Lecture 1

RISK AND UNCERTAINTY

INTRODUCTION
We live in a risky world. Forces, largely outside our control, that threaten our financial well being,
constantly surround us. Thus, some of us will experience the premature and tragic death of a beloved family
member; others will experience the loss or destruction of their property from earthquakes, hurricanes,
floods, and other natural disasters. Some others will experience poor health from cancer, heart attacks, and
other diseases. Still others may be totally and permanently disabled from a crippling automobile accident or
a catastrophic illness. Finally, others will experience the traumatic effects of a liability lawsuit.
WHAT IS RISK?
Definitions of risks are many. Economists, behavioural scientists, risk theorists, statisticians and actuaries
each have their own concept of risk. But the majority of insurance authors traditionally have defined risk in
terms of uncertainty. Based on this theory, risk is defined as uncertainty concerning the occurrence of a loss.
For example, the risk of lung cancer for smokers is present since uncertainty is present. The risk of failing in
a college course is present because there is uncertainty concerning the out come of the grade. The risk of
being killed in an automobile accident is present because uncertainty is present. In short, risk is the same
thing as uncertainty.
We measure the presence or absence of risk by assigning probability values as p=1 or p=0, respectively.
Where there is no risk and as such there is no uncertainty, we say the probability of risk p=0. For example,
assume that someone attempts to burn a steel safe immersed in a tank of water. A loss from fire cannot
possibly occur. Since the probability of loss is 0, there is no risk because there is no uncertainty.
Risk can be further classified as objective and subjective risks.
Objective Risk
Objective risk is defined as the relative variation of actual loss from expected loss. For example, assume that
a fire insurer has 5000 houses insured over a long period and, on an average, 1 percent, or 50 houses are
destroyed by fire each year. However, it would be rare for exactly 50 houses to burn each year. In some
years, as few as 45 houses may burn, while in other years, as many as 55 houses may burn. Thus, there is a
variation of 5 houses from the expected number of 50, or a variation of 10 percent. This relative variation of
actual loss from expected loss is known as objective risk.
Objective risk declines as the number of exposures increases. More specifically, objective risk varies
inversely with the square root of the number of cases under observation. In our previous example, 5000
houses were insured, and objective risk was 5/50, or 10 percent. Now assume that 0.5 million houses are
insured. The expected number of houses that will burn is now 5000, but the variation of actual loss from
expected loss is only 50. Objective risk is now 50/5000, or 1 percent
Objective risk can be statistically measured by some measure of dispersion, such as the standard deviation
or coefficient of variation. Since objective risk can be measured, it is an extremely useful concept for an
insurance company or a corporate risk manager. As the number of exposures increases, the insurance
company can predict its future loss experience more accurately because it can rely on the law of large
numbers. The law of large numbers states that as the number of exposure units increase, the more closely
will the actual loss experience approach the probable loss experience. For example, as the number of homes
under observation increases, the greater is the degree of accuracy in predicting the proportion of homes that
will burn.
Subjective Risk
Subjective risk is defined as uncertainty based on a person’s mental condition or state of mind. For example,
assume that an individual is drinking heavily in a bar and attempts to drive home after the bar closes. The
driver may be uncertain whether he or she will arrive home safely without being arrested by the police for
drunken driving. This mental uncertainty is called subjective risk.
The impact of subjective risk varies depending on the individual. Two persons in the same situation may
have a different perception of risk, and their conduct may be altered accordingly. If an individual
experiences great mental uncertainty concerning the occurrence of a loss, his or her conduct may be
affected. High subjective risk often results in conservative and prudent conduct, while low subjective risk
may result in less conservative conduct. Thus, in the preceding example, the driver may have, been
previously arrested for drunk driving and is aware that he or she has consumed too much alcohol. The driver
may then compensate for the mental uncertainty by getting someone else to drive him or her home or by
taking a cab. In contrast, another driver in the same situation may perceive the risk of being arrested for
drunken driving as slight. This second driver may drive in a careless and reckless manner; a low subjective
risk results in less conservative driving behaviour.
Chance of loss
Chance of loss is closely related to the concept of risk. Chance of loss is defined as the probability that an
event will occur. Like risk, the term probability has both objective and subjective aspects.
Objective Probability
Objective probability refers to the long run frequency of an event based on the assumption of an infinite
number of observations and of no change in the underlying conditions. Objective problem can be
determined in two ways. First, they can be determined by deductive reasoning. These probabilities are called
a priori probabilities. For example, the probability of getting a head from the toss of a perfectly balanced
coin is 1/2, since there are two sides and only one is a head. Likewise, the probability of scoring a “4” with a
single die is 1/6, since there are six sides and only one side has four dots on it.
Second, objective probabilities can be determined by inductive reasoning, rather than by deduction. For
example, the probability that a person aged ten will die before age twenty cannot be logically deduced.
However, by careful analysis of past mortality experience, life insurers can estimate the probability of death
and sell a ten year term insurance policy.
Subjective Probability
Subjective probability is the individual’s personal estimate of the chance of loss. Subjective probability need
not coincide with objective probability. For example, some persons may bet on a favourite horse since they
believe it is their lucky day. Accordingly, they may overestimate the small objective probability of winning.
A wide variety of factors has been found to influence subjective probability, including the individual’s age,
education, sex, intelligence, and use of alcohol. With respect to the latter, studies have shown that alcohol
causes persons to overestimate their physical skills and abilities.
Chance of Loss Distinguished from Risk
One should not confuse chance of loss with objective risk. They are not the same thing. As stated earlier,
chance of loss is the probability that an event will occur. Objective risk is the relative variation of actual loss
from expected loss. The chance of loss may be identical for two different groups, but objective risk may be
quite different. For example, assume that a fire insurer has 10,000 homes insured in Mumbai and 10,000
houses insured in Delhi. Also assume that the chance of loss in each city is 1 percent. Thus, on an average,
100 homes should burn annually in each city. However, if the annual variation in losses ranges from 75 to
125 in Mumbai, but only from 90 to 110 in Delhi, objective risk is greater in Mumbai even though the
chance of loss in both cities is the same.
PERIL AND HAZARD
The terms “peril” and “hazard” should not be confused with the concept of risk discussed earlier. Let us first
consider the meaning of peril.
Peril
Peril is defined as the cause of loss. Thus, if a house burns because of a fire, the peril, or cause of, loss, is
the fire. If a car is totally destroyed in an accident with another motorist, accident (collision) is the peril, or
cause of loss. Some common perils that result in the loss or destruction of property include fire, cyclone,
storm, landslide, lightning, earthquakes, theft, and burglary.
Hazard
A hazard is a condition that creates or increases the chance of loss. There are three major types of hazards:
Physical hazard; Moral hazard; Morale hazard.
Physical hazard
A physical hazard is a physical condition that increases the chance of loss. Thus, if a person owns an older
building with defective wiring, the defective wiring is a physical hazard that increases the chance of a fire.
Another example of physical hazard is a slippery road after the rains. If a motorist loses control of his car on
a slippery road and collides with another motorist, the slippery road is a physical hazard while collision is
the peril, or cause of loss.
Moral hazard
Moral hazard is dishonesty or character defects in an individual that increase the chance of loss. For
example, a business firm may be overstocked with inventories because of a severe business recession. If the
inventory is insured, the owner of the firm may deliberately burn the warehouse to collect money from the
insurer. In effect, the unsold inventory has been sold to the insurer by the deliberate loss. A large number of
fires are due to arson, which is a clear example of moral hazard.
Moral hazard is present in all forms of insurance, and it is difficult to control. Dishonest insured persons
often rationalise their actions on the grounds that “the insurer has plenty of money”. This is incorrect since
the company can pay claims only by collecting premiums from other policy owners. Because of moral
hazard, premiums are higher for all insured, including the honest. Although an individual may believe that it
is morally wrong to steal from a neighbour, he or she often has little hesitation about stealing from an
insurer and other policy owners by either causing a loss or by inflating the size of a claim after a loss occurs.
Morale hazard
Morale hazard is defined as carelessness or indifference to a loss because of the existence of insurance. The
very presence of insurance causes some insurers to be careless about protecting their property, and the
chance of loss is thereby increased. For example, many motorists know their cars are insured and,
consequently, they are not too concerned about the possibility of loss through theft. Their lack of concern
will often lead them to leave their cars unlocked. The chance of a loss by theft is thereby increased because
of the existence of insurance.
Morale hazard should not be confused with moral hazard. Morale hazard refers to insureds who are simply
careless about protecting their property because the property is insured against loss. Moral hazard is more
serious since it involves unethical or immoral behaviour by insurers who seek their own financial gain at the
expense of insurers and other policy owners.
Insurers attempt to control both moral and morale hazards by careful underwriting and by various policy
provisions, such as compulsory excess, waiting periods, exclusions, and exceptions.
BASIC CATEGORIES OF RISK
Risk can be classified into several distinct categories. The major categories of risk are as follows.
a. Pure and Speculative risks.
b. Static and Dynamic risks.
c. Fundamental and Particular Risks.
Pure and Speculative Risks
Pure risk is defined as a situation where there are only the possibilities of loss or no loss. You normally do
not profit if a loss occurs. The only possible outcomes are adverse (loss) and neutral (no loss). Examples of
pure risks include premature death, occupational and non-occupational disability, huge medical expenses,
liability lawsuits, and damage to property from fire, lightning, flood, or earthquake. People who experience
such losses normally do not profit from the loss.
In contrast, speculative risk is defined as a situation where either profit or loss is possible. Thus, if you
should purchase 500 shares of common stock, you would profit if the stock rises in price but would lose if
the price declines. Other examples of speculative risks are betting on a horse race, investing in real estate,
going into business, and producing a new product by a business firm. In these situations, both profit and loss
are possible.
It is important to distinguish between pure and speculative risks for several reasons. First, only pure risks
are insurable by private insurers. With few exceptions, speculative risks are not insurable and other
techniques for coping with risk must be used.
Second, the law of large numbers can be applied more easily to pure risks than to speculative risks. As noted
earlier, the law of large numbers is important since it enables insurers to predict loss in advance. In contrast,
it is generally difficult to apply the law of large numbers to speculative risks in order to predict future loss.
One exception is the speculative risk of gambling, where a casino can apply the law of large numbers in a
most efficient manner.
Finally, society may benefit from a speculative risk if a loss occurs, but it is harmed if a pure risk is present
and a loss occurs. For example, a firm may develop a new technological process for producing computers
more cheaply. As a result, a competitor may be forced into bankruptcy. Despite the bankruptcy, society
benefits since the computers are produced more efficiently at a lower cost to consumers. However, society
loses when most pure risks actually occur. For example, if a flood occurs or if an earthquake devastates an
area, society does not benefit.
Static and Dynamic Risks
Static risks are risks connected with losses caused by the irregular action of nature or by the mistakes and
misdeeds of human beings. Static risks are the same as pure risks and would, by definition, be present in an
unchanging economy. In contrast, dynamic risks are risks associated with a changing economy. Important
examples of dynamic risks include the changing tastes of consumers, technological change, new methods of
production, and investments in capital goods that are used to produce new and untried products.
Static and dynamic risks have several important differences. First, most static risks are pure risks, but
dynamic risks are always speculative risks where both profit and loss are possible. Second, static risks
would still be present in an unchanging economy, but dynamic risks are always associated with a changing
economy. Also, dynamic risks usually affect more individuals and have a wider impact on society than do
static risks. Finally, as stated earlier, dynamic risks may be beneficial to society but static risks are always
harmful.
Fundamental and Particular Risks
A fundamental risk is defined as a risk that affects the entire economy or large numbers of persons or groups
within the economy. Thus, the risk of double-digit inflation is a fundamental risk since, with few exceptions
the entire economy is affected by rapid inflation. Other examples of fundamental risks are severe business
recessions and high unemployment, wars, earthquakes that devastate large geographical areas, and floods
that destroy thousands of homes.
In contrast, a particular risk is a risk that affects only the individual and not the entire community or
country. Thus, the risk associated with the theft of one’s personal properties is an example of a particular
risk. Only the individual is affected, not the entire community.
The distinction between a fundamental and a particular risk is important since government assistance may
be necessary in order to insure fundamental risks. Government insurance programs, government guarantees
and subsidies are used to meet certain fundamental risks in some countries. For example, the risk of crop
failure cannot be insured privately by commercial insurers but can be insured publicly by state governments.
In addition, rural problems and the corresponding covers can be best addressed by the government, State or
Centre, more effectively.

Lecture 2

PURE RISKS - DETAILS

TYPES OF PURE RISK
Some types of pure risk pose a substantial threat to the financial security of both individuals and business
firms. The major types of pure risk that are associated with great financial and economic insecurity include
property risks, personal risks, and liability risks.
Personal Risks
Personal risks are those risks that directly affect an individual; they involve the possibility of the complete
loss or reduction of earned income, extra expenses, and the depletion of financial assets. There are four
major personal risks.
 a. Risk of old age.
b. Risk of premature death.
c. Risk of unemployment.
d. Risk of poor health.
Risk of old age
The major risk associated with old age is the possibility of insufficient income during retirement. When
older workers retire, they lose their normal work earnings. Unless they have accumulated sufficient financial
assets on which to draw, or have access to other sources of income, such as a private investment or
retirement benefits, they will be faced with a serious problem of financial and economic insecurity.
The amount of financial assets owned by retired persons generally also is unsatisfactory. Financial assets are
important since the investment income can supplement retirement income, and the assets provide a cushion
for emergencies.
The problem of insufficient income during retirement is also aggravated by the increased trend toward early
retirement or retrenchments. Workers retire early because of poor health, technological change that
eliminates jobs, plant closings, labour union pressures to expand employment opportunities for younger
workers, permanent layoffs by some firms because of restructuring to reduce labour costs, and the desire for
leisure. This may lead to increase in the duration of the retirement period, while the period of productive
work decreases. Thus, some workers may be unable to save a sufficient amount of income during their
working years to provide for a reasonable standard of living during the relatively longer retirement period.
Risk of premature death
The risk of premature death means that it is possible for a person to die before attaining a certain age. Many
persons die, before attaining the age of calculated life expectancy for males and females.
Premature death often results in great financial and economic insecurity if a family head dies prematurely.
In many cases, a family head who dies prematurely has outstanding financial obligations, such as
dependents to support, children to educate, and loan instalments to be paid off.
There are at least four costs that result from the premature death of a family head. First, the human life value
of the family head is lost forever. The human life value is defined as the present value of the family’s share
of the deceased breadwinner’s future earnings. This loss can be substantial; the human life value of even
college graduates can be substantial (say more than Rs.400,000). Second, additional expenses may be
incurred because of funeral and lawyer’s costs, estate and inheritance taxes, and the expenses of terminal
illness. Third, the family’s income from all sources may be inadequate in terms of its basic needs, quite
apart from the outstanding financial obligations. Finally, certain non-economic costs are also incurred, such
as the emotional grief of the surviving spouse and the loss of guidance and a role model for the children.
It was formerly assumed that some families experienced financial insecurity only after the family head died.
This is clearly incorrect since in the case of a long terminal illness, the family can experience a substantial
decline in its standard of living long before the death of the family head. One earlier study of widows and
orphans revealed that one fourth of all widows were living in poverty before their husband’s death.
As the length of the terminal illness increased, the proportion of families living in poverty also tended to
increase. Forty percent of the widows whose husbands were terminally ill or disabled for two years or more
before death were poor. Thus, some families will experience financial insecurity long before the family head
actually dies.
Risk of unemployment
The risk of unemployment is another major threat to a person’s financial security. Unemployment may
result from a deficiency in aggregate demand, technological and structural economic changes, seasonal
factors, and frictions in the labour market. Regardless of the cause, financial insecurity may come about in
at least three ways. First, of course, the worker loses his or her earned income. Unless there is adequate
replacement income or past savings on which to draw, the unemployed worker will be financially insecure.
Second, because of economic conditions, the worker may be able to work only part-time. Since work
earnings are reduced, the income earned may be insufficient in terms of the workers needs. Finally, if the
duration of unemployment is extended over a long period, the unemployed worker may exhaust his or her
accumulated financial assets.
Risk of poor health
Another important personal risk is the risk of poor health. Both huge medical expenses and the loss of
earned income must be considered. An unexpected illness or accident can often result in catastrophic
medical expenses. For example, the cost of a heart surgery or kidney transplant can easily exceed
Rs.100,000; the annual cost of kidney dialysis treatment in most hospitals exceeds Rs.50,000. Thus, ten
years of treatment would cost Rs.500,000. Also, the costs of a crippling automobile accident that requires
several major operations, plastic surgery, and rehabilitation can easily exceed Rs.500,000. In addition, long-
term care in a skilled nursing home can easily exceed Rs.100,000 for each year of care. Unless the person
has adequate health insurance or other sources of income to meet these expenditures, he or she will be
financially insecure. In particular the inability of some persons to pay huge medical bills is a major cause of
mental stress.
Long-term disability and the consequent loss of earned income must also be recognised as a major cause of
financial insecurity. In cases of long-term disability, there is a substantial loss of earned income, medical
expenses are also incurred, employee benefits may be lost or reduced, savings often are depleted, and
someone must take care of the disabled person. Thus, long-term disability is a major cause of financial
insecurity.
Most workers rarely think about the financial consequences of a long-term disability. However, the
probability of becoming disabled before age sixty-five is much higher than is commonly believed,
especially at the younger ages. Slightly more than one in three persons now age twenty-five will be disabled
for at least six months before reaching age sixty-five. About one in seven will be disabled for at least five
years.
Property Risks
Persons owning property are exposed to the risk of having their property damaged or lost from numerous
perils. There are two major types of losses associated with the destruction or theft of property: direct loss
and indirect or consequential loss.
Direct loss
A direct loss is defined as a financial loss that results from the physical damage, destruction, or theft of the
property. For example, assume that a person owns a workshop, and the building is insured by a fire
insurance policy. If the building is damaged or destroyed by a fire, the physical damage to the property is
known as a direct loss.
Indirect or consequential loss
An indirect loss is a financial loss that results from the indirect consequences of the physical damage,
destruction, or theft of the property. Assume a person has a workshop that is insured against Fire and
earthquake. In the event of an earthquake damaging the property, in addition to the physical damage loss,
the workshop would lose revenue for several months while it is being rebuilt. The loss of profits would be a
consequential loss. Other examples of a consequential loss would be the loss of the use of the building, the
loss of rents, and the loss of a market.
Finally, extra expenses are another type of indirect, or consequential, loss. For example, suppose a person
owns a restaurant, provision store, or dairy. If a loss occurs, s/he must continue to operate regardless of cost;
otherwise, s/he will lose customers to his/her competitors. It may be necessary to set up a temporary
operation at some alternative location, and substantial extra expenses would then be incurred.
Natural disasters
The risk of loss or damage to property from natural disasters is an important property risk that merits special
treatment. Floods, hurricanes, tornadoes, earthquakes, landslides, and other violent natural disasters can
result in a loss of crore of rupees in property damage as well as thousands of deaths. In 1977, hurricanes
caused extensive damage to human beings and property in coastal Andhra Pradesh. In the western countries
In 1986, 764 tornadoes killed fifteen people, injured another 573 people, and caused property damage in
excess of Rs.2500 crore. In 2001, a severe earthquake in Gujarat caused crores of rupees in property damage
and human losses. And, as we know, severe floods in the North Eastern states like Assam annually cause
crores of rupees of property damage.
Natural disasters cause financial insecurity because of the considerable loss of human life and the resultant
loss of income to the affected families. In addition, many property damage losses are either uninsured or
underinsured, causing substantial additional expenses.
Many homeowners do not purchase insurance because they perceive the event of a natural disaster as
improbable and, thus, perceive an extremely low probability of loss. Unless they have been made clearly
aware of a natural disaster and have obtained useful information on insurance from other sources, such as
friends and neighbours, they may not purchase the appropriate insurance, even at subsidised rates.
Liability Risks
Liability risks are another important type of pure risk that most persons face. Even in the Indian context
where awareness about liabilities to others are not very high like in developed countries, one can be held
legally liable if one does something that results in bodily injury or property damage to someone else. Take
case of Bhopal. Apart from the tarnishing of the image, Union Carbide had to pay huge sums as
compensation and still people are complaining that the amount is inadequate.
We live in a litigious society at the present time. We have the widely held notion that the way to resolve any
dispute is to sue. As a result, lawsuits of all types have increased substantially in recent years. Individuals
are being held legally liable for the negligent operation of their automobiles; business firms are being sued
because of defective products that result in harm or injury to someone else; doctors, accountants, lawyers,
engineers, and other professionals are being sued because of alleged professional malpractice. Thus, new
types of lawsuits are constantly emerging.
Liability risks are of great importance for several reasons. First, there is no maximum upper limit with
respect to the amount of the loss. You can be sued for any amount. In contrast, if you own property, there is
a maximum limit on the loss. For example, if your automobile has an actual cash value of Rs. 5,00,000, the
maximum physical damage loss is Rs. 5,00,000. But if you are negligent and cause an accident that results
in serious bodily injury to the other driver, you can be sued for any amount Rs. 5,00,000, Rs. 15,00,000, or
Rs. 25,00,000 or even more by the person you have injured.
Second, although the experience is painful, you can afford to lose your present financial assets, but you can
never afford to lose your future income and assets. Assume that you are sued and are required by the court
to pay a substantial judgment to the person you have injured. If you do not carry liability insurance or are
underinsured, your future income and assets can be attached to satisfy the judgment. If you declare
bankruptcy to avoid payment of the judgment, your ability to obtain credit will be severely impaired.
Finally, legal defence costs can be substantial. If you are sued and have no liability insurance, the cost of
hiring a lawyer to defend you and represent you in a court of law can be enormous.

Lecture 3
BURDEN OF RISK ON SOCIETY
The presence of risk results in certain undesirable social and economic effects. Risk entails major burdens
on society.
Need for Larger Emergency Funds
Worry and Fear increase.
Larger Emergency Funds
It is prudent for both individuals and business firms to set aside funds for emergency purposes. In the
absence of insurance, however, individuals and business firms must increase the size of their emergency
funds in order to pay for unexpected losses. For example, assume that you have purchased a Rs.10 lakh
home and wish to have the necessary funds in case the home is damaged by fire, storm, flood, or other
perils. Without insurance, you would probably have to save at least Rs.1 lakh annually to build up an
adequate fund within a relatively short period of time. Even then, an early loss could occur, and your
emergency fund would be insufficient to pay the loss. If you were a middle-income wage earner, you would
find such savings difficult. In any case, the higher the amount that must be saved, the more consumption
spending must be reduced, which results in a lower standard of living.
Worry and Fear
A final burden of risk is that worry and fear are present. This mental unrest must be recognised as a true cost
of risk to society. Numerous examples can illustrate the mental unrest and fear caused by risk. A college
student who needs a grade of first division in a required course in order to graduate may enter the final
examination room with a feeling of apprehension and fear. Parents may be fearful if a son or daughter
leaves on an official trip during a riot situation since the risk of getting hurt or being killed by the rioters is
present. Finally, some passengers in a commercial jet may become extremely nervous and fearful if the jet
encounters turbulence during the flight.
METHODS OF HANDLING RISK
As we stressed earlier, risk is a burden not only to the individual but to society as well. Thus, it is important
to examine some techniques for meeting the problem of risk. There are five major methods of handling risk.
a. Risk avoidance;
b. Risk retention;
c. Risk transfer;
d. Loss control; and
e. Insurance.
Risk Avoidance
Risk avoidance is one method of handling risk. For example, you can avoid the risk of being pick pocketed
in Metropolitan cities by staying out of them; you can avoid the risk of divorce by not marrying; a career
employee who is frequently transferred can avoid the risk of selling a home in a depressed real estate market
by renting instead of owning; and a business firm can avoid the risk of being sued for a defective product by
not producing the product.
But as a practical matter, not all risks can or even should be avoided. For example, you can avoid the risk of
death or disability in a plane crash by refusing to fly. But is this practical and desirable? The alternatives are
not appealing. You can drive or take a bus or train, all of which take considerable time and often involve
great fatigue. Although the risk of a plane crash is present, the safety record of commercial airlines is
excellent, and flying is a reasonable risk to assume. Or one may wish to avoid the risk of business failure by
refusing to go into business for oneself. But a person may have the necessary skills and capital to be
successful in business, and risk avoidance may not be the best approach for him to follow in this case.
Risk Retention
Risk retention is a second method of handling risk. An individual or a business firm may retain all or part of
a given risk. Risk retention can be either active or passive.
Active risk retention
Active risk retention means that an individual is consciously aware of the risk and deliberately plans to
retain all or part of it. For example, a motorist may wish to retain the risk of a small collision loss by
purchasing an own damage insurance policy with a Rs.2000 voluntary excess. A homeowner may retain a
small part of the risk of damage to the home by purchasing a Householders policy with substantial voluntary
excess. A business firm may deliberately retain the risk of petty thefts by employees, shoplifting, or the
spoilage of perishable goods. Or a business firm may use risk retention in a self-insurance program, which is
a special application of risk retention. In these cases, the individual or business firm makes a conscious
decision to retain part or all of a given risk. Active risk retention is used for two major reasons. First, risk
retention can save money. Insurance may not be purchased at all, or it may be purchased with voluntary
excesses; either way, there is often a substantial saving in the cost of insurance. Second, the risk may be
deliberately retained because commercial insurance is either unavailable or can be obtained only by the
payment of prohibitive premiums. Some physicians, for example, practice medicine without professional
liability insurance because they perceive the premiums to be inordinately high.
Passive risk retention
Risk can also be retained passively. Certain risks may be unknowingly retained because of ignorance,
indifference, or lasiness. This is often dangerous if a risk that is retained has the potential for destroying a
person financially. For example, many persons with earned incomes are not insured against the risk of long-
term disability under either an individual or group disability income plan. However, the adverse financial
consequences of a long-term disability generally are more severe than premature death. Thus, people who
are not insured against the risk of long-term disability are using the technique of risk retention in a most
dangerous and inappropriate manner.
In summary, risk retention can be an extremely useful technique for handling risk, especially in a modern
corporate risk management program. Risk retention, however, is appropriate primarily for high frequency,
low severity risks where potential losses are relatively small. Except under unusual circumstances, an
individual should not use the technique of risk retention to retain low frequency, high severity risks, such as
the risk of catastrophic losses like earthquake and floods.
Risk Transfer
Risk transfer is another technique for handling risk. Risks can be transferred by several methods, among
which is the following:
a. Transfer of risk by contracts;
b. Hedging price risks; and
c. Conversion to Public Limited Company.
Transfer of risk by contracts
Unwanted risks can be transferred by contracts. For example, the risk of a defective television or stereo set
can be transferred to the retailer by purchasing a service contract, which makes the retailer responsible for
all repairs after the warranty expires. The risk of a substantial increase in rent can be transferred to the
landlord by a long-term lease. The risk of a substantial price increase in construction costs can be transferred
to the builder by having a firm price in the contract rather than a cost-plus contract.
Hedging price risks
Hedging price risks is another example of risk transfer. Hedging is a technique for transferring the risk of
unfavourable price fluctuations to a speculator by purchasing and selling futures contracts on an organized
exchange, such as NSE.
In recent years, institutional investors have sold stock index futures contracts to hedge against adverse price
declines in the stock market. This technique is often called portfolio insurance. However, it is not formal
insurance but is a risk transfer technique that provides considerable protection against a decline in stock
prices.
Conversion to Public Limited Company
Incorporation is another example of risk transfer. If a firm is a sole proprietorship, creditors for satisfaction
of debts can attach the owner’s personal assets, as well as the assets of the firm. If a firm incorporates,
however, creditors for payment of the firm’s debts cannot attach the personal assets of the stockholders. In
essence, by incorporation, the liability of the stockholders is limited, and the risk of the firm having
insufficient assets to pay business debts is shifted to the creditors.
Loss Control
Loss control is another important method for handling risk. Loss control consists of certain activities
undertaken to reduce both the frequency and severity of losses. Thus, loss control has two major objectives:
a. Loss prevention
b. Loss reduction.
Loss prevention
Loss prevention aims at reducing the probability of loss so that the frequency of losses is reduced. Several
examples of personal loss prevention can be given. Automobile accidents can be reduced if motorists pass a
safe driving course and drive defensively. Dropping out of college can be prevented by intensive study on a
regular basis. The number of heart attacks can be reduced if individuals watch their weight, give up
smoking, and follow good health habits.
Loss prevention is also important for business firms. For example, a boiler explosion can be prevented by
periodic inspections by a safety engineer; occupational accidents can be reduced by the elimination of
unsafe working conditions and by strong enforcement of safety rules; and fire can be prevented by
forbidding workers to smoke in an area where highly flammable materials are being used. In short, the goal
of loss prevention is to prevent the loss from occurring.
Loss reduction
Although stringent loss prevention efforts can reduce the frequency of losses, some losses will inevitably
occur. Thus, the second objective of loss control is to reduce the severity of a loss after it occurs. For
example, a warehouse can install a sprinkler system so that a fire is promptly extinguished, thereby reducing
the loss; highly flammable materials can be stored in a separate area to confine a possible fire to that area; a
plant can be constructed with fire resistant materials to minimize a loss; and fire doors and fire walls can be
used to prevent a fire from spreading.
Loss control-Ideal method for handling risk
From the viewpoint of society, loss control is the ideal method for handling risk. This is true for two
reasons. First, the indirect costs of losses may be large, and in some instances, they can easily exceed the
direct costs. For example, a worker may be injured on the job. In addition to being responsible for the
worker’s medical expenses and a certain percentage of earnings (direct costs), the firm may also incur
sizeable indirect costs: a machine may be damaged and must be repaired; the assembly line may have to be
shut down; costs are incurred in training a new worker to replace the injured worker; and a contract may be
cancelled because goods are not shipped on time. By preventing the loss from occurring, both indirect costs
and direct costs are reduced.
Second, the social costs of losses must also be considered. For example, assume that the worker in the
preceding example dies from the accident. Substantial social costs are incurred because of the death. Society
is deprived forever of the goods and services that the deceased worker could have produced. The worker’s
family loses its share of the worker’s earnings and may experience considerable grief and financial
insecurity. And the worker may personally experience great pain and suffering before he or she finally dies.
In short, these social costs can be reduced through an effective loss control programme.
Insurance
A final technique for handling risk is by insurance. For most individuals, this is the most practical method
for handling a major risk. Although commercial insurance has several characteristics, three major
characteristics should be emphasised. First, risk transfer is used since a pure risk is transferred to the insurer.
Second, the pooling technique is used to spread the losses of the few over the entire group so that average
loss is substituted for actual loss. Finally, the risk may be reduced by application of the law of large
numbers, whereby an insurer can predict future loss experience with some accuracy.

