Master of Business Administration - MBA Semester 4

MF0009 – Insurance and Risk Management

Assignment Set- 1

Q.1 Explain the steps involved in risk management process?

Ans:- Risk management activities occur before, during, and after losses. Most planning is done
before losses occur. Losses involving natural disaster and other emergencies also require action
while losses are happening. After the loss, the Risk Manager must file insurance claims and
analyze loss patterns.

The risk management process involves four steps:

1. Identifying potential losses,

2. Evaluating potential losses,
3. Selecting the appropriate techniques for treating loss exposures, and
4. Implementing and administer the programme.

Each of these is discussed in some detail in the following section:

1. Identifying Potential Losses

The first step in the risk management process is to identify all major and minor loss exposures.
This step involves a painstaking analysis of all potential losses. Important loss exposures relate
to the following:

(a) Property loss exposures

• Building, plants, other structures

• Furniture, equipment, supplies
• Electronic Data Processing (EDP) equipment; computer software
• Inventory
• Accounts receivable, valuable papers and record
• Company planes, boats, mobile equipment

(b) Liability loss exposures

• Defective products
• Environmental pollution (land, water, air, noise)
• Sexual harassment of employees, discrimination against employees, wrongful termination
• Premises and general liability loss exposures
 • Liability arising from company vehicles
• Misuse of the Internet and e-mail transmission, transmission of pornographic material
• Directors’ and officers’ liability suits

(c) Business income loss exposures

• Loss of income from a covered loss

• Continuing expenses after a loss
• Extra expenses
• Contingent business income losses

(d) Human resources loss exposures

• Death or disability of key employees

• Retirement or unemployment
• Job-related injuries or disease experienced by workers

(e) Crime loss exposures

• Hold-ups, robberies, burglaries

• Employee theft and dishonesty
• Fraud and embezzlement
• Internet and computer crime exposures

(f) Employee benefit loss exposures

• Fairly to comply with Government regulations

• Violation of fiduciary responsibilities
• Group life and health and retirement plan exposures
• Failure to pay promised benefits

(g) Foreign loss exposure

• Plants, business property, inventory

• Foreign currency risks
• Kidnapping of key personnel
• Political risks

2. Evaluating Potential Losses

The second step in the risk management process is to evaluate and measure the impact of losses
on the firm. This step involves an estimation of the potential frequency and severity of loss. Loss
frequency refers to the probable number of losses that may occur during some given time period.
Loss severity refers to the probable size of the losses that may occur.

Once the Risk Manager estimates the frequency and severity of loss for each type of loss
exposure, the various loss exposures can be ranked according to their relative importance. For
example, a loss exposure with the potential for bankrupting the firm is much more important in a
risk management programme than an exposure with a small loss potential.

Catastrophic losses are difficult to predict because they occur infrequently. However, their
potential impact on the firm must be given high priority. In contrast, certain losses, such as
physical damage losses to cars and trucks, occur with greater frequency, are usually relatively
small, and can be predicted with greater accuracy.

3. Selecting the Appropriate Techniques for Treating Loss Exposures

The third step in the risk management process is to select the most appropriate techniques for
treating loss exposures. These techniques can be classified broadly as either risk control or risk
financing. Risk control refers to techniques that reduce the frequency and severity of accidental
losses. Risk financing refers to techniques that provide for the funding of accidental losses after
they control. Many Risk Managers use a combination of techniques for treating each loss
exposure.

(a) Risk Control

Risk control encompasses techniques that prevent losses from occurring or reduce the severity of
a loss after it occurs. Major risk control techniques include avoidance and loss control.

• Avoidance: Avoidance means a certain loss exposure is never acquired, or an existing

loss exposure is abandoned. For example, flood losses can be avoided by not building a
new plant in a flood plain. A pharmaceutical firm that markets a drug with dangerous side
effects can withdraw the drug from the market.
• Loss Control: Loss control has two dimensions – Loss prevention and loss reduction.
Loss prevention refers to measures that reduce the frequency of a particular loss. For
example, measures that reduce truck accidents include driver examinations, zero
tolerance for alcohol or drug abuse, and strict enforcement of safety rules. Measures that
reduce lawsuits by the consumer of a defective product include installation of safety
features on hazardous products, placement of warning labels on dangerous products, and
institution of quality control checks.

(b) Risk Financing

Risk financing refers to techniques that provide for the funding of losses after they occur. Major
risk-financing techniques include retention, non-insurance transfers and commercial insurance.

• Retention: Retention can be effectively used in a risk management programme under the
following conditions:

First, no other method of treatment is available. Insurers may be unwilling to write a

certain type of coverage, or the coverage may be too expensive. Non-insurance transfers
may not be available. In addition, although loss prevention can reduce the frequency of
loss, all losses cannot be eliminated. In these cases, retention is a residual method. If the
exposure cannot be insured or transferred, then it must be retained.

Second, the worst possible loss is not serious. For example, physical damage losses to
automobiles in a large firm’s fleet will not bankrupt the firm if the automobiles are
separated by wide distances and are no likely to be simultaneously damaged.

