DRIVE-WINTER 2013

PROGRAM/SEMESTER- MBADS (SEM 4/SEM 6) MBAFLEX/ MBAN2 (SEM 4) PGDFMN (SEM 2)

SUBJECT CODE & NAME-MF0018 & INSURANCE AND RISK MANAGEMENT
Q1 Explain the risk management methods.
(Loss control, Loss financing, Internal risk reduction) 3,4,3
Answer:
There is various risk management strategies used to handle both pure and speculative risk.
Loss control
Loss control refers to measures that reduce the severity of a loss after it occurs. For example segregation of exposure
units by having warehouses with inventories at different locations. Insurance companies provide guidance and
incentives to the company which has taken the policy to avoid the occurrence of loss.
Loss financing
Loss or risk financing refers to the manner in which the risk control measures that have been implemented shall be
financed. It is necessary to transfer or reduce risks when risk exposure of a company goes beyond the maximum limit.
But both these methods involve costs. Risk financing is defined as the funding of losses either by using the internal
reserves or by purchasing insurance. The main objective of risk financing is to spread the losses over time in order to
reduce the financial strain.
Risk avoidance
Risk avoidance is where a certain loss exposure is never acquired or the existing one is totally removed. This is one of
the strongest methods to deal with risks. The major advantage of this method is that it reduces the chance of loss to zero.
The two ways by which risk can be avoided are proactive avoidance and abandonment avoidance. In the first case, the
person does not assume any risk and therefore any project which brings in risk is not taken up. For example a company
which has chances of nuclear radiation will not set up the company, due to the perils which it can bring up.
Internal risk reduction
This strategy aims to decrease the number of losses by reducing the occurrence of loss, which can be done in two ways
namely loss prevention and loss control. Loss prevention is a desirable way of dealing with risks. It eliminates the
possibility of loss and hence risk is also removed. The examples of this are safety programs like medical care, security
guards, and burglar alarms.
Risk retention
Retention simply means that the firm retains part or all the losses incurred from a given loss. Risks may be knowingly
or unknowingly retained by the organization. They are hence classified as active and passive based on this. Active risk
retention is when the firm knows of the loss exposure and plans to retain it without making any attempt to transfer it or
reduce it. Passive retention is the failure to identify the loss exposure and retaining it unknowingly.

Q2 An organization is a legal entity which is created to do some activity of some purpose. There are elements of a life
insurance organization. Explain the elements of life insurance organization.
(Important activities, Internal organization, Distribution system, Functions of the agent) 2,3,2,3
Answer:
Insurance is the equalization of fortune. The degree to which it accomplishes that end is, of course, Hmited by its
sufficiency and the contingencies to which it applies. But, by indemnifying one set of men for their losses through
misfortune out of funds contributed by them- selves and others who, like them, in advance seemed sub- ject to the
danger of a like misfortune, it tends to spread the loss over all and thus to equalize their fortunes in the one regard.
Important activities

The important activities are to be identified and grouped according to the convenience of the insurer and for economic
reasons as well. The activities that generate income are more important than those which are purely internal. All the
activities are important for the office. A balance has to be stuck between the two types of activities.
The activities are planned to lead to the creation of hierarchic levels in the offices. This will lead to define responsibility
and authority in different levels.
Internal organization
The internal organization includes and emphasized the layouts of the departments in the office. The organization means
that the personnel are to be selected for the department as per the requirement of each department.
The internal organization at higher levels has some more departments like:
Investment
Legal
Actuarial
Vigilance
Estates
Engineering
Inspection
Audit
Group insurance
Micro-insurance
Training for employees
Training for the marketing people, etc.
Distribution system
Firms in the insurance industry vary along many dimensions, including product distribution systems. A wide variety of
distribution methods are used in the industry. Insurance distribution systems span the spectrum from the use of a
professional employee sales force, to contracting with independent sales representatives, to direct response methods
such as mail and telephone solicitation. The ongoing competitive and technological revolution in the financial services
industries has resulted in greater segmentation of distribution by product market, and to greater use of multiple
distribution methods by firms, including the establishment of marketing relationships and alliances with non-insurance
concerns. Due to the variety of distribution systems employed in the industry, the differences in contractual
relationships across them, and the recent market share gains of nontraditional distribution systems, an important area of
research is the optimal choice of distribution system. Much of the existing research on property-liability insurance
distribution has examined aspects of this question.
Functions of the agent
Insurance agents are highly qualified professionals who are trained and experienced in guiding
individuals and employers through the process of choosing appropriate, affordable health plans.
Insurance agents must be licensed by the states where they reside and practice. In Illinois
agents are required to complete 30 hours of continuing education requirements biennially in
order
to
maintain
their
licenses.
Further, many agents have completed a sequence of college level courses leading to a
professional designation, such as Registered Health Underwriter (RHU), Health Insurance
Associate (HIA), Registered Employee Benefits Consultant (REBC), Certified Employee Benefits
Specialist (CEBS), or Chartered Life Underwriter (CLU).
Agents that specialize in health insurance products and services keep abreast of new
developments and standards in the health insurance industry, learn about new options that
may better serve their clients, and, because they typically represent a number of insurance
companies, are generally able offer a wide range of options and alternatives for consumers.
Agents who practice in the individual and group health insurance markets build up clientele
over a long period of time. They write new accounts and just as important renew their existing
accounts. To this end, many agents and their clients develop relationships that last a lifetime.