Lecture 4
ROOTS OF “INSURANCE”
Insurance is also referred to as Assurance and in the early part of the 17th century the term Ensurance
(French) was quite prevalent. The term Assurance is the earlier term and was used alike for both life and
general insurance. The term insurance was initially used in 1635 in connection with Fire insurance and was
quickly adopted extensively. In 1826, it was proposed that the term insurance be used for general insurance
and the term assurance restricted for life insurance.
The origin of practice of insurance is probably lost forever in the mists of antiquity. References to practices
similar to insurance are found in the ancient Indian texts of Rigveda. Rigveda refers to the concept of
Yogakshema - loosely meaning ‘the well being, prosperity and security of people’. Archaeological
excavation at the site of Aryan civilisation has yielded evidence of a practice similar to insurance, insuring
loss of profits in industry. The codes of Hammurabi and of Manu had recognised the importance and
advisability of some practice akin to provision for sharing of future losses or Yogakshema.
The earliest evidence of elements of insurance contracts is found in the Bottomery Bonds (also called
respodentia bonds) issued by the traders and merchants in Rhodesia as early as the 4th century BC. The
Bottomery loan was a monetary advance on a ship for the period of the voyage. The loan was repayable
with an agreed rate of interest on arrival of the ship safely at its destination. If the ship failed to arrive safely
at the destination then the obligation to pay the loan was cancelled. Thus the agreed rate of interest to be
paid formed a rudimentary way of paying the premium. The Rhodesian merchants also had a practice akin
to General Average wherein all losses were shared by contributions from all interests.
But the real beginning of an insurance contract was in the 14th century when Italian traders trading with
India via nautical trade routes and with Europeans via land routes developed the concept of Bottomery
Bonds further and bifurcated it into two separate contracts.
The first contract dealt with advance of money to be repaid on safe arrival of the ship or the caravan and the
second, policy of assurance, which paid the amount stated in case of loss. This practice slowly spread to
Northern Europe and finally found a base in the Lombard Street in London. Gradually insurance became a
vital component of any mercantile transaction emanating from the Lombard Street and thus spread across
the world with the rise of the British Empire. In London the ship captains and the merchants normally used
to congregate in the coffeehouses and taverns to transact business. One of these, Lloyds (founded by
Edward Lloyd in 1860) has a very special place in insurance history as the practice of individual
underwriting took shape here.
In 1911 the underwriters at Lloyds were empowered to transact other classes of business apart from Marine
Insurance. Even today Lloyds is regarded as one of the greatest international insurance centres. Today, no
financial or trade transaction is complete without the element of insurance covering the risk inherent in the
trade. No ship sets sail or takes to air without adequate insurance coverage providing the most
comprehensive protection to all aspects of the transaction. The policies available for individuals are very
sophisticated providing much required defence against vagaries of nature and commerce.
MEANING OF INSURANCE
The business of insurance is related to the protection of the economic value of assets. Every asset has a
value. The asset would have been created through the efforts of the owner, in the expectation that, either
through the income generated there from or some other output, some of his needs would be met. In the case
of a motorcar, it provides comfort and convenience in transportation. There is no direct income. There is a
normally expected lifetime for the asset during which time it is expected to perform. The owner, aware of
this, can so manage his affairs that by the end of that lifetime, a substitute is made available to ensure that
the value or income is not lost. However, if the asset gets lost earlier, being destroyed or made non-
functional, through an accident or other unfortunate event, the owner and those deriving benefits there from
suffer. Insurance is a mechanism that helps to reduce such adverse consequences
LIFE ASSURANCE
It is the business of effecting contracts of insurance upon human life, including any contract whereby the
payment of money is assured (except death by accident only) or the happening of any specified
contingencies dependent on human life, like death at a specified age. The contract would be subject to the
payment of premiums for the term.
NON-LIFE INSURANCE OR GENERAL INSURANCE
Conventional classification of General Insurance has been in three branches-
• Fire Insurance.
• Marine Insurance.
• Miscellaneous (Accident) Insurance.
In modern times it is classified as follows:
i. Insurance of Person;
ii. Insurance of Property;
iii. Insurance of Interest; and
iv. Insurance of Liability.
WHY INSURANCE?
The entire effort of human life is to proceed from uncertainty to certainty. The rigmarole of life proceeds
with first acquiring the wherewithal to earn a living and then striving for its betterment and ensuring that the
comfort and pleasure derived from a physical commodity or a human asset continues. It is at the latter stage
that the mechanism of Insurance comes in play.
The concept of insurance is in essence related to the protection of the economic value of assets. Every asset
whether physical or in form of a human being has a value. The asset is built up in the expectation that, either
through the income generated there from or some other output, some needs of the individual would be met.
For example, in the case of an industry its production is sold and income is generated. In the case of a
vehicle, it provides comfort and convenience in transportation.
However there is a normally expected life cycle for every asset during which time it is expected to perform
its assigned role. So, a prudent individual can manage his affairs so that by the end of that life cycle, a
substitute is in place to ensure continued benefit/comfort. However, if due to an accident or other
unfortunate event, the asset gets destroyed or made non- functional earlier, the person deriving benefits
there-from suffer. Insurance is the mechanism that helps to soften the impact of such adverse consequences
by providing for some monetary substitution to face such unforeseen circumstance.
The need of insurance arises from the chances of an accidental occurrence destroying or making an asset
non-functional. Such loss producing eventualities are called perils e.g. fire, floods, breakdowns, lightning,
earthquakes, etc. However, it has to be remembered that what is being talked about is only a probability of a
loss. The protection of Insurance is against a contingency that may or may not happen.
THE CONCEPT OF RISK
The term risk may be defined as the possibility of adverse results flowing from any occurrence. Risk arises,
therefore, out of uncertainty. It can also represent the possibility of an outcome being different from the
expected.
DEFINITION
Risk is a condition where there is a possibility of an adverse deviation from a desired outcome that is
expected or hoped for; there is no requirement that the possibility be measurable, only requirement is that it
must exist.
For those who define risk as uncertainty, the greater the uncertainty, the greater is the risk. For the
individual, the higher the probability of loss, the greater is the probability of an adverse deviation from what
is hoped for and, therefore, greater is the risk.
SPREADING OF RISK
There are various methods to achieve spreading or ‘averaging’ of risks. ‘Diversification’ is an important
feature of modern economic enterprise. An insurer would normally seek to achieve spread of risks as under:
a. By writing different classes of insurance business and even within a single class, by catering to
various types of risks;
b. By writing business in different geographical locations, states within a country or different countries;
c. By incorporating as public limited company so that with the help of larger capital resources, it is in a
position to write larger volumes of business in order to achiever a larger spread of risks;
d. By means of reinsurance, i.e. by placing reinsurance business with other companies and accepting
reinsurances from other companies;
e. By entering into risk pools for certain risks, particularly, of difficult or more hazardous nature.
Risks cannot only be spread over a larger capital or a wider area; they can also be spread over a period of
time.
RISK REDUCTION THROUGH POOLING
In order to be amenable to statistical predictions, insurance risks must be handled on a large scale. There is,
in statistics, a “law of large numbers”. When you toss a coin, the chance of a head or tail coming up is half.
If the coin is tossed ten times, one cannot be sure that the head will come up five times. If the coin is tossed
1 million times, the number of heads will be closer to half a million proportionately than in the case of ten.
The variation will be less as a percentage. So also, the larger the numbers (of risks) included in the pool, the
better the chances that the assumptions regarding the probability of the risk occurring, which is the basis of
premium calculation, will be realised in practice.
People facing common risks come together and make their small contributions to a common fund. The
contribution to be made by each person is determined on the assumption that while it may not be possible to
tell beforehand, which person will suffer, it is possible to tell, on the basis of past experiences, how many
persons, on an average, may suffer losses.
The following two examples explain the above concept of insurance.
Example l
In a village, there are 400 houses, each valued at Rs. 20,000. Every year, on the average, 4 houses get burnt,
resulting into a total loss of Rs. 80,000. If all the 400 owners come together and contribute Rs. 200 each, the
common fund would be Rs. 80,000. This is enough to pay Rs. 20,000 to each of the 4 owners whose houses
got burnt. Thus the risk of 4 owners is spread over 400 house-owners of the village.
Example 2
There are 1000 persons who are all aged 50 and are healthy. It is expected that of these 10 persons may die
during the year. If the economic value of the loss suffered by the family of each dying person is taken to be
Rs. 20,000, the total loss would work out to Rs. 2,00,000/-. If each person of the group contributes Rs.200/-
a year, the common fund would be Rs. 2,00,000/-. This would be enough to pay Rs. 20,000 to the family of
each of the ten persons who die. Thus 1000 persons share the risks in cases of 10 persons.
THE INSURANCE BUSINESS
The business of insurance done by insurance companies (called insurers) is to bring together persons with
common insurance interests (sharing the same risks) collecting the share or contribution (called premium)
from all of them, and paying out compensations (called claims) to those who suffer. The premium is
determined as indicated above with some addition for the expenses of administration.
The insurer acts as a trustee for managing the common fund for and on behalf of the community. He has to
ensure that nobody is allowed to take undue advantage of the arrangement. In other words, the management
of the business requires care to prevent entry into the group of people whose risks are not of the same kind,
as well as not paying claims on losses which are not accidental. The decision to allow entry is the process of
underwriting of risk. Both underwriting and claim settlement have to be handled with great care.

Lecture 5
INSURANCE AS A SOCIAL SECURITY TOOL
On the eve of the promulgation of the Life Insurance (Emergency Provision) Ordinance, 1956, the then
Finance Minister C.D. Deshmukh said in his broadcast to the nation.
“The nationalisation of Life Insurance will be another milestone. In the implementation of the Second Five
Year Plan, it is bound to give material assistance. Into the lives of millions in the rural areas, it will
introduce a new sense of awareness of building for the future in the spirit of calm confidence which
insurance alone can give. It is a measure conceived in a genuine spirit of service to the people. It will be for
the people to respond, confound the doubters and make it a resounding success.
With this as the guiding light the corporate objectives of the Life Insurance Corporation, inter alia, sought to
achieve the following:
• Spread Life Insurance much more widely and in particular to the rural areas and to the socially and
economically backward classes with a view to reaching all insurable persons in the country and
providing them adequate financial cover against death at a reasonable cost.
• Maximise mobilisation of people’s savings by making insurance-linked savings adequately
attractive.
• Bear in mind, in the investment of funds, the primary obligation to its policyholders, whose money it
holds in trust, without losing sight of the interest of the community as a whole; the funds to be
deployed to the best advantage of the investors as well as the community as a whole, keeping in
view national priorities and obligations of attractive return.
• Conduct business with utmost economy and with the full realisation that the moneys belong to the
policyholders.
• Act as trustees of the insured public in their individual and collective capacities.
The need for these objectives is obvious in the eyes of a family, which has lost its sole breadwinner. With
his death the family’s income dies. The economic condition of the family is affected, unless other
arrangements come into being to restore the situation. Life insurance provides such an alternate
arrangement. If there was no life insurance the social cost would be reflected in an impoverished family
becoming a burden on the Government or taking to anti social means to make both ends meet. Therefore,
the life insurance business is complimentary to the state’s efforts in social management.
Conceptually under a socialistic system it is the responsibility of the State to find resources for providing
social security, where as in a capitalistic society, providing for security is largely left to the individuals. The
society provides instruments like insurance, which can be used in securing this aim. However the distinction
between these systems have got blurred over a period of time, with Socialists leaving individuals to fend for
themselves and Capitalist taking the first steps to social security.
In India, Article 41 of our Constitution requires the State, within the limits of it’s 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 and in other cases of undeserved
want. Part of the State’s obligations to the poorer sections is met through the mechanism of life insurance.
In keeping with its social responsibility as an instrument of the Government and as a good business
organisation LIC has made payments to policyholders amounting to Rs.11,170.50 crore in 1999-2000 (as
against Rs.9,106.02 crore in the previous year).
ROLE OF INSURANCE IN ECONOMIC DEVELOPMENT
Insurance benefits society by way of:
• Providing relief to the insured from any mishap;
• Reducing burden of Government in providing relief to the old citizens; and
• Providing funds to Govt. for nation building activities.
Direct investments made by LIC serve a twofold purpose. It acts as a major instrument for the mobilization
of savings of people, particularly from the middle and lower income groups. These savings are channelled
into investments for economic growth thereby creating employment. These savings in turn go into the task
of nation building. As on 31.3.2000, the total investments of the LIC exceeded Rs.1,47,000 crore, of which
more than Rs. 84000 crores were directly in Government (both State and Centre) related securities, nearly
Rs.12,000 crores in the State Electricity Boards, Rs.16,000 crores in housing loans and Rs.3,000 crores in
water supply and sewerage systems. Other investments included road transport, setting up .of industrial
estates and directly financing industry. Investments in the corporate sector (shares, debentures and term
loans) exceeded Rs. 28,000 crores.
The increasing volume of these investments can be seen here:
A. (Rupees in crore)

1969- 1974- 1979- 1995- 1996- 1997-

Year 1957 1998-99
70 75 80 96 97 98

Book value
of total
investment 381.9 1514.26 2798.43 5747.51 65057.0 82665.0 98948.0 120445.00

Book value
of socially
oriented investments - 513.21 1218.52 2472.29 50446.0 61070.0 73082.0 88831.00

B.

Type of Investment Investments Up to

31.12.5
31.3.67 31.3.77 31.3.87 31.3.96 31.3.97 31.3.98 31.3.99
7

Central Govt.
Securities 185 335 981 4675 29395 37330 45876 56185
State Govt.
& Other
Govt.
Guaranteed
Marketable
Securities 70 263 715 1683 7545 8906 10471 12928

Electricity - 61 733 2603 7580 8214 9153 10591

Housing - 121 618 1872 8731 10967 12242 14207

Water Supply
& Sewerage - 16 203 718 1881 2028 2264 2508

State Road
Transport
Corporations - - - 180 477 540 551 671

Loans to
Industrial
Estates - 1 9 37 45 45 45 45

Loans to Sugar
Co-operative - 2 2 2 37 37 37 37

31.12.5
31.3.67 31.3.77 31.3.87 31.3.96 31.3.97 31.3.98 31.3.99
7

Development
Authority-Nagaland - - - 1 1 1 1 1

Roadways - - - - - - 25 25

Power Generation
(Private Sector) - - - - - - 276 801

Municipality - - - - - - 4 4
An Insurance Company’s Profile
The IRDA Act, 1999 amending the Insurance Act, 1938 in Section 2 Sub-section 7(a) states:
“ Indian Insurance Company means any Insurer being a company -
a. which is formed and registered under Companies Act, 1956 (1 of 1956);
b. in which aggregate holding of equity shares by a foreign company either by itself or through its
subsidiary companies or its nominees do not exceed twenty six percent paid up equity capital of such
Indian Insurance Company;
whose sole purpose is to carry on life insurance business or general insurance business or re-insurance
business.”
TYPICAL ORGANISATION
A model insurance company may have following organisational set up for smooth, coordinated,
economically viable setup:
This may further percolate down to having area regional offices; branch office, call centers/ unit centers
depending upon the size of operation; revenue generation and customer service requirement specific
delegation/ earmarking of responsibility to the people is to be done so that overlapping or transgression of
function is avoided and optimum use of manpower, resource is made. If the business is transacted in many
countries then various rules/ regulations of host country are also to be taken care of; and marketing activities
to be tuned accordingly.
ACTIVITIES
The important activities of a life insurance company are:
a. Procuring from prospective buyers proposals to grant life insurance cover;
b. Checking up and specifying the terms of acceptance called Underwriting;
c. Issue contractual documents called policy incorporating various terms and condition
d. Provide after sales services including payment of policy money as per contract;
e. Conducting other supporting activities like, investment of funds, carrying out solvency measures,
finalisation of accounts, getting or causing audit of accounts, actuarial valuation including updating
mortality tables;
f. Developing new products, sales promotion activities including publicity, training of its personal
(Sales/ administration).
MAIN FUNCTIONARIES
In any service organisation the marketing and administration are two sides of a coin and have to perform
their duties complementary to each other but a person who procures new business is an important factor of
marketing group of that organisation. Such person in an insurance company has a distinct profile than any
other person of other marketing organisation of other companies because:
a. Insurance is an idea that has be explained and its usefulness clarified personally since INSURANCE
IS NOT BOUGHT, IT IS SOLD as said generally.
b. Each prospective buyer has special needs and requires specialised solutions;
c. Personalised guidance can be given only when there is live interaction with the salesperson (Agent /
Advisor)
d. Significant amount of money is to be set aside immediately and regularly for a long term in future,
for a benefit which is vague and uncertain; causing natural reluctance on the part of buyer needing
motivation to purchase, because given a choice, people tend to postpone;
e. The insurer has to assess the risk of every individual proposal with necessary information / reports
provided. The insurance advisor/ agent is first person who can provide certain information on
habits/Life styles family of proposer.
This particular profile of an insurance advisor need comprehensive training, guidance in the market enabling
the agent/advisor to be expert so as to help the insurer to assess risk properly. For this purpose IRDA Act of
1999 had necessary provision of training which has to be undertaken by a beginner before canvassing the
insurance business.

Lecture 6
ACTUARIAL PROFESSION: ROLE IN LIFE INSURANCE COMPANIES
Actuarial profession in the world is about 150 years old. In 1848, the Institute of Actuaries was established
in London. That is the oldest institute of its kind and we take it as the birth of actuarial professions from that
time. Later came Faculty of Actuaries in Scotland and many other actuarial bodies in the various parts of
world including Actuarial Society of India in the year 1944 at Mumbai.
The traditional field for actuaries was life insurance, but actuaries gradually entered into wide field such as
Pension, General Insurance, Health Insurance and investment.
While the main function of an actuary in life insurance has remained the same viz. assessment and valuation
of mortality risk, the other aspects viz. risk selection and methods of guarding against anti selection, have
become a subject of heated debate amongst life insurance actuaries in developed economies. What lies at the
center of this discussion is the vast advances in medical sciences and in particular in the field of genetics,
which can throw much more light on human vulnerability to certain fatal diseases than traditional medical
tests. This progress opens up tremendous possibilities in the medical selection of lives.
This issue of insurance selection or rather insurance denial based on genetic data becomes even more
sensitive in health and disability insurance, especially when it is partly or fully financed by the State. The
very objective of this service is to benefit the society at large and more so, the aged, the disabled and the
weak, including the genetically weak, against financial impact of illness. Hence if actuaries want their roles
to be extended into these wider fields; they may have to think beyond their actuarial definition of equity so
as to incorporate these social concerns and thus be perceived as fair in ethical terms as well.
ANNUITY BUSINESS
At present the size of annuity business sold by LIC of India is quite small in comparison to its life portfolio.
However, with the life expectancy in the country improving steadily and there being little retirement
provisions for the vast majority of our population, the pension and annuity sector is likely to witness a rapid
growth in future.
In this context an area of immense interest has come up for actuaries as they have to design and price the
annuity products in relation to improved mortality, and inflation index linked annuity; which would protect
the annuitants against rapid erosion of purchasing power.
INVESTMENT
Actuaries need to be closely associated with framing of investment policies of insurance companies, since
better than average investment return is often the highest source of surplus, particularly in life insurance.
The formidable challenge for the actuarial profession today, is that it compels the actuary to look beyond his
traditional methods of asset liability matching.
MARGINS
Margins are necessary guard against adverse future experience. Normally the values of product are judged
on past experience.
CONSISTENCY
All these assumptions are to be considered in totality not in isolation for pricing a contract. The actuary has
to consider the relative relationship more important than the values in isolation, of the factor such as:
a. Investment return and inflation;
b. New business and expenses;
c. Investment return and bonus loading;
d. Withdrawal rate and investment return; and
e. Taxes and expenses.
PRODUCT PRICING - ACTUARIAL ASPECTS
While pricing a product, long term assumptions for each parameters called basis are required to be made.
This process is the determination of:
i. Expected future experience and
ii. Extent of margins against adverse future experience
The assumption needed in pricing a Product are:-
Demographic Assumption (Mortality)
The mortality rates/ critical illness rates are covered in these assumptions. The values assigned to the
parameters should reflect the expected future experience of the policyholders which will depend on
a. Target market for the contract;
b. The underwriting controls applied; and
c. The expected movement in mortality since last investigations till the time at which will, on an
average, apply.
INVESTMENT RETURN (INTEREST RATES)
The value assigned to this parameter will be affected by significance of assumption for profitability of the
contract, extent of investment guarantee given under the contract, extent of any re-investment risk and
extent to which this can be reduced by a suitable choice of assets, extended investment mix. For the
contract, as affected by the above, the current return on the likely future return.
Expenses
The parameter value of expenses should reflect the expected expenses to be included and to be incurred in
processing and administering of the business to be underwritten for the product to be priced including
following marginal expenses:
initial procurement, initial medical examination expenses, initial administration of new business, renewal
expenses, remuneration to sales personnel for renewal of business, investment expenses, cases of
withdrawal / paid ups, and claims by maturity / death administration expenses.
The insurer shall determine the proportion of premiums towards these expenses after taking into
consideration its experience or a fixed amount per contract/case.
Commission
The normal extent to which a company decides to provide commission payment structure to its sales
organisation depending mainly as per rates paid in the market where the product is to be sold.
Inflation of Expenses
This depends on the expected future rise in inflation which should be consistent with the investment return
assumptions. While setting the value of inflation parameters, points to be considered are current rate of
inflation and expected future rates of inflation based on the past experience.
Withdrawals
The assumption on this parameter will take into consideration most recent investigation for a product or
related product of similar nature. But in the absence of suitable data, some adjustment may be necessary.
DISTRIBUTION-CHANNEL
A distribution channel is the route by which the product (or offer) prepared by the producer reaches the
ultimate consumer. The distance between the producer and the consumer is bridged by the distribution
channel.
In case of life insurance business, the agent, as defined in Insurance Act 1938 as amended by IRDA Act,
1999, is the primary component of this channel. The supervisor, on any other person, is also important to
certain extent because he initiates the process of spotting, training and motivating of the agent to proceed in
the procurement of the business.
Other intermediaries like brokers and insurance consultants are also part of this distribution channel.
The banking channel has also started performing this function of distributing insurance product along with
normal banking services, because they have a larger group of captive customer ultimately being guided into
buying insurance and having developed a sense of trust in the service provided. This process will reduce the
cost of infrastructure of the bank and in return further augment in their earnings. The ingenuity on the part
of this segment of distribution channel may be shown by designing a composite product of insurance and
banking for the benefit of customer as both his needs shall be fulfilled under one roof. However, this is yet
to see the light of day.
REINSURANCE
Reinsurance is an extension of the basic principle of insurance of spreading the risk to make it bearable. As
someone put it
Loss of one; Is shared by many; And it does not break any.
This insurance of Insurers, involves transfer of some part of risk assumed by a direct Insurer to a single or a
group of re-insurers in a pre agreed manner.
The need for this is almost axiomatic. The law of averages ensures that an adverse experience in one part of
the world is offset by favourable experience in another part. The growing volumes of Global insurance
premium (US $ 2155 billion in 1998, of which $891 billion was contributed by non life insurance premium)
means that without reinsurance support, and a major disaster like Hurricane Andrews (estimated liability US
$ 15 billion) could render even the largest direct insurers bankrupt.
The higher level of uncertainties of non-life business get reflected in the fact that almost 83% of global
reinsurance premium comes from this portfolio.
Looking at global figures some interesting trend is discernible:
• During 1990- 1997 non-life reinsurance premium grew from US $ 69 billion to about 125 billion
• About 75% of this comes from North America and Western Europe. Japan contributes about 4%.
• All others pool in just 16% (compared to 9% share in direct insurance premium).
• The reinsurance premium in life and health in the same period grew from US $ 15 billion to 22
billion. This contributed about 17% of the total global reinsurance premium.
• Consolidation among the reinsurers due to mergers and acquisitions has led to the largest four
groups cornering almost 34% of the market now (up from 22% at the beginning of this period).
Non life portfolio

Ceded premium Direct premium Cession rate

in US $ as % of in US $ as % of
in %
billion total billion total

North America 39.9 38.9 317.7 43.4 12.6

Western Europe 36.1 35.1 247.5 33.8 14.6

Japan 4.3 4.2 65.2 8.9 6.6

Asia/ Pacific 12.4 12.1 54.9 7.5 22.6

Latin America 3.3 3.2 21.7 3.0 15.1

Eastern Europe 1.7 1.6 10.3 1.4 16.4

Rest of the World 5.0 4.9 15.4 2.1 32.6

Total World 102.6 100 732.6 100 14.0

Life and health portfolio

Ceded premium Direct premium Cession rate

 in US $ as % of in US $ as % of
in %
billion total billion total

North America 10.6 49.1 661.8 44.7 1.6

Western Europe 9.1 42.1 419.8 28.4 2.2

Japan 0.6 2.6 269.8 18.2 0.2

Asia/ Pacific 0.6 2.8 110.3 7.5 0.6

Latin America 1.6 2.8 13.2 0.9 4.6

Eastern Europe 0.2 0.7 4.3 0.3 3.6

Total World 21.6 100 1479.1 100 1.5

Market share of reinsurers

Year 1990 Year 1997

Top 4 22% 29%

Top 5 to 10 11% 11%

Lloyds 5% 3%

Others 62% 55%

Top 25 Reinsurance groups

1998 1998
Net Change Adjusted Change
Rating
premium (%) shareholder (%)
written funds

1 Munich Re AAA 13,172.7 8.6 11,40.0 27.3

2 Swiss Re AAA 11,895.9 7.6 9,472.1 -2.7

3 Berkshire Hathaway AAA 7,069.1 -5.7 40,113.2 6.6

4 Employers Re AAA 5,984.0 31.7 6,020.0 12.0

5 Assicurazioni Generali AA 4,334.1 18.7 10,387.2 30.0

6 Zurich Financial Services AA+ 4,239.0 37.5 n.a. n.a.

7 Hannover Re AA+ 4,125.2 13.7 1,712.0 18.7

8 Lloyd’s A+ 3,571.7 -1.8 10,475.0 -6.3

9 Allianz AAA 3,500.2 5.3 46,553.7 32.3

10 Gerling Global AA- 3,183.5 17.0 1,186.1 65.1

 11 Scor AA- 2,412.8 4.2 1,432.5 1.9

12 Transatlantic Holdings AA 1,393.7 7.7 1,610.1 18.7

13 AXA Re AA- 1,212.6 0.9 1,350.8 7.9

14 QBE Insurance A+ 1,151.5 12.7 609.7 0.1

15 St Paul AA 1,056.2 -12.0 n.a. n.a.

16 Everest AA- 1,016.6 -0.3 1,479.2 62.8

17 Overseas Partners AApi 909.0 26.2 2,542.7 13.4

18 CAN A+ 895.2 -8.3 n.a. n.a.

19 Toa Fire & Marine AA- 823.0 -1.3 2,226.6 2.0

20 Hartford Re AA 710.6 3.3 6,423.0 5.6

21 Partner Re AA 687.0 256.2 2,113.4 76.6

22 Tokio Marine & Fire AAA 683.5 -16.5 n.a. n.a.

23 Odyssey Re A- 665.1 77.5 1,033.7 16.0

24 CCR Api 639.1 2.0 1,264.1 9.2

25 Korean Re BBpi 627.3 19.7 216.3 17.8

Source: Standard & Poor’s.

