Book-PrinciplesofInsurance.pdf

PRINCIPLES OF INSURANCE ISBN : 978-81-953729-4-2 UNIT I Origin of insurance – Definitions of Risk, Peril, Hazard – Methods of treating risk – Types of insurance organizations. Main forms of insurance –...

PRINCIPLES OF INSURANCE ISBN : 978-81-953729-4-2 UNIT I Origin of insurance – Definitions of Risk, Peril, Hazard – Methods of treating risk – Types of insurance organizations. Main forms of insurance – Essentials of a sound insurance plan – Contract of insurance – Classification of insurance - Contracts – Personal, property, liability, and guarantee Fundamental principles – good – faith, insurable interest, indemnity, subrogation, double insurance, reinsurance – Functions and importance of insurance. History of Insurance: Insurance probably made a beginning in the ancient land of Babylonia in the 18th century B.C., Babylonia king Hammurabi developed a code of law, known as the Code of Hammurabi, which codified many specific rules governing the practices of early risk-sharing activities. For instance, the code dictated that traders had to repay merchants who financed trading voyages unless thieves stole goods in transit, in which case debts would be cancelled. This was similar to the system of insurance known as bottomry which existed in Phoenicia in 1200 B. C. In this system, backers loaned money to 56 merchants to finance voyage. Merchants offered their ships (the hull was known as the ship's bottom') as collateral for such loans. When a trip succeeded, the merchant would pay the trip's backer the original loan plus interest, the equivalent of a premium. If a ship went down on its voyage, the trip's backer would cancel the merchant's loan. Insurance as we know it today took its shape in 17th century England. The policy of life of William Gybbons on June 18, 1633 was the first recorded evidence. In 1871, Lloyd's Act was passed incorporating the members of the association into a single corporate body with perpetual succession and corporate seal. Today, Lloyd's has become the world's best known insurance brand. It is commonly misunderstood that Lloyd's is an insurance company. History of India's Insurance Business: In "Rigiveda" we find the term "Yogakshema Bahamayam" which is more or less akin to the well being and security of people. This makes it clear that the traces of sharing the future losses were available even in ancient India'. This suggests that a form of "community insurance" was prevalent around 1000 BC and practiced by the Aryans. Life insurance was first set up in India OF BY AND FOR YOU PUBLICATION Page | 1 PRINCIPLES OF INSURANCE ISBN : 978-81-953729-4-2 through a British company called the Oriental Life Insurance company in 1818 followed by the Bombay Assurance company in 1823, the Madras Equitable Life Insurance Society in 1829, the Bombay Mutual Life Assurance Society 1871 and the Oriental Life Assurance Company in 1874. All of these companies operated in India but did not insure the lives of Indians. They were insuring the lives of Europeans living in India. The first General Insurance Company viz., Triton Insurance Co. Ltd., was established in Calcutta in 1850 whose shares were held mainly by the Britishers. Insurance business was conducted in India without any specific regulation for the insurance business. They were subject to Indian companies Act l866. After the start of the "Be Indian Buy Indian Movement" (called Swadeshi Movement) in 1905, indigenous enterprises sprang up in many 58 industries. Not surprisingly, the Movement also touched the insurance industry leading to the formation of dozens of life insurance companies along with provident fund companies (provident fund companies are pension funds). The first indigenous general insurance company was the Indian Mercantile Insurance company Limited set up in Bombay in 1907. The birth of the Insurance Act 1938: In 1937, the Government of India set up a consultative committee. Mr. Sushil C. Sen, a well known solicitor of Calcutta, was appointed the chair of the committee. He consulted a wide range of interested parties including the industry. It was debated in the Legislative Assembly. Finally, in 1938, the Insurance Act was passed. Nationalization of Insurance in India: The Finance Minster C. D. Deshmukh announced nationalization of the life insurance business in 1956. Life insurance business was nationalized on 19th January 1956. The Government brought together life insurers under one nationalized monopoly corporation and Life Insurance Corporation (LIC) of India was born. At that time there were 154 Indian life insurance companies. In addition there were 16 non-Indian companies and 75 provident societies issuing life insurance policies. Most of these companies were centered in the metropolitan areas like Bombay, Calcutta, Delhi and Madras. What Is Insurance? OF BY AND FOR YOU PUBLICATION Page | 2 PRINCIPLES OF INSURANCE ISBN : 978-81-953729-4-2 Insurance is a contract, represented by a policy, in which an individual or entity receives financial protection or reimbursement against losses from an insurance company. The company pools client’s risks to make payments more affordable for the insured. Definition A promise of compensation for specific potential future losses in exchange for a periodic payment. Insurance is designed to protect the financial well-being of an individual, company or other entity in the case of unexpected loss. Some forms of insurance are required by law, while others are optional. Agreeing to the terms of an insurance policy creates a contract between the insured and the insurer. In exchange for payments from the insured (called premiums), the insurer agrees to pay the policy holder a sum of money upon the occurrence of a specific event. How Insurance Works ? There is a multitude of different types of insurance policies available, and virtually any individual or business can find an insurance company willing to insure them—for a price. The most common types of personal insurance policies are auto, health, homeowners, and life. Most individuals in the United States have at least one of these types of insurance, and car insurance is required by law. Businesses require special types of insurance policies that insure against specific types of risks faced by a particular business. For example, a fast-food restaurant needs a policy that covers damage or injury that occurs as a result of cooking with a deep fryer. An auto dealer is not subject to this type of risk but does require coverage for damage or injury that could occur during test drives. Peril, risk, and hazard Peril, risk, and hazard are three words used frequently in my business. And according to the Oxford English Dictionary, they have very similar definitions: Peril: Serious and immediate danger. Risk: Situation involving exposure to danger. Hazard: Danger or risk. OF BY AND FOR YOU PUBLICATION Page | 3 PRINCIPLES OF INSURANCE ISBN : 978-81-953729-4-2 You could get away with interchanging these words in day-to-day conversation. But in insurance and financial circles, they each have a distinct meaning and it’s important to understand their differences. Consider the same words as defined by the Glossary of Insurance and Risk Management Terms: Peril: Cause of loss. Risk: Uncertainty arising from the possible occurrence of given events that would result in loss with no opportunity for gain. Hazard: Condition that increases the probability of loss. To summarize: hazards increase the risk of a specific peril. The distinction is important because in modeling there is a difference between modeling risk and modeling a peril. Hazards are built into all models as a modifier to the chance of something happening. Risk models for natural catastrophes (flood, wind, wildfire, earthquake, etc.) generally model the chances of something happening, but also the financial ramifications of that something. That financial component makes them “risk” models because risk is measured in costs. Modeling the perils themselves is a way to understand the likelihood of that peril affecting a specific location. Peril models are the first aspect of a cat model, but certain tools focus on the perils specifically. Some perils, especially flood, can be modeled with reliability if the right information is used for the model. By limiting the modeling to a peril, far fewer assumptions are needed – much of the input into a peril model is derived from direct measurements, historical records and science. There remains some work to be done with assumptions (as in any model), but the results of peril models are much less prone to errors caused by surprises (i.e. bad assumptions) than risk models. To ensure a little bit more confusion, and to close the triangle, these peril-focused models are called “hazard models”. OF BY AND FOR YOU PUBLICATION Page | 4 PRINCIPLES OF INSURANCE ISBN : 978-81-953729-4-2 There are distinct uses and purposes for risk models and for hazard (peril) models, and it’s important to understand which tool is the right for the job. Cat models are used widely and wisely throughout the insurance industry, but they are not always the right solution. To know which tool is needed, remember the difference between risk and peril, and that peril models are called hazard models. A risk treatment plan explains the action plan for each identified risk. Note that it is not possible to identify all the risks associated with any project. Some risks are unexpected and need to be managed based on the immediate assessment of the risk. For identified risks, there are four methods of treatment: Avoidance - Avoid the risk partially or in whole Reduction - Employing methods to reduce the negative impacts of risks Sharing - Sharing/outsourcing the risk component to a third party that is better equipped to handle such risks Retention - Acceptance of the risk, normally in cases where the gains from the risk component are far higher than the negative impacts of the risk Types of Risk The various types of risks present on life can be classified under two major categories which are: I. Insurable Risk II. Uninsurable Risk I. Insurable Risk: An insurable risk is one which can be insured on standard terms and conditions or otherwise. Insurable risk can further be divided in three categories: (a) Standard Risk: This type of risk is also known as formal or average risk. In insurance, the dictionary meaning of the word” standard” is an insurance written on a basis of the regular mortality and underwriting assumption used by the company. Each company lays down its own criterion on the business of which a person proposing for life insurance is judged as a normal or standard risk. It is to be noted, however, that normal or standard risk does not mean that the life is an ideal one or is of an average man but it refers to a group to which the great majority of applicants may be assigned. (b) Sub-standard Risk: It is also known as “under average risk”, “Impaired life” or “C- category life”. It lies in between the standards and uninsurable risk. It has been defined as OF BY AND FOR YOU PUBLICATION Page | 5 PRINCIPLES OF INSURANCE ISBN : 978-81-953729-4-2 those risks which do not meet the standards set for insurance at regular rates and are below standard at “mortality risk”. In fact, these are