Q3 Insurance is the most important industry. Elaborate the different types of Mediclaim and liability policies.
(Explanation of types of Mediclaim policies, Explanation of types of liability policies)5,5
Answer:
Types of Mediclaim
Mediclaim insurance plays a significant role in individuals financial planning. It offers many benefits by lessening the
burden on financial aspects and assisting in solving medical problems. Mediclaim insurance is a non-life insurance.
Mediclaim, or medical insurance, is one of the most recent forms of insurance. A mediclaim
insurance policy ensures that your medical expenses are expensed, or reimbursed by the
insurance company, in case you have to incur those during the coverage period. While the
earlier medical insurance policies required you to expense the cash and claim a refund at a
later date, the present day insurance policies for medical cover offer you an option of a
cashless transaction.
The different types of miscellaneous insurance claims are:

Various types of medical insurance policies are available in the market. An individual can choose a policy
based on age, lifestyle, and other medical considerations. Medical Insurance is sub-divided into two categories

Individual Mediclaim The Individual Mediclaim policy covers the hospitalization expenses for an
individual up to the sum assured limit. The insurance premium is
dependent on the sum assured value.
Family Floater policy Family Floater Policies are enhanced version of a Mediclaim policy. The
sum assured value floats among the family members; i.e. each opted
family member is covered under the policy, and expenses for the entire
family, up to the sum assured limit, can be claimed. The premium (per
person) for family floater plans is less than that for separate insurance
cover for each family member.
Unit Linked HealthHealth insurance companies have introduced Unit Linked Health Plans,
Plans
too. Such plans combine health insurance with an investment plan and
pay back an amount at the end of the insurance term. The returns are
based on market performance. This is only recommended for people who
have the risk-profile to invest in market-linked products.

When you decide to buy a Mediclaim policy, the insurance company examines your medical history to
ascertain the risk involved in providing you the cover expected. Based on the same, a policy is extended to
you, and you have to pay a regular premium for the same.
In case of a medical emergency/ expense, you have to furnish the corresponding bills and claim the amount
from your insurance company. This ensures adequate financial backing during a time of illness or injury.
Types of liability Policies

Liability insurance products protect you and your company from expensive lawsuits. But a
professional consultant whose product is their expertise has different liability insurance needs
from a company that sells clothing.

There are two types of liability policy:

Claims Made The insurer that covers your business when the claim is made is the insurer that will
cover the claim. If you are a construction or design professional, this is the most likely liability policy
choice because it can be years after the completion of a project for a defect to become apparent.

Occurrence The insurer that insures you at the time of the occurrence is the insurer that will handle
the claim. The insurer is obligated to work with you until the claim is resolved even if you do not
renew your policy with the insurer. These liability policies are more prevalent for businesses that
would typically be aware of a potential claim immediately.

The two types of policies are the same with the exception of when the insurers obligation starts and ends.
The liability policy provides coverage for damage from an occurrence during the policy
period. An occurrence generally means accident occurring to a third-party (someone other
than you or the insurer). However, your liability policy may include a definition of occurrence
to include continuous or repeated exposure to substantially the same harmful conditions that
includes coverage for injury to a third-party for those kinds of injuries that cause damage over
time. An example could be a gravel pit where a neighboring homeowner becomes ill due to a
constant inhalation of gravel dust from the pit.

Q4. Give short notes on:

Pricing objectives
Pricing elements
Rate computation
Answer:
Pricing objectives
The marketing manager has to decide the objectives of pricing. Pricing objectives guides the decision makers to make
price policies, to plan pricing strategies and to set actual prices.
Pricing objectives are the overall goals that describe the role of price in the long-range plans of organizations. The
pricing objectives guide the marketing manager in developing marketing plans.
The insurance pricing has the following general objectives:
1) The rating system must create adequate premium income for the insurance corporation to be able to settle its claims
and expenses; to provide a realistic return rate to the sponsors of funds and to finance continuing growth and expansion.
2) The rate must not be excessively high and allow unusual gains for the insurer. The rate must be justifiable.
3) The rates must not be discriminatory, in the sense that it must not be the same for heterogeneous buyers and must not
be different for homogeneous buyers.
4) The rating system must be easily understandable.
5) The pricing system should not be expensive to use.
6) The rates should not be frequently changed as the public cannot face wide variation in costs every year.