Lecture 7
Techniques of reinsurance
The two broad methods of arranging reinsurance covers are
i. Proportional treaty method and, (ii) Non proportional method
i. A proportional treaty is so called because premium cessions and liability from
the risk are in same proportion. So it is arranged in advance for automatic,
simultaneous and continuous reinsurance protection for all business underwritten by a
direct insurer.
The different techniques under this category are:
a. Quota share : A fixed percentage of premium for all risks in a specified portfolio is fixed as the
quota share to be ceded to the reinsurer. The obligation of the reinsurer for any loss occurring under
this portfolio is in the same proportion. This method is used by an insurer in early years of its
growth.
b. Surplus : The ceding direct insurer fixes his liability per risk (called ‘retained lines‘) and passes the
amount exceeding this limit to the reinsurer. This is used when a direct insurer is more established
and confident of retaining larger risk
c. Facultative obligatory : An upper cap for all risks is retained by the direct insurer and at his option
place the balance with a reinsurer. This is optional for the ceding company but obligatory for the
accepting reinsurer
Various combinations of these like Quota cum surplus and Facultative surplus or Facultative open cover
combine elements of different techniques.
 ii. Non proportional : In the proportional method original liability and
proportional cessions are the guiding factors but in non proportional method the
amount of loss limited by a specified amount is the criteria.
Thus the direct insure retains the ‘deductible’ amount from all losses and passes the amount above this to
the reinsurer. The reinsurer accepts ‘layers’ of claim above the retained deductible. Thus an ‘excess of loss’
cover is designed to cover any liability above the loss amount specified in the reinsurance agreement.
This method is used as:
a. Excess of loss cover per risk (WXL/R).
b. Losses for large accumulation per catastrophic event (Cat XL).
c. Stop loss cover which limits the claims burden for any one year within aggregate excess (stop loss)
limits.
The ART (Alternative Risk Transfer) of reinsurance
The search for alternative solutions has its roots in two factors:
i. The deficiencies of the traditional covers.
ii. A re- look at the basics of risk management in deciding what risks to transfer and what to retain.
The traditional reinsurance pricing is based on the basis of average risks. This forces the good risks to cross-
subsidise the bad ones. Insurance also acts as a disincentive to improve risks; which in case of self-financing
an insured is forced to seriously look at. From time to time large Corporates find that reinsurance market
lacks the capacity to offer appropriate covers and several risks are treated as un insurable.
With the development of financial markets a large number of new instruments to hedge systemic risks. The
capital market thus offers larger capacities for reinsurance.
The key features of ART solutions are
• Tailor made for specific client needs
• Multi year and multi line cover
• Spread of risk over time and within policy holders portfolio
• Risk assumption by non (re) insurers
The various types of solutions being talked about now a days are
Captives : ‘ART‘ when first coined in the US meant various forms of self- insurance. The basic procedure
for reinsurance captive consists of underwriting of the risk by a direct insurer (‘fronter’) and then ceded to
the captive in the form of a reinsurance contract. This may then be ceded partly to a professional reinsurer.
There are almost 4000 captives worldwide generating premium of US $ 21 billion (which is almost 6% of
global commercial premium.)
Finite risks : Traditionally the law of large numbers require spreading of losses in a large group of similar
risks. Finite risks in contrast spread the risk of an individual policy-holder over time. Thus individual
policyholder’s claim experience alone is the deciding factor. In fact a large part of premium not required for
claim settlement is paid back at the end of the contract period.
Integrated multi-line multi-layer products : This involves bundling several traditional lines e.g. fire,
liability, and business interruption in one group and over a period of several years. Thus tailoring the
product to specific client’s needs is the main focus here.
Multi-trigger products: This takes a more holistic approach to protecting the balance sheet of a company.
Only if in addition to the first trigger (occurrence of insured event), a second trigger (a non insurance event)
occurs during the policy term that the insurers liability arises
Contingent capital: This is the most innovative idea, as it requires financing a loss after it occurs. The
problem is that a major loss makes it almost impossible to raise fresh capital. This is where this idea comes
in. The raising of a capital at pre-agreed terms following an insured event is the essence of this solution.
Securitisation of insurance risks : The available capacity in the reinsurance market is only a fraction of the
total exposure against natural catastrophe. A Special Purpose Vehicle (a trust) is used to offer a Cat bond to
the investor.
Nationalization of General Insurance Business in India
General Insurance Business Nationalization Act, 1972
General Insurance Business was nationalized in the year 1972 through GIC Act of 1972 through which the
general insurance Business of private insurers was transferred to GIC having its headquarter at Mumbai.
The Govt. of India, through regulation framed 4 subsidies to GIC, which were entrusted to control, regulate
and develop general insurance business of the country. The subsidiaries headquarters are:
(i) The Oriental Insurance Co. - New Delhi

(ii) The New India Assurance Co. - Mumbai

(iii) The United India Insurance Co. - Chennai

(iv) The National Insurance Co. - Kolkata

There was a proposal to merge these 4 subsidiaries into one entity at one point of time. Later it was felt that
it would better serve the purpose of competition and freedom of choice if these 4 companies were made
independent from their parent holding company, viz. General Insurance Corporation. This has happened.

Lecture 8
REGULATION OF INSURANCE INDUSTRY
Introduction
Market consists of buyers, sellers, intermediaries and regulators. There is hardly any market, which is not
regulated. As between markets, the only difference in the matter of regulation could be in the degree of
regulation, which is exercised in different markets, but every market is regulated without exception.
The insurance market is a highly regulated market. For regulating any market, laws are passed by the
appropriate legislature. The market economy has to function within the legal framework. The legal
framework in turn has to undergo changes to take care of the market aspirations and the advancement in
technology.
REGULATION OF INSURANCE BUSINESS
The Indian Life Insurance Companies Act, 1912 and the Provident Fund Insurance Societies Act, 1912 were
the first comprehensive legislations in India to regulate the business of insurance, as it had been observed
that the provisions of Indian Companies Act did not meet the purpose of insurance sector. A further
legislation was passed in 1928
A comprehensive legislation viz. The Insurance Act, 1938 was passed with a view “to consolidate and
amend the law relating to the business of insurance”. It came into force with effect from July 01, 1939.
Important changes were effected in the year 1950 in the Insurance Act, 1938, whereby provisions were
made for the abolition of the chief agents, special agents and principal agents, the expenses were sought to
be limited, investments were controlled much more, the Insurance Association and Insurance Councils and
also Tariff Advisory Committees were formed as a matter of self-regulation.
After nationalisation of the insurance business in 1956, the application of the Insurance Act, 1938 to the
nationalised Life Insurance Corporation of India and the General Insurance Corporation of India and its
subsidiaries was limited.
Some of the important provisions are considered herein.
DEFINITION OF AN AGENT
The foundation of law of agency is expressed in the maxim ‘Qui facit alium, facit per se’ i.e. one, who acts
through others, acts to himself. Therefore, contracts entered into through an agent and obligations arising
from acts done by an agent, may be enforced in the same manner and will have the same legal
consequences, as if the contracts have been entered into and the acts done by the principal himself.
To this effect some legal provisions are:
1. Section 182 of the Indian Contract Act, 1982 defines the words ‘Agent’ and ‘Principal’.
An agent is a person employed to do any act for another or to represent another in dealing
with a third person.
The person for whom such act is done or who is so represented is called the ‘Principal’.
 The essence of the matter is that the principal authorises the agent to represent or act for him
in bringing the principal in contractual relationship with a third person.
2. Section 183 of the Indian Contract Act, provides that any person who is of the age of majority
according to the law to which he is subject and who is of sound mind may employ an agent. Thus a
person competent to enter into contract may appoint an agent.
3. Section 184 of the Indian Contract Act, provides that as between the principal and the third persons,
any person may become an agent but no person who is not of the age of majority and of sound mind
can become an agent so as to be responsible to his principal according to the provisions contained in
the Act. In other words, a person who is not otherwise competent to contract can be an agent so as to
bind the principal to third person but such person cannot be held liable either by the principal or by
the third party.
4. Under Section 185 of the Indian Contract Act, no consideration is necessary to create an agency.
Suppose A authorises his friend B, who has knowledge of the computer hardware to buy a computer
for him. B accepts the responsibility. Here a valid contract of agency is created between A and B
although no consideration is involved in the contract.
FIDUCIARY RELATIONSHIP OF AGENCY
The relationship of a principal and agent is fiduciary. A contract of agency is one of good faith. The agent
must disclose to his principal every fact in his knowledge, which may influence the decision of the principal
in making the contract. Further, the agent must not deal on his own account and also must not set up adverse
title, nor should he use the information obtained in the course of the agency against the principal.
CLASSIFICATION OF AGENTS
i. Classification based on the extent of their authority:
• General Agents.
• Special Agents.
• Universal Agents.
ii. Classification based on the nature of work performed:
• Mercantile Agents.
• Non-mercantile agents (advocates, wife, etc.).
i. Classification Based on the Extent of their Authority :
General Agent
A general agent is one who has the authority to do all acts connected with a trade, business or employment
such as solicitor, broker, and Commission agents. For instance, a managing director of a company may have
an implied authority to bind the company by doing anything necessary for carrying out the business of the
company in ordinary course.
Special Agent
A special agent is one who is appointed to do a particular act. He represents his principal in some particular
transaction. E.g., an agent employed to sell a piece of land or to bid at an auction. As soon as the particular
act is performed, his authority comes to an end. A special agent has no apparent authority beyond the limits
of his appointment and the principal is not bound by his acts exceeding those limits whether the aggrieved
party has its knowledge or not. Thus a person dealing with such agent should make due enquiries from the
principals to the extent of his authority
Universal Agent
A universal agent is an agent who is authorised to do all the acts, which his principal can lawfully do under
the provisions of the law of the land. Thus he enjoys extensive powers where his authority is unlimited.
CLASSIFICATION BASED ON THE NATURE OF WORK PERFORMED:
Mercantile Agent
Section 2(9) of the Sale of Goods Act, defines the term ‘Mercantile Agent’ as an agent who has the
authority to sell the goods or to consign the goods for the purpose of sale or to buy the goods or to raise the
money on the security of the goods on behalf of his principal. Thus a mercantile agent deals with buying or
selling of goods.
Non Mercantile Agents
Persons in this category are Advocates, spouse, and attorneys.
CREATION OF AGENCY
Agency relationship can be created in any of the following ways:
• by express agreement;
• by implied agreement;
• by operation of law; and
• by subsequent ratification of an unauthorised act.
Agency by express agreement
When an agency is created by words, spoken or written, it is an express agency. A written agreement may
take the form of a power of attorney or a board resolution or a clause in an appointment order, etc.
Agency by implied agreement
Where the principal does not expressly give authority to the agent, but such authority is inferred from the
conduct, situation, or relationship of parties, in such cases, courts imply an agency relationship
Situation
A is a resident of Delhi who lets out his house in Kolkata to Mr. X. A’s brother, B residing in Kolkata has
been collecting and sending the rent to A in a routine way. In this case, B is an agent of A, though not
expressly authorised by A to collect the rent.
DELEGATION OF AUTHORITY BY AN AGENT
The general rule is ‘Delegatus nonpotest delgare’ i.e. a delegatea cannot further delegate. An agent is a
delegate of the principal and therefore he cannot further delegate the authority, which he received from his
principal. The principal deputes an agent to do a certain work because of the trust and confidence which the
former reposes in the latter, therefore, the latter should not depute some other person to perform the task that
he has undertake to perform personally. The other person, called a sub-agent, may not enjoy the confidence
of the principal. Section 190 of the Indian Contract Act provides that an agent cannot lawfully employ
another to perform acts which he has expressly/ impliedly undertaken to perform personally, subject to
exceptions.
Exceptions- In the following cases delegations made by an agent to a sub-agent is lawful:
• Express permission.
• Implied permission (inferred from circumstances).
• Customs of trade.
• Nature of agency.
• Ministerial acts (clerical/ routine acts).
• Emergency.
In the above circumstances, the delegation made by the agent would be proper and the sub-agent would be
deemed to be properly appointed sub-agent, thus binding the principal. However, the agent is responsible to
the principal for the acts of the sub-agent appointed by him. The sub-agent is responsible for his acts to the
agent. Since there is no privacy of contract between the principal and the sub-agent, the principal cannot
take action against the sub-agent, except where the sub-agent acts fraudulently or commits wilful wrongs.
If, however, the sub-agent is appointed improperly, the acts of the sub-agent does not bind the principal. The
agent is responsible for the acts of the sub-agents to the principal as well as to third parties. The sub-agent is
responsible only to the agent; he is not responsible to the principal, even if the act was a fraud or wilful
wrong.

Lecture 9
DUTIES OF AN AGENT
Sections 211 to 218 of the Indian Contract Act impose the following duties upon an agent:
• To follow principal’s directions or customs of trade.
• To carry out the work with reasonable skill and diligence.
 • To render proper accounts.
• To communicate with the principal in case of difficulty.
• Not to deal on his own account.
• To pay all sums received on behalf of the principal.
• Not to make secret profits from the agency.
• Not to delegate authority.
• To take steps to protect the interest of the principal even when the agency is terminated by the
principal’s death or insanity.
RIGHTS OF AN AGENT
i. Rights to Remuneration
To receive the agreed remuneration or in the absence of any agreement, a reasonable remuneration.
In terms of Section 219, payment for any act is not due until the completion of such act. An act is
considered as complete as soon as the agent carries out his part of the work. It is immaterial whether the
relevant transaction matured or not.
Example
An agent was appointed to introduce a buyer for principal’s property. He introduced one. The sale was
settled and earnest money was paid. Subsequently the buyer could not find money to pay for the property
and the transaction fell through. The agent was entitled to get commission as his task was completed when
he found a buyer willing to buy the principal’s property.
ii. To Retain his dues from Payments due to the Principal
The agent has the right to retain his principal’s money until his claims, if any, in respect of his remuneration
or advances made, or expenses incurred in conducting the business of agency are paid.
iii. T0 have a Lien
The Agent can have a lien over the goods; documents and other property whether movable or immovable of
the principal received by him until the amount due to him for commission, disbursements and services have
been paid or accounted for to him. However, the contract between the parties may exclude any right of lien.
iv. To be Indemnified Against the Consequences of Lawful Acts
An agent appointed to import adulterated mustard oil suffered loss and punishment but he could not recover
indemnity from his principal. On the other hand, an agent who entered into a wager (a wagering agreement
is void but not unlawful) was held entitled to indemnified by his principal.
v. To be Indemnified Against Consequences of Acts done in Good Faith
vi. Right to Compensation
The Agent has a right to compensation in respect of injury caused to such him by the principal’s neglect or
want of skill.
vii. Right of Stoppage of Foods in Transit
An agent, like an unpaid seller, has a right to stop the goods in transit to the principal if he had bought the
goods whether with his own money or by incurring a personal liability for the price and the principal has
become insolvent.
Rights of a Principal
• He can enforce various duties of an agent.
• He can recover compensation from agent for any breach of duty by him.
• He can forfeit agent’s remuneration where the agent is guilty of misconduct in the business of
agency.
• Principal is entitled to any extra profit that an agent makes out of his agency including illegal
gratification, if any.
• He is entitled to all sums that agent receives on principal’s account, even though the transactions
entered into by the agent are illegal or void.
TERMINATION OF AGENCY
i. Termination by Acts of Parties
Revocation by mutual agreement
• Revocation by the principal whether express or implied. A empowers B to let his house. Afterwards
A lets it himself. This is an implied revocation of B’s authority. Revocation must be done before the
authority is exercised whether in full or in part. Revocation is only for the future acts.
• Renunciation by agent - None can be compelled to continue with agency against his will.
Renunciation may be express (resignation letter) or implied. The agent must give reasonable notice
to the principal.
ii. Termination by Operation of Law
• Upon the completion of the term of the agency.
• Upon the accomplishment of the object for which agency was created.
• Upon death or insanity of the principal or agent.
• Insolvency of the principal.
• Destruction of the subject matter of the agency business.
• Principal or agent becomes alien enemy.
• Dissolution of the company who is the principal.
• Change of law.
Consumer Protection Act, 1986.
Application of the Act
The Act applies to all goods and services. It covers private, public and co-operative sectors.
Main Objective of the Act
To provide simple, speedy and inexpensive redressal to the consumer grievances
The Act seeks to protect following rights of consumers:
i. The right to be protected against the marketing of goods which are hazardous to life and property.
ii. The right to be informed about the quality, quantity potency, purity, standard and price of goods.
iii. The right to be heard and to be assured that consumers’ interest will receive due consideration at
appropriate forum.
iv. The right to seek redressal against unfair trade practices or unscrupulous exploitation of consumers.
v. The right to consumer education.
Who is a Consumer?
One who hires any service for a consideration, which has been paid or promised or partly paid or partly
promised, or under any system of deferred payments.
It includes any beneficiary of such service other than the one who actually hires the service for
consideration and such services are availed with the approval of such person.
The Act seeks to protect following rights of consumers:
i. The right to be protected against the marketing of goods, which are hazardous to life and property.
ii. The right to be informed about the quality, quantity potency, purity, standard and price of goods.
iii. The right to be heard and to be assured that consumers’ interest will receive due consideration at
appropriate forum.
iv. The right to seek redressal against unfair trade practices or unscrupulous exploitation of consumers.
v. The right to consumer education.
REDRESSAL OF CONSUMER GRIEVANCE
Under this Act, a consumer, as an individual or along with other individuals, or through a consumer
organisation, can approach the various forum prescribed under the Act for redress, in case he is not satisfied
with the goods or service provided. He has to allege a defect in the goods or service.
A defect or deficiency is a fault, imperfection, shortcoming or inadequacy in the quality, nature or manner
of performance which is required to be maintained by or under any law or in pursuance of a contract or
undertaking in relation to that service.
In order to attend to complaints under this Act, Consumer dispute redressal forums are to be established in
each district and for each state. The forum at the district level will hear complaints up to the value of
Rs.5,00,000 and the forum at the State Level will hear complaints up to the value of Rs.20,00,000. There is
a provision also for the constitution of a national commission, which will attend to matters beyond the
jurisdiction of state forum and also appeals against the decisions of the State forum.
Limitation
Complaint is to be filed within two years from the date on which the cause of action arose. The Consumer
For Some Decided Cases shall not entertain time barred complaints
Some decided leading cases are discussed herein to educate the agents/ advisors to appreciate the stance of
the Consumer Fora and the Courts.
Case Studies
In the case of Indian Medical Association v. V.P. Shantha and others (Civil Appeal No. 688 of 1993) the
Supreme Court went into the interpretation of the term “Service” used in Consumer Protection Act (CPA)
Section 2(1) (O). The issue raised was whether services rendered free to a patient by a medical practitioner
in a Government hospital deemed to be a service for the purpose of CPA.
1. The Court distinguished between four situations (1) Services rendered at a government hospital
where all patients (rich and poor) are giving free service - is out side the purview of the CPA.
2. Services rendered at a government hospital where some services are provided on payment of charges
and also rendered to other persons free of charge will be considered as service for the purposes of
CPA. This is despite the fact that some service is being rendered free of charge.
3. Services rendered by a medical practitioner or hospital where the patient has taken an insurance
policy for medical care under which Insurance Company bears the expenses for consultation,
diagnosis and treatment is to be treated as falling under the definition of service in CPA.
Similarly if an employer bears the medical expenses of his employee and his dependants, the services
rendered to such an employee or his family members shall be treated as a service for the purpose of CPA.

Lecture 10
OMBUDSMAN
Establishment of the Ombudsman
In exercise of the powers conferred by Sub-section (1) of Section 114 of the Insurance Act, 1938 the
Central Government has framed rules known as Redressal of Public Grievances Rule 1998. In respect of
ombudsman scheme to resolve all complaints relating to settlement of claims on the part of insurance
companies in cost effective, efficient and impartial manner. The scheme had been gazetted on 11 November,
1998. Some of the important provisions of this scheme are stated hereafter.
ROLE OF THE OMBUDSMAN
The ombudsman may receive and consider complaints relating to partial or total repudiation of claims
relating to:
i. Any dispute regarding premium paid or payable in terms of the policy;
ii. Any dispute on the legal construction of the policy relating to claims;
iii. Delay in settlement of claims; and
iv. Non- issue of any insurance document to customers after receipt of premium.
The ombudsman shall act as councilor and mediator in matters within its terms of reference. His decision as
to whether the complaint is fit and proper for being considered by it or not shall be final.
Complaints to the ombudsman shall lie only when the insurer had rejected the complaint or no reply was
received within one month of the complaint or the reply was not satisfactory. A complaint can be made
within one year after the insurer had rejected the representation. The subject matter should not be already
before any court or consumers forum or arbitration.
The ombudsman shall make a recommendation within one month from the date of receipt of complaint. The
complainant may accept this recommendation stating clearly that the settlement reached is acceptable to him
in totality in full and final settlement of his claim. The ombudsman will send a copy of the recommendation
and the complainant’s acceptance letter to the insurance company. who shall comply within 15 days of
receipt of such recommendation and inform the ombudsman accordingly.
Award of the Ombudsman
If the complainant does not accept the ombudsman’s recommendation, the ombudsman shall pass an award
in writing, stating the amount awarded which shall not be in excess of what is necessary to cover the loss
suffered by the complainant as a direct consequence of the insured peril or for an amount not exceeding Rs.
20,00,000, whichever is lower. The award has to be passed within 3 months of receipt of the complainant,
who has to intimate within one month of the award, a letter of acceptance to the insured while the insurer
has to comply with the award within 15 days and inform ombudsman accordingly. Section 17 stipulates that
if the complainant does not intimate the acceptance, the award shall not be implemented.
Ex-Gratia Payments
If the Ombudsman deems fit, he may award an ex-gratia payment.
INCOME TAX ACT 1961 (As Amended)
Various provisions of Income Tax Act 1961 are applicable to Insurance business, important amongst them
are:
Section 10 (10D) exempts all proceeds out of insurance claim received by the assured from income tax and
wealth tax.
Section 80 Certain sub-sections of this section exempt the premium paid to effect an insurance policy from
the gross income of the assured in computing the total income.
Section 88: The premiums paid to effect life insurance either on his /her own life or on the life of his /her
spouse and or on the life of children provide rebate up to 20% of the savings (including certain other
savings) on the tax computed as payable.
CODE OF CONDUCT - ADVERTISEMENT AND PUBLICITY
The unhealthy competition in the insurance industry has been one of concern to all and has been deprecated
at various forums even during the pre-independence era. The methods of publicity employed by some of the
companies directly encouraged certain dishonest practice for larger business. The manner of advertising
misled the credulous.
Against this background, the Executive Committee of Insurance Council under the Insurance Act, 1938 took
cognisance of various mal-practices rampant in the industry and finalised a code of conduct. It came into
operation from the beginning of 1953. With the nationalisation of life insurance, the “code of conduct” went
into oblivion.
Bad Advertising Practices Deceptive Advertising
Deception occurs when there is a representation or omission that is likely to mislead consumers. An
advertisement or claim is ruled as deceptive if it causes a customer to take some action that would not have
been taken if the advertisement had not been deceptive. It is difficult to draft a general set of rules regarding
deception. It must be considered on ad-by-ad basis.
There must be a representation, omission or practice that is likely to mislead the consumer. In one case a
soup advertisement claimed that the product being low in fat and cholesterol it could reduce the risk of heart
disease. However, the soup was also high in sodium a fact omitted in the advertisement. Since sodium may
be harmful to those with heart disease the FTC ruled the omission made the other claims in the
advertisement deceptive.
The act or practice must be considered from the perspective of a consumer who is acting reasonably. The
advertiser is not responsible for every possible interpretation. However, advertisements directed to specific
audiences such as children will be judged on the basis of how that audience might interpret the
advertisement.
The representation, omission, or practice must be material. The claim even if it is not true, must be judged to
have had some influence over a consumer’s decision.
Puffery
There is a difference between legitimate expression of positive (and biased) information by an advertiser
and untrue and misleading material. Puffery is the most controversial area of the advertising. Some critics
categorise any statement that is not literally true as deceptive. Most consumers, however, accept the fact that
attention-getting, creative advertising will take some liberties with reality but not necessarily mislead
consumers.
The legal definition of puffery is that it is “an exaggeration or overstatement expressed in broad, vague, and
commendatory language, and is distinguishable from mis-descriptions or false representations of specific
characteristics of a product and, as such, is not actionable.”
Comparison Advertising
Comparison advertising compares competing products, usually by name. However, the conventional
wisdom of the advertising trade was that if you mentioned a competitor’s name, you were giving away free
advertising.
Comparative Advertising
Comparative advertising portrays a competitor, especially one that is named, in a negative light. If
consumers perceive that such advertising is malicious or vicious, or whose primary purpose is to belittle a
competitor they may regard the advertising as violating fundamental principles of fair play and either
disregard it or even develop a sympathy for the brand that is being attacked. Companies may sue to stop ads
in which false claims are made either about the defendant’s products or about the plaintiff’s.
i. Confusion
The most common form of unfair competition that the law recognises as wrongful is the marketing of
products or services in a way that may confuse buyers about identity, source or sponsorship.
ii. Disparagement
The disparagement of competitors is recognised by courts as an actionable wrong, but carries with it the
onerous requirement that resulting in lost business be proved. The law is concerned only with disparaging
statements that are factually untrue and injure a competitor’s business in a demonstrable fashion.
iii. Misrepresentation
Misrepresentation of the qualities of the advertised product or services, with or without derogatory of
competitive offerings, may afford the basis for a lawsuit by competitive that can show that the
misrepresentation has diverted business from them through deception of the public.
ASCI CODE OF CONDUCT FOR ADVERTISING AGENCIES
The Advertising Standard Council of India (ASCI) under Article 2(ii) of its Articles of Association adopted
a code of conduct on 20th Nov 1985. The objectives of this code of self-regulation are as follows.
i. To ensure the honesty and truthfulness of representations and claims made by advertisements and to
safe guard against misleading advertisements.
ii. To ensure that the advertisements are not offensive to generally accepted standards of public
decency.
iii. To safeguard the indiscriminate use of advertising for the promotion of the products which are
regarded as hazardous, etc.
iv. To ensure that advertisements are fair so that consumers need to be informed on choices in the
market place and the canons of generally accepted competitive behaviour in business are both
served.
The full responsibility for the observance of this code rests with the advertiser. Yet, the advertising agency
has also a responsibility. The agency should advise the client about the advertising standards to be followed.
If the client is not amenable, the matter should be referred to the Council. If the Council finds any
advertisement violating this code, all media owners shall refuse its publication.
Important features of this ASCI code as relevant to insurance industry:
i. Advertisement must be truthful.
ii. A source of data on the basis of which claims are made should be disclosed.
iii. It should not confer unjustified advantage or bring ridicule or disrepute.
iv. Advertisement shall not distort facts nor mislead the consumer.
v. Advertisements inviting the public to invest money shall not contain statements misleading as to
security, rates of return, etc.
 vi. Comparison with other manufacturer is permissible, if it is factual, accurate and capable of
substantiation.
vii. It should not denigrate other product.