Finally, losses are highly predictable. Retention can be effectively used for workers’
compensation claims, physical damage losses to automobiles, and shoplifting losses.
Based on past experience, the Risk Manager can estimate a probable range of frequency
and severity of actual losses. If most losses fall within that range, they can be budgeted
out of the firm’s income.

• Non-insurance Transfers: Non-insurance transfers are another type of risk financing

technique. Non-insurance transfers are methods other than insurance by which a pure risk
and its potential financial consequences are transferred to another party. In a risk
management programme, non-insurance transfers have several advantages:

i. The Risk Manager can transfer some potential losses that are not commercially
insurable.
ii. Non-insurance transfers often cost less than insurance.
iii. The potential loss may be shifted to someone who is in a better position to
exercise loss control.

However, non-insurance transfers have several disadvantages. They are summarised as

follows:

i. The transfer of potential loss may fail because the contract language is
ambiguous. Also, there may be no court precedents for the interpretation of a
contract that is tailor-made to fit the situation.
ii. If the party to whom the potential loss is transferred is unable to pay the loss, the
firm is still responsible for the claim.
iii. Non-insurance transfers may not always reduce insurance costs, because an
insurer may not give credit for the transfers.
(c) Insurance

Commercial insurance is also used in a risk management programme. Insurance is appropriate

for loss exposures that have a low probability of loss but for which the severity of loss is high. If
the Risk Manager uses insurance to treat certain loss exposures, five key areas must be
emphasized. They are as follows:

1. Selection of insurance coverages

2. Selection of an insurer
3. Negotiation of terms
4. Dissemination of information concerning insurance coverages
5. Periodic review of the programme

4. Implementing and administering the Risk Management Programme

At this point, we have discussed three of the four steps in the risk management process. The
fourth step is implementation and administration of the risk management programme. This step
begins with a policy statement.

(a) Risk Management Policy Statement

A risk management policy statement is necessary to have an effective risk management

programme. This statement outlines the risk management objectives of the firm, as well as
company policy with respect to treatment of loss exposures. It also educates top-level executives
with regard to the risk management process, gives the Risk Manager greater authority in the
firm, and provides standards for judging the Risk Manager’s performance.

(b) Co-operative with other Departments

The Risk Manager does not work alone. Other functional departments within the firm are
extremely important in identifying pure loss exposures and methods for treating these exposures.
These departments can co-operate in the risk management process in the following ways:

• Accounting. Internal accounting controls can reduce employee fraud and theft of cash.
• Finance. Information can be provided showing how losses can disrupt profits and cash
flow, and the effect that losses will have on the firm’s balance sheet and profit and loss
statement.
• Marketing. Accurate packaging can prevent liability lawsuits. Safe distribution
procedures can prevent accidents.
• Production. Quality control can prevent the production of defective goods and liability
lawsuits. Effective safety programmes in the plant can reduce injuries and accidents.
 • Human resources. This department may be responsible for employee benefit
programmes, pension programmes, safety programmes, and the company’s hiring,
promotion, and dismissal policies.

This list indicates how the risk management process involves the entire firm. Indeed, without the
active co-operation of the other department, the risk management programme will be failure.

(c) Periodic Review and Evaluation

To be effective, the risk management programme must be periodically reviewed and evaluated to
determine whether the objectives are being attained. In particular, risk management costs, safety
programmes, and loss-prevention programmes must be carefully monitored. Loss records must
also be examined to detect any changes in frequency and severity. Finally, the Risk Manager
must determine whether the firm’s overall risk management policies are being carried out and
whether the Risk Manager is receiving the total co-operation of the other departments in carrying
out the risk management functions.

Q.2 Discuss the relevance of insurance as social security. Bring out the latest development
in Insurance industry on social security.

Ans:- Insurance and Social Security

United Nations Declaration of Human Rights 1948 provides: “Every one has a right to adequate
standard of living for health and well being of himself and his family, including flood, clothing,
housing, medical care, necessary social services and the right to security in the event of
unemployment, sickness, disability, widowhood, or other lack of livelihood in circumstances
beyond his control.”

Under a socialistic system the responsibility of full security would be placed upon the state to
find resources for providing social security. The society provides instruments which can be used
in securing this aim. Insurance is one of the tools to achieve this aim. In capitalistic society too,
there is a tendency to provide some social security by the State under some schemes where
members are required to contribute.

In India, Article 41 of our Constitution requires the State (within limits of its economic capacity
and development) to make effective provision for securing the right to work, to education and to
provide public assistance in case of unemployment, old age, sickness and disablement. Part of
the obligations under Article 41 is met by the State through the mechanism of life insurance.