neither so good as in the standard category nor are they so bad as to be out rightly rejected. These risk carry a degree of risk above the maximum limit of thee standard class and are usually insurable for an additional amount of premium, because the mortality rates are higher than assumed in the calculation of their premiums. A substandard risk is again classified into the following: i. Constant Extra-Risk: A risk which remains constant throughout the policy term comes under this category as for example blindness, deafness or loss of teeth. ii. Increasing Extra-Risk: A risk which increase with the increase in age comes under this category as for example, patients of diabetes, high blood pressure and overweight. iii. Decreasing Extra-Risk: A risk which tends to decrease due to increase in age as for example, person of defective past history. (c) Super standard Risk: A super standard risk is one which is above the standard and presents almost no risk. This is also known as preferred risk. Generally, the insurer does not prefer to issues preferred risk policies as it increases the premium in other standard risk which may cause reduction in loss of business. II Uninsurable of Risk: It refers to those lives where the mortality rate is so high as to make the premium for the assured completely prohibitive or to make the insurer feel that the risk is almost a certainty rather than a probability in that individual case, Proposals of such lives are altogether rejected by the insurance companies: For example, proposal received from person who are suffering from cancer or serious heart ailment or tuberculosis of the last stage where the death is sure to happen in near future would be the uninsurable risk. Methods of Risk Classification Risk can be classified through following two methods: (i) Judgment or Assessment method: here, the insurer studies all the features of the life to be insured based on the material information placed before him, draws a mental picture and brings into play all his knowledge and experience to determine terms of acceptance of the risk. The company has to depend upon the combined judgment of those in the medical, actuarial, and other departments who are qualified for this work. OF BY AND FOR YOU PUBLICATION Page | 6 PRINCIPLES OF INSURANCE ISBN : 978-81-953729-4-2 The judgment method functions effectively when there is only one unfavourable factor to consider or where the decision is simply either to accept the application at standard rates or reject it entirely. Where multiple factors are involved or a proper substandard classification needed, this method is not found useful. It also requires the use of highly skilled personnel for proper risk appraisal. The method also cannot ensure uniformity in the decisions by the same persons at the same or different times. Besides it is a time consuming process. To overcome the weaknesses of this method, life insurance companies evolved the other method viz., Numerical Rating method. (ii) Numerical Rating method: under this method, each factor of insurability is compared with medico actuarially prepared standard and deviations are measured in terms of extra debit or credit points. Adverse features attract debut points while favourable ones are given credit points. The sum total of debit ratings of all ‘factors’ give the extra mortality of a particular life (risk). Thereafter total extra mortality ratings are matched with standard charts and converted into monetary value which is called the extra premium. It is on the basis of numerical ratings that underwriter classifies the risk and decides the terms of acceptance of risks. Types of insurance organizations are; 1. Self-Insurance, 2. Individual Insurer, 3. Partnership, 4. Joint Stock Companies, 5. Mutual Companies, 6. Co-Operative Insurance Organization, 7. Lloyd’s Association, 8. State Insurance. 1. Self-Insurance The plan by which an individual or concern sets up a private fund out of which to pay losses is termed “self-insurance”. The person lays aside periodically certain sum to meet the losses of any contemplated risk. While it may be called “self-insurance”, it is not, as a matter of fact, insurance OF BY AND FOR YOU PUBLICATION Page | 7 PRINCIPLES OF INSURANCE ISBN : 978-81-953729-4-2 at all because there is no hedge, no shifting or distributing of the burden of risk among larger persons. It is merely a provision for meeting the contingency. Here the insured becomes his own insurer for the particular risk. But, it can be successfully worked only when there is a wide distribution of risks subject to the same hazard, it may be lesser expensive, provided the amount of loss is tremendous. The fund, as it accumulates, belongs to the insured and he can invest it as he may deem prudent. He pays no commission to agents, no extra expenses for maintaining office. So, on the one hand, the return on an investment will be higher and on the other, the cost of operation will be lesser. The self-insurance will be successfully operated where; 1. There are several properties such as machine, motor vehicle, house factories, etc., 2. The properties or units are widely distributed, 3. These are under the influence of varied risks, and; 4. The risks are greater at one place and lesser at another place. 2. Individual Insurer An individual like other business can perform the business of insurer provided he has sufficient resources and talent of the insurance business. The individual organization has been rare in the field of insurance. 3. Partnership A partnership firm can also carry on the insurance business for the sake of profit. Since it is not an entity distinct from the persons composing it, the personal liability of partners in respect of the partnership debts is unlimited. In case of huge loss, the partners have to pay from their own personal funds and it will not be profitable for them to start an insurance business. In the early period before the advent of joint stock companies, many insurance undertakings were a partnership or unincorporated companies. They were constituted by deed of partnerships which regulated the business. Before the formation of joint-stock companies, the crown had empowered to grant application letters patent to such unincorporated companies to operate the business with limited liabilities. Sometimes, the policy-holders were permitted to share the management of the concern. These forms of insurance had been completely disappeared with the advent of joint stock companies. 4. Joint Stock Companies OF BY AND FOR YOU PUBLICATION Page | 8 PRINCIPLES OF INSURANCE ISBN : 978-81-953729-4-2 The joint stock companies are those which are organized by the shareholders who subscribe the necessary capital to start the business, are formed for earning profits for the stockholders who are the real owners of the companies. The management of a company is entrusted to a board of directors who are elected by the shareholders from among themselves. The company can operate insurance business and the policy-holders have nothing to do with die management of the concern. But, in life insurance, it is the practice to share a certain portion of profit among the certain policy-holders. The participating policy-holders are getting the bonus. Before nationalization, according to insurance act, 1938, the policy-holders had a right to elect their representatives to the board of directors to the extent of one-fourth of the total number of directors of the company. The provision enabled the policy-holders to have an effective voice in the management of the company. Most of the insurance businesses were done on a joint stock basis before nationalization. They were operating within the memorandum of association and articles of association framed by them. 5. Mutual Companies The mutual companies were co-operative associations formed for the purpose of effecting insurance on the property of its members. The policy-holders were themselves the shareholders of the companies, each member was insurer as well as insured. They had the power to participate in, management and in profit to the full extent. Whenever the income was more than the expenses and claims, it was accumulated in the form of saving and was entitled to reducing the rate of premium. Since the insured were insurers also, they always tried to reduce the management expenses and to keep the business at a sound level. The theoretical base of the mutual companies is issuing of participating policies, i.e., the policyholders had full power in management and profit, whereas the joint-stock companies, strictly were to issue non-participating policies. But, in practice, the joint-stock companies were also issuing participating policies. It made them mixed companies i.e., where the features of joint stock companies and of mutual companies were present. 6. Co-Operative Insurance Organization Co-operative insurance organizations are those concerns which are incorporated and registered under co-operative societies act. The concerns are also called ‘co-operative insurance societies’. These societies like mutual companies are a non-profit organization. The aim is to provide insurance protection to its members at the lowest reasonable price. 7. Lloyd’s Association OF BY AND FOR YOU PUBLICATION Page | 9 PRINCIPLES OF INSURANCE ISBN : 978-81-953729-4-2 Lloyd’s association is one of the greatest insurance institutions in the world. Taking its name from the coffee house of Edward Lloyd; where underwriters assembled to transact business and pick-up news, the organization traces its origin to the latter part of the seventeenth century. So, it is the oldest insurance organization in existing form in the world. In 1871, Lloyd’s act was passed incorporating the members of the association into a single corporate body with perpetual succession and a corporate seal. The power of Lloyd’s corporation was extended from the business of marine insurance to other insurances and guarantee business. The Lloyd’s association is an association of individual insurers known as ‘underwriters’. They are also termed as ‘syndicates’ or ‘names’. Any insurer who wants to become a member of such association has to deposit a certain fee as security for the regular payment of his liabilities. The association before enrolling the insurer as a member of the association will inquire about the financial position of the concern, business reputation, and experience. On satisfactory proof, the association admits him in the association. 