Lecture 11
IRDA (INSURANCE ADVT. AND DISCLOSURE) REGULATIONS, 2000
Insurance Advertisement
According to Regulation 2(b), Insurance Advertisement means any communication directly or indirectly
related to a policy and intended to result in the eventual sale or solicitation of a policy from the members of
the public, and shall include all forms, or printed and published material or any material using the print and/
or electronic medium for public communication such as:
Newspapers, magazines and sales talks, bill boards, hoarding, panels, radio, television, web-site, e-mail,
portals, representation by intermediaries, leaflets, descriptive literature/circulars, sales aids flyers,
illustrations form letters, telephone solicitation, business cards, videos, faxes, or other communication with a
prospect or a policyholder that urges him to purchase, renew, increase, retain or modify a policy of
insurance.
Explanation to the regulation states that the following shall not be considered to be an advertisement
materials used by an insurance company within its own organisation and not meant for distribution to the
public; communications with policyholders other than material urging them to purchase, increase, modify
surrender or retain a policy; materials solely used for the training, recruitment and education of an insurer’s
personnel, intermediaries, counselors, and solicitors, provided they are not used to induce the public to
purchase, increase, modify or retain a policy of insurance; any general announcement sent by a group
policyholder to members of the eligible group that policy has been written or arranged.
Misleading Advertisement
Regulation 2(d) defines unfair or misleading advertisement as any advertisement that:
i. Fails to clearly identify the product as insurance;
ii. Makes claims beyond the ability of the policy to deliver or beyond the reasonable expectation of
performance;
iii. Describes the benefits that do not match the policy provisions;
iv. Uses words or phrases in a way which hides or minimises the costs of the hazard insured against or
the risks inherent in the policy; omits to disclose or disclose insufficiently, important exclusions,
limitations and conditions of the contract;
v. Gives information in a misleading way; illustrates future benefits on assumptions which are not
realistic nor realisable in the light of the insurer’s current performance;
vi. Where the benefits are not guaranteed, does not explicitly say so as prominently as the benefits are
stated or says so in a manner or form that it could remain unnoticed;
vii. Implies a group or other relationship like sponsorship, affiliation or approval that does not exist; and
viii. Makes unfair or incomplete comparisons with products, which are not comparable or disparages
competitors.
Compliance
Every insurer or intermediary or insurance agent shall
i. Have a compliance officer whose name and official positions in the organisation shall be
communicated to the IRDA and he shall be responsible to oversee the advertising programme;
ii. Establish and maintain a system of control over the content, form, and method of dissemination of
all advertisements concerning its policies;
iii. Maintain an advertising register at its corporate office which must include a specimen of every
advertisement disseminated or issued or a record of any broadcast or telecast, etc. and a notation
attached to each advertisement indicating the manner, extent of distribution and form number of
policy advertised;
iv. Maintain a specimen of all advertisements for a minimum period of three years;
 v. File a copy of each advertisement with the IRDA as soon as it is first issued together with
information as to when the product was approved by the IRDA, description of the advertisement and
how it is used, and the media used dissemination of the policy advertised;
vi. File a certificate of compliance with their annual statement stating that to the best of its knowledge,
advertisements disseminated by it during the preceding year have complied with the provisions of
the regulations and the advertisement code; and
vii. The advertisement register shall be subject to inspection and review by the IRDA for content,
context, prominence and position of required disclosures, omissions of required information, etc.
DISCLOSURES
i. Advertisement by Insurance Companies
Every insurance company shall prominently disclose in the advertisement or that part of the advertisement
that is required to be returned to the company or insurance intermediary or insurance agent by a prospect or
an insured, the full particulars on the insurance company and not merely any trade name or monogram or
logo.
Where the benefits are more than briefly described, the form number of the policy and type of coverage
shall be disclosed fully.
ii. Advertisement by Insurance Agents
The advertisement issued by the agent must be approved by the insurance company who shall ensure that all
advertisement that pertain to the company or its products or performance comply with the IRDA regulations
and are not deceptive or misleading.
The agent is not, however, required to obtain approval of the insurance company for those advertisements
developed by the insurer and provided to the agents, for generic advertisements limited to information like
the agent’s name, logo, address, and phone number; and advertisements that consist only of simple and
correct statements describing the availability of lines of insurance, reference to experience, service and
qualifications of agents, but making no reference to specific policies, benefits, costs or insurers.
iii. Advertisements by insurance intermediaries
Only properly licensed intermediaries may advertise or solicit insurance through advertisements.
Advertising on the Internet
Every insurer or intermediary’s web site or portal shall include disclosure statements, which outline the
site’s specific policies vis-a-vis the privacy of personal information for the protection of both their own
businesses and the consumers they serve and display their registration/ license numbers on their web sites.
Endorsements and Third Party Involvement
A third party, group or association shall not :
i. Distribute information about an insurance policy, intermediary or insurer on its letterhead;
ii. Allow an insurance intermediary or insurer to distribute information about an insurance policy,
insurance company on its letter head.
iii. Distribute information about an individual insurance policy, or about an intermediary or insurer in its
envelopes, unless the third party is providing only a distribution service and is not itself soliciting the
coverage and the insurance information is a piece separate from any other information distributed by
the third party and clearly indicates its origin.
iv. Recommend that its members purchase specific insurance products;
v. Imply that a person must become a member of its organisation in order to purchase the policy;
vi. Imply that a purchaser of a policy by becoming a member of a limited group of persons shall receive
special advantages from the insurer not provided for in the policy.
Provided that a third party, group or association may endorse an insurance company or insurance
intermediary’s product and provide truthful statements, quotes, and testimonials endorsing the insurance
products to the insurance company for use in the company’s advertisements, so long as the language does
not convey directly or indirectly a recommendation that members of the organisation purchase the products.
The third party may provide an insurance company with information about its membership and collect
compensation based upon sales for that information.
Action for Non-Compliance
The IRDA may take action if the advertisement is not in accordance with the regulations. IRDA may seek
information from the advertiser within 10 days, direct the advertiser to correct or modify the advertisement
already issued, direct the advertiser to discontinue the advertisement forthwith or take any other action
deemed fit by it. Failure to comply with the directions of the IRDA will entail action including levy of
penalty.
Adherence to the Advertisement Code
Every insurer shall follow recognised standards professional conduct as prescribed by the Advertisement
Standards Council of India (ASCI) and discharge its functions in the interest of the policyholders.
i. Statutory Warning
Every proposal for an insurance product shall carry the following stipulation as prescribed in Section 41 of
the Insurance Act, 1938:
“No person shall allow or offer to allow, either directly or indirectly as an inducement to any
person to take out or renew or continue an insurance in respect of any kind of risk relating to
lives or property in India, any rebate to the whole or part of the commission payable or any
rebate of the premium shown on the policy, nor shall any person taking out or renewing or
continuing a policy except any rebate, accept such rebate as may be allowed in accordance
with the published prospectus or tables of the insurer”.
Failure to comply with the statutory warning entails a fine of rupees five hundred.
OPENING UP OF THE INSURANCE SECTOR
Objectives of nationalisation not fully realised.
After 44 years of monopoly over life insurance business and 18 years of monopoly in general insurance
business the society at large realised that the avowed objective of nationalisation was not fully realised.
There was a general feeling that the insurance sector should be opened up, in tune with the general trend in
globalisation and liberalisation.
Opening up of the sector to private participation was necessary for wider coverage, for wider product
variety better tuned to consumer needs, for efficiency gains through competition and most importantly, for
mobilising funds for infrastructure, now that other fiscal sources are drying up.
Insurance coverage in India was less than 22 per cent of the insurable population. The rate of a new policies
of LIC reached only a small percentage of the potential market. Insurance business is measured in terms of
penetration (premium collection as a fraction of GDP) and density (premium collected per capita). On both
these counts India lagged far behind peer countries. The performance of LIC and GIC in increasing
coverage and claims settlement was commendable. But the sheer size of the market required more players.
Only ten per cent of the work force had any old age income security in the form of Provident Fund or
Pensions. Insurance firms can serve this potentially huge market for pensions and annuities. They can also
serve as savings institutions.
Insurance privartisation witnessed a see-saw battle in the Parliament. The Congress party initiated
privatisation by forming the Insurance Reforms Committee (IRC) in 1993, the UF government tried to
introduce legislation in 1996, only to be thwarted by the then opposition Congress and BJP, and the BJP was
finding it rough to carry the bill through the parliament.
Trade Unions’ objection to private entry
Three objections seemed to be the most of prominent.
i. No major untapped potential and hence no need to introduce new players. Since per capita income
was low, the potential market for insurance was also low, so went the claim. But market potential
was proved to be high even if insurance was targeted at the middle class alone. LIC had only 65
million policy holders out of potential middle class of 200 million. Only 1.1 million new policies
were sold every year. Many policies lapsed within three years, since the primary purpose of buying
LIC policies was for the tax shelter. 45 percent of new policies were sold in the rural areas, which
represented a big untapped market. The very idea of buying insurance as a product, and not merely
as a savings instrument, had not caught on in India. As insurance services and products proliferate,
demand was expected to rise.
 ii. Fear of retrenchment. Though not articulated publicly, unions feared that competitive pressure would
force LIC and GIC to induct labour saving technology leading to retrenchment of employees. Also,
since LIC/GIC would be required to service non profitable segments, private companies would take
away the cream. Over time foreign companies with their technological edge and lower cost would
dominate, ant the domestic companies would be wiped out.
There certainly was no possibility of immediate retrenchment. Neither the government nor
LIC/GIC were interested in changing the existing labour laws. The fear that LIC and GIC
would be forced to cut jobs was thus misplaced. Insurance sector in UK and USA employ
substantially higher number of people than in India. Experience of other countries showed
employment going up with insurance liberalisation. Any social sector investment obligation
would apply to all players in the industry. Computerisation would enhance labour
productivity, and cost reduction might call for redefining existing jobs. But the jobs in the
industry as a whole are likely to expand, especially with the increase in the demand for
intermediaries. LIC and GIC have a wide network of branches and an in-depth knowledge of
the market. This gives them an incumbent’s advantage which can be exploited with pre-
emptive actions. On the contrary, as in the case of airline privatisation, India may find
employees migrating to private companies.
iii. Reckless profiteering and bankruptcies. The reasoning was that private firms would indulge in
reckless profiteering, leading to widespread bankruptcy. Perhaps what the unions were saying was
that in competing for the lowest premiums, insurance companies might charge prices which were too
low. Consequently, if contingency funds of an insurer were not adequate enough to pay out against
claims, it could lead to bankruptcy. This is where a well - designed regulatory mechanism becomes
operative. ensuring the solvency of insurers is a function of IRA. Insurance business cannot afford to
have excessive insolvencies. There are basically four ways of ensuring enough insolvency: (a) a
price floor; (b) restriction on capital and reserves - what kind of investments and speculative
activities firms can make; (c) placing entry barriers (licensing) to restrict the number of competitors;
and (d) creation of an industry financed grantee fund to bail out firms hit by unexpectedly high
liabilities.
Another related fear was that foreign owned companies will repatriate funds in a big way. This is unlikely to
happen in the initial years, and in any case, some regulatory curbs as in banking, can be put to limit such
outflow.
The real story behind the unions protests was that the dismantling of government monopoly would provide a
benchmark to evaluate the government’s insurance services. In the absence of competition, customers
simply don’t have other options. Through private entry, LIC/GIC would be forced to regularly upgrade
service quality, product variety, premium rates and grievance redressal mechanisms to keep up with
competition.
With deep pockets, massive investible fund, a wide and well established network LIC/GIC did not have to
worry about surviving. They however had to shape up and increase productivity, which called for more
efforts from employees. If the employees were willing to increase productivity, the privatisation provided a
good opportunity for the employees as well as the general public.

Lecture 12
LIFE INSURANCE CORPORATION
Life Insurance business in India was nationalised with effect from 1st September, 1956. From this date, the
life insurance business transacted by 154 Indian life insurers, the Indian business of 16 foreign insurers and
75 provident societies was taken over by Government of India under the Life Insurance Corporation of India
Act, 1956, passed by the Parliament on 18-6-56. The Life Insurance Corporation of India (LIC) which had
been established w.e.f. 19.5.1956 as a body corporate having perpetual succession and common seal with
power to acquire, hold and dispose property and to sue and be sued in its name.
Under Section 30 of the Act, from the appointed date i.e. 1.9.56, LIC acquired the exclusive privilege of
carrying on life insurance business in India and the certificate of registration granted to any insurer under
the Insurance Act, 1938 ceased to have effect from the said date.
Now the above provisions of section 30 have been altered by insertion of Section 30A consequent to the
enactment of the IRDA Act, 1999. As a result the exclusive privilege given to the LIC has been withdrawn.
Foundation of Commercial Contracts
The Indian Contract Act, 1872 governs commercial contracts. A contract is defined in Section 2(h) as an
agreement enforceable by law. Section 2(e) defines agreement as every promise and every set of promises
forming the consideration for each other. Thus a contract may be defined as an agreement between two or
more parties to do or to abstain from doing an act, with an intention to create a legally binding relationship.
A commercial contract to be enforceable must have following essentials:
• Offer and acceptance;
• Consensus-ad-idem;
• Free Consent;
• Lawful consideration;
• Capacity to contract;
• Certainty of the terms;
• Legality of object; and
• Capable of performance.
Insurance Contract v. Commercial Contract
Insurance is a special type of contract, in that, apart from the usual essentials of a valid contract, insurance
contracts are subject to additional principles viz. principle of utmost good faith and principle of insurable
interest. These apply to both life and non-life classes of Insurance. In the case of non-life business two
additional principles viz. indemnity and proximate cause are also applicable.
Principle of Good Faith
Commercial contracts are further governed by the Sale of Goods Act, 1930 which essentially deals with sale
of moveable goods and chattels which are tangible. Even intangible goods such as goodwill or trademark
can be subject matter of sale. In most of these contracts the buyer of goods can examine the item or service,
which is the subject matter of contract. Therefore, commercial contracts are normally subject to the
principle of caveat emptor i.e. let the buyer beware. The buyer is bound to examine the goods or seek
clarifications about the goods or services he intends to buy. However, there are exceptions to the doctrine of
‘Caveat Emptor’. The defects in the goods may be latent that on an outward examination of the goods, they
may not be detected. Such defects may surface only during functional test or usage. The buyer is protected
in such cases. Also if the goods are branded goods supposedly having particular usage, the buyer who relies
upon the judgment of the dealer in such goods is protected. Otherwise the terms of the contract (the
conditions and warranties expressly stipulated by the parties) will essentially govern the contract. The buyer
of goods and services can ask the seller to warrant as to the quality of the goods and seek indemnity in case
the warranties are not fulfilled. If the buyer had chosen to stipulate certain conditions and if the conditions
were not met, the buyer can rescind the contract and claim the price, if any, paid and also damages.
Implied Conditions and Warranties
In addition to the express conditions and warranties, there are certain implied conditions and warranties
which are essentially meant to avoid undue negotiations and which come to the rescue of the buyer in the
event of disputes. Thus buyer need not ask elaborate questions about the goods or services he intends to
buy/ avail. For example, the buyer need not ask the seller whether he had good title.
Further the buyer who has been deceived by the seller can avoid the contract, at his option, on the ground
that the contract was vitiated by fraud or misrepresentation.
So far as the seller is concerned, so long as there is no attempt to mislead the buyer and he gives answers to
the buyer’s queries truthfully, the question of the buyer avoiding the contract would not arise. There is no
need on the part of the seller to volunteer to disclose information not asked for by the buyer. So the doctrine
of ‘Caveat Emptor’ holds good in the case of commercial contract for sale of ordinary goods including
intangible goods.
However, in the case of contract of life insurance, the position regarding ‘Caveat emptor’ is somewhat
reversed. The product sold by the insurer is an intangible service viz. of underwriting risks associated with
life. Most facts relating to the health, habits, personal and family history of the insured are known only to
the proposer. The insurer can know most of these facts only if the proposer decides to disclose these facts. It
is true that the underwriter can have the assistance of medical report for life insurance proposal. Yet there
may be certain aspects, which may not be brought out even by the best medical examination.
For example, a person suffering from high blood pressure or diabetes can manage to hide these facts from
the examining doctor. History of past serious sicknesses, operations, injuries can be suppressed. Some of
these affect the life expectancy of the proposer. Hence these constitute material information from the
underwriter’s point of view.
Non-disclosure of such facts would put the insurer as well as the community of policyholders at a
disadvantage. This constitutes adverse selection, viz. tendency on the part of substandard lives to enter into
insurance scheme by resorting to non-disclosure or suppression of material facts.
It is for these reasons that the law imposes a greater duty on the parties to an insurance contract than in the
case of other commercial contracts. This duty is one of utmost good faith (Uberrimae Fide). It is the duty of
the assured to make a full disclosure to the underwriter, without being asked. In a contract of insurance,
there is an implied condition that each party must disclose every material fact known to him. This type of
contract is called Uberrimae Fide i.e. contract of utmost good faith
Utmost good faith can therefore be defined as a positive duty to disclose accurately and fully all facts
material to the risk being proposed whether requested or not.
Good Faith, A Reciprocal duty
In the case of commercial contract, the seller is not bound to disclose anything about the goods unless asked
for by the buyer. In the case of issue of shares which are movable goods, the companies issuing the shares
are required to make full and truthful disclosures in the prospectus, so as to enable the investors to make
reasoned investment decision. The buyers in the former and the investors in the latter are not required to
make any disclosures. However, in the case of insurance contract, the duty of full disclosure rests on both
parties, the insured and the insurer.
It is easier to see where the proposer might be in breach of duty rather than the insurer. In practice, there are
few breaches of the duty to disclose on the part of the insurer, as noted in decided cases:
i. Withholding from the proposer the fact that the water sprinkler system in his premises entitled him
to a substantial discount on his fire insurance premium.
ii. Similarly not disclosing non-smoker’s discount in the life insurance premium payable by a non-
smoker.
iii. Accepting an insurance which the insurer knows is unenforceable at law, for which it is not
registered to underwrite.
iv. Making untrue statements during the negotiations for the contract.
Material Facts
What is a material fact? Every circumstance is material, which would influence the judgment of a prudent
insurer in fixing the premium or determining whether he should take the risk. Therefore, facts regarding age,
height, weight, build, previous medical history, smoking drinking habits, operations, non-disclosure of
earlier insurance’s, ‘hazardous’ occupation must be disclosed. It is not for the proposer to decide which fact
is material to the risk.
There are certain circumstances, which need not be disclosed. For example:
• Facts of law, which every one is supposed to know.
• Fact of common knowledge.
• Facts which lessen the risk.
• Facts, which a survey should have revealed.
• Facts covered by policy conditions.
Facts, which could be reasonably discovered, by reference to previous policies, records which are available
with the insurer. However, in the case of Asima Sarkar Vs Western India Life Insurance Co (1942), the
Calcutta Appeal Court held that the fact that the previously declined card was available with the company
would not by itself suffice to draw the inference of waiver of this information. ‘Waiver’ would operate if the
office had taken such fact into consideration.
The Appropriate Time for Disclosure
The duty of disclosure in life insurance operates till the risk commences. The fact must be material at the
date at which it should be communicated to the insurer. A fact, which was immaterial when the contract was
made, but becomes material later on, need not be disclosed. However, if the terms of contract are sought to
be altered, then there is a duty to disclose all material facts relating to alteration. If a lapsed/paid up policy is
revived or a surrendered policy is reinstated, there would be a fresh duty to disclose all material facts at the
time of alteration; since this becomes a contract ‘novel’.
There can be a requirement in the policy itself for continuous disclosures in the case of life insurance. (Note:
In the case of companies raising capital from the public, there is requirement of continuous disclosures to
the stock exchanges). The requirement of continuous disclosure may be rare in the case of general
insurance.
The breach of Utmost good faith arises due to misrepresentation or non-disclosure. Misrepresentation
should be substantially false, must be concerned with facts which are material to the acceptance or
assessment of the risk, and this must have induced the other party to enter into a contract. Non-disclosure
should be within the knowledge of the first party and should not be known to the second party and must be
calculated to induce the other party to enter into contract on its own terms.
In life insurance contracts, there is a written proposal, which contains a declaration by the proposer that all
the statements in the proposal form are true in every respect and if any untrue statement be contained
therein, the insurer would be entitled to treat the contract as null and void and forfeit all the moneys paid
therefore. The effect of this declaration is to turn the representations in the proposal form into warranties
which must be complied in to. However, the insurer’s right to cancel the contract is limited by the
provisions of Section 45 of Indian Insurance Act, 1938. This section stipulates that a policy cannot be called
in question after 2 years, on the grounds of inaccurate or false statement, unless it is proved to be material
and ‘fraudulent’ at the time when it was made.
INSURABLE RISK
Before we discuss the second principle viz. insurable interest, it is essential to understand what is meant by
insurable risk.
All risks are not insurable. There are certain pre-requisites before a risk is covered by insurance. In order to
be insurable, the risk must be capable of:
• financial measurement.
• statistical (actuarial) estimation.
• there must be sufficient number of similar risks for rating purpose.
• the subject matter of the contract must not be against public policy.
• the premium must be reasonable.
• there must be insurable interest in the property to be insured/risk to be covered.
Financial Measurement
What is insured is not the property or life that is insured but it is the pecuniary interest of the insured in that
property or life. The interest of the insured in the property must be capable of financial determination.
Sentiments apart, it is possible to place a value upon the life of every person. Thus in life insurance the
pecuniary interest of the proposer in the subject matter (life) to be insured must be measurable in money
terms.
Statistical Estimation
For the insurer to work out the cost of premium to be charged, there must be available sufficient statistical
information about the risk.
Pooling of Risks
Insurance is basically pooling of risks. The law of large numbers applies. Insurers are managers of a pool of
premiums from which they meet the losses of those unfortunate who suffer injury or damage. It follows
from this that each insured must bring a proper contribution to the pool by way of premium. In other words,
the insured should not under insure his risks.
Public Policy
The Indian Contract Act mentions some of the agreements which are opposed to public policy.
Illustratively, they are:
• Agreements in restraint of marriage.
• Agreements in restraint of parental rights.
• Agreements in restraint of trade.
• Agreements to broker marriage.
Reasonable Premium
The premium to be charged should be reasonable so as to leave a small margin of profit for the insurer after
meeting the expenses and at the same time it should be sufficient to sustain the contingencies which have to
be met under the policy.
Insurable Interest
There is no single definition of insurable interest, which is universally accepted. The Insurance Act, 1938
does not define insurable interest. Insurable interest can be referred to the right to insure arising out of a
financial relationship recognised under law, between the insured and the subject matter of insurance.
Insurable interest is said to exist when the person insuring stands to lose if the event insured against occurs.
The courts in India have consistently held that an insurance on the life of a person, in which the person
effecting the insurance, has no interest is void as a wagering contract under Section 30 of the Indian
Contract Act. Insurable Interest is thus a legal pre-requisite for insurance.
Insurance is a contingent contract to do or not to do something, if some event collateral to such contract
does or does not happen. A wager contract, on the other hand, is a promise to pay money upon the
determination or ascertainment of an uncertain event. In wagering agreement each party stands to lose or
win on the conclusion of the event. There is no mutual gain or loss as in a valid contract.