The path of insurance has been evolved to look after the interests of people from uncertainty by
providing certainty of compensation at a given contingency. The insurance principles prove to be
more useful in modern affairs. It not only serves the ends of individuals, or of special groups of
individuals, but also tends to spread through and renovate modern social order.
Latest development in Insurance industry on social security

Insurance provides social security to individuals. Some of its uses are as follows:

i) Insurance Provides Security and Safety: The insurance provides safety and security against
the loss on a particular event. In case of life insurance, payment is made when death occurs or
the term of insurance is expired. The loss of the family at a premature death and payment in old-
age are adequately provided by insurance. In other words, security against premature death and
old-age sufferings are provided by life insurance. Similarly, the property of insured is secured
against loss on a fire in fire insurance. In other insurance, too, this security is provided against
the loss at a given contingency. The insurance provides safety and security against the loss of
earning at death or in old age, against the loss at fire, against the loss of damage, destruction or
disappearance of property, goods, furniture and machines, etc.

ii) Insurance Offers Peace of Mind: The wish for security is a prime motivating factor. This is
the wish, which tends to stimulate to work more. If this wish is unsatisfied, it will create a
tension which may manifest itself in the form of an unpleasant reaction causing reduction in
work. The security banishes fear and uncertainty. Fire windstorm, automobile accident and death
are almost beyond the control of human agency and on occurrence of any of these events may
frustrate or weaken the human mind. By means of insurance, however, feeling of insecurity may
be eliminated.

iii) Insurance Protects Mortgaged Property: At the death of the owner of the mortgaged
property, the property is taken over by the lender of money and the family is deprived of the use
of the property. At the damage or destruction of the property, he will lose his right to get the loan
repaid. The insurance provides adequate amount to the dependents at the early death of the
property-owner to pay-off the unpaid loans. Similarly, the mortgagee gets adequate amount at
the destruction of the property.

iv) Insurance Eliminates Dependency: What would happen at the death of the husband or
father or the sole bread-earner of the family? The situation of such a family needs no elaboration.
Similarly, at destruction of property and goods, the family would suffer a lot. It brings reduced
standards of living and the suffering may go to any extent of begging from the relatives,
neighbours, or friends. The economic independence of the family is reduced or, sometimes, lost
totally. The insurance is here to assist them and provide adequate amount at the time of
sufferings.

v) Life Insurance Encourages Saving: The elements of protection and investment are present
only in case of life insurance. In property insurance, only protection element exists. In most of
the life policies elements of saving predominate. These policies combine the programmes of
insurance and savings.
vi) Life Insurance Provides Profitable Investment: Individuals unwilling or unable to handle
their own funds have been pleased to find an outlet for their investment in life insurance policies.
Endowment policies, multipurpose policies, deferred annuities certainly offer better type of
investment. The element of investment, i.e. regular saving, capital information, and return of the
capital along with certain additional return are perfectly observed in life insurance. In India, the
insurance policies carry special exemption from income tax, wealth tax, gift tax and estate duty.
An individual, on his own, may not be able to invest regularly with enough of security and
profitability. The life insurance fulfils all these requirements with a lower cost. The beneficiary
of the policyholder can get a regular income from the life-insurer.

vii) Life Insurance Fulfils the needs of a Person: The needs of a person are divided into:

1. Family needs,

2. Old-age needs,

3. Re-adjustment needs,

4. Special needs, and

5. The clean-up needs.

Insurance and Economic Development

In fact, the role of financial intermediaries arises because of imperfection in the economic
system. There exists an information gap between the suppliers of funds on the one hand and the
investors on the other. They do not possess information about each other’s location, volume of
funds, nature of investment projects, etc. It necessitates the growth of financial intermediaries to
perform these functions. It has, therefore, been contended that in a developed economy where the
financial market is relatively more perfect, the role of intermediaries will diminish and their
functions will increasingly be taken over by the financial market itself. However, in developing
economies, financial intermediaries play relatively greater role in supplying the funds and
amongst these intermediaries insurers play an important role.

In the economy, the functions of financial intermediaries are performed by several institutions,
viz. insurers, co-operative banks, mutual fund, and asset management companies, etc. The
advantage with insurance companies is that they are capable of deploying their funds in long-
term projects compared to banks and other intermediaries who invest their funds mostly in short
duration projects.

In addition to acting as mobiliser of savings and as financial intermediary, insurers also

contribute to the third state of capital formation, i.e. the act of actual investment. Broadly,
insurers stimulate investment activities in the following manner:
Q.3 Write short notes on:

a. Contract of Indemnity
b. COPRA , 1986

Ans;- Contract of Indemnity

Indemnity according to the Cambridge International Dictionary is “protection against possible

damage or loss” and the Collins Thesaurus suggests the words “guarantee”, “protection”,
“security”, “compensation”, “restitution”, and “re-imbursement” amongst others as suitable
substitute for the word “Indemnity”. The words protection, security, compensation etc. are all
suited to the subject of insurance but the dictionary meaning or the alternate words suggested do
not convey the exact meaning of ‘indemnity’ as applicable in Insurance Contracts.