8. State Insurance The government of a nation sometimes owns the insurance and runs the business for the benefit of the public. The state insurance is defined as that insurance which is under the public sector put more; specifically it can be stated that when governments have taken over the insurance business particularly life insurance. France had nationalized larger insurance companies in 1946. In Brazil, Japan and Mexico, the insurances are largely nationalized. Previously, the state undertook only those insurances which were regarded to be very vital for the public interest or where private companies were not able or willing to enter the field of insurance. Social security, unemployment, crop insurance, war risk insurance, export credit insurance, aero-plane insurance were generally understate insurance. In India, the life insurance business was nationalized in 1956 and the general insurances were nationalized in 1971. Thus, the insurance business in India, today, is under the control and ownership of the central government although they are in different forms of insurances. Main forms of Insurance: In life, unplanned expenses are a bitter truth. Even when you think that you are financially secure, a sudden or unforeseen expenditure can significantly hamper this security. Depending on the extent of the emergency, such instances may also leave you debt-ridden. OF BY AND FOR YOU PUBLICATION Page | 10 PRINCIPLES OF INSURANCE ISBN : 978-81-953729-4-2 While you cannot plan ahead for contingencies arising from such incidents, insurance policies offer a semblance of support to minimize financial liability from unforeseen occurrences. There is a wide range of insurance policies, each aimed at safeguarding certain aspects of your health or assets. Broadly, there are 8 types of insurance, namely: Life Insurance Motor insurance Health insurance Travel insurance Property insurance Mobile insurance Cycle insurance Bite-size insurance Simply knowing the various insurance policies does not help. Instead, you must know how each of these plans work. Without adequate knowledge about each of them, you may not be able to protect your finances, as well as the financial well-being of your family members. Read on to learn all you need to know about the various insurance policies. Experts view that following are the essential requirements of a sound compensation plan: 1. It is simple: Simplicity is the fundamental principle of a sound sales compensation plan. Salesmen suspect any plan that they do not understand, totally and this weakens their confidence and lowers their morale. That is ‘ why, the plan of compensation must be simple to calculate and easy to understand. 2. It is adequate: A sound plan generates enough compensation for the salesmen to maintain a decent standard of living in the line. Salesmen must be allowed to earn enough to meet their obligations to save for the future. The factors like cost of living, minimum standard of living, capacity, age, education, experience etc., are to be taken into account. A critical analysis of compensation plans a good way-out in fixing adequate compensation for the employees. OF BY AND FOR YOU PUBLICATION Page | 11 PRINCIPLES OF INSURANCE ISBN : 978-81-953729-4-2 3. It is flexible: The compensation plan so designed must be capable of being adapted to varying selling conditions that are subject to change. The plan should be adjustable to the differing nature of salesmen, territories, products, compensation present in any sales territory and the like. A supple plan is one that works well both in bad and good times. 4. It is fair and equitable: To win the hearts of salesmen their beating cooperation and lasting loyalty, the compensation plan should be fair and equitable to one and all. Discrimination and partial treatment are the costly mistakes for which the sales management will have to pay heavily in intangible terms. The sales-force is quite keen and sensitive to these things of ill-treatment, discrimination, inequality, partiality and so on. No equally qualified and experienced persons are paid differently. 5. It is economical: The purpose of sound compensation plan is to increase the sales and the profits at least cost. Decreasing cost per unit, lower expense and higher profit margin on unit and total sales is the aim, in effect. The earnings of salesmen must be kept in kilt as such remuneration is one of the expenses. As per the experts view, such expense should not go beyond 5 to 15 per cent of the total sales value. 6. It is easy to administer: Administrative ease implies reduction in the complications, time consumed in accounting department, paper work involved. To provide this much desired administrative ease, easy and realistic compensation plans are to be devised and implemented. Complicated plans demonstrate mathematical excellence but have problems of red-tape and error-proneness. OF BY AND FOR YOU PUBLICATION Page | 12 PRINCIPLES OF INSURANCE ISBN : 978-81-953729-4-2 7. It is incentive oriented: It must keep employees spurred. Monetary and non-monetary rewards for extra efforts put in are really nice stimuli that propel the salesmen to new heights of performance. Additional compensation, over and above normal earning, results in increased sales and profits. This goes to distinguish between the efficient and the inefficient salesmen and improves overall performance well above the normal efforts put in by the sales-force. 8. It is timely: Any compensation plan, however adequate, attractive and fair and equitable, is bound to lose its weight, if the payment is not made within the expected time. Salesmen work for money but money is to be received at a point of time to which they are committed. Thus, the payments can be fort-nightly, monthly and the bonuses yearly or terminally. Money earned has value if it is received in the nick of the time. What is Insurance Contract? An Insurance Contract may be defined as an agreement between two parties whereby one party is called an insurer and the other is called insured. The Insurer which is the Insurance Company undertakes, in exchange of fixed premium to pay the Insured fixed amount of money on the happening of a certain event. As per the Insurance Act, 1938 Section 2(8) : ‘Insurance Company’ means any insurer being a company, association or partnership which may be wound up under 18 [the Companies Act, 1956 (1 of 1956)], or to which the Indian Partnership Act, 1932 (9 of 1932), applies; Section 2(9) : ‘Insurer’ means any individual or unincorporated body of individuals or body corporate incorporated under the law of any country carrying on Insurance business. Any Agreement can be termed as Contract if it has the essentials of a valid contract specified under the Contracts Act, 1872 i.e. OF BY AND FOR YOU PUBLICATION Page | 13 PRINCIPLES OF INSURANCE ISBN : 978-81-953729-4-2 Offer and acceptance The Offer for entering into contract generally comes from Insured. In some cases offer comes from the Insurance Company also in the form of publication of prospectus, canvassing by Agents etc. So, it is clear that Offer can come from both the sides. The main element of acceptance should be there. The Insured has to accept the payment of premium of the sum assured/insured and the Insurance Company has to agree to pay the compensation in the event of loss occurred to the Insured during the period of contract. The insurance can be for Life or for property. Consideration Certain sum is charged as premium from the Insured and against the consideration, a large sum is guaranteed to be paid by the Insurer who received the premium. Insurance contracts are Unilateral contracts, where only the insurer makes legally enforceable promises to pay for covered losses. The Company cannot sue the Insured for breach of contract. However, Insurance contracts are also Conditional Contracts i.e. if the Insured fails to abide the contract, then the Insurer is not obligated to pay for any Insured’s losses. Competenet parties: The Section and Rules as applicable in case of General Contract Act, 1872 related to competent parties is applicable in case of Insurance Contract also. Say for example, both the parties to the contract must have attained the age of Majority and the Minor cannot sign the Insurance Contract. Both the parties should be of sound mind. Legal purpose All contracts must have a legal purpose to be enforceable by the courts i.e. the objects are not forbidden by law or are not immoral or opposed to public policy. If the object of Insurance, like the consideration, is found to be unlawful, the policy is said to be Void. Types of Insurance: Insurance Life General Insurance Insurance OF BY AND FOR YOU PUBLICATION Page | 14 Fire Marine Health Motor Insurace Insurance Insurance Insurance PRINCIPLES OF INSURANCE ISBN : 978-81-953729-4-2 There are two broad types of insurance: Life Insurance General Insurance 1. Life Insurance Life Insurance refers to a policy or cover whereby the policyholder can ensure financial freedom for his/her family members after death. Suppose you are the sole earning member in your family, supporting your spouse and children. In such an event, your death would financially devastate the whole family. Life insurance policies ensure that such a thing does not happen by providing financial assistance to your family in the event of your passing. Types of Life Insurance Policies There are primarily three types of insurance policies when it comes to life insurance. These are: Term Plan - The death benefit from a term plan is only available for a specified period, for instance, 40 years from the date of policy purchase. Endowment Plan - Endowment plans are life insurance policies where a portion of your premiums go toward the death benefit, while the remaining is invested by the insurance provider. Maturity benefits, death benefit and periodic bonuses are some types of assistance from endowment policies. Whole Life Insurance - As the name suggests, such policies offer life cover for the whole life of an individual, instead of a specified term. Some insurers may restrict the whole life insurance tenure to 100 years. Benefits of Life Insurance If you possess a life insurance plan, you can enjoy the following advantages from the policy. OF BY AND FOR YOU PUBLICATION Page | 15 PRINCIPLES OF INSURANCE ISBN : 978-81-953729-4-2 Tax Benefits - If you pay life insurance premiums, you are eligible for tax benefits in India, under Section 80(C) and 10(10D) of the Income Tax Act. Thus, you can save a substantial sum of money as taxes by opting for a life insurance plan. Encourages Saving Habit - Since you need to pay policy premiums, buying such an insurance policy promotes the habit of saving money. Secures Family’s Financial Future - The policy ensures your family’s financial independence is maintained even after your demise. Helps Plan Your Retirement - Certain life insurance policies also act as investment options. For instance, pension plans offer a lump-sum payout as soon as you retire, helping you to fund your retirement. Now that you know all about life insurance policies read on to understand the various facets of other general insurance policies. General Insurance: A general insurance is a contract that offers financial compensation on any loss other than death. It insures everything apart from life. A general insurance compensates you for financial loss due to liabilities related to your house, car, bike, health, travel, etc. The insurance company promises to pay you a sum assured to cover damages to your vehicle, medical treatments to cure health problems, losses due to theft or fire, or even financial problems during travel. Simply put, a general insurance offers financial protection for all your assets against loss, damage, theft, and other liabilities. It is different from life insurance. Types of General Insurance You can get almost anything and everything insured. But there are four key types available: 1. Fire Insurance 2. Marine Insurance 3. Health Insurance 4. Motor Insurance Fire Insurance OF BY AND FOR YOU PUBLICATION Page | 16 