records concerning the stolen asset.
For example, if inventory is stolen, the thief must alter the inventory records.
Otherwise, an auditor or supervisor could discover the theft when performing a
routine inventory count. Alterations to the records require fraudulent accounting
entries that produce misstated financial information. They require that the thief
bypass those system controls limiting access to data.
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Fraud Detection
Accountants may detect fraud when performing their routine duties or auditors may
detect fraud while conducting an audit.
DETECTING THEFT
Accountants detect thefts by periodically reconciling asset records with assets on
hand. If records indicate that assets are missing, the accountant alerts management
at least one level higher than the employee responsible for the assets. For example,
accountants and auditors routinely reconcile bank accounts, count the physical
inventory and verify property and equipment records to detect theft.
DETECTING CONVERSION
Conversion occurs when a thief converts a stolen asset into currency. Many forms of
asset conversion are difficult to detect from within the organisation. The sale of
stolen inventory or equipment, for example, is more likely to be detected by the
police than by accountants or auditors. In their audits of cash disbursements,
however, auditors perform procedures to uncover fraudulent check endorsements.
These disclose the conversion of stolen or fraudulent checks into currency.
DETECTING CONCEALMENT
Accountants and auditors use their understanding of the accounting system to detect
the concealment of a theft. To conceal a theft, the criminal must record an entry that
keeps the recorded assets equal to the actual assets on hand. Because assets have
been taken, the thief must make a fraudulent credit entry to an asset account. For
example, to conceal a theft for inventory, an employee must make a credit entry to
an inventory account.
At the same time, a double-entry accounting system requires that the thief falsify a
debit entry. Commonly thieves conceal a theft by debiting an expense account such
as bad debts expense or miscellaneous expense. As an alternative, they may debit an
asset account that is less carefully controlled than that of the asset stolen. For
example, the thief may make a debit entry in a goodwill or prepaid asset account.
Accountants or auditors discover the theft by identifying the fraudulent debit entry.
CASE STUDY 12
A life insurance company is to manage so much of data pertaining to various
departments in the company, the intermediaries, the customers and various other
activities.
The number of policyholders in the leading insurance firm in India is more than 10
million. The products offered are so diverse with many permutations and
combinations. The intermediaries that distribute the insurance products, like agents
are numbering around ten lakhs and the customer grievances/ claims have to be
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properly managed to keep the customers happy. The medical records and other
particulars of the customers have to be kept safe for much number of years.
As the number of years of doing the business grows, the data turns out to be very
huge and enormous. With the setting up of private insurance companies, further
increase in data relating to customers is generated. More work is generated in the
areas of policy servicing, new business acquisition, billing, loans, investment,
personnel management and office services. All the information needs to be
streamlined to stay competitive. Every insurance company also should maintain
close coordination between its head office, regional offices, divisional offices and
branch offices.
Q. How do you think all this can be achieved using modern science and
technology?
Solution:
In the pre-computer days, agencies handled almost all customer service. Though
manual, this system was efficient in that there was no duplication of processes by
agencies and insurers. The insurer's main role was to provide financial backing and
keep statistical information.
There has been a revolution in the way insurance companies do business. The new
emerging business model depends heavily on information technology and is called
the New Business Model. Primarily, it is customer-oriented. That is, all processes are
designed to satisfy customer needs, rather than the company's needs. The new model
is also decentralized; with more responsibility and power given to the people who
are on the front lines with the customers.whether they are independent agents,
brokers, captive agents, or company employees.
Giving these people the automated tools they need to handle all customer requests,
often in a single session, lets insurers satisfy customer needs faster and better. As a
result, the new business model is flexible, responsive, and cost-efficient.
Many established companies, especially those with a keen eye on the strategic
advantages of leading-edge automation, have already adopted the new technology-
driven business model either comprehensively or in specific niches, such as a
speciality line or a residual market. And forward-thinking start-ups are now running
their entire company on the new business model and powering with a network of
personal computers.
Client/Server Technology
Client/Server is a system in which most of the active computing, or processing, can
be done on the inexpensive but powerful personal computer workstations of the
"clients". Meanwhile, the server stores a central database. Servers can be lined to
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clients by a local area network (LAN); a wide area network (WAN) using dedicated
lines, or even ordinary dial-up lines. Ultimately, the link can be the Internet or
company intranets.
Today's servers are powerful, fast, and reliable. Many have multiple processors and
hard disks that allow scalability and automatic backups in the form of data
redundancy. The clients and the server combine to become a virtual supercomputer
with enormous processing power. A client/server system thus can support a sizable
insurance company's processing environment.
Flexibility
In today's competitive environment, insurers do not have the luxury of time. They
must respond quickly to take advantage of market opportunities. Software that
powers the new automation model is tool-based. Instead of having to rely on
programming, the user/analyst simply selects a tool: to quickly change a rate, add a
field, or modify an endorsement. In business terms, insurers get a much more cost-
effective and timely way to address new or changing market conditions.
Scalability
New style automation can be used anywhere because it is scalable. The full version
of a processing system is used for company-wide functions.