In Insurance the word indemnity is defined as “financial compensation sufficient to place the
insured in the same financial position after a loss as he enjoyed immediately before the loss
occurred.” Indemnity thus prevents the insured from recovering more than the amount of his
pecuniary loss. It is undesirable that an insured should make a profit out of an event like a fire or
a motor accident because if he makes a profit there may be more fires and more vehicle
accidents.

Insurance may be for less than a complete indemnity but it may not be for more than it.

Example: To illustrate this point, let us take the example of a person who insures his car for Rs.4
lakh and it meets with an accident resulting in total loss. It is not certain that he will get Rs.4
lakh. He may have overvalued the car or may be the price of car has fallen after the policy had
been taken. The insurer will only pay an amount equal to the value of the car at the time of loss.
If he finds that a car of the same make and model is available in the market for Rs.3 lakh then he
is not liable to pay more than this sum and payment of Rs.3 lakh will indemnify the insured.
Similarly in the case of partial loss, if some part of the car needs to be replaced, the Insurer will
not pay the full value of the new part. He shall assess to what extent the old part had worn out
and after deduction of a proportionate sum he shall pay the balance amount. An insured is not
entitled to get new for old as otherwise he would be making a profit from the accident.

However there are two recent policies where there is deviation from the application of this
principle:

• One is the agreed value policy where the insurer agrees at the outset that they will accept
the value of the insured property stated in the policy (sum insured) as the true value and
will indemnify the insured to that extent in case of total loss. Such policies are obtained
on valuable pieces of art, jewellery, antiques, vintage cars etc.
 • The other type of policy is where the principle of strict indemnity is not applied is the
Reinstatement policy issued in Fire Insurance. The insured is required to insure the
property for its current replacement value and the insurer agrees that in the event of a
total loss he shall replace the damaged property with a new one or shall pay for the
replacement in full.

Other than these, there are life and personal accident policies where no financial
evaluation can be made. All other insurance policies are subject to the principle of strict
Indemnity. In most policy documents the word indemnity may not be used but the courts
follow this principle in case of any dispute coming before them.

Uses of Contract of Indemnity

• To discover over-insurance: The principle of indemnity is an essential feature of an

insurance contract, in the absence whereof this industry would have the touch of
gambling and the insured would tend to effect over-insurance and then intentionally
cause a loss to occur so that a financial gain could be achieved. So, to avoid this
intentional loss, only the actual loss becomes payable and not the assured sum (which is
higher in over-insurance). If the property is under-insured, i.e., the insured amount is less
than the actual value of the property insured, the insured is generally regarded his own
insurer for the amount of under-insurance and in case of loss he shall share the loss
himself.
• To avoid Anti-social Act: If the assured is allowed to gain more than the actual loss,
which is against the principle of indemnity, he will be tempted to gain by destruction of
his own property after getting it insured against a risk. He will be under constant
temptation to destroy the property. Thus, the whole society will be inclined towards
doing some anti-social act, i.e., the persons would be interested in gaining after
destruction of the property. So, the principle of indemnity has been applied where only
the cash-value of the loss and nothing more than this, though one might have insured for
a greater amount, will be compensated.
• To maintain the Premium at Low-level: If the principle of indemnity is not applied,
larger amount will be paid for a smaller loss and this increases the cost of insurance and
the premium of insurance will have to be raised. If premium is raised two things may
happen – first, persons may not be inclined to insure and second, unscrupulous persons
would get insurance to destroy the property to gain from such act. Both things would
defeat the very purpose of insurance. So, principle of indemnity is there to help them
because such temptation is eliminated when only actual loss and not more than the actual
financial loss is compensated provided there is insurance up to that amount.

How is Indemnity Provided?

The insurers normally provide indemnity in the following manner and the choice is entirely of
the insurer:
 • Cash payment
• Repair
• Replacement
• Reinstatement

Ans:-

The Consumer Protection Act, 1986

The Consumer Protection Act applies to all goods and services unless specifically exempted by
Central Government. The provisions of the Act are compensatory in nature.

It enshrines the following rights of the consumers:

• The right to be protected against the marketing of goods which are hazardous of life and
property;

• The right to be informed about the quality, quantity, potency, purity, standard and price
of goods so as to protect the consumer against unfair trade practices;

• The right to be heard and to be assured that consumer’s interest will receive due
consideration at appropriate forum;

• The right to seek redressal against unfair trade practices or unscrupulous exploitation of
consumers;

• The right to consumer education.

Under Section 2(e) of the Act, insurance is recognised as services.

Scope of the Consumer Protection Act, 1986 (COPRA, 1986)

The Consumer Protection Act, 1986 extends to the whole of India except the State of Jammu and
Kashmir. The provisions of the Act are in addition to, and not in derogation of, the provisions of
any other law for the time being in force. This Act applies to all types of goods and services
unless specifically exempted by the Central Government by notification. The Act provides for
setting-up of Consumer Protection Councils at Central and State levels and Consumers’
Complaints Redressal Agencies at Central, State and District levels of the country wherein States
include Union Territories also.
 Master of Business Administration - MBA Semester 4
F0009 – Insurance and Risk Management
Assignment Set- 2

Q.1 Explain the steps involved in Risk Management Technique.