PRINCIPLES OF INSURANCE ISBN : 978-81-953729-4-2 Fire insurance pays or compensates for the damages caused to your property or goods due to fire. It covers the replacement, reconstruction or repair expenses of the insured property as well as the surrounding structures. It also covers the damages caused to a third-party property due to fire. In addition to these, it takes care of the expenses of those whose livelihood has been affected due to fire. Types of fire insurance Some of the common types are: The insurer firsts value the property and then undertakes to pay Valued policy compensation up to that value in the case of loss or damage. Floating policy It covers the damages to properties lying at different places. This is known as an all-in-one policy. It has a wide coverage and Comprehensive policy includes damages due to fire, theft, burglary, etc. This covers you for a specific amount which is less than the real value Specific policy of the property. (ii) Marine Insurance Marine insurance is an agreement (contract) by which the insurance company (also known as underwriter) agrees to indemnify the owner of a ship or cargo against risks, which are incidental to marine adventures. It also includes insurance of the risk of loss of freight due on the cargo. Marine insurance that covers the risk of loss of cargo by storm known as cargo insurance. The owner of the ship may insure it against loss on account of perils of the sea. When the ship is the subject matter of insurance, it is known as hull insurance. Further, where freight is payable by the owner of cargo on safe delivery at the port of destination, the shipping company may insure the risk of loss of freight if the cargo is damaged or lost. Such a marine insurance is known as freight insurance. All marine insurance contracts are contracts of indemnity. The followings are the different types of marine insurance policies OF BY AND FOR YOU PUBLICATION Page | 17 PRINCIPLES OF INSURANCE ISBN : 978-81-953729-4-2 (a) Time Policy – This policy insures the subject matter for specified period of time, usually for one year. It is generally used for hull insurance or for cargo when small quantities are insured. (b) Voyage Policy - This is intended for a particular voyage, without any consideration for time. It is used mostly for cargo insurance. (c) Mixed Policy – Under this policy the subject matter (hull, for example) is insured on a particular voyage for a specified period of time. Thus, a ship may be insured for a voyage between Mumbai and Colombo for a period of 6 months under a mixed policy. (d) Floating Policy - Under this policy, a cargo policy may be taken for a round sum and whenever some cargo is shipped the insurance company declares its value and the total value of the policy is reduced by that amount. Such shipments may continue until the total value of the policy is exhausted. (iii) Health Insurance Health insurance refers to a type of general insurance, which provides financial assistance to policyholders when they are admitted to hospitals for treatment. Additionally, some plans also cover the cost of treatment undertaken at home, prior to a hospitalisation or after discharge from the same. With the rising medical inflation in India, buying health insurance has become a necessity. However, before proceeding with your purchase, consider the various types of health insurance plans available in India. Types of Health Insurance policies There are eight main types of health insurance policies available in India. They are: Individual Health Insurance - These are healthcare plans that offer medical cover to just one policyholder. Family Floater Insurance - These policies allow you to avail health insurance for your entire family without needing to buy separate plans for each member. Generally, husband, wife and two of their children are allowed health cover under one such family floater policy. Critical Illness Cover - These are specialised health plans that provide extensive financial assistance when the policyholder is diagnosed with specific, chronic illnesses. OF BY AND FOR YOU PUBLICATION Page | 18 PRINCIPLES OF INSURANCE ISBN : 978-81-953729-4-2 These plans provide a lump-sum payout after such a diagnosis, unlike typical health insurance policies. Senior Citizen Health Insurance - As the name suggests, these policies specifically cater to individuals aged 60 years and beyond. Group Health Insurance - Such policies are generally offered to employees of an organisation or company. They are designed in such a way that older beneficiaries can be removed, and fresh beneficiaries can be added, as per the company’s employee retention capability. Maternity Health Insurance - These policies cover medical expenses during pre-natal, post-natal and delivery stages. It covers both the mother as well as her newborn. Personal Accident Insurance - These medical insurance policies only cover financial liability from injuries, disability or death arising due to accidents. (iv) Motor Insurance Motor insurance refers to policies that offer financial assistance in the event of accidents involving your car or bike. Motor insurance can be availed for three categories of motorized vehicles, including: Car Insurance - Personally owned four-wheeler vehicles are covered under such a policy. Two-wheeler Insurance - Personally owned two-wheeler vehicles, including bikes and scooters, are covered under these plans. Commercial Vehicle Insurance - If you own a vehicle that is used commercially, you need to avail insurance for the same. These policies ensure that your business automobiles stay in the best of shapes, reducing losses significantly. Types of Motor Insurance Policies Based on the extent of cover or protection offered, motor insurance policies are of three types, namely: Third-Party Liability - This is the most basic type of motor insurance cover in India. It is the minimum mandatory requirement for all motorised vehicle owners, as per the Motor Vehicles Act of 1988. Due to the limited financial assistance, premiums for such policies also tend to be low. These insurance plans only pay the financial liability to the third-party affected in the said mishap, ensuring that you do not face legal hassle due OF BY AND FOR YOU PUBLICATION Page | 19 PRINCIPLES OF INSURANCE ISBN : 978-81-953729-4-2 to the accident. They, however, do not offer any financial assistance to repair the policyholder’s vehicle after accidents. Comprehensive Cover - Compared to the third-party liability option, comprehensive insurance plans offer better protection and security. Apart from covering third party liabilities, these plans also cover the expenses incurred for repairing the damages to the policyholder’s own vehicle due to an accident. Additionally, comprehensive plans also offer a payout in case your vehicle sustains damage due to fire, man-made and natural calamities, riots and others such instances. Lastly, you can recover your bike’s cost if it gets stolen, when you have a comprehensive cover in place. One can also opt for several add-ons with their comprehensive motor insurance policy that can make it better- rounded. Some of these add-ons include zero depreciation cover, engine and gear-box protection cover, consumable cover, breakdown assistance, etc. Own Damage Cover - This is a specialised form of motor insurance, which insurance companies offer to consumers. Further, you are eligible to avail such a plan only if you purchased the two-wheeler or car after September 2018. The vehicle must be brand new and not a second-hand one. You should also remember that you can avail this standalone own damage cover only if you already have a third party liability motor insurance policy in place. With own damage cover, you basically receive the same benefits as a comprehensive policy without the third-party liability portion of the policy. (v) Other types of Insurance Apart from life, fire and marine insurance, general insurance companies can insure a variety of other risks through different policies. Some of these risks and the different policies are outlined below. Burglary Insurance: Under this insurance the insurance company undertakes to indemnify the insured against losses from burglary i.e., loss of moveable goods by robbery and theft by breaking the house. Floods - In certain parts of India, floods are common. These floods can ravage your property leading to substantial losses. Property insurance also protects against such events. Natural Calamities - The plan also offers financial aid against damage arising from earthquakes, storms and more. OF BY AND FOR YOU PUBLICATION Page | 20 PRINCIPLES OF INSURANCE ISBN : 978-81-953729-4-2 Rebuilding or renovation of a property is immensely expensive. Thus, property insurance policies are the best option to ensure long-term financial health. Mobile Insurance - Owing to the rising price of mobile phones and their several applications today, it has become imperative to insure the device. Mobile insurance allows you to reclaim money that you spend on repairing your phone in the event of accidental damage. Further, you can also claim the same in case of phone theft, making it easier to replace the handset with a new phone. Fidelity Insurance: As a protection against the risks of loss on account of embezzlement or defalcation of cash or misappropriation of goods by employees, businessmen may get policies issued covering the risks of loss on account of fraud and dishonesty on the part of employees handling cash or in charge of stores. This is called fidelity insurance policy. The employees may also be required to sign a fidelity guarantee Bond. Cycle Insurance Bicycles are valuable properties in India as some people rely on these vehicles for their daily commute. A cycle insurance policy ensures that you have access to necessary funds should your bicycle undergo accidental damage or theft. It saves your out of pocket expenses, while also ensuring immediate repairs to the vehicle. Bite-Size Insurance Bite-sized insurance policies refer to sachet insurance plans that minimise your financial liability for a very limited tenure, generally up to a year. These insurance plans allow you to protect your finances against specific damage or threats. For instance, particular bite-sized insurance may offer accidental cover of Rs. 1 Lakh for a year. You can choose this policy when you think you might be particularly susceptible to accidental injuries. Nature or Characteristics of Insurance On the basis of the definitions of insurance discussed above, one can observe the following nature or characteristics: 1. Contract OF BY AND FOR YOU PUBLICATION Page | 21 PRINCIPLES OF INSURANCE ISBN : 978-81-953729-4-2 Insurance is a contract between the insurance company and the policyholder wherein the policyholder (insured) makes an offer and the insurance company (insurer) accepts his offer. The contract of insurance is always made in writing. 2. Consideration Like other contracts, there must be lawful consideration in insurance also. The consideration is in the form of premium which the insured agrees to pay to the insurer. 3. Co-operative Device All for one and one for all is the basis for cooperation. The insurance is a system wherein large number of persons, exposed to a similar risk, are covered and the risk is spread over among the larger insurable public. Therefore, insurance is a social or cooperative method wherein losses of one is borne by the society. 