Lecture 13
ESSENTIALS OF INSURABLE INTEREST
There must be some property, right, interest, life, limb or potential liability capable of being insured.
It is this property, right, interest, etc. which must be the subject matter of insurance.
The insured must stand in a relationship with the subject matter of insurance whereby he benefits from its
safety, well being or freedom from liability and would be prejudiced by its loss, damage, or existence of
liability.
The relationship between the insured and the subject matter of insurance must be recognised in law.
Creation of Insurable Interest
There are a number of ways in which insurable interest may arise or be limited:
By Common Low
Where the essential elements of insurable interest are automatically present, the same can be described as
having arisen at common law. The most straightforward example is ownership; one can insure his owned
car, house, etc. Similarly, the common legal duty of care, which one owes to the other, may give rise to a
liability, which is again insurable.
By Contract
In some contracts a person may agree to be liable for something, which he would not ordinarily be liable
for. For example, a landlord is normally liable for the maintenance of the tenanted property. A lease,
however, may make the tenant responsible for the maintenance or repair of the building. Such a contract
places the tenant in a legally recognised relationship to the building or potential liability. This gives him an
insurable interest, which would not be present, if the contract had not been entered into.
By Statute
Sometimes an Act of the Legislature will create an insurable interest either by granting some benefit or
imposing a duty. While the statute may create insurable interest where none would otherwise exist, there can
be statutes, which restrict liability and thereby also restrict insurable interest.
INSTANCES OF INSURABLE INTEREST IN LIFE BUSINESS
Own Life
It is presumed that a person has insurable interest in his own life to an unlimited extent. In case of his
untimely death, his estate or family would lose to the extent of the future accumulation of income, which he
hopes to make during his normal span of life. It is not easy to compute with any degree of certainty what the
future earnings of a person would be.
Insurers take into account a proposer’s capacity to pay premiums and his need for insurance, while granting
the sum insured. If the insurer refuses to grant the sum assured asked for, it will be mainly on account of
moral hazard and not so much on account of lack of insurable interest. If it is shown that a party will keep
up the policy that will be a case of ‘no insurable interest’.
Life of Spouse
Spouses have insurable interest in each other. If members of families are in business together or there is
some other financial relationship, insurable interest arises as a result of such financial involvement. Partners
can insure each other’s lives, because they stand to lose in the event of death of any of them. A creditor may
loose financially if a debtor dies before repaying a loan.
Life of Employees
Employers have insurable interest in the life of employees, so long as the employment contract continues.
Key-man insurance recognises this fact and his added financial dimension to it. Group Insurance taken out
by the employer is also based on the same principle.
Life of Children
The legal position about children’s assurances is not quite clear. It is presumed that parents have insurable
interest in the life of a child as a child i.e. so long as he is a child. Therefore most of the children’s policies
issued by insurance companies incorporate a vesting clause, whereby the policy vests in the child on
attainment of majority.
Documents Used in Life Insurance Transactions
There are several types of insurance forms/documents, which are used in day to day operations of an
insurance company. Knowledge of these forms is essential for the agent working for insurance company. In
our study, we will discuss the important forms used by the insurance companies along with the use and
significance of each one.
Generally following forms/documents are used for day-to-day working of the insurance companies.
Document required as basis of contract:
• Proposal form including personal statement.
• Medical Reports.
• Special Questionnaires / Special Reports.
• Proof of Age.
• Agents Confidential Report and Moral Hazard Report.
Document as an evidence of contract:
• First premium Receipt.
• Policy Bond.
Documents required during servicing of policy:
• Renewal Premium Notices.
• R.R. Receipt.
• Bonus Notices.
• Endorsement.
Document required at the time of claim:
• Maturity and survival Benefit claims.
• Death Claims.
 • Miscellaneous Documents.
Proposal Form
Proposal form, in which the application for insurance is to be made, is printed by the insurer and made
available through agents. The person proposing for insurance, called the proposer, is required to give details
about himself for example name, date of birth, address, occupation name of the person to be insured, the
amount of insurance, the plan and terms preferred, mode of payment, object of insurance, nomination,
Accident Benefit & Extended Disability Benefit required, previous insurance particulars. In case of female
proposer additional questions are to be answered in respect of the proposer and her husband. Previous
insurance particulars are required:-
• For comparison.
• To determine total insurance.
• To determine whether accident and extended disability benefit can be given.
The proposal form is normally given to the insurer alongwith the personal statement of health and habits. If
medical examination is required, the confidential report of the medical examiner is sent to the insurer
separately.
The form of the proposal varies depending upon the plan of insurance, type of insurance, viz., medical or
non-medical, the insurance being on one’s own life or on the life of another, etc. Similarly, additional forms
and reports may be required depending upon the size of insurance, the age and nature of risk involved.
The proposal form is an important document not only because it contains valuable information, but also
because the proposer declare at the end of the proposal form that the answers and statements are given by
him after fully understanding the questions, that they are true and complete. The statements in the proposal
form constitute the basis of the contract. If any declaration is known to be untrue, the contract shall be null
and void.
If the form is filled up in a language not familiar to the proposer or if the proposer is illiterate and can only
affix his thumb impression instead of a signature some one else familiar with the language, has to declare
that he had explained the contents to the proposer and that the proposer had understood the same. He is,
thus, still bound to the truth of the statement in the proposal and the consequences otherwise. This would be
a requirement in countries like India where there are many spoken languages other than the business
language of the insurer and because the rate of literacy is low.
It is very important to understand and also separately stated in the policy, that the proposal and its contents
is the basis of the insurance contract evidenced by the policy. Some companies attach the proposal to the
policy as part of it. It is not done so in India. As it is the basis of the contract, the proposal form has
extensive questions on the state of health habits and family history of the life to be insured, hence tends to
be lengthy.
Personal Statement
Personal statement which includes family history i.e. age & present state of health of parents, brothers,
sisters, wife, children. In case of death of any of them cause of death and age at the time of death is required.
The personal statement also elicits information of the proposer regarding history of illness accident/
operation & present state of health. In case of non-medical proposal, basic medical measurements are also
given.
Non-Medical Insurance
Proposers are normally subject to medical elimination to determine the state of health and the premium to be
charged. The degree of medical scrutiny becomes more stringent as:
• Life to be assured is older.
• Amount of insurance increases.
At one level, below certain age and Sum Assured (SA) limits, medical examination is totally avoided. The
risk is assessed and accepted on the strength of the proposer’s own statement on his family and personal
history and on the agent’s confidential report. With experience and as the base of the insured population
increases the limits (of age and SA) could move higher. This facility of non-requiring medical examination
becomes very useful particularly in rural areas, where there may not be adequate arrangements for medical
examination-
Non-medical insurance scheme result in simplification of work of assessing, the risk reduces the
inconvenience to the proposer and saves cost. Dispensing with medical examination does not mean that the
standard of selection is lowered. Non medical selection envisages a more detailed proposal form and more
detailed report from the agent and other officials. The Postal Life Insurance(PLI) also has a non-medical
scheme for persons below 35 years of age and for S.A. upto Rs. 1 lakh. The Non-medical (Special) scheme
can be availed of by literate persons aged not more than 45 years, who are employees working in
Government offices, Quasi-Government offices like Municipalities, District boards, Local boards etc. State
corporations, and Government industrial undertakings. Non-Government commercial and industrial
undertakings and reputed institutions like private colleges and schools, which normally insist on medical
examination before recruitment, provide good working environment, give fair remuneration and maintain
leave records. The employee must have completed at least one year service with his present employer to
become eligible for insurance under Non-medical (special) scheme, provided other conditions are satisfied.
Age Proof
The risk of death is higher as age advances. The likelihood that a person aged 70 years will die in the next
year is more than that of a person aged 20 years dying within one year. Age of the proposer, therefore, plays
a vital role in assessing the risk of death and therefore, the amount of premium to be charged, age is
considered along with other features like health, habits etc.
In the earlier days, age-proof was not insisted upon at the time of accepting the risk. Premium used to be
calculated on the basis of the age as stated in the proposal form. It was assumed that the age stated should
be, by and large, correct. The proof of age could be submitted later during the currency of the policy. When
the claim arose, age-proof had to be produced and if the age was proved higher, the difference in premiums
was recovered with interest from the claim amount payable. This system provided much inconvenience to
the life assured or the claimant. Delays were caused. Proof of age was also not easily available. Particularly
if it was a death claim. At times it was found, even the risk offered would not have been made available, had
the correct age been stated. For these reasons, proof of age is now- a-days insisted upon the commencement
itself.
The standard age-proofs acceptable to the life insurance companies normally are;
• Certified extract from municipal or other records, made at the time of birth.
• Certificate of baptism or certified extract from family Bible, if it contains age or date of birth.
• Certified extract from school or college records, if the dale of birth is stated therein.
• Certified extract from the service registers in the case of Government employees and employees of
Quasi-Government institutions and reputed commercial and educational institutions provided that
they insist on conclusive evidence of age at the time of recruitment of the employees.
Passport
• Identity cards issued by Defence department in case of Defence personnel showing the date of birth,
• Any other documents where date of birth has been proved on the basis of one of the other standard
proofs of age as stated above acceptable to the insurance companies.
Other alternate age-proofs which are acceptable in India is marriage certificate issued by a Roman Catholic
church. If standard proofs of age are not available, then other documents like horoscopes, elder’s
declaration, self- declaration, or certificate by village Panchayats are accepted. This is subject to the
discretion of the underwriter, who may not be very strict if he is satisfied that the risks are not much. He
may even charge some extra premium or restrict the terms to safeguard against the possibility of the correct
age being a few years higher than what is stated.
Agent's Report or a Similar Report from High-ranking Official
Agent’s report or a similar report from high-ranking official (MORAL HAZARD REPORT) is obtained
which gives information and collaborates some of statements made by the proposer in personal statement. It
also verifies his statement about occupation including source of income, previous insurance and his
recommendations whether to accept the proposal or not.
Medical Report
Medical Report is obtained from medical examiner who conducts the medical examination after going
through the personal statement and gives his opinion about the present state of the health of the proposer.
Special Questionnaire
In case of hazardous occupation a special questionnaire is required to be completed by the proposer.
The underwriter studies the above papers and takes decision in one of the following manners -
• The proposal is accepted at ordinary rate;
• Counter offer is made to accept the proposal on modified terms for which consent/ balance premium
is called for;
• In some cases further requirement like additional medical/ pathological/ radiological reports or some
additional information on his financial status etc. is called for;
• Decline the proposal - declination letter is sent;
• Postpone the consideration of the proposal for some specified period- postponement letter is sent;
and
• Drop the proposal being not in line with accepted financial norms.
Special Report
Besides the proposal form, personal statement, agent’s report, medical examiners report and age-proof,
special medical reports may be called for as a matter of routine, if the S A is very high, say Rs. 5 lac or more
the age at entry is very high, say, 60 years or more the proposer wants insurance cover under a high-risk
plan like Jeevan Mitra. Jeevan Sathi, Jeevan Griha, Jeevan Surabhi and Asha Deep.
The normal medical examination discloses some adverse feature in health like high blood pressure, presence
of sugar in blood or, other impairments. The underwriter has the right and discretion to ask for additional
information through special reports.
First Premium Receipt
After accepting the proposal and verifying the receipt of full first premium, First Premium Receipt is issued.
The First Premium Receipt signifies the date of commencement of risk by the insurer. The law does not
allow the commencement of risk without the receipt of premium. The date of issue of the first premium
receipt is not necessarily the date of commencement. The policy can be commenced by dating back in the
same financial year.
First premium receipt gives the following information -
• The terms on which the proposal is accepted,
• policy no.,
• date of commencement,
• date of maturity,
• date of last premium,
• date of next premium due,
• amount of premium,
• mode,
• due date,
• Nomination,
• table & term,
• name and address of the insured,
• whether age admitted or not,
• AB premium if any.
Renewal Premium Receipt
As per contract the assured is obliged to pay the premium during the terms of the policy on due date or
within the days of grace for which Renewal Premium Receipt is issued. It is the evidence of continuance of
risk cover till the next premium becomes due. However, in case of Salary Saving Scheme Policies, Renewal
Premium Receipt is not issued as a consolidated cheque is received from the employer. The premium
deducted from the salary and certificate of deduction of month, premium from the salary should be proof of
continuance of policy.

Lecture 14
POLICY CONTRACT
The life insurance policy is a legal contract, and the policy document is the evidence of the contract. It
contains the subject matter of the contract and sets forth the rights and duties of the insurance company and
of the policyholder. The policy document issued by the LIC is required to be signed and also stamped as per
the Stamp Act. Otherwise, it cannot be enforced in a court of law. In the case of PLl the policy is exempt
from stamp duty. Most of the standard terms and conditions are printed in the document. Special clauses,
relevant to a particular contract, are attached to the policy document and form part of the contract.
It is usual to divide the policy document into the following divisions:
• Preamble.
• Operative clause.
• Proviso.
• Schedule.
• Attestation.
• Conditions and Privileges.
Policy Preamble
A typical policy document of the LIC begins with a paragraph, which is called the preamble. The Preamble
provides that the Proposal and Declaration signed by the proposer, form part of the policy and the truth of
the statements made therein are secured to be warranties. Any untrue averments therein vitiate the validity
of the contract. Of course, they are subject to the provisions of section 45 of the Insurance Act, 1938.
The Operative Clause
The operative clause lays down the mutual obligations of the two parties. The assured has to pay the
premiums as stipulated in the policy. In consideration of this, the insurer undertakes to pay the benefits on
the happening of the events on which the benefits are payable. The benefits will include further sum or sums
as may be allocated by way of Bonus, if payable.
The payment of benefits is subject to the production of proof of:
• The happening of the event (applicable In case of death or accident).
• The age of the life assured.
• The title or right of the person claiming payment.
Proof of the title of the claimant claiming the policy monies is essential so that the benefits are paid to the
person legally entitled to receive payment and competent to give valid discharge. A person with the title to
claim payment is the policyholder himself if he is alive or, if he is not alive, the nominee under Section 39
of the Insurance Act, or The heirs, if there is no nomination. If the policy had been assigned, the title passes
on to the assignee.
The Proviso
The proviso makes the policy subject to the conditions and privileges printed on the back of the policy and
make the schedule and the endorsements a part of the policy. This clause is necessary because the signature
of the authorised official is on the first page and the conditions and privileges follow later.
The Schedule
The particulars usually embodied in the Schedule are:
• Policy number.
• Date of commencement of insurance.
• Table and term.
• Sum Assured.
• Due date, mode of payment and premium- yearly. half-yearly, quarterly, monthly.
• Instalment premium.
 • No. and date of proposal.
• Name of the nominee.
• Name, address of the proposer and life assured.
• Dale of maturity.
• Dale of last payment.
• Date of birth.
• Age whether age admitted.
• Conditions and privileges not applicable including special conditions.
The schedule gives all the particulars of the subject matter of the contract.
It identifies the proposal referred to in the preamble.
Attestation
Attestation appears at the end of the first page of the policy testifying to the fact that the insurer has entered
into the insurance contract. An authorised official of the insurer signs the policy; and gives the date.
Conditions and Privileges
The policy conditions and privileges can be classified as under:
Those, which are explanatory in nature, in the sense that they elaborate or clarify, the provisions made in the
Schedule of the policy.
• Those, which limit the scope of the assurance, or restrictive conditions.
• Those, which add to the benefits of the insurance and provide privileges.
• Those, which provide extended benefits or supplementary benefits.
Duplicate Policy
During the long duration of the policy term, people may shift residences and rearrange personal belongings.
It is possible that after some years the policy document is not found, might have been misplaced or lost.
Sometimes the document may also get damaged due to moisture or termites. The loss or damage does not
absolve the insurer of his liability to pay the policy moneys, when the claim arises. The claim, in such cases,
is paid to the claimant on furnishing an indemnity bond, with surety where necessary.
However, the policy holder may like to have a duplicate policy so that he can, if need be, use it for raising
loans from banks, finance companies etc. Depending upon the type of damage/loss of the policy document,
the insurer may issue a duplicate policy, subject to fulfilment of certain requirements like the advertisement
in the newspapers and/or an indemnity bond duly signed by the policy holder and a surety. These
requirements are intended mainly to satisfy it that there is no mischief, and to safeguard its liability. In case
the policy is lost by theft, the policyholder will have to file a first information report with the police
authorities and get the final investigation report of the police.
In case the policy document is partially burnt, mutilated or damaged, the remnants may be examined and if
the identity is clear, a duplicate policy can be issued, without advertisement and indemnity bond.
Endorsement
The standard policy form has got all the privileges and conditions printed on the back of the policy. In some
cases they require modifications as per the terms of the contract. It can be modified by the deletion /addition
by way of an endorsement attached in keeping with the terms of acceptance. Nominations made subsequent
issue to the policy are made at the back of the policy document. Some alterations are required to be made
during the currency of the policy, like change of mode, change in plan and term, sum assured etc. winch can
be effected by separate endorsement and are kept attached to the policy.
Renewal and Bonus Notice
An insurer is not legally obliged to issue the premium notices however they issue the notice as a courtesy to
the policyholder which gives the benefit to the policy holder serving as a reminder and to the insurer it helps
him preserving the business. In olden days they were required to pay the premium along with the premium
notices. Now in view of computerisation the premium can be paid by quoting the policy number Renewal
notices are not sent in the case of lapsed policies.
Life Insurance Products
Basic Elements
A life insurance product has, essentially, two basic elements:
• Risk cover - i.e. benefit payable in the event of death.
• Savings - i.e. the benefit payable in the event of survival.
Life insurance plans, which provide only risk cover during a specified period without any survival benefit,
are called TERM INSURANCE plans. Whole Life plans are effectively Term Insurance plans. Life
insurance plans, which provide for payment of policy monies only on survival of the specified period, are
called PURE ENDOWMENT plans.
All plans of life insurance are combinations of both term insurance element and pure endowment element in
different proportions. An endowment plan stipulates that a specified Sum Assured (SA) would be paid if the
life assured dies within the term selected or survives that term. The death benefit is paid by term assurance
and the survival benefit is paid by the pure endowment. An annuity plan is a pure endowment plan with the
condition that the SA is payable in instalments over a specified period of time.
Term Life Insurance
In the case of a Term life insurance contract, the sum assured is payable only in the event of death during
the term.
In case of survival, the contract comes to an end at the end of term. There is no refund of premium. These
policies are usually non-participating. Since only death risk is covered, the premium is low and the contract
is simple. Of late, however, some companies do offer participating policies under term insurance plans or
return of premiums at the end of maturity.
They help to provide collateral security for loans.
Some insurers offer term insurance policies for longer terms of 3, 5 or 6 years with fixed (level) premium
payable each year. Such contracts can be renewed for further equal periods till the life assured reaches the
age of 65 years.
Type of Term Insurance Policies
Mortgage Redemption Policies: Term insurance policies can also be for decreasing sum assured. The SA in
a decreasing term insurance plan would go on reducing to match the outstanding principal, if taken in
connection with a loan arrangement. These are called Mortgage Redemption Policies.
Increasing term insurance plans: These plans are not issued as separate contracts. Often they are provided as
riders (additional conditions) to endowment or whole life policies. Under Money Back Plan although parts
of sum assured are paid on survival of 5, 10, 15 or 20 years, the full sum assured continues to be payable on
death. In other words, there is an effective increase in SA cover on death, which is provided by increasing
term insurance cover to the extent of the survival benefits paid.
Benefits of Term Insurance Plans
There is always a need for risk cover as protection against loss due to death.
Many insurance needs are of temporary or terminating nature (Example: Mortgages) which can be protected
with temporary or terminating insurance.
Few men can be adequately insured for even the minimum level of their real life values without the
advantage of low premium Term insurance.
Persons having low income can provide for meeting family obligations at low cost.
Persons on the thresholds of new careers or business can avail of term insurance policies to save on costs, so
that they can utilise their balance income or capital for developing their career or business.
Persons, who have invested substantially in new ventures by borrowing at heavy interest rates or mortgaging
their property, can cover the risk of serious loss to the investment through term insurance at low premium.
Term insurance is also useful as supplement to endowment or whole life policies with a view to get higher
risk cover.
In modern business, indemnifying the loss to business, due to the death of the key person responsible for the
running of the business, can be done through term insurance plan.
Insurers are careful while considering proposals for large amounts of term insurance. Some people who are
not in good health may tend to take term insurance plans for large Sum Assured. That would be unfair
advantage, contravening the principle of utmost good faith. As a result, there would be adverse selection
against the interests of the insurance company and the community of policyholders.
Convertible Term Assurance Policy
A convertible term assurance policy, as currently offered by L.I.C., is a term assurance policy of specified
term 5, 6 or 7 years, which includes a provision for convertibility.
The insured can convert the policy at the end of the term into an endowment type of contract, without
having to undergo a medical examination to satisfy the insurer on the acceptability of the life for insurance
afresh.
On conversion, the premium will change suitably. Such an option can be exercised any time during the term
of the policy except in the last two years, thereby obviating adverse selection against the insurer during the
last two years.
If conversion of the policy to whole life policy or endowment assurance policy is not exercised, then it
continues as a term assurance plan.
Convertible term assurance plan would be most useful for those who are initially unable to pay the high
rates of premium required for whole life or endowment insurance plan but hope to be able to do so in the
future.
Whole Life Insurance
Under whole life plans, life insurance protection is available throughout the lifetime of the life assured.
It is effectively a long term insurance plan with a level premium. The sum assured is payable only on the
death of the insured.
Premiums are, payable till death
In the early years of life insurance, a whole life policy was deemed to have matured once the life assured
reached the age of 100. The sum assured was paid to him at the age of 100. Mortality tables were available
only upto age 100. Nowadays, insurance companies waive payment of further premiums under whole life
plan, if the premiums are paid for say, 35 or 40 years or the life assured has attained the age of 75 or 80
years.
Limited Payment whole Life Plan
Under the limited payment whole life plan the premium paying term is fixed, although the sum assured is
payable only on death.
Similar to convertible term insurance plans discussed earlier a whole life policy can have a provision for
conversion into an endowment assurance plan at the end of a fixed period, usually 5 years.
If the conversion is not exercised as specified, the policy continues as a whole life policy.
The decision for conversion can be made at the very inception of the whole life plan in which case the
conversion is automatically effected at the end of the specified period. A decision once made cannot be
changed.
Endowment Insurance
Endowment insurance plans provide for the payment of the S.A. in case of death during the term, or on
survival of the term.
This plan is a combination of term level premium plan and pure endowment plan. Since the sum assured is
payable on death or on survival, the premium charged under endowment plans are higher than term
insurance plans.
There are many variations in endowment insurance linked with the SA payable or premium paying term.
For example- the SA payable on survival can be fixed as twice the amount payable on death. The LIC’s
double endowment plan is of this kind.
On the contrary, the SA on death can be fixed as twice the amount payable on survival. The LIC’s Jeevan
Mitra and Bima Kiran policies have such provisions. The term insurance component is more than the pure
endowment component.
Generally, premiums are payable during the entire term of an endowment policy. But under limited payment
endowment plans, premium paying period is fixed as less than the term of the policy. The payment of
premiums stops at the end of this period but the S.A is payable on survival of the term or on earlier death.
Joint Life Endowment Plan
Under this plan, two lives can be insured under one contract. The sum assured is payable at the end of the
endowment term on survival of both the lives insured, or on the earlier death of either of the two. Married
couples can take such a policy covering the risk on both the lives, when both are having incomes of their
own. Partners in business can also do the same.
Money Back Endowment Plan
Some persons may need a lump sum amount even before the expiry of the term of the policy. If they take
loans under the policies, the risk cover (amount payable on death) comes down and interest payable on the
loan accumulates as a debt on the policy. To meet this need, insurers have devised endowment plans
wherein part of the S.A is made payable periodically during the term of the policy. Notwithstanding the
payments at periodic intervals, the S.A at risk (payable at death), continues to be the same till the end of the
term.
In some professions like film artistes and sportsmen, earnings would be high but only for a short duration.
They can afford to pay greater amounts as premium, for short periods. To meet the needs of such persons,
the special endowment plan is devised where the premiums charged are very high for a few initial years,
followed by lower premiums subsequently.
Benefits and Limitations of Endowment Plans
Endowment plans were the most popular, consisting of more than 70% to 80% of the total business done.
They are known and easily understood by people. There are no complications.
The SA is payable on death or on survival.
One of the reasons for the popularity of the endowment assurance plans was its advantage as savings plan.
In almost all savings plans or investment schemes, like bank deposits or shares, the total savings is equal to
the amount already set aside plus interest and appreciation. In an endowment plan, however, the total SA
(target amount to be accumulated or saved) is assured from the beginning, to be paid for in installments over
the remaining lifetime.
Marriage Endowment Plan
The Marriage endowment Plan has the specific condition that the sum assured is payable only after the
expiry of the term even if death of the life assured takes place earlier. The term is fixed corresponding to the
likely period when the daughter may get married. Premium ceases on the death of the life assured. The
object of earmarking the insured sum for the marriage of the child is taken care of.
Education Annuity Plan
In the Educational Annuity Plan the sum assured is paid in instalments spread over a specified period, say 5
years after the expiry of the term of the policy. This is normally paid in 10 half-yearly instalments. The
concept is that this policy should meet the expenses of higher education.
Children's Deferred Assurance Plan
These are insurance plans where the father or mother proposes for insurance on the life of the minor child
and pays premiums.
However, the risk on the life of the child will begin only after the child reaches a specified age.
The period during which there is no risk cover is called the Deferment period.
The day on which the risk commences is called the Deferred Date.
The risk may continue after the deferred date for a predetermined term, either as a Whole Life or an
Endowment Policy.
The original policy covers the entire term including the deferment period.
The risk will commence without medical examination on the deferred date, unless the deferment period is
less than l0 years.
The main advantage of this plan is that a policy for a relatively large amount can be taken for a relatively
low premium. This premium will continue even after the deferred date, irrespective of the state of health of
the children. The proposer has the option to say that the policy will not continue after the deferred date. In
that case, the policy terminates on that date and cash payment is made to the proposer.
With a view to making the life assured, viz. the child, the absolute owner of the policy after the deferred
date, a special provision is made by which the policy automatically vests in the life assured on the deferred
date. Thereafter, the life assured becomes the absolute owner of the policy. The policy is deemed to be a
contract between the insurance company and the life assured. That is why the vesting age has to be at least
18 years. Otherwise, the assured would remain a minor and there cannot be a valid contract with the
assured.
Under Children’s Assurance Plans, there are special provisions to cover contingencies before the deferred
date. Premiums may be waived if proposer dies before vesting date. The proposer, different from the life
assured, can terminate the policy, in which case the premium will be refunded, subject to conditions. If the
life assured dies before the deferred date, the benefits (return of premiums) follow different specifications.
Participation in surplus normally will commence after the deferred date but can be effective retrospectively
from an earlier date. There are variations in these matters between different policies.

Lecture 15
Riders Options and Guarantees
Riders
Riders are certain provisions and clauses, which defines the fate of the policy in case of certain defined
circumstances in the policy. It sometimes put some restrictions/obligations on the insured as well as insurer.
However, these riders help to increase the clarity of the policy to a great extent. Some of the policy riders as
invariably used in the policies issued by LIC of India are explained for the understanding of the concept;
however, different insurers can use their own discretion while putting various riders in the policy.
Proof of Age
It is the responsibility of the insured to submit a proof of age as acceptable by the insurer. Subsequently, if it
is found that the age is lower then the excess premium charged shall be refunded to the assured. Similarly if
the age is found more than what has been declared then the assured shall pay the difference with interest or
else the amount can be recovered from the claim amount. (It is not out of place to mention that premium
under the policy is influenced by the age factor).
Grace period for renewal premium
Grace period for renewal premium policy provides the means for depositing the renewal premium within the
period of grace after the due date.
Benefits of grace period
Policy will not lapse if the renewal premium is paid within the grace period.
Premium will be charged without interest or any other penalty.
No proof of good health needs to be submitted, during the grace period.
In case of death of the assured within the grace period (renewal premium unpaid) the claim will be paid in
full though, deductions will be made for unpaid premium.
Limits of Grace Period
Mode of payment under Grace period
the policy (in days)
Yearly 30
Half yearly 30
Quarterly 30
Monthly 15
Non Forfeiture Regulations in Case of Non Payment of Premiums
In case of non-payment of premium by the assured under the policy, all benefits under the policy are not
lost.
In case assured has paid premium for 3 full years’, policy has a provision of payment of paid up value for a
reduced amount.
Claim Concession Benefits
In case assured has paid premium for a minimum period of three years (and subsequent premium is not
paid), in case of death of assured within a period of 6 months from the due date of renewal premium in such
case claim is payable in full after deduction of outstanding premium under the policy. This is called claim
concession benefit. In case of premium payments for 5 years or more the claim concession limit can be
extended for one year, and the death claim payment (if any) is paid after deducting the unpaid premiums.
Suicide
In case assured commits suicide (whether sane or insane at the time), the insurance company will not admit
a claim under the policy except for the extent of third party’s bonafide beneficial interest acquired in the
policy for some financial consideration provided a prior notice has been served to the company at least one
month prior to the death. Suicide clause is not applicable one year after the commencement or revival of
policy.
Revival
Policy lapses due to non-payment of premium. Lapsing of a policy benefits neither the insurer nor the
insured. The life assured loses the life insurance risk cover for the full amount. It is also a reflection on the
agent’s efforts suggesting that he has not been adequately convincing.
The insurer also loses. The level premium is fixed on the assumption that barring death claims, the policies
will run for the full term of the policy. The initial expenses incurred for procuring and processing of
proposals are quite high and the insurer will recover these expenses fully, only if the policies are kept in
force throughout. Normally people enjoying bad health are more likely to value insurance and continue the
policies, while others with normal health may discontinue the policies. In that case, there is a selection
against the insurer, which means that the insurer liability becomes greater than what was assumed, while
fixing the cost of insurance.
Because lapsing affects adversely both parties, and because lapsing is not always intended by the insured to
happen (lapsing may occur due to sheer neglect to pay or because of temporary financial difficulties),
insurers facilitate revival of the lapsed policies subject to certain conditions.
The policy condition under the caption, Revival of Discontinued Policies provides that a lapsed policy can
be revived during the lifetime of the life assured, within 5 years from the date of the first unpaid premium
and before the date of maturity, on submission of proof of continued insurability and payment of all the
arrears of premium with interest. The insurance Company reserves the right to accept or decline revival.
The Life Corporation of India provides four methods of revival as under.
• Ordinary revival.
• Special revival.
• Installment revival.
• Loan cum revival scheme.
Permanent Disability Benefit
Under this policy condition the future premiums under the policy is waived in the event of assured becomes
totally and permanently disabled subject to following conditions:
The maximum limit of assurance under all policies issued on the same life (to which this benefit will be
applicable) shall not exceed Rs. 20,000/-. In case there are more than one policy and if the total assurance
exceeds Rs. 20,000/- the waiver shall apply to the first Rs.20,000/- in the order of date of the policies issued.
The disability must be as the result of Accident.
It should be total and permanent.
It should occur before assured attains the age of 70 years.
Policy Options
LIC of India provides certain options to the assured depending upon the type of plan opted by him. The
options can sometimes be used at the inception of the policies or during the currency of the policies or in
few cases even at the time of maturity of the policy.
Premium Payment Mode
Every policyholder is given the option to choose the premium payment mode. The frequency of payment of
renewal premium can be yearly, half-yearly quarterly or, monthly. He is also given the option to change the
mode of payment
The Convertible Term Assurance Plan Option
The Convertible Term Assurance Plan gives the life assured, the option to convert the policy at the end of
the specified term either into a limited payment life-policy or endowment assurance policy without under
going medical examination.
Convertible Whole Life Plan Option
The Convertible Whole Life Plan provides the option to life assured to convert, at the end of 5 years from
issue, a without profit whole life policy into an endowment policy, either with or without profits. This
option is available without undergoing medical examination.
Children's Deferred Assurance Plans
These are insurance plans where the father or mother proposes for insurance on the life of the minor child
and pays premiums. However, the risk on the life of the child will begin only after the child reaches a
specified age.
Under Children’s Deferred Assurance plans, the proposer can exercise the option on deferred date either to
continue the policy for a predetermined term, either as a whole life or an endowment policy or to have cash
option available.
Guaranteed Triple Benefit Plan
Under Guaranteed Triple Benefit plan the life assured can avail of one of the three options available to him
to receive the maturity proceeds. For example, on maturity of the policy he can have the option to receive
full sum assured plus the bonus at guaranteed rate or the other option which can be exercised is to keep the
policy proceeds to be payable on death of life assured only.
Settlement Options
Under various plans of life insurance by LIC, there is a provision for payment of the claim proceeds by
yearly, half-yearly, quarterly or monthly instalments spread over a specified period of years. The life
assured can exercise this option either at the commencement or at any time during the currency of the
policy. For example in Jeevan Shree plan has in-built option for the payment of maturity benefit in
instalments not exceeding 5 in number. These types of options are known as ‘Settlement Options’.
Extended Disability Benefit
The life assured can exercise the option to avail the benefit of premium waiver up to a sum assured of Rs. 10
lakhs on payment of extra premium. The benefit granted is called “Extended Disability Benefit’ and it
includes ‘Double Accident Benefit’ also. The ‘Extended Disability Benefit’ is the income benefit to the life
assured if he becomes wholly and permanently disabled as a result of an accident. The benefit allows
payment of monthly instalments spread over 10 years equal to sum assured under the policy as additional
benefit (in addition to sum assured payable in the policy). The Double Accident Benefit provides double the
sum assured in case of premature death of life assured by way of accident only.