7) The methods should encourage the reduction of losses by providing inducement to the insured to avoid losses.
Pricing elements
Pricing procedure is a methodical and sequential use of technique to determine the right price of the product. The
insurer can determine the pricing procedure based on Sales area (Sales Organization, Distribution Channel, and
Division), Customer Pricing Procedure (CPP), and Document Pricing Procedure (DPP).
The following elements are considered while pricing insurance products:
1. Claims cost It includes claims paid in conjunction with settlement expense, estimate far outstanding claim,
and so on.
2. Business acquirement cost It includes commission, brokerage and business development cost, and so on.
3. Management expenses These include salaries, rent and other expenses necessary for managing an
organization.
4. Profit It include return on the capital cost.
Rate computation
Insurance rating methods are used to determine the pricing of the insurance products. That is, an insurance price is the
price per unit of insurance and is a function of the price of insurance. The three basic insurance pricing (rating) methods
are:
1. Judgement rating This method is applicable where we find very less or no quantitative data of the risk
similar to that of proposed risk. The rate is mostly based on the sponsors own judgement after evaluation of all
coverages. This method is commonly used in ocean marine insurance and in some lines of inland marine
insurance.
2. Class rating Generally, this method is practically applied rating method in insurance business. In this method,
the risks are classified based on some important characteristics. Insurer will charge the same price per unit of
coverage for the insured risks that belong to the same class.
3. Merit rating The modification of class rating is referred to as merit rating. It alters the class rate of a
particular class insured based on individual loss experience. There are three different types of merit rating plans.
These plans are:
o Schedule rating In this plan, all insurance coverage is rated separately. For calculating the schedule rates, firstly, the
risk (the person or object insured) must be examined, to make out the features that are about to cause losses or to
prevent them.
o Experience rating This plan modifies the class rate based on the claim experience of a particular coverage where
the actual losses for a time (normally two or three years) are compared with the average risks in the same class.
o Retrospective rating This plan modifies the insurance price on the basis of current experience. This is usually done
by determining the final prices retrospectively in the policy contract.

Q5. Explain the creation and application of insurable interest. Give the differences between wagering and
insurance. (Creation of insurable interest, Application of insurable interest, Differences between wagering and
insurance) 2, 3, 5
Answer:
Creation of insurable interest:
True, valid, determinable, and direct economic stake of an insurance policy holder (or of the beneficiary of the policy)
in the continued existence or safety of the insured property or person. Often stated as "an interest in the outcome of a
contingency other than that arising under the contract of insurance," an insurable interest means that the policy holder
(or the beneficiary) must stand to suffer a direct financial loss if the event (against which the insurance cover was
bought) does occur. A tenant may not necessarily have a direct insurable interest in the rented property but the landlord
may. An employer may not necessarily have such claim in the life of an employee, but a married couple may in one