The same software can be "scaled down" to fit on a laptop. This means lower costs,
flexibility; more focused access to information, and improved service across the
insurer's organization.
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The Internet along with the company or industry specific intranets will ultimately put
significant insurance information directly in the hands of the consumer at a
reasonable cost. Customers will be able to inquire about their policies and coverage,
make changes, and get quotes all from the convenience of their home computers.
Better access to critical information is another benefit of the new automation model.
Integrated new-model systems put information about losses, expenses, market
penetration, and agencies at management's fingertips instantaneously. With vastly
superior data, company executives can take steps to lower operating costs with more
confidence and craft better short and long term strategies.
Finally, the new IT driven model also lets insurers give better, more focused service
to the insured's and its agents. With an integrated system, service representatives can
answer almost any question posed by a policyholder or agent. They can readily go
into the system and prepare a quote, find the cost of a policy change, or check the
status of a claim payment.
Since processing is more efficient and more work can be done with fewer
employees, progressive companies have begun to feel the positive impact of the new
business and automation models. "One-and-done" may be a catchy phrase, but it
does underscore an important message. It means that one employee can take care of
most requests from start to finish in one transaction. "One-and-done" also reiterates a
key concept expressed earlier in this chapter; by virtue of being customer-centred,
the combination of a new business model and new automation provides much greater
scope to increase business, lower costs and offer better service.
Data management is made easier by concepts like (a) database which is a structured
set of data held in a computer, especially accessible in various ways. (b) data
warehousing, which is database geared towards the business intelligence
requirements of an organisation. The data warehouse integrates data from the various
operational systems and is typically loaded from these systems at regular intervals.
Data warehouses contain historical information that enables analysis of business
performance over time. and (c) data mining which involves searching large volumes
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of data looking for patterns that accurately predict behavior in customers and
prospects.
CASE STUDY 13
"Hydra" is a leading FMCG brand in India selling Fast Moving Consumer Goods
like soaps, detergents, toiletries, cosmetics, etc. The company is an established brand
in India with over forty years of standing in the market. It has a strong distribution
network consisting of various stockists, wholesalers, distributors and retailers.
Besides that the marketing department in the company is headed by Mr. Rao who is
known for his vibrancy and out-of- the-box ideas. The company has recently crossed
one thousand crore turnover and is very up beat.
Meanwhile the insurance sector liberalized and the company management observed
the phenomenal growth opportunities in the insurance sector, which is witnessing
about thirty percent growth rate. The company management felt that it can make a
foray into the insurance industry because of its strengths in marketing and also
because insurance is production/ marketing intensive industry. The brand name of
"Hydra" can also be utilized to establish the company in insurance sector.
The formalities of applying for licenses and others were completed. The company
started its operation on 1st February 2002 under the name "Hydra Life Insurance
company". As planned earlier the company used its manpower in the distribution
channel of the parent company to promote life insurance products.
After six months of operations, which also included intense advertising campaign
and promotional activities, the company management settled down to take a look at
the resent position of the company. The following points have been reported by the
managers in the marketing department.
(a) Customers are not coming to the agents at all in spite of giving repeated
advertisements and reminders.
(b) The agents who were appointed were not able to convince the customers
about the benefits of the policies.
(c) The existing customers seldom turn out to talk to the agents or come with
requests to purchase more policies.
(d) Complaints have been received from the customers that agents suggested
unsuitable products which resulted in dissatisfaction and also lapsation of
some policies.
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Q. What do you think are the difficulties in marketing life insurance in the
above case?
Solution:
Following are the unique characteristics of life insurance distribution channels which
make it different from goods marketing or distribution channel.
The insurer needs to maintain close control over the policy product because of its
complicated nature, its long duration, and the fiduciary relationship required between
the insurer and the insured. The customers have to shell down money without
receiving any tangible item in hand, which is not the case with FMCG marketing.
Only when the agent is readily available to answer the queries he/ she can develop
long term relationship with customers which results in more business.
A buyer usually purchases life insurance infrequently, has infrequent need for claims
service, and has little day-to-day contact with the agent regarding endorsements on
policies, requests for information, and the like. It is not like Fast Moving Consumer
Goods where the requirement is regular.
This is not to imply that the life insurance agent renders no service once the contract
has been put in force. The agent stands ready as the local representative to the
insured, answers questions, and writes letters to the insurer on behalf of the insured.
But this service is not so demanding of the agent's time that a large business
operation would be required to provide it. An agent's time is best spent in securing
new sales.
(d) BETTER LIVING THROUGH SPECIALIZATION
An agent can generally make a higher income if he or she specializes. Because of its
technical nature, the most successful life insurance agent specializes in life, health,
and disability insurance, as well as pension planning. Fitting life insurance to an
individual's particular needs requires the professional service supplied by the agent.
Advanced knowledge of the subject is needed to render the quality of sales service
usually expected. An agent generally does not become an expert in all lines of
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insurance but rather concentrates in one area. With the frequent changes in tax laws
during the past several years, this statement is more true than ever.
Thus, by closely following the unique features of insurance distribution Hydra Life
Insurance can redirect its efforts and manpower to make a mark in its new business.
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