Ans;- The steps for selecting among available risk management techniques for a given situation
may be-

• Avoiding risks if possible,

• Implementing appropriate loss control measures and
• Selecting the optimal mix of risk retention and risk transfer.

1 Avoiding Risks If Possible

Risks that can be eliminated without an adverse effect on the goals of an individual or business
probably should be avoided. Without a systematic identification of pure risk exposures, however,
some risks that easily could be avoided may inadvertently be retained.

Consider the plight of the not-for-profit organization, SEWA which operates several shelters to
feed and house homeless persons. A wealthy patron dies, leaving the entire estate to SEWA.
Included in the estate are an apartment complex in Delhi and some undeveloped land near a
hazardous waste site in Mumbai. Both properties present substantial risks, whether SEWA is
aware of them or not. But the organization will not likely be interested in keeping these
properties and actively managing the risks inherent in them. After carefully considering its goals
and priorities as well as the possible and probable losses associated with the properties, SEWA
may decide that the best solution is to sell the real estate and use the cash to finance its other
activities. By doing so, the organization will avoid several risks present in the said properties.

2 Implementing Appropriate Loss Control Measures

In case of risks that a business or individual cannot or does not wish to avoid, consideration
should be given to available loss control measures. In analyzing the likely cost and benefits of
loss control alternatives, it should be recognized that loss control will always be used in
conjunction with either risk retention or risk transfer. That is, even if substantial funds are spent
to reduce loss frequency and severity, some risk will still be present. In fact, objective risk may
actually increase when actions are taken that decrease the chance of loss. Thus, either the
remaining risk will be retained or it will be transferred to another party. This phenomenon is true
whether it is specifically planned or happens by default.

Therefore, part of the cost/benefit analysis regarding potential loss control is recognition of the
likely effects on the transfer or retention of the risk existing after loss control measures are
implemented. For example, X42 store is concerned about burglars breaking into its building,
because it is located in a high-crime neighbourhood. To help protect itself, X42 is considering
installing a high-power security and alarm system. In analyzing this situation, X42 should think
about both the effect on the chance of loss due to burglary and the fact that the cost of its crime
insurance may be lowered if it installs a reliable system. Hence, X42 may purchase less
insurance and engage in relatively more risk retention following the loss control measures.

Analyzing Loss Control Decisions

The techniques used in making capital budgeting decisions in finance and accounting can be
applied to risk management decisions regarding loss control. Consider Vishal Department Store,
which has been experiencing both substantial shoplifting losses as well as occasional vandalism
to its building. Vishal is considering hiring 24 hours security guards in an attempt to decrease
both the frequency and severity of these losses. The estimated annual cost of this 24 hour
protection is Rs. 60,000 which will cover salaries and employee benefits for the guards. By
analyzing the pattern of past losses, Vishal estimates that the presence of security guards will
decrease shoplifting losses by Rs. 30,000 and vandalism losses by Rs. 20,000. In addition,
Vishal’s property insurance premiums are expected to decrease by Rs. 5,000. Should the guards
be hired?
An answer based only on these financial considerations can be obtained by comparing the size of
the savings with the amount of cash outlay required to hire the guards. The estimated savings
are:

Rs. 30,000 Decreased shoplifting losses

Rs. 20,000 Decreased vandalism losses

Rs. 5,000 Lower insurance premium

Rs 55,000 Estimated savings from hiring guards

Because the Rs. 55,000 in savings is less than the Rs. 60,000 cost of hiring the guards, Vishal
may conclude that the potential savings do not justify the loss control expense. Before making a
final decision, however, Vishal should review both the estimated costs and savings. Vishal
should also consider whether there are any additional relevant factors that may have been
overlooked. For example, would the presence of a security guard make employees feel safer?
Would this intangible consideration make it possible to hire better employees? What about
customer relations? Would they be enhanced by the presence of a guard? The financial
calculations provide a good starting point for decision-making, but the final decision often will
be made in the light of additional, less quantifiable considerations.

In this example, all costs and benefits from the proposed investment in loss control were to occur
in the same year. When a longer period of time is involved, the calculation becomes more
complicated.

Example: Consider the example of whether or not DCM should install a sprinkler system to
protect its plant in case of a fire. It is estimated that the system will cost Rs. 600,000 and have a
useful life of 15 years, with no salvage value. The firm’s insurer has stated that installation of the
sprinkler system will reduce DCM’s insurance premiums by Rs. 63,000 a year. DCM’s Risk
Manager estimates that uninsured losses to property, as well as those involving injuries to
employees, will be reduced by Rs. 80,000 a year. It is also estimated that maintenance and repair
costs to the sprinkler system would be Rs. 3,000 a year. When borrowing funds, DCM must pay
interest at approximately a 10 per cent rate, and its tax rate is 40 per cent.