4. Protection of financial risks An insurer is protected from financial risks which can be measured in terms of money. As such insurance compensates only financial or monetary loss or risks. 5. Risk sharing and risk transfer Insurance is a social device for division of financial losses which may fall on an individual or his family on the happening of some unforeseen events. When insured, the loss arising out of the events are shared by all the insured in the form of premium. Therefore the risk is transferred from one individual to a group. 6. Based upon certain principles The insurance is based upon certain principles like insurable interest, utmost good faith, indemnity, subrogation, causa-proxima, contribution, etc. 7. Regulated by Law Insurance companies are regulated by statutory laws in almost all the countries. In India, life insurance and general insurance are regulated by Life Insurance Corporation of India Act 1956, and General Insurance Business (Nationalization) Act 1972, and IRDA Regulations etc. 8. Value of Risk OF BY AND FOR YOU PUBLICATION Page | 22 PRINCIPLES OF INSURANCE ISBN : 978-81-953729-4-2 Before insuring the subject matter of the insurance contract, the risk is evaluated in order to determine the amount of premium to be charged on the insured. Several methods are being adopted to evaluate the risks involved in the subject matter. If there is an expectation of heavy loss, higher premiums will be charged. Hence, the probability of occurrence of loss is calculated at the time of insurance. 9. Payment at contingency An insurer is liable to pay compensation to the insureds only when certain contingencies arise. In life insurance, the contingency — the death or the expiry of the term will certainly occur. In such cases, the life insurer has to pay the assured sum. In other insurance contracts, the contingency — a fire accident or the marine perils, may or may not occur. So, if the contingency occurs, payment is made, otherwise no payment need to be made to the policyholders. 10. Insurance is not gambling An insurance contract cannot be considered as gambling as the person insured is assured of his loss indemnified only on the happening of such uncertain event as stipulated in the contract of insurance, whereas the game of gambling may either result into profit or loss. 11. Insurance is not a charity Premium collected from the policyholders under an insurance is the cost of risk so covered. Hence, it cannot be taken as charity. Charity lacks the element of contract of indemnity and compensation of loss to the person whosoever makes it. 12. Investment portfolio Since insurers’ liability to pay compensation to the insured arises on the happening of certain uncertain event, the insurers do not have to keep the collected premium with them. They invest the premium received in selected securities and earn interest and dividend on them. Thus, the insurers have two sources of income: the insurance premium and the investment income (i.e. interest / dividend) which occurs over time. Principles of Insurance As we discussed before, insurance is actually a form of contract. Hence there are certain principles that are important to ensure the validity of the contract. Both parties must abide by these principles. OF BY AND FOR YOU PUBLICATION Page | 23 PRINCIPLES OF INSURANCE ISBN : 978-81-953729-4-2 1] Utmost Good Faith A contract of insurance must be made based on utmost good faith. It is important that the insured disclose all relevant facts to the insurance company. Any facts that would increase his premium amount, or would cause any prudent insurer to reconsider the policy must be disclosed. If it is later discovered that some such fact was hidden by the insured, the insurer will be within his rights to void the insurance policy. 2] Insurable Interest This means that the insurer must have some pecuniary interest in the subject matter of the insurance. This means that the insurer need not necessarily be the owner of the insured property but he must have some vested interest in it. If the property is damaged the insurer must suffer from some financial losses. 3] Indemnity Protection Insurances like fire and marine insurance are contracts of indemnity. Here the insurer undertakes the responsibility of compensating the insured against any possible damage or loss that he may or may not suffer. Life insurance is not a contract of indemnity. 4] Subrogation This principle says that once the compensation has been paid, the right of ownership of the property will shift from the insured to the insurer. So the insured will not be able to make a profit from the damaged property or sell it. 5] Contribution This principle applies if there are more than one insurer. In such a case, the insurer can ask the other insurers to contribute their share of the compensation. If the insured claims full insurance from one insurer he loses his right to claim any amount from the other insurers. 6] Proximate Cause This principle states that the property is insured only against the incidents that are mentioned in the policy. In case the loss is due to more than one such peril, the one that is most effective in causing the damage is the cause to be considered. OF BY AND FOR YOU PUBLICATION Page | 24 PRINCIPLES OF INSURANCE ISBN : 978-81-953729-4-2 Components of Insurance Policy When choosing a policy, it is important to understand how insurance works. A firm understanding of these concepts goes a long way in helping you choose the policy that best suits your needs. There are three components (premium, policy limit, and deductible) to most insurance policies that are crucial. Premium: A policy's premium is its price, typically expressed as a monthly cost. The premium is determined by the insurer based on your or your business's risk profile, which may include creditworthiness. For example, if you own several expensive automobiles and have a history of reckless driving, you will likely pay more for an auto policy than someone with a single mid-range sedan and a perfect driving record. However, different insurers may charge different premiums for similar policies. So finding the price that is right for you requires some legwork. Policy Limit: The policy limit is the maximum amount an insurer will pay under a policy for a covered loss. Maximums may be set per period (e.g., annual or policy term), per loss or injury, or over the life of the policy, also known as the lifetime maximum. Typically, higher limits carry higher premiums. For a general life insurance policy, the maximum amount the insurer will pay is referred to as the face value, which is the amount paid to a beneficiary upon the death of the insured. Deductible: The deductible is a specific amount the policy-holder must pay out-of-pocket before the insurer pays a claim. Deductibles serve as deterrents to large volumes of small and insignificant claims. Deductibles can apply per-policy or per-claim depending on the insurer and the type of policy. Policies with very high deductibles are typically less expensive because the high out-of-pocket expense generally results in fewer small claims. Double insurance OF BY AND FOR YOU PUBLICATION Page | 25 PRINCIPLES OF INSURANCE ISBN : 978-81-953729-4-2 Double insurance arises where the same party is insured with two or more insurers in respect of the same interest on the same subject matter against the same risk and for the same period of time. 1. Same insured: There can be no double insurance unless at the time of the claim, the same person is entitled to benefit from each policy. 2. Same subject matter: It is not clear whether the policies must cover exactly the same property in its entirety or whether covering a substantial part of the property would suffice. What is important is that the subject matter in respect of which the claim is made is covered under both policies. 3. Same risk: Double insurance will only arise if a substantial part of the same risk is covered by both insurances. 4. Same interest: The policies must also cover the same interest. This is due to the fact that it is not the subject-matter of the insurance as such which is covered by the policy but the insured’s interest in it. There would therefore be no double insurance if two people who have different interest in the subject matter insure their own interest. 5. Same period of time: Finally, the periods of time within each of the policies’ terms during which the insured party is protected from the risk must be the same, or substantially the same. It must also be during that period of time that the event giving rise to the claim occurs. Reinsurance Reinsurance is also known as insurance for insurers or stop-loss insurance. Reinsurance is the practice whereby insurers transfer portions of their risk portfolios to other parties by some form of agreement to reduce the likelihood of paying a large obligation resulting from an insurance claim. The party that diversifies its insurance portfolio is known as the ceding party. The party that accepts a portion of the potential obligation in exchange for a share of the insurance premium is known as the reinsurer. OF BY AND FOR YOU PUBLICATION Page | 26 PRINCIPLES OF INSURANCE ISBN : 978-81-953729-4-2 Benefits of Reinsurance: By covering the insurer against accumulated individual commitments, reinsurance gives the insurer more security for its equity and solvency by increasing its ability to withstand the financial burden when unusual and major events occur. Through reinsurance, insurers may underwrite policies covering a larger quantity or volume of risk without excessively raising administrative costs to cover their solvency margins. In addition, reinsurance makes substantial liquid assets available to insurers in case of exceptional losses. Functions of an Insurance Company 1] Provides Reliability The main function of insurance is that eliminates the uncertainty of an unexpected and sudden financial loss. This is one of the biggest worries of a business. Instead of this uncertainty, it provides the certainty of regular payment i.e. the premium to be paid. 2] Protection Insurance does not reduce the risk of loss or damage that a company may suffer. But it provides a protection against such loss that a company may suffer. So at least the organization does not suffer financial losses that debilitate their daily functioning. 3] Pooling of Risk In insurance, all the policyholders pool their risks together. They all pay their premiums and if one of them suffers financial losses, then the payout comes from this fund. So the risk is shared between all of them. 4] Legal Requirements In a lot of cases getting some form of insurance is actually required by the law of the land. Like for example when goods are in freight, or when you open a public space getting fire insurance may be a mandatory requirement. So an insurance company will help us fulfill these requirements. 