Lecture 16
Policy Guarantees
Guaranteed Additions
Under certain without profit plans of LIC of India, the sum assured gets enhanced at the specified
guaranteed rate at the end of each year provided the policy is in full force, The “Guaranteed Additions’ will
be payable with the sum assured at the time of payment under the policy.
Guaranteed Surrender Value
The policy can be surrendered for cash after the premiums have been paid for at least three years. The
minimum surrender value allowable under this policy is equal to 30per cent of the total amount of the
premium paid excluding the premiums for the first year but includes the bonus additions existing at that
time.
Assignment and Nomination
Assignment
An assignee in a policy would have right to sue in his own name on the life policy provided a notice of
assignment has been served on the insurer and an acknowledgement of such notice has been received.
Absolute Assignment
Life policies may be assigned to anyone, whether or not they have an insurable interest in the life assured.
The assignee acquires all the rights and liabilities of the original assured. For the life insured to regain his
right the policy has to be reassigned to him.
Conditional Assignemnt
An assignment of a life policy could be conditional to the happening of a certain even., For example, a life
policy could be assigned to the spouse in the event of the death of the policy owner. The policyholder
remains the absolute owner of the property so as he is alive.
Nomination
It is advisable for the policyholder to appoint a nominee to receive the policy proceeds becoming payable in
the event of his or her dying during the term of the policy. The nominee unlike in an assignment, does not
derive a right to sue the insurer, except after the policy proceeds have become payable to the nominee.
Further, the policyholder may change the nominee without consulting the previous nominee or the insurance
company. The nominee has right to receive the claim amount from the insurer in the sense that he can give a
discharge to the insurer.
However, the nominee is liable to the legal heirs of the deceased policyholder. Once the payment is made to
the nominee, the insurer has no obligation to the legal heirs. In the absence of a nomination, the dependants
of the deceased policyholder will have to submit probate and other relevant succession papers, as proof of
right to a claim of insurance.
When we buy an insurance policy, what we are buying a financial security for our loved ones. An essential
assumption that goes in giving this sense of security to the person buying assurance is the fact that he/she
presumes that in case of his/her death, the assured sum would be promptly paid to the nominated person.
Though nomination is the most common route of achieving this goal, there is another route to achieve this
objective. And that is Assignment. When the policy bears nomination, the claim is settled in favour of the
nominee. It is, therefore, important for everyone buying an assurance to understand what assignment is and
how it works.
What is Assignment?
Very simply put, assignment means a legal transference, just as it happens with properties. In fact, the
concept has been borrowed from the property law. Assignment provides a route by which the holder of a
policy can pass on his/her interest in the policy to another person. The person who is transferring the policy
is termed as ‘Assignor’ whereas the person to whom the policy is transferred to is called the ‘Assignee’.
It is important to understand the basic difference between nomination and assignment. While nomination
does not create any interest in favour of the nominee as long as the the policy-holder is alive, the case is not
the same in case of assignment. In nomination, the policyholder is free to deal with the policy the way he
thinks fit. Thus the nomination can be changed by the policyholder as many times as he wants to and to
whoever he desires. Unlike this, an assignment once made cannot be altered, as it has the immediate effect
of transferring the rights to the Assignee. The person, Assignor, foregoes all his rights in the policy once he
assigns the policy to someone else.
Mr. Chatterjee assigned his policy to his minor son Mrinal and appointed the mother as the guardian to
receive the moneys till his son was minor. After sometime the family needed the money and decided to
surrender the policy. This was not permitted. They had to wait till the child became a major.
In the above case, the only manner in which Mr.Chatterjee can take back the ownership over the policy is to
have the policy reassigned to himself. It is important to remember that even the person who made the
assignment cannot cancel an assignment once made on the policy document. Thus, one will find that
whenever one takes a housing loan from a housing finance company, the company will ask the borrower to
assign the policy for mortgage risk cover to the finance company.
How to make an assignment
Making an assignment is not too difficult. There are two ways of doing this. The first is by simply endorsing
the policy document. The other way of doing this is by getting a separate assignment deed prepared. While
the former case is a preferred mode of assignment as it is exempt from stamp duty, the latter case attracts the
stamp duty. LIC of India does not charge any fee for registration of an assignment on its policies.
The modus operandi is simple. All that a policyholder is required to do is to serve a written notice of
assignment of the policy to LIC. This can be done by sending the policy document duly endorsed or the
deed of assignment for registration to LIC. LIC, on its part, records the fact of registration of assignment
and acknowledges the receipt of the notice.
Types of assignments
The assignment of life insurance policies in India is regulated under section 38 of the Insurance Act, 1938.
The Act provides for two kinds of assignments - conditional and absolute.
The conditional assignment is useful where the policyholder desires the benefit of the policy to go to a near
relative in the event of his early death. This assignment is effected for natural love and affection. In this case
when the assignee dies, the benefit reverts back to the life-assured automatically.
The absolute assignment is generally made for valuable consideration e.g, raising of loan from an
individual/institution. This assignment has the effect of passing the title in the policy absolutely to the
assignee. The policyholder in no way retains any interest in the policy. The absolute assignee can deal with
the policy in any manner he likes and may even transfer his interest to another person or surrender the
policy. Under absolute assignment when the assignee dies, the benefits go to the legal heirs of the assignee
and not the heirs of the life-assured.
Assigning a policy to a Minor
While there is no doubt that one should avoid assigning a policy to a minor, in certain situations this may be
necessary. Under such cases, it is recommended that a guardian be appointed. It must be remembered that
the consent of the guardian is necessary for his appointment. And interestingly, only the father of the minor
can appoint the guardian under the law.
When a policy is taken on the life of the child, the life-assured can assign it only after the policy vests in
him on his becoming major. Until then, all rights rest with the proposer. Similarly, when a person buys a
policy on the life of another person, the life assured cannot deal with the policy. It is only after the proposer
assigns the policy to him that he becomes its owner. In case of key-man policies, they can be assigned only
to LIC or the life assured and to no one else.
Important check-list
When assigning a policy to a minor, the appointment of a guardian is desirable.
A fresh nomination should be made whenever the policy gets reassigned to the life assured.
All assignments/reassignments should be registered with the LIC.
Proper endorsement forms should be used for different types of policies.
Invalid assignments
It is important to take some simple precautions when going in for an assignment to avoid its being invalid.
In order for an assignment to be free from any doubt it should should satisfy certain conditions. Some of
these are:
The reason for assignment must be stated clearly.
It should not violate foreign exchange laws, or any other regulations.
The assignment in favour of several persons and specifying shares of each assignee is not allowed.
A part assignment of the claim amount cannot be made.
The policyholder cannot change the assignment by willing it to someone else.
Assigned policies free from attachment
Section 60, Clause (kb), of the Code of Civil Procedure lays down that all money payable under a policy of
insurance on the life of the judgment debtor will be free from attachment. This places an assigned policy
outside the reach of the creditors.
In one case, an income tax officer attached the LIC policy in order to recover dues and hence directed the
LIC not to pay the policy money to his wife to whom the policy was assigned. LIC, on this directive,
withheld the payment. Subsequently, the Court ordered the LIC to pay 15% interest on the policy money
after maturity. (LIC vs Guranade - AIR- 1990 SC 185)
A policy cannot be mortgaged by just placing it with another person. The transaction has no legal value. A
mere deposit of a policy without an assignment does not create any charge on the policy. It can, however, be
gifted through proper endorsement, provided the policy moneys are payable in India.
Assignment of a policy automatically cancels the existing nomination. Hence, when such a policy is
reassigned in favour of the policyholder, it is necessary to make a fresh nomination to avoid delay in
payment of claim. This care is particularly necessary in cases where the loan is raised from a bank or a
housing company, or the policy is financed through provident fund in case of defence personnel.

Lecture 17
DEPOSIT AND CREDIT INSURANCE
Credit Risk
Traditionally the primary risk of financial institutions has been credit risk arising through lending. As
financial institutions entered new markets and traded new products, other risks such as market risk began to
compete for management’s attention. In the last few decades financial institutions have developed tools and
methodologies to manage market risk.
Recently the importance of managing credit risk has grabbed management’s attention as reported in some
spectacular news headlines. Once again, the biggest challenge facing financial institutions is credit risk.
New markets, products, and regulation
In the last decade, companies have expanded rapidly both nationally and globally. By expanding, these
firms have taken on new market risks and credit risks by dealing with new clients and new governments.
Even businesses that do not enter into new markets are finding that the concentration of credit risk within
their existing market is a hindrance to growth.
As a result, individuals have created risk management mechanisms in order to facilitate business. In the
financial sector, these mechanisms are interest rate and currency derivatives. In the non-financial sector, the
mechanisms are embedded in complicated sales contracts. A side effect of these products is the creation of
credit risk.
This new risk is not lost on regulators. New regulation is being created to safeguard against systemic crises.
In some cases the regulation is necessary and optimal; in others, it is not.
The challenge for both financial and non-financial institutions is to turn credit risk into an opportunity.
Individual v. Portfolio and Passive v. Active Credit Risk Management
While management’s attention has returned to credit risk, the nature of credit risk has changed. As
companies compete more aggressively for new business and market share both regionally and globally, they
naturally will take on more credit risk.
Credit risk must be managed at both the individual and the portfolio levels. Managing individual credit risks
requires specific knowledge of the counter party’s business and financial condition. While there are already
numerous methods and tools for evaluating individual, direct credit transactions, comparable innovations for
managing portfolio credit risk are only just becoming available.
Likewise much of traditional credit risk management is passive. Such activity has included transaction
limits determined by the customer’s credit rating, the transaction’s tenor, and the overall exposure level.
Now there are more active management techniques. These include regular credit reviews, collateral
agreements, downgrade triggers, termination clauses, and credit derivatives.
Credit derivatives - New Tools
Traditionally financial institutions take on credit risk by investing in loans or bonds, and commercial
institutions take on credit risk by delivering products in exchange for future payment.
Credit derivatives are specialized contracts that allow a participant to increase or decrease credit exposure to
a particular name, for a particular period of time.
Popular examples of credit derivatives include credit default swaps, total return swaps, and credit linked
notes. Other examples are basket credit default swaps and spread options which all contain some kind of
optionality. The credit derivatives technology has also been used to create innovative securities such as
collateralized bond obligations (CBO’s) and collateralized loan obligations (CLO’s) or, more generally,
collateralized debt obligations (CDO’s).
The Need for Credit Insurance
Credit insurance assists companies in meeting different needs. Credit insurance can be used to enhance bank
financing by providing improved margining ratios on accounts receivable, thereby increasing the amount of
borrowing capacity available to the policyholder. It may also be used to provide immediate cash flow relief
in the case of a bad debt loss. It allows claims to be paid quickly, long before recoveries from the bankrupt
estate become available for distribution.
Many businesses use credit insurance to stimulate sales expansion programs while minimizing credit risk, or
to provide peace of mind to the owners, officers and directors over the strength of the accounts receivable.
Another alternative for use is to improve the underlying security on an accounts receivable securitization
transaction.
Credit managers find the product appealing because it provides access to a professional credit management
team when a second credit opinion is prudent.
Like any form of insurance, Credit Insurance is usually purchased by a company to protect itself against
specific losses that could impair the performance of the company. In the case of credit insurance, protection
is offered to the supplier against the risk of the debtor going into liquidation (Insolvency); delayed or non-
payment (Protracted Default) and in respect of export risks, the unilateral cancellation of contract
(Repudiation) as well as a myriad of Political related risks.

Lecture 18
Emergency Risk Management
Emergency Risk Management is a systematic process that produces a range of measures, which contribute
to the well being of communities and the environment.
Disaster plans are in place in all emergency management areas throughout developed countries and were
prepared using the hazard analysis process. The hazard analysis process concentrated on the causes,
characteristics and affects of the hazard rather than the level of risk to a community. The process sometimes
overlooked three very important issues.
1. Process Documentation,
2. Planning,
3. Stakeholder Consultation.
The ERM process provides a logical and systematic approach that will integrate combat and other agency
specific public safety programs (prevention, preparedness, response and recovery) at local district and state
levels.
The aim of the Emergency Risk Management process is:
To identify, analyse and evaluate risks with potential to require a significant and coordinated multi agency
response.
Managing the ERM project
Responsibility for managing ERM projects, including final decision making, rests with Emergency
Management Committees at all levels because they have:
• Current and appropriate authority;
• Appropriate agency and key stakeholder representation;
• An established reporting system;
• Acknowledged and accepted expertise.
DOCUMENTATION
Each stage of the ERM process must be documented. Documentation should include assumptions, methods,
data sources and results.
The purpose of documenting the ERM process is to:
• Demonstrate the process is conducted properly;
• Provide evidence of a systematic approach to risk identification and analysis;
• Provide a record of risks and to develop the organisation’s knowledge database;
• Provide the relevant decision makers with a risk management plan for approval and subsequent
implementation;
• Provide an accountability mechanism and tool;
• Facilitate continuing monitoring and review;
• Provide an audit trail; and
• Share and communicate information.
OVERSEAS INVESTMENTS INSURANCE
Hostile action due to change in Government in Host Country
Confiscation of fixed assets
Many companies have investments in the form of subsidiaries, or via a joint venture located overseas. The
parent company may be seeking to manufacture their products within local markets or to serve their
customers in adjoining territories.
To attract inward foreign direct investment it is likely that the host government would have granted
concessions or signed specific agreements with the investing company. In many instances, such contractual
agreements or licences are a fundamental part of the overseas operations, without which the investment
would probably not be viable in the eyes of the parent.
Where a change of government occurs at a later date; or a subsequent change is made to investment
regulations, the locally held assets are exposed to selective or discriminatory action by the government,
which might restrict its operations.
Long-term agreements, which relate to say power purchase, production sharing or drilling rights etc. need to
contain provision for remedy via external arbitration to protect against future disputes.
The equity and/or shareholder loans invested by these multinational clients are equally at risk of
confiscation as in a specific project finance transaction. We have a substantial client base that utilises our
expertise in designing specific programmes to protect their assets. International banks can protect the assets
held by their overseas branches and cover is also available for inter-bank loans.
Confiscation of mobile assets
Contractors who take valuable and often specialist mobile plant and equipment overseas to undertake
construction projects, usually intend to re-export their property on completion.
Prior to re-exporting the plant and equipment the contractor is required to obtain permits and licences from
the host government. In addition to the potential risk that permits are refused, the contractor remains
exposed to a potential loss caused by both confiscation and deprivation (i.e. their inability to re-export).
If a contractor has his equipment ‘blocked’ in an overseas country, or where he is forced to abandon the
project due to war, comprehensive insurance for contractor’s plant and equipment is specifically designed to
respond in such circumstances.
Consignment stock
Many companies hold stocks of their products or raw materials in warehouses located overseas. This
enables faster deliveries to their end customers and often permits local distributors to have direct access to
stock on ‘consignment’ basis.
Ownership of the goods rests with the manufacturer until payment has been received, often prior to local
delivery. The exporter therefore remains exposed to the potential loss resulting from confiscation (or
deprivation) in addition to any physical damage due to civil unrest or war, whilst the goods are in the
warehouse.
Contract frustration
Contracts can be frustrated or cancelled due to political actions over which companies have no control and
they are therefore exposed to potential large catastrophic losses.
Imports
Importers can be faced with a loss if goods are not delivered against an advance payment. A significant
proportion of commodities purchased from lesser-developed countries are paid for in advance of their
delivery.
Exports - pre-shipment
An exporter is exposed to a potential loss during the pre-shipment stage of a contract. This is especially
important where an exporter is manufacturing goods to the buyer’s specific requirement.
Exports - post shipment
A company which has exported goods to a lesser developed country and who has not fully secured the debt
by, for example, obtaining a confirmed letter of credit, is exposed to the potential loss arising from non-
payment due to political action or inaction.
Unfair calling of on-demand bonds
Contractors who issue bank bonds (i.e. performance, tender, retention or advance payment bonds) are
exposed to a loss where a bond call could have resulted from host government action over which they have
no control, for example, embargo or licence cancellation. Individual bonds or an entire portfolio could be
exposed in this way.
Trade disruption
Border closures, blockades and sanctions might not cause a loss of the local investment, however they can
significantly interrupt its business activities.
If it becomes impossible to import or export components or materials to or from that overseas territory,
alternative-manufacturing plans may be required. Therefore a loss of profit and an increase in operating
costs are two of the possible consequences, for which we can tailor specific insurance programmes.
Exchange transfer risks
In order that the annual dividends derived from overseas operations, can be repatriated back to the parent, it
is often a requirement that an application for foreign exchange be made via the central bank in the host
country.
The central bank generally determines the allocation of foreign exchange in accordance with its own
economic priorities. It is therefore important to ensure adequate coverage is arranged to protect dividend
earnings and profits against the imposition of transfer or remittance restrictions.
Loan repayments may also be protected against the inability to remit on due dates, for example due to the
rescheduling of that country’s debts.
Project finance
The vast majority of infrastructure projects overseas require bank finance, either on a limited or non-
recourse basis.
The private insurance market now provides coverage for 10-year periods (in some cases 15 years) that
specifically protects banks making loans to overseas projects. The project sponsors will almost certainly be
seeking finance from the lenders where the assets of the project are assigned as collateral and the cash flows
derived used to repay financing.
Specific coverage is now available to protect banks and financial institutions against loss sustained resulting
from Confiscation or Exchange Transfer preventing loan repayments. In addition, physical damage losses
arising from civil unrest or political violence due to war can similarly be protected, as well as consequential
losses, such as the unravelling of hedging positions.
The major insurers are rapidly agreeing on the scope of coverage afforded to banks for specific project
financing, enabling co-insurance with both government and multilateral agencies to the further benefit of the
policy holder. As a result, projects in emerging markets can attract lower lending rates where the ‘Country
Risk’ has been transferred to a highly rated insurer. In certain instances vital projects in some countries can
only advance to ‘financial close’ when insurance support has been provided

Lecture 19
MARINE INSURANCE
Introduction
‘Marine’ insurance is essentially transit or movement of goods by ocean going vessels insurance, so-called
due to historical reasons. The roots go back to ‘bottomery bonds’ of 3rd century BC. The ‘bottomery bonds’
operated as a loan to the ship owner, the repayment of which was made contingent on the safe completion of
the voyage. This gradually transformed to premium payment and liability bearing by the Insurers. With
increasing levels of commercial activity this also got extended to on land journeys. Today it encompasses
the whole range of movement of goods and hulls. It covers various risks associated with inland transit of
goods by various means such as, rail, road, post, air, inland waterways, coastal shipment, and courier.
Transit Insurance in India
The control and regulation of transit insurance in India has been changing in line with the international
trends. The pre-1982 Regional tariffs covering specific regions were replaced with an All India Marine
Cargo Tariff in 1982. It covered the whole gamut of Inland transit insurance as well as sections covering
FOB (free on board) shipments, Tariff for import and export of specified major commodities, Custom duty
and Profits insurance, etc. However the most important part was the introduction of Inland transit clauses for
All Risk and Basic road/rail risk in line with the revised Institute Cargo Clauses (ICC) which replaced the
earlier All Risk, WA (with average) and FPA (free from particular average) clauses. In fact at the behest of
UNCTAD (UN Conference on Trade and Development) in 1979 large section of countries have adopted the
revised simplified form of Marine S.G. policy with several important changes from earlier practice.
The next phase of the change was a test of the maturity of the Indian market. In April 1994 it was decided to
de-tariff the Marine insurance portfolio. However the play of market forces ensued a bitter battle for market
share, which drove the Marine Insurance rates to very low levels. Alarmed with these developments a
‘Guide rate’ was brought back. However, devoid of the legal backing of the Insurance Act 1938 these
instructions are being followed more in the breach. As a result the transit insurance portfolio has almost
stopped growing.
Before proceeding further the following definitions will help understand the various terminologies.
ABANDONMENT
The cession by the insured to the insurer of the remains of his property, and rights relating to it, when a
constructive total loss is claimed.
Actual total loss
There is an actual total loss (a) where the subject-matter of insurance is completely destroyed; (b) where it
ceases to be a thing of the kind insured; or (c) where the insured is irretrievably deprived of it.
Assignment
1. Transfer of a right.
2. The document making the transfer of a right. The right transferred may be an interest in the subject
matter of insurance, in the contract of insurance, or in policy moneys due to the insured.
Average
1. The arithmetic mean.
2. In marine insurance, loss or damage.
3. In non-marine property insurance, where average is said to apply and there has been under-
insurance, the insured’s claim is reducible in proportion to the under-insurance.
Basis of Valuation
To protect the insurer under an open cover where shipments may be declared and added to the insurance
even after a loss a clause in the policy defines the basis to be adopted for their valuation.
Bill of Loding
A shipping document containing a description of the goods to be shipped.
Cost and Freight
Cost and freight.
Certificate of Insurance
A certificate of Insurance is issued to satisfy the requirements of the Insured or the banks in respect of each
declaration made under an open cover or open policy. The Certificate, which is substituted for specific
policy, is a simple document containing particulars of the shipment or sending. The number of open contract
under which it is issued, is mentioned, and occasionally, terms and conditions of the original cover are also
mentioned. Certificates need not be stamped when the original policy has been duly stamped.
Classification Clause
A clause in a marine cargo policy specifying the minimum standard of the vessels to be used in the carriage
if additional premium is to be avoided. Vessels must be fully classed by a recognised classification society
but additional premium may be required if a vessel is over a specified age.
Classification Society
A society formed to inspect ships and to describe and grade them for the information of insurers, e.g.,
Lloyd’s Register of Shipping. An approved ship is said to be fully classed.
Constructive Total Loss
Subject to any express provision in the policy, there is a constructive total loss where the subject-matter
insured is reasonably abandoned on account of its actual total loss appearing to be unavoidable, or because it
could not be preserved from actual total loss without an expenditure, which would exceed its value, when
the expenditure had been incurred.
In particular, there is a constructive total loss:
Where the assured is deprived of the possession of his ship or goods by a peril insured against, and (a) it is
unlikely that he can recover the ship or goods, as the case may be, or (b) the cost of recovering the ship or
goods, as the case may be, would exceed their value when recovered; or in the case of damage to goods,
where the cost of repairing the damage and forwarding the goods to their destination would exceed their
value on arrival.
Contribution
The principle whereby if two or more insurers indemnify the insured in respect of the same subject-matter
against the same peril on behalf of the same interest, they share the loss or liability proportionately.
Contributory Value
The value of a ship, its cargo and freight, on which general average contributions are based.
Cost, Insurance and Freight
A term of sale of goods in transit whereby the price paid by the buyer includes the insurance premium and
the shipping charges.
Country Damage
Damage to bale or bagged goods prior to loading on a vessel, caused by the absorption of excessive
moisture or deterioration from grit, dust or sand due to inclement weather.
Duty of Disclosure
A common law duty on the part of a proposer for insurance to disclose to the insurer all material facts, viz.,
all facts that would influence a prudent insurer in deciding whether to grant the insurance and, if so, on what
terms.
Endorsements
Whenever it becomes necessary to incorporate a change in the original policy, endorsements are issued.
Such endorsements may be in respect of changes relating to sum Insured or interest or premium or
conditions. The endorsement should be attached to the original document. Otherwise, the holder thereof
may not be aware of the changes effected.
Excess/Deductible
That part of any loss which the assured must bear himself.
F.O.B.
Free on board.
Franchise
A minimum percentage or amount of loss, which must be attained before insurers are liable to meet a claim.
Once it is attained the insurers must pay the full amount of the loss.
Freight
By the Marine Insurance Act, 1906, Section 90, “freight” includes the profit derivable by a ship owner from
the employment of his ship to carry his own goods or moveable, as well as freight payable to a third party,
but does not include passage money.
General Average
The principle in maritime law that when a sacrifice is made or an expense voluntarily incurred to preserve
the rest of a venture, the loss or expense should be shared among all the interests involved in proportion to
their value.
General Average Contribution
The payment due from a party in a marine venture to pay for a general average loss. It is in proportion to the
value of his interest as compared with the total values of all interests in the venture.
General Average Deposit
A deposit which a ship owner requires of a cargo owner as a condition of releasing his lien on cargo that is
subject to a general average contribution.
General Average Guarantee
An insurer’s guarantee that may be accepted by a ship owner in lieu of a general average deposit.
Inherent Vice
A quality in goods that produces damage to them by its own action without the assistance of an outside
agency.
Insurable Interest
Insurance requires for its validity that the insured shall be so related to the subject-matter of the insurance
that he will benefit from its survival or will suffer from loss or damage to it or may incur liability in respect
of it. In the absence of such an interest, known as an insurable interest, the insurance will be invalid.
Open Cover
A contract for cargo insurance to cover all shipments from time to time as declared, a policy being issued in
respect of each. The arrangement is subject to cancellation on notice by either party.

Lecture 20
Coverage
Additional premium payable on a marine insurance open cover or policy when the insured goods are carried
on a vessel which does not come within the scope of the Institute Classification Clause (q.v.), usually
because it is too old.
Particular Average
In marine insurance, partial loss of or damage to the subject matter of insurance.
Peril
A possible cause of loss, such as fire.
Proximate Cause
Every event is the outcome of a chain (or net) of previous events, but in the words of Bacon “It is infinite
for the law to consider the causes of causes, and their impulsions one of another; therefore it contends itself
with the immediate cause”. This immediate or effective cause, not necessarily that closest in time to the
event, is termed the proximate cause.
Recovery
Money received by an insurer in respect of a loss, thus reducing the loss, by way of subrogation, salvage or
reinsurance.
Salvage Charges
Charges recoverable under maritime law by a salver independently of contracts.
Salvage Loss
Where goods insured under a marine policy are damaged and as a result of the damage are sold short of
destination for less than their insured value there is said to be a salvage loss. The insurer must pay the
difference between the insured value and the proceeds, after deduction of sale charges and survey fee, of the
sale.
Subrogation
The right of an insurer, who has indemnified another in respect of a loss, to be put in the place of that other
person with regard to all his other means of recouping the loss.
Sue and Labour Clause
A clause in a marine insurance policy whereby the insurer accepts liability for charges incurred by the
insured in seeking to preserve his property from loss or to minimise a loss that would be covered by the
policy. The insured is said to sue and labour for the protection of his property.
Total Loss
1. A loss of the subject matter of insurance such that it is totally lost, destroyed or damaged beyond
economic repair.
2. A loss that gives rise to payment of the full sum insured.
Transit Clause
A clause in marine and aviation cargo policies providing that the cover attaches from the departure from the
place of storage at a place named in the policy until the cargo arrives at a place of storage at a named
destination or at some alternative place.
Utmost Good Faith
Insurance contracts are one of a limited class that requires the parties (insurer and insured) to exercise the
utmost good faith in their dealings with each other. Specifically the proposer of an insurance must disclose
all material facts which would influence a prudent insurer in deciding whether to accept the insurance and if
so on what terms.
Waiver Clause
A clause in a marine insurance policy which preserves the respective rights of the insurer and the insured if
either takes action to preserve the insured property from loss. The clause provides that any such action shall
not be construed as a waiver or acceptance of abandonment.
Warranty
In a contract of insurance, either (a) a promissory undertaking by the insured that some particular thing shall
or shall not be done, or that some condition shall be fulfilled or that a particular state of facts is affirmed or
negatived. It must be exactly complied with. A breach entitles the insurer to deny liability; or (b) a
requirement by the insurer as to some limitation of cover, e.g. “Warranted free of capture and seizure”.
Without Prejudice
A term used in discussion and correspondence. Where there is a dispute or negotiations for a settlement and
terms are offered “without prejudice” an offer so made or a letter so marked and subsequent letters in an
unbroken chain cannot be admitted in evidence without the consent of both parties concerned.
The policy cover
A transit policy cover essentially consists of various clauses attached to it in accordance with the needs of a
customer. A comparative chart of the basic coverage Institute Cargo Clauses-A, Institute Cargo Clauses-B,
and Institute Cargo Clauses-C is given below:
Risks I.C.C.(A) I.C.C.(B) I.C.C.(C)

Loss or damage reasonably

attributable to:

Fire or explosion Covered Covered Covered

Vessel or craft being Stranded, Covered Covered Covered

grounded, sunk or capsized.