To solve this problem systematically, DCM should compare the present value of the after-tax
cash flows from the installation of the system with the present value of the cash outlay and
maintenance cost that the system would require. The cost of the sprinkler system represents a
cash outlay of Rs. 600,000 for the firm. The insurance premium savings and loss reduction
represent a cash inflow of Rs.143,000 a year (Rs.63,000 + Rs.80,000). The maintenance cost will
be a Rs.3,000 cash outflow each year. If the net present value (present value of the cash inflow
minus the present value of the cash outflow) is positive, the system should probably be
purchased. But if the net present value is negative, it probably should not be purchased unless
there are other less quantifiable factors to be considered.

From Table 4-1, it can be seen that there is a cash outflow of Rs.600,000 in year 0 and a net
after-tax cash inflow of Rs.100,000 in years 1 through 15. The cash inflow consists of
Rs.143,000 of savings minus Rs.3,000 for maintenance and Rs.40,000 a year in income taxes.
Because depreciation is a non-cash expense, it is deducted to determine the firm’s tax liability
but is added back to the firm’s cash flow in order to determine the cash inflow of the project.
Consequently, the Rs.100,000 of cash flow represents Rs.60,000 of after-tax cash savings and
Rs.40,000 of depreciation.

In this example, the cash flows are the same for each of the 15 years. So one can multiply the
Rs.100,000 by the present value of Rs.1 per year for 15 years at the firm’s 10 per cent cost of
capital (7.6060). This figure represents the present value of a rupee received at the end of each
year for 15 years. By multiplying 7.6060 by Rs.100,000, one determines the present value of
cash inflows, which is Rs.760,600. When Rs.600,000 (the cost of installation) is subtracted from
Rs.760,600 a net present value of Rs.160,000 is obtained. From this analysis, Factory
Company’s Risk Manager can state that the installation of the sprinkler system is desirable.
 Table 4-1 Net Present Value Analysis of Installation of Sprinkler Systems

3 Selecting the Optimal Mix of Risk Retention and Risk Transfer

As stated, loss control decisions should be made as part of an overall risk management plan that
also considers the techniques of risk retention and risk transfer. To further complicate the
decision-making process, risk retention and risk transfer often will both be used, with the
relevant question being, “What is the appropriate mix between these two techniques?”

Q.2 Explain the concept of banassurance and bring out the latest development in the
banking Industry for promoting banassurance products.

Ans:- The Concept of Bancassurance

Bancassurance is a concept that has rewritten the way in which insurance products are distributed
in many parts of the world and has the potential to do the same in many other markets. By
offering a holistic financial services package, encompassing banking, insurance, lending and
investment products, banks can maximise distribution of products to a captive customer base. In
markets where it is firmly established bancassurance channels can take an impressive market
share of new life business – around 55% in France and between 20% and 30% in many other
European countries.

Bancassurance – a term coined by combining the two words ‘bank’ and ‘insurance’ (in French) –
connotes distribution of insurance products through banking channels. Bancassurance
encompasses terms such as ‘Allfinanz’ (in German), ‘Integrated Financial Services’ and
‘Assurebanking’. This concept gained currency in the growing global insurance industry and its
search for new channels of distribution, with their geographical spread and penetration in terms
of customer reach of all segments, have emerged as viable sources for the distribution of
insurance products. However, the evolution of bancassurance as a concept and its practical
implementation in various parts of the world, have thrown up a number of opportunities and
challenges. Aspects such as the most suited model for a given country with its economic, social
and cultural ramifications interacting on each other, legislative hurdles, and the mindset of
persons involved in this activity, have dominated the study and literature on bancassurance.

Bancassurance is the distribution of insurance products through the bank’s distribution channel.
It is a phenomenon wherein insurance products are offered through the distribution channels of
the banking services along with a complete range of banking and investment products and
services. To put in simple terms, bancassurance tries to exploit synergies between both the
insurance companies and banks.

Bancassurance if taken in right spirit and implemented properly can be win-win situation for all
the participants viz., banks, insurers and the customer.

Latest development in the banking Industry for promoting banassurance products

Bancassurance has developed in parallel to the dramatic expansion of the world’s life insurance
market since the mid-1980s. This expansion has relied mostly on savings-type insurance
products, a significant portion of which are very close to traditional banking products such as
fixed-income securities or mutual funds. European wide, bancassurance has been far more
successful selling savings-type products than risky products such as those relating to longevity or
disability. For these kind of risky products, as well as for property and casualty insurance,
traditional insurers have kept their market leadership. While they also have expanded very
significantly in the life insurance business, it has been at a slower pace than bancassurance
institutions, which have benefited from the recycling of savings deposits into life products in
several countries. This has notably been the case in France, Belgium, Spain and Portugal.

A range of bancassurance business models exists and this affects the type of legal structures
used. Nevertheless, these legal structures fall into three main above- mentioned categories:
“Partnerships”, “Joint ventures” or “captives”.