5] Capital Formation The pooled premiums of the policyholders help create a capital for the insurance company. This capital can then be invested in productive purposes that generate income for the company. OF BY AND FOR YOU PUBLICATION Page | 27 PRINCIPLES OF INSURANCE ISBN : 978-81-953729-4-2 Importance of Insurance Insurance has evolved as a process of safeguarding the interest of people from loss and uncertainty. It may be described as a social device to reduce or eliminate risk of loss to life and property. Insurance contributes a lot to the general economic growth of the society by provides stability to the functioning of process. The insurance industries develop financial institutions and reduce uncertainties by improving financial resources. 1. Provide safety and security: Insurance provide financial support and reduce uncertainties in business and human life. It provides safety and security against particular event. There is always a fear of sudden loss. Insurance provides a cover against any sudden loss. For example, in case of life insurance financial assistance is provided to the family of the insured on his death. In case of other insurance security is provided against the loss due to fire, marine, accidents etc. 2. Generates financial resources: Insurance generate funds by collecting premium. These funds are invested in government securities and stock. These funds are gainfully employed in industrial development of a country for generating more funds and utilised for the economic development of the country. Employment opportunities are increased by big investments leading to capital formation. 3. Life insurance encourages savings: Insurance does not only protect against risks and uncertainties, but also provides an investment channel too. Life insurance enables systematic savings due to payment of regular premium. Life insurance provides a mode of investment. It develops a habit of saving money by paying premium. The insured get the lump sum amount at the maturity of the contract. Thus life insurance encourages savings. 4. Promotes economic growth: Insurance generates significant impact on the economy by mobilizing domestic savings. Insurance turn accumulated capital into productive investments. Insurance enables to mitigate loss, financial stability and promotes trade and commerce activities those results into economic OF BY AND FOR YOU PUBLICATION Page | 28 PRINCIPLES OF INSURANCE ISBN : 978-81-953729-4-2 growth and development. Thus, insurance plays a crucial role in sustainable growth of an economy. 5. Medical support: A medical insurance considered essential in managing risk in health. Anyone can be a victim of critical illness unexpectedly. And rising medical expense is of great concern. Medical Insurance is one of the insurance policies that cater for different type of health risks. The insured gets a medical support in case of medical insurance policy. 6. Spreading of risk: Insurance facilitates spreading of risk from the insured to the insurer. The basic principle of insurance is to spread risk among a large number of people. A large number of persons get insurance policies and pay premium to the insurer. Whenever a loss occurs, it is compensated out of funds of the insurer. 7. Source of collecting funds: Large funds are collected by the way of premium. These funds are utilised in the industrial development of a country, which accelerates the economic growth. Employment opportunities are increased by such big investments. Thus, insurance has become an important source of capital formation. UNIT II Life insurance – fundamentals of life contract – principles – types – annuity contract insurance & annuity compared – Various types of annuity Theory of insurance – Theory of probability – Theorem of large numbers. Premium computation – Assessment plan – Natural premium plan – Mortality tables – Construction of mortality tables for annuities – Life fund OF BY AND FOR YOU PUBLICATION Page | 29 PRINCIPLES OF INSURANCE ISBN : 978-81-953729-4-2 valuation – Investment of fund – Suitability of various types of investment – Surplus and its distribution. FUNDAMENTALS OF LIFE INSURANCE Life insurance is a common component of most everyone’s financial plan. It can serve many helpful purposes such as; replacing lost income in the event of your death, paying any debts you leave behind (such as mortgages, car loans or credit card debts), paying for your final expenses or estate taxes, and it even can create a tax-free estate for your heirs. But what types of policies are available to you? How much insurance do you need and how much can you afford? What Makes Up a Life Insurance Contact? The contract is made up of 4 basic parts: 1. Legal Provisions-This part sets out the conditions of the contract, as well as the rights and obligations of the parties involved (you and the insurance company). 2. Application-Your initial application is part of the insurance contract. It outlines your personal information and health status. 3. Policy Specifications-This outlines the amount that your beneficiaries will receive and the amount of premiums you must pay to keep your policy from lapsing. 4. Riders and Options-These are additional provisions that you can pay more to have added on to your policy. These include such things as having your premium waived during times of disability, guaranteeing you the ability to purchase more insurance without another medical exam, and accidental death benefits. Life Insurance - Meaning Life Insurance can be defined as a contract between the insurer and policy owner. Insurer is agreed to pay an amount to the person insured or his nominee either at the date of maturity or a periodic interval or unfortunate death of the policy owner. Policy owner has to pay a fixed amount called premium in periodic intervals. This can be monthly, quarterly, half yearly or yearly. Policy owner is allowed to choose the type of payment and payment cycle. Premium amount varies depending on many factors like age of the policy owner, scheme, type of the OF BY AND FOR YOU PUBLICATION Page | 30 PRINCIPLES OF INSURANCE ISBN : 978-81-953729-4-2 policy, sum- assured, etc. Premium amount once fixed cannot be changed later. It must be noted that the life insurance is not an indemnity contract. Definition of Life insurance Life insurance has been defined by different authors differently as given below: Insurance Act 1938: Under Sec. 2(ii) of Life Insurance (Amendment Act 1950: Life insurance is the business of effecting contracts of insurance upon human life including any contract whereby the payment of money is assured on death except death by accident on the happening of any contingency depended on human life and any contract which is subject to the payment of premium for a term dependent on human life. D.S. Hansell: life insurance is a contract in which a sum of money is paid by the assured in consideration of insurer’s incurring the risk of paying a large sum upon a given contingency. R.S. Sharma: Life insurance is a contract whereby the insurer, in consideration of a premium paid either in lump sum or in periodical installments, undertakes to pay an annuity or a certain sum of money either on death of the insured or on the expiry of a certain number of years. Characteristics of Life Insurance The following characteristics or features of life insurance may be deduced from the aforesaid definitions: i) Offer and acceptance: Like other contracts of insurance, the life insurance contract is also the outcome of an offer made by the policy owner and its acceptance by the insurer. Generally, the life insurance contract is made in writing. ii) Agreed sum of money: The insurer agrees to pay a certain sum of money either on the death of the policy owner or on the maturity of the policy, whichever is earlier. iii) Premium: The policy owner is liable to pay periodically the amount of payment in the form of premium till the death of the policy owner or expiry or the period of policy, whichever is earlier iv) Not a contract of indemnity: Life insurance contract is not a contract of indemnity as the loss caused by the death cannot be measured in terms of money nor money is a compensation for loss of one’s life. OF BY AND FOR YOU PUBLICATION Page | 31 PRINCIPLES OF INSURANCE ISBN : 978-81-953729-4-2 v) Insurable interest: In life insurance, insurable interest must exist when the policy is issued though it may not exist when the policy becomes the claim. The person who has been assigned a life policy need not have insurable interest in it as the insurable interest was already present at the time of taking policy. vi) Lending helping hand: Life insurance provides helping hand to those who are left supportless and helps financially in case of death of the insured. It is also considered to be the best alternative for making savings. vii) Cover other risks: Life insurance covers other risks which are connected with the human life in addition to the risk of death. For example, total and permanent disability or temporary disability and medical expenses, compulsory retirement or the economic death risks etc. have also been covered under the purview of life insurance these days. viii) Relief from sword of Damocles: Life insurance relieves the insured from the sword of Damocles i.e., various risks and uncertainties which may occur before and after the death of the insured. The Principle of Life Insurance Life insurance operates on some basic principles common to many individuals. How the policy works is actually a function of the fact that many individuals come together as a group, and each person shares in the risk of death of the other people in the group. Life insurance companies manage this risk quantitatively and provide an organized structure for the transfer of risk from one individual to a large group of individuals. Law of Large Numbers: All life insurance policies operate on the principle of the law of large numbers. Insurance companies must use a large sample size of the population to predict death rates. While no one single person's death can be predicted, the law of large numbers allows insurers to predict death rates by looking at a large group of people. A large sample size means that a probability can be predicted as a percentage of the population. Insurers have gotten to the point where they can predict death rates every year with very good accuracy. Insurable Interest: OF BY AND FOR YOU PUBLICATION Page | 32 PRINCIPLES OF INSURANCE ISBN : 978-81-953729-4-2 Life insurance requires the principle of insurable interest. The person who is insured under the contract must have some kind of personal relationship to the policyholder. In order to purchase insurance on the life of another person, you must have a personal and economic interest in the other person's life. A person buying life insurance on the life of a stranger is doing nothing more than investing in the other person's death. Life insurance companies would not be able to accurately predict mortality rates if this was allowed to occur, and if their contracts were allowed to be used for unethical or illegal purposes, such as buying a life insurance policy on someone and killing them or having them killed. Transfer of Risk: The transfer of risk is essential to life insurance. You do not retain the risk of death in your life insurance policy. Instead, this risk is spread out among all policyholders that the insurer does business with. All customers of the insurance company contribute money to the