another's life. To an insurance company, an insurable interest is the basic reason for issuing a legal insurance cover, to
an insured (or beneficiary) it gives the legal right to enforce an insurance claim. According to legal precedents: (1) in
life insurance, an insurable-interest must be present when the insurance policy is taken, but not necessarily when a claim
occurs; for example, anyone who takes a life insurance policy on his or her spouse, and continues to pay premium even
if the marriage breaks up, is entitled to collect death benefits under the policy, (2) in marine insurance, an insurableinterest must be present when a claim occurs, but not necessarily when the policy is taken; for example, a supplier may
obtain a blanket policy for the goods to be shipped in an year but must show that the goods were actually shipped when
making a claim for loss or damage, and (3) in most other types of insurance (such as fire or auto insurance), an
insurance interest must be present, both at the time the policy is taken and when a claim occurs; for example, a
homeowner who sells the house on which fire insurance was taken, cannot collect on it in case of a fire. Insurable
interest is one of the foundations of insurance because, in its absence, insurance would be no different from gambling
and (even if legal) would not constitute a binding agreement.
Application of insurable interest: Current state laws require a policy owner to have an insurable interest in the insured
at the origin of a life insurance policy. The basic principle is that the policy owner has a bona fide interest that the
insured remains alive and well, as opposed to profiting only upon the insureds death.
For instance, a person or business can have an insurable interest in important relationships such as a family member or
key employee.
If no insurable interest exists between the policy owner and the insured at policy issuance, the life insurance policy will
be little more than a bet or wager on the insureds life. This is contrary to the purpose of life insurance and is a detriment
to consumer safety. However, determining an insurable interest can be difficult and insurance carriers and agents
sometimes attempt to push the envelope.
For example, in the late 1980s to early 1990s, some carriers in the life insurance industry deemed a company to have an
insurable interest in all active employees. A number of insurance carriers allowed employers to insure all active
employees, without their consent and knowledge, for some corporate owned life insurance plans known in the industry
as leveraged COLI.
The life insurance industry continues to deal with negative publicity from the Wall Street Journal and other publications
that still refer to all corporate owned life insurance plans, not just leveraged COLI, as "janitor's insurance" even though
they havent been sold in this manner for many years.
Although the tax laws changed in the 1990s eliminating the tax benefits associated with leveraged COLI plans, the
Pension Protection Act of 2006 was implemented to eliminate the perceived abuses of leveraged COLI plans and similar
transactions. Many life insurance professionals and groups such as AALU and ACLI had been lobbying for these types
of provisions and safeguards for years.
Differences between wagering and insurance: A wager is a contract whereby two persons or groups with different
views on the outcome of an uncertain event agre that some consideration is to pass depending on the outcome. The
contract is speculative and contingent. However it differs from insurance in various ways.
1. Wagers are generally unenforceable whilst insurance contracts are enforceable.

2. The fundamental distinction between insurance and a wager is the risk in that whereas in insurance risk exists a
priori, in a wager there is a deliberate assumption of risk.

3. In wagering contracts neither of the contracting parties has the interest other than the sum to be won or loss
depending on the outcome. Payment is dependant upon the event as agreed to by the parties and is not paid by
way of indemnity or otherwise. In insurance, the insured has an interest of the subject matter in respect of which
he may suffer loss.
4. The uncertain event upon which the uncertain event depends is prima facie adverse to the insureds interest and
insurance is effected so as to meet the loss or detriment which may be suffered on the happening of the event. In
wagers it is essential that either party may win or lose depending on the outcome of the uncertain event. In
insurance, the insured pays a premium to furnish consideration, it is not dependant upon the event insured
against and the insured cannot be called upon to contribute anything more, whether or not the event occurs.

Q6. Identify the role of insurance in managing risk financing. Explain the importance of insurance transaction.
Discuss in different perspectives of insured and insurer. (Role of insurance in managing risk financing,
Introduction of insurance transaction, Explanation of different perspectives of insured and insurer) 2, 4, 4
Answer:
Insurance as a Prime Risk Management Tool
In general, risk management deals with risks by designing the procedures and implementing the methods that lessens
the loss occurrence or the financial impacts.
Insurance is a prime risk management tool which defines risk as a preloss exercise reflecting an organizations post loss
goals. The main purpose of risk management is to minimize losses and protect people. Insurance is an easily affordable
loss prevention technique. Insurance acts as contractual transfer for risks. Insurance is an appropriate management tool
when the amount of loss is low and amount of potential loss is high. For smaller and medium sized organizations,
insurance acts as risk management tool. In certain cases, larger-sized organizations may also need the services of
insurance companies for loss settlements. Even after insuring a loss procedure, risk manager faces some problems.
Hence risk managers need to choose an appropriate insurance company, policy and agent. Increasingly, insurance is a
prime management tool which resolves the liability limitations. For example, if a production process requires chemical
components, then special toxic risk insurance is needed.
Introduction of insurance transaction
In insurance transactions, the premium is collected before providing predetermined services, that is, the payment of
claims. Insurance can be considered as the business of buying risk. Insurers have to face difficult situation while selling
a policy, as they have to decide the appreciable cost of the policy because it depends upon whether or not the losses
occur and if they do, how many and how large they will be. Thus, they charge different prices (premiums) for different
people for the policies that provide same kinds and amounts of insurance.
Different perspectives of insured and insurer
Underwriting is a process of evaluating the risk and exposures of potential clients. It is related to the rate-fixing function
of an insurer. In the insurance industry, the term underwriting refers to the process of evaluating risk. Important
principle of insurance is the transfer of risk. The risk is taken away from the insured, and transferred to the insurer. The
insurance company assumes the risks for a large number of persons. Since many people who are insured pay premiums,
there are sufficient funds available to pay claims, and still permit the insurance company to pay its expenditures and
make a sensible profit. In order to ensure that this is accurate, there must be a very good understanding of the risks and
estimates must be made of how many claims are likely to be paid. When this data is understood, a premium rate can be
determined that will guarantee that adequate funds are available.