(a) The Partnership Model

In this model, the insurance company distributes its products partly, though not exclusively,
through a banking channel. In addition, there is no dedicated legal entity to underwrite this
business, which is in practice directly accounted for on the insurer’s balance sheet. Under this
model, the insurance company typically pays distribution commission to the bank, which is in
turn offset by entry and management fees charged to policyholders. The relationship between the
bank and the insurer may also be complemented by a more or less significant shareholding or
cross-shareholding.

The business logic for such a model is the recognition by a bank of a real need to be in a position
to offer (mostly life) insurance products to its customers while being unable or unwilling to
develop such expertise internally. In some cases, it may also be a way for the bank to create
competition among various insurance providers to attract clients by adding value to its
distribution capabilities.

Examples

1. In the UK, Legal & General with Barclays Bank provides a range of life insurance products
and pays sales commission to the bank. At the same time, this business is accounted for in Legal
& General’s balance sheet. There is no strategic cross-shareholding between the two groups and
the partnership is not exclusive.

2. In France, CNP Assurances distributes its life policies through the network of la Poste, the
French Post-Office, which receives commissions for bringing insurance business to CNP. The
partnership is on an exclusive basis. In this case, the Post Office has a significant indirect
shareholding in CNP, although at 18% it is not a controlling stake.

In certain situations, what is in practice as partnership has many similarities with the captive
model (see below). In these cases, no dedicated unit carries the bancassurance activity and the
arrangement is in no way exclusive – in that the insurance companies involved use alternative,
exclusive or non-exclusive distribution channels – but there is a very strong shareholding from
the bank in the insurance company or vice versa.

(b) The Joint Venture Model

This business model relies on a more or less balanced shareholding between one or several banks
and an insurance group in a joint venture insurance company. This joint venture distributes its
products only through the network of its banking parent(s). In addition, the relationship between
the bank and the insurer is sometimes reinforced by a strategic shareholding.

The joint venture typically pays distribution commissions to the bank, which are in turn offset by
entry and management fees charges to policyholders. In addition, the bank also benefits from the
joint venture’s profitability through dividends paid. As in the case of the partnership model, the
business logic for creating a joint venture is a recognition by a bank of a real need to be in a
position to offer (mostly life) insurance products to its customers with an intention to build up
expertise in this area. Typically, the joint venture is granted exclusive access to market insurance
products through the bank’s network.

Examples

1. Ecureuil Vie in a joint venture in France 50% owned by the Caisses d’ Epargne Group and
50% by CNP Assurances. There is a significant indirect 18% strategic shareholding of Caisses d’
Epargne in CNP.

2. In Italy, BNL Vita is 50/50 owned by Banca Nazionale del Lavoro (BNL) and Unipol.
Interestingly, the value of this partnership may be such for Unipol that it has been used as an
argument to launch a takeover on BNL to avoid it being bought by Banco Bilbao Vizcaya
Argentaria.

In a limited number of situations, the joint-venture shareholding is unbalanced between the bank
and the insurance partners, although the business model is still considered a joint venture.

(c) The Captive Model

According to this model, an insurance company markets its products almost exclusively through
the distribution channel of its banking parent. In such cases, the ownership by the bank in the
insurer is typically very high, often 100%. The captive insurance company typically pays
distribution commissions to the bank, which are in turn offset by entry and management fees
charged to policyholders. In addition, the bank also benefits from the insurer’s profitability
through dividends paid. When compared to the partnership model or a joint venture, the logic for
the captive business model is the recognition by the bank of a real need to be in a position not
only to offer (mostly life) insurance products to its customers but also to keep the full know-how
and profitability of the business in-house. The insurance captive becomes an important tool of
the bank’s marketing policy and is a separate legal entity only due to regulatory constraints.
Nevertheless, it is very important that the bank management has sufficient understanding of the
insurance business.

Depending on the group structure, the insurance captive may be a direct subsidiary of the bank or
a sister company, both owned by the same holding company. This difference in terms of legal
structure generally reflects the significance of the business written by the insurance captive
through non-group channels. For instance, KBC Bank and KBC Insurance are sister companies,
both owned by KBC Group. Although KBC Insurance distributes the bulk of its business through
the bank’s network, a significant portion of its premiums, particularly those coming from Central
Europe, are sold via alternative distributors, mostly tied agents.

Examples with One Banking Shareholder

1. In France, Sogecap ranks among the largest domestic life insurers. The company is 10%
owned by Societe Generale and distributes its products almost entirely through the banking
network of its parent where it enjoys exclusivity.

2. In Spain, BBVA Seguros, 100% owned by Banco Bilbao Vizcaya Argentaria, is the bank’s
dedicated vehicle to provide its network with insurance products.

In various circumstances, several banks, usually co-operative in nature, share a common

exclusive insurance provider. In these cases, ownership in the insurer is typically split among the
various banks distributing the products, and sometimes with the involvement of an external
insurance company.

Q.3 Detail the future growth and opportunities of Indian Insurance Industry

Ans:- Insurance sector in India is one of the booming sectors of the economy and is growing at
the rate of 15-20 per cent annum. Together with banking services, it contributes to about 7 per
cent to the country's GDP. Insurance is a federal subject in India and Insurance industry in India
is governed by Insurance Act, 1938, the Life Insurance Corporation Act, 1956 and General
Insurance Business (Nationalisation) Act, 1972, Insurance Regulatory and Development
Authority (IRDA) Act, 1999 and other related Acts.