general account. This money is invested, and then claims are paid out when an individual from the group dies. Perfected Savings: Jesus Huerta deSoto describes life insurance as a perfected savings. You purchase a death benefit for your family's future. However, the contract actually matures at a predetermined age, or after a preset time. With permanent insurance, this is most obvious. A whole life insurance policy, for example, matures at age 100. If you die prior to this age, the insurer pays the money to your family. But, the policy builds a cash reserve during your lifetime. If you live to age 100, the cash reserve equals the death benefit and the insurer pays out the death benefit to you. Utmost Good faith Purchasing an insurance is entering into a contract between company and individual. This should be done in good faith by providing all relevant details with honesty. Covering any information from the insurance company may result in serious consequences for the individual in the future. This being said, the insurer must explain all aspects of a policy and ensure that there are no unexplained or hidden clauses and that the applicant is made aware of all terms and conditions. Risk & Minimal loss Insurance is a risky and companies have to do business and make profits keeping in mind the risk factor. The principle of minimal risk states that the insured individual is expected to take necessary action to limit him/her self from any hazards. This includes following a healthy lifestyle, getting a regular health check-up and more. OF BY AND FOR YOU PUBLICATION Page | 33 PRINCIPLES OF INSURANCE ISBN : 978-81-953729-4-2 Advantages of life insurance: The advantages of life insurance over other type of savings instruments available in the market are as follows. Ø Creates an Estate: Life insurance policy create an estate. At any point of time the value of any other type of savings is the total accumulation in that account only. If the savings holder unfortunately dies, the amount available to the dependents is that accumulation only. In case of life insurance, the moments of policy is taken, an estate is created to the extent of the sum assured under the policy i.e., if the policy owner dies, what becomes payable to the dependents is the sum assured (the total value of the estate) and not the total premiums paid. Ø Encourages thrift: Life insurance encourages thrift i.e., forced and compulsory savings. In case of other type of savings, the moments a person feel the need for money, there is great attraction to withdraw money from the savings accumulation. The purpose of which the savings account in opened is seldom fulfilled for that reason. In the insurance policies, there is a built-in discouragement to withdraw. Only surrender value which is a small percent of the premiums paid will be available to the policy owner if he wants to withdraw. The policy owner thus is forced to continue payment of premiums and never try to surrender a policy. This will ultimately fulfill the purpose for which the policy was purchased. Ø Gift to near and dear: Life insurance policies cannot be attached by any court of law or income tax authorities. A married man can take a policy under married women’s property Act for the benefit of his wife and/ or children separately and create separate estate for their benefit. Once a policy is obtained under this legislation, the policyholder will not have any hold or right over it. Life insurance thus can be used as a gift to the near and dear. Ø Protection against liquidation of property: A life insurance policy can be utilised as a collateral security for the housing loan. In case of the unfortunate death of the policy owner, the amount available under the life insurance policy is adjusted towards the outstanding loan and interest and the house is released to the beneficiaries without any ancumbrance. Without such a facility, the family will have to sell the house in the open OF BY AND FOR YOU PUBLICATION Page | 34 PRINCIPLES OF INSURANCE ISBN : 978-81-953729-4-2 market to clear the loan. It will be a distress sale and so would fetch only a fraction of the real market value of the house. Life insurance thus affords protection against forced liquidation of property. Ø Acts as an Emergency Fund: If immediate liquid cash is needed, a policy of the life insurance can be assigned to the life insurance company, a Bank or any other financial institutions as security for a loan. Life insurance thus acts as an Emergency Fund. Banks today grant educational loans to the students for higher education. They insist on a life insurance policy as a collateral security. Ø No stamp duty: Transfer of property contained in a life insurance policy does not attract any stamp duty like other property. It can be done by an assignment under Sec. 38 of Insurance Act 1938, either by an endorsement on the back of the policy document or on a stamp paper. Ø No tax on proceeds of policy: The proceed of a life insurance policy including any bonuses paid are not liable for income tax. Ø Tax Exemption: For gaining income tax exemptions under Sec. 80C of Income Tax Act, a person can pay premiums under policies on his/her life or an the of spouse or children, whether major, married or unmarried. Ø Simple claim settlement: Settlement of a claim under life insurance policies is very simple. In case of a death claim, the nominee receives the policy moneys. In case survival of the policyholder till the date of maturity claim is plaid to the policyholder himself. Ø Safe method of Investments: Life insurance is safe and profitable investment. The IRDA constituted by the Govt. of India in1998 keeps a constant watch and vigil over the financial position of life insurance companies. The IRDA pays special attention to the safety of the moneys paid by the policy holders. Thus, life insurance provider a safe method for investment especially by the middle class. Ø Effective management of funds: One of the important criteria for investment of funds, apart from safety and liquidity, is the management of funds. A life insurance company will have the necessary experience and expertise in this field and a policyholder gets the benefit of the same entirely free. Moreover, the policyholder will be free of all tensions. Ø Convenient Denomination: Most of the investments in the market are generally available in fixed denominations. Life insurance policies are available at denomination OF BY AND FOR YOU PUBLICATION Page | 35 PRINCIPLES OF INSURANCE ISBN : 978-81-953729-4-2 convenient to the general public and so available to practically everyone. Whether financially very sound or average. Ø Flexible policy period: Another important factor of investments available in the markets in the duration. Life insurance policies are available from very short duration of very long duration unlike many other savings instrument. Ø Bequeath to educational and Philanthropic Institutions: Life insurance can be bequeathed to educational and philanthropic institutions. It is difficult for many to gift a large sum of money in lump sum for each purpose. But life insurance provides an easy way by enabling a person make available large amount money (sum assured) to the institution of his choice, either on hid death or on the maturity of the policy, by paying small amount of premium under the policy. Ø Beneficial to Backward section of society: Even economically and socially backward sections of the society can benefit through group life Insurance schemes specially designed for that purpose and sometimes subsidized by the Govt. of India. Ø Prosperity of the Nation: Instead of the Government utilising its resources (generated through taxation) to provide social security individual can take the responsibility to provide financial security to themselves and their families. The funds so generated by Life Insurance companies are diverted towards infrastructure Development in the country. This will pave way for the prosperity of the nation. Procedure for Effecting Life Insurance The LIC of the India was set up on 1st sep. 1956. It is carrying on its business through its largest network of branches and agents. It is totally under the ownership and control of the Govt. of India. It contributes a lot in the field of life insurance. I. Filling up a proposal from: The first stage in taking out a life insurance policy is the filling up of a printed proposal from wherein various details of the prospective insured are sought. This from can be obtained from life insurance companies free of cost. It contains the following details : a) Name, nationality, permanent address, occupation, nature of duties, permanent residential address, name of the employer, length of service, father’s name. OF BY AND FOR YOU PUBLICATION Page | 36  PRINCIPLES OF INSURANCE ISBN : 978-81-953729-4-2 b) Table and term of Assurance, sum to be insured, whether premium is payable half-yearly or yearly, amount of premium, place and District of birth, proof of age. c) Object of insurance, name of nominee, age, relation with insured, full address, height and weight, details of previous policies, if any, history of parents, sister, brother, etc. d) Hereditary disease like diabetes, insanity, epilepsy, gout, asthma, tuber culosis, cancer, leprosy etc. e) When the application is a female adult, there is a further series of questions regarding pregnancy, maternity and disturbance indicative of trouble with the female generative organs. Thus the female proposers have to give the following information; educational qualification, average monthly income, marital status etc. f) In the end, the proposer has to make a declaration that the statement given in the proposal are correct and no information is concealed. The proposal is the basis of insurance contract which is submitted to the life insurance company. II. Medical Examination: After having submitted the proposal form with the insurer, the proposer is required to undergo a medical examination through one of the approved medical doctors regarding his health, height, weight, chest, tongue, eyes, condition of heart, digesting system, nervous system, etc. The medical report is directly submitted to the insurer for consideration. III. Agent’s Confidential Report: After the medical report, the agent’s confidential report is submitted to the company. It contains details relating to the personal history of the insured. Its purpose is to convince the life insurance company regarding the object of insurance, financial position of the insured and his health conditions. IV. Acceptance of the proposal: After having gone through proposal form agent’s confidential report and medical report, the insurance company has to decide whether to accept the proposal or not. Proposal is accepted only if it seems favorable to the insurance company. After acceptance of proposal, the letter of intimation regarding acceptance of proposal along with the first premium by the insured in due course. V. Payment of first premium: On the basis of premium notice, the insured deposits the amount of the first premium and the insurer becomes liable from the day on which it is paid. The contract of life insurance becomes complete on the payment of the first premium. Generally, the first premium is paid along with the proposal form. The policy may lapse on account of OF BY AND FOR YOU PUBLICATION Page | 37  PRINCIPLES OF INSURANCE ISBN : 978-81-953729-4-2 non-payment of premium within prescribed time frame. The insurance company issues receipt acknowledging the payment of premium. VI. Issue of policy: Having completed all the required formalities, the insurance company prepares the life insurance policy and sends it to the insured. The back of the policy contains all terms and conditions of the policy along with all the details of the proposal, etc. The policy bears the seal of the company and the signature of the competent authority. Types of Life Insurance: 1.Term Insurance Term insurance provides life cover in the event of your demise and don’t have any maturity benefits. This is the simplest form of insurance and cheaper than most other options present in the market. 2. Endowment Plan Endowment plan is similar to term insurance but the only difference is that the lump sum amount is paid out even if you survive the maturity period. Unlike term plan which provides no maturity benefits. 3. Unit Linked Insurance ULIPs or Unit Linked Insurance Plans invest some part of your premium towards life insurance and the rest into a financial instrument. The policy has a lock-in period of 5-years and can be continued even after the lock-in ends. You can also choose where you want to invest according to your risk appetite. 4. Whole Life Insurance Plan Whole life insurance plan covers you throughout your life where you pay the premiums for a stipulated period of time. The corpus is paid out to your family in case of death and does not have a fixed validity. This plan is perfect if you have financial dependents as the death benefit will help secure them. 5. Money Back Policy OF BY AND FOR YOU PUBLICATION Page | 38 PRINCIPLES OF INSURANCE ISBN : 978-81-953729-4-2 Money Back Policy gives you life coverage throughout the policy term and also provides regular payments on survival. The payment made is a percentage of the sum assured which is given during the plan tenure and the rest of the sum assured is paid out on maturity of the policy. In case you pass away during the tenure, the sum assured is paid regardless of the payments made to you before. 6. Annuity Pension Plan Pension plan involves paying a lump sum amount to the insurance company where the payments are sent out immediately on a regular basis or in a lump sum form. The wealth can also be left to accumulate according to your risk appetite. 7. Saving & Investment Plan Saving & Investment Plans are the types of insurance plans that provide you the assurance of lump sum funds for you and your family’s future expenses. While providing an excellent savings tool for your sort term and long term financial goals, these plans also assure your family a certain sum by way of an insurance cover. This is a broad categorization that covers both the traditional and unit linked plans. 8. Retirement Plans These plans provide you with income during retirement is called the retirement plan. These plans are offered by life insurance companies in India and help you to build a retirement corpus. On maturity, this corpus is invested for generating a regulzr income stream which is referred to as pension or annuity. 9. Child Insurance Policy A child insurance policy is a saving cum investment plan that is designed to meet your child’s future financial needs. It allows your kids to live their dreams and gives you the advantage to start investing in the children’s plan right from the time the child is born and provisions to withdraw the saving once the child reaches adulthood. Some child insurance policies do allow intermediate withdrawals at certain intervals. OF BY AND FOR YOU PUBLICATION Page | 39 PRINCIPLES OF INSURANCE ISBN : 978-81-953729-4-2 Life insurance is not just to fulfill the daily expenses of the family in the absence of breadwinner. It should be capable enough to bail out large financial exigencies. So, one should always choose one or two best types of life insurance which can support his/her family in different stages of life. Who Can You Name as a Beneficiary? Any person, corporation, or legal entity can be your beneficiary. You have two types of beneficiaries to name: primary and contingent. The primary beneficiary is the main person that you wish you money to go to when you pass. A contingent beneficiary is a person you name to inherit the money if your primary beneficiary has predeceased you. You can name multiple beneficiaries in each category, allotting them each a specific percentage of the benefit. You also are able to change your beneficiaries at any times. How Much Do You Need? The size of insurance policy you will need depends on several factors. These include if you have a spouse, the size of your family, and the nature of your financial obligations, your career stage, and your financial goals. It is also important to think about such questions as: What immediate financial expenses would your family face after your death? What is the amount of your salary you devote to expenses and future needs? How long would your family need support if you died tomorrow? How much money would you want to leave as an inheritance for your children or to fund their education? All these factors play a part in determining how much coverage you will need. How Much Can You Afford? OF BY AND FOR YOU PUBLICATION Page | 40 PRINCIPLES OF INSURANCE ISBN : 978-81-953729-4-2 How much coverage you need and how much you can actually afford may be two very different things. Such factors as the type of policy you choose, your age, and your health all play a part in determining your expense. A financial professional can help you to determine what type of policy will fit your budget and still work for your needs. Where Can You Buy Life Insurance? Some people will receive policies from their employers, other go to insurance agents or brokers. It is important that you find someone that can help you find the best policy that will fit your needs. Financial advisors can be helpful in aiding you to make your decision because they have an in-depth knowledge of how life insurance works and how it will interact with other aspects of your finances. Difference between life insurance and general insurance: BASIS OF LIFE INSURANCE GENERAL INSURANCE COMPARISON Meaning Life insurance is an insurance General insurance is an contract, wherein the insurance insurance contract, wherein the company promises to compensate insurance company promises to the insured individual for compensate the insured uncertainties of life that are death. individual or entity for the Life insurance provides protection financial loss or damage caused against life risk. due to an unfortunate event. General insurance gives protection for all the valuable things that are important to you. Term of contract Long-term contract Short-term contract Nature of contract Life insurance is not a contract of General insurance is a contract indemnity. It is considered as an of indemnity investment Insurable interest Life insurance requires the In general insurance policies, OF BY AND FOR YOU PUBLICATION Page | 41 PRINCIPLES OF INSURANCE ISBN : 978-81-953729-4-2 beneficiary to have an insurance insurance interest is expected to interest in the person who is being exist both at the time of insured. That means, insurable underwriting and at the time of interest needs to be present at the loss. time of underwriting Payment of claim Benefits under the policy are paidFinancial loss caused due to the on the occurrence of an insured insured event is remembered on event or on maturity the occurrence of the particular event Compensation value The compensation value is The compensation value is the dependent on the premium payable actual loss incurred in the under the policy insured event (maximum amount payable is subjected to the policy limit) Premium payment Premiums need to be paid Premium is paid in a lump sum periodically over the years for a as the policy is purchased for specified term short-term and plans need to be renewed on expiry Savings Many life insurance plans come General insurance plans have no with a savings element which savings component as it’s an helps the insured to build corpus indemnity contract wherein you or create wealth for future incur the premium cost to avail the protection ANNUITY An annuity is a contract between the policyholder and the insurance company, wherein the policyholder needs to make either lump-sum payment or pay in installments to receive regular income as an annuity after retirement. The annuities can be paid either immediately after payment of the lump-sum amount or after completion of the specific tenure. What is an Annuity Contract? An annuity contract is a written agreement between an insurance company and a customer outlining each party's obligations in an annuity agreement. Such a document will include the specific details of the contract, such as the structure of the annuity (variable or fixed); any penalties for early withdrawal; spousal and beneficiary provisions, such as a survivor clause and rate of spousal coverage etc,. OF BY AND FOR YOU PUBLICATION Page | 42 PRINCIPLES OF INSURANCE ISBN : 978-81-953729-4-2 How an Annuity Contract Works? An annuity contract is a contractual obligation between as many as four parties. They are the issuer (usually an insurance company), the owner of the annuity, the annuitant, and the beneficiary. The owner is the person who buys an annuity. An annuitant is an individual whose life expectancy is used as for determining the amount and timing when benefits payments will start and cease. In most cases, though not all, the owner and annuitant will be the same person. The beneficiary is the individual designated by the annuity owner who will receive any death benefit when the annuitant dies. An annuity contract is beneficial to the individual investor in the sense that it legally binds the insurance company to provide a guaranteed periodic payment to the annuitant once the annuitant reaches retirement and requests commencement of payments. Essentially, it guarantees risk-free retirement income. Types of annuities There are several life insurance annuities to choose from. Understanding how each type works will help you better understand them and choose the option that helps you reach your financial goal. Fixed annuities are consistent and predictable, making them extremely popular for retirees. According to the Insurance Information Institute (III), fixed annuity sales have increased by 36% since 2015. With a fixed annuity, the insurance company guarantees a rate of return and payment amount either for a set number of years or for the rest of your life. Variable annuities give you more control over how your contribution is used within the contract. You can choose from underlying mutual funds to take advantage of market growth while still having a guaranteed benefit to protect you from significant market downturns. Fixed-indexed annuities are fixed annuities with the chance for a higher interest rate when the index it’s tied to like the Dow Jones Industrial Average is positive. However, fixed- indexed annuities do have growth limits and don’t earn dividends, making the rate of return smaller than the index itself. Yo