Overturning or derailment of Covered Covered Covered

land conveyance.

Collision or contacts of vessel

with any external object other Covered Covered Covered

than water.

Discharge of cargo at a port of Covered Covered Covered

distress.

Earthquake, Volcanic eruption Covered Covered Not Covered

or lightning.

Loss or damage caused by:

General Average Sacrifice Covered Covered Covered

Jettison Covered Covered Covered

Washing Overboard Covered Covered Not Covered

Entry of sea, lake or river water Covered Covered Not Covered

into the vessel

Total loss of any package lost

overboard or dropped while loading Covered Covered Not Covered

on to or unloading from vessel

or craft.

Any other risk not specifically

excluded in the policy or Covered Not Covered Not Covered

the clauses.
A similar comparison of the Inland clauses A and B shows the common threads
Risks Inland Transit-A Inland Transit-B

Loss or damage reasonably

attributable to:

Fire Covered Covered

Lightning Covered Covered

Breakage of bridges Covered Covered

Loss or damage caused By:

Collision with or by the carrying vehicle. Covered Covered

Overturning of the carrying vehicle. Covered Covered

Derailment or accident to the carrying vehicle. Covered Covered

Any other risk not specifically excluded in the Covered Not Covered

policy or the clause.

In addition to these basic clauses other common clauses, which are attached to the policy, are:
i. Theft Pilferage & Non Delivery Clause;
ii. Institute War Clauses;
iii. Institute Strikes Clauses; and
iv. Inland Cargo Insurance Policy.
This policies insure cargo whilst in transit within the country, from warehouse to warehouse, being carried
by rail, road etc. Broadly, there are three policies granting different types of coverages with certain
mandatory exclusions, viz. Inland Transit(Rail/Road)’A’, ‘B’ and ‘C’ . Details:
• ‘C’: This is the most restricted covers. Insures only Fire and Lightning during transit.
• ‘B’: Coverage is broader than’C’. Insures during transit, perils as *Fire, *Lightning, * Breakage of
Bridges, *Accident with or by carrying vehicle, * Overturning and Derailment of carrying vehicle.
• ‘A’: Provides All Risks Cover and is the widest available.
The insured is allowed to cover Theft, Pilferage, Non-Delivery and Strike, Riot & Civil Commotion(SRCC)
with Cover ‘B’ and SRCC with’A’ also.
Storage cover at Carrier’s Godown at destination upto specific time limits is inbuilt.
The common clauses attached to an Inland policy are:
Warehouse to warehouse clause
A very important clause, which has been in built in the new set of Institute clauses, is ‘warehouse to
warehouse clause’. This takes away a lot of disputes, which used to arise earlier in policies where this clause
was not specifically attached. In a case where a loss was discovered at the final warehouse and the cover
was only valid till the port, the burden of proof that loss occurred during the insured leg fell on the Insured.
The revised clause makes this clause a part of all policies. The effect of this clause is that transit commences
from the time the goods leave the warehouse at the place mentioned in the policy for the commencement of
transit and continues during the ordinary course of transit, until delivered at the final warehouse at the place
mentioned in the policy for the termination of the transit.

Lecture 21
The Insurable Interest
An interesting thing about Marine Policy is that any one, who has or may have an interest in the safety of
goods being transported, can take the policy. The policy is freely assignable, meaning thereby that, when the
interest in the goods is transferred, the policy is also assigned simultaneously to the person who has acquired
the interest in the goods. The benefit of this free assignability is that in case of a loss, anyone who has an
interest in the goods at that point of time can have the benefit of the cover under the policy. However
assignment of the policy is possible only before the loss, and not after the loss.
The contract negotiated between a Buyer and Seller is subject to “Terms of Sale”, which determine the
rights and obligations of both parties. In order to avoid confusion between the buyer and the seller, a set of
internationally recognised rules have been drawn up, which precisely define each party’s obligations. These
are known as Incoterms. Depending upon the rights and obligation that a party has at the time of mishap, it
gets covered under the policy.
The Agreed Value
Conceptually it means that the value of goods is agreed to in advance and except for reasons of excessive
overvaluation is not re-examined at the time of loss. Transit policies are one of very few policies, which
permit this agreement in advance. Normally insurance is taken for Invoice cost plus Insurance charges plus
10% loading on the total figure.
The price
Though a basic guideline rate remains on the rulebook, it is not seriously followed in the competitive
market. However a proper rating will require consideration of various factors like:
1. Commodity being transported;
2. Types of packing;
3. Mode of transport;
4. Details of the Vessel used for the shipment;
5. Length/duration of journey;
6. Season in which the journey is to be undertaken;
7. Volume of business;
8. Claims experience of the Client and /or the commodity; and
9. Voluntary excess (The minimum amount which an Insured agrees to bear out of every claim,
normally in consideration of a reduction in premium rates)
The exclusions
Exclusions vary according to the type of cover opted. However general exclusions are:
Loss due to wilful misconduct of the insured.
Ordinary leakage, ordinary losses in weight or volume or ordinary wear & tear.
Loss caused by insufficiency or unsuitability of packing.
Loss proximately caused by delay, even though delay be caused by a risk
insured against.
Loss coused by inherent nature of the subject matter insured
Strikes, Riots and Civil Commotion Clause. These risks are normally
Excluded but can be covered by payment of additional premium.

Lecture 22
TYPES OF MARINE INSURANCE POLICIES GENERALLY Issued by the Insurance in India
Annual policy
If a business involves regular dispatch of goods throughout the year, and the quantity can be reasonably
estimated advance, an annual policy can be obtained on the basis of estimated annual dispatches. Premiums
collected in advance will be adjusted at the end of the year.
Declaration policy
An alternative to annual policy is declaration policy. A policy can be obtained for any specific amount so
that every dispatch to be insured for transit risks can be declared as agreed to and accounted until the sum
insured is exhausted. The policy can be extended for a further sum.
Special declaration
If sum insured selected is more than Rs. 2 crores, a special declaration policy can be obtained for which
volume discount in premium is allowed. The annual dispatches should be reasonably estimated and the
policy taken. However, the sum can be extended for a couple of times in extra-ordinary cases of genuine
reasons.
Open cover
It is a memorandum of agreement by which the insured will set out the terms of cover and rates of premium
for one-year transaction of Marine dispatches. The open cover is not a Policy and it is not negotiable. A
Certificate of insurance is issued for each declaration duly stamped for appropriate value and the Certificate
will be negotiable.
Duty policy
A deviation in Marine Insurance is to issue custom duty payable for imports by the same Marine Policy
though there may not be any transit risks are involved. In case of CIF contracts, the exporter to the extent of
CIF values would have arranged the Insurance only. Custom Duty payable, if any, would be the
responsibility of the importers and they can separately obtain Custom Duty policy on ‘stand alone basis’.
Another special feature of custom duty policy is that it is a pure indemnity policy and the insured is paid the
exact amount of loss of custom duty as a result of loss or damage to the consignment. The policy should be
obtained before the vessel reaches the port of destination.
Increased Value Insurance
This can be arranged to cover increased value of the cargo, if the Market Value of the goods at destination
on the port of landing is higher than the CIF and Duty Value of the Cargo.
This insurance shall not be valid if taken after the arrival at the destination port.
Marine Claims
Types of Losses
The various perils covered under marine policies may result in payment of different types of losses. These
may be categorised as follows:
1. Total Loss Actual or Constructive
2. Partial Loss
a. Particular Average.
b. General Average.
3. Expenses
a. Sue and Labour Charges.
b. Particular Charges.
c. Salvage Charges.
4. Extra charges, e.g., Survey fees, sale charges, etc.
Actual Total Loss
There is an actual total loss where the subject-matter insured is destroyed, or so damaged as to cease to be a
thing of the kind insured, or where the assured is irretrievably deprived.
When the subject matter is destroyed, there is a clear case of actual total loss. However, the word
‘destroyed’ is not to be interpreted literally. If a vessel is badly damaged by fire reducing it to charred metal,
absolutely beyond repair, it is deemed to be total loss. Thus, total physical destruction is not contemplated.
If a ship is ‘missing’, and no news has been received after the lapse of reasonable period, she is presumed to
be an actual total loss by a marine peril. However, if there were evidence to the contrary, e.g., outbreak of
war and the disappearance of the ship in a war zone, the cause of loss would be regarded as a war peril.
The procedure of posting a ship “missing” at Lloyd’s is as follows: If, after a reasonable time, no news has
been received of an overdue vessel, then, upon the application of an interested party, Lloyd’s will make
public enquiry for information when she was last seen or heard of at sea. Some time after this is allowed to
lapse when, failing any further news, she will be posted “missing” at Lloyd’s’, and claims for total loss will
then be settled as loss by marine perils, unless evidence is forthcoming to prove that the loss may have been
caused by war perils.
When sugar may be damaged by seawater as to lose its character as sugar, there will be an actual total loss.
Cement damaged by seawater may turn into concrete. Fish, fruit and other perishable goods may be so
damaged by fermentation or putrefaction caused by seawater damage that they will lose their original
character of the commodity insured. In such cases an actual total loss occurs. This type of loss is known as
‘Loss of Specie’.
If a vessel founders at sea and it is practically impossible to save her by salvage measures, an absolute total
loss occurs. Cargo on board the vessel will also be an actual total loss although it may still be intact. The
principle behind actual total loss in this respect is impossibility, owing to insured perils, of ever ensuring the
arrival of the property insured.
If there is an actual total loss of cargo on which freight is payable at destination, there is an actual total loss
of freight.
Where a vessel proceeding in ballast (that is, without any cargo) to the loading port to load cargo under a
charter party, becomes an actual total loss due to an insured peril, there will be a total loss of the chartered
freight contracted for.
Constructive Total Loss
There is a constructive total loss when the subject matter is reasonably abandoned because either:
a. Actual total loss appears unavoidable, or
b. To prevent actual total loss requires expenditure exceeding the saved value.
Also there is a constructive total loss when the insured is deprived of the subject matter and,
a. It is unlikely that he can recover it, or
b. The cost of recovery would exceed its value when recovered.
For easy comprehension, actual and constructive total loss are compared as follows:
Actual or Absolute Total Loss
a. Where, by a peril insured against, the assured is irretrievably deprived of the subject matter insured.
b. Where the subject -matter is destroyed by a peril insured against:
c. Where, through the operation of peril insured against, the subject matter undergoes a physical
change of character or specie and ceases to be “a thing of the kind insured.”
Constructive Total Loss
a. Where, by a peril insured against, the assured is deprived of the possession of the subject matter and
it is unlikely that he can recover it.
b. Where the assured is deprived of the possession of the subject matter by a peril insured against and
the cost of recovering it would exceed its value when recovered.
c. Where, the subject matter is so damaged by a peril insured against that the cost of repairing the
damage (together with incidental expenses) would exceed its value when repaired.
Measure of indemnity for total loss
When a loss takes place the amount to which the insured is entitled is called the “measure of indemnity”.
The measure of indemnity is the maximum sum, which the insured can recover in the event of loss.
In the case of actual or constructive total loss the measure of indemnity is the sum insured in a valued
policy.

Lecture 23
Subrogation and Abandonment
There is a distinct difference between legal rights accruing from abandonment and the rights of subrogation
The rights of subrogation arise under all contracts of indemnity whether the loss is total or partial. The
doctrine of abandonment confers on the insurers, in payment of a total loss, the right to take over the
proprietary interest of the insured in whatever remains of the subject matter. The insurer’s right to be
subrogated to the rights of the insured against third parties is not dependent upon nor connected with the
taking over the property or of any part of it.
The distinction therefore between abandonment and subrogation is that the former confers proprietary rights
(i.e., rights of ownership in the property) whereas the latter confers only the rights to proceed against third
parties who may be responsible for the loss for recovery purposes.
In this context the question arises whether an insurer, having paid a loss, is entitled to recover from a third
party more than the amount paid under the policy.
The position may be summarised as follows:
a. The rights of subrogation arise under all contracts of indemnity and arise under partial as well as
total losses.
b. The rights of the insurers to take over proprietary interest in the subject matter on payment of a total
loss are conferred by abandonment and not by subrogation. On acceptance of abandonment and
 payment of total loss the insurer may realise on the property more than what he has paid and retain
the entire proceeds.
c. Under subrogation, the insurer on payment of a loss is entitled to sue the third party in the name of
the insured, but in respect of recoveries made he is not entitled to retain anything more than the
amount of claim paid under the policy.
Particular Average
Any loss other than a total loss is a partial loss.
Particular average loss can also be the partial loss of the subject matter insured, caused by a peril insured
against, and which is not a general average loss. Particular average therefore means a fortuitous partial loss
caused by a peril insured against.
Examples of particular average are: Damage to the ship by stranding, running aground, collision etc.
damage to the cargo by fire, seawater, etc.
The essence of a particular average loss is that it must be accidental and, in order to be recoverable under
the policy, proximately caused by a peril insured against. Any loss through ordinary wear and tear, ordinary
leakage and breakage or due to the inherent nature of the subject matter insured is excluded.
It is obvious that particular average covers a very wide range of losses, and it may be damage to, or loss of
part of, the subject matter insured.
General Average
The loss must be extraordinary in nature. Damage to the vessel or her equipment whilst being used for its
intended purpose is not allowed in general average, but damage to the ship’s engines by using them to force
the ship off a strand would be extraordinary damage. Expenses necessarily incurred in carrying out the
contract of affreightment would not be extraordinary, even though they may be enhanced.
Sacrifices and expenses must be made or incurred reasonably and prudently. The general average act must
be voluntary and intentional and all accidental loss or damage is excluded.
The whole adventure must be imperilled before a general average act is justified. Sacrifices made under the
mistaken idea that peril existed, for instance, where a ship was thought to be on fire, would not be allowed.
The object of the general average loss must be the preservation of the whole adventure, and sacrifices and
expenses made or incurred for the benefit of individual interests are not general average losses.
The loss must be directly consequential on the general average act. Demurrage and loss of market are
indirect consequential losses, and are not allowed in general average.
Distinction between General Average and Particular Average
General average is a voluntary and deliberate loss whereas particular average is fortuitous or accidental.
General average losses are borne rateably by all the interests, which benefit, but particular average rests
where it falls, and is recoverable from the insurer of the particular subject matter lost or damaged.
A general average loss may include expenditure, but particular average can only be loss or damage of the
subject matter insured caused by an insured peril and would not embrace any expenses.
Sue and Labour Charges
By this clause, attention is drawn to the common law duty of the assured and his agents to act at all times as
though uninsured and to take such measures as may be reasonable for the purpose of averting or minimising
loss or damage which is covered by the insurance.
This clause is deemed to be a separate and supplemental agreement to the policy, and it binds the insurers to
pay any expenses incurred by the assured or his agents in preventing or minimising loss or damage to the
subject matter insured caused by an insured peril. Such expenses, when properly and reasonably incurred,
are payable irrespective of percentage and even in addition to a total loss, thereby emphasising the
supplementary character of the clause. In fact, sue and labour charges provide the only instance where an
insurer may be liable for more than the sum insured in respect of one casualty.
Examples of sue and labour charges are:
Hides damaged by seawater; reconditioning expenses at an intermediate port to prevent aggravation of
damage are sue and labour charges. Due to a maritime casualty a ship puts into a port of refuge for repairs,
which would take some weeks. The cost of extra fodder fed to the live cattle insured against. All risks’
during the period of repairs is sue and labour charge.
The additional cost of forwarding cargo from a port of refuge to earn the freight payable on delivery at
destination is recoverable, if, in the absence of such cost, a claim could result for a total loss on freight.

Lecture 24
Salvage Charges
salvage charges are those that are recoverable under maritime law by a salvor independent of contract.
Maritime salvage is the remuneration or reward payable according to maritime law to salvors who
voluntarily and independent of contract render services to rescue or save property at sea, such as a ship, her
cargo and freight at risk. No reward for services or payments for loss or expenses can be claimed by salvors
where the services were unsuccessful and the property was totally lost. For this reason, salvage awards are
substantial, even generous, as Courts recognise the necessity of encouraging salvage services.
Salvors have a maritime lien on the property salved and they can enforce their claim in Courts. In India, the
provisions of Indian Merchant Shipping Act, 1958, govern awards for salvage. Ordinary Courts in India
exercise the jurisdiction for salvage cases.
Average Adjusters
The adjustment of general average losses is entrusted to an average adjuster. The specialised knowledge and
the reputation for strict impartiality ensure that their findings are acceptable to all concerned. The adjuster’s
fees are allowed in general average.
The adjusters fees are payable only where the insurers are liable for the claim. Where there is no liability the
adjuster usually makes no charge for his services.
The adjuster may or may not be a member of the Association of Average Adjusters.
Customs of Lloyd’s
Before the passing of the Marine Insurance Act, 1906 in the U.K. marine insurance was entirely governed
by common law. When any practical difficulties arose which could not be resolved by reference to
precedents, the interested parties for a ruling consulted the Committee of Lloyd’s and these rulings
eventually were issued in the form of Customs of Lloyd’s.
The Rules of Practice
The Customs of Lloyd’s were adopted by the Association of Average Adjusters, which was formed in 1874
and were called the Rules of Practice. These are amended from time to time by the Association for the
guidance of its members in adjustment of average. The object of rules is to secure uniformity of practice in
average adjusting.
Excess and Franchise
Cargo insurances can be made subject to Excess and less frequently to a Franchise. The purpose of both
excesses and franchises is to make the insured his/her own insurer for the first part of any loss. This has the
effect of leaving many small claims to be dealt with by the insured, with a consequent saving to the insurer
of both claims payments and disproportionate administration costs. The purpose is also to eliminate ordinary
or inevitable loss or damage. It further means that the insured has a financial interest in any losses incurred
and this may make him more careful.
The difference between an excess and a franchise is that where an excess is imposed, the amount of excess
is always deducted from the agreed amount of the claim, whereas with a franchise, nothing is payable until
the amount of the franchise is reached when the agreed amount of the claim is paid in full. A few examples
will make this clear:
Examples Claim Amount Payable

Excess Rs.10000/- Rs. 11000/- Rs. 1000/- (i.e. Rs. 11000/- less Rs. 10000/-)

Franchise Rs.10000/- Rs. 11000/- Rs. 11000/- (as the amount of claim exceeds
 the franchise )

Franchise Rs.10000/- Rs.9700/- NIL (claim below franchise)

Franchise Rs.10000/- Rs.10000/- Rs. 10000/- (as franchise is reached)

Recoveries
For an insurer, it is of utmost importance that rights of maximum recovery from carriers or bailees are
protected, so that the cargo account cannot continue to produce a healthy commercial surplus. In this
context, the student should appreciate the importance of thorough knowledge about the procedures to be
followed for protecting recovery rights and good knowledge of the legal aspects involved, for example,
rights/immunities and responsibilities/ obligations of the carriers/bailees under respective statutes,
particularly the time limits for giving notice of loss and where necessary the time limits for filing suits, etc.
Carriage of goods by Rail
Effective from 1st July, 1990 the new Indian Railways Act, 1989 came into force, replacing the earlier Act
of 1890.
The liability of the railways is of a common carrier so long as the goods are in transit and that of a bailee
(under Sections 151, 152 and 161 of the Indian Contract Act, 1872) for a period of 7 days thereafter. The
liability of the railways ceases on expiry of 7 days after termination of the transit.
The liability of a common carrier is absolute as that of an insurer of goods for any loss, damage, destruction,
deterioration, short or non-delivery, save and except where such loss, damage, etc. is caused on account of
act of God, enemies of state, inherent vice or fault of the consignee himself.
Liability of a bailee,on the other hand, is only for failure to take reasonable care, that is for negligence and
misconduct on his part or on the part of his servants.

Lecture 25
Goods carried at owner’s risk rate
All goods are carried by railways at railway risk rate except those for which the owner’s risk rate is
applicable. Where owner’s risk and railway risk rate are in force for any goods, the consignor can choose
between the two rates, but in the event he does not opt to choose, railways will deem that carriage has been
entrusted to them at owner’s risk rate.
However, for goods booked at owner’s risk, in respect of liability for non-delivery and pilferage, a duty is
cast on the railways to make disclosures to the claimant as to the manner in which the goods were dealt with
throughout the time they were in the custody and control of the railway as in the following two cases
1. Where whole or part of such consignment is not delivered and such non-delivery is not proved by
the railways to have been due to fire or any accident to the train or
2. Where the consignment was well covered and protected and despite this, it was pointed out to the
railways before delivery that there was pilferage in transit, the railway administration shall be bound
to disclose how the consignment was dealt with throughout the period it was in their possession and
control. But if negligence or misconduct cannot be fairly inferred from such disclosure, the burden
of proving such negligence or misconduct shall lie with the claimants.
Carriage of goods by Road
The Carriers Act 1865 governs liability of road transporters, according to which anyone who carries goods
not belonging to him for hire or reward is a common carrier. The common carrier may limit his liability by a
special contract, if he chooses to do so. Otherwise his liability is absolute ‘’as of an insurer” of the goods.
The common carrier has only 3 immunities to escape liability. These immunities are:
• Act of God;
• State’s enemies; and
• Inherent nature of goods or the fault of the consignor.
The road carrier’s liability as common carrier is absolute ‘’as of an insurer” .The burden of proving
negligence on the part of the carrier is not on the claimant, but it is the carrier who has to establish that there
was no negligence on his part.
Notice of loss/damage, etc. must be given to the carrier within 6 months from the date of the knowledge of
loss.
Suit for legal action against the road carrier must be filed within 3 years from the date of damage or 3 years
from the date goods ought to have reached destination. While filing suit, party who has given notice of loss
within 6 months must be made plaintiff to the suit, as the law requires that notice should be given by
plaintiff before filing suit. Insured also should be made a proforma plaintiff to avoid technical objections.
Lecture 26
RISK MANAGEMENT
Introduction
Risk management and Insurance have been mistakenly taken to mean one and the same thing. In recent
years, an increasing number of business firms, governmental units, and other organisations have turned to
risk management as a device for handling pure risks. The truth is that insurance can also be used to meet
pure risk management. But insurance is only one of several methods for dealing with risk. Risk management
attmepts to identify the pure risks faced by the firm or organisation and uses a wide variety of methods,
including insurance, for handing these risks.
In this chapter, the principles of risk management will be discussed. We will first examine more precisely
the meaning of risk management and the basic objectives of a risk management programme. We will then
consider the risk management process, which is a systematic procedure for identifying and evaluating
potential losses, selecting the most appropriate methods for paying losses, and administering the overall
program.
Meaning of Risk Management
Risk management can be defined as various alternatives concerning the management of pure risks. It is a
discipline that provides for the systematic identification and analysis of loss exposoures faced by the firm or
organisation, and for the best methods of handling these loss exposures in relation to the firm’s profitability.
As a general rule, the risk manager is concerned only with the management of pure risks, not speculative
risks. All pure risks are treated, including those that are uninsurable.
Risk Management and Insurance Management
Risk management should not be confused with insurance management. Risk management is a much broader
concept and differs from insurance management in several respects. First, risk management places greater
emphasis on the identification and analysis of pure loss exposures. Second, insurance is only one of several
methods that can be used to meet a particular loss exposure; as you will see, the techiniques for meeting
losses, not just insurance. Finally, a successful risk management programme requires the cooperation of a
large number of individuals and departments throughout the firm, and risk management decisions have a
greater impact on the firm than insurance management decisions. Insurance management affects a smaller
number of persons.
Objectives of Risk Management
Risk management has several important objectives. These objectives can be classified into two categories:
1. objectives prior to a loss, and
2. Objectives after a loss occurs.
Objectives Prior to a Loss
A firm or organization has several risk management objectives prior to the occurrence of a loss. The most
important of these include the following:
• Economy;
• Reduction of anxiety; and
• Meeting externally imposed obligations.
The economy goal means that the firm should prepare for potential losses in the most economical way. This
involves a financial analysis of safety programme expenses, insurance premiums, and the costs associated
with the different techniques for handling losses.
The second objective, the reduction of anxiety, is more complicated. Certain loss exposures may create
greater worry and fear for the risk manager than other exposures. However, the risk manager wants to
minimize the anxiety and fear associated with all loss exposures.
The third pre-loss objective is to meet any externally imposed obligations. This means the firm must meet
certain obligations imposed on it by outsiders. For example, government regualtions may require a firm to
install safety devices to protect workers from harm. Similarly, a firm’s creditors may require that property
pledged as collatral for a loan must be insured. The risk manager must see that these externally imposed
obligations are met.
Objectives After a Loss
After a loss occurs, the risk manager has the following objectives:
• Survival of the firm;
• Continued operation;
• Stability of earnings;
• Continued growth; and
• Social responsibility.
Let us briefly examine each of these important post-loss objectives.
The first and most important risk management objective after a loss occurs is survival of the firm. Survival
means that after a loss occurs, the firm can at least resume partial operation within some reasonable time
period if it chooses to do so.
The second post loss objective is to continue operating. For some firms, the ability to continue operating
after a servere loss is an extremely important objective. This is particualrly true of certain firms, such as a
public utility firm, which is obligated to provide continuous service. But it is also extremely important for
those firms that may lose some or all of their customers to competitors if they cannot operate after a loss
occurs. This would include banks, bakeries, dairy farms, and similar firms.
Stability of earnings is the third post loss objective. This objective is closely related to the objective of
continued operations. The goal of stability of earnings may be achieved if the firm continues to operate.
However, there may be substantial costs involved in achieving this goal (such as operating at another
location), and perfect stability of earnings may not be attained.
The fourth post loss objective is continued growth of the firm. A firm may grow by developing new
products and markets or by acquisitions and mergers. The risk manager must consider the impact that a loss
will have on the firm’s ability to grow.
Finally, the goal of social responsibility is to minimize the impact that a loss has on other persons and
society in general. A severe loss by a firm can adversely affect employees, customers, suppliers, creditors,
taxpayers, and the community in general. For example, a severe loss that requires the shutting down of a
plant in a small community for an extended period can lead to depressed busines conditions and substantial
unempolyment in the community. The risk manager must therefore be concerned about the social
responsibility of the firm to the community after a loss occurs.
Lecture 27
The Risk Management Process
In order to attain the preceding goals and objectives, the risk manager must perform certain funtions. there
are four basic functions of a risk manager.
• Identifying potential losses;
• Evaluating potential losses;
• Selecting the appropriate technique or combination of techniques for handling losses; and
• Administering the programme.
In the following sections, we will examine each of these important functions of a risk manager in some
detail.
Identifying Potential Losses
The first function of a risk manager is to identify all pure loss exposures. This involves a painstaking
identification of all potential losses to the firm. The risk manager normally tries to identify six types of
potential losses.
1. Property losses;
2. Business income losses;
3. Liability losses;
4. Death or disability of key persons;
5. Losses resulting from job-related injuries or disease; and
6. Losses from fraud, criminal acts, and employee dishonesty.
The risk manager has several sources of information that can be used to identify major and minor loss
exposures. Physical inspection of company plants and operations can identify major loss exposures.
Extensive risk analysis questionnaires can be used to discover production and delivery processes can reveal
production bottlenecks where a loss can have severe financial consequences to the firm. Financial
statements can be used to identify the major assets that must be protected. Finally, reports on past losses
experienced by the firm can be invaluable in identifying major loss exposures.
Evaluating Potential Losses
After the potential losses are identified, the next step is to evaluate and measure the impact of losses on the
firm. This 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.
The risk manager must estimate the frequency and severity of loss for each type of loss exposure. The
various loss exposures can then be ranked according to their relative importance. For example, a loss
exposure with the potential for bankrupting the firm such as a liability judgement in excess of the firm’s
assets-is much more important in a risk management program than one with a small loss potential.
In addition, the relative frequency and severity of each loss exposure must be estimated so that the risk
manager can select the most appropriate techniques, or combination of techniques, for handling the loss
exposure. For example, if certain losses regularly appear and are fairly predictable, they can be budgeted out
of a firm’s income and treated as a normal operating expense. However, if the annual loss experience of a
certain type of exposure fluctutes widely, an entirely different approach may be required.
Although the risk manager must consider both loss frequency and loss severity, severity is more important,
since a single catastrophic loss could wipe the firm. There fore, the risk manager must also and maximum
probable loss must be estimated. The maximum possible loss is the worst loss that could possibly happen to
the firm during its lifetime. The maximum probable loss is the worst lost that is likely to happen. For
example, a firm may own a building valued at Rs. 50 Lakhs; thus the maximum possible loss is 50 Lakhs.
The risk manager may estimate that once every fifty years, the building will incur property damage from a
flood in excess of Rs. 40 Lakhs; so the maximum probable loss is only Rs. 40 Lakhs.
Catastrophic losses are difficult to predict in advance because they occur so infrequently. However, their
potential impact on the firm must be considered. In contrast, certain losses, such as physical damage losses
to automobiles and trucks, occur with greater frequency, are usually relatively small, and can be predicted
with greater accuracy.