The industry is not just growing in terms of number of insurers, branch offices, employees or
agents. The growth is also reflected in the business figures. There was a phenomenal growth in
the New Business Premium, Renewal Premium, Total Premium Income as well as the number of
policies sold. The following table portrays the picture of life insurance business during the past
decade.

There was about 10 fold increase in the new business life insurance premium collected over a
period of 9 years. The continuous growth witnessed in this parameter after the enactment of
IRDA Act was reversed for the first time during 2008-09, when the New Business Premium
declined by 7.2%. This indicates that the fallout of sub-prime crisis was visible in terms of the
new business procured by the Indian life insurers. However, the total premium collected by the
insurers increased by over 10% and crossed the whopping figure of Rs.2.21 lakh crores as
against Rs.2.01 lakh crores during the previous year. Although the growth in total life premium
continued during 2008-09, the rate of growth was slower at 10.2% compared to 29% growth
witnessed during the previous year. There was a growth of above 738% in the total premium
collections since the entry of private players in the year 2000. As far as the number of new
policies sold is concerned, the figure tripled from 1.69 crore policies in FY 2000 to 5.09 crore
policies during FY 2009. Of course, the number of policies increased marginally by about 1 lakh
(0.2% change over the previous year). Number of in force policies, which were just above 10
crores at the end of FT 2000, crossed 29 crores as at 31st March, 2009, registering a growth of
186%.
Table - 4: INDIAN LIFE INSURANCE INDUSTRY – BUSINESS FIGURES
 Pre-IRDA Post-IRDA
Parameter FY FY FY % change FY % change % change
1999 - 2k 06-07 07-08 over 06-07 08-09 over 07-08 over 99-2k

New Business Premium 8,299 75,649 93,713 23.9 87,005 -7.2 948.4
(Rs. Cr)
Renewal Premiums (Rs. 17,951 80,427 107,638 33.8 134,78 25.2 650.9
Cr) 6
Total Premium (Rs. Cr) 26,250 156,076 201,351 29.0 221,79 10.2 738.8
1
Benefits Paid (Rs. Cr) 14,036 55,765 62,728 12.5 57,383 -8.5 308.8
New Business Policies (In 1.69 4.61 5.08 10.2 5.09 0.2 201.2
Cr)
In force Policies (In Cr) 10.14 22.7 25.93 14.2 29 11.8 186.0
Source: IRDA, Life Insurance Council (FY 09 data is provisional)

1. Opportunities

i) Untapped Market

New comers will get the benefit of untapped market. While nationalized general insurance
companies and LIC of India have done a commendable job in extending their services
throughout the country but the choices available to the insuring public are inadequate in terms of
services, products and prices the untapped potential in quite large. The Malhotra Committee,
which went into various aspects of India’s insurance industry, estimated that in life insurance,
22% of the insurable population has been tapped so far. In India, premium per capita is only 2
and premium as percentage of GDP is 0.55%, which is very less in comparison of USA where
premium per capita is 1381 and premium as percentage of GDP is 480. This huge gap from the
global bench mark is itself lucrative.

ii) Mandatory Insurance

In disaster-prone areas, Government of India is going to make insurance mandatory. The interim
report of the high-powered committee set up by the Centre for disaster management, has
proposed mandatory insurance of life and property by people residing in disaster-prone areas
such as coastal belts, flood- prone areas, sites near nuclear, chemical and hazardous industries
and thickly populated areas.

iii) More Products Offered

A state monopoly has little incentive to offer a wide range of products. It can be seen by a lack of
certain products from LIC’s portfolio and lack of extensive categorization in several GIC
products such as health insurance. More competition in this business will spur firms to offer
several new products and more complex and extensive risk categorization.

iv) Growth of Economy

With allowing of holding of equity shares by foreign company either itself or through its
subsidiary company or nominee not exceeding 26% of paid up capital of Indian Insurance
Company, various joint ventures between foreign investors and Indian partners will be operated
resulting into supplementing domestic savings and economic progress of the nations.

v) Opportunity for Banks

Banks with their wide area network with branches in all the parts of the country will have very
good opportunity to enter the insurance business. They will succeed in this sector because they
have data base of customers, trained staff, a good network of branches besides synergy benefits.

vi) Better Customer Services

It would result in better customer services and help improve the variety and price of insurance
products. Competition will compel the players to bring new and innovative product, wider choice
of prices and quality service to consumers.

CONCLUSION:

The present report covers overall insurance industry in India, including life and general insurance
and their products such as marine, motor and health insurance. It provides the structure and
process of the industry. Market density and penetration gives an idea of the chances of further
development of the industry. Health insurance is offering opportunities in the insurance sector.
Future outlook helps to form new strategies and provide better understanding of upcoming
market growth.