Lecture 28
Selecting the Appropriate Technique For Handling Loss
After the frequency and severity of losses are estimated, the risk manager must then select the most
appropriate technique, or combination of techniques, for handling each loss exposure. They are as follows:
• Avoidance;
• Retention;
• Non insurance transfers;
• Loss control; and
 • Insurance.
In the following sections, we will examine each of these techniques in greater detail to see how they can be
applied to specific loss exposures in a risk management program.
Avoidance
Avoidance means that a certain loss exposure is never acquired, or an existing loss exposure is abandoned.
For example, a firm can avoid a flood loss by not building a plant in a flood plain. An existing loss exposure
may also be abandoned. For example, a firm that produces a highly toxic product may stop manufacturing
that product.
The major advantage of avoidance is that the chance of loss is reduced to zero, or the chance of loss that
previously existed is eliminated because the activity that produced the chance of loss has been abandoned.
Thus, it is not necessary to use other risk management techniques for the loss exposures that have been
avoided because there is no remaining exposure to be treated.
Avoidance, however, has two disadvantages. First, it may not be possible to avoid all losses. For example,
the premature death of a key executive cannot be avoided. Second, it may not be practical or feasible to
avoid the exposure. For example, a paint factory can avoid losses arising out of the production of paint.
However, without any paint production, the firm will not be in business.
Retention
Retention is another risk management technique for handling losses. Retention means that the firm retains
part or all of the losses that result from a given loss exposure.
Conditions for using retention: Retention can be used in a risk management programme if certain conditions
are met. They include the following.
• No other method of treatment is available;
• The worst possible loss is not serious; and
• Losses are highly predictable.
Retention may be used when no other method of treating the exposure is available. Insurers may not be
willling to write certain coverage, non-insurance transfers may not all losses can be eliminated. In these
cases, the retention technique is a residual method. If the exposure cannot be transferred or insured, then it
must be retained. Property damage from war would be included in this category.
Retention can also be used when the worst possible loss is not serious. For example, physical damage loss to
automobiles in a large firm’s fleet will not bankrupt the firm if wide distances separate the automobiles and,
thus, are not likely to be simultaneously damaged.
Finally, retention is appropriate when losses are highly predictable. Workers compensation claims, physical
damage losses to automobiles, and shoplifting losses fall in this catagory.From past experience, the risk
manager should be able to determine a probable range of frequency and severity of actual lavel. If most
losses fall within that range each year, they can be budgeted out of the firm’s income.
Determining retention levels The reisk manager must also determine the dollar amount of losses the firm
will retain. An important consideration here is the firm’s overall financial position. A financially strong firm
can have a higher retention level than one whose financial position is weaker. Retention level should
therefore be reviewd annually in light of the firm’s present financial position, recent loss experience, and the
cost of insurance in the market-place.
Retention levels should be established for both single occurrences and aggregate annual amounts.
Determining the maximum dollar amount of losses to retain annually may be done in several ways. A
publicly held corporation can determine its maximum annual retention in terms of the maximum uninsured
loss the company can absorb without adversely affecting the stockholders. The company’s dividend policy
and the extent to which the company’s earnings will be adversely affected by losses must be reviewd in this
light. One rule of thumb is that the maximum retention can be set at 5 percent of the company’s annual
earnings before taxes from its current operations.
Another approach is to determine the maximum annual retention as a percentage of the firm’s net working
capital; typically, this figure is between 1 and 5 percent. Although this method does not reflect the firm’s
overall financial position for absorbing a loss, it is a measure of the firm’s ability to fund a loss.
A third approach is based on the recognition that retained losses typically are paid out of retained earnings,
or pre-tax earnings. Under this formula, the maximum annual retention is equal to some percentage of
current earned surplus (typically 1 to 3 percent), plus an equal or lower percentage of average pre-tax
earnings over the past few years. This latter percentage has the effect of smoothing out the highs and lows.
Paying losses
If retention is used, the risk manager must have some established method for paying losses. The following
methods of financial losses can be used:
1. Current net income: The firm can pay losses out of its current net income, and the losses would be
treated as expenses for that year. However, payments to cover a large number of losses could exceed
current net income. Other assets of the firm may then have to be liquidated to pay losses. Moreover,
a profitable year could easily turn into an unprofitable one because of an unexpected loss, such as an
explosion, liability lawsuit, or work related accident.
2. Earmarked assets: Another method is to earmark liquid assets, such as short-term securities, to pay
losses. However, there is no assurance that the assets will be sufficient to pay an unusually large
loss. Moreover, keeping assets in liquid form may substantially reduce their rate of return; the assets
may yeild a much higher rate of return by being used in the business.
3. Borrowing: A third method is to borrow the necessary funds from a bank. However, this approach
requires a line of credit from a commercial bank, and arrangements for the loan must be made before
the loss occurs. Furthermore, interest must be paid on the loan, and the periodic repayment of the
loan can aggravate any cash flow problems the firm may have. Finally, a compensating cash balance
may also be required.
4. Captive insurer: Finally, a firm can establish a captive insurer-an insurance company established and
owned by the parent firm for the purpose of insuring the firm’s loss exposures. Most captive insurers
are located in Bermuda because of the favourable regualtory climate, low capitalisation
requirements, and low taxes.
There are several reasons why corporations have formed captive insurers. They are summarized as follows.
a. Reduction in premium costs: A captive insurer may be able to provide coverage more economically
than commercial insurers. Also, the parent firm may have difficulty in obtaining certain types of
insurance from commercial insurers.
b. Greater stability of earnings: A captive insurer can provide for greater stability of earnings over time,
since the adverse impact of change fluctuations on the firm’s income is reduced.
c. Easier access to a reinsurer: A captive insurer has easier access to a reinsurer, since many reinsurers
will deal only with insurance companies and not with insured.
d. Profit centre: A captive insurer can be a profit centre by insuring other parties as well as providing
insurance to the parent firm and its subsidiaries.
e. International advantages: Captive insurers also have some advantages in the international insurance
merkets. For example, some foreign countries require business, firms to insure their local operations
by purchasing insurance from local insurers. A captive insurer may be able to reinsure the local
insurer, which may then be in a position to write broader lines of insurance than would otherwise be
possible.

Lecture 29
Self-insurance
The term self-insurance is widely used by risk managers in their risk management programs. Self-insurance,
however, is a misnomer since it is not insurance, and a pure risk is not transferred to an insurer. Self-
insurance is merely a special form of planned retention whereby part or all of a given loss exposure is
retained by the firm.
Some risk managers believe that a retention programme must meet two requirements to be called self-
insurance. First, the firm must have a large number of homogeneous exposure units so that losses can be
predicted with some degree of accuracy based on the law of large numbers. Second, the firm must have a
liquid fund to pay losses, or alternatively, a captive insurer must be used to pay claims. However, if a
vigorous standard for predictability were established, relatively few retention programs would meet the first
requirement. In addition, since relatively few retention programs have a liquid fund or specifically
earmarked assets to pay losses, or have access to a captive insurer, relatively few retention programs would
meet the second requirement. Perhaps a better name for self-insurance is self-funding which expresses more
clearly the idea that losses are funded and paid for by the firm.
Advantages and disadvantages of retention
The retention technique has both advantages and disadvantages in a risk management program. The major
advantages are summarised as follows.
1. Save money: The firm can save considerable money in the long run if its actual losses are less than
the loss allowance in the insurer’s premium.
2. Lower expenses: There may also be sizeable expense savings. The firm at a lower cost may provide
the services provided by the insurer. Some expenses may be reduced, including loss-adjustment
expenses, general administrative expenses, commissions and brokerage fees, loss control expenses,
taxes and fees, and the insurer’s profit.
3. Encourge loss prevention: Since the exposure is retained, there may be a greater incentive for loss
prevention within the firm.
4. Increase cash flow: Cash flow may be increased by retention, since the firm can use the funds that
normally would be held by the insurer.
The retention technique, however, has several disadvantages. They are summarised as follows.
1. Possible higher losses: The losses retained by the firm may be greater than the loss allowance in the
insurance premium that is saved by not purchasing the insurance. Also, in the short run, there may be
great volatility in the firm’s loss experience.
2. Possible higher expenses: Expenses may actually be higher. Outside experts such as safety engineers
and loss prevention specialists may have to be hired. Insurers may be able to provide loss control
services more cheaply.
3. Possible higher taxes: Income taxes may also be higher. The premiums paid to an insurer are
income-tax deductible. However, if retention is used, only the amounts actually paid out are
deductible.
This concludes our discussion of retention. Let us next consider non-insurance transfers as a technique for
handling potential losses.
Non-insurance Transfers
Non-insurance transfers refer to the various methods other than insurance by which a pure risk and its
potential financial consequences can be transferred to another party. Some non-insurance techniques that are
commonly used in risk management programmes include contracts, and leases. For example, a company’s
contract with a construction firm to build a new plant can specify that the construction firm is responsible
for any damage to the plant while it is being built. A firm’s computer lease can specify that maintenance,
repairs, and any physical damage loss to the computer are the responsibility of the computer firm.
In a risk management program, non-insurance transfers have several advantages. They are summarised as
follows.
1. The risk manager can transfer some potential losses that are not commercially insurable.
2. Non-insurance transfers often cost less than insurance.
3. 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 summarized as follows.
1. 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.
2. If the party to whom the pontential loss is transferred is unable to pay the loss, the firm is still
responsible for the claim.
3. Non-insurance transfers may not always reduce insurance costs, since an insurer may not give credit
for the transfers.
Loss Control
Loss control is another method for handling loss in a risk management program. Loss control activities are
designed to reduce both the frequency and severity of losses. Unlike the techniques of avoidance of loss,
loss control deals with an exposure that the firm does not wish to abandon. The purpose of loss control
activities is to change the characteristics of the exposure so that it is more acceptable to the firm; the firm
wishes to keep the exposure but wants to reduce the frequency and severity of losses.
Several examples can illustrate how loss control measures can reduce the frequency and severity of losses.
Examples of measures that reduce loss frequency are quality control checks, driver examinations, strict
enforcement of safety rules, and improvements in product design. Examples of measures that reudce loss
severity are installation of automatic sprinkler or burglar alarm systems, early treatment of injuries, limiting
the amount of cash on the premises that can be stolen, and rehabilitation of injured workers.

Lecture 30
Insurance
Commercial insurance can also be used in a risk management program. Insurance can be advantageously
used for the treatment of loss exposures that have a low probability of loss but the severity of a potential loss
is high.
Risk mangement and insurance If the risk manager decides to use insurance to treat certain loss exposures,
five key areas must be emphasised. They are as follows.
• Selection of insurance coverage’s;
• Selection of an insurer;
• Nagotiation of terms;
• Dissemination of information concerning insurance coverage’s; and
• Periodic review of the insurance program.
First, the risk manager must select the insurance coverage’s that are needed. Since there may not be enough
money in the insurance budget to insure all possible losses, the need for insurance can be divided into
several categories depending on importance.One useful approach is to classify the need for insurance into
three categories : (1) essential, (2) desirable, and (3) avaiable. Essential insurance includes that coverage’s
required by law or by contract, such as workers compensation insurance. Essential insurance also includes
that coverage’s that will protect the firm against a catastrophic loss or a loss that threatens the firm’s
survival; liability, insurance would fall into this category. Desirable insurance is protection against losses
that may cause the firm financial difficulty, but not bankruptcy. Avaiable insurance is coverage for slight
losses that merely inconvenience the firm.
The risk manager must also determine if a deductible is needed and what size of deductible is warranted. A
deductible is used to eliminate small claims and the administrative expense of adjusting these claims.
Substantial premium savings are possible if a deductible is used. In essence, then, a deductible is a form of
risk retention.
Most risk management programmes combine the retention technique discussed earlier with commercial
insurance. In determining the size of the deductible, the firm may decide to retain only a relatively small
part of the maximum exposure to loss. The insurer normally adjusts any claims, and only losses in excess of
the deductible are paid.
Another approach is to purchase excess insurance. A firm may be financially strong and may wish to retain
a relatively large proportion of the maximum exposure to loss. Under an excess insurance plan, the insurer
does not participate in the loss until the actual loss exceeds the amount a firm has decided to retain. The
retention limit may be set at the maximum probable loss (not maximum possible loss). For example, a
retention limit of Rs. 1 crore may be established for a single fire loss to a plant valued at Rs. 25 crores. The
Rs. 1 crore would be viewed as the maximum probable loss. In the unlikely event of a total loss, the firm
would absorb the first Rs. 1 crore of loss, and the commercial insurer would pay the remaining Rs. 24
crores.
Second, the risk manager must select an insurer, or several insurers. Several important factors come into
play here. These include the financial strength of the insurer, risk management services provided by the
insurer, and the cost of protection. The insurer’s financial strength is determined by the size of policy
holders’ surplus, underwriting and investment re-suits, adequacy of reserves for outstanding liabilities, types
of insurance written, and the quality of management. Several trade publications are available to the risk
manager for determining the financial strength of a particular insurer.
The risk manager must also consider the availability of risk management services in selecting a particular
insurer. Such services include assistance in identification of loss exposures, in loss control, and in claim
adjustment. The risk manager must also determine whether a particular insurer is willing to provide the
desired insurance coverages. Other factors are the willingness of an insurer to accept all loss expousures the
risk manager wants to insure, regardless of their quality, and the insurer’s policy on cancellation. Some
insurers may cancel the insured if a major loss occurs.
The cost of insurance protection must also be considered. All other factors being equal, the risk manager
would prefer to purchase insurance at the lowest possible price. Many risk managers will therefore solicit
competitive premium bids from several insurers to get the necessary protection and services at the lowest
price.
Third, after the insurer or insurers are selected, the terms of the insurance contract must be negotiated. The
risk manager and insurer must agree on the contract language. If printed policies, endorsements, and forms
are used, the risk manager and insurer must agree on the documents that will form the basis of the contract.
If a specially tailored manuscript policy is written for the firm, the language and meaning of the contractual
provisions must be clear to both parties. In any case, the various risk management services the insurer will
provide must be clearly stated in the contract. Finally, if the firm is large, the premiums may be negotiable
between the firm and insurance company. Even if the premiums are not negotiable, the risk manager may be
able to persuade the insurer that the firm belongs in an underwriting classification with a lower rate and
arrange inspection for the purposes of special rating.
Fourth, information concerning insurance coverage must be disseminated to others in the firm. The firm’s
employees and managers must be informed about the insurance converages, the various records that must be
kept, the risk management services that the insurer will provide, and the changes in hazards that could result
in a suspension of insurance. And, of course, those persons responsible for reporting a loss must be
informed. The firms must comply with policy provisions concerning how notice of a claim is to be given
and how the necessary proofs of loss are to be assembled and presented.
Finally, the insurance program must be periodically reviewd. The risk manager has to decide whether claims
are paid promptly or not and to assess the quality of the insurer’s loss control services. Even the basic
decision-whether to purchase insurance must be periodically reviewed.

Lecture 31
Advantages and disadvantages of insurance
The use of commercial insurance in a risk management program has both advantages and disadvantages.
The major advantages are summarised as follows.
1. The firm will be indemnified after a loss occurs. The firm can continue to operate, and there may be
little or no fluctuation in earnings.
2. Uncertainty is reduced, which permits the firm to lengthen its planning horizon. Worry and fear are
reduced for managers and employees, which shold improve their performance and productivity.
3. Insurers can provide valuable risk management services, such as loss control services, exposure
analysis to identify loss exposures, and claims adjusting.
4. Insurance premiums are income-tax deductible as a business expense.
However, the use of insurance entertain disadvantages and costs. They are summarised as follows.
1. The payment of the insurance premium is a major cost, since the premium consists of a component
to pay loss costs, an amount for expenses, and an allowance for profit and contingencies. There is
also an opportunity cost. Under the retention technique discussed earlier, the premium could be
invested or used in the business until needed to pay claims. If insurance is used, premiums must be
 paid advance. Special cash flow plans are now used that allow firms to delay the payment of
premiums so that cash flow can be improved.
2. Considerable time and effort must be spent in negotiating for insurance. An insurer or insurers must
be selected, policy terms and premiums must be negotiated, the firm must cooperate with the loss
control activities of the insurer, and proof of loss must be filed with the insurer following a loss.
3. The risk manager may have less incentive to follow a program of loss control, since the insurer will
pay the claim if a loss occurs. Such a lax attitude toward loss control could increase the number of
non-insured losses as well.
In summary, the risk manager can use avoidance, retention, non-insurance transfers, and loss control and
commerical insurance in a risk management programme. Let us next consider the appropriate situations for
using each of these methods.
Which Method Should Be Used?
In determining the appropriate method or methods, a matrix can be used that classifies the various loss
exposures according to frequency and severity. The following matrix can be a useful guide to the risk
manager.
Type of Loss exposure Loss frequency Loss severity

1 Low Low

2 High Low

3 Low High

4 High High
The first loss exposure is one that is characterised by both low frequency and low severity of loss. This type
of exposure can be best handled by retention, since the loss occurs infrequently and, when it does ocur, it
seldom causes financial harm. One example of this type of exposure would be the exposure would be the
potential theft of an employee’s pen.
The second type of exposure is more serious. A loss occurs frequently, but its severity is relatively low.
Examples of this type of exposure include physical damage losses to automobiles, workers compensation
claims, shoplifting, and food spoilage. Loss control should be used here to reduce the frequency of losses. In
addition, since losses regualrly occur and are predictable, the retention technique can also be used.
However, since these relatively small losses in the aggregate can reach sizeable levels over a one year
period, commercial insurance could also be purchased on an excess basis.
The third type of exposure should be met by insurance. Insurance is best suited for low frequency, high-
severity losses. High severity means that a catastrophic potential is present, while a low probability of loss
indicates that purchase of insurance is economically feasible. Examples of this type of exposure include
fires, explosions, tornadoes, and liability lawsuits. The risk manager could also use a combination and
commercial insurance with the retention limit determinated by the principles that we have discussed earlier.
The fourth and most serious type of exposure is one characterized by both high frequency and high severity.
This type of exposure is best handled by avoidance. Retention is not advisable because of the catastrophic
loss potential, and commercial insurance may not be available or available only at prohibitively high
premiums. One example of this type of exposure is someone who applies for a truck-driving job with a
trucking firm. Assume that the applicant has been previously arrested and convicted three times for driving
while intoxicated and has also served a prison term for drunk driving. If the driver is hired and then kills
several passengers in another vehicle because he or she is drunk, the liability exposure to the firm would be
enormous. This type of exposure can be avoided by not hiring the aplicant.
Administering The Risk Management Program
We have examined three of the four management functions at this point. Let us examine the fourth and final
function of the risk manager-administration of the program.
The Risk Manager’s Position
In most large corporations, the risk manager is fairly high in the organisational structure, and, in most cases,
he or she is at least at the middle management level.
Common activities of the risk managers included loss exposure identification and measurement,
arrangement of insurance handling claims, design and installation of employee benefit plans, participation in
loss control measures, safety, group insurance, and self-insurance administration. It is apparent from these
activities that the risk manager is considered an important part of the management team.
Policy Statement
A risk management policy statement is necessary in order to have effective administration of the risk
management program. 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 in 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.
In addition, a risk management manual may be developed and used in the program. The manual describes in
some detail the risk management program of the firm and can be a very useful tool for training new
employees who will be participating in the programme. Writing such a manual also forces the risk manager
to state precisely his or her responsibilities, objectives, and available techiniques.
Cooperation with Other Departments
The risk manager does not work in isolation. Other functional departments within the firm are extremely
importnat in identifying pure loss exposures and methods for treating these exposures. These departments
can cooperate in the risk management process in the following ways:
1. Accounting: Internal accounting controls can reduce employee fraud and theft of cash.
2. Finance: Information can be provided showing how losses can disrupt profits and cash flow and the
impact that losses will have on the firm’s balance sheet and income statement.
3. Marketing: Accurate Packaging can prevent liability lawsuits. Safe distribution procedures can
prevent accidents.
4. Production: Quality control can prevent production of defective goods and so prevent ability
lawsuits. Adequate safety in the plant can reduce accidents.
5. Personnel: This department may be responsible for employee benefit programs, and safety programs.
This list indicates how the risk management process involves the entire firm. Indeed, without the active
cooperation of the other departments, the risk management programme will be a failure.
Periodic Review
To be effective, the risk management program may be periodically reviewed. In particular, those activities
relating to risk management costs, safety programs, and loss prevention must be carefully monitored. Loss
records must also be examined to deal with any changes in frequency and severity. Any new developments
that affect the original decision on handling a loss exposure must also be examined. Finally the risk manager
must determine if the firm’s risk management policies are being carried out and if he or she is receiving the
total cooperation of other departments in carrying out the risk management functions.

Lecture 32
PROFESSIONAL LIABILITY COVER
Apart from managing the risk associated with physical properties of the company mentioned above, the
company has to take care of the risks arising to the company as a result of legal proceedings that may be
taken against senior officials or directors of the company.
The Companies Amendment Act 2000 has put the position of Directors in very awkward legal or corporate
wrangles, that involve immediate heavy financial implications at the personnel level. Several joint stock
companies (especially the Information Technology companies) are interested in taking insurance cover for
their senior officials who constantly handle high voltage issues, where heavy damage claims may be
demanded for slips not made or even some which were entirely inadvertent. (Recall that Arun Jain,
Chairman and Managing Director of Polaris Software Limited was taken into police custody in December,
2002 at Jakarta, on the ground that the software supplied by the company adversely affected a banker client
in Jakarta.)
Top executives have often been hit hard by scams. The ITC or the Shaw Wallace incidents involving alleged
violation of certain laws of the land had seen senior most corporate executives hauled and even put behind
bars.
Insurers agree that these policies were not very popular earlier. But now in the new economic environment,
the imperatives have changed. Management is, therefore, compelled to think and act differently. Providing
maximum protection, both legal and financial, has also become crucial to retain top talent within the
companies.
Earlier Key-man insurance policies were common to provide for the contingency of key personnel leaving
the organisation and the consequent disruption and loss to the companies work. Now professional liability
insurance for the protection of officials continuing with the company against charges of omission and
commissions which have caused liability towards the third parties.
Public sector insurance companies have also strengthened their professional liability policies like the
directors and officer’s liability policy. Insurance personals have also started to brush up their knowledge
about the various provisions and safety features of these policies. If a liability occurs despite the officer’s
best of intensions, then the policy would offer him total financial safety.
Directors’ and officers’ Liability Policy
Directors’ and Officers’ Liability Policy. Directors and officers of companies hold position of trust and they
have responsibility to their company, the shareholder, the employees, the public at large etc. They may
become liable to pay damages for wrongful acts such as failure of supervision of the affairs of the company.
Company directors are facing increasingly onerous responsibilities, as shareholders demand higher
standards of corporate governance.
Apart from common law responsibilities, the duties of directors under the Companies Act relate to prudent
management. These duties can be delegated to the members of management. Specific duties may also be
expressed in the Articles of Association.
Thus, directors and officers may be liable to:
a. Employees, e.g. for unfair dismissal.
b. Shareholders, e.g. for imprudent expansions or loans or investment.
c. Creditors, e.g. for misrepresentation of financial conditions.
d. Members of the public, e.g. for financial loss following reliance on incorrect or inadequate or
negligent statement of financial condition etc.
The policy is therefore, designed to provide protection to directors and officers of a company against their
personal liability for financial losses arising out wrongful acts or omission in their capacity as directors or
officers.
Coverage
What the policy covers will be clear if the following definition in the policy are understood first;
‘Loss’ shall mean legal liability of the directors or officers to pay damages or costs awarded against them
and costs and expenses incurred by the directors or Officers with the written consent of underwriters in
respect of investigation, defense or settlement of any claim.
A wrongful Act shall mean actual or alleged breach of duty, breach of trust, neglect, misstatement,
misleading statement, omission, and breach of warranty of authority or other act done or wrongly attempted
by any Director or Officers.
Claims shall mean
Any writ or summons issued against or served upon any directors or officers for any Wrongful Act, or,
Any written communication alleging a wrongful Act communicated to any Director or Officer.
There are two insured’s under the policy-The Directors and Officers of the company and the Company
itself. The coverage is granted in two parts.
The insurance clause provides: “Underwriters agree, subject to the terms, conditions, limitations and
exclusions of the policy to:
Pay on behalf of the Directors or Officers of the company Loss arising from any claim first made against
them during the period of insurance and notified to Underwriters during the period of insurance by reason of
any Wrongful Act committed in the capacity of Directors or Officers of the company except for to the extent
that the company has indemnified the Directors or Officers.
Pay on behalf of the company Loss arising from any claim first made against the Directors or Officers
during the period of insurance and notified to underwriters during the period of insurance by reason of any
Wrongful Act committed when and to the extent that the company shall be required or permitted to
indemnify the Directors or Officers pursuant to the law, common or statutory, or the Memorandum and
Articles of Association.”
Coverage under (2) is known as company reimbursement provision. The company may have to indemnify
its directors and officers for litigation in respect of the latter’s breach of duty etc. in the conduct of the
company’s affairs, if such an obligation is expressly mentioned in the Company’s Articles of Association or
in an agreement between the company and the concerned director or officers.
Exclusions
Some important exclusions are as follows. The clause provides that underwriter shall not pay any loss
arising from any claim:-
Where legal action or litigation is brought in a court of law within the Excluded Territories stated in the
Schedule.
To the extent that an indemnity or payment is available from any source, other than this policy.
For any actual or alleged bodily injury, sickness, disease or death of any person or any tangible property,
including loss of use thereof. (This is a subject matter of public liability policy)
Arising out of, any actual or alleged seepage, pollution or contamination of any kind, provided, however,
that underwriters shall lay on behalf of the Directors and Officers, Cost and Expenses incurred in any
investigation, examination, inquiry, court of law or other proceedings ordered or commissioned in the first
instance by any official body within the United Kingdom of Great Britain, Northern Island, the Isle of Man
or the channel Islands in respect of any Wrong Act.
However, Underwriters total aggregate liability under (d) hereof shall not exceed, in all for the Period of
Insurance which amount is part of, and not in addition to, the limit of Aggregate Liability.
Brought about by any dishonesty, fraud or malicious conduct of the Directors or Officers shall pay on behalf
of directors or Officers: Cost and Expenses incurred in successfully defending proceedings brought in
respect of such Wrongful Act.
Brought about by any Director or Officer gaining any profit or advantage or receiving any remuneration to
which he/she was not legally entitled
Made by any third party based upon breach of any professional duty owed to such third party. (This is a
subject matter of a professional indemnity policy).
Brought about by any circumstances existing prior to or at the inception date of this policy and which the
directors or officers or the company knew or ought reasonably to have known could give rise to a claim.
For tax or fines or penalties or punitive or exemplary or multiple damages or any claim deemed uninsurable
under law.
Based upon any failure or omission on the part of any Directors or Officers to effect and maintain insurance
for or on behalf of the company.
Based upon, actual or alleged libel, slander, infringement of copyright, infringement of patent (separate
policies can be availed of)
Directly, resulting from goods or products manufactured or sold or supplied by the company (this is a
subject-